Digital Ally Inc. Annual Report 2017

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FY2017 Annual Report · Digital Ally Inc.

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FORM 10-K
DIGITAL ALLY, INC.
DECEMBER 31, 2017

TABLE OF CONTENTS

PART I

Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.

Business
Risk Factors
Unresolved Staff Comments

Properties

Legal Proceedings
Mine Safety Disclosures

PART II

Page

3
9
9
9
9
11

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of

Item 6.
Item 7.
Item 7a.
Item 8.
Item 9.
Item 9A
Item 9B.

Equity Securities
Selected Financial Data

Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk

Financial Statements and Supplementary Data

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information

PART III

Item 10.
Item 11.
Item 12.

Item 13.
Item 14.

Directors, Executive Officers and Corporate Governance
Executive Compensation

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters

Certain Relationships and Related Transactions, and Director Independence

Principal Accountant Fees and Services

PART IV

Item 15.

Exhibits and Financial Statement Schedules

SIGNATURES

Signatures

14
14
34
34
34
34
35

35
39
45

47
47

NOTE REGARDING FORWARD LOOKING STATEMENTS

This annual report on Form 10-K contains forward-looking statements as that term is defined in Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-
looking statements by terminology such as “may,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,”
“potential,” “continue,” “intends,” and other variations of these words or comparable words. In addition, any statements that refer to
expectations, projections or other characterizations of events, circumstances or trends and that do not relate to historical matters are
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. These statements are only
predictions and involve known and unknown risks, uncertainties and other factors, including the risks that may cause our or our
industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by these forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements,
which speak only as of the date of this report. Except as required by law, we do not undertake to update or revise any of the forward-
looking statements to conform these statements to actual results, whether as a result of new information, future events or otherwise.

As used in this annual report, “Digital Ally,” the “Company,” “we,” “us,” or “our” refer to Digital Ally, Inc., unless otherwise

indicated.

Item 1. Business.

Overview

PART I

Digital Ally produces digital video imaging and storage products for use in law enforcement, security and commercial
applications. Our current 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 our 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 including cloud-based fleet management and driver monitoring/training
applications. We have active research and development programs to adapt our technologies to other applications. We have the ability to
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, taxi cab and the military. We sell our products to law enforcement
agencies and other security organizations, and consumer and commercial fleet operators through direct sales domestically and third-
party distributors internationally. We have several new and derivative products in research and development that we anticipate will
begin commercial production during 2018.

Corporate History

We were incorporated in Nevada on December 13, 2000 as Vegas Petra, Inc. From that date until November 30, 2004, when
we entered into a Plan of Merger with Digital Ally, Inc., a Nevada corporation which was formerly known as Trophy Tech Corporation
(the “Acquired Company”), we had not conducted any operations and were a closely-held company. In conjunction with the merger, we
were renamed Digital Ally, Inc.

The Acquired Company, which was incorporated on May 16, 2003, engaged in the design, development, marketing and sale
of bow hunting-related products. Its principal product was a digital video recording system for use in the bow hunting industry. It
changed its business plan in 2004 to adapt its digital video recording system for use in the law enforcement and security markets. We
began shipments of our in-car digital video rear view mirror in March 2006. On January 2, 2008, we commenced trading on the
NASDAQ Capital Market under the symbol “DGLY.” We conduct our business from 9705 Loiret Boulevard, Lenexa, Kansas 66219.
Our telephone number is (913) 814-7774.

Products

We produce and sell digital audio/video recording, storage and other products in law enforcement and commercial
applications. These product series have been used primarily in law enforcement and private security applications, both of which use
the core competency of our technology in digital video compression, recording and storage. In 2011, we introduced several derivative
products as “event recorders” that can be used in taxi cab, limousine, ambulance and other commercial fleet vehicle applications
which served to greatly diversify our addressable market. Our commercial products have also been utilized by off-airport parking
service providers, cruise lines, education and NASCAR races among a diverse group of other commercial applications. We also intend
to produce and sell other digital video products in the future that will continue to expand our reach beyond the traditional law
enforcement, private security and commercial fleet applications. We have developed and continue to develop both local server and
cloud based storage, archiving and search capabilities that provide customers with innovative, useful and secure methods to store and
maintain their audio/video data. These products incorporate our standards-based digital compression capability that allows the
recording of significant time periods on a chip and circuit board which can be designed into small forms and stored. The following
describes our product portfolio.

In-Car Digital Video Mirror System for law enforcement – DVM-100, DVM-400, DVM-750, DVM-800 and DVM-800 HD

In-car video systems for patrol cars are now a necessity and have generally become standard. Current systems are primarily
digital based systems with cameras mounted on the windshield and the recording device generally in the trunk, headliner, dashboard,
console, or under the seat of the vehicle. Most manufacturers have already developed and transitioned completely to digital video, and
some have offered full HD level recordings which is currently state-of-art for the industry.

Our digital video rear view mirror unit is a self-contained video recorder, microphone and digital storage system that is
integrated into a rear-view mirror, with a monitor, GPS and 900 MHz audio transceiver. Our system is more compact and unobtrusive
than certain of our competitors because it requires no recording equipment to be located in other parts of the vehicle.

Our in-car digital video rear view mirror has the following features:

standards-based video and audio compression and recording;
system is concealed in the rear view mirror, replacing factory rear view mirror;

● wide angle zoom color camera;
●
●
● monitor in rear-view mirror is invisible when not activated;
eliminates need for analog tapes to store and catalogue;
●
easily installs in any vehicle;
●
ability to integrate with body-worn cameras including auto-activation of either system;
●
●
archives audio/video data to the cloud, computers (wirelessly) and to compact flash memory, or file servers;
● 900 MHz audio transceiver with automatic activation;
● marks exact location of incident with integrated GPS;
● playback using Windows Media Player;
● optional wireless download of stored video evidence;
● proprietary software protects the chain of custody;
●

and records to rugged and durable solid state memory.

In-Car Digital Video “Event Recorder” System –DVM-250 Plus for Commercial Fleets

Digital Ally provides commercial fleets and commercial fleet managers with the digital video tools they need to increase driver
safety, track assets in real-time and minimize the company’s liability risk all while enabling fleet managers to operate the fleet at an
optimal level. We market a product designed to address these commercial fleet markets with our DVM-250 Plus event recorders that
provides all types of commercial fleets with features and capabilities that are fully-customizable, consistent with their specific
application and inherent risks. The DVM-250 Plus is a rear-view mirror based digital audio and video recording system with many, but
not all of, the features of our DVM-800 law enforcement mirror systems at a lower price point. The DVM-250 Plus is designed to
capture “events,” such as wrecks and erratic driving or other abnormal occurrences, for evidentiary or training purposes. These markets
may find our units attractive from both a feature and cost perspective, compared to other providers. Our marketing efforts indicate that
these commercial fleets are adopting this technology, in particular the ambulance and taxi-cab markets.

Digital Ally offers a suite of data management web-based tools to assist fleet managers in the organization, archival, and
management of videos and telematics information. Within the suite, there are powerful mapping and reporting tools that help optimize
efficiency, serve as excellent training tools for teams on safety and ultimately generate a significant return on investment for the

organization.

Miniature Body-Worn Digital Video System – FirstVU HD for law enforcement and private security

This system is also a derivative of our in-car video systems, but is much smaller and lighter and more rugged and water-resistant
to handle a hostile outdoor environment. These systems can be used in many applications in addition to law enforcement and private
security and are designed specifically to be clipped to an individual’s pocket or other outer clothing. The unit is self-contained and
requires no external battery or storage devices. Current systems offered by competitors are digital based, but generally require a battery
pack and/or storage device to be connected to the camera by wire or other means. We believe that our FirstVU HD product is more
desirable for potential users than our competitors’ offerings because of its video quality, small size, shape and lightweight characteristics.
Our FirstVU HD integrates with our in-car video systems through our patented VuLink system allowing for automatic activation of both
systems.

Auto-activation and Interconnectivity between in-car video systems and FirstVU HD body worn camera products – VuLink for law
enforcement applications

Recognizing a critical limitation in law enforcement camera technology, we pioneered the development of our VuLink
ecosystem that provides intuitive auto-activation functionality as well as coordination between multiple recording devices. The United
States Patent and Trademark Office (the “USPTO”) has recognized these pioneering efforts by granting us multiple patents with claims
covering numerous features, such as automatically activating an officer’s cameras when the light bar is activated or a data-recording
device such as a smart weapon is activated. Additionally, the awarded patent claims cover automatic coordination between multiple
recording devices. Prior to this work, 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.
Our FirstVU HD integrates with our in-car video systems through our patented VuLink system allowing for automatic activation of both
systems.

This feature is becoming a standard feature required by many law agencies. Unfortunately, certain competitors have chosen to
infringe our patent and develop products that provide the same or similar features as our VuLink system. We have filed lawsuits against
two competitors Axon Enterprises, Inc. (formerly known as Taser International, Inc.) and Enforcement Video, LLC dba WatchGuard
Video that challenge their infringing products. We believe that the outcome of these lawsuits will largely define the competitive
landscape for the body-worn and in-car video market for the foreseeable future. We expect that our VuLink product and its related
patents will be recognized as the revolutionary and pioneering invention by the courts, although we can offer no assurances in this
regard.

VuVault.net and FleetVU Manager

VuVault.net is a cost-effective, fully expandable, law enforcement cloud storage solution powered by Amazon Web Services

that provides CJIS compliant redundant and security-enhanced storage of all uploaded videos.

FleetVU Manager is our web-based software for commercial fleet tracking and monitoring that features and manages video
captured by our Video Event Data Recorders of incidents requiring attention, such as accidents. This software solution features our
cloud-based web portal that utilizes many of the features of our VuVault.NET law-enforcement cloud-based storage solution.

Other Products

During the last year, we focused our research and development efforts to meet the varying needs of our customers, enhance our
existing products and commence development of new products and product categories. Our research and development efforts are
intended to maintain and enhance our competitiveness in the market niche we have carved out, as well as positioning us to compete in
diverse markets outside of law enforcement.

Market and Industry Overview

Historically, our primary market has been domestic and international law enforcement agencies. In 2012, we expanded our
scope by pursuing the commercial fleet vehicle and mass transit markets. In the future, given sufficient capital and market opportunity,
we may further expand or focus on private security, homeland security, mass transit, healthcare, general retail, educational, general
consumer and other commercial markets. In that regard, we have several installations involving private security on cruise ships and
similar markets. Our view is there are many potential private uses of our product offerings. We have made inroads into certain
commercial fleet and the ambulance service provider market, confirming that our DVM-250 Plus product and FleetVU Manager can
become a significant revenue producer for us.

Law Enforcement

We believe that law enforcement already recognizes a valuable use of our various digital audio/video products for the recording
of roadside sobriety tests. Without some form of video or audio recording, court proceedings usually consist of the police officer’s word
against that of the suspect. Records show that conviction rates increase substantially where there is video evidence to back up officer
testimony. Video evidence also helps to protect police departments against frivolous lawsuits.

The largest source of police video evidence today is in-car video. Unfortunately, some police cars still do not have in-car video,
and in those that do, the camera usually points forward rather than to the side of the road where the sobriety test takes place. The in-car
video is typically of little use for domestic violence investigations, burglary or theft investigations, disorderly conduct calls or physical
assaults. In all of these cases, the FirstVU HD may provide recorded evidence of the suspect’s actions and reactions to police
intervention.

Additionally, motorcycle patrolmen rarely have video systems. Our FirstVU body camera is well suited as a mobile application

of our digital video recording system that can be used by motorcycle police and water patrol.

Crime scene investigations, including detailed photography, are typically a large part of the budgets of metropolitan police
forces. The FirstVU may record a significant portion of such evidence at a much lower cost for gathering, analyzing and storing data
and evidence.

Commercial and Other Markets

There are numerous potential applications for our digital audio/video camera products. We believe that other potential markets
for our digital video systems, including the derivatives currently being developed, include private investigators, SWAT team members,
over-the-road trucking fleets, airport security, municipal fire departments, and the U.S. military. Other commercial markets for our
digital video systems include real estate appraisers, plumbers and electricians.

Schools

We believe our products and offerings may be of benefit in kindergarten through twelve grade school systems. We are currently
assessing our entry into this potential market through several pilot tests. Preliminary results of our exploration of this market have been
mixed, but we believe it may represent a new addressable market for our mobile audio/video recording products in the future. Recent
tragic events at schools have heightened the need for providing a “safer” environment in general for schools.

Medical applications

We believe our products and offerings may be of benefit in hospital and other medical services delivery systems. We are

currently assessing our entry into this potential market.

Private Security Companies

There are thousands of private security agencies in the United States employing a large number of guards. Police forces use
video systems for proof of correct conduct by officers, but private security services usually have no such tool. We believe that the
FirstVU HD is an excellent management tool for these companies to monitor conduct and timing of security rounds. In addition to the
FirstVU HD, the digital video security camera can provide fill-in security when guards have large areas to cover or in areas that do not
have to be monitored around the clock.

Homeland Security Market

In addition to the government, U.S. corporations are spending heavily for protection against the potential of terrorist attacks.

Public and private-sector outlays for antiterrorism measures and for protection against other forms of violence are significant. These are
potential markets for our products.

Manufacturing

We have entered into contracts with manufacturers for the assembly of the printed circuit boards used in our products. Dedicated
circuit board manufacturers are well-suited to the assembly of circuit boards with the complexity found in our products. Dedicated board
manufacturers can spread the extensive capital equipment costs of circuit board assembly among multiple projects and customers. Such
manufacturers also have the volume to enable the frequent upgrade to state-of-the-art equipment. We have identified multiple suppliers

who meet our quality, cost, and performance criteria. We also use more than one source for circuit board assembly to ensure a reliable
supply over time. We use contract manufacturers to manufacture our component subassemblies and may eventually use them to perform
final assembly and testing. Due to the complexity of our products, we believe that it is important to maintain a core of knowledgeable
production personnel for consistent quality and to limit the dissemination of sensitive intellectual property and will continue this practice.
In addition, such technicians are valuable in our service and repair business to support our growing installed customer base.

We also contract with two manufacturers that have manufacturing facilities in the Philippines and South Korea to produce our
DVM-250 Plus, DVM-800 and DVM-800 HD products. The contracts are general in nature addressing confidentiality and other matters,
have no minimum purchase requirements and require the acceptance of specific purchase orders to support any product supply
acquisitions. We are using additional contract manufacturers based in the United States for these product lines to further mitigate any
supply disruption risk and ensure competitive pricing. We typically perform final assembly, testing and quality control functions for
these products in our Lenexa, Kansas facility.

Sales and Marketing

In recent years, we have changed principally to an employee-based, direct sales force for domestic selling efforts that enables
us to control and monitor its daily activities. In this connection, we have reduced the size of certain territories and consequently increased
the sales personnel and changed the number of domestic sales territories to seven to better penetrate the market. The direct territory sales
team is supported by a team of eight inside sales coordinators, and a tele-sales specialist and a pre-sales solution design team. We also
have a bid specialist to coordinate large bid opportunities. We believe our employee-based model encourages our sales personnel in
lower performing territories to improve their efforts and, consequently, their sales results. Our executive team also supports sales agents
with significant customer opportunities by providing pricing strategies and customer presentation assistance. Our technical support
personnel may also provide sales agents with customer presentations and product specifications in order to facilitate sales activities.

We use our direct sales force and international distributors to market our products. Our key promotional activities include:

attendance at industry trade shows and conventions;

●
● direct sales, with a force of industry-specific sales individuals who identify, call upon and build on-going relationships

with key purchasers and targeted industries;
support of our direct sales with passive sales systems, including inside sales and e-commerce;

●
● print advertising in journals with specialized industry focus;
● direct mail campaigns targeted to potential customers;
● web advertising, including supportive search engines and website and registration with appropriate sourcing entities;
● our NASCAR relationship is supportive of developing new business opportunities by and between the sponsors at

NASCAR sponsored events in addition to the races;

● public relations, industry-specific venues, as well as general media, to create awareness of our brand and our

products, including membership in appropriate trade organizations; and
● brand identification through trade names associated with us and our products.

Competition

The law enforcement and security surveillance markets are extremely competitive. Competitive factors in these industries
include ease of use, quality, portability, versatility, reliability, accuracy and cost. There are direct competitors with technology and
products in the law enforcement and surveillance markets for all our products and those we have in development. Many of these
competitors have significant advantages over us, including greater financial, technical, marketing and manufacturing resources, more
extensive distribution channels, larger customer bases and faster response times to adapt new or emerging technologies and changes in
customer requirements. Our primary competitors in the in-car video systems market include L-3 Mobile-Vision, Inc., Coban
Technologies, Inc., Enforcement Video, LLC d/b/a WatchGuard Video (“WatchGuard”), Kustom Signals, Panasonic System
Communications Company, International Police Technologies, Inc. and a number of other competitors who sell, or may in the future
sell, in-car video systems to law enforcement agencies. Our primary competitors in the body-worn camera market include Axon
Enterprise, Inc. (“Axon” –formerly Taser International, Inc.), Reveal Media, WatchGuard and VieVU, Inc. We face similar and intense
competitive factors for our event recorders in the mass transit markets as we do in the law enforcement and security surveillance markets.
We will also compete with any company making surveillance devices for commercial use. There can be no assurance that we will be
able to compete successfully in these markets. Further, there can be no assurance that new and existing companies will not enter the law
enforcement and security surveillance markets in the future.

The commercial fleet security and surveillance markets likewise are also very competitive. There are direct competitors for our
DVM-250 Plus “event recorders,” which several may have greater financial, technical marketing, and manufacturing resources than we
do. Our primary competitors in the commercial fleet sector include Lytx, Inc. (previously DriveCam, Inc.) and SmartDrive Systems.

Intellectual Property

Our ability to compete effectively will depend on our success in protecting our proprietary technology, both in the United States
and abroad. We have filed for patent protection in the United States and certain other countries to cover certain design aspects of our
products.

Some of our patent applications are still under review by the USPTO and, therefore, we have not yet been issued all the patents
that we applied for in the United States. We were issued several patents in recent years, including a patent on our VuLink product which
provides automatic triggering of our body-worn camera and our in-car video systems. No assurance can be given which, or any, of the
patents relating to our existing technology will be issued from the United States or any foreign patent offices. Additionally, no assurance
can be given that we will receive any patents in the future based on our continued development of our technology, or that our patent
protection within and/or outside of the United States will be sufficient to deter others, legally or otherwise, from developing or marketing
competitive products utilizing our technologies.

We have entered into supply and distribution agreements with several companies that produce certain of our products, including
our DVM-100, DVM-250, DVM-400, DVM-800 and DVM-800 HD products. These supply and distribution agreements contain certain
confidentiality provisions that protect our proprietary technology, as well as that of the third party manufacturers.

In addition to seeking patent protection, we rely on trade secrets, know-how and continuing technological advancement to seek
to achieve and thereafter maintain a competitive advantage. Although we have entered into or intend to enter into confidentiality and
invention agreements with our employees, consultants and advisors, no assurance can be given that such agreements will be honored or
that we will be able to effectively protect our rights to our unpatented trade secrets and know-how. Moreover, no assurance can be given
that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to
our trade secrets and know-how.

Axon, a competitor in our body-camera market, requested that the USPTO commence an ex parte reexamination (“IPR”) of
our U.S. Patent No. 8,781,292 (The “‘292 Patent”). The USPTO granted this request and has completed its reexamination. The USPTO
has confirmed the validity of our ‘292 Patent which relates to our auto-activation technology for law enforcement body cameras. We
have filed suit in the U.S. District Court for the District of Kansas against Axon, alleging willful patent infringement against Axon’s
body camera product line. On February 2, 2016, we received notification that the USPTO has issued another patent relating to our auto-
activation technology for law enforcement cameras. U.S. Patent No. 9,253,452 (the “‘452 Patent”) 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. We have added Axon’s willful infringement of the ‘452 Patent to our existing lawsuit. Axon then requested
that the USPTO institute two IPR’s of our ‘452 Patent and on July 6, 2017, the USPTO denied Axon’s one petition for IPR of the ‘452
Patent, and on August 3, 2017, the Patent Office denied Axon’s final petition for IPR of the ‘452 Patent. This was Axon’s final attempt
to invalidate the ‘452 Patent before the Patent Office. Axon has requested that another IPR of our ‘292 Patent and we expect to have a
final decision on this IPR in June 2018. Axon is now barred from requesting any new IPR’s against both the ‘292 and ‘452 Patents.

Despite the USPTO’s recognition of the validity of the ‘292 Patent and ‘452 Patent, AXON continues to offer for sale, sell, and
market its Axon technology in disregard of our federally protected patent rights. As a result, we are aggressively challenging Axon’s
infringing conduct in our lawsuit against it, seeking both monetary damages and a permanent injunction preventing Axon from
continuing to sell its Axon Signal technology.

On May 27, 2016 we filed suit against WatchGuard, alleging patent infringement of our ‘292 Patent, the ‘452 Patent and our
patent No. 9,325,950 (the “‘950 Patent”) based on WatchGuard’s VISTA Wifi and 4RE In-Car product lines. We intend to aggressively
challenge WatchGuard’s infringing conduct in our lawsuit against it, seeking both monetary damages and a permanent injunction
preventing WatchGuard from continuing to sell its auto-activation technology embodied within its body-worn and in-car video systems.

The USPTO has granted multiple patents to the Company with claims covering numerous features, such as automatically
activating all deployed cameras in response to the activation of just one camera. Additionally, its patent claims cover automatic
coordination as well as digital synchronization between multiple recording devices. Digital Ally also has patent coverage directed to the
coordination between a multi-camera system and an officer’s smartphone, which allows an officer to more readily assess an event on
the scene while an event is taking place or immediately after it has occurred.

The Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car
product lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the ‘292 and ‘452
Patents and “‘950 Patent”. The Company is aggressively challenging WatchGuard’s infringing conduct, seeking both monetary damages,
as well as seeking a permanent injunction preventing WatchGuard from continuing to sell its VISTA Wifi and 4RE In-Car product lines
using Digital Ally’s own technology to compete against it. On May 8, 2017, WatchGuard filed a petition seeking IPR of the ‘950 Patent.
The Company will vigorously oppose that petition. On December 4, 2017 The Patent Trial and Appeal Board (“PTAB”) rejected the

request of WatchGuard to institute an “IPR” on the ‘950 Patent. The lawsuit also involves the ‘292 Patent and the ‘452 Patent, the same
two patents asserted against Axon. The ‘292 Patent is in the IPR process with the USPTO, while WatchGuard is now statutorily barred
from any further IPR’s challenges with respect to the ‘950 Patent. The lawsuit has been stayed pending a decision from the USPTO on
the ‘292 Patent IPR petition.

We believe the outcome of these infringement lawsuits, and in particular the Axon lawsuit will have meaningful effects upon the
entire body-worn camera market within the United States over the foreseeable future. The auto-activation technology protected by our
‘292, ‘452 and ‘950 Patents is quickly becoming standard within the industry, therefore if we are successful in challenging Axon and
WatchGuard’s infringing conduct, we believe it will have a substantial and positive impact upon our future revenue streams.

Employees

We had 128 full-time employees as of December 31, 2017. Our employees are not covered by any collective bargaining agreement

and we have never experienced a work stoppage. We believe that our relations with our employees are good.

Item 1A. Risk Factors.

Not applicable.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

We entered into a non-cancellable, long-term facility lease in September 2012 to combine all of our operations into one location,
commencing in November 2012. Our facility contains approximately 33,776 square feet and is located at 9705 Loiret Boulevard, Lenexa,
Kansas 66219. The lease will terminate on April 1, 2020. The monthly rent ranges from $35,634 to $38,533 over the term.

Management believes that its current facilities are adequate to meet its needs for the foreseeable future.

Item 3. Legal Proceedings.

The Company is subject to various legal proceedings arising from normal business operations. Although there can be no
assurances, based on the information currently available, management believes that it is probable that the ultimate outcome of each of
the actions will not have a material adverse effect on the consolidated financial statement of the Company. However, an adverse outcome
in certain of the actions could have a material adverse effect on the financial results of the Company in the period in which it is recorded.

Axon

The Company owns 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. Axon amended and 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. The Company has appealed

this decision to the United States Court of Appeals for the Federal Circuit and is awaiting its decision.

In December 2016 and January 2017, Axon filed two petitions for IPR against the ‘452 Patent. The 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, a Markman hearing was held on March 7, 2018 and the parties have
continued to engage in discovery. All remaining significant deadlines will be set when the Court issues its Markman order.

In a Markman hearing the judge determines the meaning of disputed words in a patent infringement lawsuit. A Markman hearing
is also known as a construction hearing. When a judge determines the meaning of the disputed words, it is called claim construction. To
determine patent infringement, a jury must fully understand the definition of words used in the patent. A patented invention must be
described with precise wording on its patent application. Jurists use this wording and the defined definitions from the Markman hearing
to determine if patent infringement has occurred. The name “Markman hearing” comes from a 1996 Supreme Court case Markman v.
Westview Instruments, which decided that judges were better equipped than juries to determine claim construction.

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.

The Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car
product lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the ‘292 and ‘452
Patents and ‘950 Patent. The Company is aggressively challenging WatchGuard’s infringing conduct, seeking both monetary damages,
as well as seeking a permanent injunction preventing WatchGuard from continuing to sell its VISTA Wifi and 4RE In-Car product lines
using Digital Ally’s own technology to compete against it. On May 8, 2017, WatchGuard filed a petition seeking IPR of the ‘950 Patent.
The Company will vigorously oppose that petition. On December 4, 2017 The Patent Trial and Appeal Board (“PTAB”) rejected the
request of WatchGuard V to institute an IPR review on the ‘950 Patent. The lawsuit also involves the ‘292 Patent and the ‘452 Patent,
the same two patents asserted against Axon. The ‘292 Patent is in the IPR process with the USPTO, while WatchGuard is now statutorily
barred from any further IPR’s challenges with respect to the ‘950 Patent. The lawsuit has been stayed pending a decision from the
USPTO on the ‘292 Patent IPR,which is expected in June 2018.

Utility Associates, Inc.

On October 25, 2013, the Company filed a complaint in the United States District Court for the District of Kansas (2:13-cv-
02550-SAC) to eliminate threats by a competitor, Utility Associates, Inc. (“Utility”), of alleged patent infringement regarding U.S.
Patent No. 6,831,556 (the “ ‘556 Patent”). Specifically, the lawsuit seeks a declaration that the Company’s mobile video surveillance
systems do not infringe any claim of the ‘556 Patent. The Company became aware that Utility had mailed letters to current and
prospective purchasers of its mobile video surveillance systems threatening that the use of such systems purchased from third parties
not licensed to the ‘556 Patent would create liability for them for patent infringement.

In addition, the Company began proceedings to invalidate the ‘556 Patent through a request for IPR of the ‘556 patent at the
USPTO. On July 27, 2015, the USPTO invalidated key claims in Utility’s ‘556 Patent. The Final Decision from the USPTO significantly
curtailed Utility’s ability to threaten law enforcement agencies, municipalities, and others with infringement of the ‘556 Patent. Utility
appealed this decision to the United States Court of Appeals for the Federal Circuit. The United States Court of Appeals for the Federal
affirmed the ruling of the USPTO summarily thus concluding the matter.

On June 6, 2014 the Company filed a separate Unfair Competition lawsuit against Utility in the United States District Court
for the District of Kansas. In that lawsuit it contended that Utility has disparaged the Company and illegally interfered with its contracts,
customer relationships and business expectancies by falsely asserting to its customers and others that its products violate the ‘556 Patent,
of which Utility claims to be the holder. In addition to damages, the Company sought permanent injunctive relief, prohibiting Utility
from continuing to threaten or otherwise interfere with the Company’s customers. On March 4, 2015, an initial hearing was held upon
the Company’s request for injunctive relief.

