Item
1 – Financial Statements.
DIGITAL
ALLY, INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
JUNE
30, 2019 AND DECEMBER 31, 2018
|
|
(Unaudited)
|
|
|
|
|
|
|
June 30, 2019
|
|
|
December 31, 2018
|
|
Assets
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
331,665
|
|
|
$
|
3,598,807
|
|
Accounts receivable-trade, less allowance for doubtful accounts of $90,000
– 2019 and $70,000 - 2018
|
|
|
1,612,046
|
|
|
|
1,847,886
|
|
Accounts receivable-other
|
|
|
500,968
|
|
|
|
382,412
|
|
Inventories, net
|
|
|
6,792,049
|
|
|
|
6,999,060
|
|
Income tax refund receivable, current
|
|
|
44,603
|
|
|
|
44,603
|
|
Prepaid expenses
|
|
|
429,268
|
|
|
|
429,403
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
9,710,599
|
|
|
|
13,302,171
|
|
|
|
|
|
|
|
|
|
|
Furniture, fixtures and equipment, net
|
|
|
182,975
|
|
|
|
247,541
|
|
Intangible assets, net
|
|
|
444,982
|
|
|
|
486,797
|
|
Operating lease right of use assets
|
|
|
276,338
|
|
|
|
—
|
|
Income tax refund receivable
|
|
|
45,397
|
|
|
|
45,397
|
|
Other assets
|
|
|
389,749
|
|
|
|
256,749
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
11,050,040
|
|
|
$
|
14,338,655
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders’ Deficit
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
1,857,620
|
|
|
$
|
784,599
|
|
Accrued expenses
|
|
|
1,062,234
|
|
|
|
2,080,667
|
|
Current portion of operating lease obligations
|
|
|
357,498
|
|
|
|
—
|
|
Contract liabilities-current
|
|
|
1,794,457
|
|
|
|
1,748,789
|
|
Income taxes payable
|
|
|
3,933
|
|
|
|
3,689
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
5,075,742
|
|
|
|
4,617,744
|
|
|
|
|
|
|
|
|
|
|
Long-term liabilities:
|
|
|
|
|
|
|
|
|
Proceeds investment agreement, at fair value- less current portion
|
|
|
6,240,000
|
|
|
|
9,142,000
|
|
Contract liabilities-long term
|
|
|
1,864,989
|
|
|
|
1,991,091
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
13,180,731
|
|
|
|
15,750,835
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholder’s Deficit
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value; 50,000,000 shares authorized; shares issued: 11,494,055 – 2019 and 10,445,445 – 2018
|
|
|
11,494
|
|
|
|
10,445
|
|
Additional paid in capital
|
|
|
80,990,851
|
|
|
|
78,117,507
|
|
Treasury stock, at cost (63,518 shares)
|
|
|
(2,157,226
|
)
|
|
|
(2,157,226
|
)
|
Accumulated deficit
|
|
|
(80,975,810
|
)
|
|
|
(77,382,906
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders’ deficit
|
|
|
(2,130,691
|
)
|
|
|
(1,412,180
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders’
deficit
|
|
$
|
11,050,040
|
|
|
$
|
14,338,655
|
|
See
Notes to Unaudited Condensed Consolidated Financial Statements.
DIGITAL
ALLY, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR
THE THREE AND SIX MONTHS ENDED
JUNE
30, 2019 AND 2018
(Unaudited)
|
|
Three months ended June 30,
|
|
|
Six months ended June 30,
|
|
|
|
2019
|
|
|
2018
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
1,945,724
|
|
|
$
|
2,993,700
|
|
|
$
|
3,866,188
|
|
|
$
|
4,984,813
|
|
Service and other
|
|
|
601,259
|
|
|
|
569,850
|
|
|
|
1,231,591
|
|
|
|
1,050,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
2,546,983
|
|
|
|
3,563,550
|
|
|
|
5,097,779
|
|
|
|
6,035,063
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
1,468,828
|
|
|
$
|
1,831,615
|
|
|
$
|
2,731,899
|
|
|
$
|
3,080,360
|
|
Service and other
|
|
|
127,343
|
|
|
|
113,468
|
|
|
|
233,328
|
|
|
|
226,842
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
1,596,171
|
|
|
|
1,945,083
|
|
|
|
2,965,227
|
|
|
|
3,307,202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
950,812
|
|
|
|
1,618,467
|
|
|
|
2,132,552
|
|
|
|
2,727,861
|
|
Selling, general and administrative expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development expense
|
|
|
582,905
|
|
|
|
333,760
|
|
|
|
1,045,076
|
|
|
|
773,880
|
|
Selling, advertising and promotional expense
|
|
|
1,237,947
|
|
|
|
712,008
|
|
|
|
1,993,936
|
|
|
|
1,386,413
|
|
Stock-based compensation expense
|
|
|
585,195
|
|
|
|
594,228
|
|
|
|
1,310,393
|
|
|
|
1,087,746
|
|
General and administrative expense
|
|
|
1,977,123
|
|
|
|
1,415,780
|
|
|
|
4,301,663
|
|
|
|
2,890,447
|
|
Patent litigation settlement
|
|
|
(6,000,000
|
)
|
|
|
—
|
|
|
|
(6,000,000
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total selling, general and administrative expenses
|
|
|
(1,616,830
|
)
|
|
|
3,055,776
|
|
|
|
2,651,068
|
|
|
|
6,138,486
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
2,567,642
|
|
|
|
(1,437,309
|
)
|
|
|
(518,516
|
)
|
|
|
(3,410,625
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
5,628
|
|
|
|
684
|
|
|
|
23,612
|
|
|
|
2,300
|
|
Interest expense
|
|
|
—
|
|
|
|
(152,975
|
)
|
|
|
—
|
|
|
|
(283,203
|
)
|
Change in warrant derivative liabilities
|
|
|
—
|
|
|
|
(310,195
|
)
|
|
|
—
|
|
|
|
(309,306
|
)
|
Secured convertible debentures issuance expense
|
|
|
—
|
|
|
|
(220,312
|
)
|
|
|
—
|
|
|
|
(220,312
|
)
|
Loss on the extinguishment of secured convertible debentures
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(500,000
|
)
|
Change in fair value of proceeds investment agreement
|
|
|
(2,961,000
|
)
|
|
|
—
|
|
|
|
(3,098,000
|
)
|
|
|
—
|
|
Change in fair value of secured convertible debentures
|
|
|
—
|
|
|
|
(842,783
|
)
|
|
|
—
|
|
|
|
(829,976
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income tax benefit
|
|
|
(387,730
|
)
|
|
|
(2,962,890
|
)
|
|
|
(3,592,904
|
)
|
|
|
(5,551,122
|
)
|
Income tax benefit
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(387,730
|
)
|
|
$
|
(2,962,890
|
)
|
|
$
|
(3,592,904
|
)
|
|
$
|
(5,551,122
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.03
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
(0.32
|
)
|
|
$
|
(0.78
|
)
|
Diluted
|
|
$
|
(0.03
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
(0.32
|
)
|
|
$
|
(0.78
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
11,305,248
|
|
|
|
7,129,260
|
|
|
|
11,124,222
|
|
|
|
7,153,219
|
|
Diluted
|
|
|
11,305,248
|
|
|
|
7,129,260
|
|
|
|
11,124,222
|
|
|
|
7,153,219
|
|
See
Notes to Unaudited Condensed Consolidated Financial Statements.
DIGITAL
ALLY, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2019 AND 2018
(Unaudited)
|
|
Common Stock
|
|
|
Additional Paid in
|
|
|
Treasury
|
|
|
Accumulated
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
stock
|
|
|
deficit
|
|
|
Total
|
|
Balance, December 31, 2018
|
|
|
10,445,445
|
|
|
$
|
10,445
|
|
|
$
|
78,117,507
|
|
|
$
|
(2,157,226
|
)
|
|
$
|
(77,382,906
|
)
|
|
$
|
(1,412,180
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
725,198
|
|
|
|
—
|
|
|
|
—
|
|
|
|
725,198
|
|
Restricted common stock grant
|
|
|
522,110
|
|
|
|
522
|
|
|
|
(522
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Restricted common stock forfeitures
|
|
|
(2,500
|
)
|
|
|
(2
|
)
|
|
|
2
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Issuance of common stock upon exercise of common stock purchase warrants
|
|
|
161,000
|
|
|
|
161
|
|
|
|
515,839
|
|
|
|
—
|
|
|
|
—
|
|
|
|
516,000
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,205,174
|
)
|
|
|
(3,205,174
|
)
|
Balance March 31, 2019
|
|
|
11,126,055
|
|
|
$
|
11,126
|
|
|
$
|
79,358,024
|
|
|
$
|
(2,157,226
|
)
|
|
$
|
(80,588,080
|
)
|
|
$
|
(3,376,156
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
585,195
|
|
|
|
—
|
|
|
|
—
|
|
|
|
585,195
|
|
Issuance of common stock upon exercise of common stock purchase warrants
|
|
|
368,000
|
|
|
|
368
|
|
|
|
1,047,632
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,048,000
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(387,730
|
)
|
|
|
(387,730
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2019
|
|
$
|
11,494,055
|
|
|
$
|
11,494
|
|
|
$
|
80,990,851
|
|
|
$
|
(2,157,226
|
)
|
|
$
|
(80,975,810
|
)
|
|
$
|
(2,130,691
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2017
|
|
|
7,037,799
|
|
|
$
|
7,038
|
|
|
$
|
64,923,735
|
|
|
$
|
(2,157,226
|
)
|
|
$
|
(61,909,799
|
)
|
|
$
|
863,748
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative effects of adjustment for adoption of ASC 606
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
71,444
|
|
|
|
71,444
|
|
Stock-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
493,519
|
|
|
|
—
|
|
|
|
—
|
|
|
|
493,519
|
|
Restricted common stock grant
|
|
|
84,500
|
|
|
|
84
|
|
|
|
(84
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Restricted common stock forfeitures
|
|
|
(26,450
|
)
|
|
|
(26
|
)
|
|
|
26
|
|
|
|
—
|
|
|
|
—
|
|
|
|
——
|
|
Issuance of common stock purchase warrants in connection with the issuance of subordinated notes payable
|
|
|
—
|
|
|
|
—
|
|
|
|
47,657
|
|
|
|
—
|
|
|
|
—
|
|
|
|
47,657
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,588,232
|
)
|
|
|
(2,588,232
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2018
|
|
|
7,095,849
|
|
|
$
|
7,096
|
|
|
$
|
65,464,853
|
|
|
$
|
(2,157,226
|
)
|
|
$
|
(64,426,587
|
)
|
|
$
|
(1,111,864
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
594,227
|
|
|
|
—
|
|
|
|
—
|
|
|
|
594,227
|
|
Restricted common stock grant
|
|
|
100,000
|
|
|
|
100
|
|
|
|
(100
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Restricted common stock forfeitures
|
|
|
(3,950)
|
|
|
|
(4
|
)
|
|
|
4
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Issuance of common stock purchase warrants in connection with the issuance of secured convertible debentures
|
|
|
—
|
|
|
|
—
|
|
|
|
1,684,251
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,684,251
|
|
Issuance of common stock upon conversion of secured convertible debentures and accrued interest
|
|
|
74,276
|
|
|
|
74
|
|
|
|
185,614
|
|
|
|
—
|
|
|
|
—
|
|
|
|
185,688
|
|
Issuance of common stock upon exercise of common stock purchase warrants
|
|
|
20,000
|
|
|
|
20
|
|
|
|
48,980
|
|
|
|
—
|
|
|
|
—
|
|
|
|
49,000
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,962,890
|
)
|
|
|
(2,962,890
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2018
|
|
|
7,286,175
|
|
|
$
|
7,286
|
|
|
$
|
67,977,829
|
|
|
$
|
(2,157,226
|
)
|
|
$
|
(67,389,477
|
)
|
|
$
|
(1,561,588)
|
|
See
Notes to Unaudited Condensed Consolidated Financial Statements.
DIGITAL
ALLY, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR
THE SIX MONTHS ENDED JUNE 30, 2019 AND 2018
(Unaudited)
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Cash Flows from Operating Activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,592,904
|
)
|
|
$
|
(5,551,122
|
)
|
Adjustments to reconcile net loss to net cash flows used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
206,969
|
|
|
|
275,392
|
|
Change in fair value of warrant derivative liabilities
|
|
|
—
|
|
|
|
309,306
|
|
Loss on extinguishment of secured convertible debentures
|
|
|
—
|
|
|
|
500,000
|
|
Secured convertible debentures issuance expense
|
|
|
—
|
|
|
|
220,312
|
|
Change in fair value of secured convertible note payable
|
|
|
—
|
|
|
|
829,976
|
|
Change in fair value of proceeds investment agreement
|
|
|
3,098,000
|
|
|
|
—
|
|
Interest expense added to debenture
|
|
|
—
|
|
|
|
121,271
|
|
Amortization of discount on subordinated note payable
|
|
|
—
|
|
|
|
47,657
|
|
Stock based compensation
|
|
|
1,310,393
|
|
|
|
1,087,746
|
|
Provision for inventory obsolescence
|
|
|
371,494
|
|
|
|
(437,538
|
)
|
Provision for doubtful accounts receivable
|
|
|
20,000
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Change in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
(Increase) decrease in:
|
|
|
|
|
|
|
|
|
Accounts receivable - trade
|
|
|
215,840
|
|
|
|
(79,575
|
)
|
Accounts receivable - other
|
|
|
(118,556
|
)
|
|
|
(118,461
|
)
|
Operating lease right of use asset
|
|
|
224,413
|
|
|
|
—
|
|
Inventories
|
|
|
(164,483
|
)
|
|
|
1,343,445
|
|
Prepaid expenses
|
|
|
135
|
|
|
|
90,640
|
|
Other assets
|
|
|
(133,000
|
)
|
|
|
(54,944
|
)
|
Increase (decrease) in:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
|
1,073,021
|
|
|
|
(168,117
|
)
|
Accrued expenses
|
|
|
(1,018,433
|
)
|
|
|
(132,429
|
)
|
Lease obligation with right of use asset
|
|
|
(143,252
|
)
|
|
|
—
|
|
Income taxes payable
|
|
|
244
|
|
|
|
(6,385
|
)
|
Contract liabilities
|
|
|
(80,434
|
)
|
|
|
200,759
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
|
1,269,447
|
|
|
|
(1,522,067
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows from Investing Activities:
|
|
|
|
|
|
|
|
|
Purchases of furniture, fixtures and equipment
|
|
|
(73,705
|
)
|
|
|
(28,846
|
)
|
Additions to intangible assets
|
|
|
(26,884
|
)
|
|
|
(55,055
|
)
|
Release of cash in accordance with secured convertible note
|
|
|
—
|
|
|
|
500,000
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities
|
|
|
(100,589
|
)
|
|
|
416,099
|
|
Cash Flows from Financing Activities:
|
|
|
|
|
|
|
|
|
Proceeds from subordinated notes payable
|
|
|
—
|
|
|
|
250,000
|
|
Proceeds from exercise of warrants
|
|
|
1,564,000
|
|
|
|
—
|
|
Proceeds from secured convertible debentures and detachable common stock
purchase warrants
|
|
|
—
|
|
|
|
6,250,000
|
|
Principal payment on secured convertible debentures
|
|
|
—
|
|
|
|
(3,250,000
|
)
|
Principal payment on subordinated notes payable
|
|
|
—
|
|
|
|
(1,008,500
|
)
|
Principal payment on proceeds investment agreement
|
|
|
(6,000,000
|
)
|
|
|
—
|
|
Proceeds from issuance of common stock and warrants
|
|
|
—
|
|
|
|
10,400
|
|
Loss on extinguishment of secured convertible debentures
|
|
|
—
|
|
|
|
(500,000
|
)
|
Secured convertible debentures issuance expense
|
|
|
—
|
|
|
|
(220,312
|
)
|
Principal payments on capital lease obligation
|
|
|
—
|
|
|
|
(8,492
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
(4,436,000
|
)
|
|
|
1,523,096
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(3,267,142
|
)
|
|
|
417,128
|
|
Cash and cash equivalents, beginning of period
|
|
|
3,598,807
|
|
|
|
54,712
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
331,655
|
|
|
$
|
471,840
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
Cash payments for interest
|
|
$
|
—
|
|
|
$
|
172,283
|
|
|
|
|
|
|
|
|
|
|
Cash payments for income taxes
|
|
$
|
5,756
|
|
|
$
|
6,385
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common stock grant
|
|
$
|
522
|
|
|
$
|
184
|
|
|
|
|
|
|
|
|
|
|
Restricted common stock forfeitures
|
|
$
|
2
|
|
|
$
|
30
|
|
|
|
|
|
|
|
|
|
|
Obtaining right of use asset for lease liability
|
|
$
|
500,751
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Amounts allocated to common stock purchase warrants in connection with proceeds from secured convertible debentures
|
|
$
|
—
|
|
|
$
|
1,684,251
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock upon conversion of secured convertible debentures and payment of accrued interest
|
|
$
|
—
|
|
|
$
|
185,688
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock upon exercise of common stock purchase warrants accounted for as warrant liabilities
|
|
$
|
—
|
|
|
$
|
38,600
|
|
|
|
|
|
|
|
|
|
|
Amounts allocated to common stock purchase warrants in connection with proceeds from subordinated notes payable
|
|
$
|
—
|
|
|
$
|
47,657
|
|
See
Notes to Unaudited Condensed Consolidated Financial Statements.
DIGITAL
ALLY, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature
of Business:
Digital
Ally, Inc. and subsidiary (collectively, “Digital Ally,” “Digital,” the “Company”) produces
digital video imaging and storage products for use in law enforcement, security and commercial applications. Its products are
an in-car digital video/audio recorder contained in a rear-view mirror for use in law enforcement and commercial fleets; a system
that provides its law enforcement customers with audio/video surveillance from multiple vantage points and hands-free automatic
activation of body-worn cameras and in-car video systems; a miniature digital video system designed to be worn on an individual’s
body; and cloud storage solutions. The Company has active research and development programs to adapt its technologies to other
applications. It can integrate electronic, radio, computer, mechanical, and multi-media technologies to create unique solutions
to address needs in a variety of other industries and markets, including mass transit, school bus, taxicab and the military. The
Company sells its products to law enforcement agencies and other security organizations and consumer and commercial fleet operators
through direct sales domestically and third-party distributors internationally.
The
Company was originally incorporated in Nevada on December 13, 2000 as Vegas Petra, Inc. and had no operations until 2004. On November
30, 2004, Vegas Petra, Inc. entered into a Plan of Merger with Digital Ally, Inc., at which time the merged entity was renamed
Digital Ally, Inc.
Recently
Adopted Pronouncements
In
February 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-02,
Leases
(“Topic 842”).
The guidance requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in
a manner similar to today’s accounting. Lessees initially recognize a lease liability for the obligation to make lease payments
and a right-of-use asset for the right to use the underlying asset for the lease term. The lease liability is measured at the
present value of the lease payments over the lease term. The right-of-use asset is measured at the lease liability amount, adjusted
for lease prepayments, lease incentives received and the lessee’s initial direct costs. The standard is effective for public
business entities for annual reporting periods beginning after December 15, 2018, and interim periods within that reporting period,
which is the first quarter of 2019 for the Company.
The
Company adopted the new guidance on January 1, 2019 using the optional transitional method and elected to use the package of three
practical expedients which allows the Company not to reassess whether contracts are or contain leases, lease classification and
whether initial direct costs qualify for capitalization. The Company has completed its assessment of the impact of the standard
and determined that the only lease that the Company held was an operating lease for its office and warehouse space. Upon adoption
of the standard, the Company recorded Right of Use (ROU) assets of approximately $501,000 and lease liabilities of approximately
$582,000 related to it office and warehouse space operating leases. The Company also removed deferred rent of approximately $81,000
when adopting the new guidance.
Management’s
Liquidity Plan
The
Company incurred operating losses in the six months ended June 30, 2019 and substantial operating losses for the year ended December
31, 2018 primarily due to reduced revenues and gross margins caused by competitors’ willful infringement of its patents,
specifically the auto-activation of body-worn and in-car video systems, and by competitors’ introduction of newer products
with more advanced features together with significant price cutting of their products. The Company incurred net losses of approximately
$3.6 million for the six months ended June 30, 2019 and $15.5 million during the year ended December 31, 2018 and it had an accumulated
deficit of $81.0 million as of June 30, 2019. During the six months ended June 30, 2019, the Company settled one of its patent
infringement cases and received a lump sum payment of $6.0 million which was used to pay its obligations under its Proceeds Investment
Agreement (the “PIA”), as more fully described in Note 11. In recent years the Company has accessed the public and
private capital markets to raise funding through the issuance of debt and equity. In that regard, the Company raised $1,564,000
in the six months ended June 30, 2019 from the exercise of warrants. Additionally, the Company raised funding in the form of subordinated
debt, secured debt and proceeds investment agreements totaling $16,500,000, and net proceeds of $7,324,900 from an underwritten
public offering of common stock during the year ended December 31, 2018. The Company issued common stock with detachable common
stock purchase warrants for $2,776,332 and raised funding from subordinated and secured debt totaling $1,608,500 during the year
ended December 31, 2017. During 2016, the Company raised $4.0 million of funding in the form of convertible debentures and common
stock purchase warrants. These debt and equity raises were utilized to fund its operations and management expects to continue
this pattern until it achieves positive cash flows from operations, although it can offer no assurance in this regard.
