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10-K 1 form10-k.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission file number: 001-33899
Digital Ally, Inc.
(Exact name of registrant as specified in its charter)
Nevada
(State or other jurisdiction of
incorporation or organization)
9705 Loiret Blvd., Lenexa, KS
(Address of principal executive offices)
20-0064269
(I.R.S. Employer
Identification No.)
66219
(Zip Code)
Registrant’s telephone, including area code: (913) 814-7774
Securities registered under Section 12(b) of the Exchange Act: None.
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 par value
(Title of class)
NASDAQ
(Name of each exchange on which registered)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ]
No [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ]
No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not
contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act.
Large accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
Accelerated filer [ ]
Smaller reporting company [X]
Emerging growth company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
As of June 30, 2019, the aggregate market value of the Company’s common equity held by non-affiliates computed by reference to
the closing price ($1.45) of the registrant’s most recently completed second fiscal quarter was: $13,812,480.
The number of shares of our common stock outstanding as of March 31, 2020 was: 16,026,910.
Documents Incorporated by Reference: None.
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FORM 10-K
DIGITAL ALLY, INC.
DECEMBER 31, 2019
T C
PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of 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
Item 5.
Item 6.
Item 7.
Item 7a.
Item 8.
Item 9.
Item 9A Controls and Procedures
Item 9B.
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
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N R F L S
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
We produce 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 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. We have active research and development programs to adapt our technologies to other
applications. We can integrate electronic, radio, computer, mechanical, and multi-media technologies to create unique solutions to
address needs in a variety of other industries and markets, including mass transit, school bus, taxicab and the military. We sell our
products to law enforcement agencies, private security customers and organizations and consumer and commercial fleet operators
through direct sales domestically and third-party distributors internationally.
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. We
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.
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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.
COVID – 19 Pandemic
The consolidated financial statements contained in this Report as well as the description of our business contained herein,
unless otherwise indicated, principally reflect the status of our business and the results of our operations as of December 31, 2019.
Since that date, economies throughout the world have been severely disrupted by the effects of the quarantines, business closures and
the reluctance of individuals to leave their homes as a result of the outbreak of the coronavirus (COVID-19). Although we remain open
as an “essential business,” our supply chain has been disrupted and our customers and in particular our commercial customers have
been significantly impacted which has, in turn, reduced our level of operations and activities. In addition, the capital markets have been
disrupted and our efforts to raise necessary capital will likely be adversely impacted by the outbreak of the virus and we cannot forecast
with any certainty when the disruptions caused by it will cease to impact our business and the results of our operations. In reading this
report on Form 10-K, including our discussion of our ability to continue as a going concern set forth herein, in each case, consider the
additional uncertainties caused by the outbreak of COVID-19.
Our Products
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 positive solutions to our customers’ requests. Our products
include: the DVM-800 and DVM-800 Lite, in-car digital video mirror systems for law enforcement; the FirstVU and the FirstVU HD,
body-worn cameras; our patented and revolutionary VuLink product, which integrates our body-worn cameras with our in-car systems
by providing hands-free automatic activation for both law enforcement and commercial markets; the DVM-250 and DVM-250 Plus, a
commercial line of digital video mirrors that serve as “event recorders” for the commercial fleet and mass transit markets; and FleetVU
and VuLink, our cloud-based evidence management systems. We introduced the EVO-HD product in the second quarter of 2019 and
began full-scale deliveries in the third quarter 2019. The EVO-HD is designed and built on a new and highly advanced technology
platform that will become the platform for a new family of in-car video solution products for the law enforcement and commercial
markets. We believe that the launch of these new products will help to reinvigorate our in-car and body-worn systems revenues while
diversifying and broadening the market for our product offerings. The following describes our product portfolio.
In-Car Digital Video Mirror System for law enforcement – EVO-HD, DVM-800 and DVM-800 Lite
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 if not all manufacturers have already developed and transitioned completely to digital
video, and some have offered full high definition (“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, global positioning system (“GPS”) and 900 megahertz (“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:
● wide angle zoom color camera;
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● standards-based video and audio compression and recording;
● system is concealed in the rear-view mirror, replacing factory rear-view mirror;
● monitor in rear-view mirror is invisible when not activated;
● 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.
The Company has completed development of a new in-car digital video platform under the name EVO-HD which it launched
during the second quarter of 2019. The EVO-HD is a next generation system that offers a multiple HD in-car camera solution system
with built-in patented VuLink auto-activation technology. The EVO-HD is built on an entirely new and highly advanced technology
platform that enables many new and revolutionary features, including auto activation beyond the car and body camera. No other
provider can offer built-in patented VuLink auto-activation technology. The EVO-HD provides law enforcement officers with an easier
to use, faster and more advanced system for capturing video evidence and uploading than the Company’s competitors. Additional
features include:
● a remote cloud trigger feature that allows dispatchers to remotely start recordings;
● simultaneous audio/video play back;
● cloud connectivity via cell modem, including the planned deployment of the new 5G network;
● near real-time mapping and system health monitoring;
● body-camera connectivity with built-in auto activation technology; and
● 128 gigabyte internal storage, up to 2 terabyte external solid-state drive storage.
The EVO-HD is designed and built on a new and highly advanced technology platform that will become the platform for a
whole new family of in-car video solution products for the law enforcement. The innovative EVO-HD technology replaces the current
in-car mirror-based systems with a miniaturized system that can be custom-mounted in the vehicle while offering numerous hardware
configurations to meet the varied needs and requirements of its law enforcement customers. The EVO-HD can support up to four HD
cameras, with two cameras having pre-event and evidence capture assurance (“ECA”) capabilities to allow agencies to review entire
shifts. An internal cell modem will allow for connectivity to the VuVault.net cloud, powered by Amazon Web Services (“AWS”) and
real time metadata when in the field.
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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 that they need to increase
driver safety and 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 provide all types of commercial fleets with features and capabilities which 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, which we sell 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. The commercial fleet markets may find our units attractive from both a feature and a cost perspective compared to other
providers. We believe that due to our marketing efforts, 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 are intended to
optimize efficiency, serve as excellent training tools for teams on safety and ultimately generate a significant return on investment for
the organization.
Management plans for the EVO-HD described above will also become the platform for a whole new family of in-car video
solution products for the commercial markets. The innovative EVO-HD technology will replace the current in-car mirror-based
systems with a miniaturized system that can be custom-mounted in the vehicle while offering numerous hardware configurations to
meet the varied needs and requirements of its commercial customers. In its commercial market application, the EVO-HD can support
up to four HD cameras, with two cameras having pre-event and ECA capabilities to allow customers to review entire shifts. An internal
cell modem will allow for connectivity to the FleetVU Manager cloud-based system for commercial fleet tracking and monitoring,
powered by AWS and real time metadata when in the field.
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 when 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.
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This feature is becoming a standard feature required by many law agencies. Unfortunately, certain of our competitors have
chosen to infringe our patent and develop products that provide the same or similar features as our VuLink system. We filed lawsuits
against two competitors – Axon Enterprises, Inc. (“Axon,” formerly known as Taser International, Inc.) and Enforcement Video, LLC
d/b/a WatchGuard Video (“WatchGuard”) – which challenge Axon’s and WatchGuard’s infringing products. On May 13, 2019, we and
WatchGuard resolved the dispute and executed a settlement agreement in the form of a Release and License Agreement. The litigation
has been dismissed as a result of this settlement. See Item 3, “Legal Proceedings.”
VuVault.net and FleetVU Manager
VuVault.net is a cost-effective, fully expandable, law enforcement cloud storage solution powered by AWS that provides
redundant and security-enhanced storage of all uploaded videos that comply with the United States Federal Bureau of Investigation’s
Criminal Justice Information Services Division requirements.
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. In December 2019, the we announced a partnership with Pivot International for design and
manufacture of a new and innovative Breathalyzer Device utilizing our recently issued patent. With this new technology, when an
officer is conducting a field sobriety test and the breathalyzer is activated, the digital video recording device will automatically start a
recording, later embedding the meta-data captured onto the recorded video. The ‘732 Patent was granted by the U.S. Patent Office in
August of 2019 and is an expansion of our patented VuLink automatic activation technology.
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. Recently, we have expanded into event security services
whereby we provide the hardware and software to supplement private security for NASCAR races, football and other sporting events,
concerts and events where people gather. 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 sales in the 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.
An important 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 virtually all of these cases, the FirstVU HD may provide recorded evidence of the suspect’s actions and
reactions to police intervention.
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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 potential commercial markets
for our digital video systems include sporting venues and arenas.
Schools
We believe our products and offerings may be of benefit in kindergarten through twelve grade school systems. We are
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.
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.
Event Security
Recently, we have expanded into event security services whereby we provide the hardware and software to supplement private
security for NASCAR races, football and other sporting events, concerts and similar events where people gather. In this regard, we
have obtained new customers including the Kansas City Chiefs, Met-Life Stadium, NASCAR and a number of other customers who
have a need for event security for specific dates rather than 100% of the time. We believe that this area will be a productive source of
future revenues.
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.
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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
We have an employee-based, direct sales force for domestic selling efforts that enables us to control and monitor its daily
activities and independent distributors for international sales. Our sales force is organized in seven territories. The direct territory sales
team is supported by a team of five inside sales representatives, 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., 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, Reveal Media, WatchGuard and VieVU, Inc., which was acquired
by Axon in 2018. 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.
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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 that 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-250 and DVM-800 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.
We filed lawsuits against Axon and WatchGuard to protect our various patents. See Item 3. “Legal Proceedings.”
Employees
We had 119 full-time employees as of December 31, 2019. 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 commencing in November 2012. Our facility contains
approximately 33,776 square feet and is located at 9705 Loiret Boulevard, Lenexa, Kansas 66219. The lease terminated on April 1,
2020 and the Company has been considering a three-year extension to the lease as well as other facilities in the greater Kansas City
metro area. The monthly rent ranged from $35,634 to $38,533 over the term.
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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 U.S. Patent No. 9,253,452 (the “ ‘452 Patent”), which generally covers the automatic activation and
coordination of multiple recording devices in response to a triggering event, such as a law enforcement officer activating the light bar
on the vehicle.
The Company filed suit on January 15, 2016 in the U.S. District Court for the District of Kansas (Case No: 2:16-cv-02032)
against Axon, alleging willful patent infringement against Axon’s body camera product line and Signal auto-activation product. The
Company is seeking both monetary damages and a permanent injunction against Axon for infringement of the ‘452 Patent.
In December 2016 and January 2017, Axon filed two petitions for Inter Partes Review (“IPR”) against the ‘452 Patent. The
United States Patent and Trademark Office (“USPTO”) rejected both of Axon’s petitions. Axon is now statutorily precluded from filing
any more IPR petitions against the ‘452 Patent.
The District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on
November 17, 2017, the Federal District Court of Kansas rejected Axon’s request to maintain the stay. With this significant ruling, the
parties will now proceed towards trial. Since litigation has resumed, the Court has issued a claim construction order (also called a
Markman Order) where it sided with the Company on all disputes and denied Axon’s attempts to limit the scope of the claims.
Following the Markman Order, the Court set all remaining deadlines in the case. Fact discovery closed on October 8, 2018, and a Final
Pretrial Conference took place on January 16, 2019. The parties filed motions for summary judgment on January 31, 2019.
On June 17, 2019, the Court granted Axon’s motion for summary judgment that Axon did not infringe on the Company’s patent
and dismissed the case. Importantly, the Court’s ruling did not find that Digital’s ‘452 Patent was invalid. It also did not address any
other issue, such as whether Digital’s requested damages were appropriate, and it did not impact the Company’s ability to file
additional lawsuits to hold other competitors accountable for patent infringement. This ruling solely related to an interpretation of the
claims as they relate to Axon and was unrelated to the supplemental briefing Digital recently filed on its damages claim and the
WatchGuard settlement. Those issues are separate and the judge’s ruling on summary judgment had nothing to do with Digital’s
damages request. The Company has filed an appeal to this ruling and has asked the appellate court to reverse this decision.
The Company filed its Opening Appeal Brief on August 26, 2019 and Axon filed its Responsive Brief on November 6, 2019 and
the Company filed its Reply Brief responding to Axon on November 27, 2019. The United States Court of Appeals for the Federal
Circuit scheduled oral argument on the Company’s appeal of the district court’s summary judgment order on April 6, 2020. This appeal
is to address the incorrect and mistaken dismissal of Digital Ally’s claims against Axon by Judge Carlos Murguia in the U.S. District
Court of Kansas litigation. If the Court of Appeals overturns the summary judgment ruling, a new judge will be assigned to handle the
litigation with Axon due to the recent resignation of Judge Murguia. On March 12, 2020, the panel of judges for the United States
Court of Appeals issued an order cancelling the oral arguments previously set for April 6, 2020 having determined that they will decide
the appeal based on the parties’ briefs without oral argument.
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.
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On May 13, 2019, the parties resolved the dispute and executed a settlement agreement in the form of a Release and License
Agreement. The litigation has been dismissed as a result of this settlement.
The Release and License Agreement encompasses the following key terms:
● WatchGuard paid Digital Ally a one-time, lump settlement payment of $6,000,000.
● Digital Ally granted WatchGuard a perpetual covenant not to sue if WatchGuard’s products incorporate agreed-upon modified
recording functionality. Digital Ally also granted WatchGuard a license to the ‘292 Patent and the ‘452 Patent (and related
patents, now existing and yet-to-issue) through December 31, 2023. The parties agreed to negotiate in good faith to attempt to
resolve any alleged infringement that occurs after the license period expires.
● The parties further agreed to release each other from all claims or liabilities pre-existing the settlement.
● As part of the settlement, the parties agreed that WatchGuard made no admission that it infringed any of Digital Ally’s patents.
Upon receipt of the $6,000,000 the parties filed a joint motion to dismiss the lawsuit which the Judge granted.
PGA Tour, Inc.
On January 22, 2019 the PGA Tour, Inc. (the “PGA”) filed suit against the Company in the Federal District Court for the District
of Kansas (Case No. 2:19-cv-0033-CM-KGG) alleging breach of contract and breach of implied covenant of good faith and fair dealing
relative to the Web.com Tour Title Sponsor Agreement (the “Agreement”). The contract was executed on April 16, 2015 by and
between the parties. Under the Agreement, Digital Ally would be a title sponsor of and receive certain naming and other rights and
benefits associated with the Web.com Tour for 2015 through 2019 in exchange for Digital Ally’s payment to Tour of annual
sponsorship fees. The suit was resolved and the case has been dismissed by Plaintiff with prejudice on April 17, 2019.
General
From time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy
to not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After
carefully assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded,
we vigorously defend any lawsuit filed against us. We record a liability when losses are deemed probable and reasonably estimable.
When losses are deemed reasonably possible but not probable, we determine whether it is possible to provide an estimate of the
amount of the loss or range of possible losses for the claim, if material for disclosure. In evaluating matters for accrual and disclosure
purposes, we take into consideration factors such as our historical experience with matters of a similar nature, the specific facts and
circumstances asserted, the likelihood of our prevailing, the availability of insurance, and the severity of any potential loss. We
reevaluate and update accruals as matters progress over time.
While the ultimate resolution is unknown, we do not expect that these lawsuits will individually, or in the aggregate, have a
material adverse effect to our results of operations, financial condition or cash flows. However, the outcome of any litigation is
inherently uncertain and there can be no assurance that any expense, liability or damages that may ultimately result from the resolution
of these matters will be covered by our insurance or will not be in excess of amounts recognized or provided by insurance coverage and
will not have a material adverse effect on our operating results, financial condition or cash flows.
Item 4. Mine Safety Disclosures.
Not applicable.
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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, 2019
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
Year Ended December 31, 2018
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
High Close
Low Close
$
$
$
$
$
$
$
$
4.85 $
4.91 $
1.60 $
1.35 $
2.85 $
2.70 $
4.30 $
3.10 $
2.62
1.41
0.81
1.04
2.00
2.30
2.10
2.31
Holders of Common Stock
As of December 31, 2019, we had approximately 135 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 19,678 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, 2019 total 8,063.
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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 24,662 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, 2019 total 42,812.
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 2017 with 88,401 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, 2019 total 6,250.
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. The 2008 Plan terminated in 2018 with 8,249 shares
reserved for awards that are now unavailable for issuance. Stock options granted under the 2008 Plan that remain unexercised and
outstanding as of December 31, 2019 total 32,250.
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, 2018, there were 726 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, 2019 total 9,750.
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, 2018, there were 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,
2019 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 of Common Stock authorized and
reserved for issuance under the 2015 Plan to a total of 1,250,000. At December 31, 2019, there were 3,686 shares of Common Stock
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, 2019 total 130,000.
On April 12, 2018, our Board of Directors adopted the 2018 Stock Option and Restricted Stock Plan (the “2018 Plan”). The
2018 Plan was amended on May 21, 2019 to increase the number of shares of Common Stock authorized and reserved for issuance
under the 2018 Plan to a total of 1,750,000. At December 31, 2019, there were 625,500 shares of Common Stock reserved for awards
available for issuance under the 2018 Plan. Stock options granted under the 2018 Plan that remain unexercised and outstanding as of
December 31, 2019 total 340,000.
The 2005 Plan, 2006 Plan, 2007 Plan, 2008 Plan, 2011 Plan, 2013 Plan, 2015 Plan and 2018 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
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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 4,175,000 shares issued or to be issued upon exercise of the stock options underlying the various stock
option plans.
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The following table sets forth certain information regarding the stock option plans adopted by the Company as of December
31, 2019:
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)
582,875 $
6,250 $
589,125 $
3.63
13.71
3.74
629,186
—
629,186
Plan category
Equity compensation plans approved by stockholders
Equity compensation plans not approved by
stockholders
Total all plans
Recent Sales of Unregistered Securities
The following represents an issuance of unregistered securities that has not already been reported in our Quarterly Reports on
Form 10-Q or in a Current Report on Form 8-K during 2019:
On December 23, 2019, the Company, borrowed $300,000 under an unsecured note payable to private, third-party lender. The
promissory note bears interest at the rate of 8% per annum with principal and accrued interest payable on or before its maturity date of
March 31, 2020. The Company granted the lender warrants exercisable to purchase a total of 107,000 shares of its common stock at an
exercise price of $1.40 per share until December 23, 2024. The Company allocated $71,869 of the proceeds of the promissory note to
additional paid-in-capital, which represented the grant date relative fair value of the warrants issued to the lender.
No underwriters were involved in the foregoing sale of securities. The issuances of the securities described above were
deemed to be exempt from registration under the Securities Act in reliance on Section 4(a)(2) of the Securities Act. The recipient of
securities in such transaction represented his intention to acquire the securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed to the warrants to purchase common stock agreement
issued in such transactions. The recipient had adequate access, through his relationships with us, to information about us.
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.
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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 2019 and 2018; (2) economic and
other risks for our business from the effects of the COVID-19 pandemic, including the impacts on our law-enforcement and
commercial customers, suppliers and employees and on our ability to raise capital as required; (3) our ability to increase revenues,
increase our margins and return to consistent profitability in the current economic and competitive environment; (4) our operation in
developing markets and uncertainty as to market acceptance of our technology and new products; (5) the availability of funding from
federal, state and local governments to facilitate the budgets of law enforcement agencies, including the timing, amount and restrictions
on such funding; (6) our ability to deliver our new product offerings as scheduled in 2020, such as the EVO-HD, have such new
products perform as planned or advertised and whether they will help increase our revenues; (7) whether we will be able to increase the
sales, domestically and internationally, for our products in the future; (8) our ability to maintain or expand our share of the market for
our products in the domestic and international markets in which we compete, including increasing our international revenues; (9) our
ability to produce our products in a cost-effective manner; (10) competition from larger, more established companies with far greater
economic and human resources; (11) our ability to attract and retain quality employees; (12) risks related to dealing with governmental
entities as customers; (13) our expenditure of significant resources in anticipation of sales due to our lengthy sales cycle and the
potential to receive no revenue in return; (14) characterization of our market by new products and rapid technological change; (15) our
dependence on sales of our EVO-HD, DVM-800, FirstVU HD and DVM-250 products; (16) potential that stockholders may lose all or
part of their investment if we are unable to compete in our markets and return to profitability; (17) defects in our products that could
impair our ability to sell our products or could result in litigation and other significant costs; (18) our dependence on key personnel;
(19) our reliance on third-party distributors and sales representatives for part of our marketing capability; (20) our dependence on a few
manufacturers and suppliers for components of our products and our dependence on domestic and foreign manufacturers for certain of
our products; (21) our ability to protect technology through patents and to protect our proprietary technology and information as trade
secrets and through other similar means; (22) our ability to generate more recurring cloud and service revenues; (23) risks related to
our license arrangements; (24) our revenues and operating results may fluctuate unexpectedly from quarter to quarter; (25) sufficient
voting power by coalitions of a few of our larger stockholders, including directors and officers, to make corporate governance decisions
that could have significant effect on us and the other stockholders; (26) sale of substantial amounts of our common stock that may have
a depressive effect on the market price of the outstanding shares of our common stock; (27) possible issuance of common stock subject
to options and warrants that may dilute the interest of stockholders; (28) our nonpayment of dividends and lack of plans to pay
dividends in the future; (29) future sale of a substantial number of shares of our common stock that could depress the trading price of
our common stock, lower our value and make it more difficult for us to raise capital; (30) our additional securities available for
issuance, which, if issued, could adversely affect the rights of the holders of our common stock; (31) our stock price is likely to be
highly volatile due to a number of factors, including a relatively limited public float; (32) whether the litigation against Axon will
achieve its intended objectives and result in monetary recoveries for us; (33) whether the USPTO rulings will curtail, eliminate or
otherwise have an effect on the actions of Axon and other competitors respecting us, our products and customers; and (34) whether our
patented VuLink technology is becoming the de-facto “standard” for agencies engaged in deploying state-of-the-art body-worn and in-
car camera systems and will increase our revenues; (36) whether such technology will have a significant impact on our revenues in the
long-term; (37) whether we will be able to meet the standards for continued listing on NASDAQ; and (38) indemnification of our
officers and directors.
Current Trends and Recent Developments for the Company
Overview
We supply technology-based products utilizing our portable digital video and audio recording capabilities, for the law
enforcement and security industries and for the commercial fleet and mass transit markets. We have the ability to integrate electronic,
radio, computer, mechanical, and multi-media technologies to create unique solutions to our customers’ requests. Our products include
the DVM-800 and DVM-800 Lite, in-car digital video mirror systems for law enforcement; the FirstVU and the FirstVU HD, body-
worn cameras, our patented and revolutionary VuLink product, which integrates our body-worn cameras with our in-car systems by
providing hands-free automatic activation, for both law enforcement and commercial markets; the DVM-250 and DVM-250 Plus, a
commercial line of digital video mirrors that serve as “event recorders” for the commercial fleet and mass transit markets; and FleetVU
and VuLink, our cloud-based evidence management systems. We introduced the EVO-HD product in late June 2019 and began full-
scale deployments in the third quarter 2019. It is designed and built on a new and highly advanced technology platform that will
become the platform for a new family of in-car video solution products for the law enforcement and commercial markets. We believe
that the launch of these new products will help to reinvigorate our in-car and body-worn systems revenues while diversifying and
broadening the market for our product offerings.