Based upon facts revealed at a March 4, 2015 injunction hearing, on March 16, 2015, the Company sought leave to amend its
Complaint in the unfair competition suit to assert additional claims against Utility. Those new claims included claims of actual or
attempted monopolization, in violation of § 2 of the Sherman Act, claims arising under a new Georgia statute that prohibits threats of
patent infringement in “bad faith,” and additional claims of unfair competition/false advertising in violation of § 63(a) of the Lanham
Act. The Court concluded its injunction hearing on April 22, 2015, and allowed the Company leave to add these claims, but denied its
preliminary injunction. Subsequent to the injunction hearing, Utility withdrew from the market the in-car video recording device that it
had sold in competition with the Company’s own products of similar function and which Utility had attempted to market using threats
of patent infringement. After discovery closed, Utility filed a Motion for Summary Judgment and the Company filed a Motion for Partial
Summary Judgment. On March 30, 2017, the Court entered its order granting Utility’s motion and denying the Company’s motion for
summary judgment. The Company believed the District Court had made several errors when ruling on the motions for summary
judgment, and filed an appeal to the United States Court of Appeals for the Tenth Circuit (10th Circuit”). While the appeal was pending,
Utility filed a motion for the recovery from the Company of some $800,000 in alleged attorney’s fees as provided, purportedly, under
the Lanham Patent and Uniform Trade Secrets Act. That motion was denied in its entirety by final judgement entered February 14, 2018.
On February 16, 2018, the 10th Circuit issued its decision affirming the decision of the District Court. The Company filed a petition for
rehearing by the panel and en banc which was also denied. Utility has filed its own motion for the recovery of attorney fees, on appeal
in the alleged amount of $125,000. That motion has not yet been fully briefed but the Company will oppose it on substantially the same
grounds upon which Utility’s prior motion for attorney’s fees was denied by the District Court.

The Company is also involved as a plaintiff and defendant in ordinary, routine litigation and administrative proceedings incidental
to its business from time to time, including customer collections, vendor and employment-related matters. The Company believes the
likely outcome of any other pending cases and proceedings will not be material to its business or its financial condition.

Item 4. Mine Safety Disclosures.

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and

Issuer Purchases of Equity Securities.

Market Prices

Our common stock commenced trading on the NASDAQ Capital Market on January 2, 2008 under the symbol “DGLY,” and
continues to do so. From July 2007 until we became listed on the NASDAQ Capital Market, our common stock was traded on the OTC
Bulletin Board and prior to that it was quoted in the “Pink Sheets.”

The high/low closing prices of our common stock were as follows for the periods below. In addition, the quotations below

reflect inter-dealer bid prices without retail markup, markdown, or commission and may not represent actual transactions:

Year Ended December 31, 2017

1st Quarter
2nd Quarter
3rd Quarter
4th Quarter

Year Ended December 31, 2016

1st Quarter
2nd Quarter
3rd Quarter
4th Quarter

Holders of Common Stock

High Close

Low Close

$
$
$
$

5.75 $
4.26 $
4.20 $
2.80 $

6.75 $
4.79 $
6.69 $
6.40 $

4.00
3.03
2.40
1.75

4.72
3.56
3.76
4.15

As of December 31, 2017, we had approximately 105 shareholders of record for our common stock.

Dividend Policy

To date, we have not declared or paid cash dividends on our shares of common stock. The holders of our common stock will
be entitled to non-cumulative dividends on the shares of common stock, when and as declared by our board of directors, in its discretion.
We intend to retain all future earnings, if any, for our business and do not anticipate paying cash dividends in the foreseeable future.

Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon
our financial condition, results of operations, capital requirements, general business conditions and such other factors as our board of
directors may deem relevant.

Securities Authorized for Issuance under Equity Compensation Plans

Our board of directors adopted the 2005 Stock Option and Restricted Stock Plan (the “2005 Plan”) on September 1, 2005. The
2005 Plan authorized us to reserve 312,500 shares of our common stock for issuance upon exercise of options and grant of restricted
stock awards. The 2005 Plan terminated in 2015 with 1,403 shares reserved for awards that are now unavailable for issuance. Stock
options granted under the 2005 Plan that remain unexercised and outstanding as of December 31, 2017 total 25,938.

On January 17, 2006, our board of directors adopted the 2006 Stock Option and Restricted Stock Plan (the “2006 Plan”). The
2006 Plan authorizes us to reserve 187,500 shares for future grants under it. The 2006 Plan terminated in 2016 with 11,021 shares
reserved for awards that are now unavailable for issuance. Stock options granted under the 2006 Plan that remain unexercised and
outstanding as of December 31, 2017 total 56,268.

On January 24, 2007, our board of directors adopted the 2007 Stock Option and Restricted Stock Plan (the “2007 Plan”). The
2007 Plan authorizes us to reserve 187,500 shares for future grants under it. The 2007 Plan terminated in 2016 with 82,151 shares
reserved for awards that are now unavailable for issuance. Stock options granted under the 2007 Plan that remain unexercised and
outstanding as of December 31, 2017 total 12,500.

On January 2, 2008, our board of directors adopted the 2008 Stock Option and Restricted Stock Plan (the “2008 Plan”). The
2008 Plan authorizes us to reserve 125,000 shares for future grants under it. At December 31, 2017, there were 6,324 shares reserved
for awards available for issuance under the 2008 Plan. Stock options granted under the 2008 Plan that remain unexercised and
outstanding as of December 31, 2017 total 95,375.

On March 18, 2011, our board of directors adopted the 2011 Stock Option and Restricted Stock Plan (the “2011 Plan”). The
2011 Plan authorizes us to reserve 62,500 shares for future grants under it. At December 31, 2017, there were 7,288 shares reserved for
awards available for issuance under the 2011 Plan. Stock options granted under the 2011 Plan that remain unexercised and outstanding
as of December 31, 2017 total 10,188.

On March 22, 2013, our board of directors adopted the 2013 Stock Option and Restricted Stock Plan (the “2013 Plan”). The
2013 Plan was amended on March 28, 2014 and November 14, 2014 to increase the number of shares authorized and reserved for
issuance under the 2013 Plan to a total of 300,000. At December 31, 2017, there were 1,100 shares reserved for awards available for
issuance under the 2013 Plan. Stock options granted under the 2013 Plan that remain unexercised and outstanding as of December 31,
2017 total 20,000.

On March 27, 2015, our board of directors adopted the 2015 Stock Option and Restricted Stock Plan (the “2015 Plan”). The
2015 Plan was amended on February 25, 2016 and May 31, 2017 to increase the number of shares authorized and reserved for issuance
under the 2015 Plan to a total of 1,250,000. At December 31, 2017, there were 88,900 shares reserved for awards available for issuance
under the 2015 Plan, as amended. Stock options granted under the 2015 Plan that remain unexercised and outstanding as of December
31, 2017 total 130,000.

The 2005 Plan, 2006 Plan, 2007 Plan, 2008 Plan, 2011 Plan, 2013 Plan and 2015 Plan are referred to as the “Plans.”

The Plans authorize us to grant (i) to the key employees incentive stock options (except for the 2007 Plan) to purchase shares
of common stock and non-qualified stock options to purchase shares of common stock and restricted stock awards, and (ii) to non-
employee directors and consultants’ non-qualified stock options and restricted stock. The Compensation Committee of our board of
directors administers the Plans by making recommendations to the board or determinations regarding the persons to whom options or
restricted stock should be granted and the amount, terms, conditions and restrictions of the awards.

The Plans allow for the grant of incentive stock options (except for the 2007 Plan), non-qualified stock options and restricted
stock awards. Incentive stock options granted under the Plans must have an exercise price at least equal to 100% of the fair market value

of the common stock as of the date of grant. Incentive stock options granted to any person who owns, immediately after the grant, stock
possessing more than 10% of the combined voting power of all classes of our stock, or of any parent or subsidiary corporation, must
have an exercise price at least equal to 110% of the fair market value of the common stock on the date of grant. Non-statutory stock
options may have exercise prices as determined by our Compensation Committee.

The Compensation Committee is also authorized to grant restricted stock awards under the Plans. A restricted stock award is a
grant of shares of the common stock that is subject to restrictions on transferability, risk of forfeiture and other restrictions and that may
be forfeited in the event of certain terminations of employment or service prior to the end of a restricted period specified by the
Compensation Committee.

We have filed various registration statements on Form S-8 and amendments to previously filed Form S-8’s with the SEC which
registered a total of 2,425,000 shares issued or to be issued upon exercise of the stock options underlying the various stock option plans

The following table sets forth certain information regarding the stock option plans adopted by the Company as of December

31, 2017:

Number of
Securities
to be Issued
Upon Exercise
of Outstanding
Options,
Warrants, and
Rights
(a)

Weighted-Average
Exercise Price of
Outstanding
Options, Warrants,
and Rights
(b)

Number of
Securities
Remaining
Available for
Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in
Column (a))
(c)

337,769 $
12,500 $

350,269 $

13.41
14.12

13.44

103,612
—

103,612

Plan Category

Equity compensation plans approved by stockholders
Equity compensation plans not approved by stockholders

Total all plans

Recent Sales of Unregistered Securities

On June 30, 2017, the Company borrowed an aggregate of $700,000 under notes (the “June Notes”) with two private, third-
party lenders. The unsecured Notes bore interest of 8% per annum with all principal and accrued interest due on or before their September
30, 2017 maturity date. In connection with the issuance of the June Notes the Company issued the lenders warrants exercisable to
purchase a total of 200,000 shares common stock at an exercise of $3.65 per share and an expiration date of June 29, 2022. On September
30, 2017 the Company negotiated an extension of the maturity date of one of the June Notes to December 31, 2017 and then an extension
to March 31, 2018. In connection with the first extension, the Company issued warrants exercisable to purchase 100,000 shares of
common stock at $2.60 per share until November 15, 2022. The Company retired the second June Note which had a principal balance
of $350,000.

On September 29, 2017, the Company borrowed $300,000 under an unsecured promissory note with a private, third-party
lender. Such note bore interest of 8% per annum with all principal and accrued interest due on or before its November 30, 2017 maturity
date. In connection with the note the Company issued the lender warrants exercisable to purchase a total of 100,000 shares common
stock at an exercise of $2.75 per share and an expiration date of September 30, 2022.

On December 29, 2017 the Company borrowed an additional $350,000 with the same private, third party lender and combined
the existing note issued in September 2017 into a new note (the “Secured Note”) with a principal balance of $658,500 that is due and
payable in full on March 1, 2018 and may be prepaid without penalty. The Secured Note is secured by the Company’s intellectual
property portfolio, as such term is defined in the Secured Note. In connection with issuance of the Secured Note the Company issued
warrants to the lender exercisable to purchase 120,000 shares of common stock for $3.25 per share until December 28, 2022.

The Company relied on the exemption from registration set forth in Section 4(a)(2) of the Securities Act of 1933, as amended
(the “Securities Act”) for issuance of the foregoing warrants exercisable to purchase 520,000 shares of common stock. The Company
did not pay any compensation or fees to any party in connection with the issuance of the foregoing notes or warrants.

Total Number of
Shares Purchased

Average Price Paid per
Share

(d)
Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs
[2]

—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—

Period

August 25 to 31, 2015
September 1 to 30, 2015
October 1 to 31, 2015
November 1 to 30, 2015
December 1 to 31, 2015
January 1 to 31, 2016
February 1 to 29, 2016
March 1 to 31, 2016
April 1 to 30, 2016
May 1 to 31, 2016
June 1 to 30, 2016
July 1 to 31, 2016
August 1 to 31, 2016
September 1 to 30, 2016
October 1 to 31, 2016
November 1 to 30, 2016
December 1 to 31, 2016
January 1 to 31, 2017
February 1 to 29, 2017
March 1 to 31, 2017
April 1 to 30, 2017
May 1 to 31, 2017

[1] On August 25, 2015, the Board of Directors approved the Stock Repurchase Program that authorized the repurchase of up
to $2.5 million of the Company’s common stock in the open market, or in privately negotiated transactions. The Program was
terminated effective May 31, 2017.
[2] The Stock Repurchase Program authorized the repurchase of up to $2.5 million of common stock. The number of shares
yet to be purchased was variable based upon the purchase price of the shares at the point they were acquired.

Item 6. Selected Financial Data.

Not applicable.

Item 7. 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 fiscal 2017 and 2016, and our ability to
pay the Debentures, June Note and Secured Note when due; (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, including whether deliveries will resume under the AMR contract; (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 2018 and have such new products perform as
planned or advertised; (7) whether we will be able to increase the sales, domestically and internationally, for our products, and the degree
to which the interest shown in our products, including the DVM-800 HD, FirstVU HD, VuLink, VuVault.net, FleetVU and MicroVU
HD, in 2018; (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 to their historical levels; (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, DVM-800 HD, FirstVU, First VU 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 the legal actions that the Company is taking or has taken against
Utility Associates, Axon and WatchGuard will achieve their intended objectives; (33) whether the USPTO rulings will curtail, eliminate
or otherwise have an effect on the actions of Axon, WatchGuard and Utility Associates respecting us, our products and customers; (34)
whether the remaining two claims under the ‘556 Patent have applicability to us or our products; and (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;
(36) the USPTO’s decision on WatchGuard’s petition seeking IPR of the ‘292 Patent; (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. We began shipping
our flagship digital video mirror product in March 2006. We have developed additional products to complement our original in-car
digital video products, including the DVM-800 and DVM-800 HD, both in-car digital video mirror products, and body-worn camera
including the FirstVU One and the FirstVU HD products designed for law enforcement usage. In recent years we launched the patented
and revolutionary VuLink product which integrates our body-worn cameras with our in-car systems by providing hands-free automatic
activation; and a commercial line of digital video mirrors (the DVM-250 and DVM-250 Plus) that serve as “event recorders” for the
commercial fleet and mass transit markets in order to expand our customer base beyond the traditional law enforcement agencies. We
have additional research and development projects that we anticipate will result in several new product launches in 2018 and beyond
involving in-car systems for both the law enforcement and commercial markets as well as expanding our cloud-based evidence
management systems. We believe that the launch of these new products will help to reinvigorate our in-car system revenues while
diversifying and broadening the market for our product offerings.

We experienced operating losses for all of the quarters during 2017 and 2016. The following is a summary of our recent

operating results on a quarterly basis:

December
31,2017
$2,877,661
86,295

September
30, 2017
$2,983,577
1,008,613

June
30,2017
$3,486,502
1,173,216

March
31, 2017
$5,229,860
2,276,849

December
31,2016
$3,445,610
148,807

September
30, 2016
$4,339,527
2,033,571

June
30,2016
$4,384,411
1,265,236

March
31, 2016
$4,404,943
1,853,619

For the Three Months Ended:

3.0%

33.8%

33.7%

43.5%

4.3%

46.9%

28.9%

42.1%

3,874,255

4,125,308

3,665,813

4,079,062

4,162,802

5,275,212

4,157,893

4,191,514

(3,787,960)

(3,116,695)

(2,492,597)

(1,802,213)

(4,013,995)

(3,241,641)

(2,892,657)

(2,337,895)

(131.6)%

(104.5)%

(71.5)%

(34.5)%

(116.5)%

(74.7)%

(66.0)%

(53.1)%

$(4,399,673) $(3,493,306) $(2,326,523) $(2,032,955) $(4,276,900) $(3,255,579) $(2,865,084) $(2,313,125)

Total Revenue
Gross Profit
Gross Profit
Margin
Percentage
Total Selling,
General, and
Administrative
Expenses
Operating

Loss

Operating
Margin
Percentage

Net Loss

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 our newer products, such as the FirstVU HD and FleetVU; 3) production,
quality and other supply chain issues affecting our cost of goods sold; 4) unusual increases in operating expenses, such as our
sponsorship of the Digital Ally Open golf tournament, the timing of trade shows and bonus compensation; and 5) litigation and
related expenses respecting outstanding lawsuits. We reported an operating loss of $3,787,960 on revenues of $2,877,661 for
fourth quarter 2017, which continued a series of quarterly losses resulting from competitive pressures, 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, litigation expenses relating to the patent
infringement and the reduction of our gross margins.

The factors and trends affecting our recent performance include:

●

Revenues decreased in fourth quarter 2017 to $2,877,661 compared to previous quarters. The primary reason for the
revenue decreases in 2017 is that our in-car and body-worn systems are nearing the end of their product life cycle and
competitors have released competing products with more features. Further, we incurred product quality issues in 2017
resulting in the significant delays in customer orders. We have current development projects that we believe will
address this issue by developing a new product platform specifically for in-car systems which we plan to have in
production by third quarter 2018, given sufficient resources. This new product platform will utilize advanced chipsets
that will generate new and highly advanced products for our law enforcement and commercial customers. Revenues
in 2017 were pressured by increased pricing competition from a competitor offering a free body-worn camera and
cloud storage for one year. We decided not to match this offer. Additionally, our revenues in the second, third, and
fourth quarters of 2017 were negatively impacted by the halt of deliveries under the AMR contract, which was
expected to generate significant revenues in 2017. Deliveries under the AMR contract were placed on hold after AMR
experienced two catastrophic accidents involving the loss of life in vehicles equipped with our DVM-250’s. AMR
alleged that the DVM-250 units in those vehicles failed to record the accidents. We met with AMR representatives in
the third quarter 2017 to discuss the accidents and the performance of our equipment including a plan to re-start the
contract deliveries. The parties have agreed to a plan to update and upgrade its existing equipment and resume
deliveries under the contract, including the potential roll out to new locations in the first half of 2018. The parties are
now implementing the updates/upgrades of equipment including the installation of asset tracking units (“ATU’s”) that
we anticipate will increase recurring revenue generated under the current contract for 2018 and beyond. We are
hopeful that full-scale deliveries will resume under the contract during first half of 2018, although we can offer no
assurances in this regard.
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 has recognized these pioneering efforts by granting 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 that a trend is developing where the 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 trend 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, WatchGuard 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 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 and have entered into a supply and distribution contract with a competitor (VieVu, LLC) that provides
it with exclusive distribution rights, subject to minimum purchase obligations of $2.5 million during 2018 and $3.0
million in 2019. 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 currently pending with
Axon and WatchGuard, and we can successfully monetize the underlying patents, although we can make no assurances
in this regard.
Service and other revenues increased 16% in the year ended December 31, 2017 from the year ended December 31,
2016. We are concentrating on the expansion of our recurring service revenue in order to help stabilize our revenues
on a quarterly basis. Revenues from extended warranty services increased approximately $322,000 in 2017.
Additionally, cloud storage revenues increased approximately $132,000 for the year ended December 31, 2017
compared to 2016. We are pursuing several new market channels that do not involve our traditional law enforcement
and private security customers. In that regard, we have recently announced our technology partner affiliation with
NASCAR, 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
2018 and beyond. We are testing a new revenue model that involves the long-term lease of our body-worn and/or in-
car hardware, together with a monthly subscription for our cloud storage, search and archiving services for the
underlying audio and video material. The goal of this new service revenue model is to positively impact our revenues
and improve the stability of our quarter-to-quarter revenues and operating results, although we can make no assurances
in this regard. We believe this service revenue model may appeal to our customers, in particular our commercial and
other non-law enforcement customers, because it reduces the initial capital outlay and eliminates repairs and
maintenance in exchange for making level monthly payments for the utilization of the equipment, data storage and
management services.
Our international revenues decreased to $559,822 (4% of total revenues) during the year ended December 31, 2017,
compared to $1,191,012 (7% of total revenues) during the year ended December 31, 2016. Our 2016 revenues were
aided by approximately $760,000 of revenue from the sale of our FirstVU HD body worn cameras, storage systems
and extended service agreement to a non-law enforcement international customer that will continue for three years.
Our 2017 revenues were disappointing after several positive quarters in 2016; 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, the DVM-800
HD 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.

We are a party to operating leases, title sponsorship, and license agreements that represent commitments for future payments
(described in Note 11 to our consolidated financial statements) and we have issued purchase orders in the ordinary course of business
that represent commitments to future payments for goods and services.

For the Years Ended December 31, 2017 and 2016

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 years ended December 31, 2017 and 2016, represented as a percentage of total revenues for each respective year:

Revenue
Cost of Revenue
Gross Profit

Selling, General, and Administrative Expenses:

Research and Development Expense
Selling, Advertising, and Promotional Expense
Stock-based Compensation Expense
General and Administrative Expense

Total Selling, General, and Administrative Expenses

Operating Loss

Change in Warrant Derivative Liabilities
Loss on Extinguishment of Subordinated Notes Payable
Secured Convertible Note Payable Issuance Expenses
Other Income and Interest Expense, Net
Loss Before Income Tax Benefit
Income Tax Expense (Benefit)
Net Loss

Net Loss per Share Information:

Basic

Diluted

Revenues

Years Ended December 31,

2017

2016

100 %
69 %
31 %

22 %
26 %
12 %
48 %
108 %
(77 %)
— %
(3 )%
— %
(5 )%
(85 %)
1 %
(84 %)

$(1.76)
$(1.76)

100 %
68 %
32 %

19 %
25 %
10 %
53 %
107 %
(75 %)
— %
— %
(2 )%
— %
(77 %)
— %
(77 %)

$(2.38)

Our current product offerings include the following:

Product
DVM-
750

DVM-
100

DVM-
400

DVM-
250 Plus

DVM-
800 HD

DVM-
800

Description
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.
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.
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.
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.
An in-car digital audio/video system which records in full 1080P high 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 an 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.
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.

Retail Price
$2,995

$1,895

$2,795

$1,295

$4,795

$3,995

DVM-
800 Lite

FirstVU
HD

VuLink

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.
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.
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.

Various
based on
configuration

$595

$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.

Revenues for the years ended December 31, 2017 and 2016 were derived from the following sources:

DVM-800 and DVM 800HD
FirstVu HD
DVM-250 Plus
DVM-750
DVM-100 & DVM-400
VuLink
DVM-500 Plus
Cloud service revenue
Repair and service
Accessories and other revenues

Years ended December 31,
2016
2017

48 %
11 %
9 %
4 %
2 %
2 %
— %
2 %
8 %
14 %
100 %

41 %
18 %
7 %
6 %
3 %
3 %
1 %
1 %
5 %
15 %
100 %

Our commercial event recorders (DVM-250 Plus) increased from 7% to 9% of total revenues, which trend is expected to

continue because of the appeal of our FleetVU cloud-based driver management and monitoring tool.

Product revenues for the years ended December 31, 2017 and 2016 were $12,773,560 and $15,014,647, respectively, a decrease

of $2,241,087 (15%), due to the following factors:

● Our revenues decreased in the 2017 period compared to 2016 principally because our in-car and body-worn systems are
nearing the end of their product life cycle and competitors have released competing products with more features. We have
current projects whose goal is to address this issue by developing a new product platform specifically for in-car systems
which we expect to be in production by third quarter 2018, given sufficient resources. This new product platform will

utilize advanced chipsets to generate new and highly advanced products for our law enforcement and commercial
customers. 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 and adverse marketplace effects related to the patent
litigation. One of our competitors introduced a body-camera including cloud storage free for one year which disrupted the
market during 2017 and pressured on our revenues. We chose not to match this offer. Finally, our commercial event
recorder revenues were better in the year ended December 31, 2017 compared to 2016, but not nearly as high as expected.
In early 2017 we were awarded the AMR contract for 1,550 DVM-250 systems, as well as FleetVU manager cloud storage
and system implementation, which had a positive impact on revenues. We had expected more substantial increases in our
commercial event recorder revenues given the AMR contract. AMR halted deliveries under the contract after it experienced
two catastrophic accidents involving the loss of life in vehicles equipped with our DVM-250’s. AMR alleged that the
DVM-250 units in those vehicles failed to record the accidents. We met with AMR representatives in the third quarter
2017 to discuss the accidents and the performance of our equipment including a plan to re-start the contract deliveries. The
parties have agreed upon a plan to update and upgrade our existing equipment and resume deliveries under the contract,
including the potential roll out to new locations in the first half of 2018. The parties are now implementing the
updates/upgrades of equipment, including the installation of ATU’S which would increase recurring revenue generated
under the current contract for 2018 and beyond. We are hopeful that full-scale deliveries will resume under the contract
during first half of 2018, although we can offer no assurances in this regard.

● We shipped twelve individual orders in excess of $100,000, for a total of approximately $2,717,000 in revenue for the year
ended December 31, 2017, compared to ten individual orders in excess of $100,000, for a total of approximately $2,821,000
in revenue for the year ended December 31, 2016. Our average order size decreased to approximately $2,650 in the year
ended December 31, 2017 from $2,850 during the year ended December 31, 2016. 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 $559,822 (4% of total revenues) during the year ended December 31, 2017,
compared to $1,191,012 (7% of total revenues) during the year ended December 31, 2016. Our 2016 revenues were aided
by approximately $760,000 of revenue generated by an order from a non-law enforcement international customer for our
FirstVU HD body worn cameras, storage systems and extended service agreement. Our 2017 revenues were disappointing
after several positive quarters in 2016; 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 new products, in particular the
FleetVU cloud-based driver management and monitoring tool, the DVM-800 HD and the FirstVU HD internationally.

Service and other revenues for the years ended December 31, 2017 and 2016 were $1,804,040 and $1,559,844, respectively,

an increase of $244,196 (16%), due to the following factors:

● Cloud revenues were $279,129 and $147,277 for the years ended December 31, 2017 and 2016, respectively, an increase
of $131,852 (90%). We have experienced increased interest in our cloud solutions for law enforcement and an increasing
number of our commercial customers have implemented our FleetVU cloud-based driver management/monitoring tool and
asset tracking solutions, which contributed to our increased cloud revenues in 2017.

●

● Revenues from extended warranty services were $870,282 and $542,438 for the years ended December 31, 2017 and 2016,
respectively, an increase of $327,844 (60%). We have many customers that have purchased extended warranty packages,
primarily in our DVM-800 premium service program.
Installation service revenues were $187,517 and $196,810 for the years ended December 31, 2017 and 2016, respectively,
a decrease of $9,293 (5%). Installation revenues tend to vary more than other service revenue types and are dependent on
larger customer implementations. In June 2017, AMR’s installation roll out was put on hold, which significantly reduced
third and fourth quarter 2017 installation revenues. By contrast, in third quarter 2016 we had a non-law enforcement
international customer complete a large installation. The decrease in 2017 was partially due to AMR halting its roll out of
deliveries and installations to additional locations in June 2017 as noted above.

● Software revenue, non-warranty repair and other revenues were $467,112 and $673,319 for the years ended December 31,
2017 and 2016, respectively, a decrease of $206,207 (31%). The decrease in 2017 was due to software revenue and non-
warranty repair revenues being less than 2016 levels. Software revenues were $224,215 in 2017 compared to $321,171 in
2016. Non-warranty repairs were $172,558 in 2017 compared to $296,191 in 2016.

Total revenues for the years ended December 31, 2017 and 2016 were $14,577,600 and $16,574,491, respectively, a decrease

of $1,996,891 (12%), due to the reasons noted above.

Cost of Revenue

Cost of product revenue on units sold for the years ended December 31, 2017 and 2016 was $8,771,474 and $10,461,064,

respectively, a decrease of $1,689,590 (16%). The decrease in product cost of goods sold is commensurate with the 15% decrease in

product revenues coupled with product cost of sales as a percentage of revenues decreasing to 69% in 2017 from 70% in 2016. We
increased the reserve for obsolete and excess inventories by approximately $991,000 during the year ended December 31, 2017 due to
increased levels of excess component parts of older versions of PCB boards, used trade-in inventory requiring refurbishment and the
phase-out of our DVM-750 and LaserAlly legacy products.

