As Filed with the Securities and Exchange Commission on November 15, 1999
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the Quarterly Period Ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the Transition Period From _____ To ______
Commission File Number: 000-26020
APPLIED DIGITAL SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
MISSOURI
(State or other jurisdiction of incorporation or organization)
43-1641533
(IRS Employer Identification number)
400 Royal Palm Way
Suite 410
Palm Beach, Florida 33480
(561) 366-4800
(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 Exchange Act 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 [X] No [ ]
The number of shares outstanding of each of the issuer's classes of
common stock as of the close of business on November 12, 1999:
Class Number of Shares
Common Stock; $.001 Par Value 44,708,661
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
TABLE OF CONTENTS
Item Description Page
PART I - FINANCIAL INFORMATION
1. Financial Statements
Consolidated Balance Sheets -
September 30, 1999 (unaudited) and December 31, 1998 3
Consolidated Statements of Operations -
Three and Nine Months ended September 30, 1999
and 1998 (unaudited) 4
Consolidated Statements of Stockholders' Equity -
Nine Months ended September 30, 1999
and 1998 (unaudited) 5
Consolidated Statements of Cash Flows -
Nine months ended September 30, 1999 and 1998 (unaudited) 6
Notes to Consolidated Financial Statements (unaudited) 7
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
3. Quantitative and Qualitative Disclosures About Market Risk 33
PART II - OTHER INFORMATION
1. Legal Proceedings 34
2. Changes In Securities 35
3. Defaults Upon Senior Securities 36
4. Submission of Matters to a Vote of Security Holders 36
5. Other Information 36
6. Exhibits and Reports on Form 8-K 36
SIGNATURE 37
EXHIBITS 38
2
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
Assets
September 30,
1999 December 31,
(Unaudited) 1998
------------- ------------
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 9,033 $ 4,555
Accounts receivable (net of allowance for doubtful accounts
of $1,384 in 1999 and $990 in 1998) 72,187 34,390
Inventories 40,756 20,657
Notes receivable 4,150 3,600
Prepaid expenses and other current assets 5,579 2,042
--------- ---------
Total Current Assets 131,705 65,244
Property And Equipment, Net 18,918 15,627
Notes Receivable 917 1,445
Goodwill, Net 77,445 33,430
Other Assets 11,490 8,370
--------- ---------
$ 240,475 $ 124,116
========= =========
</TABLE>
<TABLE>
<CAPTION>
Liabilities and Stockholders' Equity
<S> <C> <C>
Current Liabilities
Notes payable $ 28,863 $ 23,217
Current maturities of long-term debt 8,857 1,158
Due to shareholders of acquired subsidiary 15,000 --
Accounts payable and accrued expenses 52,671 26,382
-------- ---------
Total Current Liabilities 105,391 50,757
Long-Term Debt 40,865 2,838
-------- ---------
Total Liabilities 146,256 53,595
-------- ---------
Minority Interest 9,073 2,961
-------- ---------
Stockholders'Equity
Preferred shares:
Authorized 5,000 shares of $10 par value; special voting,
issued and outstanding 1 share, Class B voting, issued
and outstanding 1 share -- --
Common shares:
Authorized 80,000 shares of $.001 par value; issued 47,675
shares and outstanding 47,569 shares in 1999 and issued
35,683 shares and outstanding 35,577 shares in 1998 48 36
Common and preferred additional paid-in capital 78,938 60,517
Retained earnings 6,375 7,232
Treasury stock (carried at cost, 106 shares) (337) (337)
Accumulated other comprehensive income 122 112
--------- ---------
Total Stockholders' Equity 85,146 67,560
--------- ---------
$ 240,475 $ 124,116
========= =========
</TABLE>
See the accompanying notes to consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
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,
----------------------- ----------------------
1999 1998 1999 1998
----------------------- ----------------------
<S> <C> <C> <C> <C>
Revenue $ 107,262 $ 59,044 $ 231,790 $ 151,508
Cost Of Goods Sold 78,596 40,095 158,378 104,617
------ ------ ------ ------
Gross Profit 28,666 18,949 73,412 46,891
------ ------ ------ ------
Operating Costs And Expenses
Selling, general and administrative
expenses 24,022 14,337 61,838 34,954
Depreciation and amortization 2,612 1,300 6,373 3,087
Restructuring and unusual costs -- -- 2,550 --
------ ------ ------ ------
Total Operating Costs And Expenses 26,634 15,637 70,761 38,041
------ ------ ------ ------
Operating Income 2,032 3,312 2,651 8,850
Interest Income 155 94 433 313
Interest Expense (1,160) (461) (2,295) (1,127)
------ ------ ------ ------
Income Before Provision For Income Taxes,
Minority Interest And Extraordinary Loss 1,027 2,945 789 8,036
Provision For Income Taxes 644 1,021 1,086 2,763
------ ------ ------ ------
Income (Loss) Before Minority Interest And
Extraordinary Loss 383 1,924 (297) 5,273
Minority Interest (64) 258 400 627
------ ------ ------ ------
Income (Loss) Before Extraordinary Loss 447 1,666 (697) 4,646
Extraordinary Loss (Net Of Taxes of $89) -- -- 160 --
------ ------ ------ ------
Net Income 447 1,666 (857) 4,646
Preferred Stock Dividends -- 12 -- 44
------ ------ ------ ------
Net Income (Loss) Available To Common Stockholders $ 447 $ 1,654 $ (857) $ 4,602
====== ====== ====== ======
Earnings Per Share - Basic
Income (Loss) Before Extraordinary Loss $ .01 $ .05 $ (.02) $ .15
Extraordinary Loss -- -- -- --
------ ------ ------ ------
Net Income (Loss) Per Common Share - Basic $ .01 $ .05 $ (.02) $ .15
====== ====== ====== ======
Earnings Per Share - Diluted
Income (Loss) Before Extraordinary Loss $ .01 $ .05 $ (.02) $ .15
Extraordinary Loss -- -- -- --
------ ------ ------ ------
Net Income (Loss) Per Common Share - Diluted $ .01 $ .05 $ (.02) $ .15
====== ====== ====== ======
Weighted Average Number Of
Common Shares Outstanding - Basic 47,087 36,369 46,102 30,721
Weighted Average Number Of Common
Shares Outstanding - Diluted 47,424 36,863 46,736 32,041
--------------------------------------------------
</TABLE>
See the accompanying notes to consolidated financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For The Nine Month Periods Ended September 30, 1999 And 1998
(In thousands)
(Unaudited)
Accumulated
Prefered Shares Common Shares Additional Other Total
--------------- --------------- Paid-In Retained Treasury Comprehensive Stockholders'
Number Amount Number Amount Capital Earnings Stock Income Equity
------ ------ ------ ------ --------- -------- -------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance - January 1, 1998 -- $ -- 20,672 $ 21 $ 33,680 $ 2,586 $ -- $ (3) $ 36,284
--- ---- ------ ---- -------- ------- ------ ----- --------
Net income -- -- -- -- -- 4,646 -- -- 4,646
Comprehensive income -
foreign currency translation -- -- -- -- -- -- -- 191 191
unrealized gain on securities -- -- -- -- -- -- -- 6 6
--- ---- ------ ---- -------- ------- ------ ----- --------
Total Comprehensive Income -- -- -- -- -- 4,646 -- 197 4,843
Issuance of common shares -- -- 12,138 12 18,265 -- -- -- 18,277
Issuance of preferred shares 2 -- -- -- 6,897 -- -- -- 6,897
Warrants redeemed -- -- 850 1 1,949 -- -- -- 1,950
Preferred shares dividends paid -- -- -- -- -- (44) -- -- (44)
--- ---- ------ ---- -------- ------- ------ ----- --------
Balance - September 30, 1998 2 $ -- 33,660 $ 34 $ 60,791 $ 7,188 $ -- $ 194 $ 68,207
=== ==== ====== ==== ======== ======= ====== ===== ========
Balance - January 1, 1999 -- $ -- 35,577 $ 36 $ 60,517 $ 7,232 $ (337) $ 112 $ 67,560
--- ---- ------ ---- -------- ------- ------ ----- --------
Net loss -- -- -- -- -- (857) -- -- (857)
Comprehensive income -
foreign currency translation -- -- -- -- -- -- -- 12 12
unrealized gain on securities -- -- -- -- -- -- -- (2) (2)
--- ---- ------ ---- -------- ------- ------ ----- --------
Total Comprehensive Income (Loss) -- -- -- -- -- (857) -- 10 (847)
Issuance of common shares -- -- 1,602 2 16 -- -- -- 18
Issuance of common shares
for acquisition -- -- 10,390 10 18,405 -- -- -- 18,415
--- ---- ------ ---- -------- ------- ------ ----- --------
Balance - September 30, 1999 -- $ -- 47,569 $ 48 $ 78,938 $ 6,375 $ (337) $ 122 $ 85,146
=== ==== ====== ==== ======== ======= ====== ===== ========
</TABLE>
See the accompanying notes to financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
For The Nine Months
Ended September 30,
------------------------------
1999 1998
------------------------------
<S> <C> <C>
Cash Flows From Operating Activities
Net income (loss) $ (857) $ 4,646
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 6,373 3,087
Minority interest 400 627
Gain (loss) on sale of equipment and other assets 62 (76)
Non-cash restructuring cost 251 --
Change in assets and liabilities:
Increase in accounts receivable (22,767) (4,557)
Increase in inventories (15,121) (2,522)
Increase in prepaid expenses (2,603) (2,711)
Increase in deferred tax asset -- (107)
Increase (decrease) in accounts payable and accrued
expenses 19,966 (1,597)
------- --------
Net Cash Used In Operating Activities (14,296) (3,210)
------- --------
Cash Flows From Investing Activities
Increase in notes receivable - officers (857) (1,086)
Increase in other assets (1,304) (2,615)
Proceeds from sale of property, equipment and other assets 360 191
Payments for property and equipment (3,771) (1,640)
Proceeds from (payments for) asset and business
acquisitions (net of cash balances acquired) (15,852) 29
------- --------
Net Cash Used In Investing Activities (21,424) (5,121)
------- --------
Cash Flows From Financing Activities
Net amounts borrowed (paid) on notes payable (70) 8,173
Proceeds from long-term debt 51,942 891
Payments on long-term debt (8,334) (4,389)
Redemption of preferred shares -- (900)
Preferred stock dividends paid -- (44)
Issuance of common shares -- 2,350
Other financing costs (3,340) --
------- --------
Net Cash Provided By Financing Activities (40,198) 6,081
------- --------
Net Increase (Decrease) In Cash And Cash Equivalents 4,478 (2,250)
Cash And Cash Equivalents - Beginning Of Period 4,555 7,657
------- --------
Cash And Cash Equivalents - End Of Period $ 9,033 $ 5,407
======= ========
Supplemental Disclosure Of Cash Flow Information
Income taxes paid $ 880 $ 2,052
Interest paid 2,435 1,046
Noncash investing and financing activities:
Assets acquired for long-term debt 662 1,775
Issuance of common shares for acquisitions 18,415 --
Due to shareholders of acquired subsidiary 15,000 --
------- ------
</TABLE>
See the accompanying notes to consolidated financial statements.