The
Company retired all interest-bearing debt outstanding during the year ended December 31, 2018. The only long-term obligations
outstanding as of June 30, 2019 are associated with the PIA that the Company entered into during July 2018, as more fully described
in Note 6. On August 5, 2019, the Company raised funds from the issuance of $2.78 million principal balance of convertible debentures
with detachable warrants to purchase 571,248 shares of common stock with the net proceeds being used for working capital purposes,
as more fully described in Note 15.
The
Company settled its lawsuit with the PGA Tour and the case was dismissed by the Plaintiff with prejudice on April 17, 2019. See
Note 11, “Contingencies” for the details respecting the settlement. Additionally, the Company settled its lawsuit
with WatchGuard on May 13, 2019 and the case was dismissed. See Note 11, “Contingencies” for the details respecting
the settlement.
The
Company will have to restore positive operating cash flows and profitability over the next year and/or raise additional capital
to fund its operational plans, meet its customary payment obligations and otherwise execute its business plan. There can be no
assurance that it will be successful in restoring positive cash flows and profitability, or that it can raise additional financing
when needed, and obtain it on terms acceptable or favorable to the Company.
The
Company has implemented an enhanced quality control program to detect and correct product issues before they result in significant
rework expenditures affecting its gross margins and has seen progress in that regard. In addition, the Company undertook a number
of cost reduction initiatives in 2018, including a reduction of its workforce by approximately 40%, restructuring its direct sales
force and cutting other selling, general and administrative costs. The Company has increased its addressable market to non-law
enforcement customers and obtained new non-law enforcement contracts in 2018, which contracts include recurring revenue during
the period 2019 to 2020. The Company believes that its quality control, headcount reduction and cost cutting initiatives, expansion
to non-law enforcement sales channels and new product introduction will eventually restore positive operating cash flows and profitability,
although it can offer no assurances in this regard.
In
addition to the initiatives described above, the Board of Directors continues to conduct its review of a full range of strategic
alternatives to best position the Company for the future, including, but not limited to, monetizing its patent portfolio and related
patent infringement litigation against Axon Enterprise, Inc. (“Axon,” formerly Taser International, Inc.), the sale
of all or certain assets, properties or groups of properties or individual businesses or merger or combination with another company.
The result of this review may also include the continued implementation of the Company’s business plan. The August 5, 2019
issuance of $2.78 million principal balance of convertible notes was part of this strategic alternatives review. While such funding
addressed the Company’s near-term liquidity needs, it continues to consider strategic alternatives to address longer-term
liquidity needs and operational issues. There can be no assurance that any additional transactions or financings will result from
this process.
Based
on the uncertainties described above, the Company believes its business plan does not alleviate the existence of substantial doubt
about its ability to continue as a going concern within one year from the date of the issuance of these condensed consolidated
interim financial statements.
The
following is a summary of the Company’s Significant Accounting Policies:
Basis
of Consolidation:
The
accompanying financial statements include the consolidated accounts of Digital Ally and its wholly-owned subsidiary, Digital Ally
International, Inc. All intercompany balances and transactions have been eliminated during consolidation.
The
Company formed Digital Ally International, Inc. during August 2009 to facilitate the export sales of its products.
Fair
Value of Financial Instruments:
The
carrying amounts of financial instruments, including cash and cash equivalents, accounts receivable and accounts payable approximate
fair value because of the short-term nature of these items. The Company accounts for its proceeds investment agreement on a fair
value basis.
Revenue
Recognition:
The
Company applies the provisions of Accounting Standards Codification (ASC) 606-10,
Revenue from Contracts with Customers
,
and all related appropriate guidance. The Company recognizes revenue under the core principle to depict the transfer of control
to its customers in an amount reflecting the consideration to which it expects to be entitled. In order to achieve that core principle,
the Company applies the following five-step approach: (1) identify the contract with a customer, (2) identify the performance
obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations
in the contract, and (5) recognize revenue when a performance obligation is satisfied.
The
Company considers customer purchase orders, which in some cases are governed by master sales agreements, to be the contracts with
the customer. In situation where sales are to a distributor, the Company had concluded its contracts are with the distributor
as the Company holds a contract bearing enforceable rights and obligations only with the distributor. As part of part of its consideration
for the contract, the Company evaluates certain factors including the customers’ ability to pay (or credit risk). For each
contract, the Company considers the promise to transfer products, each of which is distinct, to be the identified performance
obligations. In determining the transaction price, the Company evaluates whether the price is subject to refund or adjustment
to determine the net consideration to which it expects to be entitled. As the Company’s standard payment terms are less
than one year, it has elected the practical expedient under ASC 606-10-32-18 to not assess whether a contract has a significant
financing component. The Company allocates the transaction price to each distinct product based on its relative standalone selling
price. The product price as specified on the purchase order is considered the standalone selling price as it is an observable
input which depicts the price as if sold to a similar customer in similar circumstances. Revenue is recognized when control of
the product is transferred to the customer (i.e. when the Company’s performance obligations is satisfied), which typically
occurs at shipment. Further in determining whether control has been transferred, the Company considers if there is a present right
to payment and legal title, along with risks and rewards of ownership having transferred to the customer. Customers do not have
a right to return the product other than for warranty reasons for which they would only receive repair services or replacement
product. The Company has also elected the practical expedient under ASC 340-40-25-4 to expense commissions for product sales when
incurred as the amortization period of the commission asset the Company would have otherwise recognized is less than one year.
The
Company sells its products and services to law enforcement and commercial customers in the following manner:
|
●
|
Sales
to domestic customers are made direct to the end customer (typically a law enforcement agency or a commercial customer) through
its sales force, which is composed of its employees. Revenue is recorded when the product is shipped to the end customer.
|
|
|
|
|
●
|
Sales to international
customers are made through independent distributors who purchase products from the Company at a wholesale price and sell to
the end user (typically law enforcement agencies or a commercial customer) at a retail price. The distributor retains the
margin as its compensation for its role in the transaction. The distributor generally maintains product inventory, customer
receivables and all related risks and rewards of ownership. Accordingly, upon application of steps one through five above,
revenue is recorded when the product is shipped to the distributor consistent with the terms of the distribution agreement.
|
|
|
|
|
●
|
Repair parts and
services for domestic and international customers are generally handled by its inside customer service employees. Revenue
is recognized upon shipment of the repair parts and acceptance of the service or materials by the end customer.
|
Sales
taxes collected on products sold are excluded from revenues and are reported as accrued expenses in the accompanying balance sheets
until payments are remitted.
Service
and other revenue is comprised of revenues from extended warranties, repair services, cloud revenue and software revenue. Revenue
is recognized upon shipment of the product and acceptance of the service or materials by the end customer for repair services.
Revenue for extended warranty, cloud service or other software-based products is over the term of the contract warranty or service
period. A time-elapsed method is used to measure progress because the Company transfers control evenly over the contractual period.
Accordingly, the fixed consideration related to these revenues is generally recognized on a straight-line basis over the contract
term, as long as the other revenue recognition criteria have been met.
Contracts
with some of the Company’s customers contain multiple performance obligations that are distinct and accounted for separately.
The transaction price is allocated to the separate performance obligations on a relative standalone selling price (“SSP”).
The Company determined SSP for all the performance obligations using observable inputs, such as standalone sales and historical
pricing. SSP is consistent with the Company’s overall pricing objectives, taking into consideration the type of service
being provided. SSP also reflects the amount the Company would charge for the performance obligation if it were sold separately
in a standalone sale. Multiple performance obligations consist of product, software, cloud subscriptions and extended warranties.
The
Company’s multiple performance obligations may include future in-car or body-worn camera devices to be delivered at defined
points within a multi-year contract, and in those arrangements, the Company allocates total arrangement consideration over the
life of the multi-year contract to future deliverables using management’s best estimate of selling price.
Contract
liabilities consist of deferred revenue and include payments received in advance of performance under the contract and are reported
separately as current liabilities and non-current liabilities in the Condensed Consolidated Balance Sheets. Such amounts consist
of extended warranty contracts, prepaid cloud services and prepaid installation services and are generally recognized as the respective
performance obligations are satisfied. Total contract liabilities consist of the following:
|
|
June 30, 2019
|
|
|
December 31, 2018
|
|
Contract liabilities, current
|
|
$
|
1,794,457
|
|
|
$
|
1,748,789
|
|
Contract liabilities, non-current
|
|
|
1,864,989
|
|
|
|
1,991,091
|
|
|
|
|
|
|
|
|
|
|
Total contract liabilities
|
|
$
|
3,659,446
|
|
|
$
|
3,739,880
|
|
Sales
returns and allowances aggregated $37,978 and $34,227 for the three months ended June 30, 2019 and 2018, respectively, and $112,237
and $54,246 for the six months ended June 30, 2019 and 2018, respectively. Obligations for estimated sales returns and allowances
are recognized at the time of sales on an accrual basis. The accrual is determined based upon historical return rates adjusted
for known changes in key variables affecting these return rates
Revenues
for six month ended June 30, 2019 and 2018 were derived from the following sources
|
|
Six months ended June 30,
|
|
|
|
2019
|
|
|
2018
|
|
DVM-800
|
|
$
|
1,979,681
|
|
|
$
|
2,860,907
|
|
DVM-250 Plus
|
|
|
427,343
|
|
|
|
366,351
|
|
FirstVu HD
|
|
|
735,222
|
|
|
|
642,665
|
|
EVO
|
|
|
62,942
|
|
|
|
—
|
|
DVM-100 & DVM-400
|
|
|
6,765
|
|
|
|
64,401
|
|
DVM-750
|
|
|
72,549
|
|
|
|
213,935
|
|
VuLink
|
|
|
73,919
|
|
|
|
133,001
|
|
Repair and service
|
|
|
734,332
|
|
|
|
627,874
|
|
Cloud service revenue
|
|
|
349,337
|
|
|
|
326,741
|
|
Other service revenue
|
|
|
94,430
|
|
|
|
95,635
|
|
Laser Ally
|
|
|
19,130
|
|
|
|
22,530
|
|
Accessories and other revenues
|
|
|
542,129
|
|
|
|
681,023
|
|
|
|
$
|
5,097,779
|
|
|
$
|
6,035,063
|
|
Use
of Estimates:
The
preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in
the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount
of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash
and cash equivalents:
Cash
and cash equivalents include funds on hand, in bank and short-term investments with original maturities of ninety (90) days or
less.
Accounts
Receivable:
Accounts
receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding
amounts on a weekly basis. The Company determines the allowance for doubtful accounts by regularly evaluating individual customer
receivables and considering a customer’s financial condition, credit history, and current economic conditions. Trade receivables
are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.
A
trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than thirty (30)
days beyond terms. No interest is charged on overdue trade receivables.
Inventories:
Inventories
consist of electronic parts, circuitry boards, camera parts and ancillary parts (collectively, “components”), work-in-process
and finished goods, and are carried at the lower of cost (First-in, First-out Method) or market value. The Company determines
the estimate for the reserve for slow moving or obsolete inventories by regularly evaluating individual inventory levels, projected
sales and current economic conditions.
Furniture,
fixtures and equipment:
Furniture,
fixtures and equipment is stated at cost net of accumulated depreciation. Additions and improvements are capitalized while ordinary
maintenance and repair expenditures are charged to expense as incurred. Depreciation is recorded by the straight-line method over
the estimated useful life of the asset, which ranges from three to ten years. Amortization expense on capitalized leases is included
with depreciation expense.
Intangible
assets:
Intangible
assets include deferred patent costs and license agreements. Legal expenses incurred in preparation of patent application have
been deferred and will be amortized over the useful life of granted patents. Costs incurred in preparation of applications that
are not granted will be charged to expense at that time. The Company has entered into several sublicense agreements under which
it has been assigned the exclusive rights to certain licensed materials used in its products. These sublicense agreements generally
require upfront payments to obtain the exclusive rights to such material. The Company capitalizes the upfront payments as intangible
assets and amortizes such costs over their estimated useful life on a straight-line method.
Leases:
The
Company determines if an arrangement contains a lease at inception. For arrangements where the Company is the lessee, the Company
will evaluate whether to account for the lease as an operating or finance lease. Operating leases are included in the right of
use assets (ROU) and operating lease liabilities on the condensed consolidated balance sheet as of June 30, 2019. Finance leases
would be included in furniture, fixtures and equipment, net and long-term debt and finance lease obligations on the condensed
balance sheet. The Company had an operating lease for office and warehouse space at June 30, 2019 but no financing leases.
ROU
assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term
at commencement date. The Company uses its incremental borrowing rate based on the information available at the commencement date
in determining the operating lease liabilities if the operating lease does not provide an implicit rate. Lease terms may include
the option to extend when Company is reasonably certain that the option will be exercised. Lease expense for operating leases
is recognized on a straight-line basis over the lease term
The
Company elected to apply the short-term lease measurement and recognition exemption in which ROU assets and lease liabilities
are not recognized for short term leases.
Proceeds
investment agreement:
The
Company has elected to record its proceeds investment agreement at its fair value. Accordingly, the proceeds investment agreement
will be marked-to-market at each reporting date with the change in fair value reported as a gain (loss) in the Condensed Consolidated
Statement of Operations. All issuance costs related to the proceeds investment agreement were expensed as incurred in the Condensed
Consolidated Statement of Operations.
Long-Lived
Assets:
Long-lived
assets such as furniture, fixtures and equipment and purchased intangible assets subject to amortization are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances
require a long-lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows
expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or
asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying
value exceeds its fair value. Fair value is determined through various valuation techniques, including discounted cash flow models,
quoted market values and third-party appraisals, as considered necessary.
Warranties:
The
Company’s products carry explicit product warranties that extend up to two years from the date of shipment. The Company
records a provision for estimated warranty costs based upon historical warranty loss experience and periodically adjusts these
provisions to reflect actual experience. Accrued warranty costs are included in accrued expenses. Extended warranties are offered
on selected products and when a customer purchases an extended warranty the associated proceeds are treated as contract liabilities
and recognized over the term of the extended warranty.
Shipping
and Handling Costs:
Shipping
and handling costs for outbound sales orders totaled $13,158 and $20,317 for the three months ended June 30, 2019 and 2018, respectively,
and $31,578 and $34,284 for the six months ended June 30, 2019 and 2018, respectively. Such costs are included in selling, general
and administrative expenses in the Condensed Consolidated Statements of Operations.
Advertising
Costs:
Advertising
expense includes costs related to trade shows and conventions, promotional material and supplies, and media costs. Advertising
costs are expensed in the period in which they are incurred. The Company incurred total advertising expense of approximately $510,792
and $111,677 for the three months ended June 30, 2019 and 2018, respectively, and $634,807 and $191,246 for the six months ended
June 30, 2019 and 2018, respectively. The increase was primarily attributable to our sponsorship of a NASCAR race in May 2019
and other related sponsorship opportunities. Such costs are included in selling, general and administrative expenses in the
Condensed Consolidated Statements of Operations.
Income
Taxes:
Deferred
taxes are provided for by the liability method in which deferred tax assets are recognized for deductible temporary differences
and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences.
Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion
or all the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes
in tax laws and rates on the date of enactment.
The
Company applies the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) No. 740 - Income Taxes that provides a framework for accounting for uncertainty in income taxes and provided
a comprehensive model to recognize, measure, present, and disclose in its financial statements uncertain tax positions taken or
expected to be taken on a tax return. It initially recognizes tax positions in the financial statements when it is more likely
than not the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently
measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with
the tax authority assuming full knowledge of the position and all relevant facts. Application requires numerous estimates based
on available information. The Company considers many factors when evaluating and estimating its tax positions and tax benefits,
and it recognized tax positions and tax benefits may not accurately anticipate actual outcomes. As it obtains additional information,
the Company may need to periodically adjust its recognized tax positions and tax benefits. These periodic adjustments may have
a material impact on its Condensed consolidated Statements of Operations.
The
Company’s policy is to record estimated interest and penalties related to the underpayment of income taxes as income tax
expense in the condensed consolidated statements of operations. There was no interest expense related to the underpayment of estimated
taxes during the six months ended June 30, 2019 and 2018. There were no penalties in the six months ended June 30, 2019 and 2018.
The
Company is subject to taxation in the United States and various states. As of June 30, 2019, the Company’s tax returns filed
for 2015, 2016, and 2017 and to be filed for 2018 are subject to examination by the relevant taxing authorities. With few exceptions,
as of June 30, 2019, the Company is no longer subject to Federal, state, or local examinations by tax authorities for years before
2015.
Research
and Development Expenses:
The
Company expenses all research and development costs as incurred. Development costs of computer software to be sold, leased, or
otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established
and ending when a product is available for general release to customers. In most instances, the Company’s products are released
soon after technological feasibility has been established. Costs incurred subsequent to achievement of technological feasibility
were not significant, and software development costs were expensed as incurred during the six months ended June 30, 2019 and 2018.
Common
Stock Purchase Warrants:
The
Company has common stock purchase warrants that are accounted for as equity based on their relative fair value and are not subject
to re-measurement.
Stock-Based
Compensation:
The
Company grants stock-based compensation to its employees, board of directors and certain third-party contractors. Share-based
compensation arrangements may include the issuance of options to purchase common stock in the future or the issuance of restricted
stock, which generally are subject to vesting requirements. The Company records stock-based compensation expense for all stock-based
compensation granted based on the grant-date fair value. The Company recognizes these compensation costs on a straight-line basis
over the requisite service period of the award.
The
Company estimates the grant-date fair value of stock-based compensation using the Black-Scholes valuation model. Assumptions used
to estimate compensation expense are determined as follows:
|
●
|
Expected
term is determined using the contractual term and vesting period of the award;
|
|
|
|
|
●
|
Expected volatility
of award grants made in the Company’s plan is measured using the weighted average of historical daily changes in the
market price of the Company’s common stock over the period equal to the expected term of the award;
|
|
|
|
|
●
|
Expected dividend
rate is determined based on expected dividends to be declared;
|
|
|
|
|
●
|
Risk-free interest
rate is equivalent to the implied yield on zero-coupon U.S. Treasury bonds with a maturity equal to the expected term of the
awards; and
|
|
|
|
|
●
|
Forfeitures are
accounted for as they occur.
|
Segments
of Business:
Management
has determined that its operations are comprised of one reportable segment: the sale of digital audio and video recording and
speed detection devices. For the three and six months ended June 30, 2019 and 2018, sales by geographic area were as follows:
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2019
|
|
|
2018
|
|
|
2019
|
|
|
2018
|
|
Sales by geographic area:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States of America
|
|
$
|
2,477,717
|
|
|
$
|
3,386,146
|
|
|
$
|
4,992,059
|
|
|
$
|
5,824,934
|
|
Foreign
|
|
|
69,266
|
|
|
|
177,404
|
|
|
|
105,720
|
|
|
|
210,129
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,546,983
|
|
|
$
|
3,563,550
|
|
|
$
|
5,097,779
|
|
|
$
|
6,035,063
|
|
Sales
to customers outside of the United States are denominated in U.S. dollars. All Company assets are physically located within the
United States.
Recent
Accounting Pronouncements
There
were no new material accounting pronouncements that were applicable to the Company for the six months ended June 30, 2019.
NOTE
2. BASIS OF PRESENTATION
The
condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in
the United States for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly,
they do not include all the information and footnotes required by generally accepted accounting principles in the United States
for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the three and six-month period ended June 30,
2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.
The
balance sheet at December 31, 2018 has been derived from the audited financial statements at that date but does not include all
the information and footnotes required by generally accepted accounting principles in the United States for complete financial
statements.
For
further information, refer to the financial statements and footnotes included in the Company’s annual report on Form 10-K
for the year ended December 31, 2018.
NOTE
3. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
Financial
instruments that potentially subject the Company to concentrations of credit risk consist of accounts receivable. Sales to domestic
customers are typically made on credit and the Company generally does not require collateral while sales to international customers
require payment before shipment or backing by an irrevocable letter or credit. The Company performs ongoing credit evaluations
of its customers’ financial condition and maintains an allowance for estimated losses. Accounts are written off when deemed
uncollectible and accounts receivable are presented net of an allowance for doubtful accounts. The allowance for doubtful accounts
totaled $90,000 as of June 30, 2019 and $70,000 as of December 31, 2018.
The
Company uses primarily a network of unaffiliated distributors for international sales and employee-based direct sales force for
domestic sales. No international distributor individually exceeded 10% of total revenues and no customer receivable balance exceeded
10% of total accounts receivable for the six months ended June 30, 2019 and 2018
The
Company purchases finished circuit boards and other proprietary component parts from suppliers located in the United States and
on a limited basis from Asia. Although the Company obtains certain of these components from single source suppliers, it generally
owns all tooling and management has located alternative suppliers to reduce the risk in most cases to supplier problems that could
result in significant production delays. The Company has not historically experienced significant supply disruptions from any
of its principal vendors and does not anticipate future supply disruptions. The Company acquires most of its components on a purchase
order basis and does not have long-term contracts with its suppliers.
