Digital Angel Q4 2007 Earnings Call Transcript

| About: Medical Advisory (DOC)

Digital Angel (DOC) Q4 2007 Earnings Call March 17, 2008 9:00 AM ET


Allison Tomek – Vice President of Investor Relations and Corporate Communications

Joseph J. Grillo – President and Chief Executive Officer

Lorraine M. Breece – Chief Financial Officer


Dennis Murphy

[Warrick Jervis - Trailhead Asset Management]

Kevin Dede - Morgan Joseph

Robert Kalb –Private Investor

Marty Quant – Private Investor


Welcome to the Digital Angel 2007 financial result conference call. (Operator Instructions)

Allison Tomek

Digital Angel issued two press releases this morning at approximately 7:00 a.m. Eastern. If you did not receive a copy of those announcements, you may retrieve them from Digital Angel’s website at We believe you will find the PowerPoint presentation on our website that we released this morning useful.

Before we begin the call, I must remind you that some of the information we will discuss on this call is forward-looking including but not limited to statements about the company’s future expectation including future revenues and earnings. These forward-looking statements maybe affected by the risks and uncertainties in our business.

Everything we say here today is qualified in it’s entirely. Our cautionary statement and risks factors set forth in today’s press releases and our SEC filings particularly those set forth in our Form 10-K as amended for the fiscal year ended December 31, 2006 which documents are publicly available.

These factors and others have affected historical results, may affect future results, and may cause future results to differ materially from those expressed in any forward-looking statement we may make. Our statements are as of today March 17, and we have no obligation to update any forward-looking statement we may make.

Joining me on the call today is Joseph Grillo, President and Chief Executive Officer of Digital Angel and Lorraine M. Breece, Chief Financial Officer. I will now turn the call over to Joe.

Joseph J. Grillo

With the other interesting business related news that could be distracting we appreciate your attention on this conference call, this is a of course a very important call to us at Digital Angel. As Allison mentioned we prepared an issue of presentation earlier this morning that I believe can be very useful and I’ll base the call this morning on the information in that presentation. Again if you have not seen it, you can now download it from our website.

I'll begin my comments on Slide three of that presentation.

The company has undergone significant changes during the past several months. On December 28, 2007, we completed the merger between the former Applied Digital Solutions and Digital Angel Corporation. The combined company now trades on NASDAQ as DIGA and the company is doing business as Digital Angel.

Digital Angel operates in two key core business segments, those being animal applications and the GPS in the radio communication segment. And this is very different from the past including 2007 where we had five different business segments.

Financial results for 2007 included Applied Digital Solutions which previously traded on the NASDAQ as an ADSX, included Digital Angel Corporation traded on the AMEX as DOC, and VeriChip Corporation traded on the NASDAQ as CHIP.

In addition to the merger of ADSX and stock Digital Angel, it is important to note that the company’s ownership in VeriChip recently fell below 50% as a result of VeriChip issuing additional shares in the first quarter of this year. So we expect that VeriChip’s results will not be consolidated into our company’s financial results in 2008 and going forward.

And finally an important change, there is only one new CEO responsible for the financial results you’ll see going forward in 2008 and beyond, that’s me Joe Grillo. I can honestly say that after eleven weeks with the company I’m really delighted to be a part of this organization.

To move on to Slide four, I was recruited by the Boards of Applied Digital and Digital Angel to be able to begin running the company on January 1 of this year. Lorraine Breece who is also joining us on the call today was previously the acting CFO of both

Applied Digital Solutions and Digital Angel. I’m happily report that she is accepted the position of permanent CFO of Digital Angel.

David Cairnie, our very capable Managerial Director of Signature Industries also continues to run the business in our GPS and radio communication segment headquartered in the UK.

We’ve recruited several key executives. Many of you probably are familiar with Randy Geissler who is really pioneer in the use of RFID technology in the animal applications industry. Randy is the founder and former owner of the Destron Fearing which is our primary brand in the animal applications segment.

I have personally known Randy for many, many years. I’m really excited to be working with him as he began as President of our animal applications business in January following our acquisition of Geissler Technology where Randy developed some really interesting and exciting patented technologies and cutting edge products for the animal tracking and identification market over the past years.