Cost of service and other revenue for the years ended December 31, 2017 and 2016 was $1,261,153 and $812,194, respectively,
an increase of $448,959 (55%). The increase in service and other cost of goods sold is commensurate with the 14% increase in service
and other revenues coupled with service cost of sales increasing to 70% from 52% for the year ended December 31, 2017 compared to
December 31, 2016. The primary reason for the increase was the growth in the use of certain technical support personnel to generate
direct installation and other service revenues in the year ended December 31, 2017 compared to December 31, 2016. A larger number
of our commercial and law enforcement customers have engaged us to install our equipment, such as our contract with AMR. Installation
services typically generate lower margins than our cloud storage and FleetVU cloud-based driver management and monitoring tool.
This trend has served to increase the cost of service revenue in 2017 compared to 2016.

Total cost of sales as a percentage of revenues increased to 69% during year ended December 31, 2017 compared to 68% for the
year ended December 31, 2016. We believe our gross margins will increase if we improve revenue levels and reduce product warranty
issues.

We recorded $2,990,702 and $1,999,920 in reserves for obsolete and excess inventories at December 31, 2017 and December
31, 2016, respectively. Total raw materials and component parts were $4,621,704 and $4,015,170 at December 31, 2017 and December
31, 2016, respectively, an increase of $606,534 (15%). The increase in raw materials was mostly in refurbished parts for our FirstVU
HD product. Finished goods balances were $6,964,624 and $7,215,346 at December 31, 2017 and December 31, 2016, respectively, a
decrease of $250,722 (3%). The increase in the inventory reserve is primarily due to the change in sales mix of our products, which has
resulted in a higher level of excess component parts of the older versions of our PCB boards and the phase out of our DVM-750 and
LaserAlly legacy products. Additionally, we increased our reserves on selected refurbished and items requiring repair during the year
ended December 31, 2017. We believe the reserves are appropriate given our inventory levels at December 31, 2017.

Gross Profit

Gross profit for the years ended December 31, 2017 and 2016 was $4,544,973 and $5,301,233, respectively, a decrease of
$756,260 (14%). The decrease is commensurate with the 12% decline in revenues for the year ended December 31, 2017 and the cost
of sales as a percentage of revenues increasing to 69% during the year ended December 31, 2017 from 68% for the year ended December
31, 2016. We believe that gross margins will improve during 2018 and beyond if we improve revenue levels and reduce product warranty
issues. Our goal is to improve our margins to 60% over the longer term based on the expected margins of our DVM-800, DVM-800
HD, VuLink and FirstVU HD, if they gain traction in the marketplace and we are able to increase our commercial market penetration
in 2018. 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 on 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 $15,744,438 and $17,787,421 for the years ended December 31, 2017 and
2016, respectively, a decrease of $2,042,983 (11%). Selling, general, and administrative expenses as a percentage of sales increased to
108% in 2017 from 107% in 2016.

The significant components of selling, general, and administrative expenses are as follows:

Research and Development Expenses
Selling, Advertising, and Promotional Expenses
Stock-based Compensation Expenses
Professional Fees and Expenses
Executive, Sales, and Administrative Staff Payroll
Other

Total

Year ended December 31,
2016
2017

3,149,011 $
3,873,091 $
1,752,579 $
1,526,448 $
2,698,702 $
2,744,607 $
15,744,438 $

3,186,137
4,238,895
1,592,365
1,930,625
4,115,816
2,723,583
17,787,421

$
$
$
$
$
$
$

Research and development expenses. We continue to focus on bringing new products to market, including updates and
improvements to current products. Our research and development expenses totaled $3,149,011 and $3,186,137 for the years ended
December 31, 2017 and 2016, respectively, an increase of $37,126 (1%). We employed a total of 24 engineers at December 31, 2017
compared to 32 engineers at December 31, 2016, most of whom are dedicated to research and development activities for new products.
In prior years we had increased our engineering staff of web-based developers as we expanded our offerings to include, among other
items, cloud-based evidence storage and management for our law enforcement customers (VuVault.net) and our web-based commercial
fleet driver monitoring and management tool (FleetVU Manager). Research and development expenses as a percentage of total revenues
were 22% for the year ended December 31, 2017 compared to 19% for the year ended December 31, 2016. Although we reduced our
engineering headcount in early 2018, we still 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 $3,873,091 and
$4,238,895 for the years ended December 31, 2017 and 2016, respectively, a decrease of $365,804 (9%). The decrease was primarily
attributable to the 15% decline in revenues in 2017 compared to 2016 and the reduction in promotional and advertising expenses.
Salesman salaries and commissions represent the primary components of these costs and were $3,111,435 and $3,091,676 for the years
ended December 31, 2017 and 2016, respectively, an increase of $19,759 (1%). We increased the number of salesman in 2017 compared
to 2016, in our commercial sales channel recognizing the increased commercial market opportunities while reducing the number of
salesman in our law enforcement channel. The effective commission rate was 21.3% for the year ended December 31, 2017 compared
to 18.6% for the year ended December 31, 2016.

Promotional and advertising expenses totaled $761,656 during the year ended December 31, 2017 compared to $1,147,219
during the year ended December 31, 2016, a decrease of $385,563 (34%). The decrease is primarily attributable to net promotional
expenses associated with being the title sponsor of the Web.com Tour golf tournament held annually in the Kansas City Metropolitan
area being less in 2017 compared to 2016. We incurred net promotional expenses of $266,280 in the twelve months ended December
310, 2017 relative to this sponsorship compared to $499,313 for twelve months ended December 31, 2016. The Company also decreased
the number of trade shows it attended during 2017 as management questioned the efficiency and effectiveness of many of the lesser
attended trade shows and eliminated them from the schedule.

Stock-based compensation expenses. Stock based compensation expenses totaled $1,752,579 and $1,592,365 for the years
ended December 31, 2017 and 2016, respectively, an increase of $160,214 (10%). In 2017, we granted 100,000 stock options and
522,000 shares of restricted stock to employees, officers and directors compared to 40,000 stock options and 290,000 shares of restricted
stock granted during 2016. We relied more on stock-based compensation during 2017 resulting in increased stock-based compensation
compared to 2016 as we attempted to reduce cash expenses for liquidity reasons.

Professional fees and expenses. Professional fees and expenses totaled $1,526,448 and $1,930,625 for the years ended
December 31, 2017 and 2016, respectively, a decrease of $404,177 (21%). The decrease in professional fees and expenses in 2017
compared to 2016 is primarily attributable to lower litigation expenses related to the conclusion of the Utility lawsuit and the ongoing
Axon and WatchGuard lawsuits. The Axon and WatchGuard matters continue and the reduced litigation charges in 2017 are principally
due to both the Axon and WatchGuard lawsuits being under a stay order pending final USPTO rulings on the various IPR requests,
which have largely now been ruled in our favor. The Axon case stay has been lifted and is now proceeding towards trial while the stay
on the WatchGuard litigation is expected to be lifted in June or July 2018. The legal fees related to both the Axon and WatchGuard
litigation are expected to ramp up during 2018 as we anticipate both cases will proceed to trial. We intend to pursue recovery from
Axon, WatchGuard, their insurers and other responsible parties as appropriate.

Executive, sales, and administrative staff payroll. Executive, sales, and administrative staff payroll expenses totaled
$2,698,702 and $4,115,816 for the years ended December 31, 2017 and 2016, respectively, a decrease of $1,417,114 (34%). The primary
reason for the decrease in executive, sales, and administrative staff payroll was a reduction of $855,000 in executive bonuses and the
redirection of certain technical support personnel to generate direct installation and other service revenues in the year ended December
31, 2017 compared to December 31, 2016. We had increased our technical support staff in 2017 to handle field inquiries and requests
for product installation services because our installed customer base had expanded and additional technical support and marketing was
required for our newer products, such as the DVM-800 and FirstVU HD. In 2017, we reassigned certain members of our technical
support staff to direct services for product installation and other services for our customers and we are charging their respective payroll
related expenses to service cost of sales in 2017 compared to 2016. The AMR contract includes installation services, which was one of
several larger contracts that required technical support personnel to complete installation services in 2017. In addition, during 2016 a
special bonus of $630,000 was awarded to our CEO, which did not occur in 2017.

Other. Other selling, general, and administrative expenses totaled $2,744,607 and $2,723,583 for the years ended December

31, 2017 and 2016, respectively, an increase of $21,024 (1%). The increase in other expenses in 2017 compared to 2016 is primarily

attributable to increased health insurance premiums for our associates.

Operating Loss

For the reasons previously stated, our operating loss was $11,199,465 and $12,486,188 for the years ended December 31, 2017
and 2016, respectively, an improvement of $1,286,723 (10%). Operating loss as a percentage of revenues increased to 77% in 2017
from 75% in 2016.

Interest Income

Interest income decreased to $11,818 for the year ended December 31, 2017 from $26,195 in 2016 which reflected our overall

lower cash and cash equivalent levels in 2017 compared to 2016.

Interest Expenses

We incurred interest expense of $733,736 and $3,102 during the years ended December 31, 2017 and 2016, respectively. We
issued an aggregate of $4.0 million principal amount of Debentures on December 30, 2016, which bore interest at the rate of 8% per
annum on the unpaid balance outstanding at December 31, 2017. In addition, we issued two Notes with a principal balance of $700,000
in June 2017. One of these Notes and the Secured Note had an outstanding principal balance of $1,008,500 at December 31, 2017. No
similar interest-bearing debt was outstanding during the year ended December 31, 2016.

We amortized to interest expense $405,895 and $-0-, representing the discount associated with the issuance of $1,358,500 of
the Notes and the Secured Note during the years ended December 31, 2017 and December 31, 2016, respectively. The discount resulted
from the issuance of detachable common stock purchase warrants together with the $1,358,500 principal amount of Notes and the
Secured Note, which was recorded as a discount and amortized to interest expense over the term of the underlying Notes and Secured
Note. The total remaining unamortized discount was $-0- at December 31, 2017, and 2016.

Change in Fair value of Warrant Derivative Liabilities

Detachable warrants exercisable to purchase a total of 398,916 common shares, 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 is adjusted to the estimated fair value of any unexercised warrants as of December 31, 2016 and 2017. There
remained warrants outstanding exercisable to purchase 12,200 shares of common stock at December 31, 2016 and 2017 and the warrant
derivative liability balance was $16,816 and $33,076 at December 31, 2017 and 2016, respectively

The changes in the fair value of the warrant derivatives related to unexercised warrants resulted in a gain of $16,260 and

$33,977 for the years ended December 31, 2017 and 2016, respectively.

Change in Fair Value of Secured Convertible Debentures Payable

We elected to account for the $4.0 million principal amount of Debentures outstanding at December 31, 2017 and 2016 on their
fair value basis. Therefore, we determined the fair value of the Debentures utilizing Monte Carlo simulation models which yielded an
estimated fair value of $3,262,807 and $4,000,000 for the Debentures including their embedded derivatives as of December 31, 2017
and 2016, respectively. No value was allocated to the detachable Warrants as of the origination date because of the relative fair value of
the Debentures including its embedded derivative features approximated the gross proceeds of the financing transaction. We made
principal payments totaling $750,000 reducing the outstanding amount of Debentures on August 24, 2017. The fair value of the
Debentures was $3,262,807 at December 31, 2017 representing a change in fair value of $(12,807) from December 31, 2016, which was
recognized as a charge in the Consolidated Statement of Operations.

Secured Convertible Notes Issuance Expenses

We elected to account for and record our $4.0 million Secured Convertible Note issued during December 2016 on a fair value
basis. Accordingly, we were required to expense the related issuance costs to other expense in the consolidated statements of operations.
Such costs totaled $281,570 for the year ended December 31, 2016. The issuance costs included a $200,000 placement agent fee and
the remainder was primarily legal fees. No similar debt issuances occurred in 2017.

Loss on Extinguishment of Subordinated Notes Payable

On June 30, 2017, the Company, in two separate transactions, borrowed an aggregate of $700,000 under two unsecured notes
payable to private, third-party lenders. The loans were funded on June 30, 2017 and both were represented by promissory notes (the
“June Notes”) that bore interest at the rate of 8% per annum with principal and accrued interest payable on or before their maturity date
of September 30, 2017. The June Notes were unsecured and subordinated to all existing and future senior indebtedness, as such term is
defined in the June Notes. On September 30, 2017, the Company obtained an extension of the maturity date of one of the June Notes to
December 31, 2017 and then a further extension to March 31, 2017. In connection with the first extension, the Company issued warrants
to purchase 100,000 shares of common stock at $2.60 per share until November 15, 2022. The Company treated the extension of this
debt as an extinguishment for financial accounting purposes. Accordingly, the estimated fair value of the warrants granted totaled
$180,148, which was recorded as additional paid-in-capital and a loss on extinguishment of subordinated notes payable. The Company
paid the second June Note in full in August 2017.

On September 29, 2017, the Company borrowed $300,000 under an unsecured note payable with a private, third party lender.

The loan was represented by a promissory note that bore interest at 8% per annum and was due and payable in full on November 30,
2017 and could be prepaid without penalty. Such note was unsecured and subordinated to all existing and future senior indebtedness,
as such term was defined in the note. On December 29, 2017 the Company borrowed an additional $350,000 from the same private,
third party lender and combined the existing note issued in September 2017 into a Secured Note with a principal balance of $658,500
that is due and payable in full on March 1, 2018 and may be prepaid without penalty. The Secured Note is secured by the Company’s
intellectual property portfolio, as such term is defined in the related security agreement. In connection with issuance of the Secured
Note the Company issued warrants to the lender exercisable to purchase 120,000 shares of common stock for $3.25 per share until
December 28, 2022. The Company treated the issuance and extension of this debt as an extinguishment for financial accounting
purposes. Accordingly, the estimated fair value of the warrants granted totaled $244,379, which was recorded as additional paid-in-
capital and a loss on extinguishment of subordinated notes payable.

The loss on extinguishment of subordinated notes payable aggregated $424,527 for the year ended December 31, 2017. There

were no similar extinguishment of subordinated notes payable in 2016.

Loss before Income Tax Benefit

As a result of the above, we reported a loss before income tax benefit of $12,342,457 and $12,710,688 for the years ended

December 31, 2017 and 2016, respectively, an improvement of $368,231 (3%).

Income Tax Benefit

The new tax act eliminates the alternative minimum tax (AMT) for corporations and allows any remaining AMT carryforward
to become refundable in 2018 and beyond tax returns. As a result, we did not provide a valuation reserve on the deferred tax asset
represented by the AMT tax credit carryforward as of December 31, 2017. Accordingly, we recorded an income tax benefit of $90,000
at December 31, 2017 representing the AMT credit carryforwards that are now refundable under the new tax act.

We did not record an income tax benefit related to our losses for the years ended December 31, 2016, due to our overall net
operating loss carryforward available. We have further determined to continue providing a full valuation reserve on our net deferred tax
assets as of December 31, 2017 exclusive of AMT tax credit carryforward. During 2017, we reduced our valuation reserve on deferred
tax assets by $4,385,000 whereby our deferred tax assets continue to be fully reserved due to our recent operating losses.

We had approximately $49,305,000 of net operating loss carryforwards and $1,795,000 of research and development tax credit

carryforwards as of December 31, 2017 available to offset future net taxable income.

Net Loss

As a result of the above, we reported net losses of $12,252,457 and $12,710,688 for the years ended December 31, 2017 and

2016, respectively, an improvement of $458,231 (4%).

Basic and Diluted Loss per Share

The basic and diluted loss per share was $1.76 and $2.38 for the years ended December 31, 2017 and 2016, respectively, for the
reasons previously noted. All outstanding stock options and common stock purchase warrants were considered antidilutive and therefore
excluded from the calculation of diluted loss per share for the years ended December 31, 2017 and 2016 because of the net loss reported
for each period.

Liquidity and Capital Resources

Overall:

The Company’s Board of Directors has initiated a review 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 and WatchGuard,
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 the strategic review may also include the continued implementation of the Company’s business plan with
additional debt or equity financing. The Company retained Roth Capital Partners (“Roth”) to assist in this review and process. Thus, the
Company is considering alternatives to address its near-term and long-term liquidity and operational issues. There can be no assurance
that a transaction or financing will result from this process. As part of this overall strategic alternatives process, the Board of Directors
approved a private placement that closed on April 3, 2018 and is described below in “Subsequent Developments.” Management believes
this financing has addressed the Company’s near-term liquidity needs which primarily included the repayment of principal and interest
on the Debentures, June Note and Secured Note.

Subsequent Developments:

On April 3, 2018, the Company completed a private placement (the “Private Placement”) to institutional investors of $6.05 million
in principal amount of Senior Secured Convertible Promissory Notes (the “Notes”) and warrants exercisable to purchase 806,667 shares
of common stock (the “Warrants). The Notes and Warrants were issued pursuant to a Securities Purchase Agreement (the “SPA”)
between the Company and the investors (the “Holders”). The Private Placement resulted in gross proceeds of $5.5 million before
placement agent fees and other expenses associated with the transaction. A portion of the proceeds were used to repay in full the
Debentures issued in December 2016 and the approximately $1,008,500 principal amount and accrued interest on the June Note and
Secured Note. The balance of the net proceeds will be used for working capital and general corporate purposes. Roth Capital Partners
acted as placement agent for the Company and received a placement fee of approximately $250,000.

Prior to the maturity date, the Notes bear interest at 8% per annum, which twelve (12) months’ interest amount shall be guaranteed;
provided, however, that in the event that a cash prepayment or amortization is made pursuant to the Notes, the Company shall only be
required to pay an amount equal to the annualized additional interest due on the then outstanding principal balance of the Notes. Interest
shall be paid at the Company’s discretion in cash, or subject to the equity conditions contained in the Notes, in shares of the Company’s
common stock. The Notes rank senior to the Company’s existing and future indebtedness of the Company and are secured by all assets
and intellectual property to the extent and as provided in the underlying security and related documents.

The Notes are convertible at any time after their date of issue at the option of the Holders into shares of common stock at $2.50
per share (the “Conversion Price”). The Notes mature on May 3, 2019 (the “Maturity Date”). Commencing on July 1, 2018, and
continuing for each fiscal month thereafter through the Maturity Date, the Company will make payments of principal and interest to the
Holders to fully amortize the Notes. The Conversion Price is subject to adjustment upon stock splits, reverse stock splits, and similar
capital changes.

At any time after issuance of the Notes, so long as there is no event of default under the Notes, the Company may deliver to the
Holders a notice of prepayment with respect to any portion of the principal amount of the Notes, any accrued and unpaid interest
(including, without limitation, guaranteed interest on any outstanding principal) and any other amounts due under the Notes. If the
Company exercises its right to prepay the Notes, the Company will pay to the Holders an amount in cash equal to the sum of the then
outstanding principal amount of the Notes and guaranteed interest as follows: (i) from the initial issuance date of the Notes to August 1,
2018, a 0% premium; (ii) from August 2, 2018 to December 1, 2018, a 110% premium; and (iii) from December 2, 2018 to the Maturity
Date, a 115% premium.

At any time after issuance of the Notes, in the event that the Company (i) consummates any public or private offering or other
financing or capital-raising transaction of any kind (each a “Subsequent Offering”), in which the Company receives, in one or more
contemporaneous transactions, gross proceeds of $10,000,000, (ii) receives cash, in the aggregate, of at least $10,000,000 from any
Action (as defined in the SPA), at any time upon ten (10) days written notice to the Holders, but subject to the Holders’ conversion
rights set forth herein, the Company must make a mandatory redemption in full of the Notes to the Holders. The required redemption of
the Notes would be at an amount equal to the outstanding principal amount of the Notes, any accrued and unpaid interest (including,
without limitation, guaranteed interest), and any other amounts due under the Notes at the same premium described above with respect
to prepayments.

The Notes also provide for mandatory conversion by the Holders in the event that at any time (x) the VWAP (volume weighted
average price as defined in the Notes) of the common stock listed on the trading market (as defined in the SPA) exceeds $4.50 (as
adjusted for stock splits, stock dividends, stock combinations, recapitalizations and similar events) for twenty (20) consecutive trading

days, and (y) no failure of the equity conditions (as defined in the Notes) then exists, the Company shall have the right to require the
Holders to convert all, or any part, of the conversion amount (as defined in the Notes) of the Notes (but in no event less than the lesser
of (I) two (2) times the daily average trading volume for the prior (20) consecutive trading date (as defined in the notes), and (II) all of
the conversion amount then remaining under the Notes), as designated in the mandatory conversion notice (as defined in the Notes) into
fully paid, validly issued and nonassessable shares of common stock in accordance with Notes at the conversion price as of the mandatory
conversion date (as defined in the Notes).

So long as the Notes are outstanding, the Company is prohibited from entering into any variable rate transactions (as defined

in the Notes).

Upon the occurrence of an event of default under the Notes, the Company must repay to the Holders, in cash or in shares of
common stock at the greater of (i) a 135% premium of the outstanding principal amount of the Notes and accrued and unpaid interest
hereon, in addition to the payment of all other amounts, costs, expenses and liquidated damages due in respect of the Notes; and (ii) the
outstanding principal amount of the Notes and accrued and unpaid interest hereon, in addition to the payment of all other amounts, costs,
expenses and liquidated damages due in respect of the Notes, divided by the conversion price, multiplied by (b) the highest closing price
for the common stock on the trading Market (as defined in the SPA) during the period beginning on the date of first occurrence of the
event of fault and ending one (1) day prior to the mandatory prepayment date in the prepayment section of the Notes.

The Warrants issued in conjunction with the Notes are exercisable to purchase up to 806,667 shares of common stock
commencing on the date of issuance at an exercise price of $3.00 per share (the “Exercise Price”). The Warrants will expire on the fifth
(5th) anniversary of their date of issuance. The exercise price is subject to adjustment upon stock splits, reverse stock splits, and similar
capital changes. The Warrants provide for cashless exercise in the event that after 180-days after their issuance a registration statement
on Form S-1 (or other applicable registration statement under the Securities Act of 1933, as amended (the “Securities Act”)) covering
the resale of all shares of common stock underlying the Warrants is not available for the issuance of such shares of common stock. A
Holder has no right to convert the Note or exercise the Warrant to the extent that such conversion or exercise would result in the Holder
being the beneficial owner in excess of 4.99% (or, upon election of purchaser, 9.99%), which beneficial ownership limitation may be
increased or decreased up to 9.99% upon notice to the Company, provided that any increase in such limitation will not be effective until
61 days following notice to the Company.

Pursuant to the SPA, the Company must within forty-five (45) days of the closing date file with the U.S. Securities and
Exchange Commission a registration statement on Form S-1 (or other applicable registration statement under the Securities Act)
covering the resale of all shares of common stock issuable upon conversion or exercise of the Notes and Warrants, respectively.

Discussion of Liquidity and Capital Resources:

On June 30, 2017, we borrowed an aggregate of $700,000 under notes (the “June Notes”) with two private, third-party lenders.
The unsecured Notes bore interest of 8% per annum with all principal and accrued interest due on or before their September 30, 2017
maturity date. In connection with the issuance of the June Notes we issued the lenders warrants exercisable to purchase a total of 200,000
shares of common stock at an exercise of $3.65 per share and an expiration date of June 29, 2022. On September 30, 2017 we negotiated
an extension of the maturity date of one of the June Notes to December 31, 2017 and then an extension to March 31, 2018. In connection
with the first extension, we issued warrants exercisable to purchase 100,000 shares of common stock at $2.60 per share until November
15, 2022. We retired the second June Note that had a principal balance of $350,000 in August 2017.

On September 29, 2017, we borrowed $300,000 under an unsecured promissory note with a private, third-party lender. Such
note bore interest of 8% per annum with all principal and accrued interest due on or before its November 30, 2017 maturity date. In
connection with the note we issued the lender warrants exercisable to purchase a total of 100,000 shares common stock at an exercise
of $2.75 per share and an expiration date of September 30, 2022.

On December 29, 2017, we borrowed an additional $350,000 with the same private, third party lender and combined the existing
note issued in September 2017 into a new note (the “Secured Note”) with a principal balance of $658,500 that is due and payable in full
on March 1, 2018 and may be prepaid without penalty. The Secured Note is secured by our intellectual property portfolio, as such term
is defined in the Secured Note. In connection with issuance of the Secured Note we issued warrants to the lender exercisable to purchase
120,000 shares of common stock for $3.25 per share until December 28, 2022. We used the proceeds of the foregoing note transactions
for general working capital purposes.

On August 23, 2017, we closed a $3.0 million offering of our common stock and common stock purchase warrants in a
registered direct offering. At the closing, we sold to institutional investors in a registered direct offering an aggregate of 940,000 shares
of our common stock at a price of $3.00 per share and Series B Warrants, for gross offering proceeds of $3.0 million. For each share of
common stock purchased, investors received two registered warrants, each with an exercise price of $3.36 per share (the “Series A-1
Warrant” and the “Series A-2 Warrant”). The Series A-1 Warrants are exercisable to purchase up to 680,000 shares of common stock

and have a term of five years commencing six months following the closing date. The Series A-2 warrants are immediately exercisable
to purchase a 200,000 shares of common stock and have a term of five years commencing on the closing date. Additionally, the Company
issued to certain of the investors, in lieu of shares of common stock at closing, Series B Warrants that are immediately exercisable (the
“Series B Warrant”) to purchase 60,000 shares of common stock for which the investors paid $2.99 per share at the closing and will pay
$0.01 per share upon exercise of the Series B Warrant so that such investors’ beneficial ownership interest would not exceed 9.9% of
the issued and outstanding shares of common stock. The Series B Warrants terminate upon exercise in full. After placement agent fees
and other estimated offering expenses, the net offering proceeds to us totaled approximately $2.8 million. The foregoing warrants issued
in this transaction did not contain terms that would require us to record derivative warrant liabilities that could affect our financial
statements. Proceeds of the offering were used to pay a portion of the outstanding principal balance of the Debentures, retire one of the
June Notes and for other working capital purposes.

On December 30, 2016, we completed a private placement of $4.0 million principal amount of Debentures with two institutional
investors. Such Debentures bear interest at 8% per annum payable in cash on a quarterly basis and are secured by substantially all of our
tangible and certain intangible assets. In addition, we issued the investors warrants to acquire 800,000 shares of common stock at $5.00
per share. We made payments of $750,000 against the Debentures on August 24, 2017. The Debentures mature on March 30, 2018 and
are convertible at any time six months after their date of issue at the option of the holders into shares of common stock at $5.00 per
share. In addition, we can elect to redeem the Debentures at 112% of their outstanding principal balance and could force conversion by
the holders if the market price exceeds $7.50 per share for ten consecutive trading days. We used the proceeds of this private placement
for general working capital purposes.

As discussed in “Subsequent Developments” above, we retired the maturing Debentures, June Note and Secured Note with part
of the cash proceeds of the Private Placement of Notes that closed on April 3, 2018. This recent development is a part of the strategic
alternatives initiative discussed above and addressed our near-term liquidity needs.

If we must further supplement our liquidity to support our operations in 2018, 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 2018 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 specifically the recent Private Placement, and if necessary, we believe that we could raise
additional capital during the next 12 months if required, but can offer no assurances in this regard. In addition, in early 2018 we cut our
operating overhead significantly by a reduction in work force and other cost saving measures.

Further, we had warrants outstanding exercisable to purchase 3,233,466 shares of common stock at a weighted average exercise
price $6.57 per share outstanding as of December 31, 2017. In addition, there are common stock purchase options outstanding exercisable
to purchase 250,269 shares at an average price of $18.80 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 2018, 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 of the financial statements in this Report.

We had $554,712 of available cash and equivalents (including $500,000 of restricted cash) and net working capital of
approximately $1.7 million as of December 31, 2017. Net working capital as of December 31, 2017 included approximately $2.0 million
of accounts receivable and $8.8 million of inventory.

