Applied Digital Solutions Inc - Quarterly Report (10-Q)

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, 2007


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: 0-26020

APPLIED DIGITAL SOLUTIONS, INC.

(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 No.)

1690 South Congress Avenue, Suite 200
Delray Beach, Florida 33445
(561) 805-8000
(Address, including zip code, and telephone number,
including area code, of registrant’s principal executive offices)

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

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

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

The number of shares outstanding of each of the issuer’s classes of common stock as of the close of business on November 5, 2007:


Class		Number of Shares
Common Stock: $.01 Par Value		70,870,866

APPLIED DIGITAL SOLUTIONS, INC.

TABLE OF CONTENTS


Item	Description	Page

PART I — FINANCIAL INFORMATION

1.	Financial Statements (unaudited)

	Condensed Consolidated Balance Sheets September 30, 2007 and December 31, 2006		3

	Condensed Consolidated Statements of Operations - Three and Nine-Months Ended September 30, 2007 and 2006		4

	Condensed Consolidated Statement of Stockholders’ Equity - Nine-Months Ended September 30, 2007		5

	Condensed Consolidated Statements of Cash Flows - Nine-Months Ended September 30, 2007 and 2006		6

	Notes to the Condensed Consolidated Financial Statements		7

2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		48

3.	Quantitative and Qualitative Disclosures About Market Risk		82

4.	Controls and Procedures		84

PART II — OTHER INFORMATION

1.	Legal Proceedings		84

1A.	Risk Factors		84

2.	Unregistered Sales of Equity Securities and Use of Proceeds		86

3.	Defaults Upon Senior Securities		86

4.	Submission of Matters to a Vote of Security Holders		86

5.	Other Information		86

6.	Exhibits		87

SIGNATURE

EXHIBITS


Exhibit 10.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)


	September 30,			December 31,
	2007			2006
	(unaudited)
Assets

Current Assets
Cash and cash equivalents	$	14,361		$	7,068
Restricted cash		137			81
Accounts receivable and unbilled receivables (net of allowance for doubtful accounts of $330 in 2007 and $483 in 2006)		19,037			16,020
Inventories		16,457			12,958
Deferred taxes		381			697
Other current assets		3,357			3,522
Current assets of discontinued operations		6,272			9,814

Total Current Assets		60,002			50,160

Property and Equipment, net		12,967			11,532
Goodwill, net		74,408			72,306
Intangibles, net		18,767			20,200
Deferred Offering Costs		—			5,079
Other Assets, net		3,143			997
Other Assets of discontinued operations		5,442			11,076


Total Assets	$	174,729		$	171,350


Liabilities and Stockholders’ Equity

Current Liabilities
Notes payable and current maturities of long-term debt	$	15,142		$	7,250
Accounts payable		13,569			12,874
Accrued expenses		11,601			16,245
Deferred revenue		1,782			1,638
Current liabilities of discontinued operations		13,437			16,944

Total Current Liabilities		55,531			54,951

Long-Term Debt and Notes Payable		16,746			14,203
Deferred Taxes		5,092			5,803
Other Liabilities		3,211			1,199
Deferred Revenue		521			1,091
Other Liabilities of discontinued operations		96			1,165


Total Liabilities		81,197			78,412


Commitments and Contingencies

Minority Interest		57,585			47,984
Minority Interest, discontinued operations		667			1,090

Total Minority Interest		58,252			49,074

Stockholders’ Equity
Preferred shares: Authorized 5,000 shares in 2007 and 2006 of $10 par value; special voting, no shares issued or outstanding in 2007 and 2006
Common shares: Authorized 125,000 shares in 2007 and 2006, of $.01 par value; 70,971 shares issued and 70,416 shares outstanding in 2007 and 67,088 shares issued and 66,988 shares outstanding in 2006		710			671
Additional paid-in capital		524,190			513,242
Accumulated deficit		(487,855	)		(468,596	)
Accumulated other comprehensive income		658			324

Subtotal		37,703			45,641
Treasury stock (carried at cost, 555 shares in 2007 and 100 shares in 2006)		(2,423	)		(1,777	)

Total Stockholders’ Equity		35,280			43,864


	$	174,729		$	171,350

See the accompanying notes to condensed consolidated financial statements.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)


	For The Three-Months						For The Nine-Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006

Product revenue	$	28,195		$	19,527		$	78,052		$	59,232
Service revenue		1,976			1,396			6,085			5,509

Total revenue		30,171			20,923			84,137			64,741

Cost of products sold		15,166			9,970			43,557			31,189
Cost of services sold		971			653			2,597			1,812

Total cost of products and services sold		16,137			10,623			46,154			33,001

Gross profit		14,034			10,300			37,983			31,740

Selling, general and administrative expense		17,106			11,678			46,665			35,104
Gain on sale of assets		(691	)		—			(691	)		—
Research and development		1,971			1,649			7,137			4,987

Total operating costs and expenses		18,386			13,327			53,111			40,091

Operating loss before other items		(4,352	)		(3,027	)		(15,128	)		(8,351	)

Interest and other (expense) income		(958	)		223			1,050			698
Interest expense		(2,698	)		(1,191	)		(4,911	)		(2,408	)

Total other income and (expense)		(3,656	)		(968	)		(3,861	)		(1,710	)

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries		(8,008	)		(3,995	)		(18,989	)		(10,061	)

(Provision) benefit for income taxes		(144	)		343			(488	)		382


Loss from continuing operations before minority interest and gain (loss) attributable to capital transactions of subsidiaries		(8,152	)		(3,652	)		(19,477	)		(9,679	)

Minority interest		2,570			516			6,777			1,244

Net (loss) gain on capital transactions of subsidiaries		(1,118	)		—			3,632			322

(Loss) gain attributable to changes in minority interest as a result of capital transactions of subsidiaries		(857	)		160			(6,717	)		(23	)


Loss from continuing operations		(7,557	)		(2,976	)		(15,785	)		(8,136	)

Loss from discontinued operations		(3,742	)		(623	)		(3,385	)		(1,671	)


Net loss	$	(11,299	)	$	(3,599	)	$	(19,170	)	$	(9,807	)


Loss per common share — basic and diluted
Loss from continuing operations	$	(0.11	)	$	(0.04	)	$	(0.23	)	$	(0.12	)
Loss from discontinued operations	$	(0.05	)		(0.01	)	$	(0.05	)		(0.03	)


Net loss per common share — basic and diluted	$	(0.16	)	$	(0.05	)	$	(0.28	)	$	(0.15	)


Weighted average number of common shares outstanding — basic and diluted		70,017			67,726			68,251			67,375

See the accompanying notes to condensed consolidated financial statements.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
For The Nine Months Ended September 30, 2007
(In Thousands)
(Unaudited)


											Accumulated
					Additional						Other					Total
	Common Stock				Paid-In			Accumulated			Comprehensive		Treasury			Stockholders’
	Number		Amount		Capital			Deficit			Income (Loss)		Stock			Equity

Balance — December 31, 2006		67,088	$	671	$	513,242		$	(468,596	)	$	324	$	(1,777	)	$	43,864
Net loss		—		—		—			(19,170	)		—		—			(19,170	)
Comprehensive income (loss) -
Foreign currency translation		—		—		—			—			334		—			334

Total comprehensive income (loss)		—		—		—			(19,170	)		334		—			(18,836	)

Effect of adopting FASB Interpretation No. 48 “Accounting for Uncertainties in Income Taxes”		—		—		—			(89	)		—		—			(89	)
Issuance of common shares for settlement of severance liabiltiy		2,391		25		3,009			—			—		—			3,034
Reclassification of warrant payable		—		—		1,240			—			—		—			1,240
Issuance of restricted stock and options for services		50		—		49			—			—		—			49
Issuance of common stock for option exercise		10		—		15			—			—		—			15
Issuance of common stock for settlement		729		7		793			—			—		—			800
Net issuances of common stock to InfoTech for payment of note payable		703		7		970			—			—		(646	)		331
Stock issuance costs		—		—		(59	)		—			—		—			(59	)
Repricing of common stock warrants for financing transaction						158											158
VeriChip options and restricted stock issued for services		—		—		2,598			—			—		—			2,598
Exercise of VeriChip warrant						(4	)										(4	)
Digital Angel issuance of common stock warrants						1,044											1,044
Digital Angel options and restricted stock issued for services		—		—		1,176			—			—		—			1,176
Purchase of treasury stock by VeriChip						(79	)										(79	)
InfoTech options and restricted stock issued for services		—		—		38			—			—		—			38


Balance — September 30, 2007		70,971	$	710	$	524,190		$	(487,855	)	$	658	$	(2,423	)	$	35,280

See the accompanying notes to condensed consolidated financial statements.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	For The Nine-Months
	Ended September 30,
	2007			2006
Cash Flows From Operating Activities
Net loss	$	(19,170	)	$	(9,807	)

Adjustments to reconcile net loss to net cash used in operating activities:
Loss from discontinued operations		3,385			1,671
Equity compensation and other administrative expenses		3,827			938
Depreciation and amortization		3,787			3,378
Amortization of debt discount and financing costs		2,629			354
Allowance for doubtful accounts		139			44
Allowance for inventory excess and obsolescence		396			—
Deferred income taxes		—			(847	)
Reduction in derivative warrant liability		(537	)		—
Net gain on capital transactions of subsidaries		(3,632	)		(322	)
Loss attributable to changes in minority interest as a result of capital transactions of subsidiaries		6,717			23
Minority interest		(6,777	)		(1,244	)
Gain on sale of assets		(691	)		(160	)
Change in assets and liabilities:
(Increase) decrease in restricted cash		(57	)		187
(Increase) decrease in accounts receivable		(2,695	)		1,071
Increase in inventories		(1,347	)		(2,364	)
Increase in other current assets		(79	)		(946	)
Increase (decrease) in accounts payable, accrued expenses and other short-term and long-term liabilities		2,464			(182	)
Net cash provided by discontinued operations		265			3,560

Net Cash Used In Operating Activities		(11,376	)		(4,646	)


Cash Flows From Investing Activities
Decrease in notes receivable		88			208
Decrease (increase) in other assets		10			(447	)
Proceeds from sale of assets		—			755
Payments for costs of business acquisitions, net of cash acquired		(4,277	)		(1,000	)
Payments for property and equipment		(1,981	)		(2,587	)
Net cash provided by (used in) discontinued operations		556			(340	)

Net Cash Used In Investing Activities		(5,604	)		(3,411	)


Cash Flows From Financing Activities
Net amounts borrowed on notes payable		5,127			419
Proceeds from long term debt		13,022			16,587
Payment of debt		(8,290	)		(14,124	)
VeriChip’s IPO costs		(2,879	)		(1,133	)
Proceeds from VeriChip’s IPO		18,336			—
Other financing costs		(1,207	)		—
Payment of dividend to subsidiaries’ minority shareholder		(106	)		(140	)
Issuance of common shares and warrants		15			—
Stock issuance costs		(59	)		(68	)
Proceeds from subsidiary issuance of common stock		291			657
Net cash used in discontinued operations		(6	)		(805	)

Net Cash Provided By Financing Activities		24,244			1,393


Net Increase (Decrease) In Cash And Cash Equivalents		7,264			(6,664	)

Effect Of Exchange Rate Changes On Cash And Cash Equivalents		29			27

Cash And Cash Equivalents — Beginning Of Period		7,068			22,027


Cash And Cash Equivalents — End Of Period	$	14,361		$	15,390

See the accompanying notes to condensed consolidated financial statements.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation

We develop innovative identification, location and software products for consumer, commercial and government sectors worldwide. Our unique and often proprietary products provide safety for people, animals, food chains, government/military assets, and commercial assets. Included in this diverse product line are applications for radio frequency identification systems, commonly known as RFID, end-to-end food safety systems and global positioning satellite communications systems.

The accompanying unaudited condensed consolidated financial statements of Applied Digital Solutions, Inc. and its subsidiaries (doing business as Applied Digital) (the “Company”, “Registrant”, “us”, “we”, or “our”) as of September 30, 2007, and December 31, 2006 (the December 31, 2006 financial information included in this report has been extracted from our audited financial statements included in our 2006 Annual Report on Form 10-K, as amended), and for the three and nine-months ended September 30, 2007 and 2006 have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. In the opinion of our management, all adjustments (including normal recurring adjustments) considered necessary to present fairly the unaudited condensed consolidated financial statements have been made. The unaudited condensed consolidated statements of operations for the three and nine-months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the entire year. These statements should be read in conjunction with the consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2006. Certain items in the 2006 periods have been reclassified for comparative purposes.

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. 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 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, lives of intangible assets, assumptions used in Black-Scholes valuation models, estimates of the fair value of acquired assets and assumed liabilities, the determination of whether any impairment is to be recognized on goodwill or intangibles, among others.

Continuing Operations

Currently, we operate in five business segments: Healthcare, Security and Industrial, Animal Applications, GPS and Radio Communications, and Advanced Technology. Our Healthcare and Security and Industrial segments represent the business operations of our majority-owned subsidiary, VeriChip Corporation, or VeriChip. Our Animal Applications and GPS and Radio Communications segments represent the business operations of our majority-owned subsidiary, Digital Angel Corporation, or Digital Angel. Our Advanced Technology segment represents the business operations of our wholly-owned subsidiaries, Pacific Decision Sciences Corporation, or PDSC, and Thermo Life Energy Corp., or Thermo Life. Our segments are discussed in Note 6.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Discontinued Operations

During the three-months ended June 30, 2007, we made a decision to sell our 50.9%-owned subsidiary, InfoTech USA, Inc., or InfoTech, and during the three-months ended September 30, 2007, we made a decision to sell our wholly-owned subsidiaries, Computer Equity Corporation, or Computer Equity, and Perimeter Acquisition Corp., or Perimeter. This decision was made as part of management’s strategy to streamline its operations in order to focus more of its efforts on the RFID and GPS and radio communication markets. This action was also taken in anticipation of the planned merger with Digital Angel, which is discussed below. Digital Angel currently operates in the RFID and GPS and radio communications sectors. In addition, on July 2, 2007, Digital Angel sold its subsidiary, OuterLink Corporation, or OuterLink. As a result, InfoTech, Computer Equity, Perimeter and OuterLink are now classified as discontinued operations for all periods presented in this quarterly report. InfoTech operates on a fiscal year ending September 30. InfoTech’s results of operations have been reflected in the unaudited condensed consolidated financial statements reflect their activities for the same periods reported herein. In addition, on March 1, 2001, our board of directors approved a plan to sell or close Intellesale, Inc. and various other non-core businesses. Therefore, certain liabilities associated with these sold or closed businesses are included in the net liabilities of discontinued operations. In connection with our decision to sell Computer Equity and our current estimate of its fair market value, we wrote down approximately $5.0 million of Computer Equity’s goodwill during the three-months ended September 30, 2007. Discontinued operations are more fully discussed in Note 12.

Recent Events

Changes in Our Officers and Directors

On July 3, 2007, Scott R. Silverman resigned as chairman of our board of directors. Daniel E. Penni, an existing member of our board of directors, has replaced Mr. Silverman as chairman of our board. On July 2, 2007, our board of directors appointed Michael E. Krawitz, our chief executive officer, or CEO, to fill the vacancy of Mr. Silverman and to serve as a member of our board of directors effective July 3, 2007.

Appointment of Barry Edelstein as Digital Angel’s Interim President and Chief Executive Officer to Replace Kevin McGrath

Effective August 6, 2007, Kevin McGrath resigned as Digital Angel’s president, CEO and director. The board of directors of Digital Angel approved a severance package for Mr. McGrath in the total amount of $750,000, which has been recorded in the three-months ended September 30, 2007 in selling, general and administrative expense. In exchange for the severance package, Mr. McGrath was required to enter into a severance agreement with Digital Angel containing a general release and waiver and non-competition and non-solicitation provisions. On August 6, 2007, Digital Angel’s board of directors appointed Barry Edelstein as interim president and CEO. Mr. Edelstein has served on the board of directors of Digital Angel since June 2005. Digital Angel’s board of directors has initiated a search for a new CEO.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Merger Agreement Between Us and Digital Angel

On August 8, 2007, we and Digital Angel entered into an Agreement and Plan of Reorganization by and among us, Digital Angel and Digital Angel Acquisition Corp., a Delaware corporation and our wholly-owned subsidiary (the “Acquisition Subsidiary”), pursuant to which the Acquisition Subsidiary will be merged with and into Digital Angel, with Digital Angel surviving and becoming a wholly-owned subsidiary of ours (the “Merger”). Each of our and Digital Angel’s boards of directors unanimously approved the Merger, but the consummation of the transaction remains subject to customary conditions, including the approval of the issuance of shares of our common stock in connection with the merger by our stockholders and approval of the merger by the holders of a majority of the outstanding shares of Digital Angel common stock and by the holders of a majority of the outstanding shares of Digital Angel common stock not held by us or our affiliates. A special meeting of our stockholders and a special and annual meeting of Digital Angel’s stockholders is scheduled to be held on November 27, 2007, to approve the Merger. If the Merger is approved, upon the consummation thereof, each outstanding share of Digital Angel’s common stock not currently owned by us will be converted into 1.4 shares of our common stock. The shares of our common stock to be issued to Digital Angel stockholders in connection with the Merger are expected to represent approximately 28.7% of the outstanding shares of our common stock immediately following the consummation of the Merger, based on the number of shares of our common stock and Digital Angel common stock outstanding on November 5, 2007. In addition, at the effective time, each of Digital Angel’s stock options and warrants existing on the effective date will be converted into 1.4 options and warrants to acquire shares of our common stock.

Kallina Financings

Effective August 31, 2007, we and Digital Angel entered into financings with Kallina Corporation, or Kallina. Kallina is a wholly-owned subsidiary of our current senior secured lender, Laurus Master Fund, Ltd. or Laurus. Digital Angel closed on a $6.0 million revolving asset-based financing transaction with Kallina and we entered into a $7.0 million secured term loan with Kallina. In connection with the term loan, Digital Angel entered into an intercompany secured term note in the amount of $7.0 million with us. Proceeds from the loans were used by Digital Angel to repay existing debt and for working capital purposes. As a result of the refinancings, which are more fully discussed in Note 5, Digital Angel’s domestic operations are now funded by Digital Angel, us and our lender. The refinancings, which resulted in the elimination of two of Digital Angel’s existing lenders, are expected to streamline the lending functions of the two companies in anticipation of the proposed Merger. Effective October 31, 2007, we and Kallina entered into an amendment to the $7.0 million secured term note. The amendment is more fully discussed in Note 5.

Vasa Settlement

On September 28, 2007, we and Hark M. Vasa and his family partnerships, the majority shareholder of PDSC’s predecessor at the time that we acquired that company, entered into a memorandum of settlement related to a complaint that had been filed against us and PDSC on or about January 21, 2004. On November 8, 2007, the parties entered into a Settlement Agreement and General Release. The terms of the settlement are more fully discussed in Note 15.

McMurdo Revenue Recognition

Consistent with Digital Angel’s existing policy, we recognize revenue for the McMurdo operations at the time product is shipped and title has transferred, provided that a purchase order has been received or a contract has been executed, there are no uncertainties regarding customer acceptance, the sales price is fixed and determinable and collectability is deemed probable. If uncertainties regarding customer acceptance exist, revenue is recognized when such uncertainties are resolved. There are no significant post-contract support obligations at the time of revenue recognition. Our accounting policy regarding vendor and post contract support obligation is revenue is recognized upon occurrence of the post-sale support. Costs of products sold and services provided are recorded as the related revenue is recognized. Digital Angel offers a warranty on its products. For non-fixed and fixed fee jobs, service revenue is recognized based on the actual direct labor hours in the job multiplied by the standard billing rate and adjusted to net realizable value, if necessary. Other revenue is recognized at the time service or goods are provided. It is our policy to record contract losses in their entirety in the period in which such losses are foreseeable.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Recent and Accounting Pronouncements Not Yet Adopted

In September 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, 157 — Fair Value Measurements, or FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, FAS 157 does not require any new fair value measurements. However, for some entities, the application of FAS 157 will change current practice. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We have not yet determined the impact of FAS 157 on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

In September 2006, the FASB issued SFAS 158 — Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans , or FAS 158. FAS 158 amends FASB Statements No. 87, 88, 106, and 132(R). FAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive income. It also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. Under FAS 158, the requirement to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures was effective for us as of the end of our first fiscal year ending after December 15, 2006. The initial adoption did not have an impact on our consolidated financial position, results of operations, cash flows or financial statement disclosures. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for us for our first fiscal year ending after December 15, 2008. We have not yet determined the impact that this requirement may have on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

In February, 2007, FASB issued SFAS No. 159 — The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FAS 115, or FAS 159. This statement provides companies with an option to report selected financial assets and liabilities at fair value. This statement is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. We are assessing FAS 159 and have not yet determined the impact that the adoption of FAS 159 will have on our results of operations or financial position, if any.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

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

2. Principles of Consolidation

The financial statements include our accounts and the accounts of our wholly-owned and majority-owned subsidiaries, including our approximately 52.1% owned subsidiary, VeriChip (NASDAQ:CHIP), and our approximately 56.0% owned subsidiary, Digital Angel (AMEX:DOC). The minority interest represents the portion of the outstanding voting stock of these subsidiaries that we do not own. All significant intercompany accounts and transactions have been eliminated in consolidation.

3. Inventory

Inventory consists of the following:


	September 30,			December 31,
	2007			2006
	(in thousands)
Raw materials	$	6,306		$	4,779
Work in process		1,380			1,657
Finished goods		10,705			7,912

		18,391			14,348
Allowance for excess and obsolescence		(1,934	)		(1,390	)

	$	16,457		$	12,958

At September 30, 2007 and December 31, 2006, we had $11.9 million and $8.9 million of its inventory at non-domestic locations.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

4. Loss Per Share

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


	Three-Months Ended						Nine-Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
Numerator:
Numerator for basic and diluted loss per share -
Net loss from continuing operations	$	(7,557	)	$	(2,976	)	$	(15,785	)	$	(8,136	)
Net loss from discontinued operations		(3,742	)		(623	)		(3,385	)		(1,671	)

Net loss	$	(11,299	)	$	(3,599	)	$	(19,170	)	$	(9,807	)


Denominator:
Denominator for basic and diluted loss per share -
Basic and diluted weighted-average shares		70,017			67,726			68,251			67,375

Basic and diluted loss per share:
Continuing operations	$	(0.11	)	$	(0.04	)	$	(0.23	)	$	(0.12	)
Discontinued operations		(0.05	)		(0.01	)		(0.05	)		(0.03	)

Total – Basic and diluted	$	(0.16	)	$	(0.05	)	$	(0.28	)	$	(0.15	)


(1)		The following stock options, warrants and restricted stock outstanding as of September 30, 2007 and 2006 were not included in the computation of diluted loss per share because the net effect would have been anti-dilutive:


	September 30,
	2007		2006
	(in thousands)
Stock options		5,920		6,196
Warrants		4,229		4,663
Restricted stock		50		—

		10,199		10,859

5. Financings

10.25% Senior Secured Debenture and Related Common Stock Warrants

On February 6, 2007, Digital Angel entered into a Securities Purchase Agreement pursuant to which it sold its 10.25% senior secured debenture (“debenture”) in the original principal amount of $6.0 million and issued five-year warrants to purchase 699,600 shares of its common stock at a per share exercise price of $2.973. Concurrently with the Securities Purchase Agreement, Digital Angel executed a Registration Rights Agreement (the “Registration Agreement”), pursuant to which Digital Angel is obligated to register for resale shares of its common stock sufficient to cover the shares necessary to pay the principal and interest payments due on the debenture and the shares underlying the warrants. If Digital Angel does not comply with the registration deadlines set forth in the Registration Agreement, Digital Angel will be obligated to pay each Investor, pro rata, a default payment equal to 1% of the aggregate purchase price of the debenture for each month the registration default is not cured, capped at 9%, and the exercise price is subject to certain reset provisions. The Registration Agreement has been amended to extend the registration deadline to either: (1) 60 days following the earlier of the closing of the Merger transaction or December 31, 2007; or (2) 120 days following the earlier of the closing of the Merger transaction or December 31, 2007 if the Registration Statement is subject to a full review by the SEC.