Also on March 3, we announced that David Sullivan will join the company as Chief Marketing Officer. Again, Dave is a gentleman I’ve known for many, many years and worked together at several different companies and he brings more than 20 years of experience in sales and marketing serving as past President of HID Limited in the UK, president of Fargo Electronics another subsidiary of Assa Abloy. He has a proven track record of rapidly developing and growing international businesses.

I’ll also expect to announce other key management hires in the very near future again with proven track records in streamlining operations and restructuring companies for profitability.

There are number of other positives that came out of the merger between Applied Digital and Digital Angel including the elimination of the ADSX or Applied Digital’s majority shareholder overhang. The cost savings realized by consolidating duplicate corporate functions and facilitating the best divestiture of non-core assets, I’ll be discussing a bit more later on in this presentation.

In Slide 5 we really depict in a different way and illustrate the two core business segments that comprise the company today. For all practical purposes Digital Angel is a holding company for our two core business divisions that provide safety related tracking identification products.

One segment as we’ve mentioned serves the animal market, this utilizes RFID and visual identification technologies and products. And the other segment serves the safety market for personnel and high value products. This uses different technology, GPS and satellite radio communication technologies.

We enjoy leading market positions in key geographies for both of these two core business divisions and sell the products under well known name brands, Destron Fearing on the animal application side and SARBE & McMurdo on the asset tracking site of the house.

To move on to Slide 6, it is important to note that the core businesses that we are discussing here and these brands have significant strength. Going back to 2003 and looking out to 2007 last year, the growth from these businesses have been from $34 million to $78 million which represents the compound annual growth rate of 23%.

We expect to see similar growth in 2008 with sales climbing from the $78 million level last year to a range between $92 and $98 million in 2008. And as you can see we are not relying on either one of these divisions for success. Both segments are expected to achieve approximately equal sales levels.

To summarize these two businesses in looking at Slide seven and what I have seen during the nearly three months that I have been with the company is we have two very sound fundamental businesses that provide a good foundation for future growth. Both segments performed at very healthy markets that have growth in both domestic and international markets.

The technologies in the two areas are proven and we have a lot of core competence in both our designed products and make products in these two areas in using the available technology in manufacturing processes. The competition on both sides is relatively fragmented. So, we see a lot of opportunity down the road for potential acquisitions or other types of partnering with another industry players or competitors.

As I discussed earlier we have augmented the previous management team with new complimentary talent. I think the last point here is an important one and that we are positioned for a movement of technology in leveraging technology enhancements for the different markets. This was particularly true for the animal identification market.

In my background in working at HID for many years we were able to leverage a change in businesses that used non-technology based cards and identification badges to enter their buildings or use in their offices.

Over time as our customers transferred from an older technology, non-RFID, or non-electronic cards and readers for electronic access control and employee identification purposes we were able to leverage that change in technology evolution to grow a company that started with approximately 5% of the global market in ‘93 and grew with compound annual growth rates approaching 40% to where we ended up with a worldwide market share of 50%.

I believe that in the animal applications market, a similar move in a similar direction going from visual ID products to electronic ID products will happen. Can’t say exactly when, no one has the crystal ball. But we will be well positioned to leverage that evolutionary change in technology as we go forward.

Moving on to Slide eight, we will talk a little bit more of about each of these two market segments starting with animal applications. We began this business a long time ago and through the Destron Fearing brand which has a long history as a pioneer in microchip technology for animals and before that since the 1940s in visual identification of animals.

In the last 5 years we have expanded significantly internationally both with our acquisition of Daploma to give us a bigger foundation in Europe and Denmark and also with the Greenfield operation that we started in South America in 2005 into 2006. As well as we’ve already mentioned, we’ve acquired Geissler Technology in January this year to improve our technological position with new products.

We are a leading manufacturer in chipping pets and fish as part of the US government’s wildlife protection mandate and we believe that additional legislative mandates around the world may drive the market for our products.

Again, difficult to predict exactly when and where these mandates might occur but regardless of the timing, I'm confident that the growth prospects for this segments are huge because the private sector alone and its customers have a significant vested interest in food safety, animal health and also the productivity aspects of herd management.

