Item
1 – Financial Statements.
DIGITAL
ALLY, INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
SEPTEMBER
30, 2018 AND DECEMBER 31, 2017
|
|
(Unaudited)
|
|
|
|
|
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
Assets
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
7,589,050
|
|
|
$
|
54,712
|
|
Accounts
receivable-trade, less allowance for doubtful accounts of $70,000 – 2018 and 2017
|
|
|
2,006,116
|
|
|
|
1,978,936
|
|
Accounts
receivable-other
|
|
|
378,954
|
|
|
|
338,618
|
|
Inventories,
net
|
|
|
7,370,677
|
|
|
|
8,750,713
|
|
Restricted
cash
|
|
|
—
|
|
|
|
500,000
|
|
Prepaid
expenses
|
|
|
488,706
|
|
|
|
209,163
|
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
17,833,503
|
|
|
|
11,832,142
|
|
|
|
|
|
|
|
|
|
|
Furniture,
fixtures and equipment, net
|
|
|
314,574
|
|
|
|
638,169
|
|
Intangible
assets, net
|
|
|
484,075
|
|
|
|
497,180
|
|
Income
tax refund receivable
|
|
|
90,000
|
|
|
|
90,000
|
|
Other
assets
|
|
|
244,052
|
|
|
|
115,043
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
18,966,204
|
|
|
$
|
13,172,534
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
1,501,811
|
|
|
$
|
3,193,269
|
|
Accrued
expenses
|
|
|
1,161,446
|
|
|
|
1,240,429
|
|
Derivative
liabilities
|
|
|
—
|
|
|
|
16,816
|
|
Capital
lease obligation-current
|
|
|
—
|
|
|
|
8,492
|
|
Contract
liabilities-current
|
|
|
1,608,545
|
|
|
|
1,409,683
|
|
Subordinated
and secured notes payable
|
|
|
—
|
|
|
|
1,008,500
|
|
Secured
convertible debentures, at fair value
|
|
|
—
|
|
|
|
3,262,807
|
|
Income
taxes payable
|
|
|
3,704
|
|
|
|
10,141
|
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
4,275,506
|
|
|
|
10,150,137
|
|
|
|
|
|
|
|
|
|
|
Long-term
liabilities:
|
|
|
|
|
|
|
|
|
Proceeds
investment agreement, at fair value
|
|
|
9,166,000
|
|
|
|
—
|
|
Contract
liabilities-long term
|
|
|
2,187,573
|
|
|
|
2,158,649
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
15,629,079
|
|
|
|
12,308,786
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholder’s
Equity:
|
|
|
|
|
|
|
|
|
Common
stock, $0.001 par value; 50,000,000 shares authorized; shares issued: 10,424,752 – 2018 and 7,037,799 – 2017
|
|
|
10,425
|
|
|
|
7,038
|
|
Additional
paid in capital
|
|
|
77,538,983
|
|
|
|
64,923,735
|
|
Treasury
stock, at cost (63,518 shares)
|
|
|
(2,157,226
|
)
|
|
|
(2,157,226
|
)
|
Accumulated
deficit
|
|
|
(72,055,057
|
)
|
|
|
(61,909,799
|
)
|
|
|
|
|
|
|
|
|
|
Total
stockholders’ equity
|
|
|
3,337,125
|
|
|
|
863,748
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
18,966,204
|
|
|
$
|
13,172,534
|
|
See
Notes to Condensed Consolidated Financial Statements.
DIGITAL
ALLY, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR
THE THREE AND NINE MONTHS ENDED
SEPTEMBER
30, 2018 AND 2017
(Unaudited)
|
|
Three
months ended
September 30,
|
|
|
Nine
months ended
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
2,334,863
|
|
|
$
|
2,521,663
|
|
|
$
|
7,319,676
|
|
|
$
|
10,263,833
|
|
Service
and other
|
|
|
543,196
|
|
|
|
461,914
|
|
|
|
1,593,446
|
|
|
|
1,436,106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
|
|
2,878,059
|
|
|
|
2,983,577
|
|
|
|
8,913,122
|
|
|
|
11,699,939
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
1,592,072
|
|
|
$
|
1,709,046
|
|
|
$
|
4,672,432
|
|
|
$
|
6,450,570
|
|
Service
and other
|
|
|
108,698
|
|
|
|
265,918
|
|
|
|
335,540
|
|
|
|
790,691
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
cost of revenue
|
|
|
1,700,770
|
|
|
|
1,974,964
|
|
|
|
5,007,972
|
|
|
|
7,241,261
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
1,177,289
|
|
|
|
1,008,613
|
|
|
|
3,905,150
|
|
|
|
4,458,678
|
|
Selling,
general and administrative expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development expense
|
|
|
323,981
|
|
|
|
831,573
|
|
|
|
1,097,861
|
|
|
|
2,495,924
|
|
Selling,
advertising and promotional expense
|
|
|
711,506
|
|
|
|
1,048,334
|
|
|
|
2,097,919
|
|
|
|
3,036,168
|
|
Stock-based
compensation expense
|
|
|
669,480
|
|
|
|
478,863
|
|
|
|
1,757,227
|
|
|
|
981,652
|
|
General
and administrative expense
|
|
|
1,382,038
|
|
|
|
1,766,538
|
|
|
|
4,272,484
|
|
|
|
5,356,439
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
selling, general and administrative expenses
|
|
|
3,087,005
|
|
|
|
4,125,308
|
|
|
|
9,225,491
|
|
|
|
11,870,183
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
loss
|
|
|
(1,909,716
|
)
|
|
|
(3,116,695
|
)
|
|
|
(5,320,341
|
)
|
|
|
(7,411,505
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
2,206
|
|
|
|
1,761
|
|
|
|
4,507
|
|
|
|
10,619
|
|
Interest
expense
|
|
|
(1,083,317
|
)
|
|
|
(375,048
|
)
|
|
|
(1,366,520
|
)
|
|
|
(536,035
|
)
|
Change
in warrant derivative liabilities
|
|
|
(9,799
|
)
|
|
|
3,628
|
|
|
|
(319,105
|
)
|
|
|
17,347
|
|
Secured
convertible debentures issuance expense
|
|
|
—
|
|
|
|
—
|
|
|
|
(220,312
|
)
|
|
|
—
|
|
Loss
on the extinguishment of secured convertible debentures
|
|
|
(100,000
|
)
|
|
|
—
|
|
|
|
(600,000
|
)
|
|
|
—
|
|
Change
in fair value of secured convertible debentures
|
|
|
(1,466,467
|
)
|
|
|
(6,952
|
)
|
|
|
(2,296,444
|
)
|
|
|
66,790
|
|
Change
in fair value of proceeds investment agreement
|
|
|
(98,487
|
)
|
|
|
—
|
|
|
|
(98,487
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income tax expense
|
|
|
(4,665,580
|
)
|
|
|
(3,493,306
|
)
|
|
|
(10,216,702
|
)
|
|
|
(7,852,784
|
)
|
Income
tax (expense) benefit
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(4,665,580
|
)
|
|
$
|
(3,493,306
|
)
|
|
$
|
(10,216,702
|
)
|
|
$
|
(7,852,784
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per
share information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.60
|
)
|
|
$
|
(0.56
|
)
|
|
$
|
(1.40
|
)
|
|
$
|
(1.34
|
)
|
Diluted
|
|
$
|
(0.60
|
)
|
|
$
|
(0.56
|
)
|
|
$
|
(1.40
|
)
|
|
$
|
(1.34
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average
shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
7,725,877
|
|
|
|
6,249,116
|
|
|
|
7,295,098
|
|
|
|
5,851,428
|
|
Diluted
|
|
|
7,725,877
|
|
|
|
6,249,116
|
|
|
|
7,295,098
|
|
|
|
5,851,428
|
|
See
Notes to Condensed Consolidated Financial Statements.