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We experienced operating losses for all quarters during 2019 and 2018 except for the second quarter 2019 which was aided by a
patent litigation settlement. The following is a summary of our recent operating results on a quarterly basis:
December 31,
2019
2,420,437
(88,185)
$
September 30,
2019
2,923,148
1,188,262
$
$
June 30,
2019
2,546,983
950,812
$
For the Three Months Ended:
March 31,
2019
2,550,796
1,181,740
December 31,
2018
2,378,287
56,658
$
September 30,
2018
2,878,059
1,177,289
$
$
June 30,
2018
3,563,550
1,618,467
March 31,
2018
2,471,513
1,109,394
$
(3.6)%
40.7%
37.3%%
46.3%
2.3%
40.9%
45.4%
44.9%
3,145,633
(3,233,819)
3,468,709
(2,280,447)
(1,616,830)
2,567,643
4,267,898
(3,086,158)
5,292,374
(5,235,716)
3,087,005
(1,909,716)
3,055,776
(1,437,309)
3,082,710
(1,973,316)
(133.6)%
(78.0)%
100.8%
(121.0)%
(220.1)%
(66.4)%
(40.3)%
(79.8)%
$
(3,426,984)
$
(2,985,825)
$
(387,730)
$
(3,205,174)
$
(5,327,849)
$
(4,665,580)
$
(2,962,890)
$
(2,588,232)
Total revenue
Gross profit
Gross profit margin
percentage
Total selling,
general and
administrative
expenses
Operating loss
Operating loss
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 products, such as the recently released EVO HD; (3) production, quality and other supply
chain issues affecting our cost of goods sold; (4) unusual increases in operating expenses, such as the timing of trade shows and stock-
based and bonus compensation; (5) the timing of patent infringement litigation settlements, such as the $6.0 settlement we obtained
from WatchGuard during the second quarter 2019 and (5) ongoing patent and other litigation and related expenses respecting
outstanding lawsuits. We reported an operating loss of $3,233,819 on revenues of $2,420,437 for fourth quarter 2019. The income
recognized in the second quarter 2019 ended a series of quarterly losses resulting from competitive pressures, supply chain problems,
increases in inventory reserves as our current product suite ages, product quality control issues, product warranty issues, infringement
of our patents by direct competitors such as Axon that reduced our revenues, and litigation expenses relating to the patent infringement.
The factors and trends affecting our recent performance include:
● On May 13, 2019 we reached a resolution of the pending patent infringement litigation with WatchGuard and executed a
settlement agreement that resulted in the dismissal of this case. As part of the settlement agreement, we received a one-
time $6,000,000 payment and granted WatchGuard a perpetual covenant to not sue WatchGuard if its products
incorporate agreed-upon modified recording functionality. Additionally, we granted it license to the ‘292 Patent and ‘452
Patent through December 31, 2023. As part of the settlement, the parties agree that WatchGuard made no admission that it
infringed any of our patents. See Note 12, “Contingencies” for the details respecting the settlement.
● Revenues decreased in fourth quarter 2019 to $2,420,436 compared to the previous quarters. The primary reason for the
revenue decrease in the fourth quarter 2019 is that we continue to face increased challenges for our in-car and body-worn
systems as our competitors have released new products with advanced features and have maintained their product price
cuts. We introduced a new product platform, the EVO-HD, specifically for in-car systems late in June 2019 to address our
competitors’ new product features and we experienced some positive traction in third and fourth quarter 2019. However,
we expect potential customers to review and test the EVO-HD prior to adopting the new platform for deployment and
therefore expect that the rate of adoption of the new technology will accelerate in 2020. This new product platform
utilizes advanced chipsets that will generate new and highly advanced products for our law enforcement and commercial
customers and we believe will improve product revenues in future quarters as customers become aware of and commit to
the new EVO-HD. Our law enforcement revenues declined over the prior period due to price-cutting, willful infringement
of our patents and other actions by our competitors and adverse marketplace effects related to the patent litigation. For
example, one of our competitors introduced a body-camera including cloud storage free for one year beginning in 2017
and this has continued to pressure our revenues in 2019.
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● Our objective is to expand our recurring service revenue to help stabilize our revenues on a quarterly basis. Revenues
from cloud storages have been increasing in recent quarters and reached approximately $205,714 in Q-4 2019, an increase
of $12,714 (7%) over Q-4 2018. Overall, cloud revenues increased to approximately $750,000 in 2019 compared to
approximately $694,000 for 2018, an increase of $56,000, or 8%. Additionally, revenues from extended warranties have
also been increasing and were approximately $405,179 for the year ended December 31, 2019, compared to $301,000 for
the prior year period for an increase of $104,179 (35%). We are pursuing several new market channels that do not involve
our traditional law enforcement and private security customers, such as our NASCAR affiliation and event security
solutions, which we believe will help expand the appeal of our products and service capabilities to new commercial
markets. If successful, we believe that these new market channels could yield recurring service revenues for us in the
future.
● Recognizing a critical limitation in law enforcement camera technology, during 2014 we pioneered the development of
our VuLink ecosystem that provided intuitive auto-activation functionality as well as coordination between multiple
recording devices. The USPTO granted us multiple patents with claims covering numerous features, such as
automatically activating an officer’s cameras when the light bar is activated or when a data-recording device such as a
smart weapon is activated. Additionally, our patent claims cover automatic coordination between multiple recording
devices. Prior to this innovation, officers were forced to manually activate each device while responding to emergency
scenarios - a requirement that both decreased the usefulness of the existing camera systems and diverted officers’
attention during critical moments. We believe law enforcement agencies have recognized the value of our VuLink
technology and that a trend has developed 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 and others has substantially and negatively impacted revenues that otherwise would have
been generated by our VuLink system and indirectly our body-worn and in-car systems. We believe that the results of the
current patent litigation with Axon will largely set the competitive landscape for body-worn and in-car systems for the
foreseeable future. We are seeking other ways to monetize our VuLink patents, which may include entering into license
agreements or supply and distribution agreements with competitors. We expect that this technology will have a significant
positive impact on our revenues in the long-term, particularly if we are successful in our prosecution of the patent
infringement litigation pending with Axon, and we can successfully monetize the underlying patents, although we can
make no assurances in this regard.
● We have a multi-year official partnership with NASCAR, naming us “A Preferred Technology Provider of NASCAR.” As
part of the relationship, we will provide cameras that will be mounted in the Monster Energy NASCAR Cup Series
garage throughout the season, bolstering both NASCAR’s commitment to safety at every racetrack, as well as enhancing
its officiating process through technology. Our relationship with NASCAR has yielded many new opportunities with
NASCAR related sponsors. We believe this partnership with NASCAR will demonstrate the flexibility of our product
offerings and help expand the appeal of our products and service capabilities to new commercial markets.
● Our international revenues decreased to $190,105 (2% of total revenues) during the year ended December 31, 2019,
compared to $362,338 (3% of total revenues) during the year ended December 31, 2018. Political macro-economic
tensions including illegal immigration and import/export tariffs between the United States and many countries that have
been our customers in the past have made it a difficult climate for our international sales. The international sales cycle
generally takes longer than domestic business and we continue to provide bids to a number of international customers. We
are actively marketing many of our products, including but not limited to the EVO-HD, DVM-800, DVM-750, DVM-
500+, FleetVu driver monitoring and management service and the FirstVU HD, internationally. We saw an uptick in our
international sales activity in 2020 as evidenced by the recent award of a contract with the potential of over $4.0 million
for our FirstVU HD by a sovereign nation’s national police force.
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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 and license agreements that represent commitments for future payments (described in Note
12 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, 2019 and 2018
Results of Operations
Summarized immediately below and discussed in more detail in the subsequent sub-sections is an analysis of our operating
results for the years ended December 31, 2019 and 2018, 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
Patent litigation settlement
Total selling, general and administrative expenses
Operating loss
Change in warrant derivative liabilities
Change in fair value of secured convertible notes
Change in fair value of secured convertible debentures
Change in fair value of proceeds investment agreement
Loss on extinguishment of secured convertible debentures
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
Years Ended December 31,
2019
2018
100%
69%
31%
19%
35%
20%
72%
(57)%
89%
(58)%
—%
(5)%
—%
(32)%
—%
(1)%
—%
(96)%
—%
(96)%
100%
65%
35%
13%
25%
20%
71%
—%
129%
(94)%
(3)%
—%
(20)%
(1)%
(5)%
(3)%
(12)%
(138)%
—%
(138)%
$
$
(0.87)
(0.87)
$
$
(1.93)
(1.93)
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Revenues
Our current product offerings include the following:
Product
EVO-HD
DVM-750
DVM-100
DVM-400
DVM-250 Plus
DVM-800
DVM-800 Lite
FirstVU HD
VuLink
Description
An in-car digital audio/video system which records in 1080P high definition video and is
designed for law enforcement and commercial fleet customers. This system includes two
cameras and can use up to four external cameras for a total of four video streams. This
system includes integrated, patented VuLink technology, internal GPS, and an internal Wi-
Fi Module. The system includes the choice between a Wireless Microphone Kit or the
option to use the FirstVu HD Body Camera as the wireless microphone. This system also
includes a three-year Advanced Exchange Warranty. We offer a cloud storage solution to
manage the recorded evidence and charge a monthly device license fee for our cloud
storage.
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 but the Company is supporting existing
customers with new products and repair and parts.
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 but the
Company is supporting existing customers with new products and repair and parts.
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 but the Company is
supporting existing customers with new products and repair and parts.
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 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.
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. 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.
20
Retail Price
$
4,795
$
2,995
$
1,895
$
2,795
$
1,295
$
3,995
Various prices
based
on configuration
$
$
595
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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, 2019 and 2018 were derived from the following sources:
DVM-800 and DVM 800HD
FirstVu HD
DVM-250 Plus
Cloud service revenue
DVM-750
VuLink
EVO
Repair and service
Accessories and other revenues
Years ended December 31,
2019
2018
36%
12%
11%
7%
1%
1%
3%
15%
14%
100%
45%
12%
7%
6%
4%
2%
—%
13%
11%
100%
Product revenues for the years ended December 31, 2019 and 2018 were $7,732,796 and $9,130,911 respectively, a decrease
of $1,398,115 (15%), due to the following factors:
●
In general, we have experienced pressure on our revenues as our in-car and body-worn systems are facing increased
competition because our competitors have released new products with advanced features. Additionally, our law
enforcement revenues declined over the prior period due to price-cutting, willful infringement of our patents and
other actions by our competitors, adverse marketplace effects related to the patent litigation and supply chain issues.
We introduced our EVO-HD late in second quarter 2019 with the goal of enhancing our product line features to meet
these competitive challenges and we started to see traction in late 2019. We expect customers and potential customers
to review and test the EVO-HD prior to committing to this new product platform, which may have delayed any
meaningful positive impact to revenues until 2020.
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●
●
We shipped five individual orders in excess of $100,000, for a total of approximately $951,734 in revenue for the
year ended December 31, 2019, compared to six individual orders in excess of $100,000, for a total of approximately
$984,450 in revenue for the year ended December 31, 2018. Our average order size increased to approximately
$2,259 in the year ended December 31, 2019 from $2,075 during the year ended December 31, 2018. For certain
opportunities that involve multiple units and/or multi-year contracts, we have occasionally discounted our products to
gain or retain market share and revenues.
Our international revenues decreased to $190,105 (2% of total revenues) during the year ended December 31, 2019,
compared to $362,338 (3% of total revenues) during the year ended December 31, 2018. Political macro-economic
tensions including illegal immigration and import/export tariffs between the United States and many countries that
have been our customers in the past have made it a difficult climate for our international sales. The international sales
cycle generally takes longer than domestic business and we continue to provide bids to a number of international
customers. We are actively marketing many of our products, including but not limited to the EVO-HD, DVM-800,
DVM-750, DVM-500+, FleetVu driver monitoring and management service and the FirstVU HD, internationally. We
have seen an uptick in our international sales activity in 2020 as evidenced by the recent award of a contract with the
potential over $4.0 million for our FirstVU HD by a sovereign nation’s national police force.
Service and other revenues for the years ended December 31, 2019 and 2018 were $2,708,568 and $2,160,498, respectively,
an increase of $548,070 (25%), due to the following factors:
●
●
●
●
Cloud revenues were $749,713 and $693,653 for the years ended December 31, 2019 and 2018, respectively, an
increase of $56,060 (8%). We have experienced increased interest in our cloud solutions for law enforcement
primarily due to the deployment of our new cloud-based EVO-HD in-car system, which contributed to our increased
cloud revenues in the year ended December 31, 2019. We expect this trend to continue for 2020 as the migration
from local storage to cloud storage continues in our customer base.
Revenues from extended warranty services were $1,414,308 and $1,106,289 for the years ended December 31, 2019
and 2018, respectively, an increase of $308,019 (28%). We have many customers that have purchased extended
warranty packages, primarily in our DVM-800 premium service program, and we expect the trend of increased
revenues from these services to continue into 2020.
Installation service revenues were $255,149 and $90,511 for the years ended December 31, 2019 and 2018,
respectively, an increase of $164,638 (182%). Installation revenues tend to vary more than other service revenue
types and are dependent on larger customer implementations.
Software revenue, non-warranty repair and other revenues were $289,398 and $270,045 for the years ended
December 31, 2019 and 2018, respectively, an increase of $19,353 (7%). Software revenues were $106,155 in 2019
compared to $115,458 in 2018 and non-warranty repairs were $99,647 in 2019 compared to $106,910 in 2018.
Situational security event fees were $64,800 in 2019 compared to $-0- in 2018.
Total revenues for the years ended December 31, 2019 and 2018 were $10,441,364 and $11,291,409, respectively, a decrease
of $850,045 (8%), due to the reasons noted above.
Cost of Revenue
Cost of product revenue on units sold for the years ended December 31, 2019 and 2018 was $6,577,347 and $6,805,897,
respectively, a decrease of $228,550 (3%). 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 increasing to 85% in 2019 from 75% in 2018. We
scrapped approximately $726,000 of inventory and increased the reserve/expensed obsolete and excess inventories by approximately
$856,000 during the year ended December 31, 2019 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-500, DVM-500 Plus, DVM, DVM-750 and
LaserAlly legacy products.
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Cost of service and other revenue for the years ended December 31, 2019 and 2018 was $631,388 and $523,704, respectively,
an increase of $107,864 (21%). The increase in service and other cost of goods sold is commensurate with the 25% increase in service
and other revenues for the year ended December 31, 2019. In addition, our cost of service and other revenue improved to 23.3% in
2019 compared to 24.2% in 2018.
Total cost of sales as a percentage of revenues increased to 69% during the year ended December 31, 2019 from 65% for the
year ended December 31, 2018. We believe our gross margins will improve if we improve revenue levels, continue to reduce product
warranty issues and add higher margin revenues from cloud-based and other services.
We recorded $4,144,013 and $3,287,771 in reserves for obsolete and excess inventories at December 31, 2019 and December
31, 2018, respectively. Total raw materials and component parts were $4,481,611 and $4,969,786 at December 31, 2019 and December
31, 2018, respectively, a decrease of $488,175 (10%). We scrapped older version inventory component parts that were mostly or fully
reserved during the year ended December 31, 2019 which was the primary cause for the decrease. Finished goods balances were
$4,906,956 and $4,965,594 at December 31, 2019 and December 31, 2018, respectively, a decrease of $58,638 (1%). The increase in
the inventory reserve is primarily due to a higher level of excess component parts of the older versions of our PCB boards and the
phase out of our DVM-750, DVM-500 Plus, DVM-500 and LaserAlly legacy products. We believe the reserves are appropriate given
our inventory levels at December 31, 2019.
Gross Profit
Gross profit for the years ended December 31, 2019 and 2018 was $3,232,629 and $3,961,808, respectively, a decrease of
$729,179 (18%). The decrease is commensurate with the 8% overall decline in revenues for the year ended December 31, 2019
coupled with a deterioration in the overall cost of sales percentage to 69% during the year ended December 31, 2019 from 65% for the
year ended December 31, 2018. We believe that gross margins will improve during 2020 and beyond if we improve revenue levels
primarily through the introduction of products such as the EVO-HD, continue to reduce product warranty issues and shift our revenues
to higher-margin cloud services. Our goal is to improve our margins to 60% over the longer term based on the expected margins of our
EVO-HD, DVM-800, VuLink and FirstVU HD and our cloud evidence storage and management offering, if they gain traction in the
marketplace and we are able to increase our commercial market penetration in 2020. In addition, if revenues from these products
increase, we will seek to further improve our margins from them through economies of scale and more efficiently utilizing fixed
manufacturing overhead components. We plan to continue our initiative to more efficient management of our supply chain through
outsourcing production, quantity purchases and more effective purchasing practices.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $9,265,410 and $14,517,865 for the years ended December 31, 2019 and
2018, respectively, a decrease of $5,252,455 (36%). The significant decrease was fueled by the patent litigation settlement of $6.0
million we received in second quarter 2019. Exclusive of the patent litigation settlement selling, general and administrative expenses as
a percentage of sales increased to 146% for 2019 compared to 129% in the same period in 2018. The significant components of selling,
general and administrative expenses are as follows:
The significant components of selling, general and administrative expenses are as follows:
Research and development expense
Selling, advertising and promotional expense
Stock-based compensation expense
Professional fees and expense
Executive, sales, and administrative staff payroll
Patent litigation settlement
Other
Total
23
Year ended December 31,
2018
2019
1,444,063
2,797,793
2,272,656
3,422,694
2,139,687
—
2,440,972
14,517,865
2,005,717 $
3,652,434
2,112,090
1,533,679
3,083,021
(6,000,000)
2,878,469
9,265,410 $
$
$
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Research and development expense. We continue to focus on bringing new products to market, including updates and
improvements to current products. Our research and development expenses totaled $2,005,717 and $1,444,063 for the years ended
December 31, 2019 and 2018, respectively, an increase of $561,654 (39%). We employed 16 engineers at December 31, 2019
compared to 11 engineers at December 31, 2018, most of whom are dedicated to research and development activities for new products
and primarily the EVO-HD, which was launched in late second quarter 2019, and a commercial version of the EVO-HD, which we
plan to launch in late 2020, and a non-mirror based DVM-250 that can be located in multiple places in a vehicle. We expect our
research and development activities will continue to trend higher in future quarters as we continue to expand our product offerings
based on our new EVO-HD product platform. We consider our research and development capabilities and new product focus to be a
competitive advantage and will continue to invest in this area on a prudent basis and consistent with our financial resources.
Selling, advertising and promotional expenses. Selling, advertising and promotional expense totaled $3,652,434 and
$2,797,793 for the years ended December 31, 2019 and 2018, respectively, an increase of $854,641 (31%). Salesman salaries and
commissions represent the primary components of these costs and were $2,632,729 and $2,413,680 for the years ended December 31,
2019 and 2018, respectively, an increase of $219,049 (9%). The effective commission rate was 25.2% for the year ended December 31,
2019 compared to 21.4% for the year ended December 31, 2018. We increased the number of salesmen in our law enforcement and
commercial channels in late 2018 and increased travel expenses in 2019 compared to 2018.
Promotional and advertising expenses totaled $1,019,705 during the year ended December 31, 2019 compared to $384,113
during the year ended December 31, 2018, an increase of $635,592 (165%). The increase is primarily attributable to sponsorship of the
NASCAR race in May 2019 and efforts to expand brand awareness and leverage our relationship with NASCAR for business
opportunities.
Stock-based compensation expense. Stock based compensation expense totaled $2,112,090 and $2,272,656 for the years
ended December 31, 2019 and 2018, respectively, a decrease of $160,566 (7%). The decrease is primarily due to the decreased
amortization during the year ended December 31, 2019 related to the restricted stock granted during 2019 and 2018 to our officers,
directors, and other employees. We relied more on stock-based compensation during 2019 and 2018 as we attempted to reduce cash
expenses for liquidity reasons.
Professional fees and expense. Professional fees and expenses totaled $1,533,679 and $3,422,694 for the years ended
December 31, 2019 and 2018, respectively, a decrease of $1,889,015 (55%). The professional fees are primarily attributable to legal
fees and expenses related to the ongoing Axon lawsuit and the resolution of the WatchGuard and PGA lawsuits. We resolved the PGA
lawsuit on April 17, 2019 and the associated cost was accrued as of December 31, 2019 and the WatchGuard lawsuit was settled on
May13, 2019. On June 17, 2019, the U.S. District Court granted Axon’s Motion for Summary Judgment, which accepted Axon’s
position that it did not infringe on our patent and dismissed the lawsuit in its entirety. We have appealed the Court’s ruling and the oral
arguments were set before the U.S. Court of Appeals on April 6, 2020. However, on March 12, 2020, the Court of Appeals issued an
order cancelling the oral arguments on April 6, 2020 having determined that they will decide the appeal based on the parties’ briefs
without oral argument. Our spending on legal fees on the Axon case has slowed as we wait for the appeal to be heard.
Executive, sales and administrative staff payroll. Executive, sales and administrative staff payroll expenses totaled
$3,083,021 and $2,139,687 for the years ended December 31, 2019 and 2018, respectively, an increase of $943,334 (44%). The
primary reason for the increase in executive, sales and administrative staff payroll was an increase in staff from 95 at December 31,
2018 to 117 at December 31, 2019 and bonuses paid to executives during 2019.
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Patent litigation settlement. The income attributable to our patent litigation settlement with WatchGuard was $6.0 million and
$-0- for years ended December 31, 2019 and 2018, respectively. On May 13, 2019 we reached a resolution of the litigation and
executed a settlement agreement that resulted in the dismissal of this case. As part of the agreement, we received a one-time $6.0
million payment and granted WatchGuard a perpetual covenant to not sue WatchGuard if its products incorporate agreed-upon
modified recording functionality. Additionally, we granted it a license to the ‘292 Patent and ‘452 Patent through December 31, 2023.
As part of the settlement, the parties agreed that WatchGuard made no admission that it had infringed on any of our patents. See Note
12, “Contingencies” for the details respecting the settlement.
Other. Other selling, general and administrative expenses totaled $2,878,469 and $2,440,972 for the years ended December
31, 2019 and 2018, respectively, an increase of $437,497 (18%). The increase in other expenses in 2019 compared to 2018 is primarily
attributable to higher contract employee expenses and travel costs. We have added several contract employees to our technical support
teams during 2019.