Today, Destron Fearing and our Daploma subsidiary in Europe sell millions of visual tags and this is a good business. But as I've mentioned earlier the real growth in this market is just beginning as visual tags are replaced by electronic tags.

Microchips comprise only a small fraction of the worldwide livestock tags being used today and only 5% of the cats and dogs in the United States are chipped. So the adoption and use of electronic means to identify and track all kinds of animals is really in its infancy in some ways.

We recently signed a contract with a jockey club that will accelerate the use of electronic identification for the equine market. In addition, I'm excited about our new Bio-Therm chip that senses the temperature of an animal in addition to just providing identification information. The bio-thermal technology may create substantial exponential demands for handheld readers. In summary for the animal applications business, we expect sales to grow from $44 million last year to approximately $48 million in 2008 for this segment.

And now I’ll switch over and talk a little bit more about the GPS and radio communications segment. Sales in this business increased from $16 million in 2006 to $34 million in 2007 and we expect sales to continue climbing to over $45 million this year.

Our April 2007 acquisition of McMurdo, the leading supplier of maritime emergency beacons in Europe resulted in approximately $12 million in sales in 2007. We expect McMurdo sales to climb to $19 million this year 2008. The addition to this acquisitive growth from McMurdo, sales are being positively impacted by required upgrades so the worldwide beacon population that must interface with the new 460 MHz satellite by 2009.

Our SARBE business which has enjoyed long time success in Europe and particularly in the UK has successfully provided beacons to the US Air Force as part of a development and prototype contract. The production phase of this contract is scheduled to be awarded later this year and if we are able to secure that contract, we would to expect to see a significant increase in our sales in 2009 and out through 2011.

Finally, I think we are just beginning to see the market developing for recreational safety beacons and increased purchases by consumers.

Moving on to Slide 10, we’ll talk a little bit about restructuring activities. There are going to be some significant changes required in the future to get Digital Angel in a position to unlock its full potential. As a result I've launched a top to bottom analysis of the companies businesses and operations and we will take all necessary steps to restructure operations so that we are in the best position to compete successfully in the two core businesses we’ve been discussing this morning.

I believe the company has suffered in the past by having too many diverse businesses in too many diverse markets without having any economies of scale and furthermore, management was unable to fully focus on core businesses with the greatest potential to provide returns to stockholders.

I'm pleased with the progress we are making to streamline our portfolio business and we fully expect to complete the divestitures of non-core business units InfoTech, Thermo-Life, Computer Equity or GTI, PDSC and Perimeter during the next several months. We’ve also started on a lot of right sizing and restructuring activities since I started in early January.

I'd like to give you an idea of what type of actions we’ve set into motion and most of these we were able to do on a short term and have short term impact our financial results. We decided for example to stop spending money on Washington DC lobbyist and instead redirected those dollars to hire more sales people. I've always been a firm believer in the feet on the street way to gain market share calling on more customers more often.

As I've mentioned earlier, we have recruited a senior executive, David Sullivan who has been successful in growing business rapidly in the United States, Europe and South America using these principals.

We’ve directed more of our engineering efforts towards tangible market opportunities and cost cutting through DFM or design for manufacturing improvements to continue reduce the cost of our manufactured cost of products and increase our margins going forward.

Lorraine and her team have done a successful job in consolidating corporate, G&A activities and overhead functions at the business unit level to cut cost further. I'm committed to upgrading our IT infrastructure to make sure that our managers and employees have complete and timely information to make decisions and run their businesses more effectively and I've insisted that we say “no” to a variety of expenses that we just can't afford at this time.

We’ve put into place a system of management objectives as a way to measure accountability and let managers know that in the future we are going to be looking for teamwork, good communications, hands on leaderships and we’ll plan to reward those who take on the tough blocking and tackling activities that are necessary for us to operate as efficiently as possible and aim for future profitability.

We’ve temporarily frozen salaries and implemented stock-for-pay programs to foster a sense of ownership in the success of the company going forward by its management team. These programs are just the beginning of a broader initiative to transfer a greater proportion of the company’s payroll to variable pay as earned based on performance.