6
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of Applied
Digital Solutions, Inc. (formerly Applied Cellular Technology, Inc.) (the
"Company") as of September 30, 1999 and December 31, 1998 and for the three and
nine months ended September 30, 1999 and 1998 have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the
Securities Exchange Act of 1934. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of the Company's management,
all adjustments (consisting of only normal recurring adjustments) considered
necessary to present fairly the consolidated financial statements have been
made.
The consolidated statement of operations for the three and nine months
ended September 30, 1999 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 for the year ended December 31, 1998.
2. Principles of Consolidation
The financial statements include the accounts of the Company and its
wholly owned and majority owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
3. Inventory
Inventory at September 30, 1999 and December 31, 1998 consists of:
September 30, December 31,
1999 1998
------------- ------------
Raw materials $ 4,334 $ 4,437
Work in process 2,390 2,349
Finished goods 34,853 15,246
-------- --------
41,577 22,032
Allowance for warranty, excess and
obsolescence (821) (1,375)
======== =========
$40,756 $ 20,657
======== =========
7
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
4. Financing Agreements
In August, 1998, the Company entered into a $20 million line line of
credit with State Street Bank and Trust Company secured by all of our domestic
assets at the prime lending rate or at the London Interbank Offered Rate, at our
discretion. In February 1999, the amount of the credit available under the
facility was increased to $23 million. On May 25, 1999, the Company entered
into a Term and Revolving Credit Agreement with IBM Credit Corporation (the "IBM
Agreement"). On May 26, 1999, the Company repaid the amount due to State Street
Bank and Trust Company. On July 30, 1999, the IBM Agreement was amended and
restated. The IBM Agreement, as amended, provides for:
(a) a revolving credit line of up to $38.5 million, designated as follows:
(i) a USA revolving credit line of up to $27 million, (ii) a Canadian
revolving credit line of up to C$8.978 million, and (iii) a United
Kingdom revolving credit line of up to $3 million,
(b) a term loan A of up $22 million,
(c) a term loan B of up to $25 million,
(d) a term loan C designated in Canadian dollars of up to C$10.0 million,
and
(e) a term loan D designated in Canadian dollars of up to C$8.425 million.
The revolving credit line may be used for general working capital
requirements, capital expenditures and certain other permitted purposes. The USA
revolving credit line bears interest at the 30-day LIBOR rate plus 1.75% to
1.90% depending on the Company's leverage ratio; the Canadian revolving credit
line bears interest at the base rate as announced by the Toronto-Dominion Bank
of Canada each month plus 0.1707% to .2207%, depending on the Company's leverage
ratio; the UK revolving credit line bears interest at the base rate as announced
by the National Westminster Bank PLC of England each month plus 1.4207% to
.5707%, depending upon the Company's leverage ratio. As of September 30, 1999,
the LIBOR rate was approximately 5.2853% and approximately $24.1 million was
outstanding on the revolving credit line.
Term loan A, which was used to pay off State Street Bank and Trust
Company, bears interest at the 30-day LIBOR rate plus 1.75% to 1.90%, is
amortized in quarterly installments over six years and is repayable in full on
the third anniversary of the closing date of the loan. As of September 30, 1999,
approximately $21.0 million was outstanding on this loan.
Term loan B, which may be used for acquisitions, bears interest at the
30-day LIBOR rate plus 1.75% to 1.90%, is amortized in quarterly installments
over six years and is repayable in full on the third anniversary of the closing
date of the loan. As of September 30, 1999, approximately $20.4 million was
outstanding on this loan.
Term loan C, which was used by our Canadian subsidiaries to pay off
their bank debt, bears interest at the base rate as announced by the
Toronto-Dominion Bank of Canada each month plus 0.1707%, to 0.2207%, is
amortized in quarterly installments over six years and is repayable in full on
the third anniversary of the closing date of the loan. As of September 30, 1999,
Toronto-Dominion's rate was approximately 6.25% and approximately C$9.7 million
was outstanding on this loan.
8
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
Term loan D, which may be used by one of our Canadian subsidiaries for
acquisitions, bears interest at the base rate as announced by the
Toronto-Dominion Bank of Canada each month plus 0.1707%, to 0.2207%, is
amortized in quarterly installments over six years and is repayable in full on
the third anniversary of the closing date of the loan. As of September 30, 1999,
no advances have been made under this facility.
The agreement contains standard debt covenants relating to the
financial position and performance as well as restrictions on the declarations
and payment of dividends. As of September 30, 1999, the Company was in
compliance with all debt covenants.
5. Restructuring and Unusual Charges
In the first quarter of 1999, a pre-tax charge of $2,550 was recorded
to cover restructuring costs of $2,236 and unusual charges of $314.
RESTRUCTURING CHARGE
As part of the Company's reorganization of its core business into five
reportable business groups, the Company has implemented a restructuring plan.
The restructuring plan includes the exiting of selected lines of business within
the Company's Telecommunications and Application Technology business groups, and
the associated write-off of assets. The restructuring charge of $2,236 includes
asset impairments, primarily software and other intangible assets, of $1,522,
lease terminations of $541, and employee separations of $173. The total charge
reduced net income by $1,588.
The following table sets forth the rollforward of the liabilities for
business restructuring from January 1, 1999 through September 30, 1999:
Balance, Balance,
January 1, September 30,
Type of Cost 1999 Additions Deductions 1999
-------------------- ---------- --------- --------- -------------
Asset Impairment $ -- $ 1,522 $ (1,522) $ --
Lease terminations -- 541 ( 151) 390
Employee separations -- 173 ( 73) 100
====== ======= ========= ======
Total $ -- $ 2,236 $ (1,746) $ 490
====== ======= ========= ======
Management believes that the remaining reserves for business
restructuring are adequate to complete its plan and anticipates completing the
plan and paying all related cash amounts by the end of 1999.
UNUSUAL ITEMS
During the first quarter of 1999, as part of the Company's core
business reorganization, the Company realigned certain operations within its
Telecommunications division and has recognized impairment charges and other
related costs of $314. The total charge reduced net income by $223.
9
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
6. Extraordinary Loss
In connection with the early retirement of the Company's line of credit
with State Street Bank and Trust Company and its simultaneous refinancing with
IBM Credit Corporation, deferred financing fees associated with the State Street
Bank and Trust agreement were written off during the second quarter of 1999. The
total amount of the write-off recorded as an extraordinary loss was $160, net of
income taxes.
<TABLE>
7. Earnings Per Share
The following is a reconciliation of the numerator and denominator of
basic and diluted earnings per share:
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
-------------------------------------------------
NUMERATOR:
Net income (loss) $ 447 $ 1,666 $ (857) $ 4,646
Preferred stock dividends -- 12 44
------------------------------------------------
Numerator for basic earnings per share -
Net income available to common stockholders 447 1,654 (857) 4,602
Effect of dilutive securities:
Preferred stock dividends -- 12 -- 44
------------------------------------------------
Numerator for diluted earnings per share -
Net income available to common stockholders $ 447 $ 1,666 $ (857) $ 4,646
================================================
Denominator:
Denominator for basic earnings per share -
Weighted-average shares (1) 47,087 36,369 46,102 30,721
------------------------------------------------
Effect of dilutive securities -
Redeemable preferred stock 74 114
Warrants 85 208 186 621
Employee stock options 252 -- 448 275
Contingent stock - acquisitions 212 310
------------------------------------------------
Dilutive potential common shares 337 494 634 1,320
------------------------------------------------
Denominator for diluted earnings per share - Adjusted
Weighted-average shares and assumed conversions
47,424 36,863 46,736 32,041
================================================
Basic earnings (loss) per share $ 0.01 $ 0.05 $ (0.02) $ 0.15
================================================
Diluted earnings (loss) per share $ 0.01 $ 0.05 $ (0.02) $ 0.15
================================================
- -----------------------
<FN>
(1) Includes, for the three and nine month periods ended September 30,
1999, 836,472 shares of common stock reserved for issuance to the
holders of our Canadian subsidiaries' exchangeable shares.
</FN>
</TABLE>
10
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
8. Segment Information
In 1998, the Company adopted Statement of Financial Accounting Standard
No. 131, Disclosures about Segments of an Enterprise and Related Information.
Prior year information has been restated to present our reportable segments.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in the Company's
Annual Report on Form 10-K filed for the year ended December 31, 1998, except
that intersegment 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. Segment performance is evaluated based on
stand-alone segment operating income.