Operating Loss
For the reasons previously stated, our operating loss was $6,032,781 and $10,556,057 for the years ended December 31, 2019
and 2018, respectively, an improvement of $4,523,276 (43%). Operating loss as a percentage of revenues decreased to 58% in 2019
from 94% in 2018.
Interest and Other Income
Interest income increased to $37,410 for the year ended December 31, 2019 from $19,524 in 2018, which reflected our overall
higher cash and cash equivalent levels in 2019 compared to 2018.
Interest Expense
We incurred interest expense of $43,373 and $1,366,520 during the years ended December 31, 2019 and 2018, respectively.
The decrease was attributable to lower interest-bearing debt balances outstanding in 2019 as compared to 2018. We issued an aggregate
of $2,778,000 principal amount of secured convertible notes on August 5, 2019 bearing interest at 8% per annum on the outstanding
principal balance. In May and April 2018, we issued an aggregate of $6,875,000 principal amount of secured convertible debentures
(2018 Debentures) bearing interest at the rate of 8% per annum on the outstanding principal balance. We paid the 2018 Debentures in
full on August 21, 2018, but were required to pay the remaining 12 months of guaranteed interest on the Debentures, which included a
10% premium, because they were not retired before August 1, 2018. We issued an aggregate of $300,000 principal amount of Notes on
December 23, 2019 bearing interest at 8% per annum on the outstanding principal balance.
Change in Warrant Derivative Liabilities
We issued detachable warrants exercisable to purchase a total of 398,916 common shares, as adjusted, 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.
Certain common stock purchase warrants issued in August 2014 contained anti-dilution provisions that triggered a reset to their
exercise price and number as a result of the April 2018 financing transaction. The reset provisions resulted in the 12,200 warrants held
at an exercise price of $7.32 per share increased by 159,538 warrants resulting in a final reset to 172,038 warrants at an exercise price
of $0.52 per share.
The holder of the warrants exercised its option to purchase common stock for all remaining outstanding warrants during the
year ended December 31, 2018 at the reset exercise price of $.52 per share. The net change in fair value of the warrants to the closing
market price on their respective date of exercise resulted in a net charge to change in warrant derivatives for the year ended December
31, 2018 of $319,105.
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There remained no warrants classified as derivative liabilities outstanding at December 31, 2018; therefore, the respective
warrant derivative liability balance was $0 at December 31, 2018. Furthermore, no similar instruments were outstanding during the
year ended December 31, 2019.
Change in Fair Value of Secured Convertible Notes
We elected to account for the secured convertible notes that were issued in August of 2019 on its fair value basis. Therefore, we
determined the fair value of the secured convertible notes as of their issuance date and as of December 31, 2019 to be $1,845,512 and
$1,593,809, respectively. During the year ended December 31, 2019, the holders converted an aggregate of $648,067of convertible
note principal. The change in fair value from the issuance date of August 5, 2019 and December 31, 2019 was $519,821, which was
recognized as a charge in the Consolidated Statement of Operations at December 31, 2019.
Change in Fair Value of Secured Convertible Debentures
We elected to account for the $4.0 million principal amount of 2016 Debentures that we retired on April 3, 2018 on their fair
value basis. The change in fair value of the debentures was $12,807 during the year ended December 31, 2018, which was recognized
as a gain in the Consolidated Statement of Operations. We paid these Debentures on April 3, 2018 so there was no similar fair value
change in the year ended December 31, 2019.
We elected to account for the $6.875 million principal amount of 2018 Debentures issued in April and May 2018 on their fair
value basis. Therefore, we determined the fair value of the 2018 Debentures which yielded an estimated fair value of $4,565,749
including their embedded derivatives as of their origination date. We also determined the estimated fair value of $5,354,803 for the
2018 Debentures including their embedded derivatives as of June 30, 2018. We paid the 2018 Debentures on August 21, 2018 in full
and the change in fair value of the 2018 Debentures from origination date to August 21, 2018 was $2,309,251, which was recognized
as a loss in the Consolidated Statement of Operations.
The net charge to change in fair value of secured debentures for the year ended December 31, 2019 was $-0- compared to
$2,296,444 for the year ended December 31, 2018.
Change in Fair Value of Proceeds Investment Agreement
We elected to account for the PIA that was entered into July of 2018 on its fair value basis. Therefore, we determined the fair
value of the 2018 PIA as of December 31, 2019, and December 31, 2018 to be $6,500,000 and $9,142,000, respectively. During the
year ended December 31, 2019, we settled our patent infringement litigation with WatchGuard and received a lump sum payment of
$6.0 million as further described in Note 12. In accordance with the terms of the PIA, we remitted the $6.0 million as a principal
payment toward our minimum return payment obligations under the PIA. The change in fair value from December 31, 2018 to
December 31, 2019 was $3,358,000, which was recognized as a loss in the Consolidated Statement of Operations at December 31,
2019.
In July 2018 we determined the fair value of the 2018 PIA was an estimated fair value of $9,067,513 as of its origination date.
We also determined the estimated fair value was $9,142,000 for the PIA as of December 31, 2018. The change in fair value from
origination date until December 31, 2018 was $74,487, which was recognized as a loss in the Consolidated Statement of Operations at
December 31, 2018.
Loss on Extinguishment of Secured Convertible Debentures
The Board of Directors approved the Private Placement of $6.875 million of debentures and 806,667 Warrants exercisable to
purchase 916,667 shares of our common stock. The Private Placement closed on April 3, 2018.
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The Private Placement resulted in gross proceeds of $6.25 million before placement agent fees and other expenses associated
with the transaction. A portion of the proceeds was used to repay in full the Debentures issued in December 2016, which matured on
March 30, 2018, and approximately $758,500 principal amount of the June Note and Secured Note that matured in March 2018. The
balance of the proceeds was used for working capital purposes.
In conjunction with the transaction we recorded a loss on extinguishment of the secured convertible debentures totaling $600,000
for the year ended December 31, 2018. There was no similar extinguishment of secured convertible debentures in 2019.
Secured Convertible Debentures Issuance Expenses
We elected to account for and record our secured convertible notes issued in August 2019 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
$89,148 for 2019.
We elected to account for and record our $6.875 million Secured Convertible Debenture issued in April and May 2018 on a
fair value basis. Accordingly, we were required to expense the related issuance costs to other expense in the consolidated statements of
operations. Such costs totaled $351,462 for 2018. The issuance costs included a $150,000 placement agent fee and the remainder was
primarily legal fees.
Loss before Income Tax Benefit
As a result of the above, we reported a loss before income tax benefit of $10,005,713 and $15,544,551 for the years ended
December 31, 2019 and 2018, respectively, an improvement of $5,538,838 (36%).
Income Tax Benefit
We recorded an income tax benefit of $-0- for the years ended December 31, 2019 and 2018, respectively. The effective tax
rate for both 2019 and 2018 varied from the expected statutory rate due to our continuing to provide a 100% valuation allowance on net
deferred tax assets. We determined that it was appropriate to continue the full valuation allowance on net deferred tax assets as of
December 31, 2019 and 2018 primarily because of the recurring operating losses.
We have further determined to continue providing a full valuation reserve on our net deferred tax assets as of December 31,
2019. During 2019, we increased our valuation reserve on deferred tax assets by $2,100,000 whereby our deferred tax assets continue
to be fully reserved due to our recent operating losses.
We had approximately $67,100,000 of Federal net operating loss carryforwards and $1,795,000 of research and development
tax credit carryforwards as of December 31, 2019 available to offset future net taxable income.
Net Loss
As a result of the above, we reported net losses of $10,005,713 and $15,544,551 for the years ended December 31, 2019 and
2018, respectively, an improvement of $5,538,838 (36%).
Basic and Diluted Loss per Share
The basic and diluted loss per share was $0.87 and $1.93 for the years ended December 31, 2019 and 2018, 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, 2019 and 2018 because of the net
loss reported for each period.
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Liquidity and Capital Resources and Going Concern
Overall:
Management’s Liquidity Plan. The accompanying consolidated financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company
incurred substantial operating losses in recent years due to the factors cited elsewhere in this Report and has accessed the public and
private capital markets to raise funding through the issuance of debt and equity. During the year ended December 31, 2019, the
Company settled one of its patent infringement cases and received a lump sum payment of $6.0 million, which it used to pay its
obligations under the PIA as more fully described in Note 12. 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 net proceed of approximately
$2,500,000 through issuances of secured convertible debt, $300,000 through the issuance of unsecured note payable, and $1,564,000
from the exercise of warrants in the year ended December 31, 2019. In fiscal 2018 the Company raised capital through the issuance of
subordinated debt, secured debt and the PIA totaling $16,500,000, and net proceeds of $7,324,900 from an underwritten public offering
of common stock. 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 will have to restore positive operating cash flows and profitability over the next year and/or raise additional capital
to fund its operational plans, meet its customary payment obligations and otherwise execute its business plan. There can be no
assurance that it will be successful in restoring positive cash flows and profitability, or that it can raise additional debt or equity
financing when needed and obtain it on terms acceptable or favorable to the Company.
If we must further supplement our liquidity to support our operations in 2020, 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 2020 operating plan could include raising additional capital a public offering or a private placement of debt or equity, all of
which are under consideration as part of our strategic alternatives. We demonstrated our ability to raise new debt or equity capital in
2019 and recent years. If necessary, we believe that we could raise additional capital during the next 12 months if required, but we can
offer no assurances in this regard.
On March 3, 2020, the Company consummated an underwritten public offering of 2,521,740 shares of common stock (the
“Offering”). The common shares in the Offering were sold at a public offering price of $1.15 per share. The Company has granted the
Underwriters a 45-day option to purchase up to an additional 378,261 additional shares of common stock at the public offering price,
less underwriting discounts and commissions, to cover over-allotments, if any. The gross proceeds to the Company from the offering,
before deducting underwriting discounts and commissions and other estimated offering expenses, and assuming the Underwriters do
not exercise their option to purchase the option shares, were approximately $2.9 million. The net proceeds to the Company from the
offering, after deducting underwriting discounts and commissions and the non-accountable expense reimbursement, but before
deducting other expenses in connection with the offering, and assuming the Underwriters do not exercise their option to purchase the
option Shares, are approximately $2.67 million. The Company intends to use the net proceeds from this offering to fund the repayment
of debt and for general corporate purposes.
We had warrants outstanding exercisable to purchase 4,824,573 shares of common stock at a weighted average exercise price
$5.15 per share outstanding as of December 31, 2019. In addition, there are common stock options outstanding exercisable to purchase
589,125 shares at an average price of $3.74 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 2020, although we can offer no assurances in this regard.
Our Common Stock is currently listed on The Nasdaq Capital Market (“Nasdaq”). In order to maintain that listing, we must
satisfy minimum financial and other continued listing requirements and standards, including those regarding director independence and
independent committee requirements, minimum stockholders’ equity, minimum share price, and certain corporate governance
requirements. There can be no assurances that we will be able to comply with the applicable listing standards. See “Nasdaq Listing”
below.
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Based on the uncertainties described above, we believe our business plan does not alleviate the existence of substantial doubt
about our ability to continue as a going concern within one year after the date that the audited consolidated financial statements in this
Report are filed with the Securities and Exchange Commission.
We had $359,685 of available cash and equivalents and net working capital of $764,934 as of December 31, 2019. Net working
capital as of December 31, 2019 included approximately $1.1 million of accounts receivable and $5.3 million of current inventory.
Cash, cash equivalents: As of December 31, 2019, we had cash and cash equivalents with an aggregate balance of $359,685,
a decrease from a balance of $3,598,807 at December 31, 2018. Summarized immediately below and discussed in more detail in the
subsequent subsections are the main elements of the $3,239,122 net decrease in cash during the year ended December 31, 2019:
● Operating activities: $1,124,373 of net cash used in operating activities. Net cash used in operating activities was
$1,124,373 and $9,011,857 for the years ended December 31, 2019 and 2018, respectively, an
improvement of $7,887,484. The improvement was primarily the result of our improved operating
results for the year ended December 31, 2019 compared to 2018 and increases in accounts payable
and decreases of accounts receivable offset by a decrease in accrued expenses. Our goal is to
increase revenues, return to profitability and decrease our inventory levels during the 2020, thereby
providing positive cash flows from operations, although there can be no assurances that we will be
successful in this regard.
● Investing activities: $266,144 of net cash used in investing activities. Cash used in investing activities was $266,144
and $70,948 for the years ended December 31, 2019 and 2018 respectively. In 2019 and 2018, we
incurred costs for tooling of new products, an integrated display system and for patent applications
on our proprietary technology utilized in our new products and included in intangible assets.
● Financing activities: $1,848,605 of net cash used in financing activities. Cash used in financing activities was
$1,884,605 and for the year ended December 31, 2019 compared to cash provided by $12,126,900
for the year ended December 31, 2018. On December 23, 2019, we received proceeds of $300,000
from the issuance of the unsecured promissory note payable and on August 5, 2019, we received
net proceeds of $2,500,000 from the issuance of the 2019 secured convertible notes. We also
received $1,564,000 of proceeds in 2019 from the exercise of common stock purchase warrants.
The primary reason for the cash used in financing activities is related to the repayment of $6.0
million of the PIA obligation with proceeds from the WatchGuard patent litigation settlement
received in May 2019.
The net result of these activities was a decrease in cash of $3,239,122 to $359,685 for the year ended December 31, 2019.
Commitments:
We had $359,686 of cash and cash equivalents and net positive working capital $764,934 as of December 31, 2019. Accounts
receivable balances represented $1,071,018 of our net working capital at December 31, 2019. We intend to collect our outstanding
receivables on a timely basis and reduce the overall level during 2020, which would help to provide positive cash flow to support our
operations during 2020. Inventory represented $5,280,412 of our net working capital at December 31, 2019 and finished goods
represented $4,481,611 of total current and non-current inventory. We are actively managing the level of inventory and our goal is to
reduce such level during 2020 by our sales activities, the increase of which should provide additional cash flow to help support our
operations during 2020.
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Capital Expenditures. We had no material commitments for capital expenditures at December 31, 2019.
Lease commitments- The Company entered into an operating lease with a third party in September 2012 for office and warehouse
space in Lenexa, Kansas. The terms of the lease include monthly payments ranging from $38,026 to $38,533 with a maturity date of
April 2020. The Company has the option to renew for an additional three years beyond the original expiration date, which may be
exercised at the Company’s sole discretion. The Company evaluated the renewal option at the lease commencement date to determine
if it is reasonably certain the exercise the option and concluded that it is not reasonably certain that any options will be exercised. The
weighted average remaining lease term for the Company’s office and warehouse operating lease as of December 31, 2019 was four
months.
The Company entered into an operating lease with a third party in October 2019 for copiers used for office and warehouse
purposes. The terms of the lease include 48 monthly payments of $1,598 with a maturity date of October 2023. The Company has the
option to Purchase the equipment at maturity for its estimated fair market value at that point in time. The remaining lease term for the
Company’s copier operating lease as of December 31, 2019 was 46 months.
Lease expense related to the office space and copier operating leases was recorded on a straight-line basis over the lease term.
Total lease expense under the two operating leases was approximately $400,920 for the year ended December 31, 2019.
The discount rate implicit within the Company’s operating leases was not generally determinable and therefore the Company
determined the discount rate based on its incremental borrowing rate on the information available at commencement date. As of
commencement date, the operating lease liabilities reflect a weighted average discount rate of 8%.
The following sets forth the operating lease right of use assets and liabilities as of December 31, 2019:
Assets:
Operating lease right of use assets
Liabilities:
Operating lease obligations-current portion
Operating lease obligations-less current portion
Total operating lease obligations
Following are the minimum lease payments for each year and in total.
Year ending December 31:
2020
2021
2022
2023
Total undiscounted minimum future lease payments
Imputed interest
Total operating lease liability
$
122,459
$
$
$
159,160
44,460
203,620
$
$
173,307
19,176
19,176
15,980
227,639
(24,019)
203,620
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 $-0 and $2,083
for the years ended December 31, 2019 and 2018, respectively.
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Litigation.
From time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy to
not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After carefully
assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded, we
vigorously defend any lawsuit filed against us. We record a liability when losses are deemed probable and reasonably estimable. When
losses are deemed reasonably possible but not probable, we determine whether it is possible to provide an estimate of the amount of the
loss or range of possible losses for the claim, if material for disclosure. In evaluating matters for accrual and disclosure purposes, we
take into consideration factors such as our historical experience with matters of a similar nature, the specific facts and circumstances
asserted, the likelihood of our prevailing, the availability of insurance, and the severity of any potential loss. We reevaluate and update
accruals as matters progress over time.
While the ultimate resolution is unknown we do not expect that these lawsuits will individually, or in the aggregate, have a
material adverse effect to our results of operations, financial condition or cash flows. However, the outcome of any litigation is
inherently uncertain and there can be no assurance that any expense, liability or damages that may ultimately result from the resolution
of these matters will be covered by our insurance or will not be in excess of amounts recognized or provided by insurance coverage and
will not have a material adverse effect on our operating results, financial condition or cash flows. See Item 3, “Legal Proceedings,” for
information on our litigation.
NASDAQ Listing.
Our Common Stock is currently listed on The Nasdaq Capital Market (“Nasdaq”). In order to maintain that listing, we must
satisfy minimum financial and other continued listing requirements and standards, including those regarding director independence and
independent committee requirements, minimum stockholders’ equity, minimum share price, and certain corporate governance
requirements. There can be no assurances that we will be able to comply with the applicable listing standards.
If our Common Stock is delisted from Nasdaq and is not eligible for quotation on another market or exchange, trading of our
Common Stock could be conducted in the over-the-counter market or on an electronic bulletin board established for unlisted securities
such as the Pink Sheets or the OTC Bulletin Board. In such event, it could become more difficult to dispose of, or obtain accurate price
quotations for, our Common Stock, and there would likely also be a reduction in our coverage by securities analysts and the news
media. Also, it may be difficult for us to raise additional capital if we are not listed on Nasdaq or a major exchange.
On July 11, 2019, Nasdaq notified us that, for the previous 30 consecutive business days, the minimum Market Value of
Listed Securities (the “MVLS”) for our Common Stock was below the $35 million minimum MVLS requirement for continued listing
on Nasdaq under Nasdaq Listing Rule 5550(b)(2) (the “MVLS Rule”). In accordance with Nasdaq Listing Rule 5810(c)(3)(C), we had
180 calendar days, or until January 7, 2020, to regain compliance with the MVLS Rule. To regain compliance with the MVLS Rule,
the minimum MVLS for our Common Stock must have been at least $35 million for a minimum of ten consecutive business days at
any time during this 180-day period. If we failed to regain compliance with such rule by January 7, 2020, we were subject to being be
delisted from Nasdaq. If we were delisted from The Nasdaq Capital Market, our Common Stock may lose liquidity, increase volatility,
and lose market maker support.
On January 8, 2020, we received a determination letter from the staff of Nasdaq stating that we had not regained compliance
with the MVLS Standard, since our Common Stock was below the $35 million minimum MVLS requirement for continued listing on
Nasdaq under the MLVS Rule and had not been at least $35 million for a minimum of ten consecutive business days at any time during
the 180-day grace period granted to us. Pursuant to the letter, unless we requested a hearing to appeal this determination by January 15,
2020, our Common Stock would be delisted from Nasdaq and trading of our Common Stock would have been suspended at the
opening of business on January 17, 2020.
On January 13, 2020, we requested a hearing before the Nasdaq Hearings Panel to appeal the Letter and the Staff of Nasdaq
notified us that a hearing was scheduled for February 20, 2020. We were asked to provide the Panel with a plan to regain compliance
with the minimum MLVS requirement under the MLVS Rule, which needed to include a discussion of the events that we believe will
enable us to timely regain compliance with the minimum MLVS requirement. On January 21, 2020, we submitted such a compliance
plan.
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On March 6, 2020, we received notice from the NASDAQ hearing panel that we have been granted an extension until June 30,
2020 to regain compliance with Rule 5550(b), which requires us to have at least i) $2.5 million in shareholder equity; or ii) $35 million
in market value of listed securities, or iii) net income from continuing operations of at least $500,000 in the most recently completed
fiscal year or in two of the last three fiscal years. Our goal is to meet the $2.5 million minimum shareholder equity requirement for
continued listing on NASDAQ. There can be no assurance that we will regain compliance with the NASDAQ’s Listing Rule regarding
our $2.5 million minimum shareholder equity requirement on or prior to the June 30, 2020 required date. Furthermore, even if we
regain compliance on or prior to such date, we must thereafter continue to maintain compliance with such continued listing rule.
401 (k) Plan. The Company sponsors a 401(k) retirement savings plan for the benefit of its employees. The plan, as amended,
requires it to provide 100% matching contributions for employees, who elect to contribute up to 3% of their compensation to the plan
and 50% matching contributions for employee’s elective deferrals on the next 2% of their contributions. The Company made matching
contributions totaling $108,688 and $112,622 for the years ended December 31, 2019 and 2018, respectively. Each participant is 100%
vested at all times in employee and employer matching contributions.
Consulting and Distributor Agreements. The Company entered into an agreement that required it to make monthly payments
that will be applied to future commissions and/or consulting fees to be earned by the provider. The agreement is with a limited liability
company (“LLC”) that is minority owned by a relative of the Company’s chief financial officer. Under the agreement, dated January
15, 2016 and as amended on February 13, 2017, the LLC provides consulting services for developing a new distribution channel
outside of law enforcement for its body-worn camera and related cloud storage products to customers in the United States. The
Company advanced amounts to the LLC against commissions ranging from $5,000 to $6,000 per month plus necessary and reasonable
expenses for the period through June 30, 2017, which can be automatically extended based on the LLC achieving minimum sales
quotas. The agreement was renewed in January 2017 for a period of three years, subject to yearly minimum sales thresholds that would
allow the Company to terminate the contract if such minimums were not met. As of December 31, 2019, the Company had advanced a
total of $274,731 pursuant to this agreement and established an allowance reserve of $224,731 for a net advance of $50,000. The
minimum sales threshold was not been met and the Company discontinued all advances, although the contract has not been formally
terminated. However, the exclusivity provisions of the agreement have been terminated.
On June 1, 2018 the Company entered into an agreement with an individual that required it to make monthly payments that
will be applied to future commissions and/or consulting fees to be earned by the provider. Under the agreement, the individual provides
consulting services for developing new distribution channels both inside and outside of law enforcement for its in-car and body-worn
camera systems and related cloud storage products to customers within and outside the United States. The Company was required to
advance amounts to the individual as an advance against commissions of $7,000 per month plus necessary and reasonable expenses for
the period through August 31, 2018, which was extended to December 31, 2018 by mutual agreement of the parties at $6,000 per
month. The parties have mutually agreed to further extend the arrangement on a monthly basis at $5,000 per month. As of December
31, 2019, the Company had advanced a total of $53,332 pursuant to this agreement.