DIGITAL
ALLY, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2018
(Unaudited)
|
|
Common
Stock
|
|
|
Additional
Paid in
|
|
|
Treasury
|
|
|
Accumulated
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
stock
|
|
|
deficit
|
|
|
Total
|
|
Balance,
December 31, 2017
|
|
|
7,037,799
|
|
|
$
|
7,038
|
|
|
$
|
64,923,735
|
|
|
$
|
(2,157,226
|
)
|
|
$
|
(61,909,799
|
)
|
|
$
|
863,748
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative
effects adjustment for adoption of ASC 606 (Note 1)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
71,444
|
|
|
|
71,444
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based
compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
1,757,227
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,757,227
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
common stock grant
|
|
|
484,500
|
|
|
|
485
|
|
|
|
(485
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Restricted
common stock forfeitures
|
|
|
(33,900
|
)
|
|
|
(34
|
)
|
|
|
34
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Issuance
of common stock through underwritten public offering (net of offering expenses and underwriters’ discount)
|
|
|
2,600,000
|
|
|
|
2,600
|
|
|
|
7,322,300
|
|
|
|
—
|
|
|
|
—
|
|
|
|
7,324,900
|
|
Issuance
of common stock purchase warrants in connection with issuance of subordinated notes payable
|
|
|
—
|
|
|
|
—
|
|
|
|
47,657
|
|
|
|
—
|
|
|
|
—
|
|
|
|
47,657
|
|
Issuance
of common stock purchase warrants in connection with issuance of secured convertible debentures
|
|
|
—
|
|
|
|
—
|
|
|
|
1,684,251
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,684,251
|
|
Issuance
of common stock purchase warrants in connection with issuance of proceeds investment agreement
|
|
|
—
|
|
|
|
—
|
|
|
|
932,487
|
|
|
|
—
|
|
|
|
—
|
|
|
|
932,487
|
|
Issuance
of common stock upon conversion of secured convertible debentures and accrued interest
|
|
|
117,476
|
|
|
|
117
|
|
|
|
293,571
|
|
|
|
—
|
|
|
|
—
|
|
|
|
293,688
|
|
Issuance
of common stock upon conversion of secured notes payable and accrued interest
|
|
|
47,139
|
|
|
|
47
|
|
|
|
153,153
|
|
|
|
—
|
|
|
|
—
|
|
|
|
153,200
|
|
Issuance
of common stock upon exercise of common stock purchase warrants
|
|
|
171,738
|
|
|
|
172
|
|
|
|
425,053
|
|
|
|
—
|
|
|
|
—
|
|
|
|
425,225
|
|
Net
loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(10,216,702
|
)
|
|
|
(10,216,702
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
September 30, 2018
|
|
|
10,424,752
|
|
|
$
|
10,425
|
|
|
$
|
77,538,983
|
|
|
$
|
(2,157,226
|
)
|
|
$
|
(72,055,057
|
)
|
|
$
|
3,337,125
|
|
See
Notes to Condensed Consolidated Financial Statements.