Following is the selected segment data as of and for the three months
ended September 30, 1999:
<TABLE>
<CAPTION>
------- --------- -------- -------- -------- --------- -------- --------- -------- ---------
Appli- Communi-
Tele- Network cation cations
communi- Infra- Techno- Intelle- Infra- Corporate Elimi- Consoli-
cations structure Internet logy sale.com structure Non-Core Overhead ation dated
------- --------- -------- -------- -------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
External
revenue $17,265 $ 7,398 $2,285 $11,800 $48,664 $14,552 $ 5,268 $ 30 $ -- $107,262
Intersegment
revenue -- -- -- -- 2,818 -- -- -- (2,818) --
------- ------- ------ ------- ------- ------- ------- ------- -------- --------
Total revenue 17,265 7,398 2,285 11,800 51,482 14,552 5,268 30 (2,818) 107,262
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Operating
income (loss) 571 622 280 309 2,074 671 (76) (1,562) (857) 2,032
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Total assets 39,211 7,241 2,166 26,874 72,166 20,412 14,859 57,546 -- 240,475
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
</TABLE>
Following is the selected segment data as of and for the nine months
ended September 30, 1999:
<TABLE>
<CAPTION>
------- --------- -------- -------- -------- --------- -------- --------- -------- ---------
Appli- Communi-
Tele- Network cation cations
communi- Infra- Techno- Intelle- Infra- Corporate Elimi- Consoli-
cations structure Internet logy sale.com structure Non-Core Overhead ation dated
------- --------- -------- -------- -------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
External
revenue $40,797 $19,905 $4,405 $26,498 $87,736 $36,942 $15,437 $ 70 $-- $231,790
Intersegment
revenue -- -- -- -- 5,006 -- -- -- (5,006) --
------- ------- ------ ------- ------- ------- ------- ------- -------- --------
Total revenue 40,797 19,905 4,405 26,498 92,742 36,942 15,437 70 (5,006) 231,790
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Operating
income (loss) 834 1,612 560 363 6,011 1,308 311 (6,416) (1,932) 2,651
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Total assets 39,211 7,241 2,166 26,874 72,166 20,412 14,859 57,546 -- 240,475
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
</TABLE>
11
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Following is the selected segment data as of and for the three months
ended September 30, 1998:
------- --------- -------- -------- -------- --------- -------- --------- -------- ---------
Appli- Communi-
Tele- Network cation cations
communi- Infra- Techno- Intelle- Infra- Corporate Elimi- Consoli-
cations structure Internet logy sale.com structure Non-Core Overhead ation dated
------- --------- -------- -------- -------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
External
revenue $ 8,368 $5,431 $1,006 $7,130 $14,845 $14,540 $7,176 $ 548 $ -- $59,044
Intersetment
revenue -- -- -- -- 391 -- -- -- (391) --
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Total revenue 8,368 5,431 1,006 7,130 15,236 14,540 7,176 548 (391) 59,044
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Operating
income (loss) 301 380 79 1,272 852 1,119 557 (899) (349) 3,312
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Total assets 20,943 5,904 1,056 21,643 12,248 17,132 14,156 29,134 -- 122,216
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
</TABLE>
Following is the selected segment data as of and for the nine months
ended September 30, 1998:
<TABLE>
<CAPTION>
------- --------- -------- -------- -------- --------- -------- --------- -------- ---------
Appli- Communi-
Tele- Network cation cations
communi- Infra- Techno- Intelle- Infra- Corporate Elimi- Consoli-
cations structure Internet logy sale.com structure Non-Core Overhead ation dated
------- --------- -------- -------- -------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
External
revenue $22,992 $16,008 $1,904 $12,738 $43,041 $38,342 $15,256 $1,227 $ -- $151,508
Intersegment
revenue -- -- -- -- 923 -- -- -- (923) --
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Total revenue 22,992 16,008 1,904 12,738 43,964 38,342 15,256 1,227 (923) 151,508
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Operating
Income (loss) 2,020 1,190 234 1,717 3,242 2,842 789 (2,296) (888) 8,850
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
Total assets 20,943 5,904 1,056 21,643 12,248 17,132 14,156 29,134 -- 122,216
======= ======= ====== ======= ======= ======= ======= ======= ======== ========
</TABLE>
9. Mergers and Acquisitions
In April 1999, we acquired:
(a) 100% of the outstanding shares of common stock of Port Consulting,
Inc., an integrator of information technology application systems and custom
application development services in consideration for $621 at closing, and the
assumption of debt of approximately $579. Up to an additional $2,000 is payable
in each of 2002 and 2004 if certain earnings targets are achieved.
(b) 100% of the outstanding common shares of Hornbuckle Engineering,
Inc., an integrated voice and data solutions provider based in Monterey,
California, for $3,680 paid with 555 shares of our Common Stock with a fair
value of approximately $2,000 and a cash payment of approximately $1,700. Up to
an additional $2,000 is payable in the future if certain earnings targets are
achieved.
(c) 100% of Lynch Marks & Associates, Inc., a network integration
company based in Berkley, California in exchange for 773 shares of our Common
Stock with a fair value of $2,526, Up to an additional $3,200 is payable in the
future if certain earnings targets are achieved.
12
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
(d) 100% of STR, Inc., a software solutions company based in Cleveland,
Ohio in exchange for 932 shares of our Common Stock with a fair value of $3,050.
Up to an additional $8,000 is payable in the future if certain earnings targets
are achieved.
These four acquisitions were accounted for using the purchase method of
accounting. Fair value of net assets acquired and liabilities assumed was
$1,029, resulting in goodwill of $8,898, which is being amortized over 20 years.
In May 1999, the Company entered into an agreement to merge its wholly
owned Canadian subsidiary, TigerTel Services Limited, with Contour Telecom
Management, Inc., a Canadian company. The Company received, in a reverse merger
transaction, 19,769 shares of Contour's common stock, representing approximately
75% of the total outstanding shares, with a fair value of $5,627. The
transaction was accounted for under the purchase method of accounting. Fair
value of net assets acquired and liabilities assumed was $875, resulting in
goodwill of $4,752, which is being amortized over 20 years.
In June 1999, our subsidiary Intellesale.com, Inc., purchased all of
the shares of Bostek, Inc. and Micro Components International, Incorporated
(collectively, "Bostek") for $25,200, of which $10,200 was paid in cash at
closing. Upon a successful initial public offering of Intellesale.com, $10,000
will be payable in stock of Intellesale.com and the remaining amount will be
payable in cash over time. In the event an initial public offering does not
occur, the $10,000 will be payable in cash. An additional $5,000 is contingent
upon the achievement of certain earnings targets. Bostek is engaged in the
business of acquiring open-box and off-specification computer equipment and
selling such equipment, using the internet and other selling channels. The
transaction was accounted for under the purchase method of accounting. Fair
value of net assets acquired and liabilities assumed was $3,747, resulting in
goodwill of $21,458, which is being amortized over 20 years.
Total assets acquired, including goodwill, during the second quarter of
1999, are summarized as follows:
Purchase price $40,759
Net assets acquired 5,650
---------
Goodwill $35,109
=========
Unaudited pro forma results of operations for the nine months ended
September 30, 1999 and 1998 are included below. Such pro forma information
assumes that the above transactions had occurred as of January 1, 1999 and 1998,
respectively.
Nine months Ended
September 30,
1999 1998
---------- ----------
Revenues $ 285,467 $ 236,777
Income (loss) before extraordinary loss (446) 6,033
Net income (loss) (606) 6,033
13
<PAGE>
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
10. Amendments to Purchase Agreements
In the second quarter of 1999, the Company reached tentative agreement
to settle put options that were entered into with the selling shareholders of
various companies in which the Company acquired a less than 100% interest. The
Company agreed to pay $3.9 million in a combination of cash and stock of one of
the Company's subsidiaries, Intellesale.com, in exchange for the remaining
ownership interest. Several of the purchase agreements for the subsidiaries
contained a provision whereby the seller could obtain additional "earnout
payments" upon achievement of certain earnings targets. The Company entered into
contingent agreements during the second quarter of 1999 to fix the amount of
these payments at $6.2 million in a combination of cash and stock of
Intellesale.com. These settlements are contingent upon the successful completion
of a planned public offering of Intellesale.com within one year of the date of
the agreements.
11. Subsequent Events
On October 29, 1999, we entered into an agreement to dispose of four
companies in our Communications Infrastructure group for total consideration of
$13.5 million. Additionally the Company has decided to repurchase approximately
2.7 million shares of our Common Stock.
In October 1999, Intellesale filed an Amended Registration Statement on
Form S-1 for the sale of its common stock. The Registration Statement is subject
to review and may be modified. There is no assurance that the registration of
Intellesale's common stock will become effective.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This discussion should be read in conjunction with the accompanying
consolidated financial statements and related notes in Item 1 of this report as
well as our Annual Report on Form 10-K for the year ended December 31, 1998.
Certain statements made in this report may contain forward-looking statements.
For a description of risks and uncertainties relating to such forward-looking
statements, see the Risk Factors sections later in this Item.
OUTLOOK
Our objective is to continue to grow each of our operating segments
internally and through acquisitions, both domestically and abroad. Our strategy
has been, and continues to be, to invest in and acquire businesses that
complement and add to our existing business base. We have expanded significantly
through acquisitions in the past and continue to do so. Our financial results
and cash flows are substantially dependent on not only our ability to sustain
and grow existing businesses, but to continue to grow through acquisition. We
expect to continue to pursue our acquisition strategy in 1999 and future years,
but there can be no assurance that management will be able to continue to find,
acquire, finance and integrate high quality companies at attractive prices.
RECENT DEVELOPMENTS
During the second quarter of 1999, we made several acquisitions. In
April 1999, we acquired:
(a) 100% of the outstanding shares of common stock of Port Consulting,
Inc., an integrator of information technology application systems and custom
application development services based in Jacksonville, Florida;
(b) 100% of the outstanding common shares of Hornbuckle Engineering,
Inc., an integrated voice and data solutions provider based in Monterey,
California;
(c) 100% of Lynch Marks & Associates, Inc., a network integration
company based in Berkley, California; and
(d) 100% of STR, Inc., a software solutions company based in Cleveland,
Ohio.
In May 1999, we entered into an agreement to merge our wholly owned
Canadian subsidiary, TigerTel Services Limited, with Contour Telecom Management,
Inc., a Canadian company. We received, in a reverse merger transaction, 19,769
shares of Contour's common stock, representing approximately 75% of the total
outstanding shares.
In June 1999, our subsidiary Intellesale.com, Inc., purchased all of
the shares of Bostek, Inc. and Micro Components International, Incorporated
(collectively, "Bostek"). Bostek is engaged in the business of acquiring
open-box and off-specification computer equipment and selling such equipment,
using the internet and other selling channels.