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;
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●
●
●
●
●
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)
(ii)
Identify the contract with the customer;
Identify the performance obligations in the contract;
(iii)
Determine the transaction price;
(iv)
Allocate the transaction price to the performance obligations in the contract; and
(v)
Recognize revenue when a performance obligation is satisfied.
We consider the terms and conditions of the contract and our customary business practices in identifying our contracts under
ASC 606. We determine we have a contract when the customer order is approved, we can identify each party’s rights regarding the
services to be transferred, we can identify the payment terms for the services, we have determined the customer has the ability and
intent to pay and the contract has commercial substance. At contract inception we evaluate whether the contract includes more than one
performance obligation. We apply judgment in determining the customer’s ability and intent to pay, which is based on a variety of
factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information
pertaining to the customer.
Performance obligations promised in a contract are identified based on the services and the products that will be transferred to
the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together
with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the
transfer of the services and the products is separately identifiable from other promises in the contract. Our performance obligations
consist of (i) products, (ii) professional services, and (iii) extended warranties.
The transaction price is determined based on the consideration to which we expect to be entitled in exchange for transferring
services to the customer. Variable consideration is included in the transaction price if, in our judgment it is probable that a significant
future reversal of cumulative revenue under the contract will not occur. None of our contracts contain a significant financing
component.
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance
obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance
obligation based on the relative standalone selling price (“SSP”).
Revenue is recognized at the time the related performance obligation is satisfied by transferring the control of the promised
service to a customer. Revenue is recognized when control of the service is transferred to the customer, in an amount that reflects the
consideration that we expect to receive in exchange for our services. We generate all our revenue from contracts with customers.
We review all significant, unusual or nonstandard shipments of product or delivery of services as a routine part of our
accounting and financial reporting process to determine compliance with these requirements. Extended warranties are offered on
selected products and when a customer purchases an extended warranty the associated proceeds are treated as contract liability and
recognized over the term of the extended warranty.
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Our principal customers are state, local and federal law enforcement agencies, which historically have been low risks for
uncollectible accounts. However, we have commercial customers and international distributors that present a greater risk for
uncollectible accounts than such law enforcement customers and we consider a specific reserve for bad debts based on their individual
circumstances. Our historical bad debts have been negligible, with less than $198,000 charged off as uncollectible on cumulative
revenues of $228.4 million since we commenced deliveries during 2006. As of December 31, 2019, and December 31, 2018, we had
provided a reserve for doubtful accounts of $123,224 and $70,000, respectively. Our historical bad debts have been negligible, with
less than $258,000 charged off as uncollectible on cumulative revenues of $238.9 million since we commenced deliveries during 2006.
As of December 31, 2019 and 2018, we had provided a reserve for doubtful accounts of $123,224 and $70,000, respectively.
We periodically perform a specific review of significant individual receivables outstanding for risk of loss due to
uncollectibility. Based on such review, we consider our reserve for doubtful accounts to be adequate as of December 31, 2019.
However, should the balance due from any significant customer ultimately become uncollectible then our allowance for bad debts will
not be sufficient to cover the charge-off and we will be required to record additional bad debt expense in our statement of operations.
Allowance for Excess and Obsolete Inventory. We record valuation reserves on our inventory for estimated excess or
obsolete inventory items. The amount of the reserve is equal to the difference between the cost of the inventory and the estimated
market value based upon assumptions about future demand and market conditions. On a quarterly basis, management performs an
analysis of the underlying inventory to identify reserves needed for excess and obsolescence. Management uses its best judgment to
estimate appropriate reserves based on this analysis. In addition, we adjust the carrying value of inventory if the current market value
of that inventory is below its cost.
Inventories consisted of the following at December 31, 2019 and 2018:
Raw material and component parts
Work-in-process
Finished goods
Subtotal
Reserve for excess and obsolete inventory
Total inventories
December 31, 2019
$
$
4,481,611 $
35,858
4,906,956
9,424,425
(4,144,013)
5,280,412 $
December 31, 2018
4,969,786
351,451
4,965,594
10,286,831
(3,287,771)
6,999,060
We balance the need to maintain strategic inventory levels to ensure competitive delivery performance to our customers against
the risk of inventory obsolescence due to changing technology and customer requirements. As reflected above, our inventory reserves
represented 38.2% of the gross inventory balance at December 31, 2019, compared to 32.0% of the gross inventory balance at
December 31, 2018. We had $4,144,013 and $3,287,771 in reserves for obsolete and excess inventories at December 31, 2019 and
December 31, 2018, respectively. Total raw materials and component parts were $4,481,611 and $4,969,786 at December 31, 2019 and
December 31, 2018, respectively, a decrease of $488,175 (10%). The reduction in raw materials was the result of tighter inventory
controls together with reductions in the level of FirstVU HD inventory levels. Finished goods balances were $4,906,956 and
$4,965,594 at December 31, 2019 and December 31, 2018, respectively, a decrease of $58,638 (1%). The decrease in finished goods
was primarily related to reductions in our DVM-750 product line, and test and evaluation and replacement inventory. The increase in
the inventory reserve is primarily due a higher level of excess component parts of the older versions of our PCB boards and the phase
out of our DVM-750, DVM-500 Plus and LaserAlly legacy products. We believe the reserves are appropriate given our inventory
levels at December 31, 2019.
If actual future demand or market conditions are less favorable than those projected by management or significant engineering
changes to our products that are not anticipated and appropriately managed, additional inventory write-downs may be required in
excess of the inventory reserves already established.
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Warranty Reserves. We generally provide up to a two-year parts and labor standard 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 $17,838 as of December 31,
2019 compared to $195,135 as of December 31, 2018 as we continue to reduce our warranty exposures through the roll-off of DVM-
750 and DVM-800 units from warranty coverage. Standard warranty exposure on the DVM-800 and DVM-250plus are the
responsibility of the contract manufacturers which reduced our overall warranty exposure as these are very popular products in our line.
There is a risk that we will have higher warranty claim frequency rates and average cost of claims than our history has indicated on our
legacy mirror products on our new products for which we have limited experience. Actual experience could differ from the amounts
estimated requiring adjustments to these liabilities in future periods.
Stock-based Compensation Expense. We grant stock options to our employees and directors and such benefits provided are
share-based payment awards which require us to make significant estimates related to determining the value of our share-based
compensation. Our expected stock-price volatility assumption is based on historical volatilities of the underlying stock that are
obtained from public data sources and there were 180,000 stock options granted during the year ended December 31, 2019.
If factors change and we develop different assumptions in future periods, the compensation expense that we record in the
future may differ significantly from what we have recorded in the current period. There is a high degree of subjectivity involved when
using option pricing models to estimate share-based compensation. Changes in the subjective input assumptions can materially affect
our estimates of fair values of our share-based compensation. Certain share-based payment awards, such as employee stock options,
may expire worthless or otherwise result in zero intrinsic value compared to the fair values originally estimated on the grant date and
reported in our financial statements. Alternatively, values may be realized from these instruments that are significantly in excess of the
fair values originally estimated on the grant date and reported in our financial statements. Although the fair value of employee share-
based awards is determined using an established option pricing model, that value may not be indicative of the fair value observed in a
willing buyer/willing seller market transaction. In addition, we account for forfeitures as they occur.
Accounting for Income Taxes. Accounting for income taxes requires significant estimates and judgments on the part of
management. Such estimates and judgments include, but are not limited to, the effective tax rate anticipated to apply to tax differences
that are expected to reverse in the future, the sufficiency of taxable income in future periods to realize the benefits of net deferred tax
assets and net operating losses currently recorded and the likelihood that tax positions taken in tax returns will be sustained on audit.
As required by authoritative guidance, we record deferred tax assets or liabilities based on differences between financial
reporting and tax bases of assets and liabilities using currently enacted rates that will be in effect when the differences are expected to
reverse. Authoritative guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not
that all or some portion of the deferred tax asset will not be realized. As of December 31, 2018, cumulative valuation allowances in the
amount of $21,500,000 were recorded in connection with the net deferred income tax assets. Based on a review of our deferred tax
assets and recent operating performance, we determined that our valuation allowance should be increased by $2,100,000 to a balance of
$23,600,000 to fully reserve our deferred tax assets at December 31, 2019. We determined that it was appropriate to continue to
provide a full valuation reserve on our net deferred tax assets as of December 31, 2019 because of the overall net operating loss
carryforwards available. We expect to continue to maintain a full valuation allowance until we determine that we can sustain a level of
profitability that demonstrates our ability to realize these assets. To the extent we determine that the realization of some or all of these
benefits is more likely than not based upon expected future taxable income, a portion or all of the valuation allowance will be reversed.
Such a reversal would be recorded as an income tax benefit and, for some portion related to deductions for stock option exercises, an
increase in shareholders’ equity.
As required by authoritative guidance, we have performed a comprehensive review of our portfolio of uncertain tax positions
in accordance with recognition standards established by the FASB, an uncertain tax position represents our expected treatment of a tax
position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax
expense for financial reporting purposes. We have no recorded liability as of December 31, 2019 representing uncertain tax positions.
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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 2019 we entered into the 2019 secured
convertible notes and we elected to record them on their fair value basis. During 2018 we entered into the Proceeds Investment
Agreement (PIA) and we elected to record the PIA, on its fair value basis. In accordance with ASC Topic 820 — Fair Value
Measurements and Disclosures (“ASC 820”), the Company utilizes the market approach to measure fair value for its financial assets
and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or
comparable assets, liabilities or a group of assets or liabilities, such as a business.
ASC 820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three
broad levels. The following is a brief description of those three levels:
●
●
●
Level 1 — Quoted prices in active markets for identical assets and liabilities
Level 2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
Level 3 — Significant unobservable inputs (including the Company’s own assumptions in determining the fair value)
The following table represents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a
recurring basis as of December 31, 2019.
December 31, 2019
Level 1
Level 2
Level 3
Total
Liabilities
Proceeds investment agreement
Secured convertible notes
Total
$
$
$
- $
- $
- $
- $
-
- $
6,500,000 $
1,593,809
8,093,809 $
6,500,000
1,593,809
8,093,809
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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, 2019, which raised substantial doubt about our ability to continue as a going concern within the next year, but such
doubt was not adequately mitigated by our plans to address the substantial doubt as disclosed in Note 1: Management’s Liquidity Plan
and going concern.
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.
On June 19, 2019, the Audit Committee of the Board of Directors of the Company, approved the engagement of RBSM, LLP
(“RBSM”) as the Company’s independent registered public accounting firm for the Company’s fiscal year ended December 31, 2019
and dismissed RSM US LLP (“RSM”) as the Company’s independent registered public accounting firm.
RSM’s audit reports on the Company’s consolidated financial statements as of and for the fiscal years ended December 31,
2018 and 2017 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit
scope or accounting principles, except that RSM’s audit reports for both years ended December 31, 2018 and 2017 contained an
emphasis of a matter regarding the Company’s ability to continue as a going concern.
During the fiscal years ended December 31, 2018, and 2017, and the subsequent interim periods through June 19, 2019, there
were (i) no disagreements (as described in Item 304(a)(1)(iv) of Regulation S-K and the related instructions) between the Company and
RSM on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not
resolved to RSM’s satisfaction, would have caused RSM to make reference thereto in its reports on the financial statements for such
years, and (ii) no “reportable events” within the meaning of Item 304(a)(1)(v) of Regulation S-K.
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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, 2019, 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, 2019. 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, 2019, 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, 2019, that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information.
None.
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Item 10.
Directors, Executive Officers and Corporate Governance.
PART III
Information with respect to our directors and executive officers is incorporated herein by reference to our definitive proxy
statement, to be filed no later than 120 days after December 31, 2019 (our “2020 Proxy Statement”).
Information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is
incorporated herein by reference to our 2020 Proxy Statement.
Information with respect to our code of business conduct and ethics is incorporated herein by reference to our 2020 Proxy
Statement.
Information with respect to our corporate governance disclosures is incorporated herein by reference to our 2020 Proxy
Statement.
Item 11.
Executive Compensation.
Information with respect to the compensation of our executive officers and our directors is incorporated herein by reference to
our 2020 Proxy Statement.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information with respect to security ownership of certain beneficial owners and management and related stockholder matters,
is incorporated herein by reference to our 2020 Proxy Statement.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
Information with respect to certain relationships and related transactions, and director independence is incorporated herein by
reference to our 2020 Proxy Statement.
Item 14.
Principal Accounting Fees and Services.
Information with respect to the fees paid to and services provided by our principal accountants is incorporated herein by
reference to our 2020 Proxy Statement.
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:
1.
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.
2.
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.
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3.
Exhibits:
Exhibit
Number
Description of Exhibit
2.1
Plan of Merger among Vegas Petra, Inc., a Nevada corporation, and Digital Ally, Inc., a Nevada
corporation, and its stockholders, dated November 30, 2004.
3.1(i)
Amended and Restated Articles of Incorporation of Digital Ally, Inc. (see the Amended and Restated
3.1(ii)
3.1(iii)
3.2(i)
3.2(ii)
3.3
3.4
3.5
3.6
3.7
3.8
3.9
4.1
4.2
4.3
4.4
4.5
5.1
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
Articles of Incorporation included in the Plan of Merger, filed as Exhibit 2.1 hereto).
Certificate of Change of Digital Ally, Inc., dated August 24, 2012.
Certificate of Amendment of Digital Ally, Inc., dated July 27, 2018.
Amended and Restated Bylaws of Digital Ally, Inc.
Amendment to Amended and Restated Bylaws of Digital Ally, Inc.
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.
Form of Series C Common Stock Purchase Warrant.
Opinion of Quarles & Brady, LLP
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.
(1)
(1)
(5)
(35)
(1)
(34)
(1)
(1)
(2)
(3)
(4)
(4)
(5)
(6)
(6)
(7)
(7)
(7)
(32)
(6)
(6)
(6)
(6)
(6)
(8)
(8)
(8)
(8)
(8)
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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
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
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
Allonge to 8% Subordinated Promissory Note in principal amount of $1,000,000
Amendment to Common Stock Purchase Warrant
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
10.58
Form of Voting Agreement
41
(8)
(9)
(2)
(2)
(2)
(2)
(2)
(10)
(10)
(11)
(11)
(12)
(13)
(13)
(14)
(14)
(15)
(15)
(15)
(15)
(16)
(16)
(16)
(16)
(17)
(17)
(17)
(18)
(18)
(18)
(18)
(18)
(18)
(18)
(18)
(18)
(18)
(18)
(19)
(19)
(19)
(19)
(19)
(19)
(19)
(19)
(19)
(19)
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10.59
10.60
10.61
10.62
10.63
10.64
10.65
10.66
10.67
10.68
10.69
10.70
10.71
10.72
10.73
10.74
10.75
10.76
10.77
10.78
10.79
10.80
10.81
10.82
10.83
10.84
10.85
10.86
10.87
10.88
10.89
10.90
10.91
10.92
10.93
10.94
10.95
10.96
10.97
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
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.
Form of Securities Purchase Agreement, by and among the Company and the purchaser signatories
thereto
Form of Secured Convertible Promissory Note
Form of Common Stock Purchase Warrant
Form of Security Agreement, by and among the Company and each of the secured parties thereto
Form of Intellectual Property Security Agreement, between the Company and the secured lender thereto
Form of Subsidiary Guarantee, by and among the Company, the purchasers under the Securities
Purchase Agreement, and each of the Company’s subsidiaries
Common Stock Purchase Warrant of Digital Ally, Inc.
Proceeds Investment Agreement, dated as July 31, 2018, by and between Digital Ally, Inc. and Brickell
Key Investments LP
Letter Agreement, dated as July 31, 2018, by and between Digital Ally, Inc. and Brickell Key
Investments LP
Digital Ally, Inc. 2018 Stock Option and Restricted Stock Plan
Form of Lock-Up Agreement
Form of Common Stock Purchase Warrant.
Form of Securities Purchase Agreement, dated as of August 5, 2019, by and between the Company and
the Investors.
Form of Security Agreement, dated August 5, 2019, by and among the Company, certain of the
Company’s subsidiaries and the Secured Parties.
Form of IP Security Agreement, dated August 5, 2019, by the Company, in favor of the Agent and the
Secured Parties.
Form of Subsidiary Guarantee, dated August 5, 2019, made by certain of the Company’s subsidiaries in
favor of the Investors.
10.98
10.99
10.100
14.1
Form of Consent (August 2019 Warrant Modification)
Form of Consent (August 2019 Warrant Modification)
Form of Consent and Waiver (August 2019 Warrant Modification)
Code of Ethics and Code of Conduct.
42
(19)
(19)
(19)
(19)
(20)
(20)
(21)
(21)
(21)
(22)
(23)
(24)
(24)
(24)
(25)
(25)
(25)
(25)
(25)
(26)
(26)
(26)
(26)
(27)
(27)
(27)
(27)
(27)
(27)
(29)
(29)
(29)
(30)
(31)
(33)
(33)
(33)
(33)
(33)
(36)
(36)
(36)
(2)
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21.1
23.1
23.2
23.3
24.1
31.1
31.2
32.1
32.2
Subsidiaries of Registrant
Consent of RBSM LLP
Consent of RSM US LLP
Consent of Quarles & Brady LLP (included in Exhibit 5.1)*
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
99.1
Audited Financial Statements of Digital Ally, Inc. as of and for the years ended December 31, 2019 and
*
*
*
(32)
*
*
*
*
*
*
2018.
101.INS
101.SCH
101.CAL
101.LAB
101.PRE
XBRL Instance Document **
XBRL Taxonomy Schema **
XBRL Taxonomy Calculation Linkbase **
XBRL Taxonomy Label Linkbase **
XBRL Taxonomy Presentation Linkbase **
*Filed herewith.
** 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.
Filed as an exhibit to the Company’s Form SB-2, filed October 16, 2006, No. 333-138025.
Filed as an exhibit to the Company’s Annual Report on Form 10KSB for the Year ending December 31, 2007.
Filed as an exhibit to the Company’s Current Report on Form 8-K dated November 20, 2009.
Filed as an exhibit to the Company’s Annual Report on Form 10K for the Year ending December 31, 2009.
Filed as an exhibit to the Company’s Form 8-K filed August 30, 2012.
Filed as an exhibit to the Company’s October 2006 Form SB-2.
Filed as an exhibit to the Company’s Form 8-K filed July 17, 2015
Filed as an exhibit to the Company’s Amendment No. 1 to Form SB-2, filed January 31, 2007, No. 333-138025
Filed as an exhibit to the Company’s Form S-8, filed October 23, 2007, No. 333-146874.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10) Filed as an exhibit to the Company’s Annual Report on Form 10K for the Year ending December 31, 2008.
(11) Filed as an exhibit to the Company’s Annual Report on Form 10K for the Year ending December 31, 2009.
(12) Filed as an exhibit to the Company’s Annual Report on Form 10K for the Year ending December 31, 2010.
(13) Filed as an exhibit to the Company’s Form 8-K filed June 1, 2011
(14) Filed as an exhibit to the Company’s Form 8-K filed June 3, 2011
(15) Filed as an exhibit to the Company’s Form 8-K filed November 10, 2011
(16) Filed as an exhibit to the Company’s Form 8-K filed July 30, 2012
(17) Filed as an exhibit to the Company’s Form 8-K filed December 9, 2013
(18) Filed as an exhibit to the Company’s Form 8-K filed March 21, 2014
(19) Filed as an exhibit to the Company’s Form 8-K filed August 25, 2014
(20) Filed as an exhibit to the Company’s Form 8-K filed May 28, 2015
(21) Filed as an exhibit to the Company’s Form 8-K filed July 15, 2015
(22) Filed as an exhibit to the Company’s Form 8-K filed July 17, 2015
(23) Filed as an exhibit to the Company’s Form S-8 filed May 23, 2016
(24) Filed as an exhibit to the Company’s Form 8-K filed November 16, 2016
(25) Filed as an exhibit to the Company’s Form 8-K filed January 3, 2017
(26) Filed as an exhibit to the Company’s Form 8-K filed August 25, 2017
(27) Filed as an exhibit to the Company’s Form 8-K filed April 4, 2018
(28) Filed as an exhibit to the Company’s Annual Report on Form 10K for the Year ending December 31, 2015.
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(29) Filed as an exhibit to the Company’s Form 8-K filed August 2, 2018
(30) Filed as an exhibit to the Company’s Registration Statement on Form S-8 filed August 20, 2018
(31) Filed as an exhibit to the Company’s Form 8-K filed September 26, 2018
(32) Filed as an Exhibit 5.1 to the October 2006 Form SB-2..
(33) Filed as an exhibit to the Company’s Form 8-K filed August 5, 2019.
(34) Filed as an exhibit to the Company’s Form 8-K filed December 10, 2007.
(35) Filed as an exhibit to the Company’s Registration Statement on Form S-1/A filed February 7, 2020.
(36) Filed as an exhibit to the Company’s Registration Statement on Form S-1/A filed February 12, 2020.
(b) No financial statement schedules have been provided because the information is not required or is shown either in the
financial statements or the notes thereto.
43
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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.
S
DIGITAL ALLY, INC.,
a Nevada corporation
By: /s/ S E. R
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/ S E. R
Stanton E. Ross, Director and Chief Executive Officer
/s/ L C. R
Leroy C. Richie, Director
/s/ M J. C
Michael J. Caulfield, Director
/s/ D F. H
Daniel F. Hutchins, Director
/s/ T J. H
Thomas J. Heckman, Chief Financial Officer, Secretary, Treasurer and
Principal Accounting Officer
44
Date
April 6, 2020
April 6, 2020
April 6, 2020
April 6, 2020
April 6, 2020
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DIGITAL ALLY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firms
Consolidated Financial Statements:
Consolidated Balance Sheets – December 31, 2019 and 2018
Consolidated Statements of Operations for the Years Ended December 31, 2019 and 2018
Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2019 and 2018
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019 and 2018
Notes to the Consolidated Financial Statements
F-1
Page(s)
F-2
F-4
F-5
F-6
F-7
F-8
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Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Digital Ally, Inc.
Opinion on the Financial Statement
We have audited the accompanying consolidated balance sheet of Digital Ally, Inc. and its subsidiaries (the Company) as of December
31, 2019, the related consolidated statement of operation, stockholders’ deficit and cash flow for the year ended December 31, 2019,
and the related notes to the consolidated financial statement (collectively, the financial statement). In our opinion, the financial
statement present fairly, in all material respects, the financial position of the Company as of December 31, 2019, and the results of its
operation and its cash flow for the year then ended, in conformity with accounting principles generally accepted in the United States of
America.
Change in Accounting Principles
As discussed in Note 1 and 12 to the financial statement, the Company changed its method of accounting for leases in 2019 due to the
adoption of ASU No. 2016-02, Leases (Topic 842), as amended, effective January 1, 2019, using the optional transitional method and
elected to use the package of three practical expedients which allows the Company not to reassess whether contracts are or contain
leases, lease classification and whether initial direct costs qualify for capitalization.