Slide 11, which is a geographic representation of where our manufacturing locations are, I think it gives a way of showing what one of our greatest potentials are in restructuring activities that will streamline our operations for greater profitability. Today, we manufacture the bulk of our products in Minnesota, the UK and Denmark.

While we have very significant expertise and a lot of very good people working those plants, we're taking a look with some experts that I'm bringing in who have had a lot of success in the past in implementing cost effective worldwide outsourcing plans to evaluate our current operational strategy. We’ll quantify the savings that we could expect to achieve if we change our production strategy in supply chain management.

The impact that a new production business model might have on our future financial performance may be significant and I plan to make the restructuring investments that are necessary including potential outsourcing or relocating of operations to low cost areas to achieve better economies of scale and improve our overall manufacturing operations.

We will now turn a little bit to focus on the financials of the business. If you look at Slide 12, you will see three columns of financial figures. The column on the left shows the company’s past results for 2007 including consolidation of VeriChip and the results of the businesses we are in the process of divesting.

The middle column shows 2007 results again but this time adjusted to include historical results of the company’s core business segment that we’ve been talking about, animal applications and GPS and radio communications as well as our corporate office. This pro forma view of 2007 is important because it reflects the way I believe we will see the company financially in 2008 and beyond.

The column on the right shows 2008 where we are targeting sales growth of 20% in the two core businesses animal applications, GPS and radio communications and more importantly, we are focusing the company on achieving operating profitability. On a pro forma basis 2007 operating income resulted in a loss of approximately $24 million.

Clearly, the improvement to a breakeven operating income level in 2008 would be a substantial goal to achieve. We’ve also included information on EBITDA on this chart as I have found it to be a measurement that many of our investors choose to evaluate.

If we move to Slide 13, this slide illustrates why I believe 2008 will be a year where the company will be successful at breaking even or coming close to breaking even at an operating level. This page shows a bridge which gives a depiction of how we will reach to that level of financial success.

As you can see, there were a number of very large costs that I would not expect to occur on a regular basis or were associated with the merger in 2007 of Digital Angel and Applied Digital. In fact, approximately 60% of the amount we need improve to from an operating loss of $24 million in 2007 to at or near breakeven at an operating level in 2008 is a result of these merger expenses, goodwill impairment, CEO severance payments and unusually high litigation expenses that were experienced last year.

The other 40% that we need to achieve these results relates to operational improvements such as revenue growth in the GPS and radio communications segment, cost cuts that we have already implemented in the animals application segment and reductions in corporate overhead expenses. It is a big challenge to improve this much in one year but it is improvement that I believe our team is ready to take on and the management team knows this is just the beginning.

I've ran a lot of businesses in the past that were not performing well and have managed to turn them around and grow them and achieve respectable operating margins. It won't happen overnight but we’ve begun a strategic planning process that will shoot to achieve top line growth and bottom line returns that we can be proud of in the future.

We’ll continue to fine-tune our restructuring analysis during the next few months. Not all of the activities we can undertake are short term; many of the longer term operational improvements require step by step business and operational efficiency process improvements that take time to flow through the financials.

On Slide 14, we have a depiction of the core business and it’s enterprise value. Particularly related to our core businesses and again, I’ll keep repeating this, animal applications and radio communications. As you can see, this ad price value is approximately $100 million. Understandably, this value reflects to a great extent poor historical financial performance in the past.

I'm a firm believer that if management is motivated to take the actions that we’ve outlined and in the stockholders best interest and if we have a motivated management team and employees that run the company efficiently and that we compete vigorously in these core businesses, the value of the company and its stock will rise.

I'm putting my money where my mouth is and I'm taking 100% of my remaining salary in 2008 in Digital Angel’s stock so my interests and the interests of our investors are totally aligned.

Finally in kind of wrapping up, we’ll look at Slide 15 which shows a bit of our vision statement which is to become a clear worldwide leader in our core markets of providing safety related products to the asset tracking and identification industry and also outlining again and recapping the plans that will get us there.

In 2008 will be a transition year for the company. We are going to restructure and streamline the company operations and implement top to bottom not only operational changes but cultural changes.