Cash and cash equivalents balances: As of December 31, 2017, we had cash and cash equivalents with an aggregate
unrestricted balance of $54,712, a decrease from a balance of $3,883,124 at December 31, 2016. Summarized immediately below and
discussed in more detail in the subsequent subsections are the main elements of the $3,828,412 net decrease in cash during the year
ended December 31, 2017:

● Operating activities: $6,354,853 of net cash used in operating activities. Net cash used in operating activities was
$6,354,853 and $5,902,901 for the years ended December 31, 2017 and 2016, respectively, a
deterioration of $451,952. The deterioration was primarily the result of our net loss and decreases
in accrued expenses, offset by increases in deferred revenue and accounts payable and decreases in
accounts receivable. Our goal is to increase revenues, return to profitability and decrease our
inventory levels during 2018, thereby providing positive cash flows from operations, although there
can be no assurances that we will be successful in this regard.

●

Investing activities: $476,199 of net cash used in investing activities. Cash used in investing activities was $476,199
and $940,711 for the years ended December 31, 2017 and 2016, respectively. In 2017 and 2016,
we incurred costs for an integrated display system, demo equipment, tooling of new products and
for patent applications on our proprietary technology utilized in our new products and included in
intangible assets. In connection with the $4.0 million 8% Secured Convertible Debentures issued
in December 2016, we are required to maintain a minimum cash balance of not less than $0.5
million as long as they remain outstanding.

● Financing activities: $3,002,640 of net cash provided by financing activities. Cash provided by financing activities was
$3,002,640 and $3,802,657 for the years ended December 31, 2017 and 2016, respectively. On
August 23, 2017, we closed a $3.0 million offering of our common stock and common stock
purchase warrants. After placement fees and other estimated offering expenses, the net offering
proceeds to us totaled approximately $2.8 million prior to any exercise of the warrants. Proceeds
of the offering were used to pay down a portion of the principal balance of the Debentures and one
of the June Notes and for general working capital purposes. We received $1,608,500 of proceeds
in 2017 from the issuance of the June Notes and Secured Note. On December 30, 2016 we issued
the $4.0 million 8% Secured Convertible Debentures, the proceeds of which were used for general
working capital purposes. We received $119,055 of proceeds in the year ended December 31, 2016
from the exercise of common stock warrants and options. During 2015 we acquired capital
equipment financed through capital lease obligations and payments on such obligations represented
the cash used in financing activities.

The net result of these activities was a decrease in unrestricted cash of $3,828,412 to $54,712 for the year ended December 31,

2017.

Commitments:

We had $54,712 of cash and cash equivalent balances and net positive working capital approximating $1.7 million as of
December 31, 2017. Accounts receivable balances represented $1,978,836 of our net working capital at December 31, 2017. We intend
to collect our outstanding receivables on a timely basis and reduce the overall level during 2018, which would help to provide positive
cash flow to support our operations during 2018. Inventory represented $8,750,713 of our net working capital at December 31, 2017
and finished goods represented $6,964,624 of total inventory. We are actively managing the level of inventory and our goal is to reduce
such level during 2018 by our sales activities, which should provide additional cash flow to help support our operations during 2018.

Capital Expenditures. We had no material commitments for capital expenditures at December 31, 2017.

Lease commitments-Operating Leases. We have a long-term operating lease agreement for office and warehouse space that
expires in April 2020. We have also entered into month-to-month leases for equipment and facilities. Rent expense for the years ended
December 31, 2017 and 2016 was $397,924 and $397,924, respectively, related to these leases. Following are our minimum lease
payments for each year and in total.

Year ending December 31:

2018
2019
2020

$
$
$
$

451,248
457,327
154,131
1,062,706

License agreements. We have several license agreements under which we have been assigned the rights to certain licensed
materials used in our products. Certain of these agreements require us to pay ongoing royalties based on the number of products shipped
containing the licensed material on a quarterly basis. Royalty expense related to these agreements aggregated $21,188 and $25,161 for
the years ended December 31, 2017 and 2016, respectively.

Litigation.

Axon

The Company owns 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 December 2016 and January 2017, Axon filed two petitions for Inter Parts Review (“IPR”) against the ‘452 Patent. The
USPTO rejected both of Axon’s petitions. Axon is now statutorily precluded from filing any more IPR petitions against the ‘452 Patent.

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.

The USPTO has granted multiple patents to the Company with claims covering numerous features, such as automatically
activating all deployed cameras in response to the activation of just one camera. Additionally, Digital Ally’s patent claims cover
automatic coordination as well as digital synchronization between multiple recording devices. The Company also has patent coverage
directed to the coordination between a multi-camera system and an officer’s smartphone, which allows an officer to more readily assess
an event on the scene while an event is taking place or immediately after it has occurred.

The Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car
product lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the ‘292 and ‘452
Patents and U.S. Patent No. 9,325,950 the (“ ‘950 Patent”). The Company is aggressively challenging WatchGuard’s infringing conduct,
seeking both monetary damages, as well as seeking a permanent injunction preventing WatchGuard from continuing to sell its VISTA
Wifi and 4RE In-Car product lines using Digital Ally’s technology to compete against it. On May 8, 2017, WatchGuard filed a petition
seeking IPR of the ‘950 Patent. The Company will vigorously oppose that petition. On December 4, 2017 The Patent Trial and Appeal
Board (“PTAB”) rejected the request of WatchGuard Video to institute an inter partes review (“IPR”) on the ‘950 Patent. The lawsuit
also involves the ‘292 Patent and the ‘452 Patent, the same two patents asserted against Axon. The ‘292 Patent is in the IPR process
with the USPTO, while WatchGuard is now statutorily barred from any further IPR’s challenges with respect to the ‘950 Patent. The
lawsuit has been stayed pending a decision from the USPTO on the ‘292 Patent IPR petition which is expected in June 2018.

Utility Associates, Inc.

prospective purchasers of its mobile video surveillance systems threatening that the use of such systems purchased from third parties
not licensed to the ‘556 Patent would create liability for them for patent infringement.

On June 6, 2014 the Company filed a separate Unfair Competition lawsuit against Utility in the United States District Court
for the District of Kansas. In that lawsuit it contended that Utility has disparaged the Company and illegally interfered with its contracts,
customer relationships and business expectancies by falsely asserting to its customers and others that its products violate the ‘556 Patent,
of which Utility claims to be the holder. In addition to damages, the Company sought permanent injunctive relief, prohibiting Utility
from continuing to threated or otherwise interfere with the Company’s customers. On March 4, 2015, an initial hearing was held upon
the Company’s request for injunctive relief.

Based upon facts revealed at a March 4, 2015 injunction hearing, on March 16, 2015, the Company sought leave to amend its
Complaint in the unfair competition suit to assert additional claims against Utility. Those new claims included claims of actual or
attempted monopolization, in violation of § 2 of the Sherman Act, claims arising under a new Georgia statute that prohibits threats of
patent infringement in “bad faith,” and additional claims of unfair competition/false advertising in violation of § 63(a) of the Lanham
Act. The Court concluded its injunction hearing on April 22, 2015, and allowed the Company leave to add these claims, but denied its
preliminary injunction. Subsequent to the injunction hearing, Utility withdrew from the market the in-car video recording device that it
had sold in competition with the Company’s own products of similar function and which Utility had attempted to market using threats
of patent infringement. After discovery closed, Utility filed a Motion for Summary Judgment and the Company filed a Motion for Partial
Summary Judgment. On March 30, 2017, the Court entered its order granting Utility’s motion and denying the Company’s motion for
summary judgment. The Company believed the District Court had made several errors when ruling on the motions for summary
judgment, and filed an appeal to the United States Court of Appeals for the Tenth Circuit (10th Circuit”). While the appeal was pending,
Utility filed a motion for the recovery from the Company of some $800,000 in alleged attorney’s fees as provided, purportedly, under
the Lanham Patent and Uniform Trade Secrets Act. That motion was denied in its entirety by final judgement entered February 14, 2018.
On February 16, 2018, the 10th Circuit issued its decision affirming the decision of the District Court. The Company filed a petition for
rehearing by the panel and en banc which was also denied. Utility has filed its own motion for the recovery of attorney fees, on appeal
in the alleged amount of $125,000. That motion has not yet been fully briefed but the Company will it on substantially the same grounds
upon which Utility’s prior motion for attorney’s fees was denied by the District Court.

The Company is also involved as a plaintiff and defendant in ordinary, routine litigation and administrative proceedings
incidental to its business from time to time, including customer collections, vendor and employment-related matters. The Company
believes the likely outcome of any other pending cases and proceedings will not be material to its business or its financial condition.

Sponsorship. On April 16, 2015 we entered into a Title Sponsorship Agreement under which we became the title sponsor for
a Web.com Tour golf tournament (the “Tournament”) held annually in the Kansas City Metropolitan area. Such Agreement provides us
with naming rights and other benefits for the annual Tournament for the years 2015 through 2019 in exchange for the following
sponsorship fee:

Year

2015
2016
2017
2018
2019

Sponsorship fee

375,000
475,000
475,000
500,000
500,000

$
$
$
$
$

We have the right to sell and retain the proceeds from the sale of additional sponsorships, including but not limited to a
presenting sponsorship, a concert sponsorship and founding partnerships for the Tournament. We recorded a net sponsorship expense
of $266,280 and $499,313 for the years ended December 31, 2017 and 2016, respectively. We are negotiating with the Web.com Tour
golf tournament officials to terminate our sponsorship fee commitments for the 2018 and 2019 Tournaments. There can be no assurance
that it will be successful in negotiating the termination of this sponsorship agreement or that if successful in such negotiations, on terms
acceptable or favorable to us.

401 (k) Plan. We sponsor a 401(k) retirement savings plan for the benefit of our employees. The plan, as amended, requires us
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. We made matching contributions totaling

$178,835 and $184,642 for the years ended December 31, 2017 and 2016, 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 as advance 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 December 31, 2017, the Company had advanced a total of
$286,115 pursuant to this agreement and established an allowance reserve of $85,835 for a net advance of $200,280. The minimu m
sales threshold has not been met and the Company has discontinued all advances, although the contract has not been formally terminated.

Critical Accounting Policies

Our significant accounting policies are summarized in note 1 to our 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) Persuasive evidence of an arrangement exists;
(ii) Delivery has occurred;
(iii) The price is fixed or determinable; and
(iv) Collectability is reasonably assured.

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 deferred revenue 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. We also have commercial customers and international distributors who may 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 $198,000 charged off as uncollectible on cumulative
revenues of $217.0 million since we commenced deliveries during 2006. As of December 31, 2017 and December 31, 2016, we had
provided a reserve for doubtful accounts of $70,000.

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 December 31, 2017. However,
if the balance due from any significant customer ultimately becomes 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. We use our 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 December 31, 2017 and December 31, 2016:

Raw Material and Component Parts
Work-in-Process
Finished Goods
Subtotal

Reserve for Excess and Obsolete Inventory

December 31, 2017

December 31, 2016

4,621,704 $
155,087
6,964,624
11,741,415
(2,990,702 )

4,015,170
355,715
7,215,346
11,586,231
(1,999,920 )

Total

8,750,713 $

9,586,311

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 25.5% of the gross inventory balance at December 31, 2017, compared to 17.3% of the gross inventory balance at December
31, 2016. We had $2,990,702 and $1,999,920 in reserves for obsolete and excess inventories at December 31, 2017 and December 31,
2016, respectively. Total raw materials and component parts were $4,621,704 and $4,015,170 at December 31, 2017 and December 31,
2016, respectively, an increase of $606,534 (15%). The increase in raw materials was mostly in refurbished parts for FirstVU HD
products. Finished goods balances were $6,964,624 and $7,215,346 at December 31, 2017 and December 31, 2016, respectively, a
decrease of $250,722 (3%). The decrease was primarily in the Laser Ally products that we revalued in December 2017. The increase in
the inventory reserve is primarily due to the change in sales mix of our products, which has resulted in a higher level of excess component
parts of the older versions of our PCB boards and legacy products. Additionally, we increased our reserves on selected refurbished and
other items requiring repair during the year ended December 31, 2017. We believe the reserves are appropriate given our inventory
levels at December 31, 2017.

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 $325,001 as of December 31, 2017 compared
to $374,597 as of December 31, 2016 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 Expenses. 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 100,000 stock options granted during the year ended December 31, 2017.

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, 2016, cumulative valuation allowances in the
amount of $22,455,000 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 our valuation allowance should be decreased to $18,070,000 to fully
reserve our deferred tax assets at December 31, 2017. We determined that it was appropriate to continue to provide a full valuation
reserve on our net deferred tax assets as of December 31, 2017 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 December 31, 2017 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 2016 we issued $4.0 million of Debentures
with detachable warrants to purchase common stock and in 2014 in two separate transactions we issued a total of $6.0 million of Secured
Convertible Notes with detachable warrants to purchase common stock. We elected to record the 2016 Debentures and 2014 Secured
Convertible Notes on their fair value basis. In addition, the warrants to purchase common stock issued in conjunction with the 2014
Secured Convertible Notes contained anti-dilution provisions that required them to be accounted for as derivative liabilities. We were
required to determine the fair value of these financial instruments outstanding as of December 31, 2017 and 2016 for financial reporting
purposes. The entire principal balance of the Secured Convertible Notes issued in 2014 has been converted to equity and all warrants
have been exercised, except for warrants exercisable to purchase 12,200 common shares at $5.00 per share, as of December 31, 2017.
The 2016 Convertible Debentures remain outstanding as of December 31, 2017.

In accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC 820”), we utilize the market approach to
measure fair value for our 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 our hierarchy for our financial assets and liabilities measured at fair value on a recurring basis as

of December 31, 2017.

Liabilities

Convertible Debentures
Warrant Derivative Liability

Level 1

Level 2

Level 3

Total

December 31, 2017

$
$
$

- $
- $
- $

3,262,807 $
16,816 $
3,279,623 $

3,262,807
16,816
3,279,623

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
December 31, 2017, which raised substantial doubt about our ability to continue as a going concern within the next twelve months 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 generally generate higher revenues during the second half of the calendar year compared to the first half.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 8. Financial Statements and Supplementary Data.

Our financial statements are included as an exhibit to this annual report on Form 10-K commencing on page F-1.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial

Disclosure.

None.

Item 9A. Controls and Procedures.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal
financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures
to provide reasonable assurance of achieving the control objectives, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934. Based on their evaluation as of December 31, 2017, the end of the period covered by this Annual Report on
Form 10-K, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were
effective at a reasonable assurance level to ensure that the information required to be disclosed in reports filed or submitted under the
Securities Exchange Act of 1934, including this Annual Report, were recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms, and was accumulated and communicated to management, including our principal
executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal
control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those
policies and procedures that:

● Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions

of our assets;

● Provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements
in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only
in accordance with authorizations of our management and directors; and

● Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of

our assets that could have a material effect on the financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined
to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of its
inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the
degree of compliance with the policies or procedures may deteriorate.

In connection with the filing of this Annual Report on Form 10-K, our management assessed the effectiveness of our internal

control over financial reporting as of December 31, 2017. In making this assessment, our management used the criteria set forth by
2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on our assessment using the framework in 2013 Internal Control – Integrated Framework, management believes that, as of
December 31, 2017, our internal control over financial reporting is effective.

This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control
over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the year ended December 31, 2017, that

have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information.

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance.

Our directors and executive officers and certain information about them, including their ages as of April 5, 2018, are set forth

below:

Name
Stanton E. Ross
Thomas J. Heckman
Leroy C. Richie (1)(2)(3)

Daniel F. Hutchins (1)(3)
Michael J. Caulfield (1)(2)(3)

Age
56
58
76

62
62

Position
President and Chief Executive Officer; Chairman of the Board of Directors
Vice President, Chief Financial Officer, Treasurer, and Secretary
Lead Outside Director; Chairman of the Nominating and Governance

Committee and Compensation Committee

Director; Chairman of Audit Committee
Director

(1) Member of Audit Committee
(2) Member of Compensation Committee
(3) Member of Nominating and Governance Committee

Stanton E. Ross has served as Chairman, President and Chief Executive Officer since September 2005. From March 1992 to

June 2005, Mr. Ross was the Chairman and President of Infinity Energy Resources, Inc., a publicly held oil and gas exploration and
development company (“Infinity”), and served as an officer and director of each of Infinity’s subsidiaries. He resigned all his positions
with Infinity in June 2005, except Chairman, but was reappointed President in October 2006. Mr. Ross served on the board of
directors of Studio One Media, Inc., a publicly held company, from January 2013 to March 2013. From 1991 until March 1992, he
founded and served as President of Midwest Financial, a financial services corporation involved in mergers, acquisitions and financing
for corporations in the Midwest. From 1990 to 1991, Mr. Ross was employed by Duggan Securities, Inc., an investment banking firm
in Lenexa, Kansas, where he primarily worked in corporate finance. From 1989 to 1990, he was employed by Stifel, Nicolaus & Co., a
member of the New York Stock Exchange, where he was an investment executive. From 1987 to 1989, Mr. Ross was self-employed
as a business consultant. From 1985 to 1987, Mr. Ross was President and founder of Kansas Microwave, Inc., which developed a
radar detector product. From 1981 to 1985, he was employed by Birdview Satellite Communications, Inc., which manufactured and
marketed home satellite television systems, initially as a salesman and later as National Sales Manager. Mr. Ross estimates he devoted
most of his time to Digital Ally and the balance to Infinity in 2016. In late 2007, Infinity sold a substantial portion of its operating
assets and has not required a substantial amount of his time since such point. Mr. Ross holds no public company directorships other
than with the Company and Infinity and has not held any others during the previous five years, except for Studio One Media, Inc. The
Company believes that Mr. Ross’s broad entrepreneurial, financial and business expertise and his experience with micro-cap public
companies and his role as President and Chief Executive Officer give him the qualifications and skills to serve as a Director.

Thomas J. Heckman has served as the Chief Financial Officer, Treasurer and Secretary since January 2008. From February
2001 to December 2007, Mr. Heckman was an investor/owner of several private companies and was a self-employed consultant
providing financial accounting and consulting services to private and public companies. From 1983 until 2001, Mr. Heckman was
employed by Deloitte and Touche, LLP, a subsidiary of Deloitte Touche Tohmatsu, one of the largest auditing, consulting, financial
advisory, risk management, and tax services organizations in the world. During his 18 years with Deloitte and Touche, LLP, including
six years as Accounting and Auditing Partner in the Kansas City office, Mr. Heckman specialized in IPOs and public reporting entities.
Mr. Heckman earned his Bachelor of Arts degree in Accounting at the University of Missouri – Columbia. Mr. Heckman holds no public
company directorships currently and for the previous five years.

Leroy C. Richie has been the Lead Outside Director of Digital Ally since September 2005. He is also the Chairman of the
Compensation Committee and Nominating and Governance Committee and a member of the Audit Committee. Since June 1, 1999 Mr.
Richie has been a director of Infinity Energy Resources, Inc., a publicly held oil and gas exploration and development company.
Additionally, until 2017, Mr. Richie served as a member of the boards of directors of Columbia Mutual Funds, (or mutual fund
companies acquired by or merged with Columbia Mutual Funds), a family of investment companies managed by Ameriprise Financial,
Inc. From 2004 to 2015, he was of counsel to the Detroit law firm of Lewis & Munday, P.C. He holds no other public directorships and
has not held any others during the previous five years, except for OGE Energy Corp. (2007-2014) and Kerr-McGee Corporation (1998-
2005). Mr. Richie serves as a member of the Board of Trustees and Chairman of the Compensation Committee for the Henry Ford
Health System, in Detroit. Mr. Richie was formerly Vice President of Chrysler Corporation and General Counsel for automotive legal
affairs, where he directed all legal affairs for its automotive operations from 1986 until his retirement in 1997. Before joining Chrysler,
he was an associate with the New York law firm of White & Case (1973-1978), and served as director of the New York office of the
Federal Trade Commission (1978-1983). Mr. Richie received a B.A. from City College of New York, where he was valedictorian, and
a J.D. from the New York University School of Law, where he was awarded an Arthur Garfield Hays Civil Liberties Fellowship. The
Company believes that Mr. Richie’s extensive experience as a lawyer and as an officer or director of public companies gives him the
qualifications and skills to serve as a Director.

Daniel F. Hutchins was elected a Director in December 2007. He serves as Chairman of the Audit Committee and is the
Board’s financial expert. Mr. Hutchins, a Certified Public Accountant, is a Principal with the accounting firm of Hutchins & Haake,
LLC and currently serves as a director and the Chief Financial Officer of Infinity Energy Resources, Inc., a publicly held oil and gas
exploration and development company, of which Stanton E. Ross is the Chairman and President. Mr. Hutchins has served as an instructor
for the Becker CPA exam with the Keller Graduate School of Management and has over 17 years of teaching experience preparing CPA
candidates for the CPA exam. He has 39 years of public accounting experience, including five years with Deloitte & Touche, LLP. He
has served on the boards of various non-profit groups and is a member of the American Institute of Certified Public Accountants. Mr.
Hutchins earned his Bachelor of Business Administration degree in Accounting at Washburn University in Topeka, Kansas. Mr.
Hutchins holds no other public company directorships and has not held any others during the previous five years. The Company believes
that Mr. Hutchins’ significant experience in finance and accounting gives him the qualifications and skills to serve as a Director.

Michael J. Caulfield was elected a Director in May 2016. He is a member of the Audit Committee, Compensation Committee
and Nominating and Governance Committee. He served as Vice President – Strategic Development of the Company from June 1 2009
to January 11, 2012. Mr. Caulfield was most recently (2012-2016) a Vice-Chairman at Teneo Holdings, LLC, a global advisory firm
where he was responsible for the firm’s investment banking relationships with a broad range of industrial companies. From 2006 to
2009, Mr. Caulfield served as a Managing Director at Banc of America Securities (“BAS”), where he was responsible for the merger,
acquisition, divestiture and restructuring advisory services for a number of large public and private companies. He was also in charge

of BAS’s global investment banking activities involving the Safety, Security, Engineering and Construction Industries. Prior to joining
BAS, Mr. Caulfield spent six years (2000-2006) as a Managing Director with Morgan Stanley in New York City, leading that global
investment banking firm’s efforts in the Aerospace and Defense Industries. He was also responsible for the investment banking
relationships with a number of Morgan Stanley’s largest clients. From 1989 to 2000, he worked at General Electric Capital Corp., where
he served as a Managing Director and head of the Corporate Finance Group. In this capacity, he advised GE Capital and the industrial
divisions of General Electric on such issues as capital structuring, mergers and acquisitions, and private equity transactions. Mr.
Caulfield received an MBA from the Wharton School of the University of Pennsylvania and a B.S. Degree from the University of
Minnesota. The Company believes that Mr. Caulfield’s significant experience in finance, corporate finance and investment banking
gives him the qualifications and skills to serve as a director.

Board of Directors and Committee Meetings

Our Board of Directors held five meetings and acted a number of times by unanimous consent resolutions during the fiscal year
ended December 31, 2017. Each of our directors attended at least 75% of the meetings of the Board of Directors and the committees on
which he served in the fiscal year ended December 31, 2017. Our directors are expected, absent exceptional circumstances, to attend all
Board meetings and meetings of committees on which they serve, and are also expected to attend our annual meeting of stockholders.
All directors then in office attended the 2017 Annual Meeting of stockholders.

Committees of the Board of Directors

Our Board of Directors currently has three committees: an Audit Committee, a Compensation Committee and a Nominating
and Governance Committee. Each committee has a written charter approved by the Board of Directors outlining the principal
responsibilities of the committee. These charters are also available on the Investor Relations page of our website. All our directors, other
than our Chairman and Chief Executive Officer, have met in executive sessions without management present on a regular basis in 2017
and year-to-date 2018.

Audit Committee

Our Audit Committee appoints the Company’s independent registered public accounting firm, reviews audit reports and plans,
accounting policies, financial statements, internal controls, audit fees, and certain other expenses and oversees our accounting and
financial reporting process. Specific responsibilities include selecting, hiring and terminating our independent registered public
accounting firm; evaluating the qualifications, independence and performance of our independent registered public accounting firm;
approving the audit and non-audit services to be performed by our independent registered public accounting firm; reviewing the design,
implementation, adequacy and effectiveness of our internal controls and critical accounting policies; overseeing and monitoring the
integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or
accounting matters; reviewing any earnings announcements and other public announcements regarding our results of operations in
conjunction with management and our public registered public accounting firm; conferring with management and the independent
registered public accounting firm regarding the effectiveness of internal controls, financial reporting processes and disclosure controls;
consulting with management and the independent registered public accounting firm regarding Company policies governing financial
risk management; reviewing and discussing reports from the independent registered public accounting firm on critical accounting
policies used by the Company; establishing procedures, as required under applicable law, for the receipt, retention and treatment of
complaints received by the Company regarding accounting, internal accounting controls or auditing matters and the confidential and
anonymous submission by employees of concerns regarding questionable accounting or auditing matters; reviewing and approving
related-person transactions in accordance with the Company’s policies and procedures with respect to related-person transactions and
applicable rules; reviewing the financial statements to be included in our annual report on Form 10-K; discussing with management and
the independent registered public accounting firm the results of the annual audit and the results of quarterly reviews and any significant
changes in our accounting principles; and preparing the report that the Securities and Exchange Commission requires in our annual
proxy statement. The report of the Audit Committee for the year-ended December 31, 2017 will be included in our Proxy Statement.

The Audit Committee is comprised of three Directors, each of whom is independent, as defined by the rules and regulations of
the Securities and Exchange Commission. The Audit Committee held four meetings during the year-ended December 31, 2017. On
September 22, 2005, the Company created the Audit Committee and adopted a written charter for it. The members of our Audit
Committee are Daniel F. Hutchins, Leroy C. Richie and Michael J. Caulfield. The Board of Directors determined that Mr. Hutchins
qualifies as an “audit committee financial expert,” as defined under the rules and regulations of the Securities and Exchange Commission,
and is independent as noted above.

Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by the Company’s independent registered
public accounting firm must be approved in advance by the Audit Committee to assure that such services do not impair the registered
public accounting firm independence from the Company. Accordingly, the Audit Committee has adopted an Audit and Non-Audit
Services Pre-Approval Policy (the “Policy”) that sets forth the procedures and the conditions pursuant to which services to be performed

by the independent registered public accounting firm are to be pre-approved. Pursuant to the Policy, certain services described in detail
in the Policy may be pre-approved on an annual basis together with pre-approved maximum fee levels for such services. The services
eligible for annual pre-approval consist of services that would be included under the categories of Audit Fees, Audit-Related Fees and
Tax Fees in the table, as well as services for limited review of actuarial reports and calculations. If not pre-approved on an annual basis,
proposed services must otherwise be separately approved prior to being performed by the independent registered public accounting firm.
In addition, any services that receive annual pre-approval but exceed the pre-approved maximum fee level also will require separate
approval by the Audit Committee prior to being performed. The Audit Committee may delegate authority to pre-approve audit and non-
audit services to any member of the Audit Committee, but may not delegate such authority to management.

Compensation Committee

Our Compensation Committee assists our Board of Directors in determining the development plans and compensation of our
officers, directors and employees. Specific responsibilities include approving the compensation and benefits of our executive officers;
reviewing the performance objectives and actual performance of our officers; administering our stock option and other equity
compensation plans; and reviewing and discussing with management the compensation discussion and analysis that the Securities and
Exchange Commission requires in our future Form 10-Ks and proxy statements.

Our Compensation Committee is comprised of two Directors, whom the Board considers to be independent under the rules of
the Securities and Exchange Commission. The members of our Compensation Committee are Leroy C. Richie, Chairman, and Michael
J. Caulfield. The Compensation Committee held two meetings and acted a number of times by unanimous written consent resolutions
during the year-ended December 31, 2017. Mr. Ross, our Chief Executive Officer, does not participate in the determination of his own
compensation or the compensation of directors. However, he makes recommendations to the Compensation Committee regarding the
amount and form of the compensation of the other executive officers and key employees, and he often participates in the Compensation
Committee’s deliberations about such persons’ compensation. Thomas J. Heckman, our Chief Financial Officer, also assists the
Compensation Committee in its deliberations regarding executive officer, director and employee compensation. No other executive
officers participate in the determination of the amount or the form of the compensation of executive officers or directors. The
Compensation Committee does not utilize the services of an independent compensation consultant to assist in its oversight of executive
and director compensation. On September 22, 2007, the Board of Directors adopted a written charter for the Compensation Committee

Nominating and Governance Committee

Our Nominating and Governance Committee assists our Board of Directors by identifying and recommending individuals
qualified to become members of our Board of Directors, reviewing correspondence from our stockholders, and establishing, evaluating
and overseeing our corporate governance guidelines. Specific responsibilities include the following: evaluating the composition, size
and governance of our Board of Directors and its committees and making recommendations regarding future planning and appointing
directors to our committees; establishing a policy for considering stockholder nominees for election to our Board of Directors; and
evaluating and recommending candidates for election to our Board of Directors.