NOTE
4. INVENTORIES
Inventories
consisted of the following at June 30, 2019 and December 31, 2018:
|
|
June 30, 2019
|
|
|
December 31, 2018
|
|
Raw material and component parts
|
|
$
|
4,903,170
|
|
|
$
|
4,969,786
|
|
Work-in-process
|
|
|
256,910
|
|
|
|
351,451
|
|
Finished goods
|
|
|
5,291,233
|
|
|
|
4,965,594
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
10,451,313
|
|
|
|
10,286,831
|
|
Reserve for excess and obsolete inventory
|
|
|
(3,659,264
|
)
|
|
|
(3,287,771
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
6,792,049
|
|
|
$
|
6,990,060
|
|
Finished
goods inventory includes units held by potential customers and sales agents for test and evaluation purposes. The cost of such
units totaled $141,609 and $115,456 as of June 30, 2019 and December 31, 2018, respectively.
NOTE
5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture,
fixtures and equipment consisted of the following at June 30, 2019 and December 31, 2018:
|
|
Estimated
Useful
Life
|
|
June 30, 2019
|
|
|
December 31, 2018
|
|
Office furniture, fixtures and equipment
|
|
3-10 years
|
|
$
|
821,453
|
|
|
$
|
802,681
|
|
Warehouse and production equipment
|
|
3-5 years
|
|
|
537,471
|
|
|
|
526,932
|
|
Demonstration and tradeshow equipment
|
|
2-5 years
|
|
|
466,394
|
|
|
|
426,582
|
|
Leasehold improvements
|
|
2-5 years
|
|
|
163,171
|
|
|
|
160,198
|
|
Rental equipment
|
|
1-3 years
|
|
|
126,163
|
|
|
|
124,553
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost
|
|
|
|
|
2,114,652
|
|
|
|
2,040,946
|
|
Less: accumulated depreciation and amortization
|
|
|
|
|
(1,931,677
|
)
|
|
|
(1,793,405
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net furniture, fixtures and equipment
|
|
|
|
$
|
182,975
|
|
|
$
|
247,541
|
|
Depreciation
and amortization of furniture, fixtures and equipment aggregated $63,506 and $101,252 for the three months ended June 30, 2019
and 2018, respectively, and $138,272 and $217,802 for the six months ended June 30, 2019 and 2018, respectively.
NOTE
6. DEBT OBLIGATIONS
Proceeds
investment agreement is comprised of the following:
|
|
June 30, 2019
|
|
|
December 31, 2018
|
|
2018 Proceeds Investment Agreement, at fair value
|
|
$
|
6,240,000
|
|
|
$
|
9,142,000
|
|
Less: Current portion
|
|
|
-
|
|
|
|
-
|
|
2018 Proceeds investment agreement at fair value-less current portion
|
|
$
|
6,240,000
|
|
|
$
|
9,142,000
|
|
2018
Proceeds Investment Agreement
.
On
July 31, 2018, the Company entered into a Proceeds Investment Agreement (the “PIA”) with Brickell Key Investments
LP (“BKI”), pursuant to which BKI funded an aggregate of $500,000 (the “First Tranche”) to be used (i)
to fund the Company’s litigation proceedings relating to the infringement of certain patent assets listed in the PIA and
(ii) to repay the Company’s existing debt obligations and for certain working capital purposes set forth in the PIA. Pursuant
to the PIA, BKI was granted an option to provide the Company with an additional $9.5 million, at BKI’s sole discretion (the
“Second Tranche”). On August 21, 2018, BKI exercised its option on the Second Tranche for $9.5 million which completed
the $10 million funding.
Pursuant
to the PIA and in consideration for the $10.0 million in funding, the Company agreed to assign to BKI (i) 100% of all gross, pre-tax
monetary recoveries paid by any defendant(s) to the Company or its affiliates agreed to in a settlement or awarded in judgment
in connection with the patent assets, plus any interest paid in connection therewith by such defendant(s) (the “Patent Assets
Proceeds”), up to the minimum return (as defined in the Agreement) and (ii) if BKI has not received its minimum return by
the earlier of a liquidity event (as defined in the Agreement) and July 31, 2020, then the Company agreed to assign to BKI 100%
of the Patent Asset Proceeds until BKI has received an amount equal to the minimum return on $4.0 million.
Pursuant
to the PIA, the Company granted BKI (i) a senior security interest in the Patent Assets, the claims (as defined in the Agreement)
and the Patent Assets Proceeds until such time as the minimum return is paid, in which case, the security interest on the patent
assets, the claims and the Patent Assets Proceeds will be released, and (ii) a senior security interest in all other assets of
the Company until such time as the minimum return is paid on $4.0 million, in which case, the security interest on such other
assets will be released.
The
security interest is enforceable by BKI if the Company is in default under the PIA which would occur if (i) the Company fails,
after five (5) days’ written notice, to pay any due amount payable to BKI under the PIA, (ii) the Company fails to comply
with any provision of the PIA Agreement or any other agreement or document contemplated under the PIA, (iii) the Company becomes
insolvent or insolvency proceedings are commenced (and not subsequently discharged) with respect to the Company, (iv) the Company’s
creditors commence actions against the Company (which are not subsequently discharged) that affect material assets of the Company,
(v) the Company, without BKI’s consent, incurs indebtedness other than immaterial ordinary course indebtedness up to $500,000,
(vi) the Company fails, within five (5) business days following the closing of the second tranche, to fully satisfy its obligations
to certain holders of the Company’s senior secured convertible promissory notes listed in the PIA Agreement and fails to
obtain unconditional releases from such holders as to the Company’s obligations to such holders and the security interests
in the Company held by such holders or (vii) there is an uncured non-compliance of the Company’s obligations or misrepresentations
by the Company under the PIA.
Under
the PIA, the Company issued BKI a warrant to purchase up to 465,712 shares of the Company’s common stock, par value $0.001
per share (the “PIA Warrant”), at an exercise price of $2.60 per share provided that the holder of the PIA Warrant
will be prohibited from exercising the PIA Warrant if, as a result of such exercise, such holder, together with its affiliates,
would own more than 4.99% of the total number of shares of the Company’s common stock outstanding immediately after giving
effect to such exercise. However, such holder may increase or decrease such percentage to any other percentage not in excess of
9.99%, provided that any increase in such percentage shall not be effective until 61 days after such notice to the Company. The
PIA Warrant is exercisable for five years from the date of issuance and is exercisable on a cashless exercise basis if there is
no effective registration statement. No contractual registration rights were given.
The
Company elected to account for the PIA on the fair value basis. Therefore, the Company determined the fair value of the PIA and
PIA Warrants which yielded estimated fair values of the PIA including their embedded derivatives and the detachable PIA Warrants
as follows:
Proceeds investment agreement
|
|
$
|
9,067,513
|
|
Common stock purchase warrants
|
|
|
932,487
|
|
Gross cash proceeds
|
|
$
|
10,000,000
|
|
During
the six months ended June 30, 2019, the Company settled its patent infringement litigation with WatchGuard and it received a lump-sum
payment of $6.0 million as further described in Note 11. In accordance with the terms of the PIA, the Company remitted the $6.0
as a principal payment toward its minimum return payment obligations under the PIA. The Company recorded the receipt of the $6,000,000
settlement as Patent litigation settlement income in the accompanying condensed consolidated statement of operations.
The
following represents activity in the PIA during the six months ended June 30, 2019:
Beginning balance as of January 1, 2019
|
|
$
|
9,142,000
|
|
Repayment of obligation
|
|
|
(6,000,000
|
)
|
|
|
|
|
|
Change in the fair value during the period
|
|
|
3,098,000
|
|
Ending balance as of June 30, 2019
|
|
$
|
6,240,000
|
|
NOTE
7. FAIR VALUE MEASUREMENT
In
accordance with ASC Topic 820 —
Fair Value Measurements and Disclosures
(“ASC 820”), the Company utilizes
the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other
relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets
or liabilities, such as a business.
ASC
820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three
broad levels. The following is a brief description of those three levels:
|
●
|
Level
1 — Quoted prices in active markets for identical assets and liabilities
|
|
|
|
|
●
|
Level
2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
|
|
|
|
|
●
|
Level
3 — Significant unobservable inputs (including the Company’s own assumptions in determining the fair value)
|
The
following table represents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a
recurring basis as of June 30, 2019 and December 31, 2018.
|
|
June 30, 2019
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds Investment Agreement
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6,240,000
|
|
|
$
|
6,240,000
|
|
|
|
December 31, 2018
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds Investment Agreement
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,142,000
|
|
|
$
|
9,142,000
|
|
The
following table represents the change in Level 3 tier value measurements:
|
|
Proceeds
Investment
Agreement
|
|
December 31, 2018
|
|
$
|
9,142,000
|
|
Repayment of obligation
|
|
|
(6,000,000
|
)
|
Change in fair value
|
|
|
3,098,000
|
|
|
|
|
|
|
June 30, 2019
|
|
$
|
6,240,000
|
|
NOTE
8. ACCRUED EXPENSES
Accrued
expenses consisted of the following at June 30, 2019 and December 31, 2018:
|
|
June 30, 2019
|
|
|
December 31, 2018
|
|
Accrued warranty expense
|
|
$
|
102,955
|
|
|
$
|
195,135
|
|
Accrued litigation costs
|
|
|
363,508
|
|
|
|
1,119,445
|
|
Accrued sales commissions
|
|
|
26,553
|
|
|
|
25,750
|
|
Accrued payroll and related fringes
|
|
|
265,258
|
|
|
|
186,456
|
|
Accrued insurance
|
|
|
39,112
|
|
|
|
71,053
|
|
Accrued sales returns and allowances
|
|
|
28,714
|
|
|
|
13,674
|
|
Other
|
|
|
236,134
|
|
|
|
469,154
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,062,234
|
|
|
$
|
2,080,667
|
|
Accrued
warranty expense was comprised of the following for the six months ended June 30, 2019:
|
|
2019
|
|
Beginning balance
|
|
$
|
195,135
|
|
Provision for warranty expense
|
|
|
25,341
|
|
Charges applied to warranty reserve
|
|
|
(117,521
|
)
|
|
|
|
|
|
Ending balance
|
|
$
|
102,955
|
|
NOTE
9. INCOME TAXES
The
effective tax rate for the six months ended June 30, 2019 and 2018 varied from the expected statutory rate due to the Company
continuing to provide a 100% valuation allowance on net deferred tax assets. The Company determined that it was appropriate to
continue the full valuation allowance on net deferred tax assets as of June 30, 2019 primarily because of the Company’s
history of operating losses.
The
Company has incurred operating losses in recent years and it continues to be in a three-year cumulative loss position at June
30, 2019. Accordingly, the Company determined there was not sufficient positive evidence regarding its potential for future profits
to outweigh the negative evidence of our three-year cumulative loss position under the guidance provided in ASC 740. Therefore,
it determined to continue to provide a 100% valuation allowance on its net deferred tax assets. The Company expects to continue
to maintain a full valuation allowance until it determines that it can sustain a level of profitability that demonstrates its
ability to realize these assets. To the extent the Company determines that the realization of some or all of these benefits is
more likely than not based upon expected future taxable income, a portion or all of the valuation allowance will be reversed.
NOTE
10. OPERATING LEASE
The
Company entered into an operating lease with a third party in September 2012 for office and warehouse space in Lenexa, Kansas.
The terms of the lease include monthly payments ranging from $38,026 to $38,533 with a maturity date of April 2020. The Company
has the option to renew for an additional three years beyond the original expiration date, which may be exercised at the Company’s
sole discretion. The Company evaluated the renewal option at the lease commencement date to determine if it is reasonably certain
the exercise the option and concluded that it is not reasonably certain that any options will be exercised. The weighted average
remaining lease term for the Company’s operating lease as of June 30, 2019 was .83 years.
Expense
related to the office space operating lease was recorded on a straight-line basis over the lease term. Lease expense under the
operating lease was approximately $198,861 for the six months ended June 30, 2019.
The
discount rate implicit within the Company’s operating lease was not generally determinable and therefore the Company determined
the discount rate based on its incremental borrowing rate on the information available at commencement date. As of June 30, 2019,
the operating lease liabilities reflect a weighted average discount rate of 8%.
The
following sets forth the operating lease right of use assets and liabilities as of June 30, 2019:
Assets:
|
|
|
|
Operating lease right of use assets
|
|
$
|
276,338
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Operating lease obligations-current portion
|
|
$
|
357,498
|
|
|
|
|
|
|
Operating lease obligations-less current portion
|
|
$
|
—
|
|
|
|
|
|
|
Total operating lease obligations
|
|
$
|
357,498
|
|
Following
are our minimum lease payments for each year and in total.
Year ending December 31:
|
|
|
|
2019 (period from July 1, 2019 to December 31, 2019)
|
|
$
|
229,170
|
|
2020
|
|
|
154,131
|
|
Total undiscounted minimum future lease payments
|
|
|
383,301
|
|
Imputed interest
|
|
|
(25,803
|
)
|
|
|
$
|
357,498
|
|
NOTE
11. CONTINGENCIES
Litigation.
From
time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy to
not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After
carefully assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded,
we vigorously defend any lawsuit filed against us. We record a liability when losses are deemed probable and reasonably estimable.
When losses are deemed reasonably possible but not probable, we determine whether it is possible to provide an estimate of the
amount of the loss or range of possible losses for the claim, if material for disclosure. In evaluating matters for accrual and
disclosure purposes, we take into consideration factors such as our historical experience with matters of a similar nature, the
specific facts and circumstances asserted, the likelihood of our prevailing, the availability of insurance, and the severity of
any potential loss. We reevaluate and update accruals as matters progress over time.
While
the ultimate resolution is unknown we do not expect that these lawsuits will individually, or in the aggregate, have a material
adverse effect to our results of operations, financial condition or cash flows. However, the outcome of any litigation is inherently
uncertain and there can be no assurance that any expense, liability or damages that may ultimately result from the resolution
of these matters will be covered by our insurance or will not be in excess of amounts recognized or provided by insurance coverage
and will not have a material adverse effect on our operating results, financial condition or cash flows.
Axon
The
Company owns U.S. Patent No. 9,253,452 (the “ ‘452 Patent”), which generally covers the automatic activation
and coordination of multiple recording devices in response to a triggering event, such as a law enforcement officer activating
the light bar on the vehicle.
The
Company filed suit on January 15, 2016 in the U.S. District Court for the District of Kansas (Case No: 2:16-cv-02032) against
Axon, alleging willful patent infringement against Axon’s body camera product line and Signal auto-activation product. The
Company is seeking both monetary damages and a permanent injunction against Axon for infringement of the ‘452 Patent.
In
addition to the infringement claims, the Company brought claims alleging that Axon conspired to keep the Company out of the marketplace
by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Axon bribed officials and otherwise conspired
to secure no-bid contracts for its products in violation of both state law and federal antitrust law. The Company’s lawsuit
also seeks monetary and injunctive relief, including treble damages, for these alleged violations.
Axon
filed an answer, which denied the patent infringement allegations on April 1, 2016. In addition, Axon filed a motion to dismiss
all allegations in the complaint on March 4, 2016 for which the Company filed an amended complaint on March 18, 2016 to address
certain technical deficiencies in the pleadings. Digital amended its complaint and Axon renewed its motion to seek dismissal of
the allegations that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation
of both state law and federal antitrust law on April 1, 2016. Formal discovery commenced on April 12, 2016 with respect to the
patent related claims. In January 2017, the Court granted Axon’s motion to dismiss the portion of the lawsuit regarding
claims that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state
law and federal antitrust law. On May 2, 2018, the Federal Circuit affirmed the District Court’s ruling and on October 1,
2018 the Supreme Court denied Digital Ally’s petition for review.
In
December 2016 and January 2017, Axon filed two petitions for
Inter Partes
Review (“IPR”) against the ‘452
Patent. The United States Patent and Trademark Office (“USPTO”) rejected both of Axon’s petitions. Axon is now
statutorily precluded from filing any more IPR petitions against the ‘452 Patent.
The
District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on November
17, 2017, the Federal District Court of Kansas rejected Axon’s request to maintain the stay. With this significant ruling,
the parties will now proceed towards trial. Since litigation has resumed, the Court has issued a claim construction order (also
called a
Markman
Order) where it sided with the Company on all disputes and denied Axon’s attempts to limit the scope
of the claims. Following the
Markman
Order, the Court set all remaining deadlines in the case. Fact discovery closed on
October 8, 2018, and a Final Pretrial Conference took place on January 16, 2019. The parties filed motions for summary judgment
on January 31, 2019.
On
June 17, 2019, the Court granted Axon’s motion for summary judgment that Axon did not infringe on the Company’s patent
and dismissed the case. Importantly, the Court’s ruling did not find that Digital’s ‘452 Patent was invalid.
It also did not address any other issue, such as whether Digital’s requested damages were appropriate, and it does not impact
the Company’s ability to file additional lawsuits to hold other competitors accountable for patent infringement. This ruling
solely related to an interpretation of the claims as they relate to Axon and was unrelated to the supplemental briefing Digital
recently filed on its damages claim and the WatchGuard settlement. Those issues are separate and the judge’s ruling on summary
judgment had nothing to do with Digital’s damages request. The Company has filed an appeal to this ruling and has asked
the appellate court to reverse this decision.
WatchGuard
On
May 27, 2016 the Company filed suit against WatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent infringement based on
WatchGuard’s VISTA Wifi and 4RE In-Car product lines.
On
May 13, 2019, the parties resolved the dispute and executed a settlement agreement in the form of a Release and License Agreement.
The litigation has been dismissed as a result of this settlement.
The
Release and License Agreement encompasses the following key terms:
|
●
|
WatchGuard
paid Digital Ally a one-time, lump settlement payment of $6,000,000.
|
|
|
|
|
●
|
Digital
Ally has granted WatchGuard a perpetual covenant not to sue if WatchGuard’s products incorporate agreed-upon modified
recording functionality. Digital Ally has also granted WatchGuard a license to the ‘292 Patent and the ‘452 Patent
(and related patents, now existing and yet-to-issue) through December 31, 2023. The parties have agreed to negotiate in good
faith to attempt to resolve any alleged infringement that occurs after the license period expires.
|
|
|
|
|
●
|
The
parties have further agreed to release each other from all claims or liabilities pre-existing the settlement.
|
|
|
|
|
●
|
As
part of the settlement, the parties agreed that WatchGuard is making no admission that it has infringed any of Digital Ally’s
patents.
|
Upon
receipt of the $6,000,000 the parties filed a joint motion to dismiss the lawsuit which the Judge granted.
PGA
Tour, Inc.
On
January 22, 2019 the PGA Tour, Inc. (the “PGA”) filed suit against the Company in the Federal District Court for the
District of Kansas (Case No. 2:19-cv-0033-CM-KGG) alleging breach of contract and breach of implied covenant of good faith and
fair dealing relative to the Web.com Tour Title Sponsor Agreement (the “Agreement”). The contract was executed on
April 16, 2015 by and between the parties. Under the Agreement, Digital Ally would be a title sponsor of and receive certain naming
and other rights and benefits associated with the Web.com Tour for 2015 through 2019 in exchange for Digital Ally’s payment
to Tour of annual sponsorship fees. The suit has been resolved and the case has been dismissed by Plaintiff with prejudice on
April 17, 2019.
401
(k) Plan.
The Company sponsors a 401(k) retirement savings plan for the benefit of its employees. The plan, as amended,
requires it to provide 100% matching contributions for employees, who elect to contribute up to 3% of their compensation to the
plan and 50% matching contributions for employee’s elective deferrals on the next 2% of their contributions. The Company
made matching contributions totaling $26,968 and $28,973 for the three months ended June 30, 2019 and 2018, respectively, and
$53,410 and $58,348 for the six months ended June 30, 2019 and 2018, respectively. Each participant is 100% vested at all times
in employee and employer matching contributions.
Consulting
and Distributor Agreements.
The Company entered into an agreement that required it to make monthly payments that will
be applied to future commissions and/or consulting fees to be earned by the provider. The agreement is with a limited liability
company (“LLC”) that is minority owned by a relative of the Company’s chief financial officer. Under the agreement,
dated January 15, 2016 and as amended on February 13, 2017, the LLC provides consulting services for developing a new distribution
channel outside of law enforcement for its body-worn camera and related cloud storage products to customers in the United States.
The Company advanced amounts to the LLC against commissions ranging from $5,000 to $6,000 per month plus necessary and reasonable
expenses for the period through June 30, 2017, which can be automatically extended based on the LLC achieving minimum sales quotas.
The agreement was renewed in January 2017 for a period of three years, subject to yearly minimum sales thresholds that would allow
the Company to terminate the contract if such minimums are not met. As of June 30, 2019, the Company had advanced a total of $277,151
pursuant to this agreement and established an allowance reserve of $129,140 for a net advance of $148,011. The minimum sales threshold
has not been met and the Company has discontinued all advances, although the contract has not been formally terminated. However,
the exclusivity provisions of the agreement have been terminated.