On June 28, 2007, Digital Angel entered into an amendment of the Securities Purchase Agreement in connection with the planned sale of OuterLink and as consideration, Digital Angel exchanged the 699,600 existing warrants for 841,000 newly issued seven-year warrants with an exercise price of $1.701. During the three-months ended September 30, 2007, Digital Angel fully repaid the debenture as more fully discussed below.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

The warrants contain certain anti-dilution and cash settlement provisions and, accordingly, Digital Angel has accounted for the fair value of the warrants as a derivative liability subject to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” At issuance, the fair value of the 699,600 five-year warrants, as calculated using the Black-Scholes valuation model, was approximately $1.3 million using the following assumptions: volatility of 83.13%, risk free interest rate of 4.6%, dividend rate of 0.0% and expected life of 5 years. The fair value of the warrants was recorded as a discount to the debenture and was amortized to interest expense over the life of the debenture. The debenture was repaid with the proceeds of a $7.0 million secured term note issued effective August 31, 2007, as is more fully discussed below. Upon issuance of the 841,000 seven-year warrants in exchange for the five-year warrants, we recognized approximately $127,000 of additional interest expense. The warrants fair value is required to be revalued at each balance sheet date using the Black-Scholes valuation model with changes in its value recorded in the condensed consolidated statement of operations as income or expense. At September 30, 2007, the warrants derivative fair value for the 841,000 seven-year warrants then outstanding was $717,000 using the following assumptions: volatility of 73.27%, risk free interest rate of 4.4%, dividend rate of 0.0% and expected life of 6.75 years. Approximately $241,000 and $537,000 of income net of the expense related to the exchange of the warrants, is included in the condensed consolidated statement of operations for the three and nine-months ended September 30, 2007, respectively, as a result of the changes in the fair value and replacement of the warrants.

$6.0 Million Revolving Asset-Based Financing with Kallina

On August 31, 2007, Digital Angel and certain of its wholly-owned subsidiaries, Digital Angel Technology Corporation, Fearing Manufacturing Co., Inc. and Digital Angel International (collectively, the “Eligible Subsidiaries”) entered into a $6.0 million revolving asset-based financing transaction with Kallina pursuant to the terms of a Security Agreement. Under the terms of the Security Agreement, Digital Angel may borrow, from time to time, an amount equal to the lesser of the amount of availability under the borrowing base and $6.0 million, subject to certain reserves that the lender is authorized to take in its reasonable commercial judgment (the “Revolving Facility”). The borrowing base is calculated as a percentage of the total amount of eligible accounts and inventory owned by Digital Angel and its Eligible Subsidiaries. Amounts outstanding under the Revolving Facility accrue interest at a rate equal to the prime rate plus 2.0%, but not less than 10.0% at any time. At September 30, 2007, approximately $4.3 million was outstanding under the Revolving Facility, approximately $0.7 million was available for borrowing and the interest rate was 10.0%. The Revolving Facility matures on August 31, 2010. Digital Angel and its Eligible Subsidiaries have pledged all of their respective assets, including the stock that Digital Angel holds in Signature, but excluding the stock of all other foreign subsidiaries, in support of the obligations under the Revolving Facility. Digital Angel used a portion of the proceeds from the Revolving Facility to repay all obligations under a then existing revolving invoice funding facility with Greater Bay Business Funding, a division of Greater Bay Bank N.A., or Greater Bay (the “Greater Bay Facility”). The Greater Bay Facility is more fully discussed below.

In connection with the Revolving Facility, Digital Angel issued to Kallina seven-year warrants to purchase 967,742 shares of its common stock at a per share exercise price of $1.69. The value of the warrants of approximately $1.0 million was recorded as a discount to the Revolving Facility and an increase in paid-in-capital and is being amortized to interest expense over the life of the Revolving Facility. Digital Angel also entered into a registration rights agreement with Kallina pursuant to which Digital Angel has agreed to file a registration statement no later than December 31, 2007 covering the resale by Kallina of the common shares underlying the warrants. In addition, Digital Angel paid Kallina an upfront fee equal to 3.5% of the $6.0 million Revolving Facility, which is also being amortized over the life of the Revolving Facility as interest expense.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

$7.0 Million Secured Non-Convertible Term Note

Concurrently with the closing of the Revolving Facility, we entered into a $7.0 million non-convertible term note, or the 2007 Note, with Kallina pursuant to the terms of a Securities Purchase Agreement between us and Kallina. Digital Angel and its Eligible Subsidiaries have guaranteed our obligations under the 2007 Note and we have guaranteed the obligations of Digital Angel and its Eligible Subsidiaries under the Revolving Facility.

The 2007 Note accrues interest at a rate equal to the prime rate plus 3.0%, but no less than 11.0% (11.0% as of September 30, 2007), calls for monthly principal payments of $0.2 million beginning on March 1, 2008 and originally matured on August 31, 2009. The terms of the 2007 Note were amended effective October 31, 2007, as is more fully discussed below. In connection with the 2007 Note, we issued Laurus 200,000 shares of the VeriChip common stock that we owned valued at approximately $1.2 million on August 31, 2007 and repriced approximately 1.7 million warrants that we had previously issued to Laurus in August 2006 from an exercise price of $1.88 per share to an exercise price of $1.35 per share. No other terms of the warrants were modified. The value of the VeriChip common stock and the repricing of the warrants, which totaled approximately $1.3 million, has been recorded as debt issue costs and is being amortized over the life of the 2007 Note as additional interest expense. In addition, we paid Kallina an upfront fee equal to 3.5% of the 2007 Note, which is also being amortized over the life of the 2007 Note as interest expense.

Omnibus Amendment and Waiver

On October 31, 2007, we entered into an Omnibus Amendment and Waiver, or the Amendment Agreement, among us, Laurus, Kallina and certain affiliates of Laurus and Kallina (collectively, the “Lenders”) and VeriChip. The Amendment Agreement amends outstanding financing arrangements, specifically (a) a secured term note, dated as of August 31, 2006, in favor of Laurus (the “2006 Note”), and the related agreements entered into in connection therewith, and (b) the 2007 Note (the “2007 Note” and together with the 2006 Note, the “Notes”), and the related agreements entered into in connection therewith.

The Amendment Agreement provides, among other things, that (i) the aggregate of the monthly amount due on each of the Notes will be reduced by a total of $50,000 effective November 1, 2007, (ii) the maturity date on each of the Notes is extended until February 1, 2010, and (iii) the prepayment penalty provision in each of the Notes is no longer applicable. In addition, in connection with an inter-company loan between us and VeriChip under which approximately $12.7 million was outstanding on October 31, 2007 (the “VeriChip Loan”), the Lenders agreed that such loan may be satisfied in full by VeriChip for no less than $10 million plus accrued interest if the satisfaction of the VeriChip Loan is made on or prior to November 1, 2008 and $6 million of such payment amount is paid by us to the Lenders in satisfaction of the Notes. If the VeriChip Loan is satisfied, the aggregate of the monthly amount due on the Notes will be reduced by an additional $50,000 per month.

In connection with the Amendment Agreement, we issued warrants to the Lenders to purchase a total of 2,976,198 shares of our common stock, at a price of $1.00 per share, which warrants were immediately exercisable and expire on October 31, 2014. The value of the warrants of approximately $1.7 million will be recorded as debt discount and will be amortized to interest expense over the life of the Notes. We are required to register the shares underlying the warrants on our next registration statement filed after December 31, 2007.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Under the Amendment Agreement, the Lenders also agreed to amend a Registration Rights Agreement, dated August 31, 2007, between VeriChip and Kallina to extend the filing deadline to April 30, 2008, for a registration statement that VeriChip must file for the resale of 200,000 shares of VeriChip common stock that we issued to Kallina in connection with the 2007 Note.

$7.0 Million Secured Intercompany Note Between Us and Digital Angel

Effective August 31, 2007, Digital Angel entered into a $7.0 million secured term note with us, or the IC Note. The IC Note accrues interest at a rate equal to the prime rate plus 3.0%, but no less than 11.0%, and matures on August 31, 2009. As consideration for the IC Note, Digital Angel issued us 921,402 shares of its common stock. The value of the stock issued by Digital Angel was approximately $1.4 million, based on the closing price of Digital Angel’s stock on the issuance date. The value is being amortized by Digital Angel as interest expense and accreted by us as interest income over the life of the IC Note. Accordingly, this intercompany interest expense and intercompany interest income has been eliminated in the consolidation of our financial statements. Digital Angel used the proceeds of the IC Note to repay all amounts due under the debenture. Based on Digital Angel’s election to prepay the debenture and Greater Bay Facility, it wrote off approximately $1.5 million of deferred financing costs and debt discount associated with the debenture and the Greater Bay Facility in the third quarter of 2007.

Accounts Receivable


	September 30,			December 31,
	2007			2006
	(in thousands)

Receivables assigned to factors	$	2,249		$	1,094
Advances from factors		(1,799	)		(875	)

Amounts due from factors		450			219
Unfactored accounts receivable		18,917			16,284
Allowance for doubtful accounts		(330	)		(483	)

Total accounts receivable	$	19,037		$	16,020

On March 23, 2007, Digital Angel entered into the Greater Bay Facility with Greater Bay. The Greater Bay Facility required that Digital Angel sell and assign to Greater Bay, all rights, title, and interest in the accounts receivable of its subsidiary, Digital Angel Technology Corporation. Under the Greater Bay Facility, Greater Bay advanced 80% of the eligible receivables, as defined in the Greater Bay Facility, not to exceed a maximum of $5.0 million at any given time. Greater Bay paid the remainder of the receivable upon collection. Interest was payable on the daily outstanding balance of funds drawn and was equal to the Greater Bay Bank prime rate plus 3.00%. On August 31, 2007, Digital Angel used a portion of the proceeds from the Revolving Facility to terminate and pay-off all obligations under the Greater Bay Facility.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Signature entered into an Invoice Discounting Agreement with The Royal Bank of Scotland Commercial Services Limited, or RBS, on April 9, 2003, as amended (the “Invoice Discounting Agreement”), which provides for Signature to sell with full title guarantee most of its receivables, as defined in the Invoice Discounting Agreement. Under the Invoice Discounting Agreement, RBS prepays 80% of the receivables sold in the United Kingdom and 80% of the receivables sold in the rest of the world, not to exceed an outstanding balance of £2.0 million (approximately $4.1 million at September 30, 2007) at any given time. RBS pays Signature the remainder of the receivable upon collection of the receivable. Receivables that remain outstanding 90 days from the end of the invoice month become ineligible and RBS may require Signature to repurchase the receivable. The discounting charge accrues at an annual rate of 1.5% above the base rate as defined in the Invoice Discounting Agreement (5.3% at September 30, 2007). Signature pays a commission charge to RBS of 0.16% of each receivable balance sold. The Invoice Discounting Agreement requires a minimum commission charge of £833 (approximately $1,700) per month. Discounting charges of $28,000 and $78,000 are included in interest expense for the three and nine-months ended September 30, 2007, respectively. As of September 30, 2007, $1.8 million of receivables were factored under the Invoice Discounting Agreement.

VeriChip’s Initial Public Offering and Underwriting Agreement

On February 14, 2007, VeriChip completed an initial public offering of its common stock. In connection with the initial public offering, 3,100,000 shares of its common stock were sold. We, VeriChip, and Merriman Curhan Ford & Co., as representative of the several underwriters, entered into an underwriting agreement. The initial public offering price was $6.50 per share and the underwriting discounts and commissions were $0.455 per share.

The underwriting agreement required VeriChip to reimburse the underwriters for their expenses on a non-accountable basis in the amount equal to 1.3% of the aggregate public offering price. In addition, the Company reimbursed the underwriters $150,000 of their legal fees incurred in connection with the offering.

A reconciliation of net proceeds from VeriChip’s initial public offering is provided as follows:


	Amount

Gross proceeds from public offering	$	20,150

Less fees and offering costs:
Underwriter discounts and fees		1,814
Offering costs paid prior to 2007		3,350
Offering costs paid in 2007		2,879

Net proceeds from public offering	$	12,107

The effects of the capital transactions of VeriChip and of Digital Angel on our results of operations are described in Note 8.

In addition to the financings discussed above, we have additional loans and credit facilities, which are discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Liquidity and Capital Resources from Continuing Operations,” which are presented below.

Financial Condition

As of September 30, 2007, our consolidated cash and cash equivalents totaled $14.4 million. VeriChip had a cash balance of $9.7 million, Digital Angel had a cash balance of $1.5 million and our Advanced Technology segment and “Corporate/Eliminations” had a combined cash balance of approximately $3.2 million.

We believe that we will generate sufficient funds from operations and through financing activities to operate our business over the next twelve months, and, if necessary, we intend to provide funds to Digital Angel during that time period. Our goal is to achieve profitability and to generate positive cash flows from operations. 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. Failure to generate positive cash flow from operations will have a material adverse effect on our business, financial condition and results of operations. Our ability to achieve profitability and/or generate positive cash flows from operations in the future is predicated upon numerous factors with varying levels of importance as follows:

	•		first, we will attempt to successfully implement our business plans, manage expenditures according to our budget, streamline our manufacturing processes, and generate positive cash flow from operations;

	•		second, we will continue to develop an effective marketing and sales strategy in order to grow our businesses and compete successfully in our markets;

	•		third, we will attempt to expand the market for our Bio Thermo™ and VeriMed products; and

	•		fourth, we will continue to focus on acquisitions of complementary business that generate positive cash flow, such as the McMurdo business that we acquired in April 2007, and/or divest those business that are no longer strategic or that do not generate positive cash flow from operations.

Our management believes that the above plan can be effectively implemented.

Our profitability and liquidity depend on many factors, including the success of our marketing programs, the maintenance and reduction of expenses, the protection of our intellectual property rights and our ability to successfully develop and bring to market our new products and technologies.

No assurance can be given that we will be successful in implementing the plan. Our profitability and cash flows from operations depend on many factors including the success of our marketing programs, the maintenance and reduction of expenses and our ability to successfully develop and bring to market our new products and technologies.

Debt Compliance

On June 30, 2004, InfoTech entered into a credit facility with Wells Fargo Business Credit, Inc., or Wells Fargo, as amended from time to time, providing for up to $4.0 million in borrowings. Amounts borrowed under the credit facility bear interest at Wells Fargo’s prime rate plus 3%. The credit facility matures on June 29, 2008, and automatically renews for successive one-year periods unless terminated by either party. Under the terms of the credit facility, Wells Fargo may, at its election, make advances as requested from time to time in amounts up to an amount equal to the difference between the borrowing base (described below) and the sum of (i) the amount outstanding under the credit facility; (ii) the $0.6 million letter of credit agreement outstanding under a credit facility which secures InfoTech’s obligations to IBM Credit LLC under a wholesale financing agreement; and (iii) the $0.2 million letter of credit agreement, which secures InfoTech’s borrowing under an invoicing credit facility with one of its vendors. The borrowing base is equal to the lesser of $4.0 million or the amount equal to 85% of (i) eligible accounts receivable; plus (ii) the amount of available funds on deposit at Wells Fargo; and minus (iii) certain specified reserves. As of September 30, 2007, the borrowing base was approximately $0.4 million, the letters of credit were approximately $0.8 million and $2,000 was outstanding under the credit facility. The credit facility requires InfoTech to maintain certain financial covenants, limits its capital expenditures, and contains other standard covenants including prohibitions on its incurrence of additional debt, its sales of assets and other corporate transactions without Wells Fargo’s consent. On November 8, 2007, InfoTech notified Well Fargo that as of September 30, 2007 it was not in compliance with certain financial covenants under the credit agreement. InfoTech is seeking to obtain a waiver of its non-compliance. No assurance can be given that such waiver will be granted. If such a waiver is not granted, it could have an adverse effect on InfoTech.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

6. Segment Information

We operate in five business segments: Healthcare, Security and Industrial, Animal Applications, GPS and Radio Communications, and Advanced Technology.

Healthcare Segment

Our Healthcare segment encompasses the development, marketing and sale of our healthcare and patient identification systems, specifically:

	•		infant protection systems used in hospital maternity wards and birthing centers to prevent infant abduction and mother-baby mismatching;

	•		wander prevention systems used by long-term care facilities to locate and protect their residents;

	•		asset/staff location and identification systems used by hospitals and other healthcare facilities to identify, locate and protect medical staff, patients, visitors and medical equipment; and

	•		VeriMed system designed to rapidly and accurately identify people who are unconscious, confused or unable to communicate at the time of medical treatment, for example, upon arrival at a hospital emergency room.

Security and Industrial Segment

Our Security and Industrial segment principal products encompass the sale of:

	•		vibration monitoring instruments used by engineering, construction and mining professionals to monitor the effects of human induced vibrations, such as blasting activity; and

	•		asset management systems used by industrial companies to manage and track their mobile equipment and tools.

Animal Applications Segment

Our Animal Applications segment develops, manufactures and markets visual and electronic identification tags and RFID microchips, primarily for identification, tracking and location of companion pets, fish, equine and wildlife, and livestock markets worldwide, and more recently, for animal bio-sensing applications, such as temperature reading for companion pet, horse and livestock applications. Our Animal Applications segment’s proprietary products provide security for companion pets, and food chains. This segment’s principal products are:

•

visual ear tags for livestock; and

•

implantable microchips and RFID scanners for the companion pet, equine, fish, livestock and wildlife industries.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

GPS and Radio Communications Segment

Our GPS and Radio Communications segment’s proprietary products provide location tracking and message monitoring of aircraft, and maritime vehicles and people 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™ brand, which serve commercial and military markets; and

•

alarm sounders for industrial use and other electronic components.

Advanced Technology Segment

The principal product and service in our Advanced Technology segment are service relationship management software and services.

“Corporate/Eliminations” Category

The “Corporate/Eliminations” category includes all amounts given effect to in the consolidation of our subsidiaries, such as the elimination of inter-segment revenues, expenses, assets and liabilities. “Corporate/Eliminations” also includes certain expense reductions and other income associated with companies sold or closed in 2001 and 2002, and general and administrative, interest expense and income and other expenses associated with corporate activities and functions.

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, as amended, 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.

Following is the selected segment data as of and for the three-months ended September 30, 2007:


	Segments
																	Total from
				Security and			Animal			GPS and Radio		Advanced		“Corporate/			Continuing
	Healthcare			Industrial			Applications			Communications		Technology		Eliminations”			Operations
	(in thousands)
Net revenue from external customers:
Product	$	5,768		$	1,646		$	10,346		$	9,989	$	446	$	—		$	28,195
Service		158			344			—			—		1,474		—			1,976

		5,926			1,990			10,346			9,989		1,920		—			30,171
Inter-segment revenue — product		—			—			—			—		—		—			—

Total revenue	$	5,926		$	1,990		$	10,346		$	9,989	$	1,920	$	—		$	30,171


(Loss) income from continuing operations before income taxes, minority interest, and gain (loss) attributable to capital transactions of subsidiaries	$	(1,999	)	$	(1,123	)	$	(4,019	)	$	1,163	$	1,103	$	(3,133	)	$	(8,008	)


Total assets from continuing operations	$	43,012		$	8,958		$	82,678		$	19,513	$	1,776	$	7,078		$	163,015

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Following is the selected segment data as of and for the three-months ended September 30, 2006:


	Segments
																		Total from
				Security and			Animal			GPS and Radio			Advanced		“Corporate/			Continuing
	Healthcare			Industrial			Applications			Communications			Technology		Eliminations”			Operations
	(in thousands)
Net revenue from external customers:
Product	$	4,948		$	1,406		$	8,233		$	4,146		$	794	$	—		$	19,527
Service		147			317			—			—			932		—			1,396

		5,095			1,723			8,233			4,146			1,726					20,923
Inter-segment revenue — product		—			—			21			—			—		(21	)		—

Total revenue	$	5,095		$	1,723		$	8,254		$	4,146		$	1,726	$	(21	)	$	20,923


(Loss) income from continuing operations before income taxes, minority interest, and gain (loss) attributable to capital transactions of subsidiaries	$	(1,369	)	$	(330	)	$	(944	)	$	(231	)	$	937	$	(2,058	)	$	(3,995	)


Total assets from continuing operations	$	37,636		$	11,561		$	81,575		$	8,303		$	3,853	$	(17,181	)	$	125,747

Following is the selected segment data as of and for the nine-months ended September 30, 2007:


	Segments
																	Total from
				Security and			Animal			GPS and Radio		Advanced		“Corporate/			Continuing
	Healthcare			Industrial			Applications			Communications		Technology		Eliminations”			Operations
	(in thousands)
Net revenue from external customers:
Product	$	16,676		$	5,233		$	31,635		$	23,531	$	977	$	—		$	78,052
Service		424			1,146			—			—		4,515		—			6,085

		17,100			6,379			31,635			23,531		5,492		—			84,137
Inter-segment revenue — product		—			—			—			—		—		—			—

Total revenue	$	17,100		$	6,379		$	31,635		$	23,531	$	5,492	$	—		$	84,137


(Loss) income from continuing operations before income taxes, minority interest, and gain (loss) attributable to capital transactions of subsidiaries	$	(6,331	)	$	(2,638	)	$	(8,449	)	$	240	$	3,947	$	(5,758	)	$	(18,989	)


Total assets from continuing operations	$	43,012		$	8,958		$	82,678		$	19,513	$	1,776	$	7,078		$	163,015

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Following is the selected segment data as of and for the nine-months ended September 30, 2006:


	Segments
																		Total from
				Security and			Animal			GPS and Radio			Advanced		“Corporate/			Continuing
	Healthcare			Industrial			Applications			Communications			Technology		Eliminations”			Operations
	(in thousands)
Net revenue from external customers:
Product	$	14,774		$	4,300		$	27,348		$	12,016		$	794	$	—		$	59,232
Service		282			988			589			—			3,650		—			5,509

		15,056			5,288			27,937			12,016			4,444		—			64,741
Inter-segment revenue — product		—			—			194			—			—		(194	)		—

Total revenue	$	15,056		$	5,288		$	28,131		$	12,016		$	4,444	$	(194	)	$	64,741


(Loss) income from continuing operations before income taxes, minority interest, and gain (loss) attributable to capital transactions of subsidiaries	$	(3,255	)	$	(737	)	$	(2,419	)	$	(424	)	$	2,299	$	(5,525	)	$	(10,061	)


Total assets from continuing operations	$	37,636		$	11,561		$	81,575		$	8,303		$	3,853	$	(17,181	)	$	125,747

7. Merger and Acquisition

Merger Agreement Between Us and Digital Angel

On August 8, 2007, we and Digital Angel entered into an Agreement and Plan of Reorganization by and among us, Digital Angel and Acquisition Subsidiary pursuant to which the Acquisition Subsidiary will be merged with and into Digital Angel, with Digital Angel surviving and becoming a wholly-owned subsidiary of ours. The Merger is more fully discussed in Note 1.