DIGITAL
ALLY, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017
(Unaudited)
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Cash
Flows from Operating Activities:
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(10,216,702
|
)
|
|
$
|
(7,852,784
|
)
|
Adjustments
to reconcile net loss to net cash flows used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
395,819
|
|
|
|
507,358
|
|
Gain
on disposal of equipment
|
|
|
(28,218
|
)
|
|
|
—
|
|
Change
in fair value of warrant derivative liabilities
|
|
|
319,105
|
|
|
|
(17,347
|
)
|
Loss
on extinguishment of secured convertible debentures
|
|
|
600,000
|
|
|
|
—
|
|
Secured
convertible debentures issuance expense
|
|
|
220,312
|
|
|
|
—
|
|
Change
in fair value of secured convertible debentures
|
|
|
2,296,444
|
|
|
|
(66,790
|
)
|
Change
in fair value of proceeds investment agreement
|
|
|
98,487
|
|
|
|
—
|
|
Interest
expense added to debenture
|
|
|
995,368
|
|
|
|
—
|
|
Amortization
of debt discount
|
|
|
47,657
|
|
|
|
288,895
|
|
Stock-based
compensation
|
|
|
1,757,227
|
|
|
|
981,652
|
|
Provision
for inventory obsolescence
|
|
|
(300,729
|
)
|
|
|
417,732
|
|
|
|
|
|
|
|
|
|
|
Change
in assets and liabilities:
|
|
|
|
|
|
|
|
|
(Increase)
decrease in:
|
|
|
|
|
|
|
|
|
Accounts
receivable - trade
|
|
|
(27,180
|
)
|
|
|
658,175
|
|
Accounts
receivable - other
|
|
|
(40,336
|
)
|
|
|
(93,565
|
)
|
Inventories
|
|
|
1,680,765
|
|
|
|
(893,412
|
)
|
Prepaid
expenses
|
|
|
(208,099
|
)
|
|
|
(49,629
|
)
|
Other
assets
|
|
|
(129,009
|
)
|
|
|
120,062
|
|
Increase
(decrease) in:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
|
(1,691,458
|
)
|
|
|
276,757
|
|
Accrued
expenses
|
|
|
(68,294
|
)
|
|
|
(380,744
|
)
|
Income
taxes payable
|
|
|
(6,437
|
)
|
|
|
3,095
|
|
Contract
liabilities
|
|
|
227,786
|
|
|
|
336,597
|
|
|
|
|
|
|
|
|
|
|
Net
cash used in operating activities
|
|
|
(4,077,492
|
)
|
|
|
(5,763,948
|
)
|
|
|
|
|
|
|
|
|
|
Cash
Flows from Investing Activities:
|
|
|
|
|
|
|
|
|
Purchases
of furniture, fixtures and equipment
|
|
|
(34,448
|
)
|
|
|
(316,751
|
)
|
Proceeds
from the sale of equipment
|
|
|
76,268
|
|
|
|
—
|
|
Additions
to intangible assets
|
|
|
(72,721
|
)
|
|
|
(138,765
|
)
|
Release
of restriction on cash in accordance with secured convertible note
|
|
|
500,000
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by (used) in investing activities
|
|
|
469,099
|
|
|
|
(455,516
|
)
|
Cash
Flows from Financing Activities:
|
|
|
|
|
|
|
|
|
Proceeds
from subordinated notes payable
|
|
|
250,000
|
|
|
|
1,000,000
|
|
Proceeds
from sale of common stock in underwritten public offering
|
|
|
7,324,900
|
|
|
|
—
|
|
Proceeds
from proceeds investment agreement and detachable
common stock purchase warrants
|
|
|
10,000,000
|
|
|
|
—
|
|
Proceeds
from secured convertible debentures and detachable
common stock purchase warrants
|
|
|
6,250,000
|
|
|
|
—
|
|
Principal
payment on secured convertible debentures
|
|
|
(10,834,169
|
)
|
|
|
(750,000
|
)
|
Principal
payment on subordinated notes payable
|
|
|
(1,108,500
|
)
|
|
|
(350,000
|
)
|
Proceeds
from issuance of common stock and warrants
|
|
|
89,304
|
|
|
|
2,776,932
|
|
Loss
on extinguishment of secured convertible debentures
|
|
|
(600,000
|
)
|
|
|
—
|
|
Secured
convertible debentures issuance expense
|
|
|
(220,312
|
)
|
|
|
—
|
|
Principal
payments on capital lease obligation
|
|
|
(8,492
|
)
|
|
|
(24,418
|
)
|
|
|
|
|
|
|
|
|
|
Net
cash provided by financing activities
|
|
|
11,142,731
|
|
|
|
2,652,514
|
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
7,534,338
|
|
|
|
(3,566,950
|
)
|
Cash
and cash equivalents, beginning of period
|
|
|
54,712
|
|
|
|
3,883,124
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
7,589,050
|
|
|
$
|
316,174
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
Cash
payments for interest
|
|
$
|
1,367,561
|
|
|
$
|
166,138
|
|
|
|
|
|
|
|
|
|
|
Cash
payments for income taxes
|
|
$
|
6,437
|
|
|
$
|
6,906
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
common stock grant
|
|
$
|
485
|
|
|
$
|
522
|
|
|
|
|
|
|
|
|
|
|
Restricted
common stock forfeitures
|
|
$
|
34
|
|
|
$
|
9
|
|
|
|
|
|
|
|
|
|
|
Amounts
allocated to common stock purchase warrants in connection with proceeds from secured convertible debentures
|
|
$
|
1,684,251
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Amounts
allocated to common stock purchase warrants in connection with proceeds investment agreement
|
|
$
|
932,487
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Issuance
of common stock upon conversion of secured convertible debentures and payment of accrued interest
|
|
$
|
293,688
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Issuance
of common stock upon conversion of secured notes payable and accrued interest
|
|
$
|
153,200
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Issuance
of common stock upon exercise of common stock purchase warrants accounted for as derivative warrant liabilities
|
|
$
|
335,921
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Amounts
allocated to common stock purchase warrants in connection with proceeds from subordinated notes payable
|
|
$
|
47,657
|
|
|
$
|
—
|
|
See
Notes to Condensed Consolidated Financial Statements.
DIGITAL
ALLY, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature
of Business:
Digital
Ally, Inc. and subsidiaries (collectively, “Digital Ally,” “Digital,” “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 including cloud-based fleet management and driver monitoring/training applications. The Company
has active research and development programs to adapt its technologies to other applications. It can integrate electronic, radio,
computer, mechanical, and multi-media technologies to create unique solutions to address needs in a variety of other industries
and markets, including mass transit, school bus, taxi cab and the military. The Company sells its products to law enforcement
agencies and other security organizations, and consumer and commercial fleet operators through direct sales domestically and third-party
distributors internationally.
The
Company was originally incorporated in Nevada on December 13, 2000 as Vegas Petra, Inc. and had no operations until 2004. On November
30, 2004, Vegas Petra, Inc. entered into a Plan of Merger with Digital Ally, Inc., at which time the merged entity was renamed
Digital Ally, Inc.
Accounting
Changes:
Except
for the changes discussed below, the Company has consistently applied the accounting policies to all periods presented in these
unaudited consolidated financial statements.