We’re going to focus on achieving high returns in those market segments and businesses that are demonstrating significant growth and in which we have core competence and we are going to start to develop a global strategic plan to guide the company’s organic and acquisitive future in 2009, 2010 and beyond, in both domestic and international markets.

Lastly, I’d like to address our listing status with NASDAQ this is something that I'm asked about quite often. On December of 2007, we’ve received notice that the minimum bid price for our common stock closed below a dollar for 30 consecutive business days and we are therefore not in compliance with NASDAQ rules.

However, at a minimum, we have until June 2, 2008 to regain compliance if at anytime before June 2, 2008 the bid price for common stock closes at a dollar per share or more for at least ten consecutive business days, we’ll regain compliance. If we don’t achieve compliance by June 2, 2008, we will be eligible for an addition compliance period of 180 days provided we continue to meet NASDAQ capital market initial listing criteria which we always have done in the past.

With that said, I'm very comfortable that we’ll regain compliance within the allotted time frame.

Again, thanks to everyone for joining us this morning and we are now quite happy to take any questions that you might have.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Dennis Murphy.

Dennis Murphy

Could you tell me more about your background? What is HID?

Joseph J. Grillo

HID is a leading manufacturer of RFID based cards and readers, manufactured for the electronics security industry. These cards and readers are used worldwide to gain access to facilities, businesses, parking garages, etc. I joined HID in the early 90s when it was a small company of about $2 million in sales. We grew that to about $100 million in eight years and put it up for sale to the market place.

It was acquired by Assa Abloy which is about a $ 4.5 billion dollar Swedish lock company. And I worked for Assa Abloy for six or seven years through a series of promotions until I was running its global technologies division. This is about an $800 million dollar division which included HID and a number of other global business units.


You next question comes from [Warrick Jervis - Trailhead Asset Management].

[Warrick Jervis - Trailhead Asset Management]

I have a question on the non-animal side of the business. What exactly are you doing right now in the recreation market? Do you have any products that are actually sold to consumers?

Joseph J. Grillo

Yes, we do. There are a number of particularly newer products which are smaller handheld type emergency beacon products that are sold through distribution channels in Europe primarily. We also have a very important key and exclusive distributor in the US that distributes those products through boating type stores and sporting goods type chains. So it is an important future market that we have products in but hasn’t been a large part of a proportion of our revenue in the past. I think it will be more so going in the forward.

[Warrick Jervis - Trailhead Asset Management]

Regarding the CP beacon upgrade to the new frequency, if you look at the overall marketplace for that how far along are people in making that upgrade? Is it past, units out there have already been replaced are compatible, how big is that that opportunity?

Joseph J. Grillo

I can't give you an exact dollar figure on the opportunity but we’re really just in the initial stages of that upgrade. That’s really started last year and will extend out to the end of next year.

[Warrick Jervis - Trailhead Asset Management]

You said you will not have to consult on any VeriChip going forward, how will you account for that?

Lorraine M. Breece

We will account for that under the equity method of accounting so we’ll no longer include their revenue, their assets in our financials and the new results will be presented on one line in our income statement.


Your next question comes from Kevin Dede - Morgan Joseph.

Kevin Dede - Morgan Joseph

I was hoping you can give us an update on the military aspect of the beacon side. I know that there were a couple of contracts coming up not just with the RAF but also with US AF.

Joseph J. Grillo

We regularly get important military contracts and a couple just very recently is one with Switzerland. There is a very large UK based contract that’s in the sort of final stages of I believe negotiation which should have a positive impact on our results. The US Air Force project as I've mentioned in the presentation it is there.

We’ve had a series of successes in providing development activity and delivering prototypes in 2006 and 2007. And we believe we are well positioned to get a very large piece of the actual production contract going forward though that hasn’t been the case. And like many government driven military programs, the timing can always be a little bit iffy as to when that business might actually come in.

Kevin Dede - Morgan Joseph

What is your general assessment on a mandatory beef tagging initiative government sponsored or government mandated given that one fairly recent meat packing company was shut down and in light of the other problems that have hit that industry.