McMurdo Acquisition

In April 2007, Digital Angel, through its wholly-owned subsidiary, Signature, acquired certain assets and customer contracts of McMurdo Limited (“McMurdo”), a United Kingdom based subsidiary of Chemring Group Plc (“Chemring”) and manufacturer of emergency location beacons. McMurdo is a leader in the development and manufacturing of safety equipment technology. Its products, including the original Emergency Position Indicating Radio Beacon and the first Global Maritime Distress and Safety System approved Search and Rescue Transponder, have become standard, lifesaving equipment on many recreational, commercial and military marine vehicles. This acquisition was made to broaden Digital Angel’s emergency location beacon product offering to serve the military and commercial maritime sectors and provide stability to our GPS and Radio Communication segment’s revenue base.

Pursuant to the Asset Sale and Purchase Agreement (the “Sale and Purchase Agreement”) entered into in December 2006, Signature acquired certain assets and customer contracts of McMurdo’s marine electronics business including fixed assets, inventory, customer lists, customer and supplier contracts and relations, trade and business names, and associated assets. The assets excluded certain accrued liabilities and obligations and real property, including the plant facility that Signature has a license to occupy for a period of nine months from the Completion Date (as defined in the Sale and Purchase Agreement). Signature is currently in the process of formalizing a sublease with Chemring to extend the lease of the McMurdo facility until 2022, with an opt-out provision after two to three years. Under the terms of the Sale and Purchase Agreement, Signature retained McMurdo’s employees related to the marine electronics business. In addition, pursuant to the terms of the Sale and Purchase Agreement, Digital Angel

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

guaranteed to McMurdo, Signature’s obligations and liabilities to McMurdo under the Guaranteed Agreements (as defined in the Sale and Purchase Agreement) and Chemring guaranteed to Signature, McMurdo’s obligations and liabilities under the Guaranteed Agreements. Digital Angel paid consideration of approximately $4.7 million in cash, net of a purchase price adjustment paid by Chemring in July 2007, and will make one additional purchase payment of up to $3.0 million during the fourth quarter of 2007. The purchase price payment will be determined on a threshold basis with a minimum threshold, calculated on the basis of the invoiced value of specific products sold between November 1, 2006 and October 31, 2007 and payable when the parties finalize a statement of the sales. Digital Angel expects to pay approximately $2.2 million in additional purchase price consideration as McMurdo’s revenue is expected to exceed the threshold.

The estimated fair values of assets acquired are as follows:


	April 5, 2007
	(in thousands)

Inventory	$	592
Fixed assets		2,178
Goodwill and other intangibles		1,972

Total assets acquired	$	4,742

The required purchase accounting adjustments, including the allocation of the purchase price based on the fair values of the assets acquired have been made based upon preliminary valuations, which are still in review and are subject to change. Based upon our final valuation and review, we may determine that additional tangible assets exist or their estimated useful lives require revision. We anticipate that we will finalize the purchase price allocation within the next several months. Any adjustments to the purchase price allocation will be recorded as an increase or decrease in goodwill. In addition, the purchase price payment of approximately $2.2 million that Digital Angel anticipates paying in the fourth quarter of 2007 is expected to be recorded as additional goodwill or other intangible assets.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

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 McMurdo from the date of acquisition. Unaudited pro forma results of operations for the three-months ended September 30, 2006 and the nine-months ended September 30, 2007 and 2006 are included below. Such pro forma information assumes that the above acquisition had occurred as of January 1, 2007 and 2006, respectively, 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.


	Pro Forma for the			Pro Forma for the
	Three Months Ended			Nine-Months Ended
	September 30,			September 30,
	2006			2007			2006
	(unaudited, in thousands)
Net operating revenue	$	24,230		$	88,315		$	73,486
Net loss from continuing operations		(3,119	)		(15,595	)		(8,795	)
Net loss from continuing operations per common share — basic and diluted		(0.05	)		(0.23	)		(0.13	)

8. Capital Transactions of Subsidiaries

Net Loss on Capital Transactions of Subsidiaries and Gain/Loss Attributable to Changes in Minority Interest As a Result of Capital Transactions of Subsidiaries

Gains where realized and losses on issuances of shares of stock by Digital Angel and VeriChip are reflected in the unaudited condensed consolidated statement of operations. We determined that such recognition of gains and losses on issuances of shares of stock by Digital Angel and VeriChip was appropriate since we do not plan to reacquire the shares issued and the value of the proceeds could be objectively determined. In conjunction with the contemplated merger with Digital Angel, there will no longer be gains or losses associated with the issuance of shares of stock by Digital Angel.

During the three-months ended September 30, 2007 and 2006, we recorded a loss of $1.1 million and nil, respectively, on the issuances of common stock by Digital Angel and VeriChip. During the nine-months ended September 30, 2007 and 2006, we recorded a gain of $3.6 million and $0.3 million, respectively, on the issuances of common stock by Digital Angel and VeriChip. The net gains (losses) resulted from the difference between the carrying amount of our pro-rata share of our investment in Digital Angel and VeriChip and the net proceeds from the issuances of the stock.

During the three-months ended September 30, 2007, in connection with the IC Note between us and Digital Angel, which is more fully discussed in Note 5, Digital Angel issued approximately 0.9 million shares of its common stock to us. In addition, Digital Angel issued 0.3 million shares of its common stock to us during the three-months ended June 30, 2006 under the terms a share exchange agreement between Digital Angel and us. The share exchange related to a purchase price payment made by Digital Angel in connection with its acquisition of its subsidiary, DSD Holding A/S, or DSD. Based on the substance of these transactions and the fact that the shares were issued to us in connection with a financing and exchanged in connection with an acquisition, the shares did not result in a gain or loss on issuance.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

We recorded a loss of $0.9 million and a gain of $0.2 million during the three-months ended September 30, 2007 and 2006, respectively, and loss of $6.7 million and $23,000 during the nine-months ended September 30, 2007 and 2006, respectively, attributable to changes in the minority interest ownership as a result of the capital transactions of VeriChip and Digital Angel.

The details of the capital transactions of Digital Angel and VeriChip for the three and nine-months ended September 30, 2007 and 2006 are presented in the table below:


	Three-Months Ended						Three-Months Ended
	September 30, 2007						September 30, 2006
	(in thousands except per share amounts)
	Digital						Digital
	Angel			VeriChip			Angel			VeriChip
Issuances of common stock for stock options		—			139			—			—
Issuances of common stock for restricted stock and employee severance payments		307			109			—			—
Issuance of common stock to us under financing agreement		921			—			—			—
Issuances of warrants ⁽¹⁾		—			395			—

Total issuances of common stock		1,228			643			—			—

Proceeds from stock issuances	$	—		$	103		$	—		$	—
Average price per share	$	—		$	0.16		$	—		$	—
Beginning ownership percentage		55.0	%		57.5	%		55.2	%		100.0	%
Ending ownership percentage		55.6	%		52.1	%		55.2	%		100.0	%


Change in ownership percentage		0.6	%		(5.4	)%		—	%		—


Net loss on capital transactions of subsidiaries ⁽²⁾	$	(138	)	$	(980	)	$	—		$	—

Loss attributable to changes in minority interest as a result of capital transactions of subsidiaries ⁽²⁾	$	(234	)	$	(623	)	$	160		$	—

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)


	Nine-Months Ended						Nine-Months Ended
	September 30, 2007						September 30, 2006
	(in thousands except per share amounts)
	Digital						Digital
	Angel			VeriChip			Angel			VeriChip
Issuance of common stock in initial public offering		—			3,100			—			—
Issuances of common stock for stock options		—			536			386			—
Issuances of common stock for restricted stock, consulting services and employee severance payments		433			209			—			—
Issuances of warrants ⁽¹⁾		—			395			—			—
Issuances of common stock under financing agreement and share exchange agreement between Digital Angel and us		921			—			282			—

Total issuances of common stock		1,354			4,240			668			—

Proceeds from stock issuances	$	—		$	12,494		$	1,561		$	—
Average price per share	$	—		$	2.95		$	2.34		$	—
Beginning ownership percentage		55.2	%		91.7	%		55.4	%		100.0	%
Ending ownership percentage		55.6	%		52.1	%		55.2	%		100.0	%


Change in ownership percentage		0.4	%		(39.6	)%		(0.2	)%		—


Net (loss) gain on capital transactions of subsidiaries ⁽²⁾	$	(196	)	$	3,828		$	322		$	—

Loss attributable to changes in minority interest as a result of capital transactions of subsidiaries ⁽²⁾	$	(748	)	$	(5,969	)	$	(23	)	$	—


(1)		Warrants were issued by VeriChip under the cashless exercise provision of the warrant agreement, thus no proceeds were realized.

(2)		The tax provision/benefit for the net gain (loss) on capital transactions of subsidiaries and the loss attributable to changes in minority interest as a result of capital transactions of subsidiaries have been fully reserved due to our current tax position and significant net operating loss carry forwards.

9. Stock Options, Restricted Stock, Stock Issued for Consulting Agreement and Warrants Settleable in Shares of Subsidiary Stock

As of September 30, 2007, we have six stock-based employee stock plans (four of which have been terminated with respect to any new stock option grants), and our subsidiaries collectively have nine stock-based employee compensation plans. Our plans and the plans of our subsidiaries, which were outstanding as of December 31, 2006, are more fully described in Note 12 to our consolidated financial statements in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2006. On June 17, 2007, VeriChip adopted the VeriChip 2007 Stock Incentive Plan, or the VeriChip 2007 Plan. Under the VeriChip 2007 Plan, the number of shares for which options, SARs or performance shares may be granted is 1.0 million. As of September 30, 2007, options to purchase 128,667 shares of VeriChip common stock were granted under the VeriChip 2007 Plan.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

We adopted the provisions of SFAS No. 123R Share Based Payment or, FAS 123R, on January 1, 2006 using the modified prospective application method of adoption, which required us to record compensation cost related to unvested stock awards as of December 31, 2005 by recognizing the unamortized grant date fair value of those awards over the remaining service periods of those awards with no change in historical reported earnings. Awards granted after December 31, 2005 are valued at fair value in accordance with provisions of FAS 123R and recognized on a straight line basis over the service periods of each award. Our estimated forfeiture rates for the three and nine-months ended September 30, 2007 and 2006 were based on our historical experience. Upon adoption of FAS 123R, we elected to continue using the Black-Scholes valuation model. Prior to the adoption of FAS 123R, we presented all tax benefits related to stock-based compensation as an operating cash inflow. FAS 123R requires the cash flows resulting from tax deductions in excess of compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. We did not record any excess income tax benefits relating to FAS 123R during three and nine-months ended September 30, 2007 and 2006.

On December 29, 2005, our board of directors approved a proposal that provided for vesting on December 30, 2005 of substantially all of our then outstanding and unvested stock options previously awarded to our employees and employees of our affiliates. In connection with the acceleration of these options, we stipulated that a grantee that acquires any shares through exercise of any of such options shall not be permitted to sell such shares until the earlier of: (i) the original vesting date applicable to such option or (ii) the date on which such grantee’s employment terminates for any reason. The purpose of the accelerated vesting of the options granted was to enable us to avoid recognizing in future periods non-cash compensation expense associated with such options in our consolidated statements of operations, which would have otherwise been required upon our adoption of FAS 123R on January 1, 2006. The board of directors of VeriChip approved a similar proposal, with the same stipulations regarding sale, on December 12, 2005. On November 17, 2005, the board of directors of Digital Angel approved a proposal that provided for vesting on December 30, 2005 of all of its then-outstanding and unvested stock options that were issued prior to November 17, 2005 with an exercise price above the fair market value of Digital Angel’s common stock on December 30, 2005 and with the same stipulations regarding sale.

During the three and nine-months ended September 30, 2007 and 2006, we recorded approximately $0.7 million, $1.3 million, $0.4 million and $0.8 million, respectively, in compensation expense related to stock options granted to our and our subsidiaries’ employees.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

All of InfoTech’s stock options were fully vested as of December 31, 2006, and InfoTech did not grant any options during the nine-months ended September 30, 2007. A summary of the status of our and our subsidiaries’ nonvested stock options as of September 30, 2007, and changes during the nine-months ended September 30, 2007, is presented below (in thousands, except per share amounts):


			Weighted Average
			Grant-Date
Applied Digital	Stock Options		Fair Value
Nonvested at January 1, 2007		—	$	—
Granted		110		0.77
Vested		—		—

Nonvested at September 30, 2007		110	$	0.77


				Weighted Average
				Grant-Date
VeriChip	Stock Options			Fair Value
Nonvested at January 1, 2007		50		$	10.00
Granted		422			5.89
Vested		(17	)		10.00
Forfeited or expired		—			—

Nonvested at September 30, 2007		455		$	6.20


				Weighted Average
				Grant-Date
Digital Angel	Stock Options			Fair Value
Nonvested at January 1, 2007		2,458		$	2.64
Granted		520			1.39
Vested		(303	)		2.19
Forfeited or expired		(633	)		2.11

Nonvested at September 30, 2007		2,042		$	1.94


				Weighted Average
				Grant-Date
Thermo Life Energy Corp.	Stock Options			Fair Value
Nonvested at January 1, 2007		333		$	0.11
Granted		—			—
Vested		(167	)		0.11

Nonvested at September 30, 2007		166		$	0.11

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

The weighted average per share fair value of options granted or modified by us and our subsidiaries during the three and nine-months ended September 30, 2007 and 2006 was estimated on the grant date using the Black-Scholes option-pricing model based on the following weighted average assumptions. (Thermo Life Energy Corp. did not grant any options during the nine-months ended September 30, 2007 and 2006. We did not grant any options during the nine-months ended September 30, 2006):


	Nine-Months Ended			Nine-Months Ended
Applied Digital	September 30, 2007			September 30, 2006
Weighted-average per share fair value	$	0.77			—
Estimated option life		5.00 years			—
Risk free interest rate		5.0	%		—	%
Expected volatility		60.00	%		—	%
Expected dividend yield		0.00	%		—	%


	Nine-Months Ended			Nine-Months Ended
VeriChip	September 30, 2007			September 30, 2006
Weighted-average per share fair value	$	2.98		$	5.97
Estimated option life		6.00 years			5.00 years
Risk free interest rate		4.51	%		4.29	%
Expected volatility		50.00	%		60.00	%
Expected dividend yield		0.00	%		0.00	%


	Nine-Months Ended			Nine-Months Ended
Digital Angel	September 30, 2007			September 30, 2006
Weighted-average per share fair value	$	1.39		$	2.69
Estimated option life		5.00 years			8.41 years
Risk free interest rate		4.5 – 5.2	%		5.0	%
Expected volatility		80.9 – 131.2	%		106.1 – 113.3	%
Weighted average volatility		95.9	%		108.8	%
Expected dividend yield		0.00	%		0.00	%

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 option activity under our option plans and the stock option plans of our subsidiaries as of September 30, 2007, and changes during the nine-months ended September 30, 2007 is presented below (in thousands, except per share amounts):


						Weighted
				Weighted		Average
	Stock			Average		Contractual		Aggregate
Applied Digital	Options			Exercise Price		Term		Intrinsic Value
								(in thousands)
Outstanding at January 1, 2007		6,166		$	3.27
Granted		110			1.38
Exercised		(10	)		1.50
Forfeited or Expired		(346	)		5.32

Outstanding at September 30, 2007		5,920		$	3.12		4.7	$	—	*

Exercisable at September 30, 2007		5,810		$	3.15		5.0	$	—	*


*		The intrinsic value of a stock option is the amount by which the fair value of the underlying stock exceeds the exercise price of the option. The fair value of Applied Digital’s common stock was $0.92 at September 30, 2007 based upon its closing price on the NASDAQ.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)


						Weighted
				Weighted		Average
	Stock			Average		Contractual		Aggregate
VeriChip	Options			Exercise Price		Term		Intrinsic Value
								(in thousands)
Outstanding at January 1, 2007		2,099		$	2.10
Granted		422			5.88
Exercised		(536	)		0.70
Forfeited or Expired		(22	)		5.75

Outstanding at September 30, 2007		1,963		$	3.26		5.00	$	1,496	*

Exercisable at September 30, 2007		1,530		$	2.42		4.09	$	2,443	*


*		The intrinsic value of a stock option is the amount by which the fair value of the underlying stock exceeds the exercise price of the option. The fair value of VeriChip’s common stock was $4.02 at September 30, 2007 based upon its closing price on the NASDAQ.


						Weighted
				Weighted		Average
	Stock			Average		Contractual		Aggregate
Digital Angel	Options			Exercise Price		Term		Intrinsic Value
								(in thousands)
Outstanding at January 1, 2007		11,705		$	3.84
Granted		520			2.11
Exercised		—			—
Forfeited or Expired		(1,614	)		3.87

Outstanding at September 30, 2007		10,611		$	3.75		6.85	$	470	*

Exercisable at September 30, 2007		8,569		$	3.93		6.59	$	470	*


*		The intrinsic value of a stock option is the amount by which the fair value of the underlying stock exceeds the exercise price of the option. The fair value of Digital Angel’s stock was $1.29 at September 30, 2007 based upon its closing price on the AMEX.


					Weighted
			Weighted		Average
	Stock		Average		Contractual		Aggregate
Thermo Life Energy Corp.	Options		Exercise Price		Term		Intrinsic Value
							(in thousands)
Outstanding at January 1, 2007		4,390	$	0.06
Granted		—		—
Exercised		—		—
Forfeited or Expired		—		—

Outstanding at September 30, 2007		4,390	$	0.06		4.31	$	—	*

Exercisable at September 30, 2007		4,224	$	0.05		4.15	$	—	*


*		The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. The estimated market value of Thermo Life’s stock was $0.05 at September 30, 2007.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

The total intrinsic value of options exercised during the nine-months ended September 30, 2007 and 2006 was $2.7 million and $0.7 million, respectively.

As of September 30, 2007, there was $4.4 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under our and our subsidiaries’ plans. That cost is expected to be recognized over a weighted-average period of 5.1 years. The total fair value of shares vested during the nine-months ended September 30, 2007, was nil.

Cash received from option exercise under all share-based payment arrangements for the nine-months ended September 30, 2007 was $0.4 million.

Restricted Stock

As more fully discussed in Note 1, effective August 6, 2007, Kevin McGrath resigned as Digital Angel’s president, CEO and director. In connection with Mr. McGrath’s resignation, Digital Angel issued 307,143 shares of its restricted stock valued at $430,000 to Mr. McGrath as a portion of his severance payment. The restriction will lapse one year from the date of issuance. The number of shares of restricted stock was determined by dividing $430,000 by the closing price of Digital Angel’s common stock at the close of business on August 8, 2007.

In August 2007, Digital Angel granted its chairman of the board 25,000 shares of its restricted stock. The restricted stock vested 100% on October 15, 2007. Digital Angel determined the value of the stock to be $39,000 based on the closing price of its stock on the date of the grant. The value of the restricted stock was recorded as compensation expense. In the nine- months ended September 30, 2007, $29,000 was recognized as compensation expense related to the restricted stock.

In December 2006, we issued 0.1 million shares of our restricted common stock to our chief executive officer. Fifty percent (50%) of the restricted stock vested immediately and 50% will vest on December 31, 2008. We determined the value of the stock to be $0.2 million based on the closing price of our stock on the date of grant. The value of the restricted stock is being amortized as compensation expense over the vesting period. In the nine-month period ended September 30, 2007, $32,421 of compensation expense was recorded in connection with the restricted stock.

In December 2006, VeriChip issued 0.5 million shares of its restricted common stock to its chairman of the board and chief executive officer, which shares are subject to forfeiture in the event that Mr. Silverman terminates his employment or VeriChip terminates his employment for cause on or before December 31, 2008. VeriChip determined the value of the stock to be $4.5 million based on the estimated value of its common stock of $9.00 per share on the date of grant. The value of the restricted stock is being amortized as compensation expense over the vesting period. For the three and nine-month period ended September 30, 2007, VeriChip recorded compensation expense of approximately $0.5 million and $1.6 million, respectively, in connection with the restricted stock.

In March 2007, VeriChip issued 0.1 million shares of its restricted common stock to two officers, which will vest on March 2, 2009. VeriChip determined the value of the stock to be $0.6 million based on the estimated value of its common stock of $5.75 per share on the date of grant. The value of the restricted stock is being amortized as compensation expense over the vesting period. VeriChip recorded compensation expense of approximately $0.1 million and $0.2 million in the three and nine months ended September 30, 2007 associated with this restricted stock.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

In March 2005, Digital Angel granted its and our former chairman of the board, 0.1 million shares of its restricted stock. Fifty percent (50%) of the restricted stock vested on March 7, 2006 and 50% vested on March 7, 2007. Digital Angel determined the value of the stock to be approximately $0.5 million based on the closing price of Digital Angel’s stock on the date of grant. The value of the restricted stock was recorded as deferred compensation and was amortized as compensation expense over the two year vesting period. In the nine-months ended September 30, 2007 and 2006, $42,000 and approximately $0.2 million, respectively, of compensation expense was recorded in connection with the restricted stock.

In February 2005, Digital Angel granted an employee 54,230 shares of its restricted stock. The restricted stock vested 30% on February 25, 2006, 30% on February 25, 2007 and 40% will vest on February 25, 2008. Digital Angel determined the value of the stock to be $250,000 based on the closing price of its stock on the date of grant. The value of the restricted stock has been recorded as deferred compensation and is being amortized as compensation expense over the vesting period. In the nine-months ended September 30, 2007 and 2006, $69,000 and $56,000, respectively, of compensation expense was recorded in connection with the restricted stock.

Consulting Agreement With Former CEO of Digital Angel

In August 2007, VeriChip entered into a consulting agreement with an individual, who was the former Chief Executive Officer of Digital Angel. The consulting agreement provides for identifying, contacting and introducing strategic partners to VeriChip, identifying potential merger and/or acquisition opportunities for VeriChip to consider and participating on a committee established by VeriChip for the development of certain VeriChip products. The term of the agreement is for one year. Under this consulting agreement, VeriChip issued 0.1 million shares of its common stock in August 2007, which resulted in a non-cash equity compensation charge of approximately $0.7 million during the three-months ended September 30, 2007.

Warrants Settleable in Shares of Subsidiary Stock

Previously, we had issued warrants that were exercisable into 433,323 shares of our common stock or exchangeable into 769,648 shares of the Digital Angel common stock that we own or exercisable/exchangeable into a combination of shares from both companies at the holders’ option. Therefore, in accordance with EITF Issue 00-6 “Accounting for Freestanding Derivative Financial Instruments Indexed to, and Potentially Settled in, the Stock of a Consolidated Subsidiary,” the value of the warrants was required to be recorded as a liability and marked to market each reporting period. We determine the value of the liability each quarter using the Black Scholes valuation model. The liability was subject to a floor amount equal to the original value ascribed to the warrants. On June 30, 2007, the warrants expired. As a result, the value of the warrant liability of approximately $1.2 million was reclassified to additional paid-in-capital in the nine-months ended September 30, 2007.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

10. Agreement With Former Chief Executive Officer

On December 5, 2006, we finalized and entered into an agreement, or the December 5, 2006 Agreement, with Mr. Silverman, our former chairman of the board and CEO, which provided that we pay Mr. Silverman $3.3 million. The agreement was entered into to (i) induce Mr. Silverman to assume the chief executive position at VeriChip, (ii) to allow us the option (with any necessary approvals) to issue certain incentive payments in stock as opposed to cash, and (iii) to induce Mr. Silverman to terminate the Applied Digital Solutions, Inc. Employment and Non-Compete Agreement dated April 8, 2004, or the ADS/Silverman Employment Agreement, between us and Mr. Silverman. We determined that it was in our best interest to enter into the December 5, 2006 Agreement with Mr. Silverman in order to motivate him to accept the position as VeriChip’s chief executive officer, to maintain his status on our, Digital Angel’s, VeriChip’s and InfoTech’s boards and to motivate him to improve the value of VeriChip. In connection with the aforementioned agreement the Company record a charge of $3.3 million in the fourth quarter of 2006.