On
June 1, 2018 the Company entered into an agreement with an individual that required it to make monthly payments that will be applied
to future commissions and/or consulting fees to be earned by the provider. Under the agreement, the individual provides consulting
services for developing new distribution channels both inside and outside of law enforcement for its in-car and body-worn camera
systems and related cloud storage products to customers within and outside the United States. The Company was required to advance
amounts to the individual as an advance against commissions of $7,000 per month plus necessary and reasonable expenses for the
period through August 31, 2018, which was extended to December 31, 2018 by mutual agreement of the parties at $6,000 per month.
The parties have mutually agreed to further extend the arrangement on a monthly basis at $5,000 per month. As of June 30, 2019,
the Company had advanced a total of $96,242 pursuant to this agreement.
NOTE
12. STOCK-BASED COMPENSATION
The
Company recorded pretax compensation expense related to the grant of stock options and restricted stock issued of $585,195 and
$594,228 for the three months ended June 30, 2019 and 2018 and $1,310,393 and $1,087,746 for the six months ended June 30, 2019
and 2018, respectively.
As
of June 30, 2019, the Company had adopted seven separate stock option and restricted stock plans: (i) the 2005 Stock Option and
Restricted Stock Plan (the “2005 Plan”), (ii) the 2006 Stock Option and Restricted Stock Plan (the “2006 Plan”),
(iii) the 2007 Stock Option and Restricted Stock Plan (the “2007 Plan”), (iv) the 2008 Stock Option and Restricted
Stock Plan (the “2008 Plan”), (v) the 2011 Stock Option and Restricted Stock Plan (the “2011 Plan”), (vi)
the 2013 Stock Option and Restricted Stock Plan (the “2013 Plan”), (vii) the 2015 Stock Option and Restricted Stock
Plan (the “2015 Plan”) and (vii) the 2018 Stock Option and Restricted Stock Plan (the “2018 Plan”). The
2005 Plan, 2006 Plan, 2007 Plan, 2008 Plan, 2011 Plan, 2013 Plan, 2015 Plan and 2018 Plan are referred to as the “Plans.”
These
Plans permit the grant of stock options or restricted stock to its employees, non-employee directors and others for up to a total
of 3,425,000 shares of common stock. The 2005 Plan terminated during 2015 with 14,616 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2005 Plan that remain unexercised and outstanding
as of June 30, 2019 total 13,125. The 2006 Plan terminated during 2016 with 23,399 shares not awarded or underlying options, which
shares are now unavailable for issuance. Stock options granted under the 2006 Plan that remain unexercised and outstanding as
of June 30, 2019 total 44,075. The 2007 Plan terminated during 2017 with 87,776 shares not awarded or underlying options, which
shares are now unavailable for issuance. Stock options granted under the 2007 Plan that remain unexercised and outstanding as
of June 30, 2019 total 6,875. The 2008 Plan terminated during 2018 with 8,249 shares not awarded or underlying options, which
shares are now unavailable for issuance. Stock options granted under the 2008 Plan that remain unexercised and outstanding as
of June 30, 2019 total 32,250.
The
Company believes that such awards better align the interests of our employees with those of its stockholders. Option awards have
been granted with an exercise price equal to the market price of its stock at the date of grant with such option awards generally
vesting based on the completion of continuous service and having ten-year contractual terms. These option awards typically provide
for accelerated vesting if there is a change in control (as defined in the Plans). The Company has registered all shares of common
stock that are issuable under its Plans with the SEC. A total of 626,316 shares remained available for awards under the various
Plans as of June 30, 2019.
The
fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model.
Activity
in the various Plans during the six months ended June 30, 2019 is reflected in the following table:
Options
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
Outstanding
at January 1, 2019
|
|
|
434,012
|
|
|
$
|
4.62
|
|
Granted
|
|
|
180,000
|
|
|
|
3.01
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
(17,937
|
)
|
|
|
(12.43
|
)
|
Outstanding
at June 30, 2019
|
|
|
596,075
|
|
|
$
|
3.90
|
|
Exercisable
at June 30, 2019
|
|
|
416,075
|
|
|
$
|
4.28
|
|
The
fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. Utilizing the
following assumptions: risk free rate - 2.23%, estimated term - 5.5 years, and 108% volatility. The total estimated grant
date fair value stock options issued during the six months ended June 30, 2019 was $436,217.
The
Plans allow for the cashless exercise of stock options. This provision allows the option holder to surrender/cancel options with
an intrinsic value equivalent to the purchase/exercise price of other options exercised. There were no shares surrendered pursuant
to cashless exercises during the six months ended June 30, 2019.
At
June 30, 2019, the aggregate intrinsic value of options outstanding was approximately $-0- and the aggregate intrinsic value of
options exercisable was approximately $-0-. No options were exercised in the six months ended June 30, 2019.
As
of June 30, 2019, the unrecognized portion of stock compensation expense on all existing stock options was $399,866.
The
following table summarizes the range of exercise prices and weighted average remaining contractual life for outstanding and exercisable
options under the Company’s option plans as of June 30, 2019:
|
|
|
Outstanding
options
|
|
Exercisable
options
|
|
Exercise
price
range
|
|
|
Number
of
options
|
|
|
Weighted
average
remaining
contractual life
|
|
Number
of
options
|
|
|
Weighted
average
remaining
contractual life
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.01
to $3.49
|
|
|
|
471,625
|
|
|
8.9
years
|
|
|
291,625
|
|
|
|
8.2
years
|
|
$
|
3.50
to $4.99
|
|
|
|
67,625
|
|
|
4.8
years
|
|
|
67,625
|
|
|
|
4.8
years
|
|
$
|
5.00
to $6.49
|
|
|
|
—
|
|
|
—years
|
|
|
—
|
|
|
|
—years
|
|
$
|
6.50
to $7.99
|
|
|
|
8,875
|
|
|
2.3
years
|
|
|
8,875
|
|
|
|
2.3
years
|
|
$
|
8.00
to $9.99
|
|
|
|
2,500
|
|
|
1.9
years
|
|
|
2,500
|
|
|
|
1.9
years
|
|
$
|
10.00
to $19.99
|
|
|
|
39,825
|
|
|
1.5
years
|
|
|
39,825
|
|
|
|
1.5
years
|
|
$
|
20.00
to $24.99
|
|
|
|
5,625
|
|
|
0.2
years
|
|
|
5,625
|
|
|
|
0.2
years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
596,075
|
|
|
7.7
years
|
|
|
416,075
|
|
|
|
6.8
years
|
|
Restricted
stock grants.
The Board of Directors has granted restricted stock awards under the Plans. Restricted stock awards are
valued on the date of grant and have no purchase price for the recipient. Restricted stock awards typically vest over nine months
to four years corresponding to anniversaries of the grant date. Under the Plans, unvested shares of restricted stock awards may
be forfeited upon the termination of service to or employment with the Company, depending upon the circumstances of termination.
Except for restrictions placed on the transferability of restricted stock, holders of unvested restricted stock have full stockholder’s
rights, including voting rights and the right to receive cash dividends.
A
summary of all restricted stock activity under the equity compensation plans for the six months ended June 30, 2019 is as follows:
|
|
Number
of
Restricted
shares
|
|
|
Weighted
average
grant date
fair
value
|
|
Nonvested
balance, January 1, 2019
|
|
|
772,150
|
|
|
$
|
3.40
|
|
Granted
|
|
|
522,110
|
|
|
|
2.91
|
|
Vested
|
|
|
(397,790
|
)
|
|
|
(3.84
|
)
|
Forfeited
|
|
|
(2,500
|
)
|
|
|
(2.30
|
)
|
Nonvested
balance, June 30, 2019
|
|
|
893,970
|
|
|
$
|
2.92
|
|
The
Company estimated the fair market value of these restricted stock grants based on the closing market price on the date of grant.
As of June 30, 2019, there were $976,035 of total unrecognized compensation costs related to all remaining non-vested restricted
stock grants, which will be amortized over the next 18 months in accordance with the respective vesting scale.
The
nonvested balance of restricted stock vests as follows:
Years
ended
|
|
Number
of
shares
|
|
|
|
|
|
2019
(July 1, 2019 to December 31, 2019)
|
|
|
377,525
|
|
2020
|
|
|
265,785
|
|
2021
|
|
|
250,660
|
|
NOTE
13. COMMON STOCK PURCHASE WARRANTS
The
Company has issued common stock purchase warrants in conjunction with various debt and equity issuances. The warrants are either
immediately exercisable, or have a delayed initial exercise date, no more than nine months from issue date, and allow the holders
to purchase up to 4,532,145 shares of common stock at $2.60 to $16.50 per share as of June 30, 2019. The warrants expire from
July 15, 2020 through July 31, 2023 and allow for cashless exercise.
|
|
Warrants
|
|
|
Weighted
average
exercise price
|
|
Vested
Balance, January 1, 2019
|
|
|
4,693,145
|
|
|
$
|
5.40
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
Exercised
|
|
|
(529,000)
|
|
|
|
(2.96)
|
|
Cancelled
|
|
|
—
|
|
|
|
—
|
|
Vested
Balance, June 30, 2019
|
|
|
4,164,145
|
|
|
$
|
5.71
|
|
The
total intrinsic value of all outstanding warrants aggregated $-0- as of June 30, 2019 and the weighted average remaining term
is 28 months.
The
following table summarizes the range of exercise prices and weighted average remaining contractual life for outstanding and exercisable
warrants to purchase common shares as of June 30, 2019:
|
|
|
Outstanding
and exercisable warrants
|
Exercise
price
|
|
|
Number
of
warrants
|
|
|
Weighted
average
remaining
contractual life
|
$
|
2.60
|
|
|
|
465,712
|
|
|
4.1
years
|
$
|
3.00
|
|
|
|
701,667
|
|
|
3.8
years
|
$
|
3.25
|
|
|
|
120,000
|
|
|
3.5
years
|
$
|
3.36
|
|
|
|
880,000
|
|
|
3.4
years
|
$
|
3.50
|
|
|
|
18,000
|
|
|
0.1
years
|
$
|
3.65
|
|
|
|
200,000
|
|
|
3.0
years
|
$
|
3.75
|
|
|
|
94,000
|
|
|
3.1
years
|
$
|
5.00
|
|
|
|
800,000
|
|
|
2.5
years
|
$
|
13.43
|
|
|
|
879,766
|
|
|
1.5
years
|
$
|
16.50
|
|
|
|
5,000
|
|
|
1.0
years
|
|
|
|
|
|
4,164,145
|
|
|
2.9
years
|
NOTE
14. NET LOSS PER SHARE
The
calculations of the weighted average number of shares outstanding and loss per share outstanding for the three and six months
ended June 30, 2019 and 2018 are as follows:
|
|
Three
Months Ended
June 30,
|
|
|
Six
Months Ended
June 30,
|
|
|
|
2019
|
|
|
2018
|
|
|
2019
|
|
|
2018
|
|
Numerator
for basic and diluted income per share – Net loss
|
|
$
|
(387,730
|
)
|
|
$
|
(2,962,890
|
)
|
|
$
|
(3,592,904
|
)
|
|
$
|
(5,551,122
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic loss per share –
weighted average shares outstanding
|
|
|
11,305,248
|
|
|
|
7,129,260
|
|
|
|
11,124,222
|
|
|
|
7,153,219
|
|
Dilutive
effect of shares issuable under stock options and warrants outstanding
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for
diluted loss per share – adjusted weighted average shares outstanding
|
|
|
11,305,248
|
|
|
|
7,129,260
|
|
|
|
11,124,222
|
|
|
|
7,153,219
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.03
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
(0.32
|
)
|
|
$
|
(0.78
|
)
|
Diluted
|
|
$
|
(0.03
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
(0.32
|
)
|
|
$
|
(0.78
|
)
|
Basic
loss per share is based upon the weighted average number of common shares outstanding during the period. For the three and six
months ended June 30, 2019 and 2018, all outstanding stock options and warrants to purchase common stock were antidilutive,
and, therefore, not included in the computation of diluted net loss per share.
NOTE
15. SUBSEQUENT EVENTS
On
August 5, 2019, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with several accredited
investors (the “Investors”) providing for the purchase and issuance of the following securities for a price of $2,500,000:
|
(i)
|
Issuance of 8% Senior Secured
Convertible Promissory Notes due August 4, 2020 (the “Notes”) with a principal
face amount of $2,777,779, which Notes are, subject to certain conditions, convertible
into 1,984,127 shares of the Company’s common stock (the “Common Stock”),
at a price per share of $1.40. Monthly amortization of principal and interest commence
on November 5, 2019 subject to prior conversion of shares;
|
|
|
|
|
(ii)
|
Issuance of five-year warrants
to purchase an aggregate of 571,428 shares of Common Stock at an exercise price of $1.8125,
subject to customary adjustments thereunder (the “Warrants”), which Warrants
are immediately exercisable upon issuance and on a cashless basis if the Warrants have
not been registered 180 days after the date of issuance; and
|
|
|
|
|
(iii)
|
Issuance of 89,285 shares
of Common Stock which was equal to 5% of the aggregate purchase price of the Notes, with
an aggregate value of $125,000,
|
|
|
|
|
(iv)
|
The Investors are purchasing the foregoing securities
for an aggregate purchase price of $2,500,000.
|
The Company issued to the
Investors, an aggregate of $1,153,320 in principal amount of Notes, the shares of common stock issuable from time to time
upon conversion of such Registered Notes and all of the 89,285 Commitment Shares were issued to the Investors in a registered
direct offering and registered under the Securities Act of 1933. Approximately $1,153,320 of the Notes will be issued
pursuant to an effective shelf registration statement.
The
Company issued to the Investors in a concurrent private placement pursuant to an exemption from the registration requirements
of the Securities Act, the remaining aggregate of $1,624,457.78 in principal amount of other Notes, the shares of Common Stock
issuable from time to time upon conversion of such other Notes, the Warrants and the Warrant Shares.
In
connection with the Purchase Agreement, the Company and certain of its subsidiaries entered into a security agreement, dated as
of August 5, 2019, with the Investors, pursuant to which the Company and its subsidiary granted to the Investors a security
interest in, among other items, the Company and its subsidiaries’ accounts, chattel paper, documents, equipment, general
intangibles, instruments and inventory, and all proceeds, as set forth in the Security Agreement. In addition, pursuant to an
Intellectual Property Security Agreement, dated as of August 5, 2019, the Company granted to the Investors a continuing
security interest in all of the Company’s right, title and interest in, to and under certain of the Company’s trademarks,
copyrights and patents. In addition, certain of the Company’s subsidiary jointly and severally agreed to guarantee and act
as surety for the Company’s obligation to repay the Notes pursuant to a subsidiary guarantee.
*************************************
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
This
Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. The words “believe,” “expect,” “anticipate,” “intend,”
“estimate,” “may,” “should,” “could,” “will,” “plan,”
“future,” “continue,” and other expressions that are predictions of or indicate future events and trends
and that do not relate to historical matters identify forward-looking statements. These forward-looking statements are based largely
on our expectations or forecasts of future events, can be affected by inaccurate assumptions, and are subject to various business
risks and known and unknown uncertainties, a number of which are beyond our control. Therefore, actual results could differ materially
from the forward-looking statements contained in this document, and readers are cautioned not to place undue reliance on such
forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as
a result of new information, future events or otherwise. A wide variety of factors could cause or contribute to such differences
and could adversely impact revenues, profitability, cash flows and capital needs. There can be no assurance that the forward-looking
statements contained in this document will, in fact, transpire or prove to be accurate.
Factors
that could cause or contribute to our actual results differing materially from those discussed herein or for our stock price to
be adversely affected include, but are not limited to: (1) our losses in recent years, including the six months ended June 30,
2019 and fiscal 2018; (2) macro-economic risks from the effects of the decrease in budgets for the law-enforcement community;
(3) our ability to increase revenues, increase our margins and return to consistent profitability in the current economic and
competitive environment; (4) our operation in developing markets and uncertainty as to market acceptance of our technology and
new products; (5) the availability of funding from federal, state and local governments to facilitate the budgets of law enforcement
agencies, including the timing, amount and restrictions on such funding; (6) our ability to deliver our new product offerings
as scheduled in 2019, such as the EVO-HD, have such new products perform as planned or advertised and whether they will help increase
our revenues; (7) whether we will be able to increase the sales, domestically and internationally, for our products in the future;
(8) our ability to maintain or expand our share of the market for our products in the domestic and international markets in which
we compete, including increasing our international revenues; (9) our ability to produce our products in a cost-effective manner;
(10) competition from larger, more established companies with far greater economic and human resources; (11) our ability to attract
and retain quality employees; (12) risks related to dealing with governmental entities as customers; (13) our expenditure of significant
resources in anticipation of sales due to our lengthy sales cycle and the potential to receive no revenue in return; (14) characterization
of our market by new products and rapid technological change; (15) our dependence on sales of our DVM-800, FirstVU HD and DVM-250
products; (16) potential that stockholders may lose all or part of their investment if we are unable to compete in our markets
and return to profitability; (17) defects in our products that could impair our ability to sell our products or could result in
litigation and other significant costs; (18) our dependence on key personnel; (19) our reliance on third-party distributors and
sales representatives for part of our marketing capability; (20) our dependence on a few manufacturers and suppliers for components
of our products and our dependence on domestic and foreign manufacturers for certain of our products; (21) our ability to protect
technology through patents and to protect our proprietary technology and information as trade secrets and through other similar
means; (22) our ability to generate more recurring cloud and service revenues; (23) risks related to our license arrangements;
(24) our revenues and operating results may fluctuate unexpectedly from quarter to quarter; (25) sufficient voting power by coalitions
of a few of our larger stockholders, including directors and officers, to make corporate governance decisions that could have
significant effect on us and the other stockholders; (26) sale of substantial amounts of our common stock that may have a depressive
effect on the market price of the outstanding shares of our common stock; (27) possible issuance of common stock subject to options
and warrants that may dilute the interest of stockholders; (28) our nonpayment of dividends and lack of plans to pay dividends
in the future; (29) future sale of a substantial number of shares of our common stock that could depress the trading price of
our common stock, lower our value and make it more difficult for us to raise capital; (30) our additional securities available
for issuance, which, if issued, could adversely affect the rights of the holders of our common stock; (31) our stock price is
likely to be highly volatile due to a number of factors, including a relatively limited public float; (32) whether our appeal
of the Court’s summary judgment ruling will be successful and whether the litigation against Axon will achieve its intended
objectives and result in monetary recoveries for us; (33) whether the USPTO rulings will curtail, eliminate or otherwise have
an effect on the actions of Axon and other competitors respecting us, our products and customers; (34) whether the remaining two
claims under the ’556 Patent have applicability to us or our products; (35) whether our patented VuLink technology is becoming
the
de-facto
“standard” for agencies engaged in deploying state-of-the-art body-worn and in-car camera systems
and will increase our revenues; (36) the outcome of our development of a documentation and validation program with KMC Brands
for the Hemp industry; (37) whether such technology will have a significant impact on our revenues in the long-term; and (38)
indemnification of our officers and directors.
Current
Trends and Recent Developments for the Company
Overview
We
supply technology-based products utilizing our portable digital video and audio recording capabilities, for the law enforcement
and security industries and for the commercial fleet and mass transit markets. We have the ability to integrate electronic, radio,
computer, mechanical, and multi-media technologies to create unique solutions to our customers’ requests. Our products include
the DVM-800 and DVM-800 Lite, in-car digital video mirror systems for law enforcement; the FirstVU and the FirstVU HD, body-worn
cameras; our patented and revolutionary VuLink product, which integrates our body-worn cameras with our in-car systems by providing
hands-free automatic activation, for both law enforcement and commercial markets; the DVM-250 and DVM-250 Plus, a commercial line
of digital video mirrors that serve as “event recorders” for the commercial fleet and mass transit markets; and FleetVU
and VuLink, our cloud-based evidence management systems. We introduced the EVO-HD product in late June 2019 and intend to begin
full-scale deployments in the third quarter 2019. It is designed and built on a new and highly advanced technology platform that
will become the platform for a new family of in-car video solution products for the law enforcement and commercial markets. We
believe that the launch of these new products will help to reinvigorate our in-car and body-worn systems revenues while diversifying
and broadening the market for our product offerings.