Effective
January 1, 2018, the Company adopted FASB ASC Topic 606,
Revenue from Contracts with Customers
, the Company changed certain
characteristics of the revenue recognition accounting policy as described below. ASC 606 was applied using the modified retrospective
approach, where the cumulative effect of the initial application is recognized as an adjustment to opening retained earnings at
January 1, 2018. Therefore, comparative prior periods have not been adjusted and continue to be reported under FASB ASC Topic
605,
Revenue Recognition
, or ASC 605. The following table summarizes the impact of the adoption of ASC 606 on revenue,
operating expenses and operating profit for the nine months ended September 30, 2018 (in thousands):
|
|
|
|
|
|
|
|
Amounts
without the
|
|
|
|
As
Reported
|
|
|
Adjustments
|
|
|
Adoption
of ASC 606
|
|
Revenue
|
|
|
8,913
|
|
|
|
—
|
|
|
|
8,913
|
|
Operating
Expenses
|
|
|
9,225
|
|
|
|
21
|
|
|
|
9,204
|
|
Operating
Profit (Loss)
|
|
|
(5,320
|
)
|
|
|
(21
|
)
|
|
|
(5,299
|
)
|
The
impact of the adoption of ASC 606 as of January 1, 2018 for the Company was not material and the impact of the adoption of ASC
606 on the unaudited consolidated financial statements at September 30, 2018 and the unaudited consolidated statements of operations,
equity (deficit) and cash flows for the nine months ended September 30, 2018 was not material.
Upon
adoption of ASC 606, the Company changed its accounting policy for the capitalization of costs to obtain contracts. Prior to the
adoption of ASC 606, all commissions paid to the salesforce was recognized as commission expense including any commissions earned
for future revenues. Under ASC 606, the Company is required to capitalize commissions paid to the salesforce for future revenues
and recognize as commission expense as the respective revenues are earned. This change was the principal adjustment to the Company’s
reported revenue and operating expenses included in the above table.
Management’s
Liquidity Plan
The
Company incurred substantial operating losses in the nine months ended September 30, 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 features than those of the Company
and significant price cutting of their products. The Company incurred net losses of approximately $10.1 million during the nine
months ended September 30, 2018 and $12.3 million in the year ended December 31, 2017 and it had an accumulated deficit of $72.1
million as of September 30, 2018. In recent years and including 2018, the Company has accessed the public and private capital
markets to raise funding through the issuance of debt and equity. In that regard, the Company raised funding in the form of subordinated
debt, secured debt and proceeds investment agreements totaling $16,500,000, and net proceeds of $7,324,900 from an underwritten
public offering of common stock during the nine months ended September 30, 2018. The Company issued common stock and detachable
common stock purchase warrants totaling $2,776,332 and raised funding from subordinated and secured debt totaling $1,608,500 during
the year ended December 31, 2017. During 2016, the Company raised $4.0 million of funding in the form of convertible debentures
and common stock purchase warrants. These debt and equity raises were utilized to fund its operations and management expects to
continue this pattern until it achieves positive cash flows from operations, although it can offer no assurance in this regard.
The
Company retired all interest-bearing debt outstanding during the nine months ended September 30, 2018. The only long-term obligations
outstanding as of September 30, 2018 are associated with the proceeds investment agreement that the Company entered into during
July 2018, as more fully described in Note 6.
The
Company is also negotiating with Web.com golf tournament officials to terminate its sponsorship fee commitment of $500,000 annually
for 2018 and 2019 tournaments. There can be no assurance that it will be successful in negotiating the termination of this sponsorship
agreement or that if successful, the termination will be on terms acceptable or favorable to the Company.
The
Company will have to restore positive operating cash flows and profitability over the next twelve months and/or raise additional
capital to fund its operational plans, meet its customary payment obligations and otherwise execute its business plan. There can
be no assurance that it will be successful in restoring positive cash flows and profitability, or that it can raise additional
financing when needed, and obtain it on terms acceptable or favorable to the Company.
The
Company has implemented an enhanced quality control program to detect and correct product issues before they result in significant
rework expenditures affecting the Company’s gross margins and has seen progress in that regard. In addition, the Company
has undertaken a number of cost reduction initiatives, including a reduction of its workforce by approximately 40%, restructuring
its direct sales force and cutting other selling, general and administrative costs. In 2017 the Company introduced a new full
high definition in-car video system (DVM-800 HD), which is intended to help it regain market share and improve revenues in its
law enforcement division. The Company has increased its addressable market to non-law enforcement customers and obtained new non-law
enforcement contracts in the first nine months of 2018, which contracts include recurring revenue during the period 2018 to 2020.
The Company believes that its quality control, headcount reduction and cost cutting initiatives, introduction of the DVM-800 HD
for law enforcement and expansion to non-law enforcement sales channels will restore positive operating cash flows and profitability
during the next year, although it can offer no assurances in this regard.
In
addition to the initiatives described above, the Board of Directors is conducting a review of a full range of strategic alternatives
to best position the Company for the future including, but not limited to, monetizing its patent portfolio and related patent
infringement litigation against Axon Enterprise, Inc. (“Axon” formerly Taser International, Inc.) and Enforcement
Video, LLC d/b/a WatchGuard Video (“WatchGuard”), the sale of all or certain assets, properties or groups of properties
or individual businesses or merger or combination with another company. The result of this review may also include the continued
implementation of the Company’s business plan. The Company has retained Roth Capital Partners (“Roth”) to assist
in this process. The capital raises/fundings completed on April 3, 2018, August 21, 2018, and September 28, 2018, as discussed
in Notes 6 and 13, were part of this strategic alternatives review. While such funding addressed the Company’s near-term
liquidity needs, it continues to consider strategic alternatives to address longer-term liquidity needs and operational issues.
There can be no assurance that any additional transactions or financings will result from this process.
Based
on the uncertainties described above, the Company believes its business plan does not alleviate the existence of substantial doubt
about its ability to continue as a going concern within one year from the date of the issuance of these consolidated condensed
interim financial statements.
The
following is a summary of the Company’s Significant Accounting Policies:
Basis
of Consolidation:
The
accompanying financial statements include the consolidated accounts of Digital Ally and its wholly-owned 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, its 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.
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 when incurred as the
amortization period of the commission asset the Company would have otherwise recognized is less than one year.