On March 14, 2007, we made a partial payment of our obligation to Mr. Silverman under the December 5, 2006 Agreement in the form of 503,768 shares of our common stock, which shares were issued under our 1999 Flexible Stock Plan and 2003 Flexible Stock Plan, and in cash. These shares were issued under a letter agreement between Mr. Silverman and us dated March 14, 2007. The letter agreement was intended to clarify, modify and partially satisfy certain terms of the December 5, 2006 Agreement, including our election to satisfy a portion of our obligation by issuing the 503,768 shares with a value as of March 14, 2007 of $735,501 and a cash payment of $264,499. These shares were issued to Mr. Silverman outright with no risk of forfeiture.

On June 16, 2007, our stockholders approved eliminating the remaining $2.3 million cash obligation by issuing Mr. Silverman an equal value of shares of common stock. The shares of common stock were issued to Mr. Silverman on July 5, 2007 without registration in reliance upon the exemption provided by Section 4(2) of the Securities Act of 1933, as amended, as a transaction not involving a public offering. The shares were registered on a registration statement which became effective on July 27, 2007. The shares are subject to substantial risk of forfeiture in the event that Mr. Silverman terminates his employment with VeriChip or VeriChip terminates his employment for cause on or before December 31, 2008.

11. Income Taxes

We have recorded certain state and foreign income taxes (benefits) during the three and nine-months ended September 30, 2007 and 2006. Differences in the effective income tax rates from the statutory federal income tax rate arise from state taxes (benefits) net of federal tax effects, and the increase or reduction of valuation allowances related to net operating loss carry forwards, non-deductible intangible amortization associated with acquisitions and other deferred tax assets. As of September 30, 2007, 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, 2007 and 2006.

FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN 48”) was issued to clarify the requirements of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes , relating to the recognition of income tax benefits.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

FIN 48 provides a two-step approach to recognizing and measuring tax benefits when the benefits’ realization is uncertain. The first step is to determine whether the benefit is to be recognized; the second step is to determine the amount to be recognized:

	•		Income tax benefits should be recognized when, based on the technical merits of a tax position, the entity believes that if a dispute arose with the taxing authority and were taken to a court of last resort, it is more likely than not (i.e., a probability of greater than 50 percent) that the tax position would be sustained as filed; and

	•		If a position is determined to be more likely than not of being sustained, the reporting enterprise should recognize the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the taxing authority.

Upon adoption of FIN 48 on January 1, 2007, the opening balances of other long-term liability for income taxes and accumulated deficit were adjusted for the cumulative effect of applying the provisions of FIN 48:


	Other Long-
	Term
	Liability for		Accumulated
	Income Taxes		Deficit
	(in thousands)
Balance at December 31, 2006	$	—	$	(468,596	)
Re-measurement of income tax liability upon adoption of FIN 48		89		(89	)

Balance at January 1, 2007	$	89	$	(468,685	)

The impact upon adoption was to increase accumulated deficit by approximately $89,000, which is the total amount of unrecognized other long-term liabilities. This amount includes $75,000 of income taxes and $14,000 of tax-related interest and penalties (these tax related interest and penalties represented the total amounts of accrued income tax-related interest and penalties in other long-term liabilities as of September 30, 2007). If we had recorded the $89,000 as income tax expense it would have impacted our effective tax rate.

During the three-months ended September 30, 2007, we recorded an additional FIN 48 long-term liability of $294,000 and an increase in our income tax expense. This liability for unrecognized tax benefits is related to certain current state income tax positions of our subsidiaries, taken in the third quarter of 2007.

Our total FIN 48 long-term liability is $383,000. The total amount of tax benefits, if recognized, which would impact our effective tax rate was $383,000.

We, in combination with our various consolidated subsidiaries, VeriChip, Digital Angel and InfoTech file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions in which we operate. In general, we, VeriChip, Digital Angel and InfoTech are no longer subject to U.S. federal, state or local income tax examinations for years before 2003. VeriChip is no longer subject to non-U.S. income tax examinations for years before 2001. We do not currently have any examinations ongoing.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

12. Discontinued Operations

During the three-months ended September 30, 2007, our board of directors approved the sale of InfoTech. InfoTech provides information technology products and services. In addition, on July 2, 2007, Digital Angel completed its previously announced sale of its wholly-owned subsidiary, OuterLink, to Newcomb. OuterLink provides satellite-based mobile asset tracking and data messaging systems used to manage the deployment of aircraft and land vehicles. Pursuant to the terms of the Stock Purchase Agreement, dated May 7, 2007, Digital Angel sold all of the issued and outstanding shares of stock of OuterLink for a purchase price of $1.0 million, subject to certain adjustments, based on OuterLink’s closing balance sheet. Consideration consisted of a cash payment of $0.8 million and a promissory note of $0.2 million, which matures on December 31, 2007. The Stock Purchase Agreement contains customary representations and warranties of the parties and indemnification provisions. In connection with the closing, Digital Angel also executed a one-year non-competition agreement with OuterLink. Paul F. Newcomb, President of Newcomb, was the founder and president of the predecessor company to OuterLink, which Digital Angel acquired in January 2004.

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

As a result of our board of directors’ decisions to sell InfoTech, Computer Equity, and Perimeter and Digital Angel’s board of directors’ decision to sell OuterLink, the financial condition, results of operations and cash flows of InfoTech, Computer Equity, Perimeter and OuterLink and have been reported as discontinued operations in our financial statements, and prior period information has been reclassified accordingly. In addition, on March 1, 2001, our board of directors approved a plan to offer for sale our Intellesale business segment and all of our other non-core businesses, and accordingly, certain liabilities of these businesses, which have all been sold or closed, are presented in discontinued operations for all periods presented.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

The following discloses the operating losses from discontinued operations for the three and nine-months ended September 30, 2007 and 2006:


	Three Months Ended						Nine Months Ended
InfoTech	September 30,						September 30,
(in thousands)	2007			2006			2007			2006
	(unaudited)						(unaudited)

Product revenue	$	1,438		$	2,960		$	6,551		$	9,735
Service revenue		297			274			1,043			1,059

Total net revenue		1,735			3,234			7,594			10,794

Cost of products sold		1,186			2,430			5,401			8,050
Cost of service sold		209			257			757			841


Gross profit		340			547			1,436			1,903

Selling, general and administrative expenses		538			925			1,974			2,866
Interest income		(142	)		(6	)		(5	)		(15	)
Interest expense		(47	)		(56	)		(168	)		(173	)

Loss from continuing operations minority interest and gain (loss) attributable to capital transactions of subsidiary		(387	)		(440	)		(711	)		(1,151	)
Minority interest		121			190			310			492
Net gain on capital transactions of subsidiary		(21	)		—			(21	)		5
Gain (loss) attributable to changes in minority interest as a result of capital transactions of subsidiary		134			—			134			(80	)

Loss from discontinued operations	$	(266	)	$	(250	)	$	(288	)	$	(734	)


	Three Months Ended						Nine Months Ended
OuterLink	September 30,						September 30,
(in thousands)	2007			2006			2007			2006
	(unaudited)						(unaudited)

Product revenue	$	—		$	266		$	457		$	753
Service revenue		—			525			960			1,069
Total net revenue					791			1,417			1,822

Cost of products sold		—			59			115			170
Cost of service sold		—			342			738			896

Gross profit		—			390			564			756

Selling, general and administrative expenses		—			313			730			916
Research and development expenses		—			332			667			1,152
Gain on sale of business		1,705			—			1,705			—
Interest income		—			—			—			1
Loss from continuing operations minority interest and gain (loss) attributable to capital transactions of subsidiary		1,705			(255	)		872			(1,311	)
Minority interest		(765	)		114			(391	)		588
Income (loss) from discontinued operations	$	940		$	(141	)	$	481		$	(723	)

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)


	Three Months Ended						Nine Months Ended
Computer Equity	September 30,						September 30,
(in thousands)	2007			2006			2007			2006
	(unaudited)						(unaudited)

Product revenue	$	2,348		$	2,020		$	5,463		$	7,450
Service revenue		1,353			1,465			4,188			4,432
Other revenue		—						1,550

Total net revenue		3,701			3,485			11,201			11,882

Cost of products sold		1,959			1,718			4,960			6,142
Cost of service sold		567			860			2,036			2,554


Gross profit		1,175			907			4,205			3,186

Selling, general and administrative expenses		1,091			948			3,036			2,740
Goodwill impairment		5,000			—			5,000			—
Interest and other income (expense).		(4	)		—			(11	)		—
Interest expense		(1	)		(25	)		(2	)		(66	)
Benefit (provision) for income taxes		116			2						(42	)

(Loss) income from discontinued operations	$	199		$	(64	)	$	(3,844	)	$	338

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)


	Three Months Ended					Nine Months Ended
Perimeter	September 30,					September 30,
(in thousands)	2007		2006			2007			2006
	(unaudited)					(unaudited)

Product revenue	$	584	$	90		$	891		$	476
Service revenue		608		509			1,830			1,596

Total net revenue		1,192		599			2,721			2,072

Cost of products sold		362		45			554			261
Cost of service sold		409		332			1,051			1,081


Gross profit		421		222			1,116			730

Selling, general and administrative expenses		289		319			801			1,022
Research and development expenses		99		73			284			267
Interest and other income		—		2			—			7
Provision for income taxes		—		—			(1	)		—

Income (loss) from discontinued operations	$	33	$	(168	)	$	30		$	(552	)


	Three Months Ended				Nine Months Ended
Intellesale and other Non-core businesses	September 30,				September 30,
(in thousands)	2007		2006		2007		2006
	(unaudited)				(unaudited)

Selling, general and administrative expenses	$	—	$	—	$	7	$	—
Interest and other income		243		—		243		—

Income from discontinued operations	$	243	$	—	$	236	$	—

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)


	Three Months Ended						Nine Months Ended
Total Discontinued Operations	September 30,						September 30,
(in thousands)	2007			2006			2007			2006
	(unaudited)						(unaudited)

Product revenue	$	4,370		$	5,336		$	13,362		$	18,414
Service revenue		2,258			2,773			8,021			8,156
Other revenue		—						1,550

Total net revenue		6,628			8,109			22,933			26,570

Cost of products sold		3,507			4,252			11,030			14,623
Cost of service sold		1,185			1,791			4,582			5,372


Gross profit		1,936			2,066			7,321			6,575

Selling, general and administrative expense		1,918			2,505			6,548			7,554
Goodwill impairment		5,000			—			5,000			—
Research and development		99			405			951			1,419
Interest and other income		97			(4	)		227			(7	)
Interest expense		(48	)		(81	)		(170	)		(239	)
Gain on sale of business		1,705			—			1,705			—
Benefit (provision) for income taxes		116			2			(1	)		(42	)

Loss from continuing operations minority interest and gain (loss) attributable to capital transactions of subsidiary		(3,211	)		(927	)		(3,417	)		(2,676	)
Minority interest		(644	)		304			(81	)		1,080
Net (loss) gain on capital transaction of subsidiary		(21	)		—			(21	)		5
Gain (loss) attributable to changes in minority interest as a result of capital transactions of subsidiary		134			—			134			(80	)

Loss from discontinued operations	$	(3,742	)	$	(623	)	$	(3,385	)	$	(1,671	)

Loss from discontinued operations per common share–basic and diluted	$	(0.05	)	$	(0.01	)	$	(0.05	)	$	(0.03	)

Weighted average number of common shares outstanding -basic and diluted (see Note 4)		70,017			67,726			68,251			67,375

The results above do not include any intercompany interest income/expense or allocated or common overhead expenses. We realized a gain on the sale of OuterLink of approximately $1.7 million during the three and nine-months ended September 30, 2007. The gain on the sale of OuterLink did not result in a provision for income taxes due to federal and state net operating losses and carry forwards. As a result of our decision to sell Computer Equity and our current estimate of its fair market value, we recorded a goodwill impairment charge of approximately $5.0 million during the three-months ended September 30, 2007.

In accordance with FAS 144, any additional operating losses for InfoTech, Computer Equity, Perimeter or OuterLink or changes in the values of their assets or liabilities, as well as any gain or loss on the sale of InfoTech will be reflected in our financial condition and results of discontinued operations as incurred.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

The net assets/liabilities of discontinued operations as of September 30, 2007 and December 31, 2006, were comprised of the following:


	September 30,		December 31,
InfoTech	2007		2006
(in thousands)	(unaudited)

Current assets
Cash	$	405	$	132
Accounts receivable		1,477		3,491
Inventory		106		165
Other current assets		60		91

Total current assets		2,048		3,879

Property and equipment, net		90		106
Other assets, net		30		35

Total non-current assets		120		141

Total assets	$	2,168	$	4,020


Current liabilities
Accounts payable		552		973
Accrued expenses and other current liabilities		455		1,521
Deferred revenue		114		168

Total current liabilities		1,121		2,662

Total liabilities	$	1,121	$	2,662

Minority interest		667		1,090


Net assets from discontinued operations	$	380	$	268


	September 30,		December 31,
OuterLink	2007		2006
(in thousands)			(unaudited)

Current assets
Cash	$	—	$	1
Accounts receivable		—		956
Inventory		—		503
Other current assets		—		874

Total current assets		—		2,334

Property and equipment, net		—		274
Other assets, net		—		257
Total non-current assets		—		531

Total assets	$	—	$	2,865


Current liabilities
Accounts payable		—		408
Accrued expenses and other current liabilities		—		270
Deferred revenue		—		1,770

Total current liabilities		—		2,448

Other long-term liabilities		—		1,059

Total liabilities	$	—	$	3,508


Net liabilities from discontinued operations	$	—	$	(642	)

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)


	September 30,		December 31,
Computer Equity	2007		2006
(in thousands)	(unaudited)

Current assets
Cash	$	77	$	202
Accounts receivable		1,869		1,921
Inventory		938		687
Other current assets		43		3

Total current assets		2,927		2,813

Property and equipment, net		155		192
Goodwill		4,538		9,549
Other assets, net		4		4

Total non-current assets		4,697		9,745

Total assets	$	7,624	$	12,558


Current liabilities
Accounts payable		4,230		4,438
Accrued expenses and other current liabilities		1,403		937

Total current liabilities		5,633		5,375

Other long-term liabilities		1		9

Total liabilities	$	5,634	$	5,384


Net assets from discontinued operations	$	1,990	$	7,174


	September 30,		December 31,
Perimeter	2007		2006
(in thousands)	(unaudited)

Current assets
Cash	$	1	$	1
Accounts receivable		892		467
Inventory		51		18
Other current assets		353		302

Total current assets		1,297		788

Property and equipment, net		25		27
Goodwill		530		530
Other assets, net		70		102

Total non-current assets		625		659

Total assets	$	1,922	$	1,447


Current liabilities
Accounts payable		281		112
Accrued expenses and other current liabilities		357		160
Deferred revenue		887		780

Total current liabilities		1,525		1,052

Other long-term liabilities		95		97

Total liabilities	$	1,620	$	1,149


Net assets from discontinued operations	$	302	$	298

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)


	September 30,			December 31,
Intellesale and Other Non-Core Businesses	2007			2006
(in thousands)	(unaudited)

Current liabilities
Accounts payable		3,887			4,122
Accrued expenses and other current liabilities		1,271			1,285

Total current liabilities		5,158			5,407

Total liabilities	$	5,158		$	5,407


Net liabilities from discontinued operations	$	(5,158	)	$	(5,407	)


	September 30,			December 31,
Total Discontinued Operations	2007			2006
(in thousands)	(unaudited)

Current assets
Cash	$	483		$	336
Accounts receivable		4,238			6,835
Inventory		1,095			1,373
Other current assets		456			1,270

Total current assets		6,272			9,814

Property and equipment, net		270			599
Goodwill		6,568			10,079
Other assets, net		104			398

Total non-current assets		5,442			11,076

Total assets	$	11,714		$	20,890


Current liabilities
Accounts payable		8,950			10,053
Accrued expenses and other current liabilities		3,486			4,173
Deferred revenue		1,001			2,718

Total current liabilities		13,437			16,944
Other long-term liabilities		96			1,165

Total liabilities	$	13,533		$	18,109

Minority Interest		667			1,090


Net (liabilities) assets from discontinued operations	$	(2,486	)	$	1,691

During the three and nine-months ended September 30, 2007, we extinguished approximately $0.2 million associated with our Intellesale and other non-core businesses. During the remainder of 2007, the statute of limitations of certain liabilities totaling approximately $5.2 million is scheduled to expire. These liabilities have not been guaranteed by us and we do not intend to repay these liabilities. The reversal of these liabilities will have a favorable impact on our financial condition and results of operation during the fourth quarter of 2007.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

13.

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,
	(In thousands)						(In thousands)
	2007			2006			2007			2006
Net loss	$	(11,299	)	$	(3,599	)	$	(19,170	)	$	(9,807	)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments		224			163			334			339

Total comprehensive loss	$	(11,075	)	$	(3,436	)	$	(18,836	)	$	(9,468	)

14.

Related Party Transactions

The following related party transactions are eliminated in consolidation of ours and our subsidiaries results of operations to the extent of our ownership interest.

Intercompany Term Note

On August 31, 2007, we entered into the IC Note with Digital Angel, as is more fully discussed in Note 5.

Agreement between VeriChip and Digital Angel

VeriChip and Digital Angel executed a supply and development agreement dated March 4, 2002, as amended and restated on December 27, 2005 and as amended on May 9, 2007, or the supply and development agreement. Under this agreement, Digital Angel is VeriChip’s sole supplier of human-implantable microchips.

VeriChip’s purchases of product under the supply and development agreement were approximately $0.0 million and $0.2 million in the nine-months ended September, 2007 and 2006, respectively. Under the terms of the May 9, 2007 amendment, the term of the agreement was extended from March 2013 to March 2014. Also, under the May 9, 2007 amendment, the annual minimum purchase requirements were each extended one year and, accordingly, there is no minimum purchase requirement in 2007. The approximately $0.9 million originally required to be purchased in 2007 is now required to be purchased in 2008. As of September 30, 2007, VeriChip has satisfied approximately $0.4 million of the minimum purchase requirements for 2008. As long as VeriChip meets the minimum purchase requirements, the agreement will automatically renew annually under its terms until the expiration of the last of the patents covering any of the supplied products. The supply and development agreement may be terminated prior to its stated term under specified events, including as a result of a bankruptcy event of either party or an uncured default. In addition, Digital Angel may sell the microchips to third parties if VeriChip does not take delivery and pay for a minimum number of microchips as specified in the supply and development agreement. Further, the supply and development agreement provides that Digital Angel shall, at VeriChip’s option, furnish and operate a computer database to provide data collection, storage and related services for VeriChip’s customers for a fee as provided. VeriChip does not currently utilize this service.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

The terms of the original supply and development agreement and each amendment to the agreement were negotiated by the executive officers of the respective companies and approved by the independent members of each company’s board of directors.

Digital Angel relies solely on a production agreement with RME, a subsidiary of Raytheon Company, for the manufacture of its human-implantable microchip products. The RME utilizes Digital Angel’s equipment in the production of the microchips. On April 28, 2006, Digital Angel entered into a new production agreement with RME related to the manufacture and distribution of glass-encapsulated syringe-implantable transponders, including the human-implantable microchip products sold by us expiring on June 30, 2010. The technology underlying these systems is covered, in part, by U. S. Patent No. 5,211,129, “Syringe-Implantable Identification Transponders,” which we refer to as the ‘129 patent. In 1994, Destron/IDI, Inc., a predecessor company to Digital Angel, granted a co-exclusive license under this patent, other than for certain specified fields of use related to our Animal Applications segment, which were retained by the predecessor company, to Hughes Aircraft Company, or Hughes, and its then wholly owned subsidiary, Hughes Identification Devices, Inc., or HID. The specified fields of use retained by the predecessor company do not include human identification or security applications. The rights licensed to Hughes and HID were freely assignable, and we do not know which party or parties currently have these rights or whether these rights have been assigned, conveyed or transferred to any third party.

VeriChip does not anticipate generating more than nominal revenue from the sale of its human implantable microchips prior to the expiration of the patent in April 2008. Hughes, HID, any of their respective successors in interest, or any party to whom one of the foregoing parties may have assigned its rights under the 1994 license agreement may commence a claim against VeriChip asserting that VeriChip is violating its rights. If such a claim is successful, sales of VeriChip’s human implantable systems could be enjoined, and VeriChip could be required to cease its efforts to create a market for these systems, until the patent expires in April 2008. In addition, VeriChip could be required to pay damages, which may be substantial. Regardless of whether any claimant is successful, VeriChip would face the prospect of the expenditure of funds in litigation, the diversion of management time and resources, damage to its reputation and the potential impairment in the marketability of its systems even after the expiration of the patent, which could harm our business and negatively affect our prospects.

Digital Angel and the successor to HID have executed a cross-license that includes Digital Angel obtaining a royalty free non-exclusive license to HID’s rights to the implantable human applications of the ‘129 patent, to which it purports certain ownership rights. Digital Angel has, in turn, sublicensed those rights to VeriChip.

Transition Services Agreement Between Us and VeriChip

During the four years ended December 31, 2005, we provided certain general and administrative services to VeriChip including, accounting, finance, payroll and legal services, telephone, rent and other miscellaneous items. The costs of these services, which are eliminated in consolidation, were determined based on VeriChip’s use of such services.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

On December 27, 2005, we entered into a transition services agreement with VeriChip under which we agreed to continue to provide VeriChip with certain administrative transition services, including payroll, legal, finance, accounting, information technology, tax services, and services related to VeriChip’s initial public offering. As compensation for these services, VeriChip agreed to pay us approximately $62,000 per month for fixed costs allocable to these services, among other reimbursable expenses. On December 21, 2006, we and VeriChip entered into an amended and restated transition services agreement, which became effective on February 14, 2007, the date of completion of VeriChip’s initial public offering. There is no stated expiration date to the transition services agreement. The term of the amended and restated agreement will continue until such time as VeriChip requests that we cease performing the transition services, provided that we are not obligated to continue to provide the transition services for more than twenty-four months following the effective date. Except for any request by VeriChip that we cease to perform transition services, subject to certain notice provisions, the agreement may not be terminated by either party except in the event of a material default in our delivery of the transition services or in VeriChip’s payment for those services. The services to be provided by us under the amended and restated transition services agreement are the same as those provided under the initial agreement. In connection with the December 21, 2006 amendment, the estimated monthly charge for the fixed costs allocable to these services was increased to approximately $72,000 per month, primarily as the result of an increased allocation for office space. Effective April 1, 2007, the estimated monthly charge for the fixed costs allocable to these services was reduced to $40,000 per month, primarily as a result of a reduction in allocable accounting fees and accounting and legal services.

The terms of the transition services agreement and the amendment and restatement of the agreement were negotiated between certain of VeriChip’s executive officers and certain executive officers of ours. These executive officers were independent of one another and the terms of the agreement were based upon historical amounts incurred by us for payment of such services to third parties. However, these costs may not necessarily be indicative of the costs which would be incurred by VeriChip as an independent stand alone entity.