15
<PAGE>
All acquisitions were accounted for using the purchase method of
accounting. Total assets acquired, including goodwill, during the second quarter
of 1999, are summarized as follows:
Purchase price $40,759
Net assets acquired 5,650
-------
Goodwill $35,109
=======
On September 14, 1999, we filed a registration statement with the
Securities and Exchange Commission (SEC) in preparation for the offering of
shares of one of our subsidiaries, Intellesale.com, to the public. In connection
therewith, in the second quarter of 1999, we reached tentative agreement to
settle put options that were entered into with the selling shareholders of
various companies in which we had acquired a less than 100% interest. We agreed
to pay $3.9 million in a combination of cash and stock of Intellesale.com, in
exchange for the remaining ownership interest. Several of the purchase
agreements for the subsidiaries contained a provision whereby the seller could
obtain additional "earnout payments" upon achievement of certain earnings
targets. We entered into contingent agreements during the second quarter of 1999
to fix the amount of these payments at $6.2 million in a combination of cash and
stock of Intellesale.com. The above settlements are contingent upon the
successful completion of the public offering of Intellesale.com within one year
of the date of the agreements.
As part of our reorganization of our core business into five reportable
business groups, we implemented a restructuring plan in the first quarter of
1999. The restructuring plan includes the exiting of selected lines of business
within the our Telecommunications and Application Technology business groups,
and the associated write-off of assets. In the first quarter of 1999, we
incurred a restructuring charge of $2,236 that includes asset impairments,
primarily software and other intangible assets, of $1,522, lease terminations of
$541, and employee separations of $173. In addition, during the first quarter of
1999, as part of our core business reorganization, we realigned certain
operations within our Telecommunications division and recognized impairment
charges and other related costs of $314.
In October 1999, we disposed of four business units within our
Communications Infrastructure Group for total consideration of $13.5 million. We
have concluded that the business units within this segment are no longer core to
our operations and we anticipate that we will dispose of the remaining two
business units within this segment by the end of the first quarter of 2000.
During the third quarter of 1999, in anticipation of the disposal of these four
business entities, we incurred one-time, non-recurring, pre-tax costs of
approximately $569, of which $250 is included in cost of goods sold and $319 is
included in selling, general and administrative expenses.
In May 1999, we negotiated the early retirement of our line of credit
with State Street Bank and Trust Company ("State Street Debt") and its
simultaneous refinancing with IBM Credit Corporation. The IBM Agreement, as
amended and restated, provides for a revolving credit line of up to $39.5
million, a term loan A of up $22 million, a term loan B of up to $25 million, a
term loan C designated in Canadian dollars of up to C$10.0 million, and a term
loan D designated in Canadian dollars of up to C$8.425 million. Deferred
financing fees associated with the State Street debt were written off during the
second quarter of 1999. The total amount of the write-off recorded as an
extraordinary loss was $160, net of income taxes.
16
<PAGE>
Beginning in the fourth quarter of 1998 and continuing into 1999, we
reorganized into seven operating segments to more effectively and efficiently
provide integrated communications products and services to a broad base of
customers. During the second quarter of 1999, several adjustments were made to
the composition of the Telecommunications, Internet and Non-core divisions to
better align the strengths of the respective divisions with the objectives of
those divisions. Prior year information has been restated to present our
reportable segments. The four operating segments that currently represent our
core competency are:
o Telecommunications - The Telecommunications division provides telephone
services and systems, computer telephony integration, interactive voice
response, call centers and voice messaging.
o Network Infrastructure - The Network Infrastructure division provides
computer systems, local area networks and application servers.
o Internet - The Internet division provides electronic commerce, intranet
and extranet services and wide area networks.
o Application Technology - The Application Technology division provides
global positioning systems, satellite systems, field automation, asset
management, corporate enterprise access, decision support and
voice/data technology.
Operating segments outside our core competency are:
o Intellesale.com - The Intellesale.com division, formerly known as
Inteletek, purchases and sells new and used computer equipment, and
provides peripherals, components, consulting, systems integration and
transportation of all types of computer systems.
o Communications Infrastructure - The Communications Infrastructure
division provides communications towers, fiber optics, cabling, power
distribution and communications equipment. Four of the six entities
within this business unit were disposed of in October 1999.
o Non-Core - The Non-Core division provides electrical components,
control panels, design engineering, manufacturing engineering,
automation systems and vacuum pumps.
17
<PAGE>
RESULTS OF OPERATIONS
The following table summarizes our results of operations as a
percentage of revenue for the three and nine month periods ended September 30,
1999 and 1998 and is derived from the unaudited consolidated statements of
operations in Part I, Item, 1 of this report.
<TABLE>
<CAPTION>
Relationship to Revenue
--------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------
1999 1998 1999 1998
% % % %
<S> <C> <C> <C> <C>
Revenue 100.0 100.0 100.0 100.0
Cost of goods sold 73.3 67.9 68.3 69.1
----- ----- ----- -----
Gross profit 26.7 32.1 31.7 30.9
Selling, general and administrative expenses 22.4 24.3 26.7 23.1
Depreciation and amortization 2.4 2.2 2.7 2.0
Restructuring and unusual charges -- -- 1.2 --
----- ----- ----- -----
Operating income 1.9 5.6 1.1 5.8
Interest income 0.1 0.2 0.2 0.2
Interest expense (1.1) (0.8) (1.0) (0.7)
----- ----- ----- -----
Income (loss) before provision for income taxes, 0.9 5.0 0.3 5.3
minority interest and extraordinary loss
Provision for income taxes 0.6 1.7 0.4 1.8
----- ----- ----- -----
Income (loss) before minority interest and 0.3 3.3 (0.1) 3.5
extraordinary loss
Minority interest 0.1 (0.5) (0.2) (0.4)
----- ----- ----- -----
Income (loss) before extraordinary loss 0.4 2.8 (0.3) 3.1
Extraordinary loss -- -- (0.1) --
Preferred stock dividends -- 0.0 -- 0.1
----- ----- ----- -----
Net income (loss) available to common stockholders 0.4 2.8 (0.4) 3.0
===== ===== ===== =====
</TABLE>
18
<PAGE>
Company Overview
Revenue
Revenue for the three months ended September 30, 1999 was $107.2
million, an increase of $48.2 million, or 81.7%, from $59.0 million for the
three months ended September 30, 1998. Revenue for the nine months ended
September 30, 1999 was $231.8 million, an increase of $80.3 million, or 53.0%,
from $151.5 million for the nine months ended September 30, 1998.
Revenue generated during the three and nine months ended September 30,
1999 and 1998 by operating segment was:
<TABLE>
<CAPTION>
--------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Telecommunications $ 17,265 $ 8,368 $ 40,797 $ 22,992
Network Infrastructure 7,399 5,431 19,905 16,008
Internet 2,285 1,006 4,405 1,904
Application Technology 11,800 7,130 26,498 12,738
Intellesale.com 51,482 15,236 92,742 43,964
Communications Infrastructure 14,552 14,540 36,942 38,342
Non-Core 5,268 7,176 15,437 15,256
Corporate (including amounts incurred during
consolidation) (2,789) 157 (4,936) 304
========== ======== ========= =========
Consolidated $ 107,262 $ 59,044 $231,790 $151,508
========== ======== ========= =========
</TABLE>
Changes during the quarter and year-to-date were:
o Telecommunications revenue increased 106.3% for the quarter and 77.4% for
the year as a result of TigerTel's reverse merger with Contour in May 1999.
Revenue from this entity increased by $7.6 million in the third quarter of
1999 compared to the third quarter of 1998.
o Network infrastructure revenue increased 36.2% for the quarter and 24.3%
for the year as a result of the acquisitions, in the second quarter of
1999, of Hornbuckle Engineering, Inc. and Lynch Marks & Associates. These
entities contributed $3.2 million to revenue in the third quarter.
o Internet revenue increased by 127.1% in the quarter and 131.4% for the year
as a result of our acquisition of Port Consulting in the second quarter of
1999.
o Application technology's revenue increased by 65.5% in the quarter and
108.0% for the year. This division includes the revenues of STR, Inc. an
acquisition completed during the second quarter of 1999. Revenue
contributed by STR during the third quarter amounted to $5.1 million or
108.5% of the increased revenue of this group. The decrease in revenue from
existing businesses is the result of our planned exit from certain lines of
business within this division.
o Intellesale.com's revenue increased 237.9% for the quarter and 110.9% for
the year. Bostek, which was acquired in June 1999, contributed $28.4
million in the third quarter or 78.5% of the increase for the quarter and
58.3% of the increase for the year, while existing businesses contributed
the difference.
o Communications infrastructure's revenue was flat in the quarter and
declined by 3.7% for the year. Increased competition and the slowing of
certain lines of business contributed to this decline.
19
<PAGE>
o Non-core revenue decreased 26.6% in the quarter and increased 1.2 % for the
year. One entity in this segment was sold at the beginning of 1999 and its
revenue is no longer included, and certain lines of business within this
segment continue to suffer from competition and lost market share.
Gross Profit and Gross Margin Percentage
Gross profit for the three months ended September 30, 1999 was $28.6
million, an increase of $9.7 million, or 51.3%, from $18.9 million for the three
months ended September 30, 1998. Gross profit for the nine months ended
September 30, 1999 was $73.4 million, an increase of $26.5 million, or 56.5%,
from $46.9 million for the nine months ended September 30, 1998. As a percentage
of revenue, the gross margin was 26.7% and 32.1% for the three months ended
September 30, 1999 and 1998, and was 31.7% and 30.9% for the nine months ended
September 30, 1999 and 1998, respectively.