The
Company sells its products and services to law enforcement and commercial customers in the following manner:
|
●
|
Sales
to domestic customers are made direct to the end customer (typically a law enforcement agency or a commercial customer) through
its sales force, which is composed of its employees. Revenue is recorded when the product is shipped to the end customer.
|
|
●
|
Sales
to international customers are made through independent distributors who purchase products from the Company at a wholesale
price and sell to the end user (typically law enforcement agencies or a commercial customer) at a retail price. The distributor
retains the margin as its compensation for its role in the transaction. The distributor generally maintains product inventory,
customer receivables and all related risks and rewards of ownership. Accordingly, upon application of steps one through five
above, revenue is recorded when the product is shipped to the distributor consistent with the terms of the distribution agreement.
|
|
|
|
|
●
|
Repair
parts and services for domestic and international customers are generally handled by its inside customer service employees.
Revenue is recognized upon shipment of the repair parts and acceptance of the service or materials by the end customer.
|
Sales
taxes collected on products sold are excluded from revenues and are reported as accrued expenses in the accompanying balance sheets
until payments are remitted.
Service
and other revenue is comprised of revenues from extended warranties, repair services, cloud revenue and software revenue. Revenue
is recognized upon shipment of the product and acceptance of the service or materials by the end customer for repair services.
Revenue for extended warranty, cloud service or other software-based products is over the term of the contract warranty or service
period. A time-elapsed method is used to measure progress because the Company transfers control evenly over the contractual period.
Accordingly, the fixed consideration related to these revenues is generally recognized on a straight-line basis over the contract
term, as long as the other revenue recognition criteria have been met.
Contracts
with some of the Company’s customers contain multiple performance obligations that are distinct and accounted for separately.
The transaction price is allocated to the separate performance obligations on a relative standalone selling price (“SSP”).
The Company determined SSP for all the performance obligations using observable inputs, such as standalone sales and historical
pricing. SSP is consistent with the Company’s overall pricing objectives, taking into consideration the type of service
being provided. SSP also reflects the amount the Company would charge for the performance obligation if it were sold separately
in a standalone sale. Multiple performance obligations consist of product, software, cloud subscriptions and extended warranties.
The
Company’s multiple performance obligations may include future in-car or body-worn camera devices to be delivered at defined
points within a multi-year contract, and in those arrangements, the Company allocates total arrangement consideration over the
life of the multi-year contract to future deliverables using management’s best estimate of selling price.
Contract
liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts
are generally recognized as revenue over the contractual period.
Sales
returns and allowances aggregated $72,127 and $12,390 for the three months ended September 30, 2018 and 2017, respectively, and
$126,373 and $(15,195) for the nine months ended September 30, 2018 and 2017, 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. A customer paid under a sales transaction in March
2017 that had been accrued to be returned at December 31, 2016, which then caused the negative sales returns for the nine months
ended September 30, 2017.
Revenues
for the nine months ended September 30, 2018 and 2017 were derived from the following sources:
|
|
Nine
months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
DVM-800
|
|
$
|
3,956,816
|
|
|
$
|
5,597,673
|
|
DVM-250 Plus
|
|
|
617,705
|
|
|
|
1,188,283
|
|
FirstVu
HD
|
|
|
1,070,245
|
|
|
|
1,379,625
|
|
DVM-100 &
DVM-400
|
|
|
69,496
|
|
|
|
195,223
|
|
DVM-750
|
|
|
378,660
|
|
|
|
406,314
|
|
VuLink
|
|
|
146,896
|
|
|
|
210,398
|
|
Repair
and service
|
|
|
1,093,141
|
|
|
|
1,176,144
|
|
Cloud
service revenue
|
|
|
500,305
|
|
|
|
259,961
|
|
Laser
Ally
|
|
|
79,155
|
|
|
|
35,793
|
|
Accessories
and other revenues
|
|
|
1,000,703
|
|
|
|
1,250,525
|
|
|
|
$
|
8,913,122
|
|
|
$
|
11,699,939
|
|
Use
of Estimates:
The
preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues
and expenses during the reporting period. Actual results could differ from those estimates.
Cash
and cash equivalents:
Cash
and cash equivalents include funds on hand, in bank and short-term investments with original maturities of ninety (90) days or
less.
Cash
and cash equivalents that are restricted as to withdrawal or use under the terms of the secured convertible debentures are presented
as restricted cash separate from cash and cash equivalents on the accompanying balance sheet.
Accounts
Receivable:
Accounts
receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding
amounts on a weekly basis. The Company determines the allowance for doubtful accounts by regularly evaluating individual customer
receivables and considering a customer’s financial condition, credit history, and current economic conditions. Trade receivables
are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.
A
trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than thirty (30)
days beyond terms. No interest is charged on overdue trade receivables.
Inventories:
Inventories
consist of electronic parts, circuitry boards, camera parts and ancillary parts (collectively, “components”), work-in-process
and finished goods, and are carried at the lower of cost (First-in, First-out Method) or market value. The Company determines
the estimate for the reserve for slow moving or obsolete inventories by regularly evaluating individual inventory levels, projected
sales and current economic conditions.
Furniture,
fixtures and equipment:
Furniture,
fixtures and equipment is stated at cost net of accumulated depreciation. Additions and improvements are capitalized while ordinary
maintenance and repair expenditures are charged to expense as incurred. Depreciation is recorded by the straight-line method over
the estimated useful life of the asset, which ranges from three to ten years. Amortization expense on capitalized leases is included
with depreciation expense.
Intangible
assets:
Intangible
assets include deferred patent costs and license agreements. Legal expenses incurred in preparation of patent application have
been deferred and will be amortized over the useful life of granted patents. Costs incurred in preparation of applications that
are not granted will be charged to expense at that time. The Company has entered into several sublicense agreements under which
it has been assigned the exclusive rights to certain licensed materials used in its products. These sublicense agreements generally
require upfront payments to obtain the exclusive rights to such material. The Company capitalizes the upfront payments as intangible
assets and amortizes such costs over their estimated useful life on a straight-line method.
Secured
convertible debentures:
The
Company has elected to record its debentures at their fair value. Accordingly, the debentures will be marked-to-market at each
reporting date with the change in fair value reported as a gain (loss) in the Condensed Consolidated Statement of Operations.