The costs of these services to VeriChip were $0.1 million and $0.4 million for the three and nine-months ended September 30, 2007, respectively, and $0.2 million and $0.5 million for the three and nine-months ended September 30, 2006, respectively.

Loan Agreement with VeriChip

On October 6, 2006, we and VeriChip entered into an amendment to the loan agreement which increased the principal amount available thereunder to $13.0 million and changed the interest rate to a fixed rate of 12% per annum. Previously, VeriChip’s indebtedness to us bore interest at the prevailing prime rate of interest as published from time to time by The Wall Street Journal . The amendment further provided that the loan matured in July 2008 but could be extended at our option through December 27, 2010.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

On January 19, 2007, February 8, 2007 and again on February 13, 2007, we and VeriChip entered into further amendments to the loan documents, which increased the maximum principal amount of indebtedness that VeriChip could incur to $14.5 million. A portion of this increase was used to cover approximately $0.7 million of intercompany advances made to VeriChip by us during the first week of January 2007. Upon the consummation of VeriChip’s initial public offering on February 14, 2007, the loan ceased to be a revolving line of credit, and VeriChip has no ability to incur additional indebtedness to us under the loan documents. The interest continues to accrue on the outstanding indebtedness at a rate of 12% per annum. Under the terms of the loan agreement as amended on February 8, 2007, VeriChip was required to repay us $3.5 million of principal and accrued interest upon the consummation of its offering. VeriChip paid the $3.5 million on February 14, 2007, resulting in a balance due of approximately $11.6 million on February 14, 2007. VeriChip is not obligated to repay an additional amount of its indebtedness until January 1, 2008. Effective with the payment of the $3.5 million, all interest which has accrued on the loan as of the last day of each month, commencing with the month in which such payment is made, shall be added to the principal amount. Commencing January 1, 2008 through January 1, 2010, VeriChip is obligated to repay $0.3 million on the first day of each month. A final balloon payment equal to the outstanding principal amount then due under the loan plus all accrued and unpaid interest will be due and payable on February 1, 2010. As of September 30, 2007, approximately $12.5 million was outstanding under the loan.

The loan is collateralized by interests in all property and assets of VeriChip, including the stock of VeriChip’s subsidiaries, but is not secured by any of the property or assets of VeriChip’s subsidiaries.

Satisfaction of Loan Agreement

On May 15, 2007, we and InfoTech entered into a Satisfaction of Loan Agreement, or SLA. On or about June 27, 2003, InfoTech, our majority-owned subsidiary, made a loan to us in the original principal amount of $1.0 million. The loan was scheduled to mature on June 30, 2007. In full satisfaction of our obligations under the loan and the related documents, we and InfoTech entered into the SLA where we agreed to issue and deliver to InfoTech 833,333 shares of our common stock. We were obligated to continue to pay InfoTech interest in cash on the sum of $1.0 million at the existing rate per annum under the note, which was 16%, until the date the shares are registered. The shares were registered on June 11, 2007. Since the value of the 833,333 shares issued to InfoTech exceeded $1.0 million on the effective date of the registration statement, InfoTech was required to promptly return to us the number of shares valued in excess of the $1.0 million as of that date, or approximately 129,603 shares. As of September 30, 2007, InfoTech has sold 249,266 of these shares for net proceeds of $330,840 and it has recorded a loss on the sale of the shares of approximately $23,000. In addition, during the nine-months ended September 30, 2007, InfoTech was required to record an unrealized loss of approximately $0.2 million representing the reduction in the fair market value of the shares on the date of the effectiveness of the registration statement, which value was $1.41 per share, and the value of the 454,464 unsold shares as of September 30, 2007, of $0.92 per share. Because such realized and unrealized losses resulted from transactions in our own common stock, they were eliminated upon the consolidation of InfoTech and our operating results, and accordingly, they are not reflected in the unaudited condensed consolidated financial statements. The value of our common stock held by InfoTech as of September 30, 2007, was approximately $0.6 million and these shares are reflected in the unaudited condensed consolidated balance sheet as treasury stock.

The following related party transactions are not eliminated in the consolidation of ours and our subsidiaries results of operations:

During 2006, VeriChip incurred legal fees of $0.8 million to VeriChip’s legal counsel, Akin Gump Strauss Hauer & Feld LLP, or Akin Gump. Tommy G. Thompson, a partner with Akin Gump, had been a member of VeriChip’s board of directors since July 2005, and, as a result of his directorship services, as of September 30, 2007, holds fully vested options to purchase 55,556 shares of our common stock. Effective March 8, 2007, Mr. Thompson resigned his directorship position with VeriChip.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Digital Angel’s subsidiary, DSD, leases a 13,600 square foot building located in Hvidovre, Denmark. The building is occupied by DSD’s administrative and production operations. The lease agreement has no expiration but includes a three month termination notice that can be utilized by the owner or DSD. DSD leases the building from LANO Holding ApS. LANO Holding Aps is 100% owned by Lasse Nordfjeld, president of Digital Angel’s animal applications group.

15.

Legal Proceedings

Vasa Suit

On or about January 21, 2004, Hark M. Vasa and his family partnerships, the majority shareholder of PDSC’s predecessor at the time we acquired that company, filed a complaint against us and PDSC, in the Circuit Court of the 15th Judicial District in Palm Beach County, Florida for breach of contract and the implied covenant of good faith and fair dealing. Plaintiffs sought damages arising from the purported delay in the registration of the shares they received in connection with our acquisition of PDSC’s predecessor. Trial in this case was set to commence on October 15, 2007. On September 28, 2007, the parties entered into a memorandum of settlement, and on November 8, 2007 the parties entered into a Settlement Agreement and General Release. Under the parties’ agreement, we agreed to issue shares of our common stock to Mr. Vasa valued at $2.1 million, with issuances spread over five payments ($500,000 this year, $500,000 in 2008, $400,000 in 2009, $400,000 in 2010 and $300,000 in 2011), with the shares actually issued based on the value at the time of each issuance. We will file one or more registration statements registering the resale of such shares within 180 days of each issuance. If the value of the shares received by Mr. Vasa exceeds the values set forth above on the applicable date of registration, Mr. Vasa must return to us those shares representing the excess value. If the number of shares issued on any specific issuance date does not have the values set forth above on the date the shares are required to be registered, we will be required to issue additional shares to Mr. Vasa to cover the difference or pay the difference in cash. We also agreed to fund a project with Mr. Vasa for potential business development. We will provide $250,000 per year for three years beginning in 2007. We will also provide an amount not to exceed $50,000 per year for three years to cover certain associated expenses. We accrued and charged to expense approximately $2.5 million during the three-months ended September 30, 2007, which represented the aggregate present value of these payments.

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

Verizon Suit

On August 14, 2006, our subsidiary Government Telecommunication, Inc., or GTI, filed an action against Verizon Federal, Inc. in Fairfax County Circuit Court in Virginia asserting damages arising from Verizon’s wrongful usurpation of GTI’s business opportunity with the District of Columbia Public Schools for the supply and installation of internal connection wiring and cabling equipment and related goods and services. The complaint pleads two counts: Count I — Breach of Contract, for which it is seeking lost profits of approximately $1.9 million, and Count II — Tortious Interference with Contractual Relations, for which it is seeking restitution damages of $7.0 million. On October 27, 2006, Verizon filed a motion to dismiss GTI’s complaint. Following oral arguments on the matter, on December 1, 2006, the court denied the motion. Also in December 2006, Verizon filed a counterclaim against GTI seeking $4.1 million in monies that Verizon claims are owed it by GTI on related work. Trial is set for December 3, 2007. GTI intends to vigorously pursue its case against Verizon and to vigorously defend the counterclaim action. Given the uncertainties associated with all litigation and we are unable to offer any assessment of the outcome of the complaint and Verizon’s counterclaim.

Digital Angel Corporation vs. Datamars, Inc., Datamars, S.A., The Crystal Import Corporation and Medical Management International, Inc.

On October 20, 2004, Digital Angel commenced an action in the United States District Court for the District of Minnesota against Datamars, Inc., Datamars, S.A., The Crystal Import Corporation, and Medical Management International, Inc. (“Banfield”). This suit claims that the defendants are marketing and selling syringe implantable identification transponders manufactured by Datamars that infringe Digital Angel’s 1993 patent for syringe implantable identification transponders previously found by the United States District Court for the District of Colorado to be enforceable. Certain of the locations in which the infringing transponders are or have been sold, include, but are not limited to, “Banfield, The Pet Hospital” of which certain locations are associated with PetSmart stores. The suit seeks, among other things, an adjudication of infringement, injunctive relief, and actual and, punitive damages. Digital Angel believes that the suit is well-grounded in law and fact. On February 28, 2006, the Court conducted a hearing (the “Markman Hearing”) in which each of the parties presented the Court with their views regarding the scope of the claims set forth in the subject patent. On May 22, 2006, the Court issued its order on the Markman Hearing, largely adopting Digital Angel’s views on the scope of the claims in the subject patent.

Crystal Import Corporation v. Digital Angel, et al.

On or about December 29, 2004, The Crystal Import Corporation filed an action against AVID Identification Systems, Inc. and Digital Angel in the United States District Court for the Northern District of Alabama. Crystal’s complaint primarily asserted federal and state antitrust and related claims against AVID, though it also asserted similar claims against Digital Angel. On October 12, 2005, the Alabama Court transferred the action to Minnesota. Following the docketing of the action in Minnesota, Digital Angel and AVID filed a motion seeking to stay the case until the corresponding patent infringement actions have been resolved.

Datamars and Crystal Import Settlements

On July 27, 2007, pursuant to the Court’s settlement conference procedures, the parties in the above described legal proceedings reached agreement on the terms of a global settlement, which settlement would, among other things, result in a dismissal of all claims with prejudice. On August 27, 2007 Digital Angel finalized a global settlement of this matter. Under the terms of the settlement agreement, Datamars made a lump sum payment to Digital Angel, the parties granted mutual releases, Digital Angel dismissed the infringement claims against Datamars, and Digital Angel was dismissed from the antitrust litigation. Digital Angel also granted a non-exclusive license to Datamars for syringe-implantable identification transponders that could reasonably be alleged to be covered by the patent at issue in the litigation. The financial terms of the settlement have not been disclosed.

Interest and other income (expense) for the three and nine-month periods ended September 30, 2007 includes the following amounts relating to settlement of patent and other litigation:


	Three Months Ended		Nine Months Ended
	September 30, 2007		September 30, 2007
Payments and other charges	$	(2.5) million	$	(2.5) million
Receipts and other credits	$	0.8 million	$	1.8 million

APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
(continued)

16.

Supplemental Cash Flow Information

In the nine-months ended September 30, 2007 and 2006, we had the following non-cash investing and financing activities (in thousands):


	Nine-Months		Nine-Months
	Ended		Ended
	September 30,		September 30,
	2007		2006

Issuance of shares for purchase of minority interest	$	—	$	907
Financing of equipment through capital lease		684		440
Deferred offering costs		—		1,278
Reclass of deferred financing costs to acquisition cost		494		—
Issuance of shares for legal settlement		800		—
Issuance of shares for payment of note with InfoTech		1,000		—
Issuance of shares for services		3,034		—
Issuance of shares under a share exchange agreement		—		973
Issuance of shares to former shareholders of DSD Holding		—		1,000
Issuance of Digital Angel warrants as a debt discount		1,044		—
Issuance of Digital Angel warrants to Investors		1,253		—
Issuance of VeriChip common stock and re-pricing of warrants as deferred financing costs		1,328		—

Cash paid for:
Interest		2,383		340
Taxes		617		290

17.

Subsequent Events

On October 31, 2007, we entered into the Amendment Agreement among us, the Lenders and VeriChip as discussed in Note 5.

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 2006 Annual Report on Form 10-K.

Overview

We currently engage in the following principal business activities:

	•		developing, marketing and selling RFID systems used to identify, locate and protect people and their assets for use in a variety of healthcare, security and identification applications;

	•		developing, manufacturing and marketing visual and electronic identification tags and implantable RFID microchips, primarily for identification, tracking and location of pets, livestock and other animals, and, more recently, for animal bio-sensing applications, such as temperature reading for companion pet and livestock (e.g., cattle) applications;

	•		designing, manufacturing and marketing GPS enabled products used for location tracking and message monitoring of maritime vehicles, aircraft and people in remote locations;

	•		developing and marketing service relationship management software and services; and

	•		selling vibration monitoring systems.

Recent and Other Events

During the three-months ended September 30, 2007, we entered into a merger agreement with Digital Angel, we appointed Daniel Penni as our chairman of the board of directors following the resignation of Scott Silverman, we appointed Michael Krawitz to our board of directors, Digital Angel appointed Barry Edelstein as interim president and CEO of Digital Angel to replace Kevin McGrath, we and Digital Angel entered into financing arrangements with Kallina, we settled a lawsuit with Mr. Hark Vasa and made a decision to sell our wholly-owned subsidiaries, Computer Equity and Perimeter. In addition on October 31, 2007, we entered into an amendment to certain loan agreements. Each of these events is more fully described in the Notes 1, 5, 12 and 17 to our unaudited condensed consolidated financial statements.

Recent Financial Results

During the three-months ended September 30, 2007 and 2006, we reported a loss from continuing operations of approximately $7.6 and $3.0 million, respectively, and during the nine-months ended September 30, 2007, we reported a loss from continuing operations of approximately $15.8 million as compared to a loss from continuing operations of approximately $8.1 million for the nine-months ended September 30, 2006. Our operating activities used cash of $11.4 million and $4.6 million during the nine-months ended September 30, 2007 and 2006, respectively. Historically, we have suffered losses and have not generated positive cash flows from operations. As of September 30, 2007, we had an accumulated deficit of approximately $487.9 million. (Loss) income by operating segment for the three and nine-months ended September 30, 2007 and 2006 is presented below under the heading “Results of Continuing Operations.”

We operate in five business segments: Healthcare, Security and Industrial, Animal Applications, GPS and Radio Communications, and Advanced Technology. VeriChip’s operations comprise our Healthcare and Security and Industrial segments, and Digital Angel’s operations comprise our Animal Applications and GPS and Radio Communications segments.

Revenues from each of our segments for the three-months ended September 30, 2007 and 2006 were as follows:


	Three-Months Ended
	September 30,
	2007		2006
Revenue:	(in thousands)

Healthcare	$	5,926	$	5,095
Security and Industrial		1,990		1,723
Animal Applications		10,346		8,254
GPS and Radio Communications		9,989		4,146
Advanced Technology		1,920		1,726
“Corporate/Eliminations”		—		(21	)

Total	$	30,171	$	20,923

Revenues from each of our segments for the nine-months ended September 30, 2007 and 2006 were as follows:


	Nine-Months Ended
	September 30,
	2007		2006
Revenue:	(in thousands)

Healthcare	$	17,100	$	15,056
Security and Industrial		6,379		5,288
Animal Applications		31,635		28,131
GPS and Radio Communications		23,531		12,016
Advanced Technology		5,492		4,444
“Corporate/Eliminations”		—		(194	)

Total	$	84,137	$	64,741

Our sources of revenue consist of sales of products and services from our five operating segments. Our significant sources of revenue for the three-months ended September 30, 2007 and 2006 were as follows:


	Percentage of Total Revenue
	Three-Months			Three-Months
	Ended			Ended
Sources of Revenue:	September 30,			September 30,
	2007			2006
RFID-enabled products for use in a variety of healthcare applications from our Healthcare segment		19.6	%		24.4	%

RFID-enabled security systems, asset tracking systems, and vibration monitors for use in a variety of security and industrial applications from our Security and Industrial segment		6.6	%		8.2	%

Visual identification tags and implantable microchips for the companion animal, livestock, laboratory animal, fish and wildlife markets from our Animal Applications segment		34.3	%		39.3	%

GPS enabled tracking and message monitoring, search and rescue equipment, intelligent communications products and services for telemetry, mobile data and radio communications from our GPS and Radio Communications segment		33.1	%		19.8	%

Service relationship management software and services from our Advanced Technology segment		6.4	%		8.3	%

Total		100.0	%		100.0	%

Our significant sources of revenue for the nine-months ended September 30, 2007 and 2006 were as follows:


	Percentage of Total Revenue
	Nine-Months			Nine-Months
Sources of Revenue:	Ended			Ended
	September 30, 2007			September 30, 2006
RFID-enabled products for use in a variety of healthcare applications from our Healthcare segment		20.3	%		23.3	%

RFID-enabled security systems, asset tracking systems, and vibration monitors for use in a variety of security and industrial applications from our Security and Industrial segment		7.6	%		8.2	%

Visual identification tags and implantable microchips for the companion animal, livestock, laboratory animal, fish and wildlife markets from our Animal Applications segment		37.6	%		43.2	%

GPS enabled tracking and message monitoring, search and rescue equipment, intelligent communications products and services for telemetry, mobile data and radio communications from our GPS and Radio Communications segment		28.0	%		18.6	%

Service relationship management software and services from our Advanced Technology segment		6.5	%		6.7	%

Total		100.0	%		100.0	%

Our significant sources of gross profit and gross profit margin by product type for the three-months ended September 30, 2007 and 2006 were as follows:


	Three-Months Ended					Three-Months Ended
	September 30, 2007					September 30, 2006
			Percentage of					Percentage of
Gross Profit and Gross Profit Margin by Product Type	Gross Profit		Total Gross			Gross Profit		Total Gross
For:	(in thousands)		Margin			(in thousands)		Margin

RFID-enabled products for use in a variety of healthcare applications from our Healthcare segment	$	3,397		24.2	%	$	2,753		26.7	%

RFID-enabled security systems, asset tracking systems, and vibration monitors for use in a variety of security and industrial applications from our Security and Industrial segment		1,139		8.1	%		1,015		9.9	%

Visual identification tags and implantable microchips for the companion animal, livestock, laboratory animal, fish and wildlife markets from our Animal Applications segment		3,216		22.9	%		3,092		30.0	%

GPS enabled tracking and message monitoring, search and rescue equipment, intelligent communications products and services for telemetry, mobile data and radio communications from our GPS and Radio Communications segment		5,024		35.8	%		2,148		20.9	%

Service relationship management software and services from our Advanced Technology segment		1,258		9.0	%		1,292		12.5	%

Total	$	14,034		100.0	%	$	10,300		100.0	%

Our significant sources of gross profit and gross profit margin by product type for the nine-months ended September 30, 2007 and 2006 were as follows:


	Nine-Months Ended					Nine-Months Ended
	September 30, 2007					September 30, 2006
			Percentage of					Percentage of
Gross Profit and Gross Profit Margin by	Gross Profit		Total Gross			Gross Profit		Total Gross
Product Type For:	(in thousands)		Margin			(in thousands)		Margin

RFID-enabled products for use in a variety of healthcare applications from our Healthcare segment	$	9,164		24.1	%	$	8,657		27.3	%

RFID-enabled security systems, asset tracking systems, and vibration monitors for use in a variety of security and industrial applications from our Security and Industrial segment		3,465		9.1	%		3,193		10.1	%

Visual identification tags and implantable microchips for the companion animal, livestock, laboratory animal, fish and wildlife markets from our Animal Applications segment		10,003		26.3	%		10,444		32.9	%

GPS enabled tracking and message monitoring, search and rescue equipment, intelligent communications products and services for telemetry, mobile data and radio communications from our GPS and Radio Communications segment		11,558		30.4	%		6,163		19.4	%

Service relationship management software and services from our Advanced Technology segment		3,793		10.1	%		3,283		10.3	%

Total	$	37,983		100.0	%	$	31,740		100.0	%

RESULTS OF CONTINUING OPERATIONS

The following table summarizes our results of operations as a percentage of net operating revenue for the three and nine-month periods ended September 30, 2007 and 2006, and is derived from the unaudited condensed consolidated statements of operations in Part I, Item 1 of this report.


	Relationship to						Relationship to
	Revenue						Revenue
	Three-Months Ended						Nine-Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
	%			%			%			%
Product revenue		93.5			93.3			92.8			91.5
Service revenue		6.5			6.7			7.2			8.5

Total revenue		100.0			100.0			100.0			100.0
Cost of products sold		50.3			47.7			51.8			48.2
Cost of services sold		3.2			3.1			3.1			2.8

Total cost of products and services sold		53.5			50.8			54.9			51.0

Gross profit		46.5			49.2			45.1			49.0


Operating costs and expenses:
Selling, general and administrative expense		56.7			55.8			55.4			54.2
Gain on sale of assets		(2.3	)		—			(0.8	)		—
Research and development		6.5			7.9			8.5			7.7

Total operating costs and expenses		60.9			63.7			63.1			61.9


Operating loss before other items		(14.4	)		(14.5	)		(18.0	)		(12.9	)

Interest and other (expense) income		(3.2	)		1.1			1.2			1.1
Interest expense		(8.9	)		(5.7	)		(5.8	)		(3.7	)

Total other expense		(12.1	)		(4.6	)		(4.6	)		(2.6	)

Loss from continuing operations before taxes, minority interest and losses attributable to capital transactions of subsidiaries		(26.5	)		(19.1	)		(22.6	)		(15.5	)
(Provision) benefit for income taxes		(0.5	)		1.6			(0.6	)		0.6

Loss from continuing operations before minority interest and (loss) gain attributable to capital transactions of subsidiaries		(27.0	)		(17.5	)		(23.2	)		(14.9	)
Minority interest		8.5			2.5			8.1			1.9
Net (loss) gain on capital transactions of subsidiaries		(3.7	)		—			4.3			0.5
(Loss) gain attributable to changes in minority interest as a result of capital transactions of subsidiaries		(2.8	)		0.8			(8.0	)		—

Loss from continuing operations		(25.0	)		(14.2	)		(18.8	)		(12.5	)
Loss from discontinued operations		(12.4	)		(3.0	)		(4.0	)		(2.6	)

Net loss		(37.4	)		(17.2	)		(22.8	)		(15.1	)

Results of Operations from Continuing Operations

(Loss) income from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries from each of our segments for the three and nine-months ended September 30, 2007 and 2006 was as follows (we evaluate performance based on stand-alone segment income as presented below):


	Three-Months Ended
	September 30,
	2007			2006
(Loss) income from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries by segment:	(in thousands)

Healthcare	$	(1,999	)	$	(1,369	)
Security and Industrial		(1,123	)		(330	)
Animal Applications		(4,019	)		(944	)
GPS and Radio Communications		1,163			(231	)
Advanced Technology		1,103			937
“Corporate/Eliminations” ⁽¹⁾		(3,133	)		(2,058	)

Total	$	(8,008	)	$	(3,995	)


	Nine-Months Ended
	September 30,
	2007			2006
(Loss) income from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries by segment:	(in thousands)

Healthcare	$	(6,331	)	$	(3,255	)
Security and Industrial		(2,638	)		(737	)
Animal Applications		(8,449	)		(2,419	)
GPS and Radio Communications		240			(424	)
Advanced Technology		3,947			2,299
“Corporate/Eliminations” ⁽¹⁾		(5,758	)		(5,525	)

Total	$	(18,989	)	$	(10,061	)


⁽¹⁾		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 certain interest income/expense, general administrative expense and other income/expenses associated with corporate activities and functions.