Joseph J. Grillo

Well I think that the recent incident that happened at the meat packing plant in California helps lend a lot of credibility and visibility to the importance of having good tracking of any type of food products whether it is agricultural products or meat type product from production right to the chain of selling the products through to the consumer.

A number of countries have legislated different levels of identification requirements and I think that will continue to grow in the future. Things that had maybe been optional in the past will become required. And again I think the important thing for us will be how the legislative or just end-user driven requirements of move from an older visual ID technology for livestock to electronic ID technology for livestock.

Because that type of a change will result in higher ASPs and should result in higher margins in that type of a product. I think that one of the things we are likely to see is some of that will be driven by the actual important customer partner such as the McDonalds or food chains who will require identification levels maybe above and beyond what the government requires and I think that is a healthy thing for our industry.

Kevin Dede - Morgan Joseph

So at this point, it is tough for you to see whether or not something will be handed down by the government?

Joseph J. Grillo

Well again, different governments set different requirements. We’ve seen a lot of the governments such as Canada, Australia and the EU who are a bit ahead of the US government in terms of some of the legislation of electronic technology being required. It is more optional for electronic in the US so I think it is very hard to predict. It is hard to predict the when but most experts that I talk to in the industry don’t believe it is an if question. It’s just a question of when.


Your next question comes from Robert Kalb - private investor.

Robert Kalb

Do you foresee any more charges coming off as you sell non-core assets particularly PDSC, I know you are still having transition problems about this work force and everything? Is that still going or is it?

Joseph J. Grillo

I believe we get reasonable levels of flow of money and from the sale of all the assets including PDSC. We’re not striving to run the most stringent long term processes to try to get the maximum price for some of these assets.

I don’t believe it is in the best interest of, of us to focus on them any longer or the management teams and future owners of those businesses to do anything but be expedient in moving those business out to other investors or other entities that would focus on them a lot better than we’ve been able to in the recent past. I don’t see anything but perhaps a slightly positive or results from the assets being finalized in their divestiture.

Lorraine M. Breece

We have taken an impairment charge for one of those businesses during 2007 and the carrying values of those business now that we have on our books at the end of the year, we believe we’ve approximate what we will be able to realize from the sale of those businesses.


Your next question comes from Marty Quant - private investor.

Marty Quant

Can you tell me what your current cash position is and if you anticipate needing to raise any funds for the rest of ’08. And in addition, in regards to Bio-Thermal, Mr. Geissler was the inventor of that technology and he had a strong relationship with Schering-Plough, now that he is back on board, do you anticipate maybe that technology coming to the market now finally with the [inaudible] division?

Joseph J. Grillo

I don’t believe that we’ll be required to look at any other cash needs going forward. We will take a look at that as we go forward with our restructuring activities.

Lorraine M. Breece

Today we look at our cash of course we include the availability under our revolvers so including the cash on hand and the availability we have about $6.5 million dollars today.

Joseph J. Grillo

I’ll address the Bio-Therm product and we’ve had a lot of good talks with Geissler Technology. Folks have joined us including Randy and we think that the bio-thermal product has a lot of applications for a number of potential customer. But the most important one as you mentioned could be Schering-Plough.

And with Randy coming back and the relationship that he has and we have in a long-term basis with Schering-Plough, we believe we will be able to take that technology and bring it to market. I'm not going say necessarily this year but in the recently short to midterm time frame along with Schering-Plough or other key partners.

Marty Quant

Also let me apply to you for taking the stance of taking shares in lieu of pay for the rest of ’08, I think that’s in the positive message. Can you tell me if any other management or executives have such plans?

Joseph J. Grillo

We have had a number of other executives and we are in the process of working with other executives to participate in some very new programs that we’ve initiated which are really a shares-for-pay a type of a program.

I think as the new management team and some of the existing management team and the new members coming in begin to get excited about the future and the company we are seeing a lot of enthusiasm and excitement for this type of program and getting involved in it. It’s quite gratifying to me.


At this time there are no further questions.

Joseph J. Grillo

Again, just thanks for everyone for being on the call today. We appreciate many opportunities in the future to continue to update you on the trend and the success that we are going to have here with Digital Angel in the future. Thank you.

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