We
experienced operating losses for all quarters during 2019 and 2018 except for the most recent quarter which was aided by a patent
litigation settlement. The following is a summary of our recent operating results on a quarterly basis:
|
|
|
|
|
For
the Three Months Ended:
|
|
|
|
June
30,
2019
|
|
|
March
31,
2019
|
|
|
December 31,
2018
|
|
|
September 30,
2018
|
|
|
June
30,
2018
|
|
|
March
31,
2018
|
|
Total
revenue
|
|
$
|
2,546,983
|
|
|
$
|
2,550,796
|
|
|
$
|
2,378,287
|
|
|
$
|
2,878,059
|
|
|
$
|
3,563,550
|
|
|
$
|
2,471,513
|
|
Gross
profit
|
|
|
980,812
|
|
|
|
1,181,740
|
|
|
|
56,658
|
|
|
|
1,177,289
|
|
|
|
1,618,467
|
|
|
|
1,109,394
|
|
Gross
profit margin percentage
|
|
|
37.3
|
%
|
|
|
46.3
|
%
|
|
|
2.3
|
%
|
|
|
40.9
|
%
|
|
|
45.4
|
%
|
|
|
44.9
|
%
|
Total
selling, general and administrative expenses
|
|
|
(1,616,830
|
)
|
|
|
4,267,898
|
|
|
|
5,292,374
|
|
|
|
3,087,005
|
|
|
|
3,055,776
|
|
|
|
3,082,710
|
|
Operating
income (loss)
|
|
|
2,567,642
|
|
|
|
(3,086,158
|
)
|
|
|
(5,235,716
|
)
|
|
|
(1,909,716
|
)
|
|
|
(1,437,309
|
)
|
|
|
(1,973,316
|
)
|
Operating
loss percentage
|
|
|
100.8
|
%
|
|
|
(121.0
|
)%
|
|
|
(220.1
|
)%
|
|
|
(66.4
|
)%
|
|
|
(40.3
|
)%
|
|
|
(79.8
|
)%
|
Net
loss
|
|
$
|
(387,730
|
)
|
|
$
|
(3,205,174
|
)
|
|
$
|
(5,327,849
|
)
|
|
$
|
(4,665,580
|
)
|
|
$
|
(2,962,890
|
)
|
|
$
|
(2,588,232
|
)
|
Our
business is subject to substantial fluctuations on a quarterly basis as reflected in the significant variations in revenues and
operating results in the above table. These variations result from various factors, including but not limited to: (1) the timing
of large individual orders; (2) the traction gained by products, such as the FirstVU HD, VuLink and FleetVU; (3) production, quality
and other supply chain issues affecting our cost of goods sold; (4) unusual increases in operating expenses, such as the timing
of trade shows and bonus compensation; (5) the timing of patent infringement litigation settlements, such as the $6.0 settlement
we obtained from WatchGuard during the second quarter 2019; and (5) ongoing patent and other litigation and related expenses respecting
outstanding lawsuits. We reported operating income of $2,567,642 on revenues of $2,546,983 for the three months ended June 30,
2019 primarily as a result of the $6.0 million settlement of the WatchGuard patent litigation. The income recognized in the second
quarter 2019 ended a series of quarterly losses resulting from competitive pressures, supply chain problems, increases in inventory
reserves as our current product suite ages, product quality control issues, product warranty issues, infringement of our patents
by direct competitors such as Axon and WatchGuard that reduced our revenues, and litigation expenses relating to the patent infringement.
A
number of factors and trends affected our recent performance, which include:
|
●
|
On
May 13, 2019 we reached a resolution of the pending patent infringement litigation with WatchGuard and executed a settlement
agreement that resulted in the dismissal of this case. As part of the settlement agreement, we received a one-time $6,000,000
payment and granted WatchGuard a perpetual covenant not to sue WatchGuard if its products incorporate agreed-upon modified
recording functionality. Additionally, we granted it a license to the ’292 Patent and ’452 Patent through December
31, 2023. As part of the settlement, the parties agreed that WatchGuard is making no admission that it has infringed any of
our patents. See Note 11, “Contingencies” for the details respecting the settlement.
|
|
●
|
Revenues
decreased slightly in second quarter 2019 to $2,546,983 from $2,550,796 in first quarter 2019. The primary reason for the
revenue decreases in the second quarter 2019 is that we continue to face increased challenges for our in-car and body-worn
systems because our competitors have released new products with advanced features and have maintained their product price
cuts. We introduced a new product platform, the EVO-HD, specifically for in-car systems late in June 2019 to address our competitors’
new product features. This new product platform utilizes advanced chipsets that will generate new and highly advanced products
for our law enforcement and commercial customers and we believe will improve product revenues in future quarters. Our law
enforcement revenues declined over the prior period due to price-cutting, willful infringement of our patents and other actions
by our competitors and adverse marketplace effects related to the patent litigation. For example, one of our competitors introduced
a body-camera including cloud storage free for one year that disrupted has disrupted the market since 2017 and has continued
to pressure our revenues in 2019.
|
|
|
|
|
●
|
Recognizing
a critical limitation in law enforcement camera technology, during 2014 we pioneered the development of our VuLink ecosystem
that provided intuitive auto-activation functionality as well as coordination between multiple recording devices. The USPTO
granted us multiple patents with claims covering numerous features, such as automatically activating an officer’s cameras
when the light bar is activated or when a data-recording device such as a smart weapon is activated. Additionally, our patent
claims cover automatic coordination between multiple recording devices. Prior to this innovation, officers were forced to
manually activate each device while responding to emergency scenarios - a requirement that both decreased the usefulness of
the existing camera systems and diverted officers’ attention during critical moments. We believe law enforcement agencies
have recognized the value of our VuLink technology and agencies are seeking information on “auto-activation” features
in requests for bids and requests for information involving the procurement process of body-worn cameras and in-car systems.
We believe this may result in our patented VuLink technology becoming the
de-facto
“standard” for agencies
engaged in deploying state-of-the-art body-worn and in-car camera systems. However, the willful infringement of our VuLink
patent by Axon and others has substantially and negatively impacted revenues that otherwise would have been generated by our
VuLink system and indirectly our body-worn and in-car systems. We believe that the results of the current patent litigation
will largely set the competitive landscape for body-worn and in-car systems for the foreseeable future. We are seeking other
ways to monetize our VuLink patents, which may include entering into license agreements or supply and distribution agreements
with competitors. We expect that this technology will have a significant positive impact on our revenues in the long-term,
particularly if we are successful in our prosecution of the patent infringement litigation pending with Axon and we can successfully
monetize the underlying patents, although we can make no assurances in this regard.
|
|
|
|
|
●
|
We
have asserted two significant patent infringement lawsuits involving Axon and WatchGuard that has had significant impacts
on our quarterly results primarily due to the timing and amounts of legal fees expended on such lawsuits. We settled the WatchGuard
lawsuit in May 2019 for $6,000,000 (see Note 11 for details) and in June 2019 the Court granted Axon’s Motion for Summary
Judgment and accepted Axon’s position that it did not infringe on our patents and dismissed the Axon lawsuit in its
entirety. We have appealed the Court’s ruling. Future quarterly results during 2019 and possibly beyond will continue
to be impacted as this appeal is heard and if the case moves to trial. If we win the appeal and the case moves to trial, the
jury will then determine whether Axon infringed on our patents. If the jury decides that Axon infringes our patents, they
would then determine the amount of compensatory damages owed to us by the defendants and whether such damage awards should
be trebled due to willful infringement by the defendants. In addition, there may be attempts by the defendant to settle such
lawsuit prior to such trial. A jury award or potential settlement prior to trial would likely have a significant impact on
our quarterly operating results if and when it occurs.
|
|
|
|
|
●
|
We
have announced a multi-year official partnership with NASCAR, naming us “A Preferred Technology Provider of NASCAR.”
As part of the relationship, we will provide cameras that will be mounted in the Monster Energy NASCAR Cup Series garage throughout
the season, bolstering both NASCAR’s commitment to safety at every racetrack and enhancing its officiating process through
technology. We believe this new partnership with NASCAR will demonstrate the flexibility of our product offerings and help
expand the appeal of our products and service capabilities to new commercial markets.
|
|
|
|
|
●
|
We
recently announced a new partnership with KMC Brands, based in Desoto, KS. The two companies have agreed to a five-year exploratory
venture to develop a documentation and validation program that ensures that all of the industrial hemp grown and processed
by KMC Brands is certified and traceable from start to finish. Working together, the companies are launching a program that
can validate and document the entire process of hemp farming, processing and distribution. Our technology will make it possible
for KMC Brands to track the hemp production process from the farmer who plants the seed, to the processor that makes the oils
and by-products to the retailer or distribution channel. The end consumers will thus know exactly where their hemp-based product
was grown and be able to trace the production process.
|
|
●
|
Our
objective is to expand our recurring service revenue to help stabilize our revenues on a quarterly basis. Revenues from extended
warranties have been increasing and were approximately $343,119 for Q-2 2019, an increase of $69,648 (25%) over the comparable
quarter in 2018. Additionally, revenues from cloud storage remained steady in Q-2 2019 at $169,874 compared to approximately
$181,419 for the prior year period. We are pursuing several new market channels that do not involve our traditional law enforcement
and private security customers, such as our NASCAR affiliation and new validation program with KMC Brands for the Hemp industry,
which we believe will help expand the appeal of our products and service capabilities to new commercial markets. If successful,
we believe that these new market channels could yield recurring service revenues for us in the future.
|
|
|
|
|
●
|
Our
international revenues decreased to $69,266 (3% of total revenues) during second quarter 2019, compared to $177,404 (5% of
total revenues) during second quarter 2018. Our second quarter 2019 international revenues were disappointing; however, the
international sales cycle generally takes longer than domestic business and we have provided bids to a number of international
customers. We intend to market our new EVO-HD product along with our other products, such as the FleetVu driver monitoring
and management service and the FirstVU HD, internationally.
|
Off-Balance
Sheet Arrangements
We
do not have any off-balance sheet debt nor did we have any transactions, arrangements, obligations (including contingent obligations)
or other relationships with any unconsolidated entities or other persons that may have material current or future effect on financial
conditions, changes in the financial conditions, results of operations, liquidity, capital expenditures, capital resources, or
significant components of revenue or expenses.
For
the Three Months Ended June 30, 2019 and 2018
Results
of Operations
Summarized
immediately below and discussed in more detail in the subsequent sub-sections is an analysis of our operating results for the
three months ended June 30, 2019 and 2018, represented as a percentage of total revenues for each respective year:
|
|
Three
Months Ended
June
30,
|
|
|
|
2019
|
|
|
2018
|
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost of revenue
|
|
|
63
|
%
|
|
|
55
|
%
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
37
|
%
|
|
|
45
|
%
|
Selling, general and
administrative expenses:
|
|
|
|
|
|
|
|
|
Research
and development expense
|
|
|
23
|
%
|
|
|
9
|
%
|
Selling,
advertising and promotional expense
|
|
|
48
|
%
|
|
|
20
|
%
|
Stock-based
compensation expense
|
|
|
23
|
%
|
|
|
17
|
%
|
General
and administrative expense
|
|
|
78
|
%
|
|
|
39
|
%
|
Patent
litigation settlement
|
|
|
(236
|
)
%
|
|
|
—
|
%
|
|
|
|
|
|
|
|
|
|
Total
selling, general and administrative expenses
|
|
|
(64
|
)%
|
|
|
85
|
%
|
|
|
|
|
|
|
|
|
|
Operating
income (loss)
|
|
|
101
|
%
|
|
|
(40
|
)%
|
Change in fair value
of secured convertible debentures
|
|
|
—
|
%
|
|
|
(23
|
)
%
|
Change in fair value
of proceeds investment agreement
|
|
|
(116
|
)
%
|
|
|
—
|
%
|
Secured convertible
debenture issuance expenses
|
|
|
—
|
%
|
|
|
(6
|
)
%
|
Change in warrant derivative
liabilities
|
|
|
—
|
%
|
|
|
(9
|
)
%
|
Other
income and interest expense, net
|
|
|
—
|
%
|
|
|
(5
|
)%
|
|
|
|
|
|
|
|
|
|
Loss before income
tax benefit
|
|
|
(15
|
)%
|
|
|
(83
|
)
%
|
Income
tax (provision)
|
|
|
—
|
%
|
|
|
—
|
%
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
(15
|
)
%
|
|
|
(83
|
)
%
|
|
|
|
|
|
|
|
|
|
Net loss per share information:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.03
|
)
|
|
$
|
(0.42
|
)
|
Diluted
|
|
$
|
(0.03
|
)
|
|
$
|
(042
|
)
|
Revenues
Our
current product offerings include the following:
Product
|
|
Description
|
|
Retail
Price
|
|
EVO
HD
|
|
An
in-car digital audio/video system which records in 1080P high definition video and is designed for law enforcement and commercial
fleet customers. This system includes two cameras and can use up to four external cameras for a total of four video streams.
This system includes integrated, patented VuLink technology, internal GPS, and an internal Wi-Fi Module. The system includes
the choice between a Wireless Microphone Kit or the option to use the FirstVu HD Body Camera as the wireless microphone. This
system also includes a three-year Advanced Exchange Warranty. We offer a cloud storage solution to manage the recorded evidence
and we charge a monthly device license fee for our cloud storage.
|
|
$
|
4,795
|
|
DVM-750
|
|
An
in-car digital audio/video system that is integrated into a rear view mirror primarily designed for law enforcement customers.
We offer local storage as well as cloud storage solutions to manage the recorded evidence. We charge a monthly storage fee
for our cloud storage option and a one-time fee for the local storage option. This product is being discontinued and phased
out of our product line.
|
|
$
|
2,995
|
|
DVM-100
|
|
An
in-car digital audio/video system that is integrated into a rear view mirror primarily designed for law enforcement customers.
This system uses an integrated fixed focus camera. This product is being discontinued and phased out of our product line.
|
|
$
|
1,895
|
|
DVM-400
|
|
An
in-car digital audio/video system that is integrated into a rear view mirror primarily designed for law enforcement customers.
This system uses an external zoom camera. This product is being discontinued and phased out of our product line.
|
|
$
|
2,795
|
|
DVM-250
Plus
|
|
An
in-car digital audio/video system that is integrated into a rear view mirror primarily designed for commercial fleet customers.
We offer a web-based, driver management and monitoring analytics package for a monthly service fee that is available for our
DVM-250 customers.
|
|
$
|
1,295
|
|
DVM-800
|
|
An
in-car digital audio/video system which records in 480P standard definition video that is integrated into a rear view mirror
primarily designed for law enforcement customers. This system can use an internal fixed focus camera or two external cameras
for a total of four video streams. This system also includes the Premium Package which has additional warranty. We offer local
storage as well as cloud storage solutions to manage the recorded evidence. We charge a monthly storage fee for our cloud
storage option and a one-time fee for the local storage option.
|
|
$
|
3,995
|
|
DVM-800
Lite
|
|
An
in-car digital audio/video system which records in 480P standard definition video that is integrated into a rear view mirror
primarily designed for law enforcement customers. This system can use an internal fixed focus camera or two external cameras
for a total of four video streams. This system also includes the Premium Package which has additional warranty. We offer local
storage as well as cloud storage solutions to manage the recorded evidence. We charge a monthly storage fee for our cloud
storage option and a one-time fee for the local storage option. This system is replacing the DVM-100 and DVM-400 product offerings
and allows the customer to configure the system to their needs.
|
|
|
Various
based on configuration
|
|
FirstVU
HD
|
|
A
body-worn digital audio/video camera system primarily designed for law enforcement customers. We also offer a cloud based
evidence storage and management solution for our FirstVU HD customers for a monthly service fee.
|
|
$
|
595
|
|
VuLink
|
|
An
in-car device that enables an in-car digital audio/video system and a body worn digital audio/video camera system to automatically
and simultaneously start recording.
|
|
$
|
495
|
|
We
sell our products and services to law enforcement and commercial customers in the following manner:
|
●
|
Sales
to domestic customers are made directly to the end customer (typically a law enforcement agency or a commercial customer)
through our sales force, comprised of our employees. Revenue is recorded when the product is shipped to the end customer.
|
|
|
|
|
●
|
Sales
to international customers are made through independent distributors who purchase products from us at a wholesale price and
sell to the end user (typically law enforcement agencies or a commercial customer) at a retail price. The distributor retains
the margin as its compensation for its role in the transaction. The distributor generally maintains product inventory, customer
receivables and all related risks and rewards of ownership. Revenue is recorded when the product is shipped to the distributor
consistent with the terms of the distribution agreement.
|
|
|
|
|
●
|
Repair
parts and services for domestic and international customers are generally handled by our inside customer service employees.
Revenue is recognized upon shipment of the repair parts and acceptance of the service or materials by the end customer.
|
We
may discount our prices on specific orders based upon the size of the order, the specific customer and the competitive landscape.
We believe that our systems are at least comparable to those of our principal competitors and are generally lower priced when
considering comparable features and capabilities.
Revenues
for second quarter 2019 and second quarter 2018 were derived from the following sources:
|
|
Three
months ended June 30,
|
|
|
|
2019
|
|
|
2018
|
|
DVM-800
|
|
|
35
|
%
|
|
|
50
|
%
|
FirstVu HD
|
|
|
12
|
%
|
|
|
11
|
%
|
Repair and service
|
|
|
15
|
%
|
|
|
9
|
%
|
DVM-250 Plus
|
|
|
9
|
%
|
|
|
5
|
%
|
Cloud service revenue
|
|
|
7
|
%
|
|
|
5
|
%
|
EVO HD
|
|
|
3
|
%
|
|
|
—
|
%
|
VuLink
|
|
|
1
|
%
|
|
|
3
|
%
|
DVM-750
|
|
|
—
|
%
|
|
|
4
|
%
|
DVM-100 & DVM-400
|
|
|
—
|
%
|
|
|
1
|
%
|
Accessories
and other revenues
|
|
|
18
|
%
|
|
|
12
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Product
revenues for the three months ended June 30, 2019 and 2018 were $1,945,724 and $2,993,700, respectively, a decrease of $1,047,976
(35%), due to the following factors:
|
●
|
In
general, we have experienced pressure on our revenues as our in-car and body-worn systems are facing increased competition
because our competitors have released new products with advanced features. Additionally, our law enforcement revenues declined
over the prior period due to price-cutting, willful infringement of our patents and other actions by our competitors, adverse
marketplace effects related to the patent litigation and supply chain issues. We introduced our EVO-HD late in second quarter
2019 with the goal of enhancing our product line features to meet these competitive challenges.
|
|
|
|
|
●
|
We
shipped one individual order in excess of $100,000, for a total of approximately $179,700 in revenue and deferred revenue
for the three months ended June 30, 2019, compared to three individual orders in excess of $100,000 for the three months ended
June 30, 2018 for a total of approximately $493,000 in revenue and deferred revenue. Our average order size decreased to approximately
$2,025 in the three months ended June 30, 2019 from $2,275 during the three months ended June 30 2018. For certain opportunities
that involve multiple units and/or multi-year contracts, we have occasionally discounted our products to gain or retain market
share and revenues.
|
|
|
|
|
●
|
Our
international revenues decreased to $69,266 (3% of total revenues) during second quarter 2019, compared to $177,404 (5% of
total revenues) during second quarter 2018. Our second quarter 2019 international revenues were disappointing; however, the
international sales cycle generally takes longer than domestic business and we have provided bids to a number of international
customers. We are marketing our newer products, including the FleetVu driver monitoring and management service and the FirstVU
HD, internationally.
|
Service
and other revenues for the three months ended June 30, 2019 and 2018 were $601,259 and $569,850, respectively, an increase of
$31,409 (6%), due to the reasons noted above.
|
●
|
Revenues
from extended warranty services were $343,119 and $273,471 the three months ended June 30, 2019 and 2018, respectively, an
increase of $69,648 (25%). We have many customers that have purchased extended warranty packages, primarily in our DVM-800
premium service program, and we expect the trend of increased revenues from these services to continue throughout 2019.
|
|
|
|
|
●
|
Cloud
revenues were $169,874 and $181,419 for the three months ended June 30, 2019 and 2018, respectively, a decrease of $11,545
(6%). Our cloud revenues for commercial customers were down for the three months ended June 30, 2019 compared to the same
period in 2018 primarily due to the timing of renewals on the AMR contract. However, with the introduction of the EVO-HD and
its cloud-based platform, we have experienced increased interest in our cloud solutions for law enforcement which we hope
will result in higher revenues in future quarters.
|
|
|
|
|
●
|
Installation
service revenues were $31,791 and $22,021 for the three months ended June 30, 2019 and 2018, respectively, an increase of
$9,770 (44%). Installation revenues tend to vary greater than other service revenue types and are more dependent on larger
customer implementations.
|
Total
revenues for the three months ended June 30, 2019 and 2018 were $2,546,983 and $3,563,550, respectively, a decrease of $1,016,567
(29%), due to the reasons noted above.
Cost
of Revenue
Cost
of product revenue on units sold for the three months ended June 30, 2019 and 2018 was $1,468,828 and $1,831,615, respectively,
a decrease of $362,787 (20%). The decrease in cost of goods sold is commensurate with the 35% decrease in product revenues
offset by the cost of goods sold attributable to product cost of sales as a percentage of revenues increasing to 75% in 2019 from
61% in 2018.
Cost
of service and other revenues for the three months ended June 30, 2019 and 2018 was $127,343 and $113,468, respectively, an increase
of $13,875 (12%). The increase in service and other cost of goods sold is primarily due to the 25% increase in revenues from extended
warranty services which has lower margins than our cloud services.
Total
cost of sales as a percentage of revenues increased to 63% during the three months ended June 30, 2019 compared to 55% for the
three months ended June 30, 2018. We believe our gross margins will improve during the remainder of 2019 if we can increase revenues
and continue to reduce product warranty issues.
We
had $3,659,264 and $3,287,771 in reserves for obsolete and excess inventories at June 30, 2019 and December 31, 2018, respectively.
Total raw materials and component parts were $4,903,170 and $4,969,786 at June 30, 2019 and December 31, 2018, respectively, a
decrease of $66,616 (1%). Finished goods balances were $5,291,233 and $4,965,594 at June 30, 2019 and December 31, 2018, respectively,
an increase of $325,639 (7%). The increase in the inventory reserve is primarily due a higher level of excess component parts
of the older versions of our PCB boards and the phase out of our DVM-750, DVM-500 Plus and LaserAlly legacy products. We believe
the reserves are appropriate given our inventory levels at June 30, 2019.