Emphasis of Matter Regarding Going Concern
The accompanying financial statement have been prepared assuming that the Company will continue as a going concern. As discussed
in Note 1 to the financial statement, the Company has suffered recurring losses from operations and 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 statement do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These financial statement are the responsibility of the Company’s management. Our responsibility is to express an opinion on the
Company’s financial statement based on our audit. 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 audit 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 audit 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 audit 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 audit provide a reasonable basis for our opinion.
/s/ RBSM LLP
We have served as the Company’s auditor since 2019.
Larkspur, CA
April 6, 2020
F-2
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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 sheet of Digital Ally, Inc. and its subsidiaries (the Company) as of December
31, 2018, the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the year 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, 2018, and the results of its operations
and its cash flows for the year 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 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.
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 audit. 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 audit 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 audit 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 audit 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 audit 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 audit provides a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the Company’s auditor since 2015 until 2019.
Kansas City, Missouri
March 29, 2019
F-3
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DIGITAL ALLY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2019 AND 2018
Current assets:
Assets
Cash and cash equivalents
Accounts receivable-trade, less allowance for doubtful accounts
of $123,224 – 2019 and $70,000 – 2018
Accounts receivable-other
Inventories, net
Income tax refund receivable, current
Prepaid expenses
Total current assets
Furniture, fixtures and equipment, net
Intangible assets, net
Operating lease right of use assets
Income tax refund receivable
Other assets
Total assets
Current liabilities:
Liabilities and Stockholders’ Deficit
2019
2018
$
359,685 $
3,598,807
1,071,018
514,730
5,280,412
44,650
381,090
1,847,886
382,412
6,999,060
44,603
429,403
7,651,585
13,302,171
197,063
413,268
122,459
—
532,500
247,541
486,797
—
45,397
256,749
$
8,916,875 $
14,338,655
Accounts payable
Accrued expenses
Current portion of operating lease obligations
Contract liabilities-current
Unsecured promissory note payable, net of unamortized discount of $66,061
Secured convertible notes at fair value – current portion
Income taxes payable
$
2,339,985 $
845,881
159,160
1,707,943
233,939
1,593,809
5,934
784,599
2,080,667
—
1,748,789
—
—
3,689
Total current liabilities
6,886,651
4,617,744
Long-term liabilities:
Proceeds investment agreement, at fair value
Operating lease obligation, long term
Contract liabilities-long term
Total liabilities
Commitments and contingencies
Stockholders’ Equity (Deficit):
6,500,000
44,460
1,803,143
9,142,000
—
1,991,091
15,234,254
15,750,835
Common stock, $0.001 par value; 50,000,000 shares authorized; shares issued:
12,079,095 – 2019 and 10,445,445 – 2018
Additional paid in capital
Treasury stock, at cost (63,518 shares)
Accumulated deficit
Total stockholders’ deficit
12,079
83,216,387
(2,157,226)
(87,388,619)
10,445
78,117,507
(2,157,226)
(77,382,906)
(6,317,379)
(1,412,180
Total liabilities and stockholders’ deficit
$
8,916,875 $
14,338,655
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See Notes to Consolidated Financial Statements.
F-4
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DIGITAL ALLY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED
DECEMBER 31, 2019 AND 2018
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
Patent litigation settlement
2019
2018
$
7,732,796 $
2,708,568
9,130,911
2,160,498
10,441,364
11,291,409
6,577,347
631,388
7,208,735
3,232,629
2,005,717
3,652,434
2,112,090
7,495,169
(6,000,000)
6,805,897
523,704
7,329,601
3,961,808
1,444,063
2,797,793
2,272,656
8,003,353
—
Total selling, general and administrative expenses
9,265,410
14,517,865
Operating loss
(6,032,781)
(10,556,057)
Other income (expense)
Interest income
Interest expense
Change in warrant derivative liabilities
Change in fair value of secured convertible notes
Change in fair value of secured convertible debentures
Change in fair value of proceeds investment agreement
Loss on the extinguishment of secured convertible debentures
Secured convertible notes issuance expense
Total other income (expense)
Loss before income tax (benefit)
Income tax (benefit)
Net loss
Net loss per share information:
Basic
Diluted
Weighted average shares outstanding:
Basic
Diluted
37,410
(43,373)
—
(519,821)
—
(3,358,000)
—
(89,148)
19,524
(1,366,520)
(319,105)
—
(2,296,444)
(74,487)
(600,000)
(351,462)
(3,972,932)
(4,988,494)
(10,005,713)
—
(15,544,551)
—
$
(10,005,713) $
(15,544,551)
$
$
(0.87) $
(0.87) $
(1.93)
(1.93)
11,478,618
11,478,618
8,073,257
8,073,257
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DIGITAL ALLY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2019 AND 2018
Balance, December 31, 2017
Cumulative effects adjustment for adoption of
ASC 606 (Note 1)
Stock-based compensation
Restricted common stock grant
Restricted common stock forfeitures
Issuance of common stock through underwritten
public offering (net of offering expenses and
underwriters’ discount)
Issuance of common stock purchase warrants in
connection with issuance of subordinated notes
payable
Issuance of common stock purchase warrants in
connection with issuance of secured convertible
debentures
Issuance of common stock purchase warrants in
connection with issuance of proceeds investment
agreement
Issuance of common stock upon conversion of
secured convertible debentures and accrued
interest
Issuance of common stock upon conversion of
secured notes payable and accrued interest
Issuance of common stock upon exercise of
common stock purchase warrants
Issuance of common stock upon conversion of
accounts payable
Net loss
Common Stock
Shares
Amount
Additional
Paid In
Capital
Treasury
Accumulated
stock
deficit
Total
7,037,799 $
7,038 $64,923,735 $(2,157,226) $ (61,909,799) $
863,748
—
—
484,500
(33,900)
—
—
484
(34)
—
2,272,656
(484)
34
—
—
—
—
71,444
—
—
—
71,444
2,272,656
—
—
2,600,000
2,600
7,322,300
—
—
7,324,900
—
—
47,657
—
—
47,657
—
—
1,684,251
—
—
1,684,251
—
—
932,487
—
—
932,487
117,476
117
293,571
47,139
47
153,153
171,738
172
425,053
20,693
—
21
—
63,094
—
—
—
—
—
—
—
—
293,688
153,200
425,225
63,115
—
—
(15,544,551)
(15,544,551)
Balance, December 31, 2018
10,445,445
10,445
78,117,507
(2,157,226)
(77,382,906)
(1,412,180)
Stock-based compensation
Restricted common stock grant
Restricted common stock forfeitures
Issuance of common stock upon conversion of
secured convertible notes and interest
Issuance of common stock In connection with
issuance of secured convertible notes
Issuance of common stock purchase warrants in
connection with issuance of secured convertible
debentures
Issuance of common stock upon exercise of
warrants
Issuance of common stock purchase warrants in
connection with issuance of unsecured promissory
note payable
Net loss
—
522,110
(5,370)
—
522
(5)
2,112,090
(522)
5
498,625
499
697,568
89,285
89
118,660
—
—
535,739
529,000
529
1,563,471
—
—
—
—
—
—
—
—
—
—
—
—
2,112,090
—
—
698,067
118,749
—
535,739
—
1,564,000
—
—
—
—
71,869
—
—
71,869
—
—
(10,005,713)
(10,005,713)
Balance, December 31, 2019
12,079,095 $ 12,079 $83,216,387 $(2,157,226) $ (87,388,619) $ (6,317,379)
See Notes to Consolidated Financial Statements.
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DIGITAL ALLY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2019 AND 2018
Cash Flows From Operating Activities:
Net loss
Adjustments to reconcile net loss to net cash flows used in operating activities:
$
2019
2018
(10,005,713) $
(15,544,551)
Depreciation and amortization
(Gain) on disposal of equipment
Stock based compensation
Change in fair value of warrant derivative liabilities
Amortization of debt discount
Provision for doubtful accounts receivable
Interest paid through issuance of common stock
Loss on extinguishment of secured convertible debentures
Secured convertible debentures issuance expense
Change in fair value of secured convertible debentures
Change in fair value of proceeds investment agreement
Provision for inventory obsolescence
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable – trade
Accounts receivable – other
Inventories
Prepaid expenses
Income tax refund receivable
Operating lease right of use assets
Other assets
Increase (decrease) in:
Accounts payable
Accrued expenses
Income taxes payable
Operating lease obligations
Contract liabilities
390,151
—
2,112,090
—
5,808
60,000
50,000
—
89,148
519,821
3,358,000
856,242
716,868
(132,318)
862,406
48,313
45,350
378,292
(275,751)
1,555,386
(1,234,786)
2,245
(297,131)
(228,794)
500,177
(28,218)
2,272,656
319,105
47,657
—
—
600,000
220,312
2,296,444
74,487
597,798
131,050
(43,794)
1,153,855
(148,796)
—
—
(141,706)
(2,345,555)
862,126
(6,452)
—
171,548
Net cash used in operating activities
(1,124,373)
(9,011,857)
Cash Flows from Investing Activities:
Purchases of furniture, fixtures and equipment
Additions to intangible assets
Proceeds from the sale of equipment
Net cash used in investing activities
Cash Flows from Financing Activities:
Proceeds from unsecured promissory note payable
Payoff of proceeds investment agreement
Proceeds from proceeds investment agreement and detachable
common stock warrants
Proceeds from secured convertible debentures and detachable common stock
purchase warrants
Secured convertible debenture issuance expense
Proceeds from sale of common stock in underwritten public offering
Principal payment on subordinated notes payable
Principal payment on secured convertible debentures
Proceeds from issuance of common stock upon exercise of warrants
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(204,013)
(62,131)
—
(266,144)
300,000
(6,000,000)
(42,526)
(104,690)
76,268
(70,948)
250,000
—
—
10,000,000
2,500,000
(89,148)
—
(123,457)
—
1,564,000
6,250,000
(220,312)
7,324,900
(1,108,500)
(9,850,000)
89,304
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Loss on extinguishment of secured convertible debentures
Payments on capital lease obligations
—
—
(600,000)
(8,492)
Net cash (used in) provided by financing activities
(1,848,605)
12,126,900
Net (decrease) increase in cash and cash equivalents
Cash, cash equivalents, beginning of year
Cash, cash equivalents, end of year
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
$
$
$
$
$
Impact of Adoption of ASC 842 - obtaining right of use asset for lease liability $
500,751 $
Amounts allocated to common stock purchase warrants in connection with
proceeds from secured convertible debentures
Issuance of common stock upon conversion of secured convertible notes
$
$
535,739 $
1,684,251
648,067 $
293,688
Issuance of common stock related to the issuance of secured convertible notes $
118,749 $
(3,239,122)
3,598,807
3,044,095
554,712
359,685 $
3,598,807
30,937 $
1,367,561
3,755 $
6,452
522 $
5 $
71,869 $
— $
— $
484
34
—
—
—
932,487
63,115
— $
153,200
— $
335,921
— $
47,657
Amounts allocated to common stock purchase warrants in connection with
issuance of unsecured promissory note payable
Amounts allocated to common stock purchase warrants in connection with
proceeds investment agreement
Issuance of common stock upon conversion of accounts payable
Issuance of common stock upon conversion of secured notes payable and
accrued interest
Issuance of common stock upon exercise of common stock purchase warrants
accounted for as derivative warrant liabilities
Amounts allocated to common stock purchase warrants in connection with
proceeds from subordinated notes payable
$
$
$
$
$
$
See Notes to Consolidated Financial Statements.
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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 subsidiary (collectively, “Digital Ally,” “Digital,” and the “Company”) produces digital video imaging and
storage products for use in law enforcement, security and commercial applications. Its products are an in-car digital video/audio
recorder contained in a rear-view mirror for use in law enforcement and commercial fleets; a system that provides its law enforcement
customers with audio/video surveillance from multiple vantage points and hands-free automatic activation of body-worn cameras and
in-car video systems; a miniature digital video system designed to be worn on an individual’s body; and cloud storage solutions. The
Company has active research and development programs to adapt its technologies to other applications. It can integrate electronic,
radio, computer, mechanical, and multi-media technologies to create unique solutions to address needs in a variety of other industries
and markets, including mass transit, school bus, taxicab and the military. The Company sells its products to law enforcement agencies,
private security customers and 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 and Going Concern
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course of business. The Company incurred operating losses in the
year ended December 31, 2019 and substantial operating losses for the year ended December 31, 2018 primarily due to reduced
revenues and gross margins caused by competitors’ willful infringement of its patents, specifically the auto-activation of body-worn
and in-car video systems, and by competitors’ introduction of newer products with more advanced features together with significant
price cutting of their products. The Company incurred net losses of approximately $10.0 million for the year ended December 31, 2019
and $15.5 million during the year ended December 31, 2018 and it had an accumulated deficit of $87.4 million as of December 31,
2019. During the year ended December 31, 2019, the Company settled one of its patent infringement cases and received a lump sum
payment of $6.0 million, which was used to pay its obligations under its Proceeds Investment Agreement as more fully described in
Note 12. In recent years the Company has accessed the public and private capital markets to raise funding through the issuance of debt
and equity. In that regard, the Company raised $1,564,000 in the year ended December 31, 2019 from the exercise of warrants, the
Company borrowed $300,000 pursuant to a short-term promissory note payable on December 23, 2019 with detachable warrants to
purchase 107,000 shares of common stock and on August 5, 2019, the Company raised funds from the issuance of $2.78 million
principal balance of secured convertible notes with detachable warrants to purchase 571,248 shares of common stock with the net
proceeds being used for working capital purposes as more fully described in Note 6. Additionally, the Company raised funding in the
form of subordinated debt, secured debt and Proceeds Investment Agreement totaling $16,500,000 and net proceeds of $7,324,900
from an underwritten public offering of common stock during the year ended December 31, 2018. 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 settled its lawsuit with the PGA Tour and the case was dismissed by the Plaintiff with prejudice on April 17,
2019. Additionally, the Company settled its lawsuit with WatchGuard on May 13, 2019 and the case was dismissed. See Note 12,
“Contingencies” for the details respecting the settlements.
The Company will have to restore positive operating cash flows and profitability over the next year and/or raise additional capital
to fund its operational plans, meet its customary payment obligations and otherwise execute its business plan. There can be no
assurance that it will be successful in restoring positive cash flows and profitability, or that it can raise additional financing when
needed, and obtain it on terms acceptable or favorable to the Company.
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The Company has increased its addressable market to non-law enforcement customers and obtained new non-law enforcement
contracts in 2019 and 2018, which contracts include recurring revenue during the period 2020 to 2023. The Company believes that its
quality control and cost cutting initiatives, expansion to non-law enforcement sales channels and new product introduction will
eventually restore positive operating cash flows and profitability, although it can offer no assurances in this regard.
In addition to the initiatives described above, the Board of Directors 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.), 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’s August 5, 2019 issuance of $2.78
million principal balance of convertible notes was part of this strategic alternatives review. The Company has an active shelf
registration statement on Form S-3, which it utilized to raise $2.9 million in gross proceeds through the issuance of 2,521,740 common
shares in an underwritten public offering at $1.15 per share on March 3, 2020. While such funding addressed the Company’s near-term
liquidity needs, it continues to consider strategic alternatives to address longer-term liquidity needs and operational issues. There can
be no assurance that any additional transactions or financings will result from this process.
Based on the uncertainties described above, the Company believes its business plan does not alleviate the existence of substantial
doubt about its ability to continue as a going concern within one year from the date of the issuance of these consolidated financial
statements. The accompanying consolidated financial statements do not include any adjustments related to the recoverability and
classification of asset amounts or the classification of liabilities that might be necessary should the Company be unable to continue as a
going concern.
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. All intercompany balances and transactions have been eliminated during consolidation.
The Company formed Digital Ally International, Inc. during August 2009 to facilitate the export sales of its products.
Fair Value of Financial Instruments:
The carrying amounts of financial instruments, including cash and cash equivalents, accounts receivable, 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, secured convertible debentures and proceeds investment agreement on a fair value basis.
Revenue Recognition:
The Company applies the provisions of Accounting Standards Codification (ASC) 606-10, Revenue from Contracts with
Customers, and all related appropriate guidance. The Company recognizes revenue under the core principle to depict the transfer of
control to its customers in an amount reflecting the consideration to which it expects to be entitled. In order to achieve that core
principle, the Company applies the following five-step approach: (1) identify the contract with a customer, (2) identify the performance
obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the
contract, and (5) recognize revenue when a performance obligation is satisfied.
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The Company considers customer purchase orders, which in some cases are governed by master sales agreements, to be the
contracts with the customer. In situation where sales are to a distributor, the Company had concluded its contracts are with the
distributor as the Company holds a contract bearing enforceable rights and obligations only with the distributor. As part of part of its
consideration for the contract, the Company evaluates certain factors including the customers’ ability to pay (or credit risk). For each
contract, the Company considers the promise to transfer products, each of which is distinct, to be the identified performance
obligations. In determining the transaction price, the Company evaluates whether the price is subject to refund or adjustment to
determine the net consideration to which it expects to be entitled. As the Company’s standard payment terms are less than one year, it
has elected the practical expedient under ASC 606-10-32-18 to not assess whether a contract has a significant financing component.
The Company allocates the transaction price to each distinct product based on its relative standalone selling price. The product price as
specified on the purchase order is considered the standalone selling price as it is an observable input which depicts the price as if sold
to a similar customer in similar circumstances. Revenue is recognized when control of the product is transferred to the customer (i.e.
when the Company’s performance obligations is satisfied), which typically occurs at shipment. Further in determining whether control
has been transferred, the Company considers if there is a present right to payment and legal title, along with risks and rewards of
ownership having transferred to the customer. Customers do not have a right to return the product other than for warranty reasons for
which they would only receive repair services or replacement product. The Company has also elected the practical expedient under
ASC 340-40-25-4 to expense commissions for product sales when incurred as the amortization period of the commission asset the
Company would have otherwise recognized is less than one year.
The Company sells its products and services to law enforcement and commercial customers in the following manner:
● Sales to domestic customers are made direct to the end customer (typically a law enforcement agency or a
commercial customer) through its sales force, which is composed of its employees. Revenue is recorded when the
product is shipped to the end customer.
● Sales to international customers are made through independent distributors who purchase products from the
Company at a wholesale price and sell to the end user (typically law enforcement agencies or a commercial
customer) at a retail price. The distributor retains the margin as its compensation for its role in the transaction. The
distributor generally maintains product inventory, customer receivables and all related risks and rewards of
ownership. Accordingly, upon application of steps one through five above, revenue is recorded when the product is
shipped to the distributor consistent with the terms of the distribution agreement.
● Repair parts and services for domestic and international customers are generally handled by its inside customer
service employees. Revenue is recognized upon shipment of the repair parts and acceptance of the service or
materials by the end customer.
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Sales taxes collected on products sold are excluded from revenues and are reported as accrued expenses in the accompanying
balance sheets until payments are remitted.
Service and other revenue is comprised of revenues from extended warranties, repair services, cloud revenue and software
revenue. Revenue is recognized upon shipment of the product and acceptance of the service or materials by the end customer for repair
services. Revenue for extended warranty, cloud service or other software-based products is over the term of the contract warranty or
service period. A time-elapsed method is used to measure progress because the Company transfers control evenly over the contractual
period. Accordingly, the fixed consideration related to these revenues is generally recognized on a straight-line basis over the contract
term, as long as the other revenue recognition criteria have been met.
Contracts with some of the Company’s customers contain multiple performance obligations that are distinct and accounted for
separately. The transaction price is allocated to the separate performance obligations on a relative standalone selling price (“SSP”). The
Company determined SSP for all the performance obligations using observable inputs, such as standalone sales and historical pricing.
SSP is consistent with the Company’s overall pricing objectives, taking into consideration the type of service being provided. SSP also
reflects the amount the Company would charge for the performance obligation if it were sold separately in a standalone sale. Multiple
performance obligations consist of product, software, cloud subscriptions and extended warranties.
The Company’s multiple performance obligations may include future in-car or body-worn camera devices to be delivered at
defined points within a multi-year contract, and in those arrangements, the Company allocates total arrangement consideration over the
life of the multi-year contract to future deliverables using management’s best estimate of selling price.
Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract
and are reported separately as current liabilities and non-current liabilities in the Consolidated Balance Sheets. Such amounts consist of
extended warranty contracts, prepaid cloud services and prepaid installation services and are generally recognized as the respective
performance obligations are satisfied. During the year ended December 31, 2018, the Company recognized revenue of $1.7 million
related to its contract liabilities at January 1, 2018. Total contract liabilities consist of the following: Contract liabilities consist of
deferred revenue and include payments received in advance of performance under the contract and are reported separately as current
liabilities and non-current liabilities in the Consolidated Balance Sheets. Such amounts consist of extended warranty contracts, prepaid
cloud services and prepaid installation services and are generally recognized as the respective performance obligations are satisfied.
Total contract liabilities consist of the following:
Contract liabilities, current
Contract liabilities, non-current
December 31, 2019 December 31, 2018
1,748,789
$
1,991,091
1,707,943 $
1,803,143
Total contract liabilities
$
3,511,086 $
3,739,880
Sales returns and allowances aggregated $134,825 and $132,477 for the years ended December 31, 2019 and 2018, respectively.
Obligations for estimated sales returns and allowances are recognized at the time of sales on an accrual basis. The accrual is determined
based upon historical return rates adjusted for known changes in key variables affecting these return rates.
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Revenues for the years ended December 31, 2019 and 2018 were derived from the following sources:
DVM-800
Repair and service
FirstVu HD
DVM-250 Plus
Cloud service revenue
DVM-750
VuLink
EVO
Laser Ally
DVM-100 & DVM-400
Accessories and other revenues
Year ended December 31,
2019
3,756,544 $
1,505,849
1,264,457
1,133,557
754,586
—
140,392
287,012
—
7,890
1,591,077
10,441,364 $
2018
5,090,804
1,466,845
1,386,737
757,676
693,653
403,390
190,951
—
79,155
75,421
1,146,777
11,291,409
$
$
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. Management utilizes various other
estimates, including but not limited to determining the estimated lives of long-lived assets, determining the potential impairment of
long-lived assets, the fair value of warrants, options, proceeds investment agreement and convertible debt, the recognition of revenue,
inventory valuation reserve, the valuation allowance for deferred tax assets and other legal claims and contingencies. The results of any
changes in accounting estimates are reflected in the financial statements in the period in which the changes become evident. Estimates
and assumptions are reviewed periodically, and the effects of revisions are reflected in the period that they are determined to be
necessary.
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.
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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 or market, with cost determined by standard cost methods, which
approximate the first-in, first-out method. Inventory costs include material, labor and manufacturing overhead. Service inventories that
exceed the estimated requirements for the next 12 months based on recent usage levels are reported as other long-term assets.
Management has established inventory reserves based on estimates of excess and/or obsolete current and non-current inventory.