Healthcare Segment

Three-Months Ended September 30, 2007 Compared to the Three-Months Ended September 30, 2006


	Three-Months						Three-Months
	Ended						Ended
	September 30,			% Of			September 30,			% Of			Change
	2007			Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	5,768			97.3	%	$	4,948			97.1	%	$	820			16.6	%
Service		158			2.7			147			2.9			11			7.5

Total revenue		5,926			100.0			5,095			100.0			831			16.3

Gross Profit:
Product ⁽¹⁾		3,350			58.1			2,692			54.4			658			24.4
Service ⁽²⁾		47			29.7			61			1.2			(14	)		(23.0	)

Total gross profit		3,397			57.3			2,753			54.0			644			23.4
Selling, general and administrative expense		4,472			75.5			3,466			68.0			1,006			29.0
Research and development		672			11.3			503			9.9			169			33.6
Interest and other income (expense)		(47	)		(0.8	)		(13	)		(0.3	)		(34	)	NM		⁽³⁾
Interest expense		(205	)		(3.5	)		(140	)		(2.7	)		(65	)		46.4

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	(1,999	)		(33.7	)%	$	(1,369	)		(26.9	)%	$	630			46.0	%


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue — Our Healthcare segment’s revenue increased approximately $0.8 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase in revenue was primarily due to increased sales of infant protection systems reflecting increased sales volumes generated by our key dealers for both new systems and the sale of RFID tags and other consumables to our installed base. Revenue from the sale of our wander prevention products also increased for the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006.

Gross Profit and Gross Profit Margin - Our Healthcare segment’s gross profit increased approximately $0.6 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. Gross profit margin increased to 57.3% in the three-months ended September 30, 2007 compared to 54.0% in the three-months ended September 30, 2006. The increase in gross profit margin was due to improved inventory management as a result of the consolidation of operations from Vancouver to Ottawa.

Selling, General and Administrative Expense - Our Healthcare segment’s selling, general and administrative expense increased approximately $1.0 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase was a result of increased sales and marketing expenses associated with the build out of our VeriMed business, primarily through increased sales staff and fees related to our market development efforts. As a percentage of our Healthcare segment’s revenue, selling general and administrative expense was 75.5% and 68.0% in the three-months ended September 30, 2007 and 2006, respectively. We attribute the increase in selling, general and administrative expense as a percentage of revenue primarily to the additional costs resulting from equity based compensation and increased costs related to becoming a public entity in February 2007.

Research and Development - Our Healthcare segment’s research and development increased approximately $0.2 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. As a percentage of our Healthcare segment’s revenue, research and development was 11.3% and 9.9% in the three-months ended September 30, 2007 and 2006, respectively. The increase in research and development expense was primarily due to higher compensation costs related to changes in the foreign exchange rate relating to our Canadian employees.

Nine-Months Ended September 30, 2007 Compared to the Nine-Months Ended September 30, 2006


	Nine-Months						Nine-Months
	Ended						Ended
	September 30,			% Of			September 30,			% Of			Change
	2007			Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	16,676			97.5	%	$	14,774			98.1	%	$	1,902			12.9	%
Service		424			2.5			282			1.9			142			50.4

Total revenue		17,100			100.0			15,056			100.0			2,044			13.6

Gross Profit:
Product ⁽¹⁾		9,051			54.3			8,566			58.0			485			5.7
Service ⁽²⁾		113			26.7			91			0.6			22			24.2

Total gross profit		9,164			53.6			8,657			57.5			507			5.9
Selling, general and administrative expense		12,361			72.3			9,752			64.8			2,609			26.8
Research and development		2,394			14.0			1,807			12.0			587			32.5
Interest and other expense		(150	)		(0.9	)		(69	)		(0.5	)		(81	)	NM		⁽³⁾
Interest expense		(590	)		(3.5	)		(284	)		(1.9	)		(306	)	NM		⁽³⁾

Income (loss) from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	(6,331	)		(37.0	)%	$	(3,255	)		(21.6	)%	$	3,076			94.5	%


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue – Our Healthcare segment’s revenue increased approximately $2.0 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The increase was due primarily to increased sales of infant protection systems reflecting increased sales volumes generated by our key dealers for both new systems and the sale of RFID tags and other consumables to our installed base. Revenue from the sale of our wander prevention products also increased for the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006.

Gross Profit and Gross Profit Margin – Our Healthcare segment’s gross profit increased approximately $0.5 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. Our Healthcare segment’s gross profit margin was 53.6% and 57.5% in the nine-months ended September 30, 2007 and 2006, respectively. The decrease in gross profit and gross profit margin was principally due to increased warranty costs related to our former Vancouver operations, which we closed in early 2007. We have implemented a process to reduce these costs and management believes that the process will result in gross margins increasing by the end of 2007.

Selling, General and Administrative Expense - Our Healthcare segment’s selling, general and administrative expense increased approximately $2.6 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. As a percentage of our Healthcare segment’s revenue, selling general and administrative expense was 72.3% and 64.8% in the nine-months ended September 30, 2007 and 2006, respectively. The increase was a result of increased sales and marketing expenses associated with the build out of our VeriMed business, primarily through increased sales staff and fees related to our market development efforts.

Research and Development - Our Healthcare segment’s research and development increased approximately $0.6 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. As a percentage of our Healthcare segment’s revenue, research and development was 14.0% and 12.0% in the nine-months ended September 30, 2007 and 2006, respectively. The increase in research and development was primarily due to the costs of duplicative staffing during the period that we were closing our Vancouver facility in early 2007.

Interest Expense - Our Healthcare segment’s interest expense increased approximately $0.3 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006 due primarily to the increased amount owed and increased interest rate under VeriChip’s loan agreement with us, and VeriChip’s increased borrowings under its revolving credit facility with the Royal Bank of Canada.

Security and Industrial Segment

Three-Months Ended September 30, 2007 Compared to the Three-Months Ended September 30, 2006


	Three-Months						Three-Months
	Ended						Ended
	September 30,			% Of			September 30,			% Of			Change
	2007			Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	1,646			82.7	%	$	1,406			81.6	%	$	240			17.1	%
Service		344			17.3			317			18.4			27			8.5

Total revenue		1,990			100.0			1,723			100.0			267			15.5

Gross Profit:
Product ⁽¹⁾		993			60.3			831			59.1			162			19.5
Service ⁽²⁾		146			42.4			184			9.0			(38	)		(20.7	)

Total gross profit		1,139			57.2			1,015			58.9			124			12.2
Selling, general and administrative expense		1,620			81.4			882			51.2			738			83.7
Research and development		468			23.5			380			22.1			88			23.2
Interest and other income (expense)		10			0.5			(4	)		(0.2	)		14		NM		⁽³⁾
Interest expense		(184	)		(9.2	)		(79	)		(4.6	)		105		NM		⁽³⁾

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	(1,123	)		(56.4	)%	$	(330	)		(19.2	)%	$	793		NM		⁽³⁾


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue - Our Security and Industrial segment’s revenue increased $0.3 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase was primarily due to continued strong demand in the worldwide construction market for our vibration monitoring systems. The strength or weakness of the worldwide construction market has historically had a significant influence on the sales volumes of our vibration monitoring instruments.

Gross Profit and Gross Profit Margin - Our Security and Industrial segment’s gross profit increased approximately $0.1 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. Our Security and Industrial segment’s gross profit margin was 57.2% in the three-months ended September 30, 2007 compared to 58.9% in the three-months ended September 30, 2006. The decrease in gross profit margin was primarily due to increased revenues from tool management products compared to the three-months ended September 30, 2006, which have a lower gross margin than our vibration monitoring products.

Selling, General and Administrative Expense - Our Security and Industrial segment’s selling, general and administrative expense increased approximately $0.7 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. As a percentage of our Security and Industrial segment’s revenue, selling, general and administrative expense was 81.4% and 51.2% in the three-months ended September 30, 2007 and 2006, respectively. We attribute the increase in selling, general and administrative expense as a percentage of revenue primarily to the additional costs resulting from the issuance of equity based compensation and increased costs related to becoming a public entity.

Research and Development - Our Security and Industrial segment’s research and development increased approximately $0.1 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. As a percentage of our Security and Industrial segment’s revenue, research and development was 23.5% and 22.1% in the three-months ended September 30, 2007 and 2006, respectively. Our Security and Industrial’s research and development efforts relate primarily to the development of a new family of vibration monitoring products.

Interest Expense - Our Security and Industrial segment’s interest expense increased approximately $0.1 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006 due primarily to the increased amount owed and increased interest rate under VeriChip’s loan agreement with us, and VeriChip’s increased borrowings under its revolving credit facility with the Royal Bank of Canada.

Nine-Months Ended September 30, 2007 Compared to the Nine-Months Ended September 30, 2006


	Nine-Months						Nine-Months
	Ended						Ended
	September 30,			% Of			September 30,			% Of			Change
	2007			Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	5,233			82.0	%	$	4,300			81.3	%	$	933			21.7	%
Service		1,146			18.0			988			18.7			158			16.0

Total revenue		6,379			100.0			5,288			100.0			1,091			20.6

Gross Profit:
Product ⁽¹⁾		2,906			55.5			2,665			62.0			241			9.0
Service ⁽²⁾		559			48.8			528			8.4			31			5.9

Total gross profit		3,465			54.3			3,193			60.4			272			8.5
Selling, general and administrative expense		4,472			70.1			2,828			53.5			1,644			58.1
Research and development		1,109			17.4			893			16.9			216			24.2
Interest and other income		30			0.5			8			0.2			22		NM		⁽³⁾
Interest expense		(552	)		(8.7	)		(217	)		(4.1	)		(335	)	NM		⁽³⁾

Income (loss) from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	(2,638	)		(41.4	)%	$	(737	)		(13.9	)%	$	1,901		NM		⁽³⁾


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue - Our Security and Industrial segment’s revenue increased approximately $1.1 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The increase was primarily due to continued strong demand in the worldwide construction market for our vibration monitoring systems. The strength or weakness of the worldwide construction market has historically had a significant influence on the sales volumes of our vibration monitoring instruments.

Gross Profit and Gross Profit Margin - Our Security and Industrial segment’s gross profit increased approximately $0.3 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2007. Our Security and Industrial segment’s gross profit margin was 54.3% in the nine-months ended September 30, 2007 compared to 60.4% in the nine-months ended September 30, 2006. The decline in gross margin was due to increased inventory reserves for slower moving inventory and due to increased revenues from tool management products compared to the nine-months ended September 30, 2006, which have a lower gross margin than our vibration monitoring products.

Selling, General and Administrative Expense - Our Security and Industrial segment’s selling, general and administrative expense increased approximately $1.6 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. As a percentage of our Security and Industrial segment’s revenue, selling, general and administrative expense was 70.1% in the nine-months ended September 30, 2007 compared to 53.5% in the nine-months ended September 30, 2006. We attribute the increase in selling, general and administrative expense as a percentage of revenue primarily to the additional costs resulting from the issuance of equity based compensation and increased costs related to becoming a public entity.

Research and Development - Our Security and Industrial segment’s research and development increased approximately $0.2 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. As a percentage of our Security and Industrial segment’s revenue, research and development was 17.4% and 16.9% in the nine-months ended September 30, 2007 and 2006, respectively. Our Security and Industrial’s research and development efforts relate primarily to the development of a new family of vibration monitoring products.

Interest Expense - Our Security and Industrial segment’s interest expense increased approximately $0.3 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006 due primarily to the increased amount owed and increased interest rate under VeriChip’s loan agreement with us, and VeriChip’s increased borrowings under the revolving credit facility with the Royal Bank of Canada.

Animal Applications Segment

Three-Months Ended September 30, 2007 Compared to the Three-Months Ended September 30, 2006


	Three-Months						Three-Months
	Ended						Ended
	September 30,			% Of			September 30,			% Of			Change
	2007			Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	10,346			100.00	%	$	8,233			99.7	%	$	2,113			25.7	%
Service		—			—			—			—			—			—
Intercompany — product		—			—			21			0.3			(21	)		(100.0	)

Total revenue		10,346			100.0			8,254			100.0			2,092			25.3

Gross Profit:
Product ⁽¹⁾		3,216			31.1			3,092			37.5			124			4.0
Service ⁽²⁾		—			—			—			—			—			—
Intercompany — product		—			—			10			0.1			(10	)		(100.0	)

Total gross profit		3,216			31.1			3,102			37.6			114			3.7
Selling, general and administrative expense		5,502			53.2			3,459			41.9			2,043			59.1
Research and development		586			5.7			576			7.0			10			1.7
Interest and other income		1,107			10.7			89			1.1			1,018		NM
Interest expense		(2,254	)		(21.8	)		(100	)		(1.2	)		2,154		NM

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	(4,019	)		(38.8	)%	$	(944	)		(11.4	)%	$	3,075		NM		⁽³⁾


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue - Our Animal Applications segment’s revenue increased approximately $2.1 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase was principally due to an increase in microchip sales of approximately $2.6 million to Schering-Plough, our exclusive distributor in the U.S. of our companion pet implantable microchips. This increase was partially offset by a decrease of electronic identification and visual product sales to livestock customers of approximately $0.4 million as a result of increased competition.

Gross Profit and Gross Profit Margin - Our Animal Applications segment’s gross profit increased approximately $0.1 million, in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The gross profit margin decreased to 31.1% in the three-months ended September 30, 2007 compared to 37.6% in the three-months ended September 30, 2006. We attribute the increase in gross profit to increased sales in the current period as well as the decrease in gross profit margin primarily due to a decrease in the average selling price for companion pet product sold in the U.S., higher freight costs for air shipments and increased depreciation expense on new machinery.

Selling, General and Administrative Expense - Our Animal Applications segment’s selling, general and administrative expense increased approximately $2.0 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase in selling, general and administrative expense relates primarily to merger expenses of approximately $0.6 million, severance expenses for Digital Angel’s former CEO of approximately $0.8 million, higher compensation expense related to an increase in compensation expense for additional personnel, as well as to approximately $0.1 million in expenses associated with Digital Angel’s executive search for a new CEO. Selling, general and administrative expense as a percentage of revenue increased to 53.2% from 41.9% in the same respective periods. For consistency in presentation, Digital Angel’s corporate and administrative expenses have been allocated to our Animal Applications segment.

Interest and Other Income - Our Animal Applications segment’s interest and other income increased approximately $1.0 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase in interest and other income relates primarily to the settlement of a lawsuit during the three-months ended September 30, 2007 that we initiated to protect certain of our intellectual property.

Interest Expense - Our Animal Applications segment’s interest expense increased approximately $2.2 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase in interest expense relates primarily to interest payments on higher debt balances, discount amortization and deferred debt cost amortization and the write off of $1.5 million of deferred financing and debt discount costs associated with the early payoff of Digital Angel’s 10.25% debenture and Greater Bay Facility debt.

Nine-Months Ended September 30, 2007 Compared to the Nine-Months Ended September 30, 2006


	Nine-Months						Nine-Months
	Ended						Ended
	September 30,			% Of			September 30,			% Of			Change
	2007			Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	31,635			100.0	%	$	27,348			97.2	%	$	4,287			15.7	%
Service		—			—			589			2.1			(589	)		(100.0	)
Intercompany — product		—			—			194			2.4			(194	)		(100.0	)

Total revenue		31,635			100.0			28,131			100.0			3,504			12.5

Gross Profit:
Product ⁽¹⁾		10,003			31.6			9,855			35.8			148			1.5
Service ⁽²⁾		—			—			589			100.0			(589	)		(100.0	)
Intercompany — product		—			—			115			0.4			(115	)		(100.0	)

Total gross profit		10,003			31.6			10,559			37.5			(556	)		(5.3	)
Selling, general and administrative expense		14,924			47.2			10,905			38.8			4,019			36.9
Research and development		1,864			5.9			2,097			7.5			(233	)		(11.1	)
Interest and other income		1,511			4.8			306			1.1			1,205		NM		⁽³⁾
Interest expense		(3,175	)		(10.0	)		(282	)		(1.0	)		2,893		NM		⁽³⁾

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	(8,449	)		(26.7	)%	$	(2,419	)		(8.6	)%	$	6,030		NM		⁽³⁾


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue - Our Animal Applications segment’s revenue increased approximately $3.5 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The increase was principally due to an increase in microchip sales of approximately $5.6 million to Schering-Plough, Digital Angel’s exclusive distributor in the U.S. of our companion pet, implantable microchips. Partially offsetting the increase was a decrease of electronic identification and visual product sales to livestock customers of $1.3 million. The decrease in e-tag sales in the U.S. is primarily due to the U.S. Department of Agriculture’s decision to continue the national identification system as voluntary. We also experienced a decrease in sales to fish and wildlife customers of $0.5 million, due to decreased service revenue, and a decrease in sales to VeriChip of $0.2 million.

Gross Profit and Gross Profit Margin - Our Animal Applications segment’s gross profit decreased approximately $0.6 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The gross margin was 31.6% in the nine-months ended September 30, 2007 compared to 37.5% in the nine-months ended September 30, 2006. We attribute the decrease in gross profit and gross profit margin in the nine-months ended September 30, 2007 to a decrease in high margin engineering service revenue, a decrease in the average sales price for companion pet products in the U.S., higher material and freight costs associated with fulfilling demand for companion pet products in the U.S., warranty costs for e-tags shipped to Canada, and increased overhead costs related to the startup of molding operations in our St. Paul facility, which we have begun to offset by a decrease in the visual product material cost.

Selling, General and Administrative Expense - Our Animal Applications segment’s selling, general and administrative expense increased approximately $4.0 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. This was attributable to an increase of $1.0 million in legal expenses related to the maintenance and protection of our intellectual property, an increase of $0.3 million related to consulting services, severance expenses to Digital Angel’s former CEO of approximately $0.8 million, approximately $0.8 million of merger expenses associated with the planned merger between us and Digital Angel, approximately $0.1 million related to the executive search for a new CEO of Digital Angel and an increase related to compensation expense for the addition of new personnel. Selling, general and administrative expense as a percentage of revenue increased to 47.2% from 38.8% in the same respective periods as a result of the increase in expenses. During the three-months ended September 30, 2007, Digital Angel reached a settlement in the lawsuit that it initiated to protect certain intellectual property and as a result, we expect that our legal expenses in this segment will decrease going forward. For consistency in presentation, Digital Angel’s corporate and administrative expenses have been allocated to our Animal Applications segment.

Research and Development - Our Animal Applications segment’s research and development expense decreased approximately $0.2 million in the nine-months ended September 30, 2007, compared to the nine-months ended September 30, 2006, and as a percentage of revenue, research and development decreased to 5.9% from 7.5%. The decrease is primarily due to the completion of a large scale RFID antenna project in 2006. Research and development expenses relate to new product development associated with RFID microchips and related scanners.

Interest and Other Income - Our Animal Applications segment’s interest and other income increased approximately $1.2 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase in interest and other income relates primarily to the settlement of a lawsuit during the nine-months ended September 30, 2007 that we initiated to protect certain of our intellectual property.

Interest Expense - Our Animal Applications segment’s interest expense increased approximately $2.9 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The increase in interest expense relates primarily to interest payments on higher debt balances, discount amortization and deferred debt cost amortization and the write off of $1.5 million of deferred financing and debt discount costs associated with the early payoff of Digital Angel’s 10.25% debenture and Greater Bay Facility debt.

GPS and Radio Communications Segment

Three-Months Ended September 30, 2007 Compared to the Three-Months Ended September 30, 2006


	Three-Months						Three-Months
	Ended						Ended
	September 30,			% Of			September 30,			% Of			Change
	2007			Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	9,989			100.0	%	$	4,146			100.0	%	$	5,843		NM		⁽³⁾
Service		—			—			—			—			—			—

Total revenue		9,989			100.0			4,146			100.0			5,843		NM		⁽³⁾

Gross Profit:
Product ⁽¹⁾		5,024			50.3			2,148			51.8			2,876		NM		⁽³⁾
Service ⁽²⁾		—			—			—			—			—			—

Total gross profit		5,024			50.3			2,148			51.8			2,876		NM		⁽³⁾
Selling, general and administrative expense		3,575			35.8			2,174			52.4			1,401			64.4	%
Research and development		245			2.5			190			4.6			55			28.9
Interest and other income		—			—			2			—			(2	)		(100.0	)
Interest expense		(41	)		(0.4	)		(17	)		(0.4	)		24		NM		⁽³⁾

Income (loss) from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	1,163			11.6	%	$	(231	)		(5.6	)	$	1,394		NM		⁽³⁾


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue - Our GPS and Radio Communication segment’s revenue increased approximately $5.8 million, in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase in revenue was principally due to an increase in sales of SARBE ^TM products of $0.8 million, an increase in sales of alarm products of $0.2 million and the inclusion of $4.4 million of sales from our McMurdo division that was acquired on April 5, 2007. We believe that McMurdo will provide us with more predictable revenue in our search and rescue beacon business going forward.

Gross Profit and Gross Profit Margin - Our GPS and Radio Communications segment’s gross profit increased approximately $2.9 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. Of this increase, $1.9 million is attributable to McMurdo, which was acquired in April 2007, with the remaining increase due to increase SARBE ^TM and alarm products sales. The gross profit margin was 50.3% in the three-months ended September 30, 2007 as compared to 51.8% in the three-months ended September 30, 2006. The decrease in gross profit margin relates primarily to the addition of the McMurdo operations as currently, we earn lower margins at our McMurdo division than we do at our existing business lines. Excluding McMurdo, Signature’s gross profit margin increased due to the increase in sales and favorable product mix.

Selling, General and Administrative Expense - Our GPS and Radio Communications segment’s selling, general and administrative expense increased approximately $1.4 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase in selling, general and administrative expense relates primarily to compensation expense due to the addition of McMurdo which had expenses of $0.8 million in the third quarter. The remaining $0.6 million is due to an increase in bonus accruals and commission expense relating to the increased sales. As a percentage of revenue, selling, general and administrative expense decreased to 35.8% in the three-months ended September 30, 2007 from 52.4% in the three-months ended September 30, 2006. The decrease in selling, general and administrative expense as a percentage of revenue resulted primarily from the increase in revenue and lower selling, general and administrative expense as a percentage of revenue at McMurdo.

Research and Development - Our GPS and Radio Communications segment’s research and development expenses remained relatively consistent in the three-months ended September 30, 2007 as compared to the three-months ended September 30, 2006. The expense includes an increase of $0.2 million of additional McMurdo research and development expense, and decreased expense of $0.2 million at Signature. This decrease is due to the substantial completion of the development of a new search and rescue beacon for the U.S. Air Force. The development of the new pilot location beacon was our first contract with a branch of the U.S. Military, as previous sales of our location beacons have been to foreign governments. Revenue from the contract, totaling approximately $0.9 million, is expected to be earned in the three-months ended December 31, 2007.

Nine-Months Ended September 30, 2007 Compared to the Nine-Months Ended September 30, 2006


	Nine-Months						Nine-Months
	Ended						Ended
	September 30,			% Of			September 30,			% Of			Change
	2007			Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	23,531			100.0	%	$	12,016			100.0	%	$	11,515			95.8	%
Service		—			—			—			—			—			—

Total revenue		23,531			100.0			12,016			100.0			11,515			95.8

Gross Profit:
Product ⁽¹⁾		11,558			49.1			6,163			51.3			5,395			87.5
Service ⁽²⁾		—			—			—			—			—			—

Total gross profit		11,558			49.1			6,163			51.3			5,395			87.5
Selling, general and administrative expense		9,430			40.1			6,360			52.9			3,070			48.3
Research and development		1,770			7.5			190			1.6			1,580		NM		⁽³⁾
Interest and other income		—			—			4			—			(4	)		(100.0	)
Interest expense		(118	)		(0.5	)		(41	)		(0.3	)		77		NM		⁽³⁾

Income (loss) from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	240			1.0	%	$	(424	)		(3.5	)%	$	664		NM		⁽³⁾


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue — Our GPS and Radio Communication segment’s revenue increased approximately $11.5 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The increase in revenue was primarily due to an increase in sales of SARBE ^TM product’s of $1.6 million, an increase in sales of alarm products of $0.7 million, an increase in Radio Hire division sales of $0.7 million and the inclusion of $8.2 million of sales from our McMurdo division, which was acquired on April 5, 2007.