Gross
Profit
Gross
profit for the three months ended June 30, 2019 and 2018 was $950,812 and $1,618,467, respectively, a decrease of $667,655 (41%).
The decrease is commensurate with the 29% decrease in total revenues and the cost of sales as a percentage of revenues increasing
to 63% during the three months ended June 30, 2019 from 55% for the three months ended June 30, 2018. We believe that gross margins
will improve during 2019 if we improve revenue levels primarily through the introduction of products such as the EVO-HD, continue
to reduce product warranty issues and shift our revenues to higher-margin cloud services. Our goal is to improve our margins to
60% over the longer term based on the expected margins of our EVO-HD, DVM-800, VuLink and FirstVU HD and our cloud evidence storage
and management offering, if they gain traction in the marketplace and we are able to increase our commercial market penetration
in 2019. In addition, if revenues from these products increase, we will seek to further improve our margins from them through
economies of scale and more efficiently utilizing fixed manufacturing overhead components. We plan to continue our initiative
to more efficient management of our supply chain through outsourcing production, quantity purchases and more effective purchasing
practices.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses were $(1,616,830) and $3,055,776 for the three months ended June 30, 2019 and 2018, respectively,
a decrease of $4,672,606 (153%). The significant decrease was fueled by the patent litigation settlement of $6 million that we
received in second quarter 2019. Exclusive of the patent litigation settlement, overall selling, general and administrative expenses
as a percentage of sales increased to 172% in second quarter 2019 compared to 85% in the same period in 2018. The significant
components of selling, general and administrative expenses are as follows:
|
|
Three Months Ended June 30,
|
|
|
|
2019
|
|
|
2018
|
|
Research and development expense
|
|
$
|
582,905
|
|
|
$
|
333,760
|
|
Selling, advertising and promotional expense
|
|
|
1,237,947
|
|
|
|
712,008
|
|
Stock-based compensation expense
|
|
|
585,195
|
|
|
|
594,228
|
|
Professional fees and expense
|
|
|
228,476
|
|
|
|
422,320
|
|
Executive, sales and administrative staff payroll
|
|
|
1,090,868
|
|
|
|
431,138
|
|
Other
|
|
|
657,779
|
|
|
|
562,322
|
|
Patent litigation settlement
|
|
|
(6,000,000
|
)
|
|
|
—
|
|
Total
|
|
$
|
(1,616,830
|
)
|
|
$
|
3,055,776
|
|
Research
and development expense.
We continue to focus on bringing new products to market, including updates and improvements to
current products. Our research and development expenses totaled $582,905 and $333,760 for the three months ended June 30, 2019
and 2018, respectively, an increase of $249,145 (75%). We employed 15 engineers at June 30, 2019 compared to 11 engineers at June
30, 2018, most of whom are dedicated to research and development activities for new products and primarily the EVO-HD, which was
launched in late second quarter 2019. Research and development expenses as a percentage of total revenues were 23% for the three
months ended June 30, 2019 compared to 9% for the three months ended June 30, 2018. We consider our research and development capabilities
and new product focus to be a competitive advantage and will continue to invest in this area on a prudent basis and consistent
with our financial resources.
Selling,
advertising and promotional expenses.
Selling, advertising and promotional expense totaled $1,237,947 and $712,008 for
the three months ended June 30, 2019 and 2018, respectively, an increase of $525,939 (74%). The increase was primarily attributable
to our sponsorship of a NASCAR race in May 2019 and other related sponsorship opportunities. Salesmen salaries and commissions
represent the primary components of these overall costs and were $727,155 and $594,831 for the three months ended June 30, 2019
and 2018, respectively, an increase of $132,324 (22%). We increased the number of salesmen in our law enforcement and commercial
channels in late 2018 and have increased travel expenses in 2019 compared to 2018. The effective commission rate was 28.5% for
the three months ended June 30, 2019 compared to 16.7% for the three months June 30, 2018.
Promotional
and advertising expenses totaled $510,792 during the three months ended June 30, 2019 compared to $111,677 during the three months
ended June 30, 2018, an increase of $399,115 (357%). The increase is primarily attributable to sponsorship of the NASCAR race
in May 2019 and efforts to expand brand awareness and leverage our relationship with NASCAR for business opportunities.
Stock-based
compensation expense.
Stock based compensation expense totaled $585,195 and $594,228 for the three months ended June 30,
2019 and 2018, respectively, a decrease of $9,033 (2%). We continue to rely on stock-based compensation during 2019 and 2018 as
we attempt to reduce cash expenses for liquidity reasons.
Professional
fees and expense
. Professional fees and expenses totaled $228,476 and $422,320 for the three months ended June 30, 2019
and 2018, respectively, a decrease of $193,844 (46%). The professional fees are primarily attributable to legal fees and expenses
related to the ongoing Axon lawsuit and the resolution of the WatchGuard and PGA lawsuits. The PGA lawsuit was resolved on April
17, 2019 and the cost to resolve this matter was accrued as of June 30, 2019. The WatchGuard lawsuit was settled on May 13, 2019.
On June 17, 2019, the Court granted Axon’s Motion for Summary Judgment which accepted Axon’s position that it did
not infringe on our patent and dismissed the lawsuit in its entirety. We have appealed the Court’s ruling and are confident
that the appellate court will reverse the judge’s decision. If we are successful with the appeal, we intend to pursue recovery
from Axon and their insurers and other responsible parties as appropriate. If the jury determines Axon infringed our patents,
they would then determine the amount of compensatory damages owed to us and whether such damage awards should be trebled due to
willful infringement by Axon. In addition, there may be attempts by Axon to settle the lawsuit prior to the trial. Such jury award
and/or potential settlement prior to trial would likely have a significant impact on our quarterly operating results if and when
it occurs.
Executive,
sales and administrative staff payroll.
Executive, sales and administrative staff payroll expenses totaled $1,090,868
and $431,138 for the three months ended June 30, 2019 and 2018, respectively, an increase of $659,730 (153%). The primary reason
for the increase in executive, sales and administrative staff payroll was an increase in staff from 83 at June 30, 2018 to 113
at June 30, 2019 and bonuses paid to executives in second quarter 2019.
Other
.
Other selling, general and administrative expenses totaled $657,779 and $562,322 for the three months ended June 30, 2019 and
2018, respectively, an increase of $95,457 (17%). The increase in other expenses in second quarter 2019 compared to second quarter
2018 is primarily attributable to higher contract employee expenses and travel costs. We have added several contract employees
to our technical support teams during 2019.
Patent
litigation settlement.
The income attributable to our patent litigation settlement was $6,000,000 and $-0- for the three
months ended June 30, 2019 and 2018, respectively. On May 13, 2019 we reached a resolution of the pending patent infringement
litigation with WatchGuard and executed a settlement agreement that resulted in the dismissal of this case. As part of such agreement,
we received a one-time $6,000,000 payment and granted WatchGuard a perpetual covenant to not sue WatchGuard if its products incorporate
agreed-upon modified recording functionality. Additionally, we granted it a license to the ‘292 Patent and ‘452 Patent
through December 31, 2023. As part of the settlement, the parties agreed that WatchGuard was making no admission that it had infringed
any of our patents. See Note 11, “Contingencies” for the details respecting the settlement.
Operating
Income (Loss)
For
the reasons stated, our operating income was $2,567,642 for the three months ended June 30, 2019 compared to an operating loss
of $(1,437,309) for the three months ended June 30, 2018, an improvement of $4,004,951 (279%). Operating income as a percentage
of revenues increased to 101% in 2019 from an operating loss of (40%) in 2018.
Interest
Income
Interest
income increased to $5,628 for the three months ended June 30, 2019 from $684 in 2018, which reflected our higher cash and cash
equivalent levels in 2019 compared to 2018.
Change
in Warrant Derivative Liabilities
Detachable
warrants exercisable to purchase a total of 398,916 shares of common stock, as adjusted, were issued in conjunction with $2.0
million and $4.0 million Secured Convertible Notes during March and August 2014. The warrants were required to be treated as derivative
liabilities because of their anti-dilution and down-round provisions. Accordingly, we estimated the fair value of such warrants
as of their respective dates of issuance and recorded a corresponding derivative liability in the balance sheet. Upon exercise
of the warrants we recognized a gain/loss based on the closing market price of the underlying common stock on the dates of exercise.
In addition, the warrant derivative liability was adjusted to the estimated fair value of any unexercised warrants as of December
31, 2017 and June 30, 2018.
The
holder of the warrants exercised its option to purchase common stock for all remaining outstanding warrants during the year ended
December 31, 2018. There remained no warrants classified as derivative liabilities outstanding at December 31, 2018 therefore
the respective warrant derivative liability balance was $0 at June 30, 2019 and December 31, 2018 and no change in fair value
was recorded for the three months ended June 30, 2019
The
changes in the fair value of the warrant derivatives related to unexercised warrants resulted in a charge of $310,195 for the
three months ended June 30, 2018.
Change
in Fair Value of Secured Convertible Debentures
We
elected to account for the $6.875 million principal amount of the 2018 Debentures issued in April and May 2018 on their fair value
basis. Therefore, we determined the fair value of the 2018 Debentures which yielded an estimated fair value of $4,565,749 including
their embedded derivatives as of their origination date. We also determined the estimated fair value of $5,354,803 for the debentures
including their embedded derivatives as of June 30, 2018. The change in fair value of the 2018 Debentures was $842,783 from origination
date to June 30, 2018, which was recognized as a loss in the Condensed Consolidated Statement of Operations. We paid these Debentures
on August 21, 2018 so there was no similar fair value change in the three months ended June 30, 2019.
Change
in Fair Value of Proceeds Investment Agreement
We
elected to account for the Proceeds Investment Agreement (the “PIA”) that we entered into July of 2018 on its fair
value basis. Therefore, we determined the fair value of the 2018 PIA as of June 30, 2019, and March 31, 2019 to be $6,240,000
and $9,279,000, respectively. During the six months ended June 30, 2019, we settled our patent infringement litigation with WatchGuard
and received a lump sum payment of $6.0 million as further described in Note 11. In accordance with the terms of the PIA, we remitted
the $6.0 million as a principal payment toward our minimum return payment obligations under the PIA. The change in fair value
from March 31, 2019 and June 30, 2019 was $2,961,000, which was recognized as a loss in the Condensed Consolidated Statement of
Operations at June 30, 2019. There was no similar PIA at June 30, 2018.
Secured
Convertible Debentures Issuance Expenses
We
elected to account for and record our $6.875 million principal amount of the 2018 Debentures issued in April and May 2018 on a
fair value basis. Accordingly, we were required to expense the related issuance costs to other expense in the condensed consolidated
statements of operations. Such costs totaled $220,312 for the three months ended June 30, 2018. The issuance costs included a
$150,000 placement agent fee and the remainder was primarily legal fees. No similar debt issuances occurred during the three months
ended June 30, 2019.
Interest
Expense
We
incurred interest expense of $-0- and $152,975 during the three months ended June 30, 2019 and 2018. We issued an aggregate of
$6.875 million principal amount of Debentures in April and May 2018 bearing interest at the rate of 8% per annum on the outstanding
principal balance.
All
interest-bearing debt had been paid off prior to December 31, 2018 so there was no interest expense for the three months ended
June 30, 2019.
Loss
before Income Tax Benefit
As
a result of the above, we reported a loss before income tax benefit of $387,730 and $2,962,890 for the three months ended June
30, 2019 and 2018, respectively, an improvement of $2,575,160 (87%).
Income
Tax Benefit
We
did not record an income tax related to our losses for the three months ended June 30, 2019 due to our overall net operating loss
carryforwards available. We have further determined to continue providing a full valuation reserve on our net deferred tax assets
as of June 30, 2019.
We
had approximately $61,600,000 of net operating loss carryforwards and $1,795,000 of research and development tax credit carryforwards
as of December 31, 2018 available to offset future net taxable income.
Net
Loss
As
a result of the above, we reported net losses of $387,730 and $2,962,890 for the three months ended June 30, 2019 and 2018, respectively,
an improvement of $2,575,160 (87%).
Basic
and Diluted Income (Loss) per Share
The
basic and diluted loss per share was ($0.03) and ($0.42) for the three months ended June 30, 2019 and 2018, respectively, for
the reasons previously noted. All outstanding stock options were considered antidilutive and therefore excluded from the calculation
of diluted loss per share for the three months ended June 30, 2019 and 2018 because of the net loss reported for each period.
For
the Six Months Ended June 30, 2019 and 2018
Results
of Operations
Summarized
immediately below and discussed in more detail in the subsequent subsections is an analysis of our operating results for the six
months ended June 30, 2019 and 2018, represented as a percentage of total revenues for each respective year:
|
|
Six Months Ended
June 30,
|
|
|
|
2019
|
|
|
2018
|
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost of revenue
|
|
|
58
|
%
|
|
|
55
|
%
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
42
|
%
|
|
|
45
|
%
|
Selling, general and administrative expenses:
|
|
|
|
|
|
|
|
|
Research and development expense
|
|
|
21
|
%
|
|
|
13
|
%
|
Selling, advertising and promotional expense
|
|
|
39
|
%
|
|
|
23
|
%
|
Stock-based compensation expense
|
|
|
26
|
%
|
|
|
18
|
%
|
General and administrative expense
|
|
|
84
|
%
|
|
|
48
|
%
|
Patent litigation settlement
|
|
|
(118
|
)%
|
|
|
—
|
%
|
|
|
|
|
|
|
|
|
|
Total selling, general and administrative expenses
|
|
|
52
|
%
|
|
|
102
|
%
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(10
|
)%
|
|
|
(57
|
)%
|
Change in fair value of secured notes payable
|
|
|
—%
|
|
|
|
(14
|
)%
|
Change in fair value proceeds investment agreement
|
|
|
(60
|
)%
|
|
|
—
|
%
|
Loss on the extinguishment of secured convertible debentures
|
|
|
—%
|
|
|
|
(8
|
)%
|
Change in warrant derivative liabilities
|
|
|
—%
|
|
|
|
(5
|
)%
|
Secured convertible debentures issuance expense
|
|
|
—%
|
|
|
|
(4
|
)%
|
Other income and interest expense, net
|
|
|
—%
|
|
|
|
(4
|
)%
|
|
|
|
|
|
|
|
|
|
Loss before income tax benefit
|
|
|
(70
|
)%
|
|
|
(92
|
)%
|
Income tax benefit
|
|
|
—
|
%
|
|
|
—
|
%
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(70
|
)%
|
|
|
(92
|
)%
|
|
|
|
|
|
|
|
|
|
Net loss per share information:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.32
|
)
|
|
$
|
(0.78
|
)
|
Diluted
|
|
$
|
(0.32
|
)
|
|
$
|
(0.78
|
)
|
Revenues
for the six months ended 2019 and 2018, respectively, were derived from the following sources:
|
|
Six months ended June 30,
|
|
|
|
2019
|
|
|
2018
|
|
DVM-800
|
|
|
39
|
%
|
|
|
47
|
%
|
FirstVU HD
|
|
|
15
|
%
|
|
|
11
|
%
|
DVM-250 Plus
|
|
|
8
|
%
|
|
|
6
|
%
|
Cloud service revenue
|
|
|
7
|
%
|
|
|
6
|
%
|
VuLink
|
|
|
2
|
%
|
|
|
2
|
%
|
EVO
|
|
|
1
|
%
|
|
|
—
|
%
|
DVM-750
|
|
|
—
|
%
|
|
|
4
|
%
|
DVM-100 & DVM-400
|
|
|
—
|
%
|
|
|
1
|
%
|
Repair and service
|
|
|
14
|
%
|
|
|
10
|
%
|
Accessories and other revenues
|
|
|
14
|
%
|
|
|
13
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Product
revenues for the six months ended June 30, 2019 and 2018 were $3,866,188 and $4,984,813, respectively, a decrease of $1,118,625
(22%), due to the following factors:
|
●
|
In
general, we have experienced pressure on our revenues as our in-car and body-worn systems faced increased competition because
our competitors have released new products with advanced features. Additionally, our law enforcement revenues declined over
the prior period due to price-cutting, willful infringement of our patents and other actions by our competitors, adverse marketplace
effects related to the patent litigation and supply chain issues. We introduced the EVO-HD late in second quarter 2019 with
the goal of enhancing our product line features to meet these competitive challenges.
|
|
|
|
|
●
|
We
shipped two individual orders in excess of $100,000, for a total of approximately $300,000 in revenue and deferred revenue
for the six months ended June 30, 2019 compared to three individual orders in excess of $100,000, for a total of approximately
$493,000 in revenue and deferred revenue for the six months ended June 30, 2018. Our average order size decreased to approximately
$2,035 in the six months ended June 30, 2019 from $2,216 during the six months ended June 30, 2018. For certain opportunities
that involve multiple units and/or multi-year contracts, we have occasionally discounted our products to gain or retain market
share and revenues.
|
|
|
|
|
●
|
Our
international revenues decreased to $105,720 (2% of total revenues) during the six months ended June 30, 2018, compared to
$210,129 (3% of total revenues) during the six months ended June 30, 2018. Our international revenues for the six months ended
June 30, 2019 were disappointing; however, the international sales cycle generally takes longer than domestic business and
we have provided bids to a number of international customers. We plan to market the EVO-HD along with our other products,
including the FleetVu driver monitoring and management service and the FirstVU HD, internationally.
|
Service
and other revenues for the six months ended June 30, 2019 and 2018 were $1,231,591 and $1,050,250, respectively, an increase of
$181,341 (17%), due to the following factors:
|
●
|
Revenues
from extended warranty services were $670,689 and $526,133 for the six months ended June 30, 2019 and 2018, respectively,
an increase of $144,556 (27%). We have many customers that have purchased extended warranty packages, primarily in our DVM-800
premium service program, and we expect the trend of increased revenues from these services to continue throughout 2019.
|
|
|
|
|
●
|
Cloud
revenues were $349,337 and $326,741 for the six months ended June 30, 2019 and 2018, respectively, an increase of $22,596
(7%). We have experienced increased interest in our cloud solutions for law enforcement primarily due to the deployment of
our new cloud-based EVO-HD in-car system which contributed to our increased cloud revenues in six months ended June 30, 2019.
We expect this trend to continue for 2019 as the migration from local storage to cloud storage continues in our customer base.
|
|
|
|
|
●
|
Installation
service revenues were $83,027 and $46,565 for the six months ended June 30, 2019 and 2018, respectively, an increase of $36,462
(78%). Installation revenues tend to vary greater than other service revenue types and are more dependent on larger customer
implementations.
|
Total
revenues for the six months ended June 30, 2019 and 2018 were $5,097,779 and $6,035,063, respectively, a decrease of $937,284
(16%), due to the reasons noted above.
Cost
of Revenue
Cost
of product revenue on units sold for the six months ended June 30, 2019 and 2018 was $2,731,899 and $3,080,360, respectively,
a decrease of $348,461 (11%). The decrease in cost of goods sold is commensurate with the 22% decrease in product revenues offset
by the cost of goods sold attributable to product cost of sales as a percentage of revenues increasing to 71% in 2019 from 62%
in 2018.
Cost
of service and other revenues for the six months ended June 30, 2018 and 2017 was $233,328 and $226,842, respectively, an increase
of $6,486 (3%). The increase in service and other cost of goods sold is primarily due to the 17% increase in service revenues
for the six months ended June 30, 2019 compared to 2018.
Total
cost of sales as a percentage of revenues increased to 58% during the six months ended June 30, 2019 compared to 55% for the six
months ended June 30, 2018. We believe our gross margins will improve during the remainder of 2019 if we can increase revenues
and continue to reduce product warranty issues.
Gross
Profit
Gross
profit for the six months ended June 30, 2019 and 2018 was $2,132,552 and $2,727,861, respectively, a decrease of $595,309 (22%).
The decrease is primarily attributable to the 16% decrease in revenues and the cost of sales as a percentage of revenues increasing
to 58% during the six months ended June 30, 2019 from 55% for the six months ended June 30, 2018. We believe that gross margins
will improve during 2019 if we improve revenue levels primarily through the introduction of products such as the EVO-HD, continue
to reduce product warranty issues and shift our revenues to higher-margin cloud services. Our goal is to improve our margins to
60% over the longer term based on the expected margins of our EVO-HD, DVM-800, VuLink and FirstVU HD and our cloud evidence storage
and management offering, if they gain traction in the marketplace and we are able to increase our commercial market penetration
in 2019. In addition, if revenues from these products increase, we will seek to further improve our margins from them through
economies of scale and more efficiently utilizing fixed manufacturing overhead components. We plan to continue our initiative
to more efficient management of our supply chain through outsourcing production, quantity purchases and more effective purchasing
practices.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses were $2,651,068 and $6,138,486 for the six months ended June 30, 2019 and 2018, respectively,
a decrease of $3,487,418 (57%). The significant decrease was fueled by the patent litigation settlement of $6.0 million that we
received in second quarter 2019. Exclusive of the patent litigation settlement overall selling, general and administrative expenses
as a percentage of sales increased to 170% for the six months ended June 30, 2019 compared to 102% in the same period in 2018.