Our Nominating and Governance Committee strives for a Board composed of individuals who bring a variety of complementary
skills, expertise or background and who, as a group, will possess the appropriate skills and experience to oversee our business. The
diversity of the members of the Board relates to the selection of its nominees. While the Committee considers diversity and variety of
experiences and viewpoints to be important factors, it does not believe that a director nominee should be chosen or excluded solely or
largely because of race, color, gender, national origin or sexual orientation or identity. In selecting a director nominee for
recommendation to our Board, our Nominating and Governance Committee focuses on skills, expertise or background that would
complement the existing members on the Board. Accordingly, although diversity may be a consideration in the Committee’s process,
the Committee and the Board of Directors do not have a formal policy regarding the consideration of diversity in identifying director
nominees.

When the Nominating and Governance Committee has either identified a prospective nominee or determined that an additional
or replacement director is required, the Nominating and Governance Committee may take such measures as it considers appropriate in
connection with its evaluation of a director candidate, including candidate interviews, inquiry of the person or persons making the
recommendation or nomination, engagement of an outside search firm to gather additional information, or reliance on the knowledge of
the members of the Board of Directors or management. In its evaluation of director candidates, including the members of the Board
eligible for re-election, the Nominating and Governance Committee considers a number of factors, including: the current size and
composition of the Board of Directors, the needs of the Board of Directors and the respective committees of the Board, and such factors
as judgment, independence, character and integrity, age, area of expertise, diversity of experience, length of service, and potential
conflicts of interest.

The Nominating and Governance Committee of the Board selects director nominees and recommends them to the full Board

of Directors. In relation to such nomination process, the Committee:

●
●
●
●
●
●
●
●

determines the criteria for the selection of prospective directors and committee members;
reviews the composition and size of the Board and its committees to ensure proper expertise and diversity among its members;
evaluates the performance and contributions of directors eligible for re-election;
determines the desired qualifications for individual directors and desired skills and characteristics for the Board;
identifies persons who can provide needed skills and characteristics;
screens possible candidates for Board membership;
reviews any potential conflicts of interests between such candidates and the Company’s interests; and
shares information concerning the candidates with the Board, and solicit input from other directors.

The Nominating and Governance Committee has specified the following minimum qualifications that it believes must be met
by a nominee for a position on the Board: the highest personal and professional ethics and integrity; proven achievement and competence
in the nominee’s field and the ability to exercise sound business judgment; skills that are complementary to those of the existing Board;
the ability to assist and support management and make significant contributions to our success; the ability to work well with the other
directors; the extent of the person’s familiarity with the issues affecting our business; an understanding of the fiduciary responsibilities
that are required of a member of the Board of Directors; and the commitment of time and energy necessary to diligently carry out those
responsibilities. A candidate for director must agree to abide by our Code of Ethics and Conduct.

After completing its evaluation, the Nominating and Governance Committee makes a recommendation to the full Board of
Directors as to the persons who should be nominated to the Board, and the Board of Directors determines the nominees after considering
the recommendation and report of the Committee.

Our Nominating and Governance Committee is comprised of three Directors, whom the Board considers to be independent
under the rules of the Securities and Exchange Commission. The Nominating and Governance Committee held one meeting during the
year ended December 31, 2017. The members of our Nominating and Governance Committee are Leroy C. Richie, who serves as
Chairman, and Michael J. Caulfield. The Committee was created by our Board of Directors on December 27, 2007, when the Board of
Directors adopted a written charter, which was amended in February 2010.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee is made up of two independent, non-employee directors, Messrs. Richie and Caulfield. No
interlocking relationship exists between the members of our Compensation Committee and the board of directors or compensation
committee of any other company.

Code of Ethics and Conduct

Our Board of Directors has adopted a Code of Ethics and Conduct that is applicable to all our employees, officers and directors.
Our Code of Ethics and Conduct is intended to ensure that our employees act in accordance with the highest ethical standards. The Code
of Ethics and Conduct is available on the Investor Relations page of our website at http://www.digitalally.com. and the Code of Ethics
and Conduct was filed as an exhibit to our annual report on Form 10-K filed March 4, 2008.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Act of 1934, as amended, requires our executive officers and directors, and persons who own
more than ten percent of our common stock, to file with the Securities and Exchange Commission reports of ownership of, and
transactions in, our securities and to provide us with copies of those filings. To our knowledge, based solely on our review of the copies
of such forms received by us, or written representations from certain reporting persons, we believe that during the year ended December
31, 2017, all filing requirements applicable to our officers, directors and greater than ten percent beneficial owners were complied with.

Item 11. Executive Compensation.

The following table presents information concerning the total compensation of the Company’s Chief Executive Officer and
Chief Financial Officer (the “Named Executive Officers”) for services rendered to the Company in all capacities for the years ended
December 31, 2017 and 2016:

Name and Principal Position
Stanton E. Ross
Chairman, CEO and President
Thomas J. Heckman
Vice President, Chief Financial
Officer, Treasurer, and Secretary

Summary Compensation Table

Stock
Awards ($)
Salary ($) Bonus ($)
(1)(3)(4)(5)
$220,000 $25,000 $1,087,500
$220,000 $985,000 $462,700
$682,500
$—
$220,000

Option
Awards
($) (1)
$—
$—
$—

Year
2017
2016
2017

All Other
Compensation
($) (2)
$22,516
$15,030
$23,672

Total ($)
$1,355,016
$1,682,730
$926,172

2016

$220,000

$—

$462,700

$—

$19,658

$702,358

(1) Represents aggregate grant date fair value pursuant to ASC Topic 718 for the respective year for stock options granted. Please
refer to Note 12 to the consolidated financial statements for further description of the awards and the underlying assumptions
utilized to determine the amount of grant date fair value related to such grants.

(2) Amounts included in all other compensation include the following items: the employer contribution to the Company’s 401(k)
Retirement Savings Plan (the “401(k) Plan”) on behalf of the named executive. We are required to provide a 100% matching
contribution for all who elect to contribute up to 3% of their compensation to the plan and a 50% matching contribution for all
employees’ elective deferral between 4% and 5%. The employee is (i) 100% vested at all times in the employee contributions and
employer matching contributions; (ii) Company paid healthcare insurance; (iii) Company paid contributions to health savings
accounts; and (iv) Company paid life, accident and disability insurance. See “All Other Compensation Table” below.

(3) Stock awards include the following restricted stock granted during 2017 to Mr. Ross: (i) 125,000 shares at $5.10 per share that
vest ratably over the two-year period ending January 22, 2019; and (ii) 150,000 shares at $3.00 per share that vest ratably over the
one-year period ending August 14, 2018.

(5) Stock awards include the following restricted stock granted to each person during 2016: (i) 35,000 shares at $5.94 per share that
vest ratably over the two-year period ending January 3, 2018; and (ii) 65,000 shares at $3.92 per share that vest ratably over the
two-year period ending May 11, 2018.

All Other Compensation Table

401(k) Plan
Contribution
by Company

Company
Paid
Healthcare
Insurance

Flexible &
Health
Savings
Account
Contributions
by Company

Company
Paid Life,
Accident,
&
Disability
Insurance

Other
Contractual

Payments Total

Name and Principal Position

Year

Stanton E. Ross

2017

$5,517

$15,373

$1,100

Chairman, CEO and President

2016

$3,992

$10,512

$—

Thomas J. Heckman
Vice President, Chief Financial
Officer, Treasurer, and Secretary

2017

$8,800

$13,546

2016

$9,070

$9,262

$800

$526

$—

$22,516

$15,030

$23,672

$19,658

Compensation Policy. Our executive compensation plan is based on attracting and retaining qualified professionals who possess
the skills and leadership necessary to enable us to achieve earnings and profitability growth to satisfy its stockholders. We must,
therefore, create incentives for these executives to achieve both our and individual performance objectives using performance-based
compensation programs. No one component is considered by itself, but all forms of the compensation package are considered in total.
Wherever possible, objective measurements will be utilized to quantify performance, but many subjective factors still come into play
when determining performance.

Compensation Components. The main elements of its compensation package consist of base salary, stock options or restricted

stock awards and bonus.

Base Salary. The base salary for each executive officer is reviewed and compared to the prior year, with considerations given for
increase or decrease. The review is generally on an annual basis, but may take place more often in the discretion of the Compensation
Committee.

For fiscal year 2018, the Compensation Committee of the Board of Directors (the “Committee”) set the annual base salaries of
Stanton E. Ross, President and Chief Executive Officer, and Thomas J. Heckman, Chief Financial Officer, Treasurer and Secretary, at
$220,000 each. This represents no increase or decrease from the previous year.

For fiscal year 2017, the Compensation Committee of the Board of Directors (the “Committee”) set the annual base salaries of
Stanton E. Ross, President and Chief Executive Officer, and Thomas J. Heckman, Chief Financial Officer, Treasurer and Secretary, at
$220,000 each. This represents no increase or decrease from the previous year.

For fiscal year 2016, the Compensation Committee of the Board of Directors (the “Committee”) set the annual base salaries of
Stanton E. Ross, President and Chief Executive Officer, and Thomas J. Heckman, Chief Financial Officer, Treasurer and Secretary, at
$220,000 each. This represents an increase from the $175,000 annual base salary for each individual during the four previous years.

The Committee plans to review the base salaries for possible adjustments on an annual basis. Base salary adjustments will be based
on both individual and our performance and will include both objective and subjective criteria specific to each executive’s role and
responsibility with us.

Stock Options and Restricted Stock Awards. The Compensation Committee determined stock option and restricted stock
awards based on numerous factors, some of which include responsibilities incumbent with the role of each executive with us, tenure
with us, as well as our performance. The vesting period of options and restricted stock is also tied, in some instances, to our performance
directly related to certain executive’s responsibilities with us. The Committee determined that Messrs. Ross and Heckman were eligible
for awards of stock options or restricted stock in 2017 based on their performance. Refer to grant of Plan-Based Awards table below for
restricted stock awards made in 2017. The Committee also determined that Messrs. Ross and Heckman would be eligible in 2018 for
awards of restricted stock or stock options provided each person is employed with us at such point.

Bonuses. The Compensation Committee determined to award bonuses to each of the executive officers in 2017, as set forth in
the foregoing table. The Compensation Committee awarded Mr. Ross a bonus of $25,000 in 2017. Refer to the section entitled
“Executive Compensation” for the bonuses paid to Messrs. Ross and Heckman in 2017 and 2016. The Compensation Committee reviews
each executive officer’s performance on a quarterly basis and determines what, if any, portion of the bonus he has earned and will be
paid as of such point.

Other. In July 2008, we amended and restated our 401(k) retirement savings plan (the “401(k) Plan”). The amended plan
requires us to provide a 100% matching contribution for employees who elect to contribute up to 3% of their compensation to the plan
and a 50% matching contribution for employee’s elective deferrals between 4% and 5%. We have made matching contributions for
executives who elected to contribute to the 401(k) Plan during 2010. Each participant is 100% vested at all times in employee and
employer matching contributions. As of December 31, 2017, a total of 76,040 shares of our common stock were held in the 401(k) Plan.
Mr. Heckman, as trustee of the 401(k) Plan, holds the voting power as to the shares of our common stock held in the 401(k) Plan. We
have no profit sharing plan in place for our employees. However, we may consider adding such a plan to provide yet another level of
compensation to our compensation plan.

The following table presents information concerning the grants of Plan-based awards to the Named Executive Officers during the year
ended December 31, 2017:

Grants of Plan-Based Awards

Date
Approved by
Compensation
Committee

All Other Stock
Awards: Number
of Shares of Stock
or Units:
(#) (1)

Exercise or
Base Price of
Option
Awards
($/Share)

Grant Date
Fair Value of
Stock Awards
($) (3)

Grant
Date

1/23/2017
8/15/2017
1/23/2017
8/15/2017

125,000 (1)
150,000 (2)
75,000 (1)
100,000 (2)

$ —
$ —
$ —
$ —

$
$
$
$

637,500
450,000
382,500
300,000

Name

Stanton E. Ross
Chairman, CEO and President
Thomas J. Heckman
Vice President, CFO, Treasurer, and
Secretary

(1) These restricted stock awards were made under the Digital Ally, Inc. Stock Option and Restricted Stock Plans and vest over a two-

year period (100% on January 23, 2019) contingent upon whether the individual is still employed by us at that point.

(2) These restricted stock awards were made under the Digital Ally, Inc. Stock Option and Restricted Stock Plans and vest over a one-

year period (100% on August 15, 2018) contingent upon whether the individual is still employed by us at that point.

(3) Stock awards noted represent the aggregate amount of grant date fair value as determined under ASC Topic 718. Please refer to
Note 12 to the consolidated financial statements for further description of the awards and the underlying assumptions utilized to
determine the amount of grant date fair value related to such grants.

The following table presents information concerning the outstanding equity awards for the Named Executive Officers as of

December 31, 2017:

Outstanding Equity Awards at Fiscal Year-End

Option Awards

Stock Awards

Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
(#)

Number of
Securities
Underlying
Unexercised
Options
Exercisable
(#) (1)

Number of
Securities
Underlying
Unexercised
Options
Unexercisable
(#)

Option
Exercise
Price
($)

Option
Expiration
Date

Equity
Incentive
Plan
Awards:
Number
of
Unearned
Shares,
Units or
Other
Rights
that
Have Not
Vested

Equity
Incentive
Plan
Awards:
Market
or Payout
Value of
Unearned
Shares,
Units, or
Other
Rights
that
Have Not
Vested

Number
of
Shares
or Units
of Stock
that
Have
Not
Vested
(1)

Market
Value
of
Shares
or Units
of Stock
that
Have
Not
Vested
(2)

Name

Stanton E. Ross
Chairman, CEO and President

Thomas J. Heckman
CFO, Treasurer and Secretary

15,000
18,750
3,750
37,500

12,500
3,750
3,750
2,500
12,500

—
—
—
—

—
—
—
—
—

— $ 4.80 1/12/2022 360,000 $ 954,000
— $ 13.20 1/10/2021
— $ 14.24 5/5/2019
— $ 54.40 1/2/2018

— $ 13.20 1/10/2021 260,000 $ 689,000
— $ 24.80 7/30/2019
— $ 14.24 5/5/2019
— $ 12.72 3/30/2019
— $ 54.40 1/2/2018

— $ —

(1) These stock option and restricted stock awards were made under the Digital Ally, Inc. Stock Option and Restricted Stock Plans and

vest over the prescribed period contingent upon whether the individual is still employed by the Company at that point.

(2) Market value based upon the closing market price of $2.65 on December 31, 2017.

The following table presents information concerning the stock options exercised and the vesting of restricted stock awards

during 2017 for the Named Executive Officers for the year ending December 31, 2017:

Stanton E. Ross
Chairman, CEO & President

Thomas J. Heckman
CFO, Treasurer and Secretary

Option Exercises and Restricted Stock Vested

Option Awards

Stock Awards

Number of
Shares Acquired
Realized on
Exercise
(#)

Value
Realized on
Exercise
($)

Number of Shares
Acquired on
Vesting
(#)

Value on Vesting
($)

— $

—

75,000 $

294,875 (1)

— $

—

75,000 $

294,875 (1)

(1) Based on the closing market price of our common stock of $4.20 on January 3, 2017, the date of vesting for 17,500 shares, $4.75
on February 12, 2017, the date of vesting for 15,000 shares, $4.05 on May 11, 2017, the date of vesting for 32,500 shares, and $1.85
on October 30, 2017 the date of vesting for 10,000 shares.

The following table sets forth (a) the aggregate number of shares of restricted stock and shares subject to options granted
under our stock option and restricted stock plans during the year-ended December 31, 2017 and (b) the average per share exercise
price of such options.

Stock Option and Restricted Stock Grants

Name of Individual or Group
Stanton E. Ross, Chairman of the Board,
CEO & President
Leroy C. Richie, Director
Daniel F. Hutchins, Director
Michael J. Caulfield, Director
Thomas J. Heckman, Vice President, CFO,
Treasurer & Secretary
All executive officers, as a group
All directors who are not executive officers, as a group
All employees who are not executive officers, as a group

Number of
Restricted Shares
of Common Stock
Granted

Number of

Options Granted

Average per Share
Exercise Price

275,000
—
—
—

175,000
450,000
—
72,000

— $
30,000 $
30,000 $
30,000 $

— $
— $
90,000 $
10,000 $

—
3.00
3.00
3.00

—
—
3.00
3.00

Employment Contracts; Termination of Employment and Change-in-Control Arrangements

We do not have any employment agreements with any of our executive officers. However, on December 23, 2008, we entered

into retention agreements with the following executive officers: Stanton E. Ross and Thomas J. Heckman.

Retention Agreements - Potential Payments upon Termination or Change of Control

The following table sets forth for each named executive officer potential post-employment payments and payments on a change

in control and assumes that the triggering event took place on January 1, 2018.

Retention Agreement Compensation

Name
Stanton E. Ross
Thomas J. Heckman
Total

Change in Control
Payment Due
Based Upon
Successful
Completion of
Transaction

Severance
Payment Due
Based on
Termination After
Change of
Control Occurs

$
$
$

55,000 $
55,000 $
110,000 $

220,000 $
220,000 $
440,000 $

Total

275,000
275,000
550,000

The retention agreements guarantee the executive officers specific payments and benefits upon a Change in Control of the
Company. The retention agreements also provide for specified severance benefits if, after a Change in Control of the Company occurs,
the executive officer voluntarily terminates employment for “Good Reason” or is involuntarily terminated without “Cause.”

Under the retention agreements, a “Change in Control” means (i) one party alone, or acting with others, has acquired or gained
control over more than 50% of the voting shares of the Company; (ii) the Company merges or consolidates with or into another entity
or completes any other corporate reorganization, if more than 50% of the combined voting power of the surviving entity’s securities
outstanding immediately after such merger, consolidation or other reorganization is owned by persons who were not stockholders of the
Company immediately prior to such merger, consolidation or other reorganization; (iii) a majority of the Company’s Board of Directors
is replaced and/or dismissed by the stockholders of the Company without the recommendation of or nomination by the Company’s
current Board of Directors; (iv) the Company’s Chief Executive Officer (the “CEO”) is replaced and/or dismissed by stockholders
without the approval of the Company’s Board of Directors; or (v) the Company sells, transfers or otherwise disposes of all or
substantially all of the consolidated assets of the Company and the Company does not own stock in the purchaser or purchasers having

more than 50% of the voting power of the entity owning all or substantially all of the consolidated assets of the Company after such
purchase.

“Good Reason” means either (i) a material adverse change in the executive’s status as an executive or other key employee of
the Company, including without limitation, a material adverse change in the executive’s position, authority, or aggregate duties or
responsibilities; (ii) any adverse change in the executive’s base salary, target bonus or benefits; or (iii) a request by the Company to
materially change the executive’s geographic work location.

“Cause” means (i) the executive has acted in bad faith and to the detriment of the Company; (ii) the executive has refused or
failed to act in accordance with any specific lawful and material direction or order of his or her supervisor; (iii) the executive has
exhibited, in regard to employment, unfitness or unavailability for service, misconduct, dishonesty, habitual neglect, incompetence, or
has committed an act of embezzlement, fraud or theft with respect to the property of the Company; (iv) the executive has abused alcohol
or drugs on the job or in a manner that affects the executive’s job performance; and/or (v) the executive has been found guilty of or has
plead nolo contendere to the commission of a crime involving dishonesty, breach of trust, or physical or emotional harm to any person.
Prior to termination for Cause, the Company shall give the executive written notice of the reason for such potential termination and
provide the executive a 30-day period to cure such conduct or act or omission alleged to provide grounds for such termination.

If any Change in Control occurs and the executive continues to be employed as of the completion of such Change in Control,
upon completion of such Change in Control, as payment for the executive’s additional efforts during such Change in Control, the
Company shall pay the executive a Change in Control benefit payment equal to three months of the his base salary at the rate in effect
immediately prior to the Change in Control completion date, payable in a lump sum net of required tax withholdings. If any Change in
Control occurs, and if, during the one-year period following the Change in Control, the Company terminates the executive’s employment
without Cause or the executive submits a resignation for Good Reason (the effective date of such termination or resignation, the
“Termination Date”), then:

(a) The Company shall pay the executive severance pay equal to 12 months of his base salary at the higher of the rate in
effect immediately prior to the Termination Date or the rate in effect immediately prior to the occurrence of the event or events
constituting Good Reason, payable on the Termination Date in a lump sum net of required tax withholdings, plus all other
amounts then payable by the Company to the executive less any amounts then due and owing from the executive to the
Company;
(b) The Company shall provide continuation of the executive’s health benefits at the Company’s expense for 18 months
following the Termination Date; and

the Termination Date.

The executive is not entitled to the above severance benefits for a termination based on death or disability, resignation without
Good Reason or termination for Cause. Following the Termination Date, the Company shall also pay the executive all reimbursements
for expenses in accordance with the Company’s policies, within ten days of submission of appropriate evidence thereof by the executive.

Director Compensation

Our non-employee directors received the restricted stock grants noted in the section below entitled “Director Compensation”
for their service on the Board of Directors in 2017, including on the Audit, Nominating and Governance and Compensation Committees.

During 2017 we paid cash compensation to our non-employee Board members as noted in the section below entitled “Director
Compensation” for their service on the Board of Directors in 2017, including on the Audit, Nominating and Governance and
Compensation Committees. Neither the chairmen of each committee of the Board nor any members of any committee received any
additional cash compensation for their service on such committees in 2017.

In May 2016, we granted to Messrs. Richie, Caulfield, Hutchins and Elliot M. Kaplan, a former director, options to acquire
10,000 shares of common stock each at an exercise price of $3.92 per share for their service on the Board until the next annual meeting
of stockholders with vesting to occur on May 1, 2017, provided each person remained a director at such date. Mr. Kaplan resigned from
the board of directors effective September 9, 2016 for health reasons. In connection with his resignation and in recognition of his many
years of service, we accelerated the vesting of the stock options awarded to him in May 2016 as a director, paid him the $45,000 balance
of his cash compensation as a director for 2016/2017, vested any other unvested stock options and restricted stock awards and extended
the termination date of his stock options to May 1, 2018.

In August 2017, we granted to Messrs. Richie, Caulfield and Hutchins options to acquire 30,000 shares of common stock each
at an exercise price of $3.00 per share for their service on the Board until the next annual meeting of stockholders with vesting to occur
on August 14, 2018, provided each person remained a director at such date.

Director compensation for the year ended December 31, 2017 was as follows:

Name
Stanton E. Ross, Chairman of the Board (1)
Leroy C. Richie
Daniel F. Hutchins
Michael J. Caulfield

Director Compensation

Fees
Earned or
Paid in Cash
($)

Stock
Awards
($) (2)

Option
Awards
($) (2)

Total
($)

$
$
$
$

$
—
72,500 (3) $
62,500 (4) $
62,500 (4) $

— $
— $
— $
— $

— $
74,754 $
74,754 $
74,754 $

—
147,254
137,254
137,254

(1)

(2)

(3)

(4)

Mr. Ross’s compensation and option awards are provided in the Executive Compensation table because he did not receive
compensation or stock options for his services as a director.
Represents aggregate grant date fair value pursuant to ASC Topic 718 for stock options and restricted stock granted. Please
refer to Note 12 to the consolidated financial statements for further description of the awards and the underlying assumptions
utilized to determine the amount of grant date fair value related to such grants.
Mr. Richie’s fees earned or paid in cash includes $60,000 in cash fees paid during 2017 and $12,500 accrued fees earned but
unpaid as of December 31, 2017.
Mr. Hutchins’ and Caulfield’s fees earned or paid in cash includes $35,000 in cash fees paid during 2017 and $27,500 accrued
fees earned but unpaid as of December 31, 2017.

Stock Option and Restricted Stock Grants to Directors

Name of Individual
Stanton E. Ross (1)
Leroy C. Richie (2)
Daniel F. Hutchins (2)
Michael J. Caulfield (2)

Number of
Restricted
Shares of
Common
Stock
Granted

Number of
Options
Granted

Average per
Share
Exercise
Price

—
—
—
—

— $
30,000 $
30,000 $
30,000 $

—
3.00
3.00
3.00

(1) Mr. Ross’s compensation and option awards are noted in the Executive Compensation table because he did not receive compensation

or stock options for his services as a director.

(2) The stock option grants were issued on August 14, 2017 with vesting to occur on August 14, 2018.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related

Stockholder Matters.

The following table sets forth information regarding ownership of our common stock by:

Security Ownership of Certain Beneficial Owners

●

●
●
●

each person or group of affiliated persons known by us to be the beneficial owner of more than 5% of our outstanding
common stock;
each of our directors and nominees for director;
each of our named executive officers; and
all directors and executive officers as a group.

The amounts for our named executive officers and directors as a group and our significant stockholders are as of April 5, 2018,
unless otherwise indicated in a footnote below. Beneficial ownership in this table is determined in accordance with the rules of the SEC,
and does not necessarily indicate beneficial ownership for any other purpose. Under these rules, the number of shares of common stock
deemed outstanding includes all shares of restricted stock and those shares issuable upon exercise of options held by the respective
person or group that may be exercised within 60 days after April 5, 2018. For purposes of calculating each person’s or group’s percentage
ownership, unvested stock options exercisable within 60 days and all shares of restricted stock are included for that person or group, but

not for any other person or group. Percentage of beneficial ownership is based on the shares of common stock outstanding as of April
5, 2018.

Name and Address of Beneficial Owner
5% Stockholders (excluding executive officers and directors):
None (1)(2)(3)(4)

Amount and
Nature of
Beneficial

Percent
of Class

(1) Based solely on a review of Schedule 13G/A filed on February 2, 2018 by Hudson Bay Master Fund, Ltd. and a Schedule 13G/A
filed on February 12, 2016 by CVI Investments, Inc. and a Schedule 13G/A filed on January 18, 2018 by Empery Asset
Management, LP.
(2) Hudson Bay Master Fund, Ltd. owns warrants exercisable to purchase a total of 439,883 shares of common stock at a price of
$13.43 per share, warrants exercisable to purchase a total of 400,000 shares at a price of $5.00 per share and warrants exercisable
to purchase a total of 45,533 shares at a price of $3.36 per share. The warrants contain provisions that limit the number of shares
issuable upon their exercise to 4.99% beneficial ownership of our common stock, or 9.99% beneficial ownership if the holder gives
us written notice, which it has not. An increase in the ownership limit to 9.9% would amount to beneficial ownership of 771,850
shares if the holder exercised that portion of its warrants.
(3) CVI Investments, Inc. owns warrants exercisable to purchase a total of 439,883 shares of common stock at a price of $13.43 per
share and warrants exercisable to purchase a total of 400,000 shares at a price of $5.00 per share. The warrants contain provisions
that limit the number of shares issuable upon their exercise to 4.99% beneficial ownership of our common stock, or 9.99% if the
holder gives us written notice, which it has not. An increase of the ownership limit to 9.9% would amount to beneficial ownership
of 771,850 shares if the holder exercised that portion of its warrants.
(4) Empery Asset Management, LP owns warrants exercisable to purchase a total of 660,000 shares of common stock at a price of
$3.36 per share. The warrants contain provisions that limit the number of shares issuable upon their exercise to 4.99% beneficial
ownership of our common stock, or 9.99% if the holder gives us written notice, which it has not. An increase of the ownership limit
to 9.9% would amount to beneficial ownership of 660,000 shares if the holder exercised that portion of its warrants.