Gross Profit and Gross Profit Margin - Our GPS and Radio Communications segment’s gross profit increased approximately $5.4 million in the nine-months ended September 30, 2007 as compared to the nine-months ended September 30, 2006. The increase in gross profit relates to the previously mentioned increase in sales from our existing businesses and the inclusion of approximately $3.5 million of gross profit from McMurdo. The gross profit margin decreased to 49.1% in the nine-months ended September 30, 2007 compared to 51.3% in the nine-months ended September 30, 2006. The decrease primarily relates to the inclusion of McMurdo as currently we earn lower margins at our McMurdo division than we do for our existing business lines. Excluding McMurdo, Signature’s gross profit margin increased slightly due to the increased sales and favorable product mix.

Selling, General and Administrative Expense - Our GPS and Radio Communications segment’s selling, general and administrative expense increased approximately $3.2 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. Excluding the $1.6 million of expenses related to McMurdo, the remaining increase is due primarily to an increase in exhibition and advertising expenses, increased overseas travel related to SARBE ^TM sales, increased bonus and commission expense, as well as an increase in compensation expense associated with the addition of new personnel and general salary increases. As a percentage of revenue, selling, general and administrative expense decreased to 40.1% in the nine-months ended September 30, 2007 from 52.9% in the nine-months ended September 30, 2006. The decrease in selling, general and administrative expense as a percentage of revenue resulted primarily from the increase in sales and lower selling, general and administrative expenses as a percentage of revenue at McMurdo.

Research and Development - Our GPS and Radio Communications segment’s research and development increased approximately $1.6 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. This increase was driven by the addition of $1.1 million of development costs for the development of a new search and rescue beacon. The development of the new pilot location beacon is more fully discussed in the comparison of our GPS and Radio Communications segment’s results of operations for the three-months ended September 30, 2007. In addition, we incurred approximately $0.5 million in research and development expense related to the acquisition of McMurdo, which was acquired on April 5, 2007.

Advanced Technology Segment

Three-Months Ended September 30, 2007 Compared to the Three-Months Ended September 30, 2006


	Three-Months						Three-Months
	Ended						Ended
	September 30,			% Of			September 30,		% Of			Change
	2007			Revenue			2006		Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	446			23.2	%	$	794		46.0	%	$	(348	)		(43.8	)%
Service		1,474			76.8			932		54.0			542			58.2

Total revenue		1,920			100.0			1,726		100.0			194			11.2

Gross Profit:
Product ⁽¹⁾		446			100.0			794		100.0			(348	)		(43.8	)
Service ⁽²⁾		812			55.1			498		53.4			314			63.1

Total gross profit		1,258			65.5			1,292		74.9			(34	)		(2.6	)
Selling, general and administrative expense		311			16.2			414		24.0			(103	)		(24.9	)
Interest and other income		157			8.2			59		3.4			98		NM
Interest expense		(1	)		(0.1	)		—		—			(1	)	NM

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	1,103			57.4	%	$	937		54.3	%	$	166		17.7		%


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue - Our Advanced Technology segment’s revenue increased approximately $0.2 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006 primarily as a result of an increase in billings for services.

Gross Profit and Gross Profit Margin - Our Advanced Technology segment’s gross profit on product sales decreased approximately $0.4 million during the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. This decrease was partially offset by an increase in gross profit on service revenue. The decrease in product gross profit was due to a change, during the fourth quarter of 2006, in the estimated time period to complete the delivery of a software system to our Advance Technology segment’s major customer. The increase in gross profit on service revenue was due to additional billings during the three-months ended September 30, 2007. The gross profit margin for our Advanced Technology segment was 65.5% in the three-months ended September 30, 2007 compared to 74.7% in the three-months ended September 30, 2006. The decrease in the gross profit margin resulted from the change in mix to more service revenue than product revenue during the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006.

Selling General and Administrative Expense - Our Advanced Technology segment’s selling, general and administrative expense decreased approximately $0.1 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. As a percentage of revenue our Advanced Technology segment’s revenue, selling general and administrative expense was 16.2% and 24.0% in the three-months ended September 30, 2007 and 2006, respectively.

Interest and Other Income - Our Advanced Technology segment’s interest and other income for the three-months ended September 30, 2007 increased approximately $0.1 million compared to the three-months ended September 30, 2006. The increase in interest and other income related primarily to an increase in intercompany interest income.

Nine-Months Ended September 30, 2007 Compared to the Nine-Months Ended September 30, 2006


	Nine-Months					Nine-Months
	Ended					Ended
	September 30,		% Of			September 30,			% Of			Change
	2007		Revenue			2006			Revenue			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Product	$	977		17.8	%	$	794			17.9	%	$	183			23.0	%
Service		4,515		82.2			3,650			82.1			865			23.7

Total revenue		5,492		100.0			4,444			100.0			1,048			23.6

Gross Profit:
Product ⁽¹⁾		977		100.0			794			100.0			183			23.0
Service ⁽²⁾		2,816		62.4			2,489			68.2			327			13.1

Total gross profit		3,793		69.1			3,283			73.9			510			15.5
Selling, general and administrative expense		1,058		19.3			1,073			24.1			(15	)		(1.4	)
Interest and other income		1,212		22.1			91			2.0			1,121		NM
Interest expense		—		—			(2	)		—			2		NM

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	3,947		71.9	%	$	2,299			51.7	%	$	1,648			71.7	%


⁽¹⁾		The percentage of revenue is calculated as a percentage of product revenue.

⁽²⁾		The percentage of revenue is calculated as a percentage of service revenue.

⁽³⁾		NM = Not meaningful.

Revenue - Our Advanced Technology segment’s service relationship management software revenue increased approximately $1.0 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006, primarily as a result of an increase in billings for services.

Gross Profit and Gross Profit Margin - Our Advanced Technology segment’s service relationship management software gross profit on product and service increased approximately $0.5 million in the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006 as a result of the increase in revenue. The gross profit margin for our Advanced Technology segment was 69.1% in the nine-months ended September 30, 2007 compared to 73.9% in the nine-months ended September 30, 2006. The decrease in gross profit margin is primarily related to lower margins earned on service revenue.

Interest and Other Income - Our Advanced Technology segment’s interest and other income for the nine-months ended September 30, 2007 increased approximately $1.1 million compared to the nine-months ended September 30, 2006. The increase in interest and other income related primarily to the settlement of a lawsuit during the nine-months ended September 30, 2007. The settlement amount was approximately $0.9 million less than the amount that we had previously reserved.

“Corporate/Eliminations”

Three-Months Ended September 30, 2007 Compared to the Three-Months Ended September 30, 2006


	Three-Months			Three-Months
	Ended			Ended
	September 30,			September 30,			Change
	2007			2006			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Elimination of intercompany product revenue	$	—		$	(21	)	$	21		NM	%

Total		—			(21	)		21		NM

Gross Profit:
Elimination of intercompany product gross profit		—			(10	)		10		NM

Total		—			(10	)		10		NM
Selling, general and administrative expense		1,626			1,283			343		26.7
Gain on sale of asset		691			—			691		NM
Interest and other (expense) income		(2,185	)		90			(2,275	)	NM
Interest expense		(13	)		(855	)		(842	)	98.5

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	(3,113	)	$	(2,058	)	$	1,055		(51.3	)%


⁽¹⁾		NM = Not meaningful.

Selling, General and Administrative Expense - Corporate/Elimination’s selling, general and administrative expense increased approximately $0.3 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase was principally due to legal expenses related to a lawsuit that we settled in the three-months ended September 30, 2007.

Gain on Sale of Asset - Corporate/Elimination’s gain on sale of asset resulted from our giving 200,000 shares of the VeriChip common stock that we owned to our lender under the terms of a loan agreement dated August 31, 2007. The gain represents the difference between the fair market value and the book value of the 200,000 shares.

Interest and Other (Expense) Income — Corporate/Elimination’s interest and other (expense) income increased approximately $2.3 million in the three-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase was primarily as a result of the cost of settlement of a lawsuit during the three-months ended September 30, 2007.

Interest Expense - Corporate/Elimination’s interest expense decreased approximately $0.8 million during the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The decrease in interest expense is due to lower average borrowings and an increase in intercompany borrowings.

Nine-Months Ended September 30, 2007 Compared to the Nine-Months Ended September 30, 2006


	Nine-Months			Nine-Months
	Ended			Ended
	September 30,			September 30,			Change
	2007			2006			Increase (Decrease)
	(dollar amounts in thousands)
Revenue:
Elimination of intercompany product revenue	$	—		$	(194	)	$	194		NM	%

Total		—			(194	)		194		NM

Gross Profit:
Elimination of intercompany product gross profit		—			(115	)		115		NM

Total		—			(115	)		115		NM
Selling, general and administrative expense		4,420			4,186			234		NM
Gain on sale of assets		691			—			691		NM
Interest and other (expense) income		(1,553	)		358			1,911		NM
Interest expense		(476	)		(1,582	)		(1,106	)	NM

Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries	$	(5,758	)	$	(5,525	)	$	(233	)	NM	%


⁽¹⁾		NM = Not meaningful.

Selling, General and Administrative Expense - Corporate/Elimination’s selling, general and administrative expense increased approximately $0.2 million in the three-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The increase was principally due to legal expenses related to a lawsuit that we settled in the nine-months ended September 30, 2007.

Interest and Other (Expense) Income - Corporate/Elimination’s interest and other (expense) income increased approximately $1.9 million in the nine-months ended September 30, 2007 compared to the three-months ended September 30, 2006. The increase was primarily the result of the cost of settlement of a lawsuit during the 2007 period.

Interest Expense - Corporate/Elimination’s interest expense decreased approximately $1.1 million during the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006. The decrease in interest expense is due to a lower average borrowings and an increase in intercompany borrowings.

Income Taxes

Net Gain/Loss on Capital Transactions of Subsidiaries and Loss Attributable to Changes in Minority Interest as a Result of Capital Transactions of Subsidiaries

Gains where realized and losses on issuances of shares of stock by Digital Angel and VeriChip are reflected in the unaudited condensed consolidated statement of operations. We determined that such recognition of gains and losses on issuances of shares of stock by Digital Angel and VeriChip was appropriate because we do not plan to reacquire the shares issued and the value of the proceeds could be objectively determined.

During the three-months ended September 30, 2007 and 2006, we recorded a loss of $1.1 million and nil, respectively, on the issuances of common stock by Digital Angel and VeriChip. During the nine-months ended September 30, 2007 and 2006, we recorded a gain of $3.6 million and $0.3 million, respectively, on the issuances of common stock by Digital Angel and VeriChip. The net gains (losses) resulted from the difference between the carrying amount of our pro-rata share of our investment in VeriChip and Digital Angel and the net proceeds from the issuances of the stock.

During the three-months ended September 30, 2007, in connection with the IC Note between us and Digital Angel, which is more fully discussed in Note 5 to our unaudited condensed consolidated financial statements, Digital Angel issued approximately 0.9 million shares of its common stock to us. In addition, Digital Angel issued 0.3 million shares of its common stock to us during the three-months ended June 30, 2006 under the terms a share exchange agreement between Digital Angel and us. The share exchange related to a purchase price payment made by Digital Angel in connection with its acquisition of its subsidiary, DSD. Based on the substance of these transactions and the fact that the shares were issued to us in connection with a financing and exchanged in connection with an acquisition, the shares did not result in a gain or loss on issuance.

We recorded a loss of $0.9 million and a gain of $0.2 million during the three-months ended September 30, 2007 and 2006, respectively, and loss of $6. million and $23,000 during the nine-months ended September 30, 2007 and 2006, respectively, attributable to changes in the minority interest ownership of VeriChip and Digital Angel as a result of their capital transactions.

The details of the capital transactions of Digital Angel and VeriChip for the three and nine-months ended September 30, 2007 and 2006 are presented in Note 8 to our unaudited condensed consolidated financial statements.

Net Loss

During the three-months ended September 30, 2007 and 2006, we reported a loss from continuing operations of approximately $7.6 million and $3.0 million, respectively. Included in the loss from continuing operations for the three-months ended September 30, 2007 was approximately $1.1 million of loss attributable to capital transactions of subsidiaries as compared to $0.0 million in the three-months ended September 30, 2006 and a loss of approximately $0.9 million due to changes in minority interest as a result of capital transactions of subsidiaries compared to a gain of $0.2 million in the three-months ended September 30, 2007 and 2006, respectively. Excluding these gains/losses, the loss from continuing operations was $5.6 million and $3.1 million, respectively, for the three-months ended September 30, 2007 and 2006. The increase in the loss for the three-months ended September 30, 2007 compared to September 30, 2006 relates primarily to (i) net litigation settlement expense; (ii) additional interest expense; (iii) merger expenses; (iv), severance expense; and (v) increased stock-based compensation expense’ among other items. Each of these items is more fully discussed above in the context of the appropriate segment.

During the nine-months ended September 30, 2007 and 2006, we reported loss from continuing operations of approximately $15.8 million and $8.1 million, respectively. The increase in the loss for the nine-months ended September 30, 2007 compared to the nine-months ended September 30, 2006 resulted primarily from (i) net litigation settlement expense; (ii) additional interest expense; (iii) merger expenses: (iv) severance expense; (v) increase in research and development related to our locator beacons and RFID healthcare systems; (vi) increase in stock-based compensation expense due primarily to the issuance of stock options; (vii) additional investment in our VeriMed patient identification infrastructure; and (viii) costs associated with defending our implantable microchip patent, among other items. Each of these items is more fully discussed above in the context of the appropriate segment.

LIQUIDITY AND CAPITAL RESOURCES FROM CONTINUING OPERATIONS

As of September 30, 2007, cash and cash equivalents totaled $14.4 million, an increase of $7.3 million, or 102%, from $7.1 million at December 31, 2006.

Operating activities used cash of $11.4 million and $4.6 million during the nine-months ended September 30, 2007 and 2006, respectively. During the nine-months ended September 30, 2007, cash was used primarily to fund losses and for payment of accounts payable, accrued expenses and other liabilities as well as for purchases of inventory. During the nine-months ended September 30, 2006, cash was used primarily to fund losses and to purchase inventory and for payments of other current assets.

Adjustments to reconcile operating losses to net cash used in operating activities included the following:

	•		Accounts and unbilled receivables, net of allowance for doubtful accounts, increased $3.0 million, or 18.8%, to $19.0 million at September 30, 2007, from $16.0 million at December 31, 2006. The increase was primarily due to the increase in revenue in the three-months ended September 30, 2007 as compared to the fourth quarter of 2006.

	•		Inventories increased 27.0% to $16.5 million at September 30, 2007 from $13.0 million at December 31, 2006. The increase was principally due to inventory associated with the acquisition of McMurdo in April 2007.

	•		Accounts payable increased $0.7 million, or 5.4%, to $13.6 million at September 30, 2007 compared to $12.9 million at December 31, 2006. The increase was primarily due to accounts payable associated with McMurdo. McMurdo was acquired in April 2007.

	•		Accrued expenses decreased $4.6 million, or 28.6%, to $11.6 million at September 30, 2007 compared to $16.2 million at December 31, 2006. The decrease was primarily a result of the payment of initial public offering costs that were accrued by VeriChip as of December 31, 2006 and paid during the nine-months ended September 30, 2007 and to the settlement of the $3.3 million obligation to our former CEO during the nine-months ended September 30, 2007. Approximately $3.0 million of the settlement was paid in shares of our common stock.

Investing activities used cash of $5.6 million and $3.4 million during the nine-months ended September 30, 2007 and 2006, respectively. During the nine-months ended September 30, 2007, cash was used primarily to purchase approximately $2.0 million of property and equipment, cash of $4.3 million was used for business acquisition, and cash of $0.6 million was used by discontinued operations. During the nine-months ended September 30, 2006, cash of $1.0 million was used for business acquisitions, net of cash acquired, cash of approximately $2.6 million was used to purchase property and equipment and cash of $0.3 million was used by discontinued operations.

Financing activities provided cash of $24.2 million and $1.4 million during the nine-months ended September 30, 2007 and 2006, respectively. During the nine-months ended September 30, 2007, cash of approximately $18.3 million was provided by VeriChip’s initial public offering, cash of $13.0 million was provided by long-term debt, offset by $8.3 million used for payments on long term debt and $5.1 million was provided by net borrowings on notes payable. During the nine-months ended September 30, 2006, $16.6 million was provided by borrowings, offset by $14.1 million used for payment of long term debt.

Laurus Master Fund, Ltd. Financing

On August 24, 2006, we closed a $13.5 million non-convertible debt financing transaction with Laurus pursuant to the terms of a Securities Purchase Agreement (the “Laurus Agreement”) dated August 24, 2006, between us and Laurus. On October 31, 2007, we entered into an amendment to the Laurus Agreement, which is more fully described in Note 5 to our unaudited condensed consolidated financial statements.

Under the terms of the Laurus Agreement, as amended on October 31, 2007, Laurus extended financing to us in the form of the 2006 Note. The 2006 Note accrues interest at a rate of 12% per annum, payable monthly, and has a maturity date of February 1, 2010. We are obligated to make monthly principal payments of $200,000 from November 1, 2007 to August 1, 2008 and $250,000 beginning on September 1, 2008 to the maturity date. The terms of the 2006 Note allow for optional redemption without a prepayment penalty. The 2006 Note also provides for certain events of default, including (i) failure to pay principal and interest when due; (ii) a violation of a covenant; (iii) any material misrepresentation made in the Note or a related agreement; (iv) bankruptcy or insolvency; and (v) a change of control as defined in the Note, among others. The covenants in the Laurus Agreement include, among others, (i) the maintenance of listing or quotation of our common stock on a principal market; (ii) monthly, quarterly and annual financial reporting requirements; (iii) maintenance of adequate insurance; and (iv) approvals for certain events such as declaring dividends, creating new indebtedness not specifically allowed under the terms of the Laurus Agreement, among others. In the event of default, Laurus is entitled to additional interest on the outstanding principal balance of the 2006 Note and on all outstanding obligations under the 2006 Note and the related agreements entered into in conjunction with the 2006 Note in an amount equal to 1% per month.

To secure our obligations under the Laurus Agreement, we have granted Laurus a first priority security interest in substantially all of our assets, and we have pledged all of the issued and outstanding capital stock owned by us in InfoTech and Digital Angel and certain of our other wholly-owned subsidiaries and 65% and of the outstanding stock that we own in VeriChip.

$6.0 million Revolving Asset-Based Financing With Kallina

On August 31, 2007, Digital Angel and the Eligible Subsidiaries entered into a $6.0 million revolving asset-based financing transaction with Kallina pursuant to the terms of a Security Agreement and a Revolving Facility. At September 30, 2007, approximately $4.3 million was outstanding under the Revolving Facility and approximately $0.7 million was available for borrowing. The terms of the Revolving Facility are more fully described in Note 5 to our condensed consolidated financial statements.

$7.0 Million Non-Convertible Term Note and Intercompany Note

Concurrently with the closing of the Revolving Facility, we entered into the 2007 Note with Kallina pursuant to the terms of a Securities Purchase Agreement between us and Kallina. Digital Angel and its Eligible Subsidiaries have guaranteed our obligations under the 2007 Note and we have guaranteed the obligations of Digital Angel and its Eligible Subsidiaries under the Revolving Facility. The Revolving Facility is discussed above and the 2007 Note is discussed in Note 5 to our condensed consolidated financial statements.

Effective August 31, 2007, Digital Angel entered into the IC Note with us. The terms of the IC Note and the transactions entered into in connection therewith are more fully described in Note 5 to our condensed consolidated financial statements.

Royal Bank of Canada Credit Agreement

VeriChip’s subsidiary, VHI, has entered into a credit facility dated March 15, 2006 with the Royal Bank of Canada, or RBC, providing for up to CDN$1.5 million, or approximately USD $1.5 million based on the exchange rate as of September 30, 2007, of revolving credit loans, provided that outstanding borrowings under the facility may not exceed at any time an amount determined by reference to eligible accounts receivable plus eligible inventory, in each case as defined in the agreement of VHI, or CDN $3.8 million at September 30, 2007. At September 30, 2007, approximately $1.1 million was outstanding under the facility. The facility is not a committed facility as it provides that loans are made available to VHI at the sole discretion of RBC and that RBC may cancel or restrict the availability or any unutilized portion thereof at any time or from time to time. Borrowings may be made in either Canadian or U.S. dollars, and bear interest at a floating rate per annum equal to the Canadian or U.S. dollar prime rate, as applicable, announced by RBC from time to time, plus in each case 1%. The facility also provides for letters of credit and letters of guarantee denominated in Canadian dollars. Borrowings, letters of credit and letters of guarantee under the facility are secured by all of the assets of VHI and its subsidiary, and are guaranteed by VHI’s subsidiary in the amount of CDN $2.0 million. The loan agreements contain customary representations and warranties and events of default for loan arrangements of this type. In addition, the loan agreements contain customary covenants restricting VHI’s ability to, among other things, merge or enter into business combinations, create liens, or sell or otherwise transfer assets.

Loan Agreement with VeriChip

We have funded and financed VeriChip’s operations since it began operation in January 2002, which resulted in an amount due to us by VeriChip totaling approximately $8.6 million (which included $0.4 million of accrued interest) at December 31, 2005. On December 27, 2005, we and VeriChip converted the amounts due, including accrued interest, into an $8.5 million revolving line of credit under the terms of a loan agreement, security agreement and a revolving line of credit note. On October 6, 2006, January 19, 2007, February 8, 2007 and again on February 13, 2007, we and VeriChip entered into amendments to the loan documents. The terms of the loan documents are more fully discussed in Note 14 to our condensed consolidated financial statements.

Invoice Discounting Agreement

Line of Credit - DSD

DSD and its wholly-owned subsidiary, Daploma International A/S, or Daploma, are party to a credit agreement with Danske Bank. On June 1, 2006, DSD and Daploma International A/S amended the borrowing availability from DKK 12 million (approximately $2.3 million at September 30, 2007) to DKK 18 million (approximately $3.4 million at September 30, 2007). In connection with the amendment, Digital Angel executed a Letter of Support which confirms that Digital Angel will maintain their holding of 100% of the share capital of Daploma, and that Digital Angel shall neither sell, nor pledge, nor in any way dispose of any part of Daploma or otherwise reduce its influence on Daploma 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%. At September 30, 2007, the annual interest rate on the facility was 6.6%. Borrowing availability under the credit facility considers guarantees outstanding. At September 30, 2007, the borrowing availability on the credit agreement was DKK 0.3 million (approximately $58,000 at September 30, 2007). The credit agreement will remain effective until further notice. DSD can terminate the credit agreement and pay the outstanding balance, or Danske Bank may demand the credit line be settled immediately at any given time, without prior notice.

Note Payable-DSD

As of September 30, 2007, DSD is party to a note payable with Danske Bank. Principal and interest payments of DKK 0.3 million ($57,000 at September 30, 2007) plus interest are payable quarterly through December 15, 2008. The interest rate on the note is calculated based on the international rates Danske Bank can establish on a loan in DKK in the international market plus 2.0%. The interest rate on the note payable was 5.5% at September 30, 2007.