Gross profit for the three and nine months ended September 30, 1999 and
1998 by operating segment was:
<TABLE>
<CAPTION>
--------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Telecommunications $ 5,837 $ 4,304 $16,853 $11,963
Network Infrastructure 2,574 944 6,226 2,841
Internet 1,696 397 3,314 841
Application Technology 5,367 4,319 14,537 8,234
Intellesale.com 7,943 3,877 19,588 10,414
Communications Infrastructure 3,930 2,966 8,732 7,817
Non-Core 1,289 1,878 4,093 4,179
Corporate (including amounts incurred during
consolidation) 30 264 69 602
--------------------------------------------------
Consolidated $28,666 $18,949 $73,412 $46,891
==================================================
</TABLE>
Gross margin percentage for the three and nine months ended September
30, 1999 and 1998 by operating segment was:
<TABLE>
<CAPTION>
--------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------------
1999 1998 1999 1998
% % % %
<S> <C> <C> <C> <C>
Telecommunications 33.8 51.4 41.3 52.0
Network Infrastructure 34.8 17.4 31.3 17.7
Internet 74.2 39.5 75.2 44.2
Application Technology 45.5 60.6 54.9 64.6
Intellesale.com 15.4 25.4 21.1 23.7
Communications Infrastructure 27.0 20.4 23.6 20.4
Non-Core 24.5 26.2 26.5 27.4
--------------------------------------------------
Consolidated 26.7 32.1 31.7 30.9
==================================================
</TABLE>
20
<PAGE>
Changes during the quarter and year-to date were:
o Telecommunications gross profits increased by 35.6% for the quarter and
40.9% for the year, but margins declined to 33.8% from 51.4% for the
quarter and to 41.3% from 52.0% for the year. The increase in absolute
dollars is as a result of the acquisition of Contour, but this acquisition
also contributed to the lower overall gross margin. Contour's margins are
historically lower than those of the other entities within this division.
o Network infrastructures improvement is solely attributable to the
acquisitions during the second quarter of 1999. The companies acquired are
service oriented companies with most expenses being classified as selling,
general and administrative.
o Internet's increase is due to the inclusion of Port Consulting, acquired in
the second quarter of 1999.
o Application technology increased in absolute dollar amounts due to the
acquisition of STR but declined as a percentage of revenue as we
implemented our planned exit from a once highly profitable but declining
market.
o Intellesale.com's dollar gross profit increased as a result of increased
revenue from Bostek and internal growth, but our margins declined as we
continued our expansion and focus our business on Internet commerce. We do
not anticipate that margins will decline any further in the future.
o Communication infrastructure's gross profit and margin improved, despite
flat revenue for the quarter and declining revenue for the year, as
construction projects were completed during the quarter at higher than
previously estimated gross profits.
o Non-core's gross profit and margin declined due to the sale of one business
at the beginning of 1999 and the overall poor performance of the units
within this division.
Selling, General and Administrative Expense
Selling, general and administrative expense for the three months ended
September 30, 1999 was $24.0 million, an increase of $9.7 million, or 67.8%,
from $14.3 million for the three months ended September 30, 1998. Selling,
general and administrative expense for the nine months ended September 30, 1999
was $61.8 million, an increase of $26.9 million, or 77.1%, from $34.9 million
for the nine months ended September 30, 1998. As a percentage of revenue,
selling, general and administrative expense was 22.4% and 24.3% for the three
months ended September 30, 1999 and 1998, respectively and was 26.7% and 23.1%
for the nine months ended September 30, 1999 and 1998, respectively.
21
<PAGE>
Selling, general and administrative expense for the three and nine
months ended September 30, 1999 and 1998 by operating segment was:
<TABLE>
<CAPTION>
---------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Telecommunications (1) $ 4,800 $ 3,793 $14,382 $ 9,510
Network Infrastructure 1,901 553 4,528 1,624
Internet 1,393 311 2,708 591
Application Technology (1) 4,597 2,692 12,566 5,705
Intellesale.com 5,737 2,968 13,259 7,006
Communications Infrastructure 3,059 1,709 6,943 4,599
Non-Core 1,201 1,198 3,314 3,116
Corporate (including amounts incurred during
consolidation) (1) 1,334 1,113 4,138 2,803
---------------------------------------------
Consolidated $ 24,022 $14,337 $61,838 $34,954
=============================================
- ---------
<FN>
(1) Includes restructuring and unusual charges incurred in the first nine
months of 1999 of $511 in the Telecommunications division, $400 in the
Application Technology division and $1,639 in the corporate overhead
expense.
</FN>
</TABLE>
Selling, general and administrative expense as a percentage of revenue
for the three and nine months ended September 30, 1999 and 1998 by operating
segment was:
<TABLE>
<CAPTION>
------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------------
1999 1998 1999 1998
% % % %
<S> <C> <C> <C> <C>
Telecommunications (1) 27.8 45.3 35.3 41.4
Network Infrastructure 25.7 10.2 22.7 10.1
Internet 61.0 30.9 61.5 31.0
Application Technology (1) 39.0 37.8 47.4 44.8
Intellesale.com 11.1 19.5 14.3 15.9
Communications Infrastructure 21.0 11.8 18.8 12.0
Non-Core 22.8 16.7 21.5 20.4
------------------------------------------
Consolidated (1) 22.4 24.3 26.7 23.1
==========================================
- ---------
<FN>
(1) Includes, as a percentage of total revenue, restructuring and unusual
charges incurred in the first nine months of 1999 of 0.2% in the
Telecommunications division, 0.2% in the Application Technology
division and 0.7% in the corporate overhead expense.
</FN>
</TABLE>
Changes during the quarter and year-to-date were:
o Telecommunications increased in absolute dollar terms but, as a percentage
of revenue, declined 17.5 percentage points from 45.3% in the third quarter
of 1998 to 27.8% in 1999 and declined 6.1 percentage points from 41.4% for
the nine months ended September 30, 1998 to 35.3% in 1999 reflecting this
division's continued success in reducing overhead expenses.
o Network infrastructure increased significantly over 1998 as a result of
acquisitions made in the second quarter of 1999. These companies are more
service oriented and have higher SG&A expenses.
22
<PAGE>
o Internet increased significantly over 1998 as a result of the switch in
entities comprising this group from a hardware oriented company with higher
cost of goods sold and lower SG&A expenses to a service oriented company
with lower cost of goods sold but higher SG&A expenses.
o Application technology increased in dollar terms due to an acquisition in
the second quarter of 1999. As a percentage of revenue, SG&A expense in
this division has not increased significantly over prior periods.
o Intellesale.com's SG&A expenses increased in dollar terms as a result of
the acquisition of Bostek in June 1999 and the increase of Internet related
business and the consolidation of operations into one facility. However, as
a percentage of sales, SG&A expense has declined slightly from prior
periods to a level that is expected to remain constant in the immediate
future.
o Communications infrastructure has increased both in dollar amounts and as a
percentage of revenue in 1999 over 1998 as a result of increased labor,
union and benefit costs and one-time charges recorded in the third quarter
of 1999 of approximately $569 in anticipation of the sale of four units in
October 1999.
o Non-core SG&A did not increase in dollar terms but increased as a
percentage of sales as sales continue to decline at certain units within
this division.
Depreciation and Amortization
Depreciation and amortization expense for the three months ended
September 30, 1999 was $2.6 million, an increase of $1.3 million, or 100.0%,
from $1.3 million for the three months ended September 30, 1998. Depreciation
and amortization expense for the nine months ended September 30, 1999 was $6.4
million, an increase of $3.3 million, or 106.5%, from $3.1 million for the nine
months ended September 30, 1998.
Depreciation and amortization expense for the three and nine months
ended September 30, 1999 and 1998 by operating segment was:
<TABLE>
<CAPTION>
--------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Telecommunications $ 465 $ 211 $1,127 $ 433
Network Infrastructure 51 10 86 27
Internet 23 8 46 16
Application Technology 461 356 1,208 813
Intellesale.com 132 57 317 165
Communications Infrastructure 200 138 481 377
Non-Core 164 124 468 273
Corporate (including amounts incurred during
consolidation) 1,116 396 2,640 983
-------------------------------------------------
Consolidated $2,612 $1,300 $6,373 $3,087
=================================================
</TABLE>
Changes during the quarter and year-to-date were:
o Telecommunications increased due to TigerTel's reverse merger with Contour
in May 1999 as well as amortization of goodwill of subsidiaries acquired at
the beginning of 1999.
o Network infrastructure increased due to the two acquisitions completed in
the second quarter of 1999.
o Internet increased due to the increase in depreciable assets in this
division in 1999.
23
<PAGE>
o Application technology increased due to the acquisition completed in the
second quarter of 1999.
o Intellesale.com increased due to the acquisition of Bostek and the increase
in depreciable assets in 1999.
o Communications infrastructure and non-core both increased in 1999 due to
the acquisition of depreciable assets.
Restructuring and Unusual Charges
As part of the Company's reorganization of its core business into five
reportable business groups, the Company has implemented a restructuring plan.
The restructuring plan includes the exiting of selected lines of business within
the Company's Telecommunications and Application Technology business groups, and
the associated write-off of assets. The restructuring charge of $2,236 includes
asset impairments, primarily software and other intangible assets, of $1,522,
lease terminations of $541, and employee separations of $173. In addition,
during the first quarter of 1999, as part of the Company's core business
reorganization, the Company realigned certain operations within its
Telecommunications division and has recognized impairment charges and other
related costs of $314.
Operating Income (Loss)
Operating income for the three months ended September 30, 1999 was $2.0
million, a decrease of $1.3 million, or 39.4% from $3.32 million for the three
months ended September 30, 1998. Operating income for the nine months ended
September 30, 1999 was $2.7 million, a decrease of $6.2 million, or 69.7%, from
$8.9 million for the nine months ended September 30, 1998. Changes in operating
income are a result of the factors discussed above. Excluding the $2.6 million
restructuring and unusual charges mentioned above, operating income for the nine
months ended September 30, 1999 was $5.3 million.
Operating income (loss) during the three and nine months ended
September 30, 1999 and 1998 by operating segment was:
<TABLE>
<CAPTION>
-----------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Telecommunications (1) $ 571 $ 301 $ 834 $2,021
Network Infrastructure 622 380 1,612 1,190
Internet 280 79 560 234
Application Technology (1) 309 1,272 363 1,717
Intellesale.com 2,074 852 6,011 3,242
Communications Infrastructure 671 1,119 1,308 2,842
Non-Core (76) 557 311 789
Corporate (including amounts incurred during
consolidation) (1) (2,419) (1,248) (8,348) (3,185)
------------------------------------------------
Consolidated $2,032 $3,312 $2,651 $8,850
================================================
- -------------
<FN>
(1) Includes restructuring and unusual charges incurred in the first nine
months of 1999 of $511 in the Telecommunications division, $400 in the
Application Technology division and $1,639 in the corporate overhead
expense.