All issuance costs related to the debentures were expensed as incurred in the 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 Condensed Consolidated
Statement of Operations. All issuance costs related to the proceeds investment agreement were expensed as incurred in the statement
of operations.
Long-Lived
Assets:
Long-lived
assets such as property, plant and equipment and purchased intangible assets subject to amortization are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances
require a long-lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows
expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or
asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying
value exceeds its fair value. Fair value is determined through various valuation techniques, including discounted cash flow models,
quoted market values and third-party appraisals, as considered necessary.
Warranties:
The
Company’s products carry explicit product warranties that extend up to two years from the date of shipment. The Company
records a provision for estimated warranty costs based upon historical warranty loss experience and periodically adjusts these
provisions to reflect actual experience. Accrued warranty costs are included in accrued expenses. Extended warranties are offered
on selected products and when a customer purchases an extended warranty the associated proceeds are treated as deferred revenue
and recognized over the term of the extended warranty.
Shipping
and Handling Costs:
Shipping
and handling costs for outbound sales orders totaled $12,378 and $11,858 for the three months ended September 30, 2018 and 2017,
respectively, and $46,662 and $51,949 for the nine months ended September 30, 2018 and 2017, respectively. Such costs are included
in selling, general and administrative expenses in the Condensed Consolidated Statements of Operations.
Advertising
Costs:
Advertising
expense includes costs related to trade shows and conventions, promotional material and supplies, and media costs. Advertising
costs are expensed in the period in which they are incurred. The Company incurred total advertising expense of approximately $104,395
and $346,935 for the three months ended September 30, 2018 and 2017, respectively, and $295,641 and $617,264 for the nine months
ended September 30, 2018 and 2017, respectively. Such costs are included in selling, general and administrative expenses in the
Condensed Consolidated Statements of Operations.
Income
Taxes:
Deferred
taxes are provided for by the liability method in which deferred tax assets are recognized for deductible temporary differences
and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences.
Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion
or all the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes
in tax laws and rates on the date of enactment.
The
Company applies the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) No. 740 - Income Taxes that provides a framework for accounting for uncertainty in income taxes and provided
a comprehensive model to recognize, measure, present, and disclose in its financial statements uncertain tax positions taken or
expected to be taken on a tax return. It initially recognizes tax positions in the financial statements when it is more likely
than not the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently
measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with
the tax authority assuming full knowledge of the position and all relevant facts. Application requires numerous estimates based
on available information. The Company considers many factors when evaluating and estimating its tax positions and tax benefits,
and it recognized tax positions and tax benefits may not accurately anticipate actual outcomes. As it obtains additional information,
the Company may need to periodically adjust its recognized tax positions and tax benefits. These periodic adjustments may have
a material impact on its 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 nine months ended September 30, 2018 and 2017. There have been no penalties in the nine months ended September 30,
2018 and 2017.
The
Company is subject to taxation in the United States and various states. As of September 30, 2018, the Company’s tax returns
filed for 2014, 2015, and 2016 and to be filed for 2017 are subject to examination by the relevant taxing authorities. With few
exceptions, as of September 30, 2018, the Company is no longer subject to Federal, state, or local examinations by tax authorities
for years before 2014.
Research
and Development Expenses:
The
Company expenses all research and development costs as incurred. Development costs of computer software to be sold, leased, or
otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established
and ending when a product is available for general release to customers. In most instances, the Company’s products are released
soon after technological feasibility has been established. Costs incurred subsequent to achievement of technological feasibility
were not significant, and software development costs were expensed as incurred during the nine months ended September 30, 2018
and 2017.
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 condensed 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 the condensed consolidated statement of operations.
The
Company has common stock purchase warrants that are accounted for as equity based on their relative fair value and are not subject
to re-measurement.
Stock-Based
Compensation:
The
Company grants stock-based compensation to its employees, board of directors and certain third-party contractors. Share-based
compensation arrangements may include the issuance of options to purchase common stock in the future or the issuance of restricted
stock, which generally are subject to vesting requirements. The Company records stock-based compensation expense for all stock-based
compensation granted based on the grant-date fair value. The Company recognizes these compensation costs on a straight-line basis
over the requisite service period of the award.
The
Company estimates the grant-date fair value of stock-based compensation using the Black-Scholes valuation model. Assumptions used
to estimate compensation expense are determined as follows:
|
●
|
Expected
term is determined using the contractual term and vesting period of the award;
|
|
●
|
Expected
volatility of award grants made in the Company’s plan is measured using the weighted average of historical daily changes
in the market price of the Company’s common stock over the period equal to the expected term of the award;
|
|
●
|
Expected
dividend rate is determined based on expected dividends to be declared;
|
|
●
|
Risk-free
interest rate is equivalent to the implied yield on zero-coupon U.S. Treasury bonds with a maturity equal to the expected
term of the awards; and
|
|
●
|
Forfeitures
are accounted for as they occur.
|
Segments
of Business:
Management
has determined that its operations are comprised of one reportable segment: the sale of digital audio and video recording and
speed detection devices. For the three and nine months ended September 30, 2018 and 2017, sales by geographic area were as follows:
|
|
Three
Months Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Sales
by geographic area:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United
States of America
|
|
$
|
2,787,618
|
|
|
$
|
2,747,053
|
|
|
$
|
8,612,552
|
|
|
$
|
11,373,569
|
|
Foreign
|
|
|
90,441
|
|
|
|
236,524
|
|
|
|
300,570
|
|
|
|
326,370
|
|
|
|
$
|
2,878,059
|
|
|
$
|
2,983,577
|
|
|
$
|
8,913,122
|
|
|
$
|
11,699,939
|
|
Sales
to customers outside of the United States are denominated in U.S. dollars. All Company assets are physically located within the
United States.
New Accounting Pronouncement:
In
February 2016, the FASB issued ASU 2016-2,
Leases (Topic 842)
, to increase transparency and comparability among organizations
by recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under existing
GAAP guidance. ASU 2016-02 requires a lessee to recognize a liability to make lease payments (the lease liability) and a right-of-use
asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 is effective for
the fiscal year beginning after December 15, 2018 (including interim periods within that year) using a modified retrospective
approach and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of this
ASU on its consolidated financial statements, but expects that the adoption of ASU 2016-02 will not have a material impact on
its consolidated balance sheet.