The following table sets forth, as of April 5, 2018, the number and percentage of outstanding shares of common stock beneficially
owned by each director of the Company, each named officer of the Company, and all our directors and executive officers as a group.
We have no other class of capital stock outstanding.

Security Ownership of Executive Officers and Directors

Name and Address of Beneficial Owner
Executive Officers & Directors: (1)
Stanton E. Ross (2)
Leroy C. Richie (3)
Daniel F. Hutchins (4)
Michael J. Caulfield (5)
Thomas J. Heckman (6)

Amount and
Nature of
Beneficial
Ownership

Percent
of Class

599,012
52,343
58,950
12,855
576,134

8.5 %
0.7 %
0.8 %
0.2 %
8.1 %

All officers and directors as a group (five individuals)

1,299,294

18.3 %

(1) The address of these persons is c/o Digital Ally, Inc. 9705 Loiret Blvd, Lenexa, KS 66219.
(2) Mr. Ross’s total shares include: (i) 310,000 restricted shares that are subject to forfeiture to us and (ii) vested options exercisable
to purchase 37,500 shares of common stock. Mr. Ross has pledged 200,525 common shares and options exercisable to purchase
37,500 shares of common stock at $8.00 per share to the lenders as collateral for personal loans.

(3) Mr. Richie’s total shares include: (i) 7,000 restricted shares of common stock that are subject to forfeiture to us, and (ii) vested

options exercisable to purchase 13,125 shares of common stock.

(4) Mr. Hutchins’ total shares include: (i) 7,000 restricted shares of common stock that are subject to forfeiture to us, and (ii) vested

options exercisable to purchase 25,000 shares of common stock.

(5) Mr. Caulfield’s total shares include vested options exercisable to purchase 10,000 shares of common stock.
(6) Mr. Heckman’s total shares include (i) 210,000 restricted shares that are subject to forfeiture to us; (ii) vested options exercisable
to purchase 22,500 shares of common stock; and (iii) 107,486 shares of common stock held in the Company’s 401(k) Plan (on
December 31, 2017) as to which Mr. Heckman has voting power as trustee of the 401(k) Plan. Mr. Heckman has pledged 143,059
common shares to financial institutions as collateral for personal loans.

Item 13. Certain Relationships and Related Transactions, and Director Independence.

Certain Relationships and Related Person Transactions

We engaged in no reportable transactions with related persons during the years ended December 31, 2017 and 2016 other than

the following:

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 paid the LLC advances 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 December 31, 2017, the Company had advanced a total of $286,115 pursuant to this agreement and established an
allowance reserve of $85,835 for a net advance of $200,280. The LLC did not meet its minimum sales quotas and all advances have
been discontinued, although the contract had not been terminated at December 31, 2017.

Director Independence

In accordance with the Nasdaq Stock Market listing standards, our Board of Directors undertook its annual review of the
independence of the directors and considered whether any director had a material relationship with the Company or its management that
could compromise his ability to exercise independent judgment in carrying out his responsibilities. As a result of this review, the Board
affirmatively determined that the current board members, other than Mr. Ross, our President and Chief Executive Officer, are
“independent directors” under the Nasdaq rules. Additionally, the members of our three standing committees are required to be, and the
Board of Directors has determined that each member is, independent in accordance with the Nasdaq and SEC rules.

Item 14. Principal Accountant Fees and Services.

The following table is a summary of the fees billed to us by RSM US LLP for the fiscal years ended December 31, 2017 and

2016:

Fee Category
Audit Fees
Audit-Related Fees
Tax Fees
All Other Fees
Total Fees

Fiscal 2017 Fees Fiscal 2016 Fees
156,600
$
3,400
—
15,627
175,627

174,100 $
33,000
—
9,674
216,774 $

Audit Fees. Such amount consists of fees billed for professional services rendered in connection with the audit of our annual
financial statements and review of the interim financial statements included in our quarterly reports. It also includes services that are
normally provided by our independent registered public accounting firms in connection with statutory and regulatory filings or
engagements.

Audit-Related Fees. Consists of fees billed for assurance and related services that are reasonably related to the performance of the
audit or review of our financial statements and are not reported under “Audit Fees.” These services include employee benefit plan audits,
consents issued for certain filings with the SEC, accounting consultations in connection with acquisitions, attest services that are not
required by statute or regulation, and consultations concerning financial accounting and reporting standards.

Tax Fees. Tax fees consist of fees billed for professional services related to tax compliance, tax advice and tax planning. These
services include assistance regarding federal, state and international tax compliance, tax audit defense, customs and duties, mergers and
acquisitions, and international tax planning.

All Other Fees. Consists of fees for products and services other than the services reported above. In fiscal 2017, such fees were
related primarily to server hardware and telephone system maintenance and upgrades. In fiscal 2016, such fees were related primarily
to server hardware and telephone system maintenance and upgrades.

The Audit Committee’s practice is to consider and approve in advance all proposed audit and non-audit services to be provided by

our independent registered public accounting firm. All the fees shown above were pre-approved by the Audit Committee.

The audit report of RSM US LLP on our consolidated financial statements for the year ended December 31, 2017 did not contain
an adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles.

During our fiscal year ended December 31, 2017, there were no disagreements with RSM US LLP on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements if not resolved to RSM US
LLP’s satisfaction would have caused it to make reference to the subject matter of such disagreements in connection with its reports on
the financial statements for such periods.

During our fiscal years ended December 31, 2017, there were no reportable events (as described in Item 304(a)(1)(v) of Regulation

S-K).

PART IV

Item 15. Exhibits and Financial Statement Schedules.

(a)

The following documents are filed as part of this annual report on Form 10-K:

Consolidated Financial Statements:

The consolidated financial statements required to be included in Part II, Item 8, Financial Statements and Supplementary
Data, begin on Page F-1 and are submitted as a separate section of this Annual Report.

Financial Statement Schedules:

All schedules are omitted because they are not applicable or are not required, or because the required information is
included in the consolidated financial statements or notes in this Annual Report.

Exhibits:

Exhibit
Number

Description

Incorporated by Reference to:

Filed
Herewith

2.1

3.1

3.2
3.3
3.4

3.5

3.6

3.7

3.8

3.9

4.1
4.2
4.3
4.4

Plan of Merger among Vegas Petra, Inc., a Nevada
corporation, and Digital Ally, Inc., a Nevada
corporation, and its stockholders, dated November 30,
2004.
Amended and Restated Articles of Incorporation of
Registrant, dated December 13, 2004.
Amended and Restated By-laws of Registrant.
Audit Committee Charter, dated September 22, 2005.
Compensation Committee Charter, dated September
22, 2005
Nominating Committee Charter dated December 27,
2007.
Corporate Governance Guidelines

Nominating and Governance Charter, Amended and
Restated as of February 25, 2010.
Strategic Planning Committee Charter, dated June 28,
2009.
Certificate of Change Pursuant to NRS 78.209 of
Digital Ally, Inc.
Form of Common Stock Certificate.
Form of Common Stock Purchase Warrant.
Form of Series A Common Stock Purchase Warrant.
Form of Series B Common Stock Purchase Warrant.

Exhibit 2.1 of the Company’s Form SB-2, filed
October 16, 2006, No. 333-138025 (the “October
2006 Form SB-2).

Exhibit 3.1 of the October 2006 Form SB-2.

Exhibit 3.2 of the October 2006 Form SB-2.
Exhibit 3.3 of the October 2006 Form SB-2.
Exhibit 3.4 of the October 2006 Form SB-2.

Exhibit 3.5 of the Annual Report on Form 10KSB for
the Year ending December 31, 2007.
Exhibit 99.1 of the Current Report on Form 8-K
dated November 20, 2009.
Exhibit 3.7 of the Annual Report on Form 10K for
the Year ending December 31, 2009.
Exhibit 3.8 of the Annual Report on Form 10K for
the Year ending December 31, 2009.
Exhibit 3.1 to Form 8-K filed August 30, 2012.

Exhibit 4.1 of the October 2006 Form SB-2.
Exhibit 4.2 of the October 2006 Form SB-2.
Exhibit 4.1 to Form 8-K filed July 17, 2015
Exhibit 4.2 to Form 8-K filed July 17, 2015

4.5
5.1

10.1
10.2
10.3

10.4

10.5

10.6

10.7

10.8

10.9

10.10

10.11

10.12

10.13

10.14

10.15

10.16

10.17

10.18

10.19

10.20

10.21

10.22

10.23
10.24

10.25

10.26
10.27

10.28

Form of Series C Common Stock Purchase Warrant.
Opinion of Quarles & Brady LLP as to the legality of
securities being registered (includes consent).
2005 Stock Option and Restricted Stock Plan.
2006 Stock Option and Restricted Stock Plan.
Form of Stock Option Agreement (ISO and Non-
Qualified) 2005 Stock Option Plan.
Form of Stock Option Agreement (ISO and Non-
Qualified) 2006 Stock Option Plan.
Promissory Note Extension between Registrant and
Acme Resources, LLC, dated May 4, 2006, in the
principal amount of $500,000.
Promissory Note between Registrant and Acme
Resources, LLC, dated September 1, 2004, in the
principal amount of $500,000.
Promissory Note Extension between Registrant and
Acme Resources, LLC, dated October 31, 2006.
Software License Agreement with Ingenient
Technologies, Inc., dated March 15, 2004.*
Software License Agreement with Ingenient
Technologies, Inc., dated April 5, 2005.*
Stock Option Agreement with Daniels & Kaplan, P.C.,
dated September 25, 2006.
Memorandum of Understanding with Tri Square
Communications (Hong Kong) Co., Ltd. dated
November 29, 2005.
2007 Stock Option and Restricted Stock Plan.

Form of Stock Option Agreement (ISO and Non-
Qualified) 2007 Stock Option Plan.
Amendment to 2007 Stock Option and Restricted
Stock Plan.
2008 Stock Option and Restricted Stock Plan.

Form of Stock Option Agreement (ISO and Non-
Qualified) 2008 Stock Option Plan.
Promissory Note with Enterprise Bank dated February
13, 2009.
First Amendment to Promissory Note with Enterprise
Bank dated February 13, 2009.
First Amendment to Promissory Note with Enterprise
Bank dated June 30, 2009.
Modification and Renewal of Promissory Note with
Enterprise Bank dated February 1, 2010.
Forms of Restricted Stock Agreement for 2005, 2006,
2007 and 2008 Stock Option and Restricted Stock
Plans.
Loan Modification or Renewal Agreement of
Promissory Note with Enterprise Bank dated March 2,
2011.
2011 Stock Option and Restricted Stock Plan
Form of Stock Option Agreement for 2011 Stock
Option and Restricted Stock Plan
8% Subordinated Promissory Note in principal amount
of $1,500,000
Common Stock Purchase Warrant
8% Subordinated Promissory Note in principal amount
of $1,000,000
Common Stock Purchase Warrant

Exhibit 4.3 to Form 8-K filed July 17, 2015
Exhibit 5.1 of the October 2006 Form SB-2.

Exhibit 10.1 of the October 2006 Form SB-2.
Exhibit 10.2 of the October 2006 Form SB-2.
Exhibit 10.3 of the October 2006 Form SB-2.

Exhibit 10.4 of the October 2006 Form SB-2.

Exhibit 10.5 of the October 2006 Form SB-2.

Exhibit 10.6 of the Company’s Amendment No. 1 to
Form SB-2, filed January 31, 2007, No. 333-138025
(“Amendment No. 1 to Form SB-2”)
Exhibit 10.7 of Amendment No. 1 to Form SB-2.

Exhibit 10.8 of Amendment No. 1 to Form SB-2.

Exhibit 10.9 of Amendment No. 1 to Form SB-2.

Exhibit 10.10 of Amendment No. 1 to Form SB-2.

Exhibit 10.11 of Amendment No. 1 to Form SB-2.

Exhibit 10.3 of the Company’s Form S-8, filed
October 23, 2007, No. 333-146874.
Exhibit 10.13 of the Annual Report on Form 10KSB
for the Year ending December 31, 2007.
Exhibit 10.14 of the Annual Report on Form 10KSB
for the Year ending December 31, 2007.
Exhibit 10.15 of the Annual Report on Form 10KSB
for the Year ending December 31, 2007.
Exhibit 10.16 of the Annual Report on Form 10KSB
for the Year ending December 31, 2007.
Exhibit 10.17 of the Annual Report on Form 10KSB
for the Year ending December 31, 2007.
Exhibit 10.18 of the Annual Report on Form 10K for
the Year ending December 31, 2008.
Exhibit 10.19 of the Quarterly Report on Form 10Q
for the Quarter ending June 30, 2008.
Exhibit 10.20 of the Annual Report on Form 10K for
the Year ending December 31, 2009.
Exhibit 10.21 of the Annual Report on Form 10K for
the Year ending December 31, 2009.

Exhibit 10.22 of the Annual Report on Form 10K for
the Year ending December 31, 2010.

Exhibit 10.23 to Form 8-K filed June 1, 2011
Exhibit 10.24 to Form 8-K filed June 1, 2011

Exhibit 10.25 to Form 8-K filed June 3, 2011

Exhibit 10.26 to Form 8-K filed June 3, 2011
Exhibit 10.27 to Form 8-K filed November 10, 2011

Exhibit 10.28 to Form 8-K filed November 10, 2011

10.29

10.30
10.31

10.32

10.33

10.34

10.35

10.36

10.37

10.38
10.39
10.40
10.41
10.42
10.43
10.44
10.45
10.46
10.47
10.48
10.49
10.50
10.51
10.52
10.53

10.54
10.55
10.56
10.57

10.58
10.59
10.60
10.61
10.62
10.63

10.64

10.65

10.66

10.67
10.68
10.69

10.70

Allonge to 8% Subordinated Promissory Note in
principal amount of $1,000,000

Exhibit 10.29 to Form 8-K filed November 10, 2011

Amendment to Common Stock Purchase Warrant Exhibit 10.30 to Form 8-K filed November 10, 2011

Second Allonge to 8% Subordinated Note, dated July
24, 2012.
Allonge to 8% Subordinated Note ($1.0 million) dated
July 24, 2012.
Second Amendment to Common Stock Purchase
Warrants (300,000 shares) dated July 24, 2012.
Amendment to Common Stock Purchase Warrants
(150,000 shares) dated July 24, 2012.
Third Allonge to 8% Subordinated Note, dated
December 4, 2013.
Second Allonge to 8% Subordinated Note ($1.0
million) dated December 4, 2013.
Common Stock Purchase Warrant (40,000 shares),
dated December 4, 2013
Securities Purchase Agreement
Registration Rights Agreement
Form of Senior Secured Convertible Note
Form of Warrant to Purchase Common Stock
Pledge and Security Agreement
Patent Assignment for Security
Trademarks Assignment for Security
Guaranty
Deposit Account Control Agreement
Form of Voting Agreement
Form of Lock-Up Agreement
Securities Purchase Agreement
Registration Rights Agreement
Form of Senior Secured Convertible Note
Form of Warrant to Purchase Common Stock
Amended and Restated Pledge and Security
Agreement
Patent Assignment for Security
Trademarks Assignment for Security
Amended and Restated Guaranty Agreement
Deposit Account Control Agreement-incorporated by
reference to Exhibit 10.46 to the Company’s Current
Report on Form 8-K filed on March 25, 2014
Form of Voting Agreement
Form of Lock-Up Agreement
Reaffirmation Agreement
Senior Secured Convertible Note
Warrant to Purchase Common Stock
Fourth Allonge to 8% Subordinated Note ($1.5
million) dated May 27, 2015
Third Allonge to 8% Subordinated Note ($1.0 million)
dated May 27, 2015
Fifth Allonge to 8% Subordinated Note ($1.5 million)
dated July 15, 2015
Fourth Allonge to 8% Subordinated Note ($1.0
million) dated July 15, 2015
Common Stock Purchase Warrant
Securities Purchase Agreement
Amended and Restated 2015 Stock Option and
Restricted Stock Plan
Series A Warrant Amendment Agreement

Exhibit 10.31 to Form 8-K filed July 30, 2012

Exhibit 10.32 to Form 8-K filed July 30, 2012

Exhibit 10.33 to Form 8-K filed July 30, 2012

Exhibit 10.34 to Form 8-K filed July 30, 2012

Exhibit 10.35 to Form 8-K filed December 9, 2013

Exhibit 10.36 to Form 8-K filed December 9, 2013

Exhibit 10.37 to Form 8-K filed December 9, 2013

Exhibit 10.38 to Form 8-K filed March 21, 2014
Exhibit 10.39 to Form 8-K filed March 21, 2014
Exhibit 10.40 to Form 8-K filed March 21, 2014
Exhibit 10.41 to Form 8-K filed March 21, 2014
Exhibit 10.42 to Form 8-K filed March 21, 2014
Exhibit 10.43 to Form 8-K filed March 21, 2014
Exhibit 10.44 to Form 8-K filed March 21, 2014
Exhibit 10.45 to Form 8-K filed March 21, 2014
Exhibit 10.46 to Form 8-K filed March 21, 2014
Exhibit 10.47 to Form 8-K filed March 21, 2014
Exhibit 10.48 to Form 8-K filed March 21, 2014
Exhibit 10.49 to Form 8-K filed August 25, 2014
Exhibit 10.50 to Form 8-K filed August 25, 2014
Exhibit 10.51 to Form 8-K filed August 25, 2014
Exhibit 10.52 to Form 8-K filed August 25, 2014
Exhibit 10.53 to Form 8-K filed August 25, 2014

Exhibit 10.54 to Form 8-K filed August 25, 2014
Exhibit 10.55 to Form 8-K filed August 25, 2014
Exhibit 10.56 to Form 8-K filed August 25, 2014
Exhibit 10.57 to Form 8-K filed August 25, 2014

Exhibit 10.58 to Form 8-K filed August 25, 2014
Exhibit 10.59 to Form 8-K filed August 25, 2014
Exhibit 10.60 to Form 8-K filed August 25, 2014
Exhibit 10.61 to Form 8-K filed August 28, 2014
Exhibit 10.62 to Form 8-K filed August 28, 2014
Exhibit 10.63 to Form 8-K filed May 28, 2015

Exhibit 10.64 to Form 8-K filed May 28, 2015

Exhibit 10.65 to Form 8-K filed July 15, 2015

Exhibit 10.66 to Form 8-K filed July 15, 2015

Exhibit 10.67 to Form 8-K filed July 15, 2015
Exhibit 10,1 to Form 8-K filed July 17, 2015
Exhibit 10.1 to Form S-8 filed May 23, 2016

Exhibit 4.1 to Form 8-K filed November 16, 2016

10.71
10.72
10.73
10.74
10.75
10.76
10.77
10.78
10.78
10.78
10.78

14.1

21.1

23.1
23.3

24.1
31.1

31.2

32.1

32.2

99.1

Series B Warrant Amendment Agreement
Series C Warrant Amendment Agreement
Securities Purchase Agreement
8% Senior Secured Convertible Debenture
Common Stock Purchase Warrant
Security Agreement
Subsidiary Guarantee
Form of Series A-1 Warrant
Form of Series A-2 Warrant
Form of Series A-3 Warrant
Form of Securities Purchase Agreement, dated as of
August 21, 2017, by and among Digital Ally, Inc. and
the purchasers signatory thereto.
Code of Ethics and Code of Conduct.

Subsidiaries of Registrant

Consent of RSM US LLP
Consent of Quarles & Brady LLP (Included in 5.1
above)
Power of Attorney.
Certificate of Stanton E. Ross, Chief Executive
Officer, pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
Certificate of Thomas J. Heckman, Chief Financial
Officer, pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
Certificate of Stanton E. Ross, Chief Executive
Officer, pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
Certificate of Thomas J. Heckman, Chief Financial
Officer, pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
Audited Financial Statements of Digital Ally, Inc. as
of and for the years ended December 31, 2017 and
2016.
XBRL Instance Document.
XBRL Taxonomy Extension Schema Document

Exhibit 4.2 to Form 8-K filed November 16, 2016
Exhibit 4.3 to Form 8-K filed November 16, 2016
Exhibit 10.66 to Form 8-K filed January 3, 2017
Exhibit 10.67 to Form 8-K filed January 3, 2017
Exhibit 10.68 to Form 8-K filed January 3, 2017
Exhibit 10.69 to Form 8-K filed January 3, 2017
Exhibit 10.70 to Form 8-K filed January 3, 2017
Exhibit 4.1 to Form 8-K filed August 25, 2017
Exhibit 4.2 to Form 8-K filed August 25, 2017
Exhibit 4.3 to Form 8-K filed August 25, 2017
Exhibit 10.1 to Form 8-K filed August 25, 2017

Exhibit 3.5 of the Annual Report on Form 10-KSB
for the Year ending December 31, 2007.
Exhibit 21.1 of the Annual Report on Form 10-K for
the Year ending December 31, 2015.

Exhibit 5.1 of the October 2006 Form SB-2.

X
X

101.INS**
101.SCH**
101.CAL** XBRL Taxonomy Calculation Linkbase Document.
101.LAB**
101.PRE** XBRL Taxonomy Presentation Linkbase Document.

XBRL Taxonomy Labels Linkbase Document.

* Information marked [*] has been omitted pursuant to a Confidential Treatment Request filed with the Securities and Exchange
Commission. Omitted material for which confidential treatment has been granted has been filed separately with the Securities and
Exchange Commission.

** The XBRL related information in Exhibit 101 to this Annual Report on Form 10-K shall not be deemed “filed” for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability of that Section and shall not be
incorporated by reference into any filing or other document pursuant to the Securities Act of 1933, as amended, except as shall be
expressly set forth by specific reference in such filing or document.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused

this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SIGNATURES

DIGITAL ALLY, INC.,
a Nevada corporation

By: /s/ STANTON E. ROSS

Stanton E. Ross
President and Chief Executive Officer

Each person whose signature appears below authorizes Stanton E. Ross to execute in the name of each such person who is then
an officer or director of the registrant, and to file, any amendments to this Annual Report on Form 10-K necessary or advisable to enable
the registrant to comply with the Securities Exchange Act of 1934 and any rules, regulations and requirements of the Securities and
Exchange Commission in respect thereof, which amendments may make such changes in such Report as such attorney-in-fact may deem
appropriate.

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by

following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature and Title

/s/ STANTON E. ROSS
Stanton E. Ross, Director and Chief Executive Officer

/s/ LEROY C. RICHIE
Leroy C. Richie, Director

/s/ MICHAEL J. CAULFIELD
Michael J. Caulfield, Director

/s/ DANIEL F. HUTCHINS
Daniel F. Hutchins, Director

/s/ THOMAS J. HECKMAN
Thomas J. Heckman, Chief Financial Officer, Secretary, Treasurer, and
Principal Accounting Officer

Date

April 13, 2018

DIGITAL ALLY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page(s)

Report of Independent Registered Public Accounting Firm

Consolidated Financial Statements:

Consolidated Balance Sheets – December 31, 2017 and 2016

Consolidated Statements of Operations for the Years Ended
December 31, 2017 and 2016

Consolidated Statements of Stockholders’ Equity for the Years Ended
December 31, 2017 and 2016

Consolidated Statements of Cash Flows for the Years Ended
December 31, 2017 and 2016

Notes to the Consolidated Financial Statements

F-2

F-3

F-4

F-5

F-6 – F-7

F-8 – F-29

F-1

Report of Independent Registered Public Accounting Firm

To the Stockholders and the Board of Directors of Digital Ally, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Digital Ally, Inc. and its subsidiaries (the Company) as of December
31, 2017 and 2016, the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended, and
the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements
present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its
operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States
of America.

Emphasis of Matter Regarding Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed
in Note 1 to the financial statements, the Company has suffered recurring losses from operations and negative cash flows from operating
activites. This raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to
these matters also are described in Note 1. The financial statements do not include any adjustments that might result from the outcome
of this uncertainty. Our opinion is not modified with respect to this matter.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the
Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting
Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S.
federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part
of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing
an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding
the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and
significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that
our audits provide a reasonable basis for our opinion.

RSM US LLP

We have served as the Company’s auditor since 2015.

Kansas City, Missouri
April 13, 2018

F-2

DIGITAL ALLY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2017 AND 2016

Current assets:

Assets

Cash and cash equivalents
Accounts receivable-trade, less allowance for doubtful accounts of $70,000 – 2017
and 2016
Accounts receivable-other
Inventories, net
Restricted cash
Prepaid expenses

Total current assets

Furniture, fixtures and equipment, net
Restricted cash
Intangible assets, net
Income tax refund receivable

Other assets

Total assets

Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable
Accrued expenses
Derivative liabilities
Capital lease obligation-current
Deferred revenue-current
Subordinated and secured notes payable
Secured convertible debentures, at fair value
Income taxes payable

Total current liabilities

Secured convertible debentures, at fair value
Capital lease obligation-less current portion
Deferred revenue-long term

Total liabilities

Commitments and contingencies

2017

2016

54,712 $

3,883,124

1,978,936
338,618
8,750,713
500,000
209,163

2,519,184
341,326
9,586,311
—
402,158

11,832,142

16,732,103

638,169
—
497,180
90,000

873,902
500,000
467,176
—

115,043

261,915

13,172,534 $

18,835,096

3,193,269 $
1,240,429
16,816
8,492
1,409,683
1,008,500
3,262,807
10,141

2,455,579
1,542,729
33,076
32,792
925,932
—
—
7,048

10,150,137

4,997,156

—
—
2,158,649

4,000,000
8,492
2,073,176

12,308,786

11,078,824

Common stock, $0.001 par value; 25,000,000 shares authorized; shares issued:
7,037,799 – 2017 and 5,552,449 – 2016
Additional paid in capital
Treasury stock, at cost (63,518 shares)
Accumulated deficit

Total stockholders’ equity

7,038
64,923,735
(2,157,226 )
(61,909,799 )

5,552
59,565,288
(2,157,226 )
(49,657,342 )

863,748

7,756,272

Total liabilities and stockholders’ equity

13,172,534 $

18,835,096

See Notes to Consolidated Financial Statements.

F-3

DIGITAL ALLY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED
DECEMBER 31, 2017 AND 2016

Revenue:
Product
Service and other
Total revenue

Cost of revenue:

Product
Service and other
Total cost of revenue

Gross profit

Selling, general and administrative expenses:

Research and development expense
Selling, advertising and promotional expense
Stock-based compensation expense
General and administrative expense

Total selling, general and administrative expenses

Operating loss

Interest income
Interest expense
Change in fair value of warrant derivative liabilities
Change in fair value of secured convertible notes payable
Loss on extinguishment of subordinated notes payable
Secured convertible debentures issuance expense
Loss before income tax (benefit)
Income tax (benefit)
Net loss

Net loss per share information:

Basic
Diluted

Weighted average shares outstanding:

Basic
Diluted

2017

2016

12,773,560 $
1,804,040
14,577,600

15,014,647
1,559,844
16,574,491

8,771,474
1,261,153
10,032,627

10,461,064
812,194
11,273,258

4,544,973

5,301,233

3,149,011
3,873,091
1,752,579
6,969,757
15,744,438
(11,199,465 )

11,818
(733,736 )
16,260
(12,807 )
(424,527 )
—
(12,342,457 )
(90,000 )
(12,252,457 ) $

3,186,137
4,238,895
1,592,365
8,770,024
17,787,421
(12,486,188 )

26,195
(3,102 )
33,977
—
—
(281,570 )
(12,710,688 )
—
(12,710,688 )

(1.76 ) $
(1.76 ) $

(2.38 )
(2.38 )

6,974,281
6,974,281

5,347,042
5,347,042

$
$

See Notes to Consolidated Financial Statements.