</FN>
</TABLE>
24
<PAGE>
Operating income as a percentage of revenue for the three and nine
months ended September 30, 1999 and 1998 by operating segment was:
<TABLE>
<CAPTION>
--------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------
1999 1998 1999 1998
% % % %
<S> <C> <C> <C> <C>
Telecommunications (1) 3.3 3.6 2.0 8.8
Network Infrastructure 8.4 7.0 8.1 7.4
Internet 12.3 7.9 12.7 12.3
Application Technology (1) 2.6 17.8 1.4 13.5
Intellesale.com 4.0 5.6 6.5 7.4
Communications Infrastructure 4.6 7.7 3.5 7.4
Non-Core (1.4) 7.8 2.0 5.2
-------------------------------------------
Consolidated (1) 1.9 5.6 1.1 5.8
===========================================
- ---------------
<FN>
(1) Includes, as a percentage of total revenue, restructuring and unusual
charges incurred in the first nine months of 1999 of 0.2% in the
Telecommunications division, 0.2% in the Application Technology
division and 0.7% in the corporate overhead expense.
</FN>
</TABLE>
Interest Income and Expense
Interest income was $ 0.2 million and $0.1 million for the three months
ended September 30, 1999 and 1998, respectively, and was $0.4 million and $0.3
million for the nine months ended September 30, 1999 and 1998, respectively.
Interest income is earned primarily from short-term investments and notes
receivable.
Interest expense was $1.2 million and $0.5 million for the three months
ended September 30, 1999 and 1998, respectively and was $2.3 million and $1.1
million for the nine months ended September 30, 1999 and 1998, respectively.
Interest expense is principally associated with revolving credit lines, notes
payable and term loans.
Income Taxes
We had an effective income tax rate of 62.7% and 34.7% for the three
months ended September 30, 1999 and 1998, respectively and 1347.6% and 34.4% for
the nine months ended September 30, 1999 and 1998, respectively. The
fluctuations in the tax rate during 1999 are a result of the loss arising in the
first quarter of 1999, primarily due to the $2.6 million restructuring and
unusual charges mentioned above, and the effect of various State income tax
laws. Changes in the effective rate also arise from the effect of purchase
accounting and the resulting amortization of goodwill, which is substantially
non-deductible for income tax purposes.
Extraordinary Loss
In connection with the early retirement of the Company's line of credit
with State Street Bank and Trust Company and its simultaneous refinancing with
IBM Credit Corporation, deferred financing fees associated with the State Street
Bank and Trust agreement were written off during the second quarter of 1999. The
total amount of the write-off recorded as an extraordinary loss was $160, net of
income taxes.
25
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1999, cash and cash equivalents totaled $9.0
million, an increase of $4.4 million, or 95.7% from $4.6 million at December 31,
1998. Cash is generally applied to the our revolving line of credit as it is
collected. Cash of $14.3 million and $3.2 million was used in operations during
the first nine months of 1999 and 1998, respectively. Excluding assets and
liabilities acquired or assumed in connection with acquisitions, cash used in
the first nine months of 1999 was due to the net loss, after adjusting for
non-cash expenses and increases in accounts receivable, inventories and accounts
payable and accrued expenses. Accounts receivable increased $22.7 million, or
66.0% from $34.4 million at December 31, 1998 as a result of increased levels of
sales, particularly in the Telecommunications division and at Intellesale.com,
and slightly slower collections. Inventories increased by $15.1 million, or
72.9% from $20.7 million at December 31, 1998. This increase was related
primarily to the growth in sales over the Internet at Intellesale.com. Accounts
payable and accrued expenses increased by $19.9 million, or 54.2% from $26.4
million at December 31, 1998 due to the higher inventory levels discussed above.
Excluding assets and liabilities acquired or assumed in connection with
acquisitions, cash used in the first nine months of 1998 was primarily due to
net income, after adjusting for non-cash expenses, and increases in accounts
receivable, inventories and prepaid expenses of $4.5 million, $2.5 million and
$2.7 million, respectively, and a decrease in accounts payable of $1.6 million.
Investing activities used cash of $21.4 million and $5.1 million during
the first nine months of 1999 and 1998, respectively. In the first nine months
of 1999, cash of $15.8 million was used to pay for the cost of asset and
business acquisitions, $1.3 million was spent on other assets and payments of
$3.7 million were made for property and equipment. During the first nine months
of 1998, $1.6 million was used to purchase property and equipment, $2.6 million
was paid for other assets and $1.1 million was loaned to officers of the
Company.
Financing activities provided cash of $40.2 million and $6.1 million
during the first nine months of 1999 and 1998, respectively. During the first
nine months of 1999, $51.9 million was raised through long-term debt, which was
offset mainly by payments of $8.3 million on long-term debt. During the first
nine months of 1998, $2.3 million was raised through the issuance of common
shares, $0.9 million was raised through long term debt and $8.2 million was
raised through notes payable. These sources of cash were offset mostly by
payments of $4.4 million on long-term debt and $0.9 paid for the redemption of
preferred shares.
One of our stated objectives is to maximize cash flow, as management
believes positive cash flow is an indication of financial strength. However, due
to our significant growth rate, our investment needs have increased.
Consequently, we may continue, in the future, to use cash from operations and
may continue to finance this use of cash through financing activities such as
the sale of common stock and/or bank borrowing, if available.
In August, 1998, we entered into a $20 milion line of credit with State
Street Bank and Trust Company secured by all of our domestic assets at the prime
lending rate or at the London Interbank Offered Rate, at our discretion. In
February 1999, the amount of the credit available under the facility was
increased to $23 million. On May 25, 1999, we entered into a Term and Revolving
Credit Agreement with IBM Credit Corporation (the "IBM Agreement"). On May 26,
1999, we repaid the amount due to State Street and Trust Company. On July 30,
1999, the IBM Agreement was amended and restated. The IBM Agreement, as amended,
provides for:
(a) a revolving credit line of up to $38.5 million, designated as follows:
(i) a USA revolving credit line of up to $27 million, (ii) a Canadian
revolving credit line of up to C$8.978 million, and (iii) a United
Kingdom revolving credit line of up to $3 million,
26
<PAGE>
(b) a term loan A of up $22 million,
(c) a term loan B of up to $25 million,
(d) a term loan C designated in Canadian dollars of up to C$10.0 million,
and
(e) a term loan D designated in Canadian dollars of up to C$8.425 million.
The revolving credit line may be used for general working capital
requirements, capital expenditures and certain other permitted purposes. The USA
revolving credit line bears interest at the 30-day LIBOR rate plus 1.75% to
1.90% depending on the Company's leverage ratio; the Canadian revolving credit
line bears interest at the base rate as announced by the Toronto-Dominion Bank
of Canada each month plus 0.1707% to 0.2207%, depending on the Company's
leverage ratio; the UK revolving credit line bears interest at the base rate as
announced by the National Westminster Bank PLC of England each month plus
1.4207% to 0.5707%, depending upon the Company's leverage ratio. As of September
30, 1999, the LIBOR rate was approximately 5.2853% and approximately $24.1
million was outstanding on the revolving credit line.
Term loan A, which was used to pay off State Street Bank and Trust
Company, bears interest at the 30-day LIBOR rate plus 1.75% to 1.90%, is
amortized in quarterly installments over six years and is repayable in full on
the third anniversary of the closing date of the loan. As of September 30, 1999,
approximately $21.0 million was outstanding on this loan.
Term loan B, which may be used for acquisitions, bears interest at the
30-day LIBOR rate plus 1.75% to 1.90%, is amortized in quarterly installments
over six years and is repayable in full on the third anniversary of the closing
date of the loan. As of September 30, 1999, approximately $20.4 million was
outstanding on this loan.
Term loan C, which was used by our Canadian subsidiaries to pay off
their bank debt, bears interest at the base rate as announced by the
Toronto-Dominion Bank of Canada each month plus 0.1707%, to 0.2207%, is
amortized in quarterly installments over six years and is repayable in full on
the third anniversary of the closing date of the loan. As of September 30, 1999,
Toronto-Dominion's rate was approximately 6.25% and approximately C$9.7 million
was outstanding on this loan.
Term loan D, which may be used by one of our Canadian subsidiaries for
acquisitions, bears interest at the base rate as announced by the
Toronto-Dominion Bank of Canada each month plus 0.1707%, to 0.2207%, is
amortized in quarterly installments over six years and is repayable in full on
the third anniversary of the closing date of the loan. As of September 30, 1999,
no advances have been made under this facility.
The agreement contains standard debt covenants relating to the
financial position and performance as well as restrictions on the declarations
and payment of dividends. As of September 30, 1999, the Company was in
compliance with all debt covenants.
As of September 30, 1999, there were 47,568,948 shares of Common Stock
outstanding. In addition, 836,472 shares of Common Stock are reserved for
issuance in exchange for the exchangeable shares of our Canadian subsidiaries.
Since January 1, 1999, we have issued an aggregate of 12,013,862 shares of
Common Stock, of which 5,928,220 shares of Common Stock were issued as earnout
payments in acquisitions, 3,512,308 were issued in connection with new
acquisitions, 2,508,668 were issued in exchange for exchangeable shares, and
64,666 shares of Common Stock were issued for services rendered, including
services under employment agreements and employee bonuses.
27
<PAGE>
We have entered into earnout arrangements with selling shareholders
under which they are entitled to additional consideration for their interests in
the companies they sold to us. Under these agreements, assuming that all
earnouts are achieved, and assuming certain levels of profitability in the
future, we are contingently liable for additional consideration amounting to
approximately $4.5 million based on achieved 1999 results, approximately $8.3
million based on achieved 2000 results, approximately $10.9 million based on
achieved 2001 results and approximately $2.0 million in each of the years 2002,
2003 and 2004. All amounts earned and payable have been accrued in the
accompanying balance sheets. During the second quarter of 1999, the Company
entered into contingent agreements with some of the subsidiaries to fix the
earnout payments due to such subsidiaries' former shareholders at $6.2 million
in a combination of cash and stock of one of the Company's subsidiaries,
Intellesale.com. These agreements are contingent upon the successful completion
of the pending public offering of Intellesale.com within one year of the date of
the agreements.
We have entered into put options with the selling shareholders of those
companies in which we acquired less than a 100% interest. These options provide
for us to acquire the remaining portion we do not own after periods ranging from
4 to 5 years from the dates of acquisition at amounts per share generally equal
to 10% - 20% of the average annual earnings per share of the company before
income taxes for, generally, a two-year period ending on the effective date of
the put multiplied by a multiple ranging from 4 to 5. These requirements are
recorded as changes in minority interest based upon current operating results.