The significant components of selling, general and administrative expenses are as follows:
|
|
Six Months Ended June 30,
|
|
|
|
2019
|
|
|
2018
|
|
Research and development expense
|
|
$
|
1,045,076
|
|
|
$
|
773,880
|
|
Selling, advertising and promotional expense
|
|
|
1,993,936
|
|
|
|
1,386,413
|
|
Stock-based compensation expense
|
|
|
1,310,393
|
|
|
|
1,087,746
|
|
Professional fees and expense
|
|
|
1,169,452
|
|
|
|
810,905
|
|
Executive, sales and administrative staff payroll
|
|
|
1,705,289
|
|
|
|
953,918
|
|
Other
|
|
|
1,426,922
|
|
|
|
1,125,624
|
|
Patent litigation settlement
|
|
|
(6,000,000
|
)
|
|
|
—
|
|
Total
|
|
$
|
2,651,068
|
|
|
$
|
6,138,486
|
|
Research
and development expense.
We continue to focus on bringing new products to market, including updates and improvements to
current products; however, we are now relying more on contracted engineering services on an “as-needed” basis. Our
research and development expenses totaled $1,045,076 and $773,880 for the six months ended June 30, 2019 and 2018, respectively,
an increase of $271,196 (35%). We employed 15 engineers at June 30, 2019 compared to 11 engineers at June 30, 2018, most of whom
are dedicated to research and development activities for new products and primarily the EVO-HD, which we launched in late second
quarter 2019. Research and development expenses as a percentage of total revenues were 21% for the six months ended June 30, 2019
compared to 13% for the six months ended June 30, 2018 We consider our research and development capabilities and new product focus
to be a competitive advantage and will continue to invest in this area on a prudent basis and consistent with our financial resources.
Selling,
advertising and promotional expenses.
Selling, advertising and promotional expense totaled $1,993,936 and $1,386,413 for
the six months ended June 30, 2019 and 2018, respectively, an increase of $607,523 (44%). Salesman salaries and commissions represent
the primary components of these costs and were $1,359,129 for the six months ended June 30, 2019 compared to $1,189,667 for the
six months ended June 30, 2018, an increase of $169,462 (14%). We increased the number of salesmen in our law enforcement and
commercial channels in late 2018 and increased travel expenses in 2019 compared to 2018. The overall effective commission rate
was 26.7% for the six months ended June 30, 2019 compared to 19.7% for the six months ended June 30, 2018.
Promotional
and advertising expenses totaled $634,807 during the six months ended June 30, 2019 compared to $191,246 during the six months
ended June 30, 2018, an increase of $443,561 (232%). The increase is primarily attributable to sponsorship of the NASCAR race
in May 2019 and efforts to expand brand awareness and leverage our relationship with NASCAR for business opportunities.
Stock-based
compensation expense.
Stock based compensation expense totaled $1,310,393 and $1,087,746 for the six months ended June
30, 2018 and 2017, respectively, an increase of $222,647 (20%). The increase is primarily due to the increased amortization during
the six months ended June 30, 2019 related to the restricted stock granted during 2019 and 2018 to our officers, directors, and
other employees. We relied more on stock-based compensation during 2019 and 2018 resulting in increased stock-based compensation
as we attempted to reduce cash expenses for liquidity reasons.
Professional
fees and expense
. Professional fees and expenses totaled $1,169,452 and $810,905 for the six months ended June 30, 2019
and 2018, respectively, an increase of $358,547 (44%). The professional fees are primarily attributable to legal fees and expenses
related to the ongoing Axon lawsuit and the resolution of the WatchGuard and PGA lawsuits. The PGA lawsuit was resolved on April
17, 2019 and the cost to resolve this matter was accrued as of June 30, 2019. The WatchGuard lawsuit was settled on May13, 2019.
On June 17, 2019, the Court granted Axon’s Motion for Summary Judgment which accepted Axon’s position that it did
not infringe on our patent and dismissed the lawsuit in its entirety. We have appealed the Court’s ruling and are confident
that the appellate court will reverse the judge’s decision. If we are successful with the appeal, we intend to pursue recovery
from Axon and their insurers and other responsible parties as appropriate. If the juries determine Axon infringed our patents,
they would then determine the amount of compensatory damages owed to us and whether such damage awards should be trebled due to
willful infringement by Axon. In addition, there may be attempts by Axon to settle the lawsuit prior to the trial. Such jury award
and/or potential settlement prior to trial would likely have a significant impact on our quarterly operating results if and when
they occur.
Executive,
sales and administrative staff payroll.
Executive, sales and administrative staff payroll expenses totaled $1,705,289
and $953,918 for the six months ended June 30, 2019 and 2018, respectively, an increase of $751,371 (79%). The primary reason
for the increase in executive, sales and administrative staff payroll was an increase in staff from 83 at June 30, 2018 to 113
at June 30, 2019 and bonuses paid to executives during the six months ended June 30, 2019.
Other
.
Other selling, general and administrative expenses totaled $1,426,922 and $1,125,624 for the six months ended June 30, 2019 and
2018, respectively, an increase of $301,298 (27%). The increase in other expenses in the six months ended June 30, 2019 compared
to 2018 is primarily attributable to higher contract employee expenses and travel costs. We have added several contract employees
to our technical support teams during 2019.
Patent
litigation settlement.
The income attributable to our patent litigation settlement was $6,000,000 and $-0- for the six
months ended June 30, 2019 and 2018, respectively. On May 13, 2019 we reached a resolution of the pending patent infringement
litigation with WatchGuard and executed a settlement agreement that resulted in the dismissal of this case. As part of the settlement
agreement, we received a one-time $6,000,000 payment and granted WatchGuard a perpetual covenant to not sue WatchGuard if its
products incorporate agreed-upon modified recording functionality. Additionally, we granted it license to the ‘292 Patent
and ‘452 Patent through December 31, 2023. As part of the settlement, the parties agreed that WatchGuard made no admission
that it had infringed any of our patents. See Note 11, “Contingencies” for the details respecting the settlement.
Operating
Loss
For
the reasons previously stated, our operating loss was $518,516 and $3,410,625 for the six months ended June 30,
2019 and 2018, respectively an improvement of $2,892,109 (84%). Operating loss as a percentage of revenues decreased
to 10% for the first six months of 2019 from 57% for the same period in 2018.
Interest
Income
Interest
income increased to $23,612 for the six months ended June 30, 2019 from $2,300 in 2018 which reflected our overall higher cash
and cash equivalent levels in 2019 compared to 2018.
Interest
Expense
We
incurred interest expense of $-0- and $283,203 during the six months ended June 30, 2019 and 2018. We issued an aggregate of $6.875
million principal amount of Debentures in April and May 2018 bearing interest at the rate of 8% per annum on the outstanding principal
balance.
All
interest bearing debt had been paid off prior to December 31, 2018 so there was no interest expense for the six months ended June
30, 2019.
Change
in Warrant Derivative Liabilities
Detachable
warrants exercisable to purchase a total of 398,916 shares of common stock, as adjusted, were issued in conjunction with $2.0
million and $4.0 million Secured Convertible Notes during March and August 2014. The warrants were required to be treated as derivative
liabilities because of their anti-dilution and down-round provisions. Accordingly, we estimated the fair value of such warrants
as of their respective date of issuance and recorded a corresponding derivative liability in the balance sheet. Upon exercise
of the warrants we recognized a gain/loss based on the closing market price of the underlying common stock on the date of exercise.
In addition, the warrant derivative liability was adjusted to the estimated fair value of any unexercised warrants as of December
31, 2017 and June 30, 2018.
The
holder of the warrants exercised its option to purchase common stock for all remaining outstanding warrants during the year ended
December 31, 2018. There remained no warrants classified as derivative liabilities outstanding at December 31, 2018 therefore
the respective warrant derivative liability balance was $0 at December 31, 2018 and no change in fair value for the six months
ended June 30, 2019
The
changes in the fair value of the warrant derivatives related to unexercised warrants resulted in a charge of $309,306 for the
six months ended June 30, 2018.
Secured
Convertible Debentures Issuance Expenses
We
elected to account for and record our $6.875 million Secured Convertible Debenture issued in April and May 2018 on a fair value
basis. Accordingly, we were required to expense the related issuance costs to other expense in the condensed consolidated statements
of operations. Such costs totaled $220,312 for the six months ended June 30, 2018. The issuance costs included a $150,000 placement
agent fee and the remainder was primarily legal fees. No similar debt issuances occurred in 2019.
Loss
on Extinguishment of Secured Convertible Debentures
The
Board of Directors approved the Private Placement of $6.875 million of debentures and 806,667 Warrants exercisable to purchase
916,667 shares of common stock of the Company. The Private Placement closed on April 3, 2018.
The
Private Placement resulted in gross proceeds of $6.25 million before placement agent fees and other expenses associated with the
transaction. A portion of the proceeds was used to repay in full the Debentures issued in December 2016, which matured on March
30, 2018, and approximately $758,500 principal amount of the June Note and Secured Note that matured in March 2018. The balance
of the proceeds was used for working capital purposes.
In
conjunction with the transaction the Company recorded a loss on extinguishment of the secured convertible debentures totaling
$500,000 for the six months ended June 30, 2018. There was no similar extinguishment of secured convertible debentures in 2019.
Change
in Fair Value of Proceeds Investment Agreement
We
elected to account for the PIA that we entered into July of 2018 on its fair value basis. Therefore, we determined the fair value
of the 2018 PIA Agreement as of June 30, 2019, and December 31, 2018 to be $6,240,000 and $9,142,000, respectively. During the
six months ended June 30, 2019, we settled our patent infringement litigation with WatchGuard and it received a lump sum payment
of $6.0 million as further described in Note 11. In accordance with the terms of the PIA, we remitted the $6.0 million as a principal
payment toward our minimum return payment obligations under the PIA. The change in fair value from December 31, 2018 to June 30,
2019 was $3,098,000, which was recognized as a loss in the Condensed Consolidated Statement of Operations at June 30, 2019. There
was no similar PIA at June 30, 2018.
Change
in Fair Value of Secured Convertible Notes Payable
We
elected to account for the $4.0 million principal amount of Debentures which were paid off on April 3, 2018 on their fair value
basis. The change in fair value of the debentures was $12,807 during the six months ended June 30, 2018 which was recognized as
a gain in the Condensed Consolidated Statement of Operations. We paid these Debentures on April 3, 2018 so there was no similar
fair value change in the six months ended June 30, 2019.
We
elected to account for the $6.875 million principal amount of the 2018 Debentures issued in April and May 2018 on their fair value
basis. Therefore, we determined the fair value of the 2018 Debentures which yielded an estimated fair value of $4,565,749 including
their embedded derivatives as of their origination date. We also determined the estimated fair value of $5,354,803 for the debentures
including their embedded derivatives as of June 30, 2018. The change in fair value of the 2018 Debentures was $842,783 from origination
date to June 30, 2018, which was recognized as a loss in the Condensed Consolidated Statement of Operations. We paid these Debentures
on August 21, 2018 so there was no similar fair value change in the six months ended June 30, 2019.
Loss
before Income Tax Benefit
As
a result of the above, we reported a loss before income tax benefit of $3,592,904 and $5,551,122 for the six months ended June
30, 2019 and 2018, respectively, an improvement of $1,958,218 (35%).
Income
Tax Benefit
We
did not record an income tax benefit related to our losses for the six months ended June 30, 2019 due to our overall net operating
loss carryforwards available. We have further determined to continue providing a full valuation reserve on our net deferred tax
assets as of June 30, 2019.
We
had approximately $61,600,000 of net operating loss carryforwards and $1,795,000 of research and development tax credit carryforwards
as of December 31, 2018 available to offset future net taxable income.
Net
Loss
As
a result of the above, we reported net losses of $3,592,904 and $5,551,122 for the six months ended June 30, 2019 and 2018, respectively,
an improvement of $1,958,218 (35%).
Basic
and Diluted Loss per Share
The
basic and diluted loss per share was ($0.32) and ($0.78) for the six months ended June 30, 2019 and 2018, respectively, for the
reasons previously noted. All outstanding stock options were considered antidilutive and therefore excluded from the calculation
of diluted loss per share for the six months ended June 30, 2019 and 2018 because of the net loss reported for each period.
Liquidity
and Capital Resources
Management’s
Liquidity Plan -
The Company incurred substantial operating losses in recent years due to the factors cited elsewhere
in this Report and has accessed the public and private capital markets to raise funding through the issuance of debt and equity.
During the six months ended June 30, 2019, the Company settled one of its patent infringement cases and received a lump sum payment
of $6.0 million which we used to pay our obligations under the PIA, as more fully described in Note 11. In recent years the Company
has accessed the public and private capital markets to raise funding through the issuance of debt and equity. In that regard,
the Company raised $1,564,000 in the six months ended June 30, 2019 from the exercise of warrants. Additionally, the Company raised
funding in the form of subordinated debt, secured debt and proceeds investment agreements totaling $16,500,000, and net proceeds
of $7,324,900 from an underwritten public offering of common stock during the year ended December 31, 2018. The Company issued
common stock with detachable common stock purchase warrants for $2,776,332 and raised funding from subordinated and secured debt
totaling $1,608,500 during the year ended December 31, 2017. During 2016, the Company raised $4.0 million of funding in the form
of convertible debentures and common stock purchase warrants. These debt and equity raises were utilized to fund its operations
and management expects to continue this pattern until it achieves positive cash flows from operations, although it can offer no
assurance in this regard.
On
August 5, 2019, the Company raised funds from the issuance of $2.78 million principal balance of convertible debentures with detachable
warrants to purchase 571,248 shares of common stock with the net proceeds being used for working capital purposes as more fully
described in Note 15.
The
Company retired all interest-bearing debt outstanding during the year ended December 31, 2018 and had no interest-bearing debt
outstanding during the six months ended June 30, 2019. The only long-term obligations outstanding as of June 30, 2019 is associated
with the proceeds investment agreement which the Company entered into during July 2018 that is more fully described in Note 6.
The
Company will have to restore positive operating cash flows and profitability over the next year and/or raise additional capital
to fund its operational plans, meet its customary payment obligations and otherwise execute its business plan. There can be no
assurance that it will be successful in restoring positive cash flows and profitability, or that it can raise additional debt
or equity financing when needed and obtain it on terms acceptable or favorable to the Company.
The
Company has implemented an enhanced quality control program to detect and correct product issues before they result in significant
rework expenditures affecting the Company’s gross margins and has seen progress in that regard. In addition, the Company
undertook a number of cost reduction initiatives, including a reduction of its workforce in 2018 by approximately 40%, restructuring
its direct sales force and cutting other selling, general and administrative costs. The Company increased its addressable market
to non-law enforcement customers and obtained new non-law enforcement contracts in 2017 and 2018, which contracts include recurring
revenue during the period 2019 to 2020. It believes that its quality control, headcount reduction and cost cutting initiatives,
and expansion to non-law enforcement sales channels will restore positive operating cash flows and profitability during the next
year, although it can offer no assurances in this regard.
If
we must further supplement our liquidity to support our operations in 2019, given our recent history of net operating losses and
negative cash flows, we do not believe that traditional banking indebtedness would be available to us given our recent operating
history. Our 2019 operating plan could include raising additional capital through an asset sale, a public offering or a private
placement of debt or equity, all of which are under consideration as part of our strategic alternatives. We have demonstrated
our ability to raise new debt or equity capital in recent years and most recently by the underwritten public offering in September
2018, PIA Financing in August 2018 and the convertible note offering in August 2019. If necessary, we believe that we could raise
additional capital during the next 12 months if required, but we can offer no assurances in this regard.
Further,
we had warrants outstanding exercisable to purchase 4,164,145 shares of common stock at a weighted average exercise price $5.71
per share outstanding as of June 30, 2019. In addition, there are common stock options outstanding exercisable to purchase 416,075
shares at an average price of $4.28 per share. We could potentially use such outstanding warrants to provide near-term liquidity
if we could induce their holders to exercise their warrants by adjusting/lowering the exercise price on a temporary or permanent
basis if the exercise price was below the then market price of our common stock, although we can offer no assurances in this regard.
Ultimately, we must restore profitable operations and positive cash flows to provide liquidity to support our operations and,
if necessary, to raise capital on commercially reasonable terms in 2019, although we can offer no assurances in this regard.
Based
on the uncertainties described above, we believe our business plan does not alleviate the existence of substantial doubt about
our ability to continue as a going concern within one year after the date that the financial statements in this Report are filed
with the Securities and Exchange Commission.
We
had $331,665 of available cash and equivalents and net working capital of approximately $4,634,857 as of June 30, 2019. Net working
capital as of June 30, 2019 includes approximately $1.6 million of accounts receivable and $6.8 million of inventory.
Cash
and cash equivalents balances:
As of June 30, 2019, we had cash and cash equivalents with an aggregate balance of $331,655,
a decrease from a balance of $3,598,807 at December 31, 2018. Summarized immediately below and discussed in more detail in the
subsequent subsections are the main elements of the $3,267,142 net decrease in cash during the six months ended June 30, 2019:
|
●
|
Operating
activities
:
|
$1,269,447
of net
cash provided by
operating activities. Net cash provided by operating activities was $1,269,447 for the
six months ended June 30, 2019 compared to cash used in operating activities of $1,522,067 for the six months ended June 30,
2018, an improvement of $2,791,514. The improvement was primarily the result of our improved operating results for the six
months ended June 30, 2019 compared to 2018 and increases in accounts payable offset by decreases in accrued expenses. Our
goal is to increase revenues, return to profitability and decrease our inventory levels during the remainder of 2019, thereby
providing positive cash flows from operations, although there can be no assurances that we will be successful in this regard.
|
|
|
|
|
|
●
|
Investing
activities
:
|
$100,589
of net
cash used in
investing activities. Cash used in investing activities was $100,589 for the six months ended
June 30, 2019 compared to cash provided by investing activities of $416,099 for the six months ended June 30, 2018. We satisfied
the requirements to maintain a minimum cash balance of $500,000 on March 30, 2018 and the restriction was lifted and the funds
became available for working capital needs. In 2019 and 2018, we incurred costs for tooling of new products and for patent
applications on our proprietary technology utilized in our new products and included in intangible assets.
|
|
|
|
|
|
●
|
Financing
activities:
|
$4,436,000
of net
cash used in
financing activities. Cash used in financing activities for the six months ended June 30, 2019
was $4,436,000 compared to cash provided by financing activities of $1,523,096 for the six months ended June 30, 2018. We
received $1,564,000 of proceeds in the six months ended June 30, 2019 from the exercise of common stock warrants. On May 30,
2019, we repaid $6,000,000 under the PIA. On April 3, 2018 and May 11, 2018, we received proceeds of $6,250,000 from the 2018
Debentures and warrants, primarily for full repayment of the 2016 Debentures issued in December 2016 and other outstanding
debt of the company, working capital and general corporate purposes.
|
The
net result of these activities was a decrease in cash of $3,267,142 to $331,355 for the six months ended June 30, 2019.
Commitments:
We
had $331,665 of cash and cash equivalent balances and net working capital approximating $4,634,857 as of June 30, 2019. Accounts
receivable balances represented $1,612,046 of our net working capital at June 30, 2019. We intend to collect our outstanding receivables
on a timely basis during 2019, which would help to provide positive cash flow to support our operations during the balance of
2019. Inventory represented $6,792,049 of our net working capital at June 30, 2019 and finished goods represented $5,291,233 of
total inventory. We are actively managing the overall level of inventory and our goal is to reduce such levels during the balance
of 2019 by our sales activities, which should provide additional cash flow to help support our operations during 2019.
Capital
Expenditures
.
We had no material commitments for capital expenditures at June 30, 2019.
Lease
Commitments-Operating Leases
. We have a non-cancelable long-term operating lease agreement for office and warehouse space
that expires during April 2020. We have also entered into month-to-month leases for equipment and facilities. Rent expense related
to these leases was $198,861 and $198,861 for the six months ended June 30, 2019 and 2018, respectively. Following are our minimum
lease payments for each year and in total.
Year ending December 31:
|
|
|
|
2019(period from July 1, 2019 to December 31, 2019)
|
|
$
|
229,170
|
|
2020
|
|
|
154,131
|
|
|
|
|
|
|
|
|
$
|
383,301
|
|
Litigation.
From
time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy to
not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After
carefully assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded,
we vigorously defend any lawsuit filed against us. We record a liability when losses are deemed probable and reasonably estimable.
When losses are deemed reasonably possible but not probable, we determine whether it is possible to provide an estimate of the
amount of the loss or range of possible losses for the claim, if material for disclosure. In evaluating matters for accrual and
disclosure purposes, we take into consideration factors such as our historical experience with matters of a similar nature, the
specific facts and circumstances asserted, the likelihood of our prevailing, the availability of insurance, and the severity of
any potential loss. We reevaluate and update accruals as matters progress over time.
While
the ultimate resolution is unknown we do not expect that these lawsuits will individually, or in the aggregate, have a material
adverse effect to our results of operations, financial condition or cash flows. However, the outcome of any litigation is inherently
uncertain and there can be no assurance that any expense, liability or damages that may ultimately result from the resolution
of these matters will be covered by our insurance or will not be in excess of amounts recognized or provided by insurance coverage
and will not have a material adverse effect on our operating results, financial condition or cash flows.