F-4

DIGITAL ALLY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2017 AND 2016

Balance, December 31, 2015
Stock-based compensation
Restricted common stock grant
Restricted common stock forfeitures
Issuance of common stock upon exercise of stock
options
Issuance of common stock upon conversion of
secured convertible note payable to equity
Net loss

Additional
Treasury Accumulated
Common Stock
Paid In
Stock
Shares Amount Capital
5,241,999 $ 5,242 $ 57,854,178 $ (2,157,226 ) $ (36,946,654 ) $ 18,755,540
— 1,592,365
—
—
—
—

— 1,592,365
(290 )
5

—
290,000
(4,600 )

—
—
—

290
(5 )

Deficit

Total

5,050

19,050

—

19,055

20,000
—

20
—

99,980
—

100,000
—
—
— (12,710,688 ) (12,710,688 )

Balance, December 31, 2016

5,552,449 5,552 59,565,288 (2,157,226 ) (49,657,342 ) 7,756,272

Stock-based compensation

—

— 1,752,579

Restricted common stock grant
Restricted common stock forfeitures
Issuance of common stock upon exercise of common
stock purchase warrants
Issuance of common stock and warrants, net of
issuance costs of $223,068
Issuance of common stock purchase warrants in
connection with issuance of subordinated notes
payable

522,000
(36,650 )

522
(36 )

(522 )
36

60,000

540

940,000

940 2,775,392

—

—
—

—

— 1,752,579

—
—

—

—
—

600

— 2,776,332

—

830,422

—

830,422

Net loss

—

— (12,252,457 ) (12,252,457 )

Balance, December 31, 2017

7,037,799 $ 7,038 $ 64,923,735 $ (2,157,226 ) $ (61,909,799 ) $

863,748

See Notes to Consolidated Financial Statements.

F-5

DIGITAL ALLY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2017 AND 2016

Cash Flows From Operating Activities:

Net loss
Adjustments to reconcile net loss to net cash flows used in operating activities:

2017

2016

(12,252,457 ) $

(12,710,688 )

Depreciation and amortization
Secured convertible debenture expenses
Stock based compensation
Change in fair value of warrant derivative liabilities
Amortization of discount on subordinated note payable
Loss on extinguishment of subordinated notes payable
Change in fair value of secured convertible note payable
Provision for inventory obsolescence
Provision for doubtful accounts receivable

Change in assets and liabilities:
(Increase) decrease in:

Accounts receivable - trade
Accounts receivable - other
Inventories
Prepaid expenses
Income tax refund receivable
Other assets

Increase (decrease) in:
Accounts payable
Accrued expenses
Income taxes payable
Deferred revenue

Net cash used in operating activities
Cash Flows from Investing Activities:

Purchases of furniture, fixtures and equipment
Additions to intangible assets
Release (restriction) of cash in accordance with secured convertible note
Net cash used in investing activities
Cash Flows from Financing Activities:

Proceeds from issuance of subordinated notes payable
Proceeds from issuance of common stock and warrants, net of issuance costs
Proceeds from secured convertible debentures and detachable common stock
purchase warrants
Secured convertible debenture issuance expense
Principal payment on subordinated notes payable
Principal payment on secured convertible debentures
Proceeds from exercise of stock options and warrants
Principal payments on capital lease obligations
Net cash provided by financing activities

Net decrease in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period

681,928
—
1,752,579
(16,260 )
405,895
424,527
12,807
990,782
—

540,248
2,708
(155,184 )
192,995
(90,000 )
146,872

737,690
(302,300 )
3,093
569,224
(6,354,853 )

(322,714 )
(153,485 )
—
(476,199 )

1,608,500
2,776,332

—
—
(600,000 )
(750,000 )
600
(32,792 )
3,002,640
(3,828,412 )
3,883,124

54,712 $

574,080
281,570
1,592,365
(33,977 )
—
—
—
797,509
(4,997 )

854,722
(198,853 )
277,946
183,857
—
54,606

1,081,419
606,402
(3,091 )
744,229
(5,902,901 )

(340,674 )
(100,037 )
(500,000 )
(940,711 )

—
—

4,000,000
(281,570 )
—
—
119,055
(34,828 )
3,802,657
(3,040,955 )
6,924,079
3,883,124

F-6

Supplemental disclosures of cash flow information:

Cash payments for interest

Cash payments for income taxes

Supplemental disclosures of non-cash investing and financing activities:

Restricted common stock grant

Restricted common stock forfeitures

$ 238,259 $ 3,089

$ 6,908 $ 10,591

522 $

290

(36 ) $

(5 )

Amounts allocated to common stock purchase warrants in connection with proceeds from subordinated notes
payable

$ 830,422 $ —

See Notes to Consolidated Financial Statements.

F-7

DIGITAL ALLY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business:

Digital Ally, Inc. and subsidiaries (collectively, “Digital Ally,” “Digital,” the “Company,” “we,” “ours” and “us”) 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, taxi cab 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.

Management’s Liquidity Plan

The Company incurred substantial operating losses in the year ended December 31, 2017 and recent years primarily due to reduced
revenues and gross margins caused by specific product quality issues resulting in the significant delays in customer orders and product
rework expenditures and introduction by competitors of newer products with more features than those of the Company. In addition, the
Company’s revenues and gross margins have been significantly and negatively impacted by its competitors’ willful infringement of the
Company’s patents, specifically the auto-activation of body-worn and in-car video systems, and its competitor’s significant price cutting
of their products. The Company has incurred net losses of approximately $12.3 million in 2017 and $12.7 million in 2016 and it had an
accumulated deficit of $61.9 million as of December 31, 2017. 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 funding in the form of subordinated
and secured debt totaling $1,608,500 and the issuance of common stock and warrants totaling $2,776,332 during 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 had outstanding $1,008,500 principal amount of subordinated and secured notes payable which were to mature
prior to or on March 31, 2018. Additionally, the $3.3 million principal amount of 8% Secured Convertible Debentures (the “Debentures”)
matured on March 30, 2018. The notes and Debentures represent current liabilities as of December 31, 2017 and required the Company
to negotiate extensions and/or raise substantial funds through the issuance of new debt and/or equity to liquidate such notes and
Debentures. As part of the Company’s overall strategic alternatives process which commenced in November 2017, the Board of
Directors approved a private placement (the “Private Placement”) of $6.05 million principal amount of 8% Senior Secured Convertible
Notes (the “Notes”) and 806,667 warrants (the “Warrants”) exercisable to purchase 806,667 shares of common stock of the Company.
This Private Placement closed on April 3, 2018 and is described in Subsequent Events Footnote 15. A portion of the proceeds were used
to repay in full the Debentures and approximately $1,008,500 principal amount and accrued interest on the subordinated and secured
notes that were due to mature. The balance of the net proceeds will be used for working capital and general corporate purposes. The
Company believes that this financing has addressed its near-term liquidity needs.

The Company is also negotiating with the Web.com golf tournament officials to terminate its sponsorship fee commitment of
$500,000 annually for 2018 and 2019 tournaments. There can be no assurance that it will be successful in negotiating the termination
of this sponsorship agreement or that if successful in such negotiation on terms acceptable or favorable to the Company. These conditions
indicate that there is substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the
financial statements are issued.

The Company will have to restore positive operating cash flows and profitability over the next twelve months 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 if
and when needed, and obtain it on terms acceptable or favorable to the Company.

F-8

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
has undertaken significant cost reduction initiatives, including a significant lay-off of employees reducing its workforce by
approximately 40%, restructuring its direct sales force and cutting other selling, general and administrative costs. The Company
introduced a new full high definition in-car video system (DVM-800 HD), which is intended to help it regain market share and improve
revenues in its law enforcement division. In late 2017 the Company entered into a three-year supply and distribution agreement with a
competitor (“VieVu”) that includes minimum purchase requirements of $2.5 million in 2018 and $3.0 million in 2019 to maintain its
exclusive status. The Company has increased its addressable market to non-law enforcement customers and obtained new non-law
enforcement contracts in 2017 and early 2018, which contracts include recurring revenue over the 2018 to 2020 period. The Company
believes that its quality control, headcount reduction and cost cutting initiatives, introduction of the DVM-800 HD for law enforcement
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.

In addition to the initiatives described above, the Board of Directors is conducting a 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.) and Enforcement Video, LLC d/b/a WatchGuard
Video (“WatchGuard”), 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 Company has retained Roth Capital Partners (“Roth”) to assist in this process. The private placement of Notes and Warrants
completed on April 3, 2018 was a part of this strategic alternatives review. While the Private Placement 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 after the date of the financial statements in this Report.

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 subsidiaries,
Digital Ally International, Inc., MP Ally, LLC, Medical Devices Ally, LLC and Digitaldeck, LLC. 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. In addition,
Medical Devices Ally, LLC was formed in July 2014, MP Ally, LLC was formed in July 2015, and Digitaldeck, LLC was formed in
June 2017, all of which have been inactive since formation.

Fair Value of Financial Instruments:

The carrying amounts of financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and
subordinated notes payable approximate fair value because of the short-term nature of these items. The Company accounts for its
derivative liabilities and its secured convertible debentures on a fair value basis.

Revenue Recognition:

Revenues from the sale of products are recorded when the product is shipped, title and risk of loss has transferred to the purchaser,
payment terms are fixed or determinable and payment is reasonably assured. 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 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. Revenue is recorded
when the product is shipped to the distributor consistent with the terms of the distribution agreement.

F-9

●

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 an accrued expense 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 are treated as deferred revenue and recognized over the term of
the contracted warranty or service period on a straight-line method.

Multiple element arrangements consisting of product, software, cloud and extended warranties are offered to our customers.
Revenue arrangements with multiple deliverables are divided into separate units and revenue is allocated using the relative selling price
method based upon vendor-specific objective evidence of selling price or third-party evidence of the selling prices if vendor-specific
objective evidence of selling prices does not exist. If neither vendor-specific objective evidence nor third-party evidence exists,
management uses its best estimate of selling price. The majority of the Company’s allocations of arrangement consideration under
multiple element arrangements are performed using vendor-specific objective evidence by utilizing prices charged to customers for
deliverables when sold separately. The Company’s multiple element arrangements 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. The Company has not utilized third-party evidence of selling price.

The net expense (income) related to sales returns and allowances aggregated $(18,503) and $494,790 for the years ended
December 31, 2017 and 2016, respectively. Obligations for 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. A customer paid under a sales transaction in March 2017 that had been accrued to be returned at December 31, 2016, which the
caused the negative sales returns for the year ended December 31, 2017.

Use of Estimates:

The preparation of the 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.

Cash and cash equivalents that are restricted as to withdrawal or use under the terms of the secured convertible debentures are

presented as restricted cash separate from cash and cash equivalents on the accompanying balance sheet.

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

F-10

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 two 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.

Secured convertible debentures:

The Company has elected to record its debentures at fair value. Accordingly, the debentures will be marked-to-market at each
reporting date with the change in fair value reported as a gain (loss) in the Consolidated Statements of Operations. All issuance costs
related to the debentures were expensed as incurred in the Consolidated Statements of Operations.

Long-Lived Assets:

Long-lived assets such as property, plant 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 deferred revenue and recognized
over the term of the extended warranty.

Shipping and Handling Costs:

Shipping and handling costs for outbound sales orders totaled $64,745 and $93,685 for the years ended December 31, 2017 and

2016, respectively. Such costs are included in general and administrative expenses in the 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 $761,656 and $1,147,219 for the years ended December 31, 2017 and 2016, respectively. Such costs are included i n
selling, advertising and promotional expenses in the 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

F-11

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 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 Consolidated Statements of Operations. There was no interest expense related to the underpayment of estimated taxes
during the years ended December 31, 2017 and 2016. There were no penalties in 2017 and 2016.

The Company is subject to taxation in the United States and various states. As of December 31, 2017, the Company’s tax returns
filed for 2014, 2015, and 2016 and to be filed for 2017 are subject to examination by the relevant taxing authorities. With few exceptions,
as of December 31, 2017, the Company is no longer subject to Federal, state, or local examinations by tax authorities for years before
2014.

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 2017 and 2016.

Common Stock Purchase Warrants:

The Company has common stock purchase warrants that are accounted for as liabilities under the caption of derivative liabilities
on the consolidated balance sheet and recorded at fair value due to the warrant agreements containing anti-dilution provisions. The
change in fair value is being recorded in Consolidated Statements of Operations.

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.

F-12

Segments of Business:

The Company 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 year ended December 31, 2017 and 2016, sales by geographic area were as follows:

Sales by geographic area:

United States of America
Foreign

Year Ended December 31,
2016
2017

14,017,778 $
559,822
14,577,600 $

15,383,479
1,191,012
16,574,491

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:

In May 2014, the FASB issued Accounting Standard Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers”
(“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of
promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it
becomes effective. The standard is effective for interim and annual periods beginning after December 15, 2017 and permits the use of
either the retrospective or cumulative effect transition method. Additionally, this new guidance will require significantly expanded
disclosures about revenue recognition.

The Company will adopt the new guidance on January 1, 2018 using the modified retrospective approach, which will result in an
adjustment to accumulated deficit for the cumulative effect of applying this standard to contracts in process as of the adoption date.
Under this approach, the Company will not revise the prior financial statements presented, but will provide additional disclosures of the
amount by which each financial statement line item is affected in the current reporting period during 2018 as a result of applying the
new revenue guidance. This will include a qualitative explanation of the significant changes between the reported results under the
revenue standard and the previous guidance.

The Company has substantially completed its assessment of the potential impact this guidance will have on its consolidated
financial statements and related disclosures. Based on that assessment, the Company currently expects the most significant impact of
this new guidance will be the capitalization of costs to both obtain contracts, which are expected to result in adjustments of approximately
$71,000 to decrease the opening balance of accumulated deficit upon adoption.

In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. The amendments
in the ASU require entities that measure inventory using the first-in, first-out or average cost methods to measure inventory at the lower
of cost and net realizable value. Net realizable value is defined as estimated selling price in the ordinary course of business less
reasonably predictable costs of completion, disposal and transportation.. The Company adopted this new standard on January 1, 2017
and such adoption did not have any impact on its consolidated financial statements.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes.
This ASU simplifies the presentation of deferred income taxes by eliminating the requirement for entities to separate deferred tax
liabilities and assets into current and noncurrent amounts in classified balance sheets. Instead, it requires deferred tax assets and liabilities
be classified as noncurrent in the balance sheet. The Company adopted this new standard on January 1, 2017 and such adoption did not
have any impact on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The objective of ASU 2016-02 is to recognize lease
assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. ASU 2016-02 is effective

for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of ASU 2016-02
is permitted. The Company is evaluating the effects adoption of this guidance will have on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718). The objective of ASU 2016-
09 is to reduce the complexity of certain aspects of the accounting for employee share-based payment transactions. As a result of this
ASU, there are changes to minimum statutory withholding requirements, accounting for forfeitures, and accounting for income taxes.
The Company adopted this new standard on January 1, 2017 and elected to account for forfeitures as they occur.

F-13

In August 2016, the FASB issued ASU 2016-15, Clarification on Classification of Certain Cash Receipts and Cash Payments on
the Statement of Cash Flows, to create consistency in the classification of eight specific cash flow items. This standard is effective for
calendar-year SEC registrants beginning in 2018. The Company is evaluating the effects adoption of this guidance will have on its
consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash (Topic 230), which amends the
existing guidance relating to the disclosure of restricted cash and restricted cash equivalents on the statement of cash flows. ASU 2016-
18 is effective for the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, and early adoption is
permitted. The Company is evaluating the impact of adoption of ASU 2016-18 on its Consolidated Statements of Cash Flows.

In May 2017, the FASB issued ASU 2017-09, Stock Compensation (Topic 718)-Scope of Modification Accounting, to provide
guidance on determining which changes to terms and conditions of share-based payment awards require an entity to apply modification
accounting under Topic 718. The ASU is effective for annual periods beginning after December 15, 2017, and interim periods within
those annual periods. The Company is evaluating the effects adoption of this guidance will have on its consolidated financial statements.

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260)-Distinguishing Liabilities from Equity (Topic 480);
Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II)
Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain
Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. The amendments in Part I of the ASU change the
classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When
determining whether certain financial instruments should be classified as liabilities or equity instruments a down round feature no longer
precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments in Part II
recharacterize the indefinite deferral of certain provisions of Topic 480 with a scope exception and do not have an accounting effect.
The ASU is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. The
Company is evaluating the effects adoption of this guidance will have on its consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815)-Targeted Improvements to Accounting for
Hedging Activities. The new guidance is intended to more closely align hedge accounting with entities’ hedging strategies, simplify the
application of hedge accounting, and increase the transparency of hedging programs. The ASU is effective for annual periods beginning
after December 15, 2018, and interim periods within those annual periods. The Company is evaluating the effects adoption of this
guidance will have on its consolidated financial statements.

NOTE 2. 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 $70,000 as of December 31, 2017 and 2016.

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 years ended December 31, 2017 and 2016.

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 3. ACCOUNTS RECEIVABLE – ALLOWANCE FOR DOUBTFUL ACCOUNTS

The allowance for doubtful accounts receivable was comprised of the following for the years ended December 31, 2017 and

2016:

F-14

Beginning balance
Provision for bad debts
Charge-offs to allowance, net of recoveries
Ending balance

NOTE 4. INVENTORIES

December 31,
2017

December 31,
2016

70,000 $
—
—
70,000 $

74,997
2,224
(7,221 )
70,000

Inventories consisted of the following at December 31, 2017 and 2016:

Raw material and component parts
Work-in-process
Finished goods
Subtotal

Reserve for excess and obsolete inventory

Total

December 31,
2017

December 31,
2016

4,621,704 $
155,087
6,964,624
11,741,415
(2,990,702 )
8,750,713 $

4,015,170
355,715
7,215,346
11,586,231
(1,999,920 )
9,586,311

Finished goods inventory includes units held by potential customers and sales agents for test and evaluation purposes. The cost of

such units totaled $680,805 and $634,059 as of December 31, 2017 and December 31, 2016, respectively.

NOTE 5. FURNITURE, FIXTURES AND EQUIPMENT

Furniture, fixtures and equipment consisted of the following at December 31, 2017 and 2016:

Office furniture, fixtures and equipment
Warehouse and production equipment
Demonstration and tradeshow equipment
Leasehold improvements
Rental equipment

Total cost

Less: accumulated depreciation and amortization
Net furniture, fixtures and equipment

Estimated
Useful Life
3-10 years
3-5 years
2-5 years
2-5 years
1-3 years

December 31,
2017

December 31,
2016

881.306 $
515,368
426,582
160,198
93,592
2,077,046

(1,438,877 )

638,169 $

1,074,533
643,250
451,750
153,828
60,354
2,383,715

(1,509,813 )
873,902

Depreciation and amortization of furniture, fixtures and equipment aggregated $558,447 and $530,958 for the years ended December
31, 2017 and 2016, respectively.

NOTE 6. INTANGIBLE ASSETS

Intangible assets consisted of the following at December 31, 2017 and 2016:

December 31, 2017
Accumulated
Amortization

Net Carrying
Value

Gross value

Gross Value

December 31, 2016
Accumulated
Amortization

Net Carrying
Value

Amortized intangible assets:

Licenses
Patents and Trademarks

Unamortized intangible assets:

73,892 $
379,616
453,508

20,672 $
169,069
189,741

53,220 $
210,547
263,767

73,892 $
374,348
448,240

10,115 $
80,093
90,208

63,777
294,255
358,032

Patents and trademarks
pending
Total

233,413
686,921 $

—
189,741 $

233,413
497,180 $

109,144
557,384 $

—
90,208 $

109,144
467,176

F-15

Patents and trademarks pending will be amortized beginning at the time they are issued by the appropriate authorities. If

issuance of the final patent or trademark is denied, then the amount deferred will be immediately charged to expense.

Amortization expense for the years ended December 31, 2017 and 2016 was $123,481 and $43,122, respectively. Estimated

amortization for intangible assets with definite lives for the next five years ending December 31 and thereafter is as follows:

Year Ending December 31:

2018
2019
2020
2021
2022
thereafter

114,060
109,078
19,077
10,556
10,556
440

263,767

NOTE 7. SECURED CONVERTIBLE DEBENTURES, SUBORDINATED AND SECURED NOTES PAYABLE, AND
CAPITAL LEASE OBLIGATIONS

2016 Secured Convertible Debentures. Secured Convertible Debentures is comprised of the following:

Secured convertible debentures, at fair value

Less: Current maturities of secured convertible debentures, at fair value
Secured convertible debentures, at fair value-long-term

December 31,
2017

December 31,
2016

3,262,807 $

(3,262,807 )

— $

4,000,000

—
4,000,000

On December 30, 2016, the Company completed a private placement (the “Private Placement”) of $4.0 million in principal
amount of the Debentures and common stock warrants (the “Warrants”) to two institutional investors. The Debentures and Warrants
were issued pursuant to a Securities Purchase Agreement (the “Purchase Agreement”) between the Company and the purchasers’
signatory thereto (the “Holders”). The Private Placement resulted in gross proceeds of $4.0 million before placement agent fees and
other expenses associated with the transaction totaling $281,570, which was expensed as incurred.

The Company elected to account for the Debentures on the fair value basis. Therefore, the Company determined the fair value

of the Debentures utilizing Monte Carlo simulation models which yielded an estimated fair value of $4.0 million for the Debentures
including their embedded derivatives as of the origination date. No value was allocated to the detachable Warrants as of the origination
date because of the relative fair value of the convertible note including its embedded derivative features approximated the gross proceeds
of the financing transaction. The Company made principal payments of $750,000 on August 24, 2017 on the Debentures. The change
in the fair value of the Debentures between December 31, 2016 and December 31, 2017 was $12,807 and was reflected as expense in
the Consolidated Statements of Operations.

Prior to the maturity date, the Debentures bear interest at 8% per annum with interest payable in cash quarterly in arrears on
the first business day of each calendar quarter following the issuance date. The Debentures rank senior to the Company’s existing and
future indebtedness and are secured by substantially all tangible and certain intangible assets of the Company.

The Debentures are convertible at any time six months after their date of issue at the option of the holders into shares of the
Company’s common stock at $5.00 per share (the “Conversion Price”). The Debentures mature on March 30, 2018. The Warrants are
exercisable to purchase up to an aggregate of 800,000 shares of the Company’s common stock commencing on the date of issuance at
an exercise price of $5.00 per share (the “Exercise Price”). The Warrants will expire on the fifth anniversary of their date of issuance.
The Conversion Price and Exercise Price are subject to adjustment upon stock splits, reverse stock splits, and similar capital changes.

The Company has the right, subject to certain limitations, to redeem the Debenture with 30 days advance notice with the
redemption amount determined as the sum of (a) 112% of the then outstanding principal amount of the Debenture, (b) accrued but
unpaid interest and (c) all liquidated damages and other amounts due in respect of the Debenture, if any.

F-16

Additionally, if following the six-month anniversary of the Original Issue Date, the VWAP (volume weighted average price),
for each of any ten (10) consecutive trading days exceeds $7.50 per share, the Company has the right, subject to certain limitations, to
provide written notice to the Holders to cause them to convert all or part of the then outstanding principal amount of the Debenture plus
accrued but unpaid interest.

Upon the occurrence of an event of default, the Debentures bear interest at 18% per annum and a Holder may require the
Company to redeem all or a portion of its Debenture. The Company has agreed to maintain a cash balance of $500,000 while the
Debentures are outstanding, which is reflected as restricted cash in the accompanying balance sheet. The Holders have agreed to
beneficial conversion limitation that effectively blocks either Holder from converting the Debenture or exercising the Warrant to the
extent that such conversion or exercise would result in the Holder being the beneficial owner in excess of 4.99% (or, upon election of
purchaser, 9.99%), which beneficial ownership limitation may be increased or decreased up to 9.99% upon notice to the Company,
provided that any increase in such limitation will not be effective until 61 days following notice to the Company.

During the year ended December 31, 2017, the Company was required to make payments totaling $750,000 to the holders of

the Debentures resulting from the repayment provisions of the Debentures relative to additional capital raises.

Subordinated and Secured Notes Payable. Subordinated and secured notes payable is comprised of the following:

Subordinated and secured notes payable, at par

1,008,500 $

—

December 31,
2017

December 31,
2016

On June 30, 2017, the Company, in two separate transactions, borrowed an aggregate of $700,000 under two unsecured notes
payable to private, third-party lenders. The loans were funded on June 30, 2017 and both were represented by promissory notes (the
“June Notes”) that bore interest at the rate of 8% per annum with principal and accrued interest payable on or before their maturity date
of September 30, 2017. The June Notes were unsecured and subordinated to all existing and future senior indebtedness, as such term
was defined in the June Notes. The Company granted the lenders warrants (the “Warrants”) exercisable to purchase a total of 200,000
shares of its common stock at an exercise price of $3.65 per share until June 29, 2022. The Company allocated $288,895 of the proceeds
of the Notes to additional paid-in-capital, which represented the grant date relative fair value of the Warrants issued to the lenders. The
discount was amortized to interest expense ratably over the terms of the Note. On September 30, 2017, the Company obtained an
extension of the maturity date of one of the June Notes to December 31, 2017 and then an extension to March 31, 2018. In connection
with the extension, the Company issued warrants to purchase 100,000 shares of stock at $2.60 per share until November 15, 2022. The
Company treated the extension of this debt as an extinguishment for financial accounting purposes. Accordingly, the estimated fair value
of the warrants granted totaled $180,148, which was recorded as additional paid-in-capital and a loss on extinguishment of subordinated
notes payable. The Company paid the second June Note in full in August 2017.

On September 29, 2017, the Company borrowed $300,000 under an unsecured note payable with a private, third party lender.
Such note bore interest at 8% per annum and was due and payable in full on November 30, 2017. The note was unsecured and
subordinated to all existing and future senior indebtedness, as such term was defined in the note. The Company issued warrants to the
lender exercisable to purchase 100,000 shares of common stock for $2.75 per share until September 30, 2022. The Company allocated
$117,000 of the proceeds of the note to additional paid-in-capital, which represented the grant date relative fair value of the warrants
issued to the lender. The discount was amortized to interest expense ratably over the terms of the note. On December 29, 2017 the
Company borrowed an additional $350,000 with the same private, third party lender and combined the existing note payable plus accrued
interest into a new note (the “Secured Note”) for $658,500 that is due and payable in full on March 1, 2018 and may be prepaid without
penalty. The Secured Note is secured by the Company’s intellectual property portfolio, as such term is defined in the security agreement
relating to the Secured Note. In connection with issuance of the Secured Note the Company issued warrants to the lender exercisable to
purchase 120,000 shares of common stock for $3.25 per share until December 28, 2022. The Company treated the issuance and extension
of this debt as an extinguishment for financial accounting purposes. Accordingly, the estimated fair value of the warrants granted totaled
$244,379, which was recorded as additional paid-in-capital and a loss on extinguishment of subordinated notes payable.

The discount amortized to interest expense totaled $405,895 and $-0- for the years ended December 31, 2017, and 2016,

respectively.

Capital Leases. Future minimum lease payments under non-cancelable capital leases having terms in excess of one year are as

follows:

F-17

Year Ending December 31:

2018
Total future minimum lease payments
Less amount representing interest
Present value of minimum lease payments
Less current portion

Capital lease obligations, less current portion

8,574
8,574
82
8,492
8,492

—

Assets under capital leases are included in furniture, fixtures and equipment as follows:

Office furniture, fixtures and equipment
Less: accumulated amortization
Net furniture, fixtures and equipment

NOTE 8. FAIR VALUE MEASUREMENT

December 31,
2017

December 31,
2016

250,843 $
(223,533 )

27,310 $

382,928
(294,895 )
88,033

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 December 31, 2017 and 2016.