Adoption of Accounting Pronouncements:
In
August 2016, the FASB issued ASU 2016-15,
Clarification on Classification of Certain Cash Receipts and Cash Payments on the
Statement of Cash Flows
, to create consistency in the classification of eight specific cash flow items. This standard is effective
for calendar-year SEC registrants beginning in 2018. The adoption of this guidance had no effect on the Company’s consolidated
condensed financial statements.
In
November 2016, the FASB issued ASU 2016-18,
Statement of Cash Flows - Restricted Cash (Topic 230),
which amends the existing
guidance relating to the disclosure of restricted cash and restricted cash equivalents on the statement of cash flows. ASU 2016-18
is effective for the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, and early adoption
is permitted. The adoption of ASU 2016-18 had no effect on the Company’s Consolidated Condensed Statements of Cash Flows.
In
May 2017, the FASB issued ASU 2017-09,
Stock Compensation (Topic 718)-Scope of Modification Accounting
, to provide guidance
on determining which changes to terms and conditions of share-based payment awards require an entity to apply modification accounting
under Topic 718. The ASU is effective for annual periods beginning after December 15, 2017, and interim periods within those annual
periods. The adoption of this guidance had no effect on the Company’s consolidated condensed financial statements.
NOTE
2. BASIS OF PRESENTATION
The
condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in
the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all the information and footnotes required by generally accepted accounting principles in the United States
for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2018 are
not necessarily indicative of the results that may be expected for the year ending December 31, 2018.
The
balance sheet at December 31, 2017 has been derived from the audited financial statements at that date, but does not include all
the information and footnotes required by generally accepted accounting principles in the United States for complete financial
statements.
For
further information, refer to the financial statements and footnotes included in the Company’s annual report on Form 10-K
for the year ended December 31, 2017.
NOTE
3. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
Financial
instruments that potentially subject the Company to concentrations of credit risk consist of accounts receivable. Sales to domestic
customers are typically made on credit and the Company generally does not require collateral while sales to international customers
require payment before shipment or backing by an irrevocable letter or credit. The Company performs ongoing credit evaluations
of its customers’ financial condition and maintains an allowance for estimated losses. Accounts are written off when deemed
uncollectible and accounts receivable are presented net of an allowance for doubtful accounts. The allowance for doubtful accounts
totaled $70,000 as of September 30, 2018 and December 31, 2017.
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 for the nine months ended September 30,
2018 and 2017. One individual customer exceeded 10% of total accounts receivable as of September 30, 2018 and totaled $205,259,
or 10% of total accounts receivable. No individual customer receivable balance exceeded 10% of total accounts receivable as of
September 30, 2017.
The
Company purchases finished circuit boards and other proprietary component parts from suppliers located in the United States and
on a limited basis from Asia. Although the Company obtains certain of these components from single source suppliers, it generally
owns all tooling and management has located alternative suppliers to reduce the risk in most cases to supplier problems that could
result in significant production delays. The Company has not historically experienced significant supply disruptions from any
of its principal vendors and does not anticipate future supply disruptions. The Company acquires most of its components on a purchase
order basis and does not have long-term contracts with its suppliers.
NOTE
4. INVENTORIES
Inventories
consisted of the following at September 30, 2018 and December 31, 2017:
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
Raw
material and component parts
|
|
$
|
4,462,562
|
|
|
$
|
4,621,704
|
|
Work-in-process
|
|
|
268,989
|
|
|
|
155,087
|
|
Finished
goods
|
|
|
5,329,099
|
|
|
|
6,964,624
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
10,060,650
|
|
|
|
11,741,415
|
|
Reserve
for excess and obsolete inventory
|
|
|
(2,689,973
|
)
|
|
|
(2,990,702
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
7,370,677
|
|
|
$
|
8,750,713
|
|
Finished
goods inventory includes units held by potential customers and sales agents for test and evaluation purposes. The cost of such
units totaled $371,149 and $680,805 as of September 30, 2018 and December 31, 2017, respectively.
NOTE
5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture,
fixtures and equipment consisted of the following at September 30, 2018 and December 31, 2017:
|
|
Estimated
Useful
Life
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
Office
furniture, fixtures and equipment
|
|
3-10
years
|
|
$
|
802,681
|
|
|
$
|
881,306
|
|
Warehouse
and production equipment
|
|
3-5
years
|
|
|
523,408
|
|
|
|
515,368
|
|
Demonstration
and tradeshow equipment
|
|
2-5
years
|
|
|
426,582
|
|
|
|
426,582
|
|
Leasehold
improvements
|
|
2-5
years
|
|
|
160,198
|
|
|
|
160,198
|
|
Rental
equipment
|
|
1-3
years
|
|
|
119,999
|
|
|
|
93,592
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
cost
|
|
|
|
|
2,032,868
|
|
|
|
2,077,046
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
accumulated depreciation and amortization
|
|
|
|
|
(1,718,294
|
)
|
|
|
(1,438,877
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
furniture, fixtures and equipment
|
|
|
|
$
|
314,574
|
|
|
$
|
638,169
|
|
Depreciation
and amortization of furniture, fixtures and equipment aggregated $309,993 and $412,558 for the nine months ended September 30,
2018 and 2017, respectively.
NOTE
6. DEBT OBLIGATIONS
Secured
convertible debentures and proceeds investment agreement is comprised of the following:
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
2016
Secured convertible debentures, at fair value
|
|
$
|
—
|
|
|
$
|
3,262,807
|
|
2018
Secured convertible debentures, at fair value
|
|
|
—
|
|
|
|
—
|
|
2018
Proceeds investment agreement, at fair value
|
|
|
9,166,000
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Secured
convertible debentures and proceeds investment agreement, at fair value
|
|
$
|
9,166,000
|
|
|
$
|
3,262,807
|
|
2016
Secured Convertible Debentures
.
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 convertible 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 nine months ended September 30, 2018 related
to the repayment and extinguishment of the 2016 Debentures.