Manufacturing inventory is reviewed for obsolescence and excess quantities on a quarterly basis, based on estimated future
use of quantities on hand, which is determined based on past usage, planned changes to products and known trends in markets and
technology. Changes in support plans or technology could have a significant impact on obsolescence.
To support our world-wide service operations, we maintain service spare parts inventory, which consists of both consumable
and repairable spare parts. Consumable service spare parts are used within our service business to replace worn or damaged parts in a
system during a service call and are generally classified in current inventory as our stock of this inventory turns relatively quickly.
However, if there has been no recent usage for a consumable service spare part, but the part is still necessary to support systems under
service contracts, the part is considered to be non-current and included within non-current inventories within our consolidated balance
sheet. Consumables are charged to cost of goods sold when issued during the service call.
As these service parts age over the related product group’s post-production service life, we reduce the net carrying value of
our repairable spare part inventory on the consolidated balance sheet to account for the excess that builds over the service life. The
post-production service life of our systems is generally seven to twelve years and, at the end of twelve years, the carrying value for
these parts in our consolidated balance sheet is reduced to zero. We also perform periodic monitoring of our installed base for
premature end of service life events and expense, through cost of sales, the remaining net carrying value of any related spare parts
inventory in the period incurred.
Furniture, fixtures and equipment:
Furniture, fixtures and equipment is stated at cost net of accumulated depreciation. Additions and improvements are
capitalized while ordinary maintenance and repair expenditures are charged to expense as incurred. Depreciation is recorded by the
straight-line method over the estimated useful life of the asset, which ranges from three to ten years. Amortization expense on
capitalized leases is included with depreciation expense. The cost and accumulated depreciation related to assets sold or retired are
removed from the accounts and any gain or loss is credited or charged to income.
Intangible assets:
Intangible assets include deferred patent costs and license agreements. Legal expenses incurred in preparation of patent
application have been deferred and will be amortized over the useful life of granted patents. Costs incurred in preparation of
applications that are not granted will be charged to expense at that time. The Company has entered into several sublicense agreements
under which it has been assigned the exclusive rights to certain licensed materials used in its products. These sublicense agreements
generally require upfront payments to obtain the exclusive rights to such material. The Company capitalizes the upfront payments as
intangible assets and amortizes such costs over their estimated useful life on a straight-line method.
Leases:
The Company determines if an arrangement contains a lease at inception. For arrangements where the Company is the lessee, the
Company will evaluate whether to account for the lease as an operating or finance lease. Operating leases are included in the right of
use assets (ROU) and operating lease liabilities on the consolidated balance sheet as of December 31, 2019. Finance leases would be
included in furniture, fixtures and equipment, net and long-term debt and finance lease obligations on the balance sheet. The Company
had operating leases for copiers and its office and warehouse space at December 31, 2019 but no financing leases.
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ROU assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease
term at commencement date. The Company uses its incremental borrowing rate based on the information available at the
commencement date in determining the operating lease liabilities if the operating lease does not provide an implicit rate. Lease terms
may include the option to extend when Company is reasonably certain that the option will be exercised. Lease expense for operating
leases is recognized on a straight-line basis over the lease term.
The Company elected to apply the short-term lease measurement and recognition exemption in which ROU assets and lease
liabilities are not recognized for short term leases.
Secured convertible debentures:
The Company has elected to record its debentures at fair value. Accordingly, the debentures are marked-to-market at each
reporting date with the change in fair value reported as a gain (loss) in the Consolidated Statement of Operations. All issuance costs
related to the debentures were expensed as incurred in the Consolidated Statement of Operations.
Proceeds investment agreement:
The Company has elected to record its proceeds investment agreement at its fair value. Accordingly, the proceeds investment
agreement will be marked-to-market at each reporting date with the change in fair value reported as a gain (loss) in the Consolidated
Statement of Operations. All issuance costs related to the proceeds investment agreement were expensed as incurred in the
Consolidated Statement of Operations.
Senior Convertible Notes:
The Company has elected to record its senior convertible notes at its fair value. Accordingly, the senior convertible notes will be
marked-to-market at each reporting date with the change in fair value reported as a gain (loss) in the Consolidated Statement of
Operations. All issuance costs related to the senior convertible notes were expensed as incurred in the Consolidated Statement of
Operations.
Long-Lived Assets:
Long-lived assets such as furniture, fixtures and equipment and purchased intangible assets subject to amortization are
reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, the Company first compares
undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-
lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the
carrying value exceeds its fair value. Fair value is determined through various valuation techniques, including discounted cash flow
models, quoted market values and third-party appraisals, as considered necessary.
Warranties:
The Company’s products carry explicit product warranties that extend up to two years from the date of shipment. The
Company records a provision for estimated warranty costs based upon historical warranty loss experience and periodically adjusts
these provisions to reflect actual experience. Accrued warranty costs are included in accrued expenses. Extended warranties are offered
on selected products and when a customer purchases an extended warranty the associated proceeds are treated as contract liabilities and
recognized over the term of the extended warranty.
Shipping and Handling Costs:
Shipping and handling costs for outbound sales orders totaled $65,312 and $66,053 for the years ended December 31, 2019
and 2018, respectively. Such costs are included in general and administrative expenses in the Consolidated Statements of Operations.
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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 $1,019,707 and $384,113 for the years ended December 31, 2019 and 2018, respectively. Such costs are included in
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
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, 2019 and 2018. There were no penalties in 2019 and 2018.
The Company is subject to taxation in the United States and various states. As of December 31, 2019, the Company’s tax
returns filed for 2016, 2017, and 2018 and to be filed for 2019 are subject to examination by the relevant taxing authorities. With few
exceptions, as of December 31, 2018, the Company is no longer subject to Federal, state, or local examinations by tax authorities for
years before 2016.
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 2019 and 2018.
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 Statement of Operations.
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The Company has common stock purchase warrants that are accounted for as equity based on their relative fair value and are
not subject to re-measurement.
Stock-Based Compensation:
The Company grants stock-based compensation to its employees, board of directors and certain third-party contractors. Share-
based compensation arrangements may include the issuance of options to purchase common stock in the future or the issuance of
restricted stock, which generally are subject to vesting requirements. The Company records stock-based compensation expense for all
stock-based compensation granted based on the grant-date fair value. The Company recognizes these compensation costs on a straight-
line basis over the requisite service period of the award.
The Company estimates the grant-date fair value of stock-based compensation using the Black-Scholes valuation model.
Assumptions used to estimate compensation expense are determined as follows:
●
●
●
●
●
Expected term is determined using the contractual term and vesting period of the award;
Expected volatility of award grants made in the Company’s plan is measured using the weighted average of historical
daily changes in the market price of the Company’s common stock over the period equal to the expected term of the
award;
Expected dividend rate is determined based on expected dividends to be declared;
Risk-free interest rate is equivalent to the implied yield on zero-coupon U.S. Treasury bonds with a maturity equal to
the expected term of the awards; and
Forfeitures are accounted for as they occur.
Segments of Business:
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, 2019 and 2018, sales by geographic area were as follows:
Sales by geographic area:
United States of America
Foreign
Year ended December 31,
2018
2019
$
$
10,251,259 $
190,105
10,441,364 $
10,929,071
362,338
11,291,409
Sales to customers outside of the United States are denominated in U.S. dollars. All Company assets are physically located within the
United States.
Reclassification of Prior Year Presentation
Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications
had no effect on the reported results of operations.
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Recently Adopted Accounting Standards
In February 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-02, Leases (“Topic 842”). The guidance
requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in a manner similar to
today’s accounting. Lessees initially recognize a lease liability for the obligation to make lease payments and a right-of-use asset for
the right to use the underlying asset for the lease term. The lease liability is measured at the present value of the lease payments over
the lease term. The right-of-use asset is measured at the lease liability amount, adjusted for lease prepayments, lease incentives
received and the lessee’s initial direct costs. The standard is effective for public business entities for annual reporting periods beginning
after December 15, 2018, and interim periods within that reporting period, which is the first quarter of 2019 for the Company.
The Company adopted the new guidance on January 1, 2019 using the optional transitional method and elected to use the
package of three practical expedients which allows the Company not to reassess whether contracts are or contain leases, lease
classification and whether initial direct costs qualify for capitalization. The Company has completed its assessment of the impact of the
standard and determined that the only lease that the Company held was an operating lease for its office and warehouse space. Upon
adoption of the standard, the Company recorded Right of Use (ROU) assets of approximately $501,000 and lease liabilities of
approximately $582,000 related to it office and warehouse space operating leases. The Company also removed deferred rent of
approximately $81,000 when adopting the new guidance.
For financial liabilities measured using the fair value option in ASC 825, ASU 2016-01, Financial Instruments — Overall
(Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, issued in January 2016, requires
entities to recognize the changes in fair value of liabilities caused by a change in instrument specific credit risk (own credit risk) in
other comprehensive income. The ASU is effective for calendar-year public business entities beginning in 2018. For all other calendar-
year entities, it is effective for annual periods beginning in 2019 and interim periods beginning in 2020. Entities can early adopt certain
provisions of the new standard, including this provision related to financial liabilities measured under the fair value option. We have
considered this guidance and its impact on this debt accounted for at fair value. Based on discussions with our valuation expert and
knowledge of the Company there was no change in valuation caused by a change in the Company’s credit risk during the period from
August 5, 2019 to December 31, 2019.
ASU 2018-09, Codification improvements, clarifies the accounting for a debt extinguishment when the fair value option is
elected. Upon extinguishment an entity shall include in net income the cumulative amount of the gain or loss previously recorded in
other comprehensive income for the extinguished debt that resulted from changes in instrument-specific credit risk. The ASU is
effective for calendar-year public business entities beginning in 2019. For all other calendar-year entities, it is effective for annual
periods beginning in 2020 and interim periods beginning in 2021. Early adoption is permitted for any fiscal year or interim period for
which an entity’s financial statements have not yet been issued or have not been made available to be issued. We have considered this
guidance and its impact on this debt accounted for at fair value. Based on discussions with our valuation expert and knowledge of the
Company there was no change in valuation caused by a change in the Company’s credit risk during the period from August 5, 2019 to
December 31, 2019. Since there is no change accounted for as a change in Credit Risk (included in other comprehensive income/loss)
there is no impact to the Company’s financial statements from this new guidance.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses” to improve information on credit losses
for financial assets and net investment in leases that are not accounted for at fair value through net income. ASU 2016-13 replaces the
current incurred loss impairment methodology with a methodology that reflects expected credit losses. In April 2019 and May 2019,
the FASB issued ASU No. 2019-04, “Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815,
Derivatives and Hedging, and Topic 825, Financial Instruments” and ASU No. 2019-05, “Financial Instruments-Credit Losses (Topic
326): Targeted Transition Relief” which provided additional implementation guidance on the previously issued ASU. In November
2019, the FASB issued ASU 2019-10, “Financial Instruments - Credit Loss (Topic 326), Derivatives and Hedging (Topic 815), and
Leases (Topic 842),” which defers the effective date for public filers that are considered small reporting companies (“SRC”) as defined
by the Securities and Exchange Commission to fiscal years beginning after December 15, 2022, including interim periods within those
fiscal years. Since the Company is an SRC, implementation is not needed until January 1, 2023. The Company will continue to
evaluate the effect of adopting ASU 2016-13 will have on the Company’s consolidated financial statements.
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In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-13, Fair Value Measurement (Topic
820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, to improve the effectiveness of
disclosures. The amendments remove, modify, and add certain disclosure requirements in Topic 820, “Fair Value Measurement.” The
amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to
develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for
only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied
retrospectively to all periods presented upon their effective date. The amendments are effective for fiscal years beginning after
December 15, 2019. Early adoption is permitted, including adoption in an interim period. Furthermore, an entity is permitted to early
adopt any removed or modified disclosures upon issuance of the update and delay adoption of the additional disclosures until their
effective date. The Company is currently evaluating the effects the adoption of ASU 2018-13 will have on the disclosures.
In August 2018, the FASB issued ASU No. 2018-15, Intangible-Goodwill and Other Internal-Use Software (Subtopic 350-40),
or ASU 2018-15. ASU 2018-15 updates guidance regarding accounting for implementation costs associated with a cloud computing
arrangement that is a service contract. The amendments under ASU 2018-15 are effective for interim and annual fiscal periods
beginning after December 15, 2019, with early adoption permitted. The Company does not expect the adoption of ASU 2018-15 to
have a material impact on its financial statements.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes - simplifying the accounting for income taxes (Topic 740),
which is meant to simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740,
Income Taxes. The amendment also improves consistent application and simplify GAAP for other areas of Topic 740 by clarifying and
amending existing guidance. We do not expect the adoption of this standard to have a significant impact on our financial position and
results of operations.
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 $123,224 as of December 31, 2019 and $70,000 as of December 31, 2018.
The Company uses primarily a network of unaffiliated distributors for international sales and employee-based direct sales
force for domestic sales. No international distributor individually exceeded 10% of total revenues and no customer receivable balance
exceeded 10% of total accounts receivable for the years ended December 31, 2019 and 2018.
The Company purchases finished circuit boards and other proprietary component parts from suppliers located in the United
States and on a limited basis from Asia. Although the Company obtains certain of these components from single source suppliers, it
generally owns all tooling and management has located alternative suppliers to reduce the risk in most cases to supplier problems that
could result in significant production delays. The Company has not historically experienced significant supply disruptions from any of
its principal vendors and does not anticipate future supply disruptions. The Company acquires most of its components on a purchase
order basis and does not have long-term contracts with its suppliers.
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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, 2019 and
2018:
Beginning balance
Provision for bad debts
Charge-offs to allowance, net of recoveries
Ending balance
NOTE 4. INVENTORIES
December 31, 2019 December 31, 2018
70,000
$
—
—
70,000
70,000 $
60,000
(6,776)
123,224 $
$
Inventories consisted of the following at December 31, 2019 and 2018:
Raw material and component parts
Work-in-process
Finished goods
Subtotal
Reserve for excess and obsolete inventory
Total inventories
December 31, 2019 December 31, 2018
4,969,786
$
351,451
4,965,594
10,286,831
(3,287,771)
6,999,060
4,481,611 $
35,858
4,906,956
9,424,425
(4,144,013)
5,280,412 $
$
Finished goods inventory includes units held by potential customers and sales agents for test and evaluation purposes. The
cost of such units totaled $80,711 and $115,456 as of December 31, 2019 and 2018, respectively.
NOTE 5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consisted of the following at December 31, 2019 and 2018:
Office furniture, fixtures and equipment
Warehouse and production equipment
Demonstration and tradeshow equipment
Leasehold improvements
Rental equipment
Total cost
Less: accumulated depreciation and amortization
Estimated
Useful Life
3-10 years $
3-5 years
2-5 years
2-5 years
1-3 years
December 31, 2019 December 31, 2018
802,681
526,932
426,582
160,198
124,553
2,040,946
(1,793,405)
397,795 $
210,700
252,001
163,171
93,923
1,117,591
(920,528)
Net furniture, fixtures and equipment
$
197,063 $
247,541
Depreciation and amortization of furniture, fixtures and equipment aggregated $254,491 and $385,104 for the years ended December
31, 2019 and 2018, respectively. The cost and accumulated depreciation related to assets sold or retired are removed from the accounts
and any gain or loss is credited or charged to income. The Company retired fixed assets during 2019 totaling $1,127,368, all of which
were fully depreciated resulting in no gain or loss for the year ended December 31, 2019.
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NOTE 6. INTANGIBLE ASSETS
Intangible assets consisted of the following at December 31, 2019 and 2018:
December 31, 2019
December 31, 2018
Gross value
Accumulated
amortization
Net
carrying
value
Gross value
Accumulated
amortization
Net
carrying
value
Amortized intangible assets:
Licenses
Patents and Trademarks
$
73,893 $
542,420
41,785 $
326,220
32,108 $
216,200
73,893 $
452,599
31,228 $
273,586
42,665
179,013
616,313
368,005
248,308
526,492
304,814
221,678
Unamortized intangible assets:
Patents and trademarks pending
164,960
—
164,960
265,119
—
265,119
Total
$
781,273 $
368,005 $
413,268 $
791,611 $
304,814 $
486,797
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, 2019 and 2018 was $135,660 and $115,073, 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:
2020
2021
2022
2023
2024
NOTE 7. DEBT OBLIGATIONS
Debt obligations is comprised of the following:
$
$
97,502
87,967
62,399
440
—
248,308
2019 Secured convertible notes, at fair value
2018 Proceeds investment agreement, at fair value
Unsecured promissory note payable, less unamortized discount of
$66,061 at December 31, 2019
Debt obligations
December 31, 2019 December 31, 2018
—
$
9,142,000
1,593,809 $
6,500,000
$
233,939
8,327,748 $
—
9,142,000
2019 Secured Convertible Notes.
On August 5, 2019, the Company, entered into a securities purchase agreement with several accredited investors providing for
the issuance of (i) the Company’s 8% secured convertible notes due August 4, 2020 with a principal face amount of $2,777,777.78,
which convertible notes are, subject to certain conditions, convertible into 1,984,126 shares of the Company’s common stock, at a price
per share of $1.40; (ii) five-year warrants to purchase an aggregate of 571,428 shares of Common Stock at an exercise price of
$1.8125, which warrants are immediately exercisable upon issuance and on a cashless basis if the Warrants have not been registered
180 days after the date of issuance; and (iii) the issuance of shares of common stock equal to 5% of the aggregate purchase price of the
convertible notes, with an aggregate value of $125,000 (the “Commitment Shares”). The accredited investors purchased the foregoing
securities for an aggregate cash purchase price of $2,500,000.
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Pursuant to the purchase agreement, an aggregate of $1,153,320 in principal amount of convertible notes (the “Registered
Notes”), the conversion shares underlying the Registered Notes and all of the Commitment Shares were issued to the accredited
investors in a registered direct offering pursuant to a prospectus supplement to the Company’s currently effective shelf registration
statement on Form S-3. Accordingly, $1,153,320 in original principal amount of our convertible notes were issued as Registered Notes
pursuant to the shelf registration statement and therefore freely tradable.
In a related transaction and in accordance with the purchase agreement, the Company issued to the accredited investors in a
concurrent private placement pursuant to an exemption from the registration requirements of the Securities Act provided in Section
4(a)(2) of the Securities Act and/or Regulation D promulgated thereunder, (1) the remaining aggregate of $1,624,457.78 in principal
amount of convertible notes, (2) the shares of common stock issuable from time to time upon conversion of such convertible notes, and
(3) the common shares underlying the common stock purchase warrants. On September 5, 2019, the Company filed a Registration
Statement on Form S-1 covering the securities issued in the concurrent private placement including an aggregate of $1,624,457.78 in
principal amount of previously non-registered convertible notes, the shares of common stock issuable from time to time upon
conversion of such non-registered convertible notes and the common stock underlying the common stock purchase warrants. Such
Registration Statement on Form S-1 was declared effective by the Securities and Exchange Commission on September 12, 2019.
In connection with the purchase agreement, the Company and its subsidiary entered into a security agreement, dated as of
August 5, 2019, with the investors, pursuant to which the Company and its subsidiary granted a security interest in, among other items,
the Company and its subsidiary’s accounts, chattel paper, documents, equipment, general intangibles, instruments and inventory, and
all proceeds, as set forth in the security agreement. In addition, pursuant to an intellectual property security agreement, dated as of
August 5, 2019, the Company granted a continuing security interest in all of the Company’s right, title and interest in, to and under
certain of the Company’s trademarks, copyrights and patents. In addition, the Company’s subsidiary jointly and severally agreed to
guarantee and act as surety for the Company’s obligation to repay the convertible notes pursuant to a subsidiary guarantee.
Under the purchase agreement, the convertible notes and warrants contain provisions whereby the accredited investors are
prohibited from exercising their rights to convert the notes or exercise the warrants if, as a result of such conversion or exercise, such
holder, together with its affiliates, would own more than 4.99% of the total number of shares of the Company’s common stock
outstanding immediately after giving effect to such exercise. However, the investors may increase or decrease such percentage to any
other percentage not in excess of 9.99%, provided that any increase in such percentage shall not be effective until 61 days after such
notice to the Company.
The Company elected to account for the secured convertible notes on the fair value basis. Therefore, the Company determined
the fair value of the (1) secured convertible notes, (2) the Commitment Shares and (3) the common stock purchase warrants which
yielded estimated fair values of the secured convertible notes including their embedded derivatives, the Commitment Shares and the
detachable common stock purchase warrants. The following represents the resulting fair value as determined on August 5, 2019, the
date of origination:
Secured convertible notes
Common stock issued as Commitment Shares
Common stock purchase warrants
Gross cash proceeds
$
1,845,512
118,749
535,739
$
2,500,000
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Under the fair value basis, the Company determines the fair value of the secured convertible notes and adjusts the carrying
value of the secured convertible notes at each reporting date with the resulting charge or credit being reflected in the consolidated
statement of operations. Following is an analysis of the activity in the secured convertible notes during the year ended December 31,
2019:
Balance at December 31, 2018
$
Issuance of convertible notes on August 5, 2019, at fair value
Principal repaid during the period by issuance of common stock
Principal repaid during the period by payment of cash
Change in fair value of secured convertible note during the period
Amount
—
1,845,512
(648,067)
(123,457)
519,821
Balance at December 31, 2019
$
1,593,809
Following is a range of certain estimates and assumptions utilized as of December 31, 2019 and August 5. 2019 (inception
date) to determine the fair value of secured convertible notes:
Volatility – range
Risk-free rate
Contractual term
Calibrated stock price
Debt yield
December 31, 2019
Assumptions
August 5, 2019
Assumptions
115%
1.60%
0.6 years
1.06
123.6%
$
110%
1.78%
0.9 years
0.86
88.6%
$
Under the fair value basis, legal, accounting and miscellaneous costs directly related to the issuance of the secured convertible
notes are charged to expense as incurred. A total of $89,148 of such issuance costs were charged to operations during the year ended
December 31, 2019.
2018 Proceeds Investment Agreement.
On July 31, 2018, the Company entered into a Proceeds Investment Agreement (the “PIA Agreement”) with Brickell Key
Investments LP (“BKI”), pursuant to which BKI funded an aggregate of $500,000 (the “First Tranche”) to be used (i) to fund the
Company’s litigation proceedings relating to the infringement of certain patent assets listed in the PIA Agreement and (ii) to repay the
Company’s existing debt obligations and for certain working capital purposes set forth in the PIA Agreement. Pursuant to the PIA
Agreement, BKI was granted an option to provide the Company with an additional $9.5 million, at BKI’s sole discretion (the “Second
Tranche”). On August 21, 2018, BKI exercised its option on the Second Tranche for $9.5 million which completed the $10 million
funding.