The foregoing discussion of our credit facilities and related agreements is a summary of the material terms of those agreements and is qualified in its entirety by reference to the terms and provisions of those agreements.

Financial Condition

	•		first, we will attempt to successfully implement our business plans, manage expenditures according to our budget, streamline our manufacturing processes, and generate positive cash flow from operations;

	•		second, we will continue to develop an effective marketing and sales strategy in order to grow our businesses and compete successfully in our markets;

	•		third, we will attempt to expand the market for our Bio Thermo™ and VeriMed products; and

	•		fourth, we will continue to focus on acquisitions of complementary business that generate positive cash flow, such as the McMurdo business that we acquired in April 2007, and/or divest those business that are no longer strategic or that do not generate positive cash flow from operations.

Our management believes that the above plan can be effectively implemented.

Debt Compliance

Outlook

We are constantly looking for ways to maximize shareholder value. As such, we are continually seeking operational efficiencies and synergies within our operating segments as well as evaluating acquisitions of businesses and customer bases that complement our operations. These strategic initiatives may include acquisitions, raising additional funds through debt or equity offerings, or the divestiture of business units that are not critical to our long-term strategy or other restructuring or rationalization of existing operations. We will continue to review all alternatives to ensure maximum appreciation of our shareholders’ investments. However, initiatives may not be found, or if found, they may not be on terms favorable to us.

During the remainder of 2007, and during 2008, we expect to reverse certain liabilities in amounts up to approximately $5.9 million related to businesses that we sold or closed during 2001 and 2002. Approximately $5.2 million of these liabilities related to our discontinued operations. These liabilities have not been guaranteed by us and we do not intend to repay these liabilities. The reversal of these liabilities will have a favorable impact on our financial condition and results of operation.

Impact of Recently Issued Accounting Standards

In September 2006, the FASB issued SFAS 157 — Fair Value Measurements, or FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, FAS 157 does not require any new fair value measurements. However, for some entities, the application of FAS 157 will change current practice. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We have not yet determined the impact of FAS 157 on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

In September 2006, the FASB issued SFAS 158 — Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans , or FAS 158. FAS 158 amends FASB Statements No. 87, 88, 106, and 132(R). FAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive income. It also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. Under FAS 158, the requirement to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures was effective for us as of the end of our first fiscal year ending after December 15, 2006. The initial adoption did not have any impact on our consolidated financial position, results of operations, cash flows or financial statement disclosures. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for us for our first fiscal year ending after December 15, 2008. We have not yet determined the impact that this requirement may have on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

In February, 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an amendment of FAS 115, or FAS 159. This statement provides companies with an option to report selected financial assets and liabilities at fair value. This statement is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. We are assessing FAS 159 and have not yet determined the impact that the adoption of FAS 159 will have on our results of operations or financial position, if any.

FORWARD LOOKING STATEMENTS AND ASSOCIATED RISKS

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

	•		our growth strategies including, without limitation, our ability to deploy our products and services including VeriChip™ and Bio-Thermo™;

	•		anticipated trends in our business and demographics;

	•		the ability to hire and retain skilled personnel;

	•		relationships with and dependence on technological partners;

	•		our reliance on government contractors;

	•		uncertainties relating to customer plans and commitments;

	•		our ability to successfully integrate the business operations of acquired companies;

	•		our future profitability and liquidity;

	•		our ability to maintain compliance with the covenants under our credit facilities;

	•		our ability to obtain patents, enforce those patents, preserve trade secrets, and operate without infringing on the proprietary rights of third parties;

	•		governmental export and import policies, global trade policies, worldwide political stability and economic growth;

	•		expectations about the outcome of litigation and asserted claims;

	•		regulatory, competitive or other economic influences;

	•		our ability to successfully mitigate the risks associated with foreign operations;

	•		our ability to successfully implement our business strategy;

	•		our expectation that we will incur losses, on a consolidated basis, for the foreseeable future;

	•		our ability to fund our operations;

	•		borrowings under VeriChip’s and DSD’s existing bank facilities are payable on demand and the facilities could be terminated at any time without notice;

	•		the impact on our success of the relative maturity in the United States, and limited size, of the markets for our infant protection and wander prevention systems and vibration monitoring instruments;

	•		the degree of success we have in leveraging our brand reputation, reseller network and end-use customer base for our infant protection and wander prevention systems to gain inroads in the emerging market for asset/staff location and identification systems;

	•		the rate and extent of the U.S. healthcare industry’s adoption of radio frequency identification, or RFID, asset/staff location and identification systems;

	•		the relative degree of market acceptance of our zonal, or cell identification, active RFID systems compared to competing technologies, such as lower power Ultra Wide Band-based location technologies, 802.11 and Zigbee-based location and wireless networking technologies;

	•		uncertainty as to whether we will be able to increase our sales of infant protection and wander prevention systems outside of North America;

	•		our reliance on third-party dealers to successfully market and sell our products;

	•		our reliance on a single source supplier for our implantable microchip;

	•		we may become subject to costly product liability claims and claims that our products infringe the intellectual property rights of others;

	•		our ability to comply with current and future regulations relating to our businesses;

	•		uncertainty as to whether a market for our VeriMed and Evitrace systems will develop and whether we will be able to generate more than a nominal level of revenue from the sale of these systems;

	•		the potential for patent infringement claims to be brought against us asserting that we hold no rights for the use of the implantable microchip technology and that we are violating another party’s intellectual property rights. If such a claim is successful, we could be enjoined from engaging in activities to market the systems that utilize the implantable microchip and be required to pay substantial damages;

	•		the negative impact of the expiration of patents in 2008 and 2009 relating to our implantable microchip technology;

	•		market acceptance of our VeriMed system, which will depend in large part on the future availability of insurance reimbursement for the VeriMed system microchip implant procedure from government and private insurers, and the timing of such reimbursement, if it, in fact, occurs;

	•		our ability to provide uninterrupted, secure access to the VeriMed database;

	•		conflict of interest risks related to our continued affiliation with our majority-owned subsidiaries;

	•		our ability to comply with the obligations in our various registration rights agreements;

	•		the impact of new accounting pronouncements;

	•		our ability to establish and maintain proper and effective internal accounting and financial controls; and

	•		all statements referring to the future or future events.

In some cases, you can identify forward-looking statements by terms such as “may,” “should,” “could,” “would,” “anticipates,” “expects,” “attempt,” “intends,” “plans,” “hopes,” “believes,” “seeks,” “estimates” and similar expressions intended to identify forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from estimates or forecasts contained in the forward-looking statements. Some of these risks and uncertainties are beyond our control. Also, these forward-looking statements represent our estimates and assumptions only as of the date the statement was made.

The information in this Form 10-Q is as of September 30, 2007, or, where clearly indicated, as of the date of this filing. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. We also may make additional disclosures in our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K that we may file from time to time with the Securities and Exchange Commission. Please also note that we provide a cautionary discussion of risks and uncertainties under the section entitled “Risk Factors” in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2006. These are factors that could cause our actual results to differ materially from expected results. Other factors besides those listed could also adversely affect us.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In connection with our Canadian, European and South American subsidiaries, we have operations and sales in various regions of the world. Additionally, we export and import to and from other countries. Our operations may, therefore, be subject to volatility because of currency fluctuations, inflation and changes in political and economic conditions in these countries. Sales and expenses are denominated in local currencies and may be affected as currency fluctuations affect our product prices and operating costs or those of our competitors.

We presently do not use any derivative financial instruments to hedge our exposure to adverse fluctuations in interest rates, foreign exchange rates, fluctuations in commodity prices or other market risks, nor do we invest in speculative financial instruments. As of September 30, 2007, our debt consisted of the following:

	•		the 2006 Note with Laurus, which has a fixed interest rate;

	•		the 2007 Note with Kallina that accrues interest at a rate per annum equal to the “prime rate” published in The Wall Street Journal from time to time, plus 3.0% (but such rate shall not at any time be less than 11.0%);

	•		VeriChip’s borrowings under its credit agreement with the RBC bearing interest at the Bank of Canada prime plus 1%;

	•		Digital Angel’s borrowings under Danish credit facilities bearing interest at prime plus 2%;

	•		Digital Angel’s borrowings under the Revolving Facility with Kallina that accrues interest at a rate per annum equal to the “prime rate” published in The Wall Street Journal from time to time, plus 2.0% (but such rate shall not at any time be less than 10.0%);

	•		an equipment loan bearing variable interest rates ranging from 6.00% to 8.14%; and

	•		a mortgage and capitalized leases with fixed or implicit interest rates.

Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are short-term. Due to the nature of our short-term investments, we have concluded that there is no material market risk exposure and, therefore, no quantitative tabular disclosure is required.

A 10% change in the applicable foreign exchange rates would result in an increase or decrease in our foreign currency gains and losses and translation adjustments of a de minimis amount. Therefore, no quantitative tabular disclosure is required.

The table below presents the principal amount and weighted-average interest rate for our debt portfolio (the fair value of our debt with variable interest rates reflects its carrying value):


	Carrying Value at September 30, 2007
	(dollars in thousands)
Total notes payable and long-term debt	$	31,436
Notes payable bearing interest at fixed interest rates	$	14,432
Weighted-average interest rate during the nine-months ended September 30, 2007		22.1	% ⁽¹⁾


(1)		Includes approximately $1.5 million of debt discount and debt issue costs associated with the repayment of Digital Angel’s debentures and the Greater Bay Facility effective August 31, 2007.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 240.13a — 15(e) and 240.15d — 15(e)) as of the end of the quarterly period ended September 30, 2007. Based on that evaluation, they have concluded that the Company’s disclosure controls and procedures as of the end of the period covered by this report are effective in timely providing them with material information relating to the Company required to be disclosed in the reports the Company files or submits under the Exchange Act. The Company’s disclosure controls and procedures are designed to provide reasonable assurances of achieving their objectives and the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective in reaching that level of reasonable assurance.

(b) Changes in Internal Control Over Financial Reporting

There have not been any changes in the Company’s internal controls over financial reporting identified in connection with an evaluation thereof that occurred during the Company’s third fiscal quarter that have materially affected, or are reasonable likely to materially affect the Company’s internal control over financial reporting. There were no significant deficiencies or material weaknesses, and therefore no corrective actions were taken.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are currently involved in several legal proceedings. We have accrued our estimate of the probable costs for the resolution of these claims. Our estimate has been developed in consultation with outside counsel handling our defense in these matters and is based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. It is possible, however, that future results of operations and cash flows for any particular quarterly or annual period could be materially affected by changes in our estimates. During the third quarter of 2007, we and Digital Angel entered into agreements for the settlement of legal proceedings. See Note 15 to our unaudited condensed consolidated financial statements, which is incorporated herein by reference, for a description of certain of these proceedings.

ITEM 1A. RISK FACTORS

Our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 includes a detailed discussion of the risk factors that could materially affect our business, financial condition or future results. The information presented below is a discussion of the material changes and updates to these risk factors and should be read in conjunction with the risk factors and information disclosed in the Form 10-K .

If we fail to continue to meet all applicable Nasdaq Capital Market requirements, our stock could be delisted by the Nasdaq Capital Market. If delisting occurs, it would adversely affect the market liquidity of our common stock and harm our businesses.

Our common stock is currently traded on the Nasdaq Capital Market under the symbol “ADSX.” If we fail to meet any of the continued listing standards of the Nasdaq Capital Market, our common stock could be delisted from the Nasdaq Capital Market. These continued listing standards include specifically enumerated criteria, such as:

	•		a $1.00 minimum closing bid price;

	•		shareholders’ equity of $2.5 million, market value of publicly-held shares of $35 million, or net income from continuing operations of $500,000 in the most recently completed fiscal year or in two of the last three most recently completed fiscal years;

	•		500,000 shares of publicly-held common stock with a market value of at least $1 million;

	•		300 round-lot stockholders; and

	•		compliance with Nasdaq’s corporate governance requirements, as well as additional or more stringent criteria that may be applied in the exercise of Nasdaq’s discretionary authority.

On November 8, 2007, and for the eleven consecutive trading days before November 8, 2007, our common stock was below $1.00. For continued listing of our common stock on the Nasdaq, Nasdaq Marketplace Rule 4310(c)(4) requires that the minimum bid price of a share of our common stock be at least $1.00. If the closing bid price of our common stock does not increase to $1.00 and remain at $1.00 or more for 30 consecutive business days, the Nasdaq will promptly notify us and we will have a period of 180 calendar days from such notification to achieve compliance. To regain compliance, the closing bid price of our common stock would have to remain at $1.00 or more for a minimum of ten consecutive trading days. If we do not regain compliance during this first 180-day period, Nasdaq will determine whether we meet the Nasdaq Capital Market initial listing criteria set out in Marketplace Rule 4310(c), except for the minimum bid price requirement. If at that time we meet the initial listing criteria (currently we do meet the initial listing criteria, except for the minimum bid price requirement), we will be eligible for an additional 180-day cure period. If we are not eligible for the additional cure period, Nasdaq will provide us with written notification that our common stock will be delisted. In such case, we will have the right to appeal Nasdaq’s delisting determination to a Listing Qualifications Panel. The 180-day cure period described above relates exclusively to our minimum bid price deficiency. We may be delisted during the 180-day period for failure to maintain compliance with any other continued listing requirements that occur during this period. Even if we are successful in curing a non-compliance, Nasdaq may seek to delist us for our failure to meet enumerated conditions for continued listing.

If our common stock is delisted from the Nasdaq Capital Market, trading of our common stock most likely will be conducted in the over-the-counter market on an electronic bulletin board established for unlisted securities, such as the Pink Sheets or the OTC Bulletin Board. Such delisting could also adversely affect our ability to obtain financing for the continuation of our operations and could result in the loss of confidence by investors, suppliers and employees.

Our stock prices and business may be adversely affected if the Merger is not completed.

If the Merger is not completed, the market price of our common stock may decline. If the Merger is not completed, we will still be required to pay significant costs incurred in connection with the Merger, including legal, accounting, and financial advisory fees. Additionally, if the Merger is not completed, we will have incurred significant costs, including the diversion of management resources, for which we will have received little or no benefit.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

As part of the consideration for the IC Note, the terms of which are more fully described in Note 5 to our condensed consolidated financial statements, Digital Angel issued us 856,886 shares of its common stock and agreed to pay us a structuring fee of $100,000, which Digital Angel paid by issuing to us 64,516 shares of its common stock. Thus, the total number of shares of Digital Angel common stock received in connection with the IC Note was 921,402. These securities were issued without registration in reliance upon the exemption provided by Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D promulgated thereunder.

The following table provides information regarding repurchases made by VeriChip of its common stock under a stock repurchase program:

ISSUER PURCHASES OF EQUITY SECURITIES ⁽¹⁾


					(c) Total Number of		(d) Approximate Dollar
			(b) Average		Shares (or Units)		Value of Shares (or
	(a) Total Number		Price Paid per		Purchased as Part of		Units) that May Yet Be
	of Shares (or		Share (or		Publicly Announced		Purchased Under the
Period	Units) Purchased ⁽²⁾		Unit) ⁽³⁾		Plans or Programs		Plans or Programs
9/20/2007 - 9/30/2007		18,000	$	4.38		18,000	$	1,420,000
10/1/2007 - 10/31/2007		163,199	$	4.18		163,199	$	740,000

Total		181,199	$	4.20		181,199	$	740,000


(1)		VeriChip’s stock repurchase program was announced on September 20, 2007. VeriChip’s board of directors unanimously authorized the repurchase of up to $1.5 million of VeriChip common stock over a four month period.

(2)		All shares were purchased through VeriChip’s publicly announced stock repurchase plan. The purchases were made in open market transactions.

(3)		The average price paid per share includes commissions paid to effect the transactions.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

On September 28, 2007, we and Hark M. Vasa and his family partnerships, the majority shareholder of PDSC’s predecessor at the time that we acquired that company, entered into a memorandum of settlement related to a complaint that had been filed against us on or about January 21, 2004. On November 8, 2007, the parties entered into a settlement Agreement and General Release. The terms of the settlement are more fully discussed in Note 15 to our condensed consolidated financial statements.

Website Access to Information and Disclosure of Web Access to Company Reports

Our website address is: http://www.adsx.com . We make available free of charge through our website our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, Forms 3, 4 and 5, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission.

ITEM 6. EXHIBITS

Exhibits

We have listed the exhibits by numbers corresponding to the Exhibit Table of Item 601 in Regulation S-K on the Exhibit list attached to this report.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	Applied Digital Solutions, Inc. (Registrant)
Dated: November 9, 2007	By:	/s/ lorraine m. breece
		Lorraine M. Breece
		Senior Vice President and Acting Chief Financial Officer

EXHIBITS


Exhibit
No.		Description

2.1		Agreement and Plan of Reorganization by and among Applied Digital Solutions, Inc., Digital Angel Corporation and Digital Angel Acquisition Corp., dated August 8, 2007 (incorporated by reference to Exhibit 2.1 to the registrant’s Form 8-K filed with the Commission on August 9, 2007)

3.1		Certificate of Incorporation of Applied Digital Solutions, Inc., a Delaware corporation (incorporated by reference to Exhibit 3.1 to the registrant’s Form 8-K filed with the Commission on April 25, 2007)

3.2		Bylaws of Applied Digital Solutions, Inc., a Delaware corporation (incorporated by reference to Exhibit 3.2 to the registrant’s Form 8-K filed with the Commission on April 25, 2007)

3.3		Amended and Restated Bylaws of Applied Digital Solutions, Inc. (incorporated by reference to Exhibit 3.3 to the registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 9, 2007)

10.1*		Settlement Agreement and General Release among Applied Digital Solutions, Inc., Pacific Decision Sciences Corporation and Hark M. Vasa and his family partnerships, dated September 28, 2007

10.2		Consulting Agreement between VeriChip Corporation and Randolph K. Geissler, dated August 8, 2007 (incorporated by reference to Exhibit 10.7 to the registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 9, 2007)

10.3		Letter Agreement between Digital Angel Corporation and Kevin McGrath, dated August 8, 2007 (incorporated by reference to Exhibit 10.8 to the registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 9, 2007)

10.4		Amendment No. 6 to Securities Purchase Agreement between Digital Angel Corporation and Imperium Master Fund, Ltd., dated August 24, 2007 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed with the Commission on August 30, 2007)

10.5		Omnibus Amendment and Waiver among Applied Digital Solutions, Inc., VeriChip Corporation, Laurus Master Fund, Ltd., Kallina Corporation, PSource Structured Debt Limited, Valens Offshore SPV II, Corp. and Valens U.S. SPV I, LLC, dated October 31, 2007 (incorporated by reference to Exhibit 10.1 to the registrant’s Form 8-K filed with the Commission on November 6, 2007)

10.6		Warrant Issued to PSource Structured Debt Limited to Purchase Common Stock of Applied Digital Solutions, Inc., dated October 31, 2007 (incorporated by reference to Exhibit 10.2 to the registrant’s Form 8-K filed with the Commission on November 6, 2007)

10.7		Warrant Issued to Valens Offshore SPV II, Corp. to Purchase Common Stock of Applied Digital Solutions, Inc., dated October 31, 2007 (incorporated by reference to Exhibit 10.3 to the registrant’s Form 8-K filed with the Commission on November 6, 2007)

10.8		Warrant Issued to Valens U.S. SPV I, LLC to Purchase Common Stock of Applied Digital Solutions, Inc., dated October 31, 2007 (incorporated by reference to Exhibit 10.4 to the registrant’s Form 8-K filed with the Commission on November 6, 2007)

10.9		Securities Purchase Agreement between Applied Digital Solutions, Inc. and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.1 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.10		Secured Term Note between Applied Digital Solutions, Inc. and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.2 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)


Exhibit
No.		Description

10.11		Master Security Agreement between Applied Digital Solutions, Inc. and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.3 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.12		Stock Pledge Agreement among Applied Digital Solutions, Inc., Kallina Corporation, Computer Equity Corporation, Digital Angel Corporation and Digital Angel Technology Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.4 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.13		Intellectual Property Security Agreement between Applied Digital Solutions, Inc. and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.5 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.14		Intercreditor Agreement among Applied Digital Solutions, Inc., Kallina Corporation, Laurus Master Fund, Ltd., Valens U.S. SPV I, LLC, and Valens Offshore SPV II, Corp., dated August 31, 2007 (incorporated by reference to Exhibit 10.6 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.15		Guaranty by Applied Digital Solutions, Inc. in favor of Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.7 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.16		Amendment and Partial Assignment of Loans, Liens and Documents among Kallina Corporation, Valens U.S. SPV I, LLC, and certain other parties named therein, dated August 31, 2007 (incorporated by reference to Exhibit 10.8 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.17		Amendment and Partial Assignment of Loans, Liens and Documents among Kallina Corporation, Valens Offshore SPV II, Corp., and certain other parties named therein, dated August 31, 2007 (incorporated by reference to Exhibit 10.9 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.18		Amendment to Warrant among Applied Digital Solutions, Inc., Laurus Master Fund, Ltd., Valens Offshore SPV I, Ltd., and Valens U.S. SPV I, LLC, dated August 31, 2007 (incorporated by reference to Exhibit 10.10 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.19		Intellectual Property Security Agreement between Applied Digital Solutions, Inc. and Laurus Master Fund, Ltd., dated August 31, 2007 (incorporated by reference to Exhibit 10.11 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.20		Registration Rights Agreement between Kallina Corporation and VeriChip Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.12 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.21		Secured Term Note among Applied Digital Solutions, Inc., Digital Angel Corporation, Digital Angel Technology Corporation, Fearing Manufacturing Co., Inc. and Digital Angel International, dated August 31, 2007 (incorporated by reference to Exhibit 10.13 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.22		Digital Angel Corporation Security Agreement among Applied Digital Solutions, Inc., Digital Angel Corporation, Digital Angel Technology Corporation, Fearing Manufacturing Co., Inc. and Digital Angel International, dated August 31, 2007 (incorporated by reference to Exhibit 10.14 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.23		Subordination Agreement among Applied Digital Solutions, Inc., Kallina Corporation, Valens Offshore SPV II, Corp. and Valens U.S. SPV I, LLC, dated August 31, 2007 (incorporated by reference to Exhibit 10.15 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.24		Secured Revolving Note among Digital Angel Corporation, certain of Digital Angel Corporation’s subsidiaries and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.16 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)


Exhibit
No.		Description

10.25		Security Agreement among Digital Angel Corporation, certain of Digital Angel Corporation’s subsidiaries and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.17 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.26		Stock Pledge Agreement among Digital Angel Corporation, Digital Angel Technology Corporation and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.18 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.27		Intellectual Property Security Agreement among Digital Angel Corporation, certain of Digital Angel Corporation’s subsidiaries and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.19 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.28		Registration Rights Agreement between Digital Angel Corporation and Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.20 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.29		Common Stock Purchase Warrant issued to Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.21 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

10.30		Subsidiary Guaranty by Digital Angel Corporation and certain of Digital Angel Corporation’s subsidiaries in favor of Kallina Corporation, dated August 31, 2007 (incorporated by reference to Exhibit 10.22 to the registrant’s Form 8-K filed with the Commission on November 7, 2007)

31.1		Certification by Michael K. Krawitz, Chief Executive Officer, pursuant to Exchange Act Rules 13A-14(a) and 15d-14(a)*

31.2		Certification by Lorraine M. Breece, Chief Financial Officer, pursuant to Exchange Act Rules 13A-14(a) and 15d-14(a)*

32.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

32.2		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*