The
change in fair value of the 2016 Debentures was $(12,807) and $0 for the nine months ended September 30, 2018 and 2017,
respectively.
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 pursuant to 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
|
|
$
|
4,565,749
|
|
Common
stock purchase warrants
|
|
|
1,684,251
|
|
|
|
|
|
|
Gross
cash proceeds
|
|
$
|
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 $2,309,250 and $0 for the three and nine months ended September
30, 2018 and 2017, respectively.
The
following represents activity in the 2018 Debentures during the nine months ended September 30, 2018:
Beginning
balance as of January 1, 2018
|
|
$
|
-
|
|
Origination
date at fair value of the Debentures
|
|
|
4,565,749
|
|
Conversions
exercised during the period
|
|
|
(275,000
|
)
|
Principal
payments made on Debentures
|
|
|
(6,600,000
|
)
|
Change
in the fair value during the period
|
|
|
2,309,251
|
|
Ending
balance as of September 30, 2018
|
|
$
|
-
|
|
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 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 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.
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 and the detachable PIA Warrants as follows:
Proceeds
investment agreement
|
|
$
|
9,067,513
|
|
Common
stock purchase warrants
|
|
|
932,487
|
|
|
|
|
|
|
Gross
cash proceeds
|
|
$
|
10,000,000
|
|
The
following represents activity in the PIA during the nine months ended September 30, 2018:
Beginning
balance as of January 1, 2018
|
|
$
|
-
|
|
Origination
date at fair value of the proceeds investment agreement
|
|
|
9,067,513
|
|
|
|
|
|
|
Change
in the fair value during the period
|
|
|
98,487
|
|
Ending
balance as of September 30, 2018
|
|
$
|
9,166,000
|
|
Subordinated
and Secured Notes Payable
. Subordinated and secured notes payable is comprised of the following:
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
Subordinated
and secured notes payable, at par
|
|
$
|
—
|
|
|
$
|
1,008,500
|
|
On
June 30, 2017, the Company, in two separate transactions, borrowed an aggregate of $700,000 under two unsecured notes payable
to private, third-party lenders. The loans were funded on June 30, 2017 and both were represented by promissory notes (the “June
Notes”) that bore interest at the rate of 8% per annum with principal and accrued interest payable on or before their maturity
date of September 30, 2017. The June Notes were unsecured and subordinated to all existing and future senior indebtedness, as
such term was defined in the June Notes. The Company granted the lenders warrants (the “Warrants”) exercisable to
purchase a total of 200,000 shares of its common stock at an exercise price of $3.65 per share until June 29, 2022. The Company
allocated $288,895 of the proceeds of the Notes to additional paid-in-capital, which represented the grant date relative fair
value of the Warrants issued to the lenders. The discount was amortized to interest expense ratably over the terms of the Note.
On September 30, 2017, the Company obtained an extension of the maturity date of one of the June Notes to December 31, 2017 and
then an extension to March 31, 2018. In connection with the initial extension, the Company issued warrants exercisable to purchase
100,000 shares of stock at $2.60 per share until November 15, 2022. On March 16, 2018, the Company issued warrants exercisable
to purchase 60,000 shares of stock at $3.25 per share until March 15, 2029 for the subsequent extension. The Company treated the
initial extension of this debt as an extinguishment for financial accounting purposes. Accordingly, the estimated fair value of
the warrants granted totaled $180,148, which was recorded as additional paid-in-capital and a loss on extinguishment of subordinated
notes payable. The Company allocated $32,370 of the proceeds of the Notes to additional paid-in-capital, which represented the
grant date relative fair value of the Warrants for the subsequent extension. The discount was amortized to interest expense ratably
over the terms of the Note. The Company paid the second June Note in full in August 2017.
On
September 29, 2017, the Company borrowed $300,000 under an unsecured note payable with a private, third party lender. Such note
bore interest at 8% per annum and was due and payable in full on November 30, 2017. The note was unsecured and subordinated to
all existing and future senior indebtedness, as such term was defined in the note. The Company issued warrants to the lender exercisable
to purchase 100,000 shares of common stock for $2.75 per share until September 30, 2022. The Company allocated $117,000 of the
proceeds of the note to additional paid-in-capital, which represented the grant date relative fair value of the warrants issued
to the lender. The discount was amortized to interest expense ratably over the terms of the note. On December 29, 2017 the Company
borrowed an additional $350,000 with the same private, third party lender and combined the existing note payable plus accrued
interest into a new note (the “Secured Note”) for $658,500 that 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 $47,657 and $-0- for the nine months ended September 30, 2018, and 2017, respectively.
NOTE
7. FAIR VALUE MEASUREMENT
In
accordance with ASC Topic 820 —
Fair Value Measurements and Disclosures
(“ASC 820”), the Company utilizes
the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other
relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets
or liabilities, such as a business.
ASC
820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three
broad levels. The following is a brief description of those three levels:
●
|
Level
1 — Quoted prices in active markets for identical assets and liabilities
|
|
|
●
|
Level
2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
|
|
|
●
|
Level
3 — Significant unobservable inputs (including the Company’s own assumptions in determining the fair value)
|
The
following table represents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a
recurring basis as of September 30, 2018 and December 31, 2017.
|
|
September
30, 2018
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured
convertible debentures
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Proceeds
investment agreement
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,166,000
|
|
|
$
|
9,166,000
|
|
Warrant
derivative liability
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,166,000
|
|
|
$
|
9,166,000
|
|
|
|
December
31, 2017
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured
convertible debentures
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,262,807
|
|
|
$
|
3,262,807
|
|
Warrant
derivative liability
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
16,816
|
|
|
$
|
16,816
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,279,623
|
|
|
$
|
3,279,623
|
|
The
following table represents the change in Level 3 tier value measurements:
|
|
|
|
|
2016
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
Warrant
|
|
|
Secured
|
|
|
Secured
|
|
|
Proceeds
|
|
|
|
|
|
|
derivative
|
|
|
Convertible
|
|
|
Convertible
|
|
|
Investment
|
|
|
|
|
|
|
liability
|
|
|
Debentures
|
|
|
Debentures
|
|