Pursuant to the PIA Agreement and in consideration for the $10 million in funding, the Company agreed to assign to BKI (i)
100% of all gross, pre-tax monetary recoveries paid by any defendant(s) to the Company or its affiliates agreed to in a settlement or
awarded in judgment in connection with the patent assets, plus any interest paid in connection therewith by such defendant(s) (the
“Patent Assets Proceeds”), up to the minimum return (as defined in the Agreement) and (ii) if BKI has not received its minimum return
by the earlier of a liquidity event (as defined in the Agreement) and July 31, 2020, then the Company agreed to assign to BKI 100% of
the Patent Asset Proceeds until BKI has received an amount equal to the minimum return on $4.0 million.
Pursuant to the PIA Agreement, the Company granted BKI (i) a senior security interest in the Patent Assets, the claims (as
defined in the Agreement) and the Patent Assets Proceeds until such time as the minimum return is paid, in which case, the security
interest on the patent assets, the claims and the Patent Assets Proceeds will be released, and (ii) a senior security interest in all other
assets of the Company until such time as the minimum return is paid on $4.0 million, in which case, the security interest on such other
assets will be released.
The security interest is enforceable by BKI if the Company is in default under the PIA Agreement which would occur if (i) the
Company fails, after five (5) days’ written notice, to pay any due amount payable to BKI under the PIA Agreement, (ii) the Company
fails to comply with any provision of the PIA Agreement or any other agreement or document contemplated under the PIA Agreement,
(iii) the Company becomes insolvent or insolvency proceedings are commenced (and not subsequently discharged) with respect to the
Company, (iv) the Company’s creditors commence actions against the Company (which are not subsequently discharged) that affect
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material assets of the Company, (v) the Company, without BKI’s consent, incurs indebtedness other than immaterial ordinary course
indebtedness up to $500,000, (vi) the Company fails, within five (5) business days following the closing of the second tranche, to fully
satisfy its obligations to certain holders of the Company’s senior secured convertible promissory notes listed in the PIA Agreement and
fails to obtain unconditional releases from such holders as to the Company’s obligations to such holders and the security interests in the
Company held by such holders or (vii) there is an uncured non-compliance of the Company’s obligations or misrepresentations by the
Company under the PIA Agreement.
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Under the PIA Agreement, the Company issued BKI a warrant to purchase up to 465,712 shares of the Company’s common
stock, par value $0.001 per share (the “PIA Warrant”), at an exercise price of $2.60 per share provided that the holder of the PIA
Warrant will be prohibited from exercising the PIA Warrant if, as a result of such exercise, such holder, together with its affiliates,
would own more than 4.99% of the total number of shares of the Company’s common stock outstanding immediately after giving
effect to such exercise. However, such holder may increase or decrease such percentage to any other percentage not in excess of 9.99%,
provided that any increase in such percentage shall not be effective until 61 days after such notice to the Company. The PIA Warrant is
exercisable for five years from the date of issuance and is exercisable on a cashless exercise basis if there is no effective registration
statement. No contractual registration rights were given.
The Company elected to account for the PIA on the fair value basis. Therefore, the Company determined the fair value of the
PIA and PIA Warrants which yielded estimated fair values of the PIA including their embedded derivatives and the detachable PIA
Warrants as follows:
Proceeds investment agreement
Common stock purchase warrants
Gross cash proceeds
$
9,067,513
932,487
$
10,000,000
The Company utilized a probability weighted present value of expected patent asset proceeds for the litigation involving both
Axon and WatchGuard (see Note 12 – Commitments and Contingencies) which involved estimates of the amount and timing of the
expected patent asset proceeds from the alleged patent infringement. The fair value of the PIA is updated for actual and estimated
activity affecting the probability weighted present value of expected patent asset proceeds at each reporting date with the change
charged/credited to operations. Following is a range of certain estimates and assumptions utilized as of December 31, 2019 and 2018 to
probability weighted present value of expected patent asset proceeds for the litigation involving both Axon and WatchGuard:
December 31, 2019
December 31, 2018
Discount rate
Expected term to patent asset proceeds payment
Probability of success
Estimated minimum return payable to BKI
Negotiation discount
$
3.0% - 16.6%
4.7% - 21.75%
0.58 years - 4 years
0.93 years - 1.1 years
5.9% - 38.5%
21 million
$
43.3%
17.7% - 77.0%
22.5 million
54.4%
During the year ended December 31, 2019, the Company settled its patent infringement litigation with WatchGuard whereby it
received a lump-sum payment of $6.0 million as further described in Note 12. In accordance with the terms of the PIA, the Company
remitted the $6.0 as a principal payment toward its minimum return payment obligations under the PIA. The Company recorded the
receipt of the $6,000,000 settlement as Patent litigation settlement income in the accompanying condensed consolidated statement of
operations.
The following represents activity in the PIA during the year ended December 31, 2019 and 2018:
Beginning balance as of January 1, 2018
Origination date at fair value of the Debentures
Change in the fair value during the period
Ending balance as of December 31, 2018
Beginning balance as of January 1, 2019
Repayment of obligation
Change in the fair value during the period
Ending balance as of December 31, 2019
Unsecured Promissory Note Payable.
$
$
$
$
-
9,067,513
74,487
9,142,000
9.142,000
(6,000,000)
3,358,000
6,500,000
On December 23, 2019, the Company, borrowed $300,000 under an unsecured note payable to a private, third-party lender.
The promissory note bears interest at the rate of 8% per annum with principal and accrued interest payable on or before its maturity
date of March 31, 2020. The Company granted the lender warrants exercisable to purchase a total of 107,000 shares of its common
stock at an exercise price of $1.40 per share until December 23, 2024. The Company allocated $71,869 of the proceeds of the
promissory note to additional paid-in-capital, which represented the grant date relative fair value of the warrants issued to the lender.
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The discount will be amortized to interest expense ratably over the term of the promissory note which approximates the effective
interest method. The amortization of discount resulted in $5,808 of the discount amortized to interest expense during the year ended
December 31, 2019.
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2018 Secured Convertible Debentures.
On April 3, 2018, and May 11, 2018, the Company completed a private placement (the “2018 Private Placement”) of $6.875
million in principal amount of senior secured convertible promissory notes (the “2018 Debentures”) and warrants to purchase 916,667
shares of common stock of the Company (the “2018 Warrants”) to institutional investors. The 2018 Debentures and 2018 Warrants
were issued pursuant to a securities purchase agreement between the Company and the purchasers’ signatory thereto. Additionally, a
portion of the 2018 Debentures and 2018 Warrants were issued to two institutional investors pursuant to their respective participation
rights under a securities purchase agreement, dated August 21, 2017. One of the institutional investors that participated in the 2017
common stock issuance closed its tranche with the Company on May 11, 2018. The 2018 Private Placement resulted in gross cash
proceeds of $6.25 million ($6.875 million par value) before placement agent fees and other expenses associated with the transaction.
The proceeds were used primarily for full repayment of the 2016 Debentures described above, other outstanding subordinated debt of
the Company, working capital and general corporate purposes.
The Company elected to account for the 2018 Debentures on the fair value basis. Therefore, the Company determined the fair
value of the 2018 Debentures and 2018 Warrants which yielded estimated fair values of the 2018 Debentures including their embedded
derivatives and the detachable 2018 Warrants as follows:
Secured convertible debentures
Common stock purchase warrants
Gross cash proceeds
$
4,565,749
1,684,251
$
6,250,000
The Company paid the remaining balances of the 2018 Debentures on August 21, 2018 from proceeds of the 2018 proceeds
investment agreement described below. The change in fair value of the 2018 Debentures was $2,309,251 for the year ended December
31, 2018.
The following represents activity in the 2018 Debentures during the year ended December 31, 2018:
Beginning balance as of January 1, 2018
Origination date at fair value of the Debentures
Conversions exercised during the period
Principal payments made on Debentures
Change in the fair value during the period
Ending balance as of December 31, 2018
2016 Secured Convertible Debentures.
$
$
-
4,565,749
(275,000)
(6,600,000)
2,309,251
-
On December 30, 2016, the Company completed a private placement (the “2016 Private Placement”) of $4.0 million in
principal amount of the secured convertible debentures (the “2016 Debentures”) and common stock warrants (the “2016 Warrants”) to
two institutional investors. The 2016 Debentures and 2016 Warrants were issued pursuant to a Securities Purchase Agreement between
the Company and the purchasers’ signatory thereto. The 2016 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 2016 Debentures on the fair value basis. Therefore, the Company determined the fair
value of the 2016 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 2016 Warrants as
of the origination date because of the relative fair value of the 2016 Debentures including their 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 2016 Debentures.
The Company paid the remaining balance of the 2016 Debentures on April 3, 2018 from proceeds of the 2018 secured
convertible debentures described below. The Company recorded debt extinguishment costs of $600,000 during the year ended
December 31, 2018 related to the repayment and extinguishment of the 2016 Debentures.
The change in fair value of the 2016 Debentures was $-0- and $(12,807) for the years ended December 31, 2019 and 2018,
respectively.
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Unsecured Promissory Notes Payable.
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 was due and payable in full on March 1, 2018 and could be
prepaid without penalty. The Secured Note was 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 Company paid the remaining balances of the Secured Note and subordinated note with an aggregate principal balance of
$1,008,500 on April 3, 2018.
On March 7, 2018 the Company borrowed $250,000 under a secured note payable with a private, third party lender (the
“March Note”). The March Note bears interest at 12% per annum and contained an original maturity date of June 7, 2018. The
Company negotiated an extension of the maturity date to September 30, 2018. The March Note was secured by the inventory of the
Company and junior to senior liens held by the holders of the 2018 Debentures and subordinated to all existing and future senior
indebtedness, as such term was defined in the March Note. Such Note was convertible at any time after its date of issue at the option of
the holder into shares of the Company’s common stock at a conversion price of $3.25 per share. The conversion price and exercise
price were subject to adjustment upon stock splits, reverse stock splits, and similar capital changes. The Company issued warrants to
the lender exercisable to purchase 36,000 shares of common stock for $3.50 per share until March 7, 2019. The Company allocated
$15,287 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. The Company made a principal
payment of $100,000 on August 21, 2018 on the March Note. The holder converted the remaining principal and outstanding interest of
the March Note into 47,319 shares of the Company’s common stock on September 20, 2018.
The discount amortized to interest expense totaled $-0- and $47,657 for the years ended December 31, 2019, and 2018,
respectively.
NOTE 8. FAIR VALUE MEASUREMENT
In accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC 820”), the Company utilizes the
market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant
information generated by market transactions involving identical or comparable assets, liabilities or a group of assets or liabilities, such
as a business.
ASC 820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three
broad levels. The following is a brief description of those three levels:
●
●
●
Level 1 — Quoted prices in active markets for identical assets and liabilities
Level 2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
Level 3 — Significant unobservable inputs (including the Company’s own assumptions in determining the fair value)
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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, 2019 and 2018.
Liabilities:
Secured convertible debentures
Proceeds investment agreement
Liabilities:
Secured convertible debentures
Proceeds investment agreement
Level 1
Level 2
Level 3
Total
December 31, 2019
$
$
$
$
— $
—
— $
— $
—
— $
1,593,809 $
6,500,000
8,093,809 $
1,593,809
6,500,000
8,093,809
Level 1
Level 2
Level 3
Total
December 31, 2018
— $
—
— $
— $
—
— $
— $
9,142,000
9,142,000 $
—
9,142,000
9,142,000
The following table represents the change in Level 3 tier value measurements:
2019
Secured
Convertible
Notes
Proceeds
Investment
Agreement
Total
Balance, December 31, 2018
$
— $
9,142,000 $
9,142,000
Principal payments made on debentures
—
(6,000,000)
(6,000,000)
New secured convertible debentures
Conversion of secured convertible debentures
Repayment of 2019 secured convertible notes
Change in fair value of secured convertible debentures and proceeds
investment agreement
1,845,512
(648,067)
(123,457)
—
—
1,845,512
(648,067)
(123,457)
519,821
3,358,000
3,877,821
Balance, December 31, 2019
$
1,593,809 $
6,500,000 $
8,093,809
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NOTE 9. ACCRUED EXPENSES5
Accrued expenses consisted of the following at December 31, 2019 and 2018:
Accrued warranty expense
Accrued litigation costs
Accrued sales commissions
Accrued payroll and related fringes
Accrued insurance
Accrued rent
Accrued sales returns and allowances
Other
December 31, 2019 December 31, 2018
195,135
$
1,119,445
25,750
186,456
71,053
81,160
13,674
387,994
2,080,667
17,838 $
295,000
28,480
233,254
78,579
—
18,258
174,472
845,881 $
$
Accrued warranty expense was comprised of the following for the years ended December 31, 2019 and 2018:
Beginning balance
Provision for warranty expense
Charges applied to warranty reserve
$
2019
2018
195,135 $
47,355
(224,651)
325,001
181,826
(311,692)
Ending balance
$
17,838 $
195,135
NOTE 10. INCOME TAXES
The components of income tax provision (benefit) for the years ended December 31, 2019 and 2018 are as follows:
Current taxes:
Federal
State
Total current taxes
Deferred tax provision (benefit)
Income tax provision (benefit)
2019
2018
$
$
— $
—
—
—
— $
—
—
—
—
—
A reconciliation of the income tax (provision) benefit at the statutory rate of 21% for the years ended December 31, 2019 and
2018 to the Company’s effective tax rate is as follows:
U.S. Statutory tax rate
State taxes, net of Federal benefit
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
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2019
2018
21.0%
5.1%
—%
(2.6)%
—%
(22.4)%
(1.1)%
—%
21.0%
5.1%
—%
(3.0)%
—%
(22.1)%
(1.0)%
—%
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Significant components of the Company’s deferred tax assets (liabilities) as of December 31, 2019 and 2018 are as follows:
Deferred tax assets:
Stock-based compensation
Start-up costs
Inventory reserves
Uniform capitalization of inventory costs
Allowance for doubtful accounts receivable
Equipment depreciation
Deferred revenue
Debt and PIA obligations carried at fair value
Accrued expenses
Net operating loss carryforward
Research and development tax credit carryforward
State jobs credit carryforward
Charitable contributions carryforward
Total deferred tax assets
Valuation reserve
Total deferred tax assets
Domestic international sales company
Total deferred tax liabilities
$
2019
2018
605,000 $
115,000
1,080,000
85,000
90,000
240,000
915,000
1,045,000
110,000
17,515,000
1,795,000
230,000
55,000
650,000
115,000
860,000
90,000
45,000
140,000
975,000
225,000
385,000
16,080,000
1,795,000
230,000
50,000
23,880,000
(23,740,000)
21,640,000
(21,500,000)
140,000
(140,000)
(140,000)
140,000
(140,000)
(140,000)
Net deferred tax assets (liability)
$
— $
—
The valuation allowance on deferred tax assets totaled $23,740,000 and $21,500,000 as of December 31, 2019 and 2018,
respectively. The Company records the benefit it 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,” the Company records 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. 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% of
the corporation’s AMT Credit carried forward to one of these years starting in 2018 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 incurred operating losses in 2019 and 2018 and it continues to be in a three-year cumulative loss position at
December 31, 2019 and 2018. Accordingly, the Company determined there was not sufficient positive evidence regarding its potential
for future profits to outweigh the negative evidence of our three-year cumulative loss position under the guidance provided in ASC
740. Therefore, it determined to increase our valuation allowance by $2,240,000 to continue to fully reserve its deferred tax assets at
December 31, 2019. 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.
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At December 31, 2019, the Company had available approximately $67,100,000 of Federal net operating loss carryforwards
available to offset future taxable income generated. Such tax net operating loss carryforwards expire between 2026 and 2039. In
addition, the Company had research and development tax credit carryforwards totaling $1,795,000 available as of December 31, 2019,
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 2038, 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, 2019 and 2018 varied from the expected statutory rate due to the
Company continuing to provide a 100% valuation allowance on net deferred tax assets. The Company determined that it was
appropriate to continue the full valuation allowance on net deferred tax assets as of December 31, 2019 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 2015 and all prior tax years.
NOTE 11. OPERATING LEASE
The Company entered into an operating lease with a third party in September 2012 for office and warehouse space in Lenexa,
Kansas. The terms of the lease include monthly payments ranging from $38,026 to $38,533 with a maturity date of April 2020. The
Company has the option to renew for an additional three years beyond the original expiration date, which may be exercised at the
Company’s sole discretion. The Company evaluated the renewal option at the lease commencement date to determine if it is reasonably
certain the exercise the option and concluded that it is not reasonably certain that any options will be exercised. The weighted average
remaining lease term for the Company’s office and warehouse operating lease as of December 31, 2019 was four months.
The Company entered into an operating lease with a third party in October 2019 for copiers used for office and warehouse
purposes. The terms of the lease include 48 monthly payments of $1,598 with a maturity date of October 2023. The Company has the
option to Purchase the equipment at maturity for its estimated fair market value at that point in time. The remaining lease term for the
Company’s copier operating lease as of December 31, 2019 was 46 months.
Lease expense related to the office space and copier operating leases were recorded on a straight-line basis over their respective
lease terms. Total lease expense under the two operating leases was approximately $400,920 for the year ended December 31, 2019.
The discount rate implicit within the Company’s operating leases was not generally determinable and therefore the Company
determined the discount rate based on its incremental borrowing rate on the information available at commencement date. As of
commencement date, the operating lease liabilities reflect a weighted average discount rate of 8%.
The cash outflows from operating leases for the year ended December 31, 2019 was $400,920. The weighted average remaining
lease term and the weighted average discount rate for operating leases at December 31, 2019 were 5.6 months and 8%, respectively.
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The following sets forth the operating lease right of use assets and liabilities as of December 31, 2019:
Assets:
Operating lease right of use assets
Liabilities:
Operating lease obligations-current portion
Operating lease obligations-less current portion
Total operating lease obligations
$
$
$
$
122,459
159,160
44,460
203,620
The components of lease expense were as follows for the year ending December 31, 2019:
Selling, general and administrative expenses
$
400,920
Following are the minimum lease payments for each year and in total.
Year ending December 31:
2020
2021
2022
2023
Total undiscounted minimum future lease payments
Imputed interest
Total operating lease liability
NOTE 12. COMMITMENTS AND CONTINGENCIES
$
$
173,307
19,176
19,176
15,980
227,639
(24,019)
203,620
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 $0
and $2,083 for the years ended December 31, 2019 and 2018, respectively.
Litigation.
From time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy
to not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After
carefully assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded,
we vigorously defend any lawsuit filed against us. We record a liability when losses are deemed probable and reasonably estimable.
When losses are deemed reasonably possible but not probable, we determine whether it is possible to provide an estimate of the
amount of the loss or range of possible losses for the claim, if material for disclosure. In evaluating matters for accrual and disclosure
purposes, we take into consideration factors such as our historical experience with matters of a similar nature, the specific facts and
circumstances asserted, the likelihood of our prevailing, the availability of insurance, and the severity of any potential loss. We
reevaluate and update accruals as matters progress over time.
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While the ultimate resolution is unknown, based on the information currently available, we do not expect that these lawsuits
will individually, or in the aggregate, have a material adverse effect to our results of operations, financial condition or cash flows.
However, the outcome of any litigation is inherently uncertain and there can be no assurance that any expense, liability or damages that
may ultimately result from the resolution of these matters will be covered by our insurance or will not be in excess of amounts
recognized or provided by insurance coverage and will not have a material adverse effect on our operating results, financial condition
or cash flows.
Axon
The Company owns U.S. Patent No. 9,253,452 (the “ ‘452 Patent”), which generally covers the automatic activation and
coordination of multiple recording devices in response to a triggering event, such as a law enforcement officer activating the light bar
on the vehicle.
The Company filed suit on January 15, 2016 in the U.S. District Court for the District of Kansas (Case No: 2:16-cv-02032)
against Axon, alleging willful patent infringement against Axon’s body camera product line and Signal auto-activation product. The
Company is seeking both monetary damages and a permanent injunction against Axon for infringement of the ‘452 Patent.
In December 2016 and January 2017, Axon filed two petitions for Inter Partes Review (“IPR”) against the ‘452 Patent. The
United States Patent and Trademark Office (“USPTO”) rejected both of Axon’s petitions. Axon is now statutorily precluded from filing
any more IPR petitions against the ‘452 Patent.
The District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on
November 17, 2017, the Federal District Court of Kansas rejected Axon’s request to maintain the stay. With this significant ruling, the
parties will now proceed towards trial. Since litigation has resumed, the Court has issued a claim construction order (also called a
Markman Order) where it sided with the Company on all disputes and denied Axon’s attempts to limit the scope of the claims.
Following the Markman Order, the Court set all remaining deadlines in the case. Fact discovery closed on October 8, 2018, and a Final
Pretrial Conference took place on January 16, 2019. The parties filed motions for summary judgment on January 31, 2019.
On June 17, 2019, the Court granted Axon’s motion for summary judgment that Axon did not infringe on the Company’s patent
and dismissed the case. Importantly, the Court’s ruling did not find that Digital’s ‘452 Patent was invalid. It also did not address any
other issue, such as whether Digital’s requested damages were appropriate, and it did not impact the Company’s ability to file
additional lawsuits to hold other competitors accountable for patent infringement. This ruling solely related to an interpretation of the
claims as they relate to Axon and was unrelated to the supplemental briefing Digital recently filed on its damages claim and the
WatchGuard settlement. Those issues are separate and the judge’s ruling on summary judgment had nothing to do with Digital’s
damages request. The Company has filed an appeal to this ruling and has asked the appellate court to reverse this decision.
The Company filed its Opening Appeal Brief on August 26, 2019 and Axon filed its Responsive Brief on November 6, 2019 and
the Company filed its Reply Brief responding to Axon on November 27, 2019. The United States Court of Appeals for the Federal
Circuit scheduled oral argument on the Company’s appeal of the district court’s summary judgment order on April 6, 2020. This appeal
will address the incorrect and mistaken dismissal of Digital Ally’s claims against Axon by Judge Carlos Murguia in the U.S. District
Court of Kansas litigation. If the Court of Appeals overturns the summary judgment ruling, a new judge will be assigned to handle the
litigation with Axon due to the recent resignation of Judge Murguia. On March 12, 2020, the panel of judges for the United States
Court of Appeals issued an order cancelling the oral arguments previously set for April 6, 2020 having determined that they will decide
the appeal based on the parties’ briefs without oral argument.
WatchGuard
On May 27, 2016, the Company filed suit against WatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent
infringement based on WatchGuard’s VISTA Wifi and 4RE In-Car product lines.
On May 13, 2019, the parties resolved the dispute and executed a settlement agreement in the form of a Release and License
Agreement. The litigation has been dismissed as a result of this settlement.
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The Release and License Agreement encompasses the following key terms:
● WatchGuard paid Digital Ally a one-time, lump settlement payment of $6,000,000.