During the second quarter of 1999, the Company contingently agreed to pay $3.9
million in a combination of cash and stock of one of the Company's subsidiaries,
Intellesale.com, in exchange for the remaining ownership interest. These
agreements are contingent upon the successful completion of the pending public
offering of Intellesale.com within one year of the date of the agreements.
Our sources of liquidity include, but are not limited to, funds from
operations and funds available under the IBM Agreement. We may be able to use
additional bank borrowings, proceeds from the sale of common and preferred
shares, proceeds from the exercise of stock options and warrants, and the
raising of other forms of debt or equity through private placement or public
offerings. There can be no assurance however, that these options will be
available, or if available, on favorable terms. We believe that our current cash
position, augmented by financing activities, if available, will provide us with
sufficient resources to finance our working capital requirements for the
foreseeable future. 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. We
believe that we have the financial resources to meet our future business
requirements.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Certain statements in this Form 10-Q, and the documents incorporated by
reference herein, constitute "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995.
Applied Digital Solutions intends that such forward-looking statements be
subject to the safe harbors created thereby. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
our actual results, performance or achievements to be materially different from
any future results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, the following:
our continued ability to sustain our growth through product development and
business acquisitions; the successful completion and integration of future
acquisitions; the ability to hire and retain key personnel; the continued
development of technical, manufacturing, sales, marketing and management
capabilities; relationships with and dependence on third-party suppliers;
anticipated competition; uncertainties relating to economic conditions where we
operate; uncertainties relating to government and regulatory policies;
28
<PAGE>
uncertainties relating to customer plans and commitments; rapid technological
developments and obsolescence in the industries in which we operate and compete;
potential performance issues with suppliers and customers; governmental export
and import policies; global trade policies; worldwide political stability and
economic growth; the highly competitive environment in which we operate;
potential entry of new, well-capitalized competitors into our markets; changes
in our capital structure and cost of capital; and uncertainties inherent in
international operations and foreign currency fluctuations. The words "believe",
"expect", "anticipate", "intend" and "plan" and similar expressions identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date the statement
was made.
Risk Factors
In addition to the other information contained herein, the following
factors should be considered carefully in evaluating our company and its
business.
Competition
Each segment of our business is highly competitive, and it is expected
that competitive pressures will continue. Many of our competitors have far
greater financial, technological, marketing, personnel and other resources. The
areas that we have identified for continued growth and expansion are also target
market segments for some of the largest and most strongly capitalized companies
in the United States, Canada and Europe. There can be no assurance that we will
have the financial, technical, marketing and other resources required to compete
successfully in this environment in the future.
Uncertainty of Future Financial Results
While we have been profitable for the last three fiscal years, future
financial results are uncertain. There can be no assurance that we will continue
to be operated in a profitable manner. Profitability depends upon many factors,
including the success of our various marketing programs, the maintenance or
reduction of expense levels and our ability to successfully coordinate the
efforts of the different segments of our company and its business.
Future Sales of and Market for the Shares
Although we previously announced that we intended to limit the use of
stock in future acquisitions and to focus on cash transactions, we have
effected, and may continue to effect, acquisitions or contract for certain
services through the issuance of Common Stock or other equity securities as we
have typically done in the past. In addition, we have agreed to certain "price
protection" provisions in acquisition agreements which may result in additional
shares of common stock being issued to selling shareholders as of the effective
date of the registration of the shares such selling shareholder previously
received as consideration. Such issuances of additional securities may be viewed
as being dilutive of the value of the Common Stock in certain circumstances and
may have an adverse impact on the market price of the Common Stock.
Risks Associated with Acquisitions and Expansion
We have engaged in a continuing program of acquisitions of other
businesses which are considered to be complementary to our lines of business,
and it is anticipated that such acquisitions will continue to occur. Our total
assets were approximately $240 million as of September 30, 1999 and $124
million, $61 million, $33 million and $4 million as of December 31, 1998, 1997,
1996 and 1995, respectively. Our revenue was approximately $232 million for the
nine months ended September 30, 1999 and approximately $207 million, $103
29
<PAGE>
million, $20 million and $2 million for the years ended December 31, 1998, 1997,
1996 and 1995, respectively. Managing these dramatic changes in the scope of the
business will present ongoing challenges to management, and there can be no
assurance that our operations as currently structured, or as affected by future
acquisitions, will be successful.
We may require substantial additional capital, and there can be no
assurance as to the availability of such capital when needed, nor as to the
terms on which such capital might be made available to us.
It is our policy to retain existing management of acquired companies,
under the overall supervision of senior management. The success of the
operations of these subsidiaries will depend, to a great extent, on the
continued efforts of the management of the acquired companies.
Dependence on Key Individuals
Our future success is highly dependent upon our ability to attract and
retain qualified key employees. We are organized with a small senior management
team, with each of our separate operations under the day-to-day control of local
managers. If we were to lose the services of any member of our central
management team, the overall operations could be adversely affected, and the
operations of any of the individual facilities could be adversely affected if
the services of the local managers should be unavailable. We have entered into
employment contracts with key officers and employees of senior management and
certain subsidiaries. The agreements are for periods of one to ten years through
September 2009. Some of the employment contracts also call for bonus
arrangements based on earnings.
Lack of Dividends on Common Stock; Issuance of Preferred Stock
We do not have a history of paying dividends on our Common Stock, and
there can be no assurance that such dividends will be paid in the foreseeable
future. Under the terms of the IBM Agreement, there are restrictions on the
declaration and payment of dividends. We intend to use any earnings which may be
generated to finance the growth of the businesses. Our Board of Directors has
the right to authorize the issuance of preferred stock, without further
stockholder approval, the holders of which may have preferences as to payment of
dividends.
Possible Volatility of Stock Price
Our Common Stock is quoted on the Nasdaq Stock Market(R), which stock
market has experienced and is likely to experience in the future significant
price and volume fluctuations which could adversely affect the market price of
our Common Stock without regard to our operating performance. In addition, we
believe that factors such as the significant changes to the business resulting
from continued acquisitions and expansions, quarterly fluctuations in the
financial results or cash flows, shortfalls in earnings or sales below analyst
expectations, changes in the performance of other companies in the same market
sectors and the performance of the overall economy and the financial markets
could cause the price of our Common Stock to fluctuate substantially.
YEAR 2000 COMPLIANCE
Background. Some computers, software, and other equipment include
programming code in which calendar year data is abbreviated to only two digits.
As a result of this design decision, some of these systems could fail to operate
or fail to produce correct results if "00" is interpreted to mean 1900, rather
than 2000. These problems are widely expected to increase in frequency and
severity as the year 2000 approaches, and are commonly referred to as the
"Millennium Bug" or "Year 2000 problem".
30
<PAGE>
Assessment. The Year 2000 problem could affect computers, software, and
other equipment used, operated, or maintained by us. Accordingly, we are
reviewing our internal computers, software, applications and related equipment
and our systems other than information technology systems to ensure that they
will be Year 2000 compliant. We believe that our Year 2000 plan will be
completed in all material respects prior to the anticipated Year 2000 failure
dates. We spent approximately $200,000 in 1998 on our Year 2000 compliance plan
and estimate an additional $450,000 will be spent in 1999, most of which relates
to new equipment. There can be no assurance however, that the total costs will
be limited to this amount.
Software Sold to Consumers. We are in the process of identifying all
potential Year 2000 problems with any of the software products we develop and
market. However, we believe that it is not possible to determine with complete
certainty that all Year 2000 problems affecting our software products will be
identified or corrected due to the complexity of these products. In addition,
these products interact with other third party vendor products and operate on
computer systems which are not under our control. For non-compliant products, we
are providing recommendations as to how an organization may address possible
Year 2000 issues regarding that product. Software updates are available for
most, but not all, known issues. Such information is the most currently
available concerning the behavior of our products and is provided "as is"
without warranty of any kind. However, variability of definitions of
"compliance" with the Year 2000 and of different combinations of software,
firmware, and hardware may lead to lawsuits against us. The outcome of any such
lawsuits and the impact on our financial results of operations, cash flow and
financial position are not estimable at this time.
Internal Infrastructure. We believe that our major computers, software
applications, and related equipment used in connection with our internal
operations are not subject to significant Year 2000 problems, because the
computer programs we use are primarily off-the-shelf, recently developed
programs from third-party vendors. We are in the process of obtaining assurances
from such vendors as to the Year 2000 compliance of their products. Most vendors
are reluctant to provide written assurances and, although some vendors may make
verbal assurances of Year 2000 compliance, there can be no certainty that the
systems utilized will not be affected. We have assessed all 40 of our operating
locations and have determined that 29 of the 40 locations are Year 2000
compliant. Of the remaining 11 locations, 7 are in the process of upgrading
their current systems and 4 are replacing their systems. All internal
infrastructure systems and equipment are expected to be Year 2000 compliant
prior to the anticipated Year 2000 failure dates.
Systems Other than Information Technology Systems. In addition to
computers and related systems, the operation of office and facilities equipment,
such as fax machines, photocopiers, telephone switches, security systems,
elevators, and other common devices may be affected by the Year 2000 problem. We
have assessed all 40 of our operating locations and have determined that 38 of
the 40 locations are Year 2000 compliant. The remaining 2 locations are in the
process of upgrading or replacing the current systems. All non-information
technology systems and equipment are expected to be Year 2000 compliant prior to
the anticipated Year 2000 failure dates.
Suppliers. We have initiated communications with third party suppliers
of the major computers, software, and other equipment used, operated, or
maintained by us to identify and, to the extent possible, to resolve issues
involving the Year 2000 problem. However, we have limited or no control over the
actions of these third party suppliers. Thus, while we expect that we will be
able to resolve any significant Year 2000 problems with these systems, there can
be no assurance that these suppliers will resolve any or all Year 2000 problems
with these systems before the occurrence of a material disruption to our
business or any of our customers. Any failure of these third parties to resolve
Year 2000 problems with their systems in a timely manner could have a material
adverse effect on our business, financial condition, results of operations and
cash flows.