Axon
The
Company owns U.S. Patent No. 9,253,452 (the “ ‘452 Patent”), which generally covers the automatic activation
and coordination of multiple recording devices in response to a triggering event, such as a law enforcement officer activating
the light bar on the vehicle.
The
Company filed suit on January 15, 2016 in the U.S. District Court for the District of Kansas (Case No: 2:16-cv-02032) against
Axon, alleging willful patent infringement against Axon’s body camera product line and Signal auto-activation product. The
Company is seeking both monetary damages and a permanent injunction against Axon for infringement of the ‘452 Patent.
In
addition to the infringement claims, the Company brought claims alleging that Axon conspired to keep the Company out of the marketplace
by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Axon bribed officials and otherwise conspired
to secure no-bid contracts for its products in violation of both state law and federal antitrust law. The Company’s lawsuit
also seeks monetary and injunctive relief, including treble damages, for these alleged violations.
Axon
filed an answer, which denied the patent infringement allegations on April 1, 2016. In addition, Axon filed a motion to dismiss
all allegations in the complaint on March 4, 2016 for which the Company filed an amended complaint on March 18, 2016 to address
certain technical deficiencies in the pleadings. Digital amended its complaint and Axon renewed its motion to seek dismissal of
the allegations that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation
of both state law and federal antitrust law on April 1, 2016. Formal discovery commenced on April 12, 2016 with respect to the
patent related claims. In January 2017, the Court granted Axon’s motion to dismiss the portion of the lawsuit regarding
claims that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state
law and federal antitrust law. On May 2, 2018, the Federal Circuit affirmed the District Court’s ruling and on October 1,
2018 the Supreme Court denied Digital Ally’s petition for review.
In
December 2016 and January 2017, Axon filed two petitions for
Inter Partes
Review (“IPR”) against the ‘452
Patent. The United States Patent and Trademark Office (“USPTO”) rejected both of Axon’s petitions. Axon is now
statutorily precluded from filing any more IPR petitions against the ‘452 Patent.
The
District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on November
17, 2017, the Federal District Court of Kansas rejected Axon’s request to maintain the stay. With this significant ruling,
the parties will now proceed towards trial. Since litigation has resumed, the Court has issued a claim construction order (also
called a
Markman
Order) where it sided with the Company on all disputes and denied Axon’s attempts to limit the scope
of the claims. Following the
Markman
Order, the Court set all remaining deadlines in the case. Fact discovery closed on
October 8, 2018, and a Final Pretrial Conference took place on January 16, 2019. The parties filed motions for summary judgment
on January 31, 2019.
On
June 17, 2019, the Court granted Axon’s motion for summary judgment that Axon did not infringe on the Company’s patent
and dismissed the case. Importantly, the Court’s ruling did not find that Digital’s ‘452 Patent was invalid.
It also did not address any other issue, such as whether the Company’s requested damages were appropriate, and it does not
impact the Company’s ability to file additional lawsuits to hold other competitors accountable for patent infringement.
This ruling solely related to an interpretation of the claims as they relate to Axon and was unrelated to the supplemental briefing
the Company recently filed on its damages claim and the WatchGuard settlement. Those issues are separate and the judge’s
ruling on summary judgment had nothing to do with the Company’s damages request. The Company has filed an appeal to this
ruling and has asked the appellate court to reverse this decision.
WatchGuard
On
May 27, 2016 the Company filed suit against WatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent infringement based on
WatchGuard’s VISTA Wifi and 4RE In-Car product lines.
On
May 13, 2019, the parties resolved the dispute and executed a settlement agreement in the form of a Release and License Agreement.
The litigation has been dismissed as a result of this settlement.
The
Release and License Agreement encompasses the following key terms:
|
●
|
WatchGuard
paid Digital Ally a one-time, lump settlement payment of $6,000,000.
|
|
|
|
|
●
|
Digital
Ally has granted WatchGuard a perpetual covenant not to sue if WatchGuard’s products incorporate agreed-upon modified
recording functionality. Digital Ally has also granted WatchGuard a license to the ‘292 Patent and the ‘452 Patent
(and related patents, now existing and yet-to-issue) through December 31, 2023. The parties have agreed to negotiate in good
faith to attempt to resolve any alleged infringement that occurs after the license period expires.
|
|
|
|
|
●
|
The
parties have further agreed to release each other from all claims or liabilities pre-existing the settlement.
|
|
|
|
|
●
|
As
part of the settlement, the parties agreed that WatchGuard is making no admission that it has infringed any of Digital Ally’s
patents.
|
Upon
receipt of the $6,000,000 the parties filed a joint motion to dismiss the lawsuit which the Judge granted.
PGA
Tour, Inc.
On
January 22, 2019 the PGA Tour, Inc. (the “PGA”) filed suit against the Company in the Federal District Court for the
District of Kansas (Case No. 2:19-cv-0033-CM-KGG) alleging breach of contract and breach of implied covenant of good faith and
fair dealing relative to the Web.com Tour Title Sponsor Agreement (the “Agreement”). The Agreement was executed on
April 16, 2015 by and between the parties. Under the Agreement, Digital Ally would be a title sponsor of and receive certain naming
and other rights and benefits associated with the Web.com Tour for 2015 through 2019 in exchange for Digital Ally’s payment
to Tour of annual sponsorship fees. The suit has been resolved and the case has been dismissed by Plaintiff with prejudice on
April 17, 2019.
401
(k) Plan.
In July 2008, the Company amended and restated its 401(k) retirement savings plan. The amended plan requires
the Company to provide 100% matching contributions for employees who elect to contribute up to 3% of their compensation to the
plan and 50% matching contributions for employee’s elective deferrals on the next 2% of their contributions. The Company
has made matching contributions totaling $26,968 and $28,973 for the three months ended June 30, 2019 and 2018, respectively,
and $53,410 and $58,348 for the six months ended June 30, 2019 and 2018, respectively. Each participant is 100% vested at all
times in employee and employer matching contributions.
Consulting
and Distributor Agreements.
The Company entered into an agreement that required it to make monthly payments that will
be applied to future commissions and/or consulting fees to be earned by the provider. The agreement is with a limited liability
company (“LLC”) that is minority owned by a relative of the Company’s chief financial officer. Under the agreement,
dated January 15, 2016 and as amended on February 13, 2017, the LLC provides consulting services for developing a new distribution
channel outside of law enforcement for its body-worn camera and related cloud storage products to customers in the United States.
The Company advanced amounts to the LLC against commissions ranging from $5,000 to $6,000 per month plus necessary and reasonable
expenses for the period through June 30, 2017, which can be automatically extended based on the LLC achieving minimum sales quotas.
The agreement was renewed in January 2017 for a period of three years, subject to yearly minimum sales thresholds that would allow
the Company to terminate the contract if such minimums are not met. As of June 30, 2019, the Company had advanced a total of $277,151
pursuant to this agreement and established an allowance reserve of $129,140 for a net advance of $148,011. The minimum sales threshold
has not been met and the Company has discontinued all advances, although the contract has not been formally terminated. However,
the exclusivity provisions of the agreement have been terminated.
On
June 1, 2018 the Company entered into an agreement with an individual that required it to make monthly payments that will be applied
to future commissions and/or consulting fees to be earned by the provider. Under the agreement, the individual provides consulting
services for developing new distribution channels both inside and outside of law enforcement for its in-car and body-worn camera
systems and related cloud storage products to customers within and outside the United States. The Company was required to advance
amounts to the individual as an advance against commissions of $7,000 per month plus necessary and reasonable expenses for the
period through August 31, 2018, which was extended to December 31, 2018 by mutual agreement of the parties at $6,000 per month.
The parties have mutually agreed to further extend the arrangement on a monthly basis at $5,000 per month. As of June 30, 2019,
the Company had advanced a total of $96,242 pursuant to this agreement.
Critical
Accounting Policies
Critical
Accounting Policies
Our
significant accounting policies are summarized in note 1 to our condensed consolidated financial statements included in Item 1,
“Financial Statements”, of this report. While the selection and application of any accounting policy may involve some
level of subjective judgments and estimates, we believe the following accounting policies are the most critical to our financial
statements, potentially involve the most subjective judgments in their selection and application, and are the most susceptible
to uncertainties and changing conditions:
|
●
|
Revenue
Recognition / Allowance for Doubtful Accounts;
|
|
|
|
|
●
|
Allowance
for Excess and Obsolete Inventory;
|
|
|
|
|
●
|
Warranty
Reserves;
|
|
|
|
|
●
|
Stock-based
Compensation Expense;
|
|
|
|
|
●
|
Accounting
for Income Taxes;
|
|
|
|
|
●
|
Determination
of Fair Value Calculation for Financial Instruments and Derivatives; and
|
|
|
|
|
●
|
Going
Concern Analysis.
|
Revenue
Recognition / Allowances for Doubtful Accounts.
Revenue is recognized for the shipment of products or delivery of service
when all four of the following conditions are met:
|
(i)
|
Identify
the contract with the customer;
|
|
|
|
|
(ii)
|
Identify
the performance obligations in the contract;
|
|
|
|
|
(iii)
|
Determine
the transaction price;
|
|
|
|
|
(iv)
|
Allocate
the transaction price to the performance obligations in the contract; and
|
|
|
|
|
(v)
|
Recognize
revenue when a performance obligation is satisfied.
|
We
consider the terms and conditions of the contract and our customary business practices in identifying our contracts under ASC
606. We determine we have a contract when the customer order is approved, we can identify each party’s rights regarding
the services to be transferred, we can identify the payment terms for the services, we have determined the customer has the ability
and intent to pay and the contract has commercial substance. At contract inception we evaluate whether the contract includes more
than one performance obligation. We apply judgment in determining the customer’s ability and intent to pay, which is based
on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit
and financial information pertaining to the customer.
Performance
obligations promised in a contract are identified based on the services and the products that will be transferred to the customer
that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with
other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby
the transfer of the services and the products is separately identifiable from other promises in the contract. Our performance
obligations consist of (i) products, (ii) professional services, and (iii) extended warranties.
The
transaction price is determined based on the consideration to which we expect to be entitled in exchange for transferring services
to the customer. Variable consideration is included in the transaction price if, in our judgment it is probable that a significant
future reversal of cumulative revenue under the contract will not occur. None of our contracts contain a significant financing
component.
If
the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation.
Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation
based on the relative standalone selling price (“SSP”).
Revenue
is recognized at the time the related performance obligation is satisfied by transferring the control of the promised service
to a customer. Revenue is recognized when control of the service is transferred to the customer, in an amount that reflects the
consideration that we expect to receive in exchange for our services. We generate all our revenue from contracts with customers.
We
review all significant, unusual or nonstandard shipments of product or delivery of services as a routine part of our accounting
and financial reporting process to determine compliance with these requirements. Extended warranties are offered on selected products
and when a customer purchases an extended warranty the associated proceeds are treated as contract liability and recognized over
the term of the extended warranty.
Our
principal customers are state, local and federal law enforcement agencies, which historically have been low risks for uncollectible
accounts. However, we have commercial customers and international distributors that present a greater risk for uncollectible accounts
than such law enforcement customers and we consider a specific reserve for bad debts based on their individual circumstances.
Our historical bad debts have been negligible, with less than $218,000 charged off as uncollectible on cumulative revenues of
$233.5 million since we commenced deliveries during 2006. As of June 30, 2019, and December 31, 2018, we had provided a reserve
for doubtful accounts of $90,000 and $70,000, respectively.
We
periodically perform a specific review of significant individual receivables outstanding for risk of loss due to uncollectibility.
Based on such review, we consider our reserve for doubtful accounts to be adequate as of June 30, 2019. However, should the balance
due from any significant customer ultimately become uncollectible then our allowance for bad debts will not be sufficient to cover
the charge-off and we will be required to record additional bad debt expense in our statement of operations.
Allowance
for Excess and Obsolete Inventory.
We record valuation reserves on our inventory for estimated excess or obsolete inventory
items. The amount of the reserve is equal to the difference between the cost of the inventory and the estimated market value based
upon assumptions about future demand and market conditions. On a quarterly basis, management performs an analysis of the underlying
inventory to identify reserves needed for excess and obsolescence. Management uses its best judgment to estimate appropriate reserves
based on this analysis. In addition, we adjust the carrying value of inventory if the current market value of that inventory is
below its cost.
Inventories
consisted of the following at June 30, 2019 and December 31, 2018:
|
|
June
30, 2019
|
|
|
December
31, 2018
|
|
Raw material and component parts
|
|
$
|
4,903,170
|
|
|
$
|
4,969,786
|
|
Work-in-process
|
|
|
256,910
|
|
|
|
351,451
|
|
Finished goods
|
|
|
5,291,233
|
|
|
|
4,965,594
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
10,451,313
|
|
|
|
10,286,831
|
|
Reserve for excess and obsolete inventory
|
|
|
(3,659,264
|
)
|
|
|
(3,287,771
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
6,792,049
|
|
|
$
|
6,990,060
|
|
We
balance the need to maintain strategic inventory levels to ensure competitive delivery performance to our customers against the
risk of inventory obsolescence due to changing technology and customer requirements. As reflected above, our inventory reserves
represented 35.0% of the gross inventory balance at June 30, 2019, compared to 32.0% of the gross inventory balance at December
31, 2018. We had $3,659,264 and $3,287,771 in reserves for obsolete and excess inventories at June 30, 2019 and December 31, 2018,
respectively. Total raw materials and component parts were $4,903,170 and $4,969,786 at June 30, 2019 and December 31, 2018, respectively,
a decrease of $66,616 (1%). Finished goods balances were $5,291,233 and $4,965,594 at June 30, 2019 and December 31, 2018, respectively,
an increase of $325,639 (7%). The increase in the inventory reserve is primarily due a higher level of excess component parts
of the older versions of our PCB boards and the phase out of our DVM-750, DVM-500 Plus and LaserAlly legacy products. We believe
the reserves are appropriate given our inventory levels at June 30, 2019.
If
actual future demand or market conditions are less favorable than those projected by management or significant engineering changes
to our products that are not anticipated and appropriately managed, additional inventory write-downs may be required in excess
of the inventory reserves already established.
Warranty
Reserves.
We generally provide up to a two-year parts and labor warranty on our products to our customers. Provisions
for estimated expenses related to product warranties are made at the time products are sold. These estimates are established using
historical information on the nature, frequency, and average cost of claims. We actively study trends of claims and take action
to improve product quality and minimize claims. Our warranty reserves were decreased to $102,955 as of June 30, 2019 compared
to $195,135 as of December 31, 2018, primarily for expected replacements associated with select FirstVU HD customers. We have
limited experience with the FirstVU HD and DVM-800 and will monitor our reserve for all warranty claims related to these two newer
products. There is a risk that we will have higher warranty claim frequency rates and average cost of claims than our history
has indicated on our legacy mirror products on our new products for which we have limited experience. Actual experience could
differ from the amounts estimated requiring adjustments to these liabilities in future periods.
Stock-based
Compensation Expense
.
We grant stock options to our employees and directors and such benefits provided are share-based
payment awards which require us to make significant estimates related to determining the value of our share-based compensation.
Our expected stock-price volatility assumption is based on historical volatilities of the underlying stock that are obtained from
public data sources and there were 180,000 options granted during the six months ended June 30, 2019.
If
factors change and we develop different assumptions in future periods, the compensation expense that we record in the future may
differ significantly from what we have recorded in the current period. There is a high degree of subjectivity involved when using
option pricing models to estimate share-based compensation. Changes in the subjective input assumptions can materially affect
our estimates of fair values of our share-based compensation. Certain share-based payment awards, such as employee stock options,
may expire worthless or otherwise result in zero intrinsic value compared to the fair values originally estimated on the grant
date and reported in our financial statements. Alternatively, values may be realized from these instruments that are significantly
in excess of the fair values originally estimated on the grant date and reported in our financial statements. Although the fair
value of employee share-based awards is determined using an established option pricing model, that value may not be indicative
of the fair value observed in a willing buyer/willing seller market transaction. In addition, we account for forfeitures as they
occur.
Accounting
for Income Taxes.
Accounting for income taxes requires significant estimates and judgments on the part of management.
Such estimates and judgments include, but are not limited to, the effective tax rate anticipated to apply to tax differences that
are expected to reverse in the future, the sufficiency of taxable income in future periods to realize the benefits of net deferred
tax assets and net operating losses currently recorded and the likelihood that tax positions taken in tax returns will be sustained
on audit.
As
required by authoritative guidance, we record deferred tax assets or liabilities based on differences between financial reporting
and tax bases of assets and liabilities using currently enacted rates that will be in effect when the differences are expected
to reverse. Authoritative guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely
than not that all or some portion of the deferred tax asset will not be realized. As of December 31, 2018, cumulative valuation
allowances in the amount of $21,500,000 were recorded in connection with the net deferred income tax assets. Based on a review
of our deferred tax assets and recent operating performance, we determined that it was appropriate to continue to provide a full
valuation reserve on our net deferred tax assets as of June 30, 2019 because of the overall net operating loss carryforwards available.
We expect to continue to maintain a full valuation allowance until we determine that we can sustain a level of profitability that
demonstrates our ability to realize these assets. To the extent we determine that the realization of some or all of these benefits
is more likely than not based upon expected future taxable income, a portion or all of the valuation allowance will be reversed.
Such a reversal would be recorded as an income tax benefit and, for some portion related to deductions for stock option exercises,
an increase in shareholders’ equity.
As
required by authoritative guidance, we have performed a comprehensive review of our portfolio of uncertain tax positions in accordance
with recognition standards established by the FASB, an uncertain tax position represents our expected treatment of a tax position
taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax
expense for financial reporting purposes. We have no recorded liability as of June 30, 2019 representing uncertain tax positions.
We
have generated substantial deferred income tax assets related to our operations primarily from the charge to compensation expense
taken for stock options, certain tax credit carryforwards and net operating loss carryforwards. For us to realize the income tax
benefit of these assets, we must generate sufficient taxable income in future periods when such deductions are allowed for income
tax purposes. In some cases where deferred taxes were the result of compensation expense recognized on stock options, our ability
to realize the income tax benefit of these assets is also dependent on our share price increasing to a point where these options
have intrinsic value at least equal to the grant date fair value and are exercised. In assessing whether a valuation allowance
is needed in connection with our deferred income tax assets, we have evaluated our ability to generate sufficient taxable income
in future periods to utilize the benefit of the deferred income tax assets. We continue to evaluate our ability to use recorded
deferred income tax asset balances. If we fail to generate taxable income for financial reporting in future years, no additional
tax benefit would be recognized for those losses, since we will not have accumulated enough positive evidence to support our ability
to utilize net operating loss carryforwards in the future. Therefore, we may be required to increase our valuation allowance in
future periods should our assumptions regarding the generation of future taxable income not be realized.
Determination
of Fair Value for Financial Instruments and Derivatives.
During 2018 we entered into the proceeds investment agreement
(PIA). We elected to record the PIA, on their fair value basis. In accordance with ASC Topic 820 —
Fair Value Measurements
and Disclosures
(“ASC 820”), the Company utilizes the market approach to measure fair value for its financial
assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving
identical or comparable assets, liabilities or a group of assets or liabilities, such as a business.
ASC
820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three
broad levels. The following is a brief description of those three levels:
|
●
|
Level
1 — Quoted prices in active markets for identical assets and liabilities
|
|
|
|
|
●
|
Level
2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
|
|
|
|
|
●
|
Level
3 — Significant unobservable inputs (including the Company’s own assumptions in determining the fair value)
|
The
following table represents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a
recurring basis as of June 30, 2019.
|
|
June 30, 2019
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds investment agreement
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
6,240,000
|
|
|
$
|
6,240,000
|
|
Going
Concern Analysis.
In
accordance with ASU 2014-15,
Presentation of Financial Statements- Going Concern
(Subtopic 205-40) – Disclosure of
Uncertainties about an Entity’s Ability to Continue as a Going Concern, we are required to evaluate whether there are conditions
or events, considered in the aggregate, that raise substantial doubt about our ability to continue as a going concern within one
year after the date that our financials are issued. When management identifies conditions or events that raise substantial doubt
about their ability to continue as a going concern it should consider whether its plans to mitigate those relevant conditions
or events will alleviate the substantial doubt. If conditions or events raise substantial doubt about an entity’s ability
to continue as a going concern, but the substantial doubt is alleviated as a result of management’s plans, the entity should
disclose information that enables user of financial statements to understand the principal events that raised the substantial
doubt, management’s evaluation of the significance of those conditions or events, and management’s plans that alleviated
substantial doubt about the entity’s ability to continue as a going concern.
We
performed the analysis and our overall assessment was there were conditions or events, considered in the aggregate as of June
30, 2019, which raised substantial doubt about our ability to continue as a going concern within the next year, but such doubt
was not adequately mitigated by our plans to address the substantial doubt as disclosed in Note 1: Management’s Liquidity
Plan.
Inflation
and Seasonality
Inflation
has not materially affected us during the past fiscal year. We do not believe that our business is seasonal in nature however;
we usually generate higher revenues during the second half of the calendar year than in the first half.