● Digital Ally granted WatchGuard a perpetual covenant not to sue if WatchGuard’s products incorporate agreed-upon modified
recording functionality. Digital Ally also granted WatchGuard a license to the ‘292 Patent and the ‘452 Patent (and related
patents, now existing and yet-to-issue) through December 31, 2023. The parties agreed to negotiate in good faith to attempt to
resolve any alleged infringement that occurs after the license period expires.
● The parties further agreed to release each other from all claims or liabilities pre-existing the settlement.
● As part of the settlement, the parties agreed that WatchGuard made no admission that it infringed any of Digital Ally’s patents.
Upon receipt of the $6,000,000 the parties filed a joint motion to dismiss the lawsuit which the Judge granted.
PGA Tour, Inc.
On January 22, 2019 the PGA Tour, Inc. (the “PGA”) filed suit against the Company in the Federal District Court for the District
of Kansas (Case No. 2:19-cv-0033-CM-KGG) alleging breach of contract and breach of implied covenant of good faith and fair dealing
relative to the Web.com Tour Title Sponsor Agreement (the “Agreement”). The contract was executed on April 16, 2015 by and
between the parties. Under the Agreement, Digital Ally would be a title sponsor of and receive certain naming and other rights and
benefits associated with the Web.com Tour for 2015 through 2019 in exchange for Digital Ally’s payment to Tour of annual
sponsorship fees. The suit was resolved and the case has been dismissed by Plaintiff with prejudice on April 17, 2019.
401 (k) Plan. The Company sponsors a 401(k) retirement savings plan for the benefit of its employees. The plan, as amended,
requires it to provide 100% matching contributions for employees, who elect to contribute up to 3% of their compensation to the plan
and 50% matching contributions for employee’s elective deferrals on the next 2% of their contributions. The Company made matching
contributions totaling $108,688 and $112,622 for the years ended December 31, 2019 and 2018, respectively. Each participant is 100%
vested at all times in employee and employer matching contributions.
Consulting and Distributor Agreements. The Company entered into an agreement that required it to make monthly payments
that will be applied to future commissions and/or consulting fees to be earned by the provider. The agreement is with a limited liability
company (“LLC”) that is minority owned by a relative of the Company’s chief financial officer. Under the agreement, dated January
15, 2016 and as amended on February 13, 2017, the LLC provides consulting services for developing a new distribution channel
outside of law enforcement for its body-worn camera and related cloud storage products to customers in the United States. The
Company advanced amounts to the LLC against commissions ranging from $5,000 to $6,000 per month plus necessary and reasonable
expenses for the period through June 30, 2017, which can be automatically extended based on the LLC achieving minimum sales
quotas. The agreement was renewed in January 2017 for a period of three years, subject to yearly minimum sales thresholds that would
allow the Company to terminate the contract if such minimums are not met. As of December 31, 2019, the Company had advanced a
total of $274,731 pursuant to this agreement and established an allowance reserve of $224,731 for a net advance of $50,000. The
minimum sales threshold was not met, and the Company discontinued all advances, although the contract has not been formally
terminated. However, the exclusivity provisions of the agreement have been terminated.
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On June 1, 2018 the Company entered into an agreement with an individual that required it to make monthly payments that
will be applied to future commissions and/or consulting fees to be earned by the provider. Under the agreement, the individual provides
consulting services for developing new distribution channels both inside and outside of law enforcement for its in-car and body-worn
camera systems and related cloud storage products to customers within and outside the United States. The Company was required to
advance amounts to the individual as an advance against commissions of $7,000 per month plus necessary and reasonable expenses for
the period through August 31, 2018, which was extended to December 31, 2018 by mutual agreement of the parties at $6,000 per
month. The parties have mutually agreed to further extend the arrangement on a monthly basis at $5,000 per month. As of December
31, 2019, the Company had advanced a total of $53,332 pursuant to this agreement.
NOTE 13. STOCK-BASED COMPENSATION
The Company recorded pretax compensation expense related to the grant of stock options and restricted stock issued of
$2,112,090 and $2,272,656 for the years ended December 31, 2019 and 2018, respectively.
As of December 31, 2019, the Company had adopted seven separate stock option and restricted stock plans: (i) the 2005 Stock
Option and Restricted Stock Plan (the “2005 Plan”), (ii) the 2006 Stock Option and Restricted Stock Plan (the “2006 Plan”), (iii) the
2007 Stock Option and Restricted Stock Plan (the “2007 Plan”), (iv) the 2008 Stock Option and Restricted Stock Plan (the “2008
Plan”), (v) the 2011 Stock Option and Restricted Stock Plan (the “2011 Plan”), (vi) the 2013 Stock Option and Restricted Stock Plan
(the “2013 Plan”), (vii) the 2015 Stock Option and Restricted Stock Plan (the “2015 Plan”) and (vii) the 2018 Stock Option and
Restricted Stock Plan (the “2018 Plan”). The 2005 Plan, 2006 Plan, 2007 Plan, 2008 Plan, 2011 Plan, 2013 Plan, 2015 Plan and 2018
Plan are referred to as the “Plans.”
These Plans permit the grant of stock options or restricted stock to its employees, non-employee directors and others for up to
a total of 4,175,000 shares of common stock. The 2005 Plan terminated during 2015 with 19,678 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, 2019 total 8,063. The 2006 Plan terminated during 2016 with 24,662 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, 2019 total 42,812. The 2007 Plan terminated during 2017 with 88,401 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, 2019 total 6,250. The 2008 Plan terminated during 2018 with 8,249 shares not awarded or
underlying options, which shares are now unavailable for issuance. Stock options granted under the 2008 Plan that remain unexercised
and outstanding as of December 31, 2019 total 32,250.
The Company believes that such awards better align the interests of our employees with those of its stockholders. Option
awards have been granted with an exercise price equal to the market price of its stock at the date of grant with such option awards
generally vesting based on the completion of continuous service and having ten-year contractual terms. These option awards typically
provide for accelerated vesting if there is a change in control (as defined in the Plans). The Company has registered all shares of
common stock that are issuable under its Plans with the SEC. A total of 629,186 shares remained available for awards under the
various Plans as of December 31, 2019.
The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model.
Activity in the various Plans during the years ended December 31, 2019 and 2018 is reflected in the following table:
Outstanding at January 1, 2018
Options
Granted
Exercised
Forfeited
Outstanding at December 31, 2018
Exercisable at December 31, 2018
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Number of
Shares
Weighted
Average
Exercise Price
350,269 $
160,000
—
(76,257)
434,012 $
354,012 $
13.44
2.20
—
(45.52)
4.62
5.17
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Outstanding at January 1, 2019
Options
Granted
Exercised
Forfeited
Outstanding at December 31, 2019
Exercisable at December 31, 2019
Number of
Shares
Weighted
Average
Exercise Price
434,012 $
180,000
—
(24,887)
589,125 $
499,125 $
4.62
3.01
—
(13.78)
3.74
3.87
The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. The total
estimated grant date fair value stock options issued during the year ended December 31, 2019 and 2018 was $436,217 and $284,384,
respectively.
The Company has utilized the following assumptions in its Black-Scholes option valuation model to calculate the estimated
grant date fair value of the options during the years ended December 31, 2019 and 2018:.
Volatility – range
Risk-free rate
Contractual term
Exercise price
2019
Assumptions
2018
Assumptions
107.6%
2.23%
107.5%
2.74%
5.5 years
3.01
$
5.5 years
2.20
$
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 years ended December 31, 2019 and 2018.
At December 31, 2019 and 2018, the aggregate intrinsic value of options outstanding was approximately $-0- and $76,800,
respectively, and the aggregate intrinsic value of options exercisable was approximately $-0- and $76,800, respectively. No options
were exercised in the years ended December 31, 2019 and 2018.
As of December 31, 2019, the unrecognized portion of stock compensation expense on all existing stock options was
$181,757 and will be recognized over the next five 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, 2019:
Outstanding options
Exercisable options
Exercise price
range
Number of
options
Weighted average
remaining
contractual life
Number of
options
Weighted average
remaining
contractual life
$
$
$
$
$
$
$
0.01 to $3.49
3.50 to $4.99
5.00 to $6.49
6.50 to $7.99
8.00 to $9.99
10.00 to $19.99
20.00 to $24.99
470,313
66,875
—
8,437
2,500
39,750
1,250
589,125
8.4 years
4.3 years
— years
1.8 years
1.4 years
1.0 years
0.1 years
7.3 years
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380,313
66,875
—
8,437
2,500
39,750
1,250
499,125
8.1 years
4.3 years
— years
1.8 years
1.4 years
1.0 years
0.1 years
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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 one 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 years ended December 31, 2019 and
2018 is as follows:
Nonvested balance, January 1, 2018
Granted
Vested
Forfeited
Nonvested balance, December 31, 2018
Nonvested balance, January 1, 2019
Granted
Vested
Forfeited
Nonvested balance, December 31, 2019
Number of
Restricted
shares
791,725 $
484,500
(470,175)
(33,900)
772,150 $
Number of
Restricted
shares
772,150 $
522,110
(774,015)
(5,370)
514,875 $
Weighted
average
grant date
fair
value
4.37
2.27
(3.83)
(4.04)
3.40
Weighted
average
grant date
fair
value
3.40
2.91
(3.35)
(3.46)
2.97
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, 2019, there were $379,623 of total unrecognized compensation costs related to all remaining non-vested
restricted stock grants, which will be amortized over the next 12 months in accordance with their respective vesting scale.
The nonvested balance of restricted stock vests as follows:
2020
2021
Years ended
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Number of
shares
264,750
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NOTE 14. COMMON STOCK PURCHASE WARRANTS
The Company has issued common stock purchase warrants in conjunction with various debt and equity issuances. The
warrants are either immediately exercisable, or have a delayed initial exercise date, no more than six months from their respective issue
date and allow the holders to purchase up to 4,824,573 shares of common stock at $1.40 to $16.50 per share as of December 31, 2019.
The warrants expire from July 15, 2020 through December 23, 2024 and allow for cashless exercise.
Certain common stock purchase warrants issued in August 2014 contained anti-dilution provisions that triggered a reset as a
result of the April 2018 financing transaction. The reset provisions resulted in the 12,200 warrants held at an exercise price of $7.32 per
share increased by 159,538 warrants resulting in a final reset to 172,038 warrants at an exercise price of $0.52 per share. All warrants
subject to the reset provision have now been exercised.
The following table summarizes information about shares issuable under warrants outstanding during the years ended
December 31, 2019 and 2018:
Vested Balance, January 1, 2018
Granted
Warrant reset
Exercised
Cancelled
Vested Balance, December 31, 2018
Vested Balance, January 1, 2019
Granted
Exercised
Cancelled
Vested Balance, December 31, 2019
Warrants
3,233,466 $
1,478,379
159,538
(171,738)
(42,500)
4,657,145 $
Warrants
4,693,145 $
678,428
(529,000)
(18,000)
4,824,573 $
Weighted
average
exercise price
6.57
2.90
0.52
(0.52)
(8.50)
5.54
Weighted
average
exercise price
5.40
1.75
(2.96)
(3.50)
5.15
The total intrinsic value of all outstanding warrants aggregated $-0- as of December 31, 2019 and the weighted average
remaining term is 33.2 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, 2019:
Exercise price
Number of warrants
Weighted average
remaining
contractual life
Outstanding and exercisable warrants
1.40
1.81
2.60
3.00
3.25
3.36
3.36
3.65
3.75
5.00
13.43
16.50
107,000
571,428
465,712
701,667
120,000
680,000
200,000
200,000
94,000
800,000
879,766
5,000
5.0 years
4.6 years
3.6 years
3.3 years
3.0 years
2.2 years
3.2 years
2.5 years
2.6 years
2.0 years
1.1 years
0.5 years
$
$
$
$
$
$
$
$
$
$
$
$
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4,824,573
2.8 years
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NOTE 15. STOCKHOLDERS’ EQUITY
Underwritten Public Offering - On September 26, 2018, the Company entered into an underwriting agreement with Roth
Capital Partners, LLC, as the representative of the underwriters and sole book-running manager, pursuant to which the Company
agreed to sell to the underwriters in a firm commitment underwritten public offering (the “Offering”) an aggregate of 2,400,000 shares
of the Company’s common stock, par value $0.001 per share at a public price of $3.05 per share. The Company also granted the
Underwriters a forty-five (45)-day option to purchase up to an additional 360,000 shares of common stock to cover over-allotments, if
any. Aegis Capital Corp. was a co-manager for the Offering. The Offering was registered and the common stock was issued pursuant to
the Company’s effective shelf registration statement on Form S-3 (File No. 333-225227), which was initially filed with the Securities
and Exchange Commission on May 25, 2018 and was declared effective on June 6, 2018.
On September 28, 2018, the underwriter exercised its over-allotment option to acquire an additional 200,000 shares at $3.05
per share. The partial exercise of the over-allotment option resulted in additional gross proceeds of $610,000. The net proceeds to the
Company from the Offering totaled approximately $7,324,900 including the partial exercise of the over-allotment option, after
deducting underwriting discounts and commissions and estimated expenses payable by the Company.
Under the underwriting agreement the Company agreed not to contract to issue or announce the issuance or proposed issuance
of any Common Stock or Common Stock equivalents for sixty (60) days following the closing of the Offering, subject to certain
exclusions as set forth therein. The Company’s executive officers and directors have entered into sixty (60)-day Lock-Up Agreements
with the Representative pursuant to which they have agreed not to sell, transfer, assign or otherwise dispose of the shares of the
Company’s common stock owned by them, subject to certain exclusions as set forth therein.
Approval of the 2018 Stock Option Plan and Restricted Stock Plan - On July 5, 2018 at the Company’s annual meeting, the
Company’s stockholders approved the 2018 Digital Ally, Inc. Stock Option and Restricted Stock Plan and reserving 1,000,000 shares
for issuance under such Plan.
NOTE 16. 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, 2019 and 2018 are as follows:
Numerator for basic and diluted income per share – Net loss
Year ended December 31,
2019
(10,005,713) $
2018
(15,544,551)
$
Denominator for basic loss per share – weighted average shares
outstanding
Dilutive effect of shares issuable upon conversion of convertible debt
and the exercise of stock options and warrants outstanding
11,478,618
8,073,257
—
—
Denominator for diluted loss per share – adjusted weighted average
shares outstanding
11,478,618
8,073,257
Net loss per share:
Basic
Diluted
$
$
(0.87) $
(0.87) $
(1.93)
(1.93)
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Basic loss per share is based upon the weighted average number of common shares outstanding during the period. For the
years ended December 31, 2019 and 2018, all shares issuable upon conversion of convertible debt and the exercise of outstanding stock
options and warrants were antidilutive, and, therefore, not included in the computation of diluted income (loss) per share.
Note 17 - Subsequent events
2020 Issuance of Restricted Common Stock.- On January 3, 2020, the board of directors approved the grant of 530,050
restricted common shares to officers and employees of the Company. Such shares will generally vest one-half on January 2, 2021 and
one half on January 2, 2022, provided that each grantee remains an officer or employee on such dates.
2019 Secured Convertible Notes.- Subsequent to December 31, 2019, the holders of the 2019 Convertible Notes exercised
their right to convert principal balances aggregating $1,259,074 into equity. In addition, the Company exercised their right to prepay in
cash the remaining outstanding principal balance aggregating $574,341. Their remain no outstanding 2019 Convertible notes as a result
of these conversions and prepayments.
Underwritten public offering - On March 3, 2020, the Company consummated an underwritten public offering of 2,521,740
shares of common stock (the Offering”). The Offering was conducted pursuant to an underwriting agreement, dated February 27,
between the Company and Aegis Capital Corp. (the “Underwriters”). The common stock in the Offering was sold at a public offering
price of $1.15 per share. The Company has granted the Underwriters a 45-day option to purchase up to an additional 378,261
additional shares of common stock at the public offering price, less underwriting discounts and commissions, to cover over-allotments,
if any.
The common stock in the Offering was issued pursuant to the Company’s effective shelf registration statement on Form S-3
(File No. 333-225227). The underwriting agreement contained customary representations, warranties and agreements by the Company,
customary conditions to closing, indemnification obligations of the Company and the Underwriters. The Underwriters received
discounts and commissions of seven percent (7%) of the gross cash proceeds received by the Company from the sale of the common
shares in the Offering. In addition, the Company agreed to pay the Underwriters (a) a non-accountable expense reimbursement of 1%
of the gross proceeds received and (b) “road show” expenses, diligence fees and the fees and expenses of the Underwriters’ legal
counsel not to exceed $50,000.
Under the underwriting agreement, the Company and its officers and directors executed lock-up agreements whereby, (a) the
Company has agreed not to engage in the following for a period of 45 days from the date of the pricing of the Offering, (1) offer, sell or
otherwise transfer or dispose of, directly or indirectly, any shares of capital stock of the Company, or (2) file or caused to be filed any
registration statement with the SEC relating to the offering of any shares of the Company’s capital stock or any securities convertible
into or exercisable or exchangeable for shares of the Company’s capital stock, and (b) the Company’s executive officers and directors,
as of the pricing date of the Offering, have agreed, subject to certain exceptions, not to offer, issue, sell, contract to sell, encumber,
grant any option for the sale of or otherwise dispose of any securities of the Company without the prior written consent of the
Underwriters, for a period of 45 days from the date of the offering.
The gross proceeds to the Company from the offering, before deducting underwriting discounts and commissions and other
estimated offering expenses, and assuming the Underwriters do not exercise their option to purchase the option shares, are
approximately $2.9 million. The net proceeds to the Company from the offering, after deducting underwriting discounts and
commissions and the non-accountable expense reimbursement, but before deducting other expenses in connection with the offering,
and assuming the Underwriters do not exercise their option to purchase the option Shares, are approximately $2.67 million. The
Company intends to use the net proceeds from this offering to fund the repayment of debt and for general corporate purposes.
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Debt Financing:- The Company entered two debt instruments subsequent to December 31, 2019 as follows:
● During February 2020, the Company borrowed a total of $289,000 from the Company’s Chairman, CEO & President under an
unsecured promissory note bearing interest at 6% through its May 28, 2020 maturity date. The proceeds from the note were
used for general corporate purposes.
● On January 17, 2020, the Company borrowed a total of $100,000 from an individual under an unsecured promissory note
bearing interest at 8% through its April 17, 2020 maturity date. In connection with the loan, the Company issued the
individual a warrant for the purchase of 35,750 shares of common stock at $1.40 per share for a period of five years from the
date of the note. The proceeds from the note were used for general corporate purposes.
NASDAQ Listing - Our Common Stock is currently listed on The Nasdaq Capital Market (“Nasdaq”). In order to maintain
that listing, we must satisfy minimum financial and other continued listing requirements and standards, including those regarding
director independence and independent committee requirements, minimum stockholders’ equity, minimum share price, and certain
corporate governance requirements. There can be no assurances that we will be able to comply with the applicable listing standards.
If our Common Stock is delisted from Nasdaq and is not eligible for quotation on another market or exchange, trading of our
Common Stock could be conducted in the over-the-counter market or on an electronic bulletin board established for unlisted securities
such as the Pink Sheets or the OTC Bulletin Board. In such event, it could become more difficult to dispose of, or obtain accurate price
quotations for, our Common Stock, and there would likely also be a reduction in our coverage by securities analysts and the news
media. Also, it may be difficult for us to raise additional capital if we are not listed on Nasdaq or a major exchange.
On July 11, 2019, Nasdaq notified us that, for the previous 30 consecutive business days, the minimum Market Value of
Listed Securities (the “MVLS”) for our Common Stock was below the $35 million minimum MVLS requirement for continued listing
on Nasdaq under Nasdaq Listing Rule 5550(b)(2) (the “MVLS Rule”). In accordance with Nasdaq Listing Rule 5810(c)(3)(C), we had
180 calendar days, or until January 7, 2020, to regain compliance with the MVLS Rule. To regain compliance with the MVLS Rule,
the minimum MVLS for our Common Stock must have been at least $35 million for a minimum of ten consecutive business days at
any time during this 180-day period. If we failed to regain compliance with such rule by January 7, 2020, we were subject to being be
delisted from Nasdaq. If we were delisted from The Nasdaq Capital Market, our Common Stock may lose liquidity, increase volatility,
and lose market maker support.
On January 8, 2020, we received a determination letter from the staff of Nasdaq stating that we had not regained compliance
with the MVLS Standard, since our Common Stock was below the $35 million minimum MVLS requirement for continued listing on
Nasdaq under the MLVS Rule and had not been at least $35 million for a minimum of ten consecutive business days at any time during
the 180-day grace period granted to us. Pursuant to the letter, unless we requested a hearing to appeal this determination by January 15,
2020, our Common Stock would be delisted from Nasdaq and trading of our Common Stock would have been suspended at the
opening of business on January 17, 2020.
On January 13, 2020, we requested a hearing before the Nasdaq Hearings Panel to appeal the Letter and the Staff of Nasdaq
notified us that a hearing was scheduled for February 20, 2020. We were asked to provide the Panel with a plan to regain compliance
with the minimum MLVS requirement under the MLVS Rule, which needed to include a discussion of the events that we believe will
enable us to timely regain compliance with the minimum MLVS requirement. On January 21, 2020, we submitted such a compliance
plan.
On March 6, 2020, we received notice from the NASDAQ hearing panel that the Company has been granted an extension
until June 30, 2020 to regain compliance with Rule 5550(b), which requires us to have at least i) $2.5 million in shareholder equity; or
ii) $35 million in market value of listed securities, or iii) net income from continuing operations of at least $500,000 in the most
recently completed fiscal year or in two of the last three fiscal years. Our goal is to meet the $2.5 million minimum shareholder equity
requirement for continued listing on NASDAQ. There can be no assurance that we will regain compliance with the NASDAQ’s Listing
Rule regarding our $2.5 million minimum shareholder equity requirement on or prior to the June 30, 2020 required date. Furthermore,
even if we regain compliance on or prior to such date, we must thereafter continue to maintain compliance the continued listing rule.
COVID – 19 Pandemic - The accompanying consolidated financial statements as well as the Notes to the Consolidated
Financial Statements, unless otherwise indicated, principally reflect the status of our business and the results of our operations as of
December 31, 2019. Since that date, economies throughout the world have been severely disrupted by the effects of the quarantines,
business closures and the reluctance of individuals to leave their homes as a result of the outbreak of the coronavirus (COVID-19).
Although we remain open as an “essential business,” our supply chain has been disrupted and our customers and in particular our
commercial customers have been significantly impacted which has in turn reduced our operations and activities. In addition, the capital
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markets have been disrupted and our efforts to raise necessary capital will likely be adversely impacted by the outbreak of the virus and
we cannot forecast with any certainty when the disruptions caused by it will cease to impact our business and the results of our
operations. In reading the our consolidated financial statements, including our discussion of our ability to continue as a going concern
set forth herein, in each case, consider the additional uncertainties caused by the outbreak of COVID - 19.
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