31
<PAGE>
Internet. As more of our business is conducted over the internet, it is
possible that we experience dispersed, intermittent telecommunications problems
experienced by local internet service providers and their users throughout the
country and world, preventing those customers from being able to access our
Web-site. This could be combined with, or result from, intermittent power
problems which could cause similar problems with accessing the Web-site.
Additionally, many customers may be using older systems which may not be Year
2000 compliant, and this would prevent them from accessing our Web-site. Under
this scenario, we would continue operations, but our Web-site would be
inaccessible to the individuals or groups affected by these problems. If our
credit card processors are not Year 2000 compliant, we will not be able to
process credit card sales. If our vendors are not Year 2000 compliant, we will
not be able to obtain products from our vendors or our vendors may not be able
to ship products sold to our customers. In the event of this worst case
scenario, we could lose significant revenues from customers unable to purchase
from the site, be unable to ensure delivery of products to customers, incur
expenses to repair our systems, face interruptions in the work of our employees,
lose advertising revenue and suffer damage to our reputation.
Contingency Plans. At certain subsidiaries, where we feel it is
necessary, we are preparing contingency plans relating specifically to
identified Year 2000 risks and developing cost estimates relating to these
plans. Contingency plans may include stockpiling raw materials, increasing
inventory levels, securing alternate sources of supply and other appropriate
measures. We anticipate completion of the Year 2000 contingency plans prior to
the anticipated Year 2000 failure dates. Once developed, Year 2000 contingency
plans and related cost estimates will be tested in certain respects and
continually refined as additional information becomes available.
Most Likely Consequences of Year 2000 Problems. We expect to identify
and resolve all Year 2000 problems that could materially adversely affect our
business operations and cash flows. However, we believe that it is not possible
to determine with complete certainty that all Year 2000 problems have been
identified or corrected. The number of devices that could be affected and the
interactions among these devices are simply too numerous. In addition, one
cannot accurately predict how many Year 2000 problem-related failures will occur
or the severity, duration, or financial consequences of these perhaps inevitable
failures. As a result, we expect that we may suffer the following consequences:
1. A significant number of operational inconveniences and
inefficiencies for us and our clients that may divert management's time and
attention and financial and human resources from its ordinary business
activities; and
2. A lesser number of serious system failures that may require
significant efforts by us or our customers to prevent or alleviate material
business disruptions.
Based on the activities described above, we do not believe that the
Year 2000 problem will have a material adverse effect on our business, results
of operations or cash flows. The estimate of the potential impact on our
financial position, overall results of operations or cash flows for the Year
2000 problem could change in the future. The discussion of our efforts, and
management's expectations, relating to Year 2000 compliance are forward-looking
statements. Our ability to achieve Year 2000 compliance and the level of
incremental costs associated therewith, could be adversely impacted by, among
other things, the availability and cost of programming and testing resources,
vendors' ability to modify proprietary software, and unanticipated problems
identified in the ongoing compliance review.
32
<PAGE>
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards (FAS) 133, Accounting for Derivative
Instruments and Hedging Activities. In 1999, the FASB issued FAS 137, Accounting
for Derivative Instruments and Hedging Activities - Deferral of the Effective
Date of FAS 133. We do not have any derivative instruments or hedging
transactions.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
With our Canadian and United Kingdom subsidiaries, we have operations
and sales in various regions of the world. Additionally, we may 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 may be
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.
Domestic borrowings under our Credit Agreement are at the London
Interbank Offered Rate plus a factor. Canadian and UK borrowings are at the
prime rates plus a factor established by Toronto-Dominion Bank of Canada and the
National Westminster Bank PLC of England, respectively. Such rates are subject
to adjustment at any time.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We and certain of our subsidiaries are parties to various legal actions
as either plaintiff or defendant. In the opinion of management, these
proceedings will not have a material adverse effect on the financial position,
cash flows or overall trends in our results. The estimate of the potential
impact on our financial position, overall results of operations or cash flows
for these proceedings could change in the future. We are not subject to any
environmental or governmental proceedings.
On May 17, 1999, we were named as defendants in a suit brought in the
United States District Court for the District of New Hampshire, in a matter
styled John H. Martin, Jr. v. Applied Cellular Technology, Inc. The plaintiff, a
former Vice President of sales and Chief Operating Officer of our former
subsidiary, Tech Tools, Inc., alleges that: (i) we verbally agreed to sell our
controlling interest in Tech Tools to plaintiff; (ii) we repudiated the sale;
and (iii) we caused Tech Tools to commence a wrongful civil action against
plaintiff for conversion and to file a false report against plaintiff alleging
plaintiff's illegal diversion of Tech Tool's funds which subjected plaintiff to
criminal proceedings. Based on these allegations, plaintiff is seeking monetary
damages in the amount of $20 million. We believe that plaintiff's claims are
without merit and intend to defend ourselves vigorously. We do not expect this
litigation to have a material adverse effect on our financial position, overall
results of operations or cash flows.
34
<PAGE>
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following table lists all unregistered securities sold by us from
January 1, 1999 through September 30, 1999. These shares were issued without
registration in reliance upon the exemption provided by Section 4(2) of the
Securities Act of 1933, as amended, and Regulation D promulgated thereunder.
Number of
Issued Common
Name/Entity/Nature Note For Shares
The Americom Group, Inc. 1 Acquisition 106,581
The Americom Group, Inc. 8 Acquisition 45,319
Advanced Telecommunications, Inc. 1 Acquisition 550,000
Aurora Electric, Inc. 8 Acquisition 7,224
Consolidated Micro Components 1,2 Acquisition 649,696
Cra-Tek Company 5 Acquisition 121,465
Cybertech Station, Inc. 1 Acquisition 49,806
Cybertech Station, Inc. 8 Acquisition 17,629
Data Path Technologies, Inc. 1,2 Acquisition 1,393,230
GDB Software Services, Inc. 1,2 Acquisition 627,879
Hornbuckle Engineering, Inc. 7 Acquisition 554,563
Information Products Center, Inc. 1 Acquisition 662,252
Information Products Center, Inc. 8 Acquisition 514,880
Innovative Vacuum Solutions, Inc. 1 Acquisition 426,213
Innovative Vacuum Solutions, Inc. 8 Acquisition 1,461
Lynch, Marks & Associates, Inc. 6 Acquisition 773,142
PPL, Ltd. 1 Acquisition 929,230
PPL, Ltd. 8 Acquisition 305,024
STR, Inc. 6 Acquisition 932,039
TigerTel Services Limited 2 Acquisition 43,877
Winward Electric Service Inc. 1 Acquisition 533,333
Winward Electric Service Inc. 8 Acquisition 188,667
Charles Phillips 3 Asset Acquisition 7,018
Services 4 Services 64,666
---------
Total 9,505,194
=========
-----------------
1. Represents shares issued in connection with the "earnout" provision of the
Agreement of Sale.
2. Represents shares issued as a finders fee in connection with the
acquisition of the company.
3. Represents shares issued in connection with the acquisition of certain
assets by one of the Company's subsidiaries, Intellesale.com.
4. Represents shares issued for professional services or under employment or
other such agreements.
5. Represents shares issued to a selling shareholder to acquire such
shareholders minority interest.
6. Represents shares issued to the selling shareholders to acquire such
shareholders 100% interest in such company.
7. Represents shares issued to the selling shareholders, as partial
consideration, to acquire such shareholders 100% interest in such company.
8. Represents shares issued in connection with the "price protection"
provision of the Agreement of Sale.
35
<PAGE>
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECUTIRY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
The following Current Reports on Form 8-K were filed by the Company
between July 1, 1999 and the date of this report:
(1) On August 16, 1999, in our Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1999, we reported that, on July
30, 1999, we amended the IBM Agreement and had entered into an
Amended and Restated Term and Revolving Credit Agreement. On
October 5, 1999, we filed a Current Report on Form 8-K/A
reporting that on September 29, 1999, we entered into Amendment
No. 1 to the Amended and Restated IBM Agreement.
(2) On August 12, 1999, we filed a Current Report on Form 8-K/A
which included the required financial statements and pro forma
financial information in connection with our subsidiary,
Intelleslae.com, Inc.'s acquisition of Bostek, Inc. and Micro
Components International, Incorporated.
(3) On September 14, 1999, we filed a Current Report on Form 8-K
which included a copy of our press release announcing that our
subsidiary, Intellesale.com, Inc., filed a preliminary
Registration Statement on Form S-1 to sell shares of its common
stock.
36
<PAGE>
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)
Date: November 15, 1999 By: /s/ David A. Loppert
-------------------------------------
David A. Loppert, Vice President,
Treasurer and Chief Financial Officer
37
<PAGE>
Exhibit Index
Number Description of Exhibits
27 Financial Data Schedule.
38
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
Exhibit 27
FINANCIAL DATA SCHEDULE
This schedule contains summary financial information extracted from the
Registrant's interim unaudited consolidated financial statements as of and for
the nine months ended September 30, 1999, and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<CIK> 0000924642
<NAME> Applied Digital Solutions, Inc.
<S> <C>
<PERIOD-START> Jan-01-1999
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-END> Sep-30-1999
<CASH> 9,033,000
<SECURITIES> 0
<RECEIVABLES> 73,571,000
<ALLOWANCES> 1,384,000
<INVENTORY> 40,756,000
<CURRENT-ASSETS> 131,705,000
<PP&E> 36,333,000
<DEPRECIATION> 17,416,000
<TOTAL-ASSETS> 240,475,000
<CURRENT-LIABILITIES> 105,391,000
<BONDS> 40,865,000
0
0
<COMMON> 48,000
<OTHER-SE> 85,098,000
<TOTAL-LIABILITY-AND-EQUITY> 240,475,000
<SALES> 227,000,000
<TOTAL-REVENUES> 231,790,000
<CGS> 142,383,000
<TOTAL-COSTS> 158,378,000
<OTHER-EXPENSES> 70,761,000
<LOSS-PROVISION> 396,000
<INTEREST-EXPENSE> 2,295,000
<INCOME-PRETAX> 789,000
<INCOME-TAX> 1,086,000
<INCOME-CONTINUING> (697,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 160,000
<CHANGES> 0
<NET-INCOME> (857,000)
<EPS-BASIC> (0.02)
<EPS-DILUTED> (0.02)
</TABLE>