Liabilities:

Secured convertible debentures
Warrant derivative liability

Liabilities:

Secured convertible debentures
Warrant derivative liability

Level 1

Level 2

Level 3

Total

December 31, 2017

— $
—
— $

3,262,807 $
16,816
3,279,623 $

3,262,807
16,816
3,279,623

Level 1

Level 2

Level 3

Total

December 31, 2016

— $
—
— $

4,000,000 $
33,076
4,033,076 $

4,000,000
33,076
4,033,076

The following table represents the change in level 3 tier value measurements:

December 31, 2016
Principal payments made on debentures
Change in fair value
December 31, 2017

Warrant Derivative
Liability

Secured Convertible
Debentures

33,076 $
—
(16,260 )
16,816 $

4,000,000 $
(750,000 )
12,807
3,262,807 $

Total

4,033,076
(750,000 )
(3,453 )
3,279,623

F-18

NOTE 9. ACCRUED EXPENSES

Accrued expenses consisted of the following at December 31, 2017 and 2016:

Accrued warranty expense
Accrued senior convertible note issuance costs
Accrued sales commissions
Accrued payroll and related fringes
Accrued insurance
Accrued rent
Accrued sales returns and allowances
Other

December 31,
2017

December 31,
2016

325,001 $
—
19,500
242,508
53,888
134,684
17,936
446,912
1,240,429 $

374,597
204,000
36,389
270,781
81,610
182,409
215,802
177,141
1,542,729

Accrued warranty expense was comprised of the following for the years ended December 31, 2017 and 2016:

Beginning balance
Provision for warranty expense
Charges applied to warranty reserve
Ending balance

NOTE 10. INCOME TAXES

2017

2016

374,597 $
287,611
(337,207 )
325,001 $

159,838
343,142
(128,383 )
374,597

The components of income tax provision (benefit) for the years ended December 31, 2017 and 2016 are as follows:

Current taxes:
Federal
State

Total current taxes
Deferred tax provision (benefit)
Income tax provision (benefit)

2017

2016

(90,000 ) $
—
(90,000 )
—
(90,000 ) $

—
—
—
—
—

A reconciliation of the income tax (provision) benefit at the statutory rate of 34% for the years ended December 31, 2017 and

2016 to the Company’s effective tax rate is as follows:

U.S. Statutory tax rate
State taxes, net of Federal benefit
Executive compensation
Federal Research and development tax credits
Stock based compensation
Revaluation of deferred tax assets based on changes in enacted tax laws
Change in valuation reserve on deferred tax assets
Other, net
Income tax (provision) benefit

2017

2016

34.0 %
4.8 %
— %
0.1 %
(3.6 )%
(64.8 )%
30.0 %
0.2 %
0.7 %

34.0 %
3.5 %
(1.3 )%
1.6 %
(2.1 )%
— %
(34.2 )%
(1.5 )%
0.0 %

F-19

Significant components of the Company’s deferred tax assets (liabilities) as of December 31, 2017 and 2016 are as follows:

Deferred tax assets:

Stock-based compensation
Start-up costs
Inventory reserves
Uniform capitalization of inventory costs
Allowance for doubtful accounts receivable
Other reserves
Equipment depreciation
Deferred revenue
Derivative liabilities
Accrued expenses
Net operating loss carryforward
Research and development tax credit carryforward
Alternative minimum tax credit carryforward
State jobs credit carryforward
State research and development credit carryforward
Charitable contributions carryforward

Total deferred tax assets
Valuation reserve

Total deferred tax assets

Domestic international sales company

Total deferred tax liabilities

2017

2016

995,000
115,000
780,000
80,000
40,000
—
100,000
920,000
90,000
145,000
12,870,000
1,795,000
—
230,000
—
45,000

18,205,000
(18,070,000 )

135,000
(135,000 )
(135,000 ))

1,615,000
175,000
785,000
110,000
30,000
5,000
40,000
1,165,000
15,000
340,000
15,755,000
1,955,000
90,000
230,000
280,000
60,000

22,650,000
(22,455,000 )

195,000
(195,000 )
(195,000 )

Net deferred tax assets (liability)

— $

—

The valuation allowance on deferred tax assets totaled $18,070,000 and $22,455,000 as of December 31, 2017 and December 31,
2016, respectively. We record the benefit we will derive in future accounting periods from tax losses and credits and deductible
temporary differences as “deferred tax assets.” In accordance with ASC 740, “Income Taxes,” we record a valuation allowance to reduce
the carrying value of our deferred tax assets if, based on all available evidence, it is more likely than not that some or all of the deferred
tax assets will not be realized.

On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Act”). The Act, which is also commonly referred to as
“U.S. tax reform,” significantly changes U.S. corporate income tax laws by, among other things, reducing the U.S. corporate income
tax rate to 21% starting in 2018. As a result, in the fourth quarter of 2017, the Company revalued the Company’s net deferred tax assets
based on the new lower corporate income tax rate. The result of this revaluation of the Company’s deferred tax assets as of December
31, 2017 resulted in a reduction in net deferred tax assets of approximately $7,995,000 related to the reduction the U.S. corporate income
tax rate to 21% starting in 2018. The valuation allowance on deferred tax assets as of December 31, 2017 was likewise reduced to retain
the 100% valuation allowance as discussed further below.

Under the Act, corporations are no longer subject to the AMT, effective for taxable years beginning after December 31, 2017.
However, where a corporation has an AMT Credit from a prior taxable year, the corporation still carries it forward and may use a portion
of it as a refundable credit in any taxable year beginning after 2017 but before 2022. Generally, 50 percent of the corporation’s AMT
Credit carried forward to one of these years will be claimable and refundable for that year. In tax years beginning in 2021, however, the
entire remaining carryforward generally will be refundable. The Company has generated an AMT credit carryforward on prior years
totaling $90,000 which previously was fully reserved based on all available evidence, the Company considered it more likely than not
that all of the AMT tax credit carryforward would not be realized. Based on the provisions of the new Act, the Company now considers
it more likely than not that all of the AMT tax credit carryforward will be realized. Accordingly, the Company has recognized an income
benefit of $90,000 during the year ended December 31, 2017 which it has recognized as an income tax refund receivable as of December
31, 2017.

The Company has incurred operating losses in 2017 and 2016 and it continues to be in a three-year cumulative loss position at
December 31, 2017 and 2016. 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.

F-20

Therefore, it determined to decrease our valuation allowance by $4,385,000 to recognize the effects of reducing the U.S. corporate
income tax rate to 21% starting in 2018 and to continue to fully reserve its deferred tax assets at December 31, 2017. 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. 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.

At December 31, 2017, the Company had available approximately $49,305,000 of Federal net operating loss carryforwards
available to offset future taxable income generated. Such tax net operating loss carryforwards expire between 2026 and 2037. In addition,
the Company had research and development tax credit carryforwards totaling $1,795,000 available as of December 31, 2017, which
expire between 2023 and 2037.

The Internal Revenue Code contains provisions under Section 382 which limit a company’s ability to utilize net operating loss
carry-forwards in the event that it has experienced a more than 50% change in ownership over a three-year period. Current estimates
prepared by the Company indicate that due to ownership changes which have occurred, approximately $765,000 of its net operating loss
and $175,000 of its research and development tax credit carryforwards are currently subject to an annual limitation of approximately
$1,151,000, but may be further limited by additional ownership changes which may occur in the future. As stated above, the net operating
loss and research and development credit carryforwards expire between 2023 and 2036, allowing the Company to potentially utilize all
of the limited net operating loss carry-forwards during the carryforward period.

As discussed in Note 1, “Summary of Significant Accounting Policies,” tax positions are evaluated in a two-step process. The
Company first determines whether it is more likely than not that a tax position will be sustained upon examination. If a tax position
meets the more-likely-than-not recognition threshold, it is then measured to determine the amount of benefit to recognize in the financial
statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate
settlement. Management has identified no tax positions taken that would meet or exceed these thresholds and therefore there are no
gross interest, penalties and unrecognized tax expense/benefits that are not expected to ultimately result in payment or receipt of cash in
the consolidated financial statements.

The effective tax rate for the years ended December 31, 2017 and 2016 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 December 31, 2017 primarily because of the current year
operating losses.

The Company’s federal and state income tax returns are closed for examination purposes by relevant statute and by examination

for 2013 and all prior tax years.

NOTE 11. COMMITMENTS AND CONTINGENCIES

Operating Leases. The Company had a non-cancelable long-term operating lease agreement for office and warehouse space
that expires during April 2020. The Company also entered into month-to-month leases for equipment. Rent expense for the years ended
December 31, 2017 and 2016 was $397,724 and $397,724, respectively, related to these leases. Following are the minimum lease
payments for each year and in total.

Year Ending December 31:

2018
2019
2020

451,248
457,327
154,131
1,062,706

License agreements. The Company has several license agreements under which it has been assigned the rights to certain
licensed materials used in its products. Certain of these agreements require the Company to pay ongoing royalties based on the number
of products shipped containing the licensed material on a quarterly basis. Royalty expense related to these agreements aggregated
$21,188 and $25,161 for the years ended December 31, 2017 and 2016, respectively.

Litigation.

The Company is subject to various legal proceedings arising from normal business operations. Although there can be no
assurances, based on the information currently available, management believes that it is probable that the ultimate outcome of each of
the actions will not have a material adverse effect on the Consolidated Financial Statements of the Company. However, an adverse

F-21

outcome in certain of the actions could have a material adverse effect on the financial results of the Company in the period in which it
is recorded.

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.

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.

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.

The USPTO has granted multiple patents to the Company with claims covering numerous features, such as automatically
activating all deployed cameras in response to the activation of just one camera. Additionally, Digital Ally’s patent claims cover
automatic coordination as well as digital synchronization between multiple recording devices. It also has patent coverage directed to the
coordination between a multi-camera system and an officer’s smartphone, which allows an officer to more readily assess an event on
the scene while an event is taking place or immediately after it has occurred.

The Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car
product lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the U.S Patent No.
8,781,292 (‘292 Patent) and ‘452 Patents and U.S. Patent No. 9,325,950 the (“ ‘950 Patent”). The Company is aggressively challenging
WatchGuard’s infringing conduct, seeking both monetary damages, as well as seeking a permanent injunction preventing WatchGuard
from continuing to sell its VISTA Wifi and 4RE In-Car product lines using Digital Ally’s own technology to compete against it. On
May 8, 2017, WatchGuard filed a petition seeking IPR of the ‘950 Patent. The Company will vigorously oppose that petition. On
December 4, 2017 The Patent Trial and Appeal Board (“PTAB”) rejected the request of WatchGuard Video to institute an IPR on the
‘950 Patent. The lawsuit also involves the ‘292 Patent and the ’452 Patent, the same two patents asserted against Axon. The ‘292 Patent
is in the IPR process with the USPTO which is expected to be ruled on in June 2018, while WatchGuard is now statutorily barred from
any further IPR’s challenges with respect to the ‘950 Patent. The lawsuit has been stayed pending a decision from the USPTO on the
‘292 Patent IPR petition which is expected in June 2018.

F-22

Utility Associates, Inc.

On June 6, 2014 the Company filed a separate Unfair Competition lawsuit against Utility in the United States District Court
for the District of Kansas. In that lawsuit it contended that Utility has disparaged the Company and illegally interfered with its contracts,
customer relationships and business expectancies by falsely asserting to its customers and others that its products violate the ‘556 Patent,
of which Utility claims to be the holder. In addition to damages, the Company sought permanent injunctive relief, prohibiting Utility
from continuing to threated or otherwise interfere with the Company’s customers. On March 4, 2015, an initial hearing was held upon
the Company’s request for injunctive relief.

Based upon facts revealed at a March 4, 2015 injunction hearing, on March 16, 2015, the Company sought leave to amend its
Complaint in the unfair competition suit to assert additional claims against Utility. Those new claims included claims of actual or
attempted monopolization, in violation of § 2 of the Sherman Act, claims arising under a new Georgia statute that prohibits threats of
patent infringement in “bad faith,” and additional claims of unfair competition/false advertising in violation of § 63(a) of the Lanham
Act. The Court concluded its injunction hearing on April 22, 2015, and allowed the Company leave to add these claims, but denied its
preliminary injunction. Subsequent to the injunction hearing, Utility withdrew from the market the in-car video recording device that it
had sold in competition with the Company’s own products of similar function and which Utility had attempted to market using threats
of patent infringement. After discovery closed, Utility filed a Motion for Summary Judgment and the Company filed a Motion for Partial
Summary Judgment. On March 30, 2017, the Court entered its order granting Utility’s motion and denying the Company’s motion for
summary judgment. The Company believed the District Court had made several errors when ruling on the motions for summary
judgment, and filed an appeal to the United States Court of Appeals for the Tenth Circuit (10th Circuit”). While the appeal was pending,
Utility filed a motion for the recovery from the Company of some $800,000 in alleged attorney’s fees as provided, purportedly, under
the Lanham Patent and Uniform Trade Secrets Act. That motion was denied in its entirety by final judgement entered February 14, 2018.
On February 16, 2018, the 10th Circuit issued its decision affirming the decision of the District Court. The Company filed a petition for
rehearing by the panel and en banc which has also been denied. Utility has filed its own motion for the recovery of attorney fees, on
appeal in the alleged amount of $125,000. That motion has not yet been fully briefed but will be opposed by the Company on
substantially the same grounds up which Utility’s prior motion for attorney’s fees was denied by the District Court.

likely outcome of any other pending cases and proceedings will not be material to its business or its financial condition.

Sponsorship. On April 16, 2015 the Company entered into a Title Sponsorship Agreement (the “Agreement”) under which it
became the title sponsor for a Web.com Tour golf tournament (the “Tournament”) held annually in the Kansas City Metropolitan area.
The Agreement provides the Company with naming rights and other benefits for the 2015 through 2019 annual Tournament in exchange
for the following sponsorship fee:

Year
2015
2016
2017
2018
2019

Sponsorship
Fee

375,000
475,000
475,000
500,000
500,000

$
$
$
$
$

The Company has the right to sell and retain the proceeds from the sale of additional sponsorships, including but not limited to a
presenting sponsorship, a concert sponsorship and founding partnerships for the Tournament. The Company recorded a net sponsorship

F-23

expense of $266,280 and $499,313 for the years ended December 31, 2017 and 2016, respectively. The Company is negotiating with
the Web.com Tour golf tournament officials to terminate our sponsorship fee commitments for the 2018 and 2019 Tournaments. There
can be no assurance that it will be successful in negotiating the termination of this sponsorship agreement or that if successful in such
negotiations, whether the terms will be acceptable or favorable to the Company.

401 (k) Plan. The Company sponsors a 401(k) retirement savings plan for the benefit of our 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 $178,835 and $184,642 for the years ended December 31, 2017 and 2016, 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 the LLC 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 December 31, 2017, the Company had advanced a total of $286,115 pursuant to this
agreement and established an allowance reserve of $85,835 for a net advance of $200,280. The minimum sales threshold has not been
met, and the Company has discontinued all advances, although the contract has not been formally terminated.

NOTE 12. STOCK-BASED COMPENSATION

The Company recorded pretax compensation expense related to the grant of stock options and restricted stock issued of

$1,752,579 and $1,592,365, for the year ended December 31, 2017 and 2016, respectively.

As of December 31, 2017, 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”) and (vii) the 2015 Stock Option and Restricted Stock Plan (the “2015 Plan”). The 2005 Plan, 2006 Plan, 2007 Plan, 2008 Plan,
2011 Plan, 2013 Plan and 2015 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 2,425,000 shares of common stock. The 2005 Plan terminated during 2015 with 1,403 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 December 31, 2017 total 25,938. The 2006 Plan terminated during 2016 with 11,021 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 December 31, 2017 total 56,268. The 2007 Plan terminated during 2017 with 82,151 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 December 31, 2017 total 12,500.

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 103,612 shares remained available for awards under the various Plans as
of December 31, 2017.

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. There were

100,000 stock options issued during the year ended December 31, 2017.

Activity in the various Plans during the year ended December 31, 2017 is reflected in the following table:

F-24

Outstanding at January 1, 2017

Options

Granted
Exercised
Forfeited

Outstanding at December 31, 2017

Exercisable at December 31, 2017

Number of
Shares

Weighted
Average
Exercise Price

362,440 $
100,000
—
(112,171 )
350,269 $

250,269 $

18.46
3.00
—
(17.73 )
13.44

18.80

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. The

weighted-average fair value of options granted in 2017 was $2.49 per share.

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 year ended December 31, 2017.

At December 31, 2017, 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 year ended December 31, 2017.

As of December 31, 2017, the unrecognized portion of stock compensation expense on all existing stock options was $155,738,

which will be recognized over the next ten months.

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 December 31, 2017:

Exercise Price
Range

Number of
Options

Weighted Average
Remaining
Contractual Life

Number of
Options

Weighted Average
Remaining
Contractual Life

Outstanding Options

Exercisable Options

$
$
$
$
$
$
$
$

0.01 to $3.99
4.00 to $6.99
7.00 to $9.99
10.00 to $12.99
13.00 to $15.99
16.00 to $18.99
19.00 to $29.99
30.00 to $55.00

179,624
32,625
13,507
6,200
49,563
—
6,250
62,500
350,269

8.3 years
4.7 years
3.8 years
1.4 years
2.7 years
—years
1.6 years
0.1 years
5.3 years

79,624
32,625
13,507
6,200
49,563
—
6,250
62,500
250,269

6.5 years
4.7 years
3.8 years
1.4 years
2.7 years
—years
1.6 years
0.1 years
3.5 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 year ended December 31, 2017 is as

follows:

Nonvested balance, January 1, 2017

Granted
Vested
Forfeited

Nonvested balance, December 31, 2017

F-25

Number of

Restricted Shares

Weighted Average
Grant Date
FairValue

495,300 $
522,000
(188,925 )
(36,650 )
791,725 $

5.75
3.80
(6.21 )
(5.39 )
4.37

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 December 31, 2017, there were $1,602,464 of total unrecognized compensation costs related to all remaining non-vested
restricted stock grants, which will be amortized over the next 36 months in accordance with the respective vesting scale.

The nonvested balance of restricted stock vests as follows:

Year Ended December 31,

2018
2019
2020

Number of
Shares

491,275
282,825
17,625

NOTE 13. COMMON STOCK PURCHASE WARRANTS

The Company has issued common stock purchase warrants (the “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 six months from issue
date, and allow the holders to purchase up to 3,233,466 shares of common stock at $2.75 to $16.50 per share as of December 31, 2017.
The Warrants expire from December 3, 2018 through February 23, 2023 and allow for cashless exercise.

In addition to the warrants described in Note 7, the Company issued warrants in conjunction with the equity offering in August
2017. The investors were issued 680,000 Series A-1 warrants that have an initial exercise date of February 23, 2018, terminate on
February 23, 2023 and an exercise price of $3.36 per share. The investors also received 200,000 Series A-2 warrants what were
immediately exercisable at $3.36 per share until August 23, 2022. In addition, the placement agent received 94,000 of warrants with an
initial exercise date of February 23, 2018 at an exercise price of $3.75 per share until August 21, 2022.

The Series A-1 and A-2 warrants provide that if, at the time of exercise, there is no effective registration statement registering,
or no current prospectus available for, the issuance of the shares of common stock upon exercise, then they may also be exercised, in
whole or in part, at such time by means of a cashless exercise, or “net share settlement.” Because the Company and the holders of the
warrants have met applicable requirements under the Securities Act of 1933, as amended, no further action is needed on the part of the
Company to issue the shares of common stock issuable upon exercise of the warrants on an unrestricted basis through a cashless exercise
if for some reason the registration statement was not effective at the point of exercise. These warrants are accounted for as equity, as it
is only a transaction within the Control of the Company that would give the holder the option for cash settlement.

There were 60,000 of pre-funded Series B warrants issued with the August 2017 equity offering, at a price of $2.99 and an

exercise price of $0.01. All Series B warrants were exercised for common stock in September 2017.

Vested Balance, January 1, 2017

Granted
Exercised
Cancelled

Vested Balance, December 31, 2017

Warrants

2,379,290 $
1,554,000
(60,000 )
(639,824 )
3,233,466 $

Weighted
Average
Exercise Price

10.47
3.31
3.00
13,43
6.57

The total intrinsic value of all outstanding Warrants aggregated $-0- as of December 31, 2017 and the weighted average

remaining term is 43 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 December 31, 2017:

F-26

Exercise Price

Number of Options

Weighted Average
Remaining
Contractual Life

Outstanding and Exercisable Warrants

$
$
$
$
$
$
$
$
$
$

2.60
2.75
3.25
3.36
3.65
3.75
5.00
8.50
13.43
16.50

100,000
112,200
120,000
880,000
200,000
94,000
800,000
42,500
879,766
5,000

3,233,466

4.9 years
4.3 years
5.0 years
4.9 years
4.5 years
4.6 years
4.0 years
0.9 years
3.1 years
2.5 years

3.6 years

NOTE 14. NET LOSS PER SHARE

The calculation of the weighted average number of shares outstanding and loss per share outstanding for the years ended

December 31, 2017 and 2016 are as follows:

Numerator for basic and diluted income per share – Net loss
Denominator for basic loss per share – weighted average shares outstanding

Year Ended December 31,
2016
2017
(12,710,688 )
(12,252,457 ) $
5,347,042
6,974,281

Dilutive effect of shares issuable under stock options and warrants outstanding

—

Denominator for diluted loss per share – adjusted weighted average shares outstanding

6,974,281

5,347,042

Net loss per share:

Basic
Diluted

$
$

(1.76 ) $
(1.76 ) $

(2.38 )
(2.38 )

Basic loss per share is based upon the weighted average number of common shares outstanding during the period. For the years
ended December 31, 2017 and 2016, all outstanding stock options to purchase common stock were antidilutive, and, therefore, not
included in the computation of diluted income (loss) per share.

NOTE 15. SUBSEQUENT EVENTS

The Company’s Board of Directors has initiated a review 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 and WatchGuard,
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 the strategic review may also include the continued implementation of the Company’s business plan with
additional debt or equity financing. The Company retained Roth Capital Partners LLC (“Roth”) to assist in this review and process.
Thus, the Company is considering alternatives to address its near-term and long-term liquidity and operational issues. There can be no
assurance that a transaction or financing will result from this process. As part of this strategic alternatives review process, the Board of
Directors approved the Private Placement of the Notes and Warrants and it closed on April 3, 2018. The Company believes this financing
addressed its near-term liquidity needs which primarily included the repayment of principal and interest on the Debentures, June Note
and Secured Note.

The Notes and Warrants were issued pursuant to a SPA between the Company and institutional investors (the “Holders”). The

Private Placement resulted in gross proceeds of $5.5 million before placement agent fees and other expenses associated with the

F-27

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 $1,008,500 principal amount of the June Note and Secured Note that matured in March 2018. The balance of
the proceeds will be used for working capital and general corporate purposes. Roth Capital Partners acted as placement agent for the
Company and received a placement fee of approximately $250,000.

Prior to the maturity date, the Notes bear interest at 8% per annum, which twelve (12) months’ interest amount shall be guaranteed;
provided, however, that in the event that a cash prepayment or amortization is made pursuant to the Notes, then the Company shall only
be required to pay an amount equal to the annualized additional interest due on the then outstanding principal balance of the Notes.
Interest shall be paid at the Company’s discretion in cash, or subject to the equity conditions contained in the Notes, in shares of the
Company’s common stock. The Notes rank senior to the Company’s existing and future indebtedness of the Company and are secured
by all assets and intellectual property to the extent and as provided in the underlying security and related documents.

The Notes are convertible at any time after their date of issue at the option of the Holders into shares of Common Stock at $2.50
per share (the “Conversion Price”). The Notes mature on May 3, 2019 (the “Maturity Date”). Commencing on July 1, 2018 and
continuing for each fiscal month thereafter through the Maturity Date, the Company will make payments of principal and interest to the
Holders to fully amortize the Notes. The Conversion Price is subject to adjustment upon stock splits, reverse stock splits, and similar
capital changes.

The Notes also provide for mandatory conversion by the Holders in the event that at any time (x) the VWAP (as defined in the
Notes) of the common stock listed on the trading market (as defined in the SPA) exceeds $4.50 (as adjusted for stock splits, stock
dividends, stock combinations, recapitalizations and similar events) for twenty (20) consecutive trading days, and (y) no failure of the
equity conditions (as defined in the Notes) then exists, the Company shall have the right to require the Holders to convert all, or any
part, of the conversion amount (as defined in the Notes) of the Notes (but in no event less than the lesser of (I) two (2) times the daily
average trading volume for the prior (20) consecutive trading date (as defined in the notes), and (II) all of the conversion amount then
remaining under the Notes), as designated in the mandatory conversion notice (as defined in the Notes) into fully paid, validly issued
and nonassessable shares of common stock in accordance with Notes at the conversion price as of the mandatory conversion date (as
defined in the Notes).

So long as the Notes are outstanding, the Company is prohibited from entering into any Variable Rate Transactions (as defined

in the Notes).

Upon the occurrence of an event of default under the Notes, the Company must repay to the Holders, in cash or in shares of
common stock at the greater of (i) a 135% premium of the outstanding principal amount of the Notes and accrued and unpaid interest
hereon, in addition to the payment of all other amounts, costs, expenses and liquidated damages due in respect of the Notes; and (ii) the
outstanding principal amount of the Notes and accrued and unpaid interest hereon, in addition to the payment of all other amounts, costs,
expenses and liquidated damages due in respect of the Notes, divided by the conversion price, multiplied by (b) the highest closing price
for the common stock on the trading market (as defined in the SPA) during the period beginning on the date of first occurrence of the
event of fault and ending one (1) day prior to the mandatory prepayment date in the prepayment section of the Notes.

The Warrants issued in conjunction with the Note are exercisable to purchase up to an aggregate of 806,667 shares of common
stock commencing on the date of issuance at an exercise price of $3.00 per share. The Warrants will expire on the fifth (5th) anniversary
of their date of issuance. The exercise price is subject to adjustment upon stock splits, reverse stock splits, and similar capital changes.

F-28

The Warrants provide for cashless exercise in the event that after 180-days after their issuance a registration statement on Form S-1 (or
other applicable registration statement under the Securities Act of 1933, as amended (the “Securities Act”)) covering the resale of all
shares of common stock underlying the Warrants is not available for the issuance of such shares of common stock. A Holder has no
right to convert the Note or exercise the Warrant to the extent that such conversion or exercise would result in the Holder being the
beneficial owner in excess of 4.99% (or, upon election of purchaser, 9.99%), which beneficial ownership limitation may be increased
or decreased up to 9.99% upon notice to the Company, provided that any increase in such limitation will not be effective until 61 days
following notice to the Company.

Pursuant to the SPA, the Company must within forty-five (45) days of the closing date file with the U.S. Securities and Exchange
Commission a registration statement on Form S-1 (or other applicable registration statement under the Securities Act) covering the
resale of all shares of common stock issuable upon conversion or exercise of the Notes and Warrants, respectively.

The Axon litigation in the Federal District Court in Kansas has been stayed since 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, a Markman hearing was held on March 7, 2018 and the parties have
continued to engage in discovery. All remaining significant deadlines will be set when the Court issues its Markman order.

On December 4, 2017 The PTAB rejected the request of WatchGuard to institute an inter partes review (“IPR”) on the ‘950
Patent. The lawsuit also involves the ‘292 Patent and the ‘452 Patent, the same two patents asserted against Axon. The ‘292 patent is in
the IPR process with the USPTO which is expected to be ruled on in June 2018, while WatchGuard is now statutorily barred from any
further IPR’s challenges with respect to the ‘950 patent. The lawsuit has been stayed pending a decision from the USPTO on the ‘292
Patent IPR petition which is expected in June 2018.

On February 16, 2018, the 10th Circuit issued its ruling that affirmed the decision of the District Court which granted Utility’s
motion and denying the Company’s motion for summary judgment in their entireties. The Company is currently considering whether to
file a petition for certiorari with the United States Supreme Court.

*************************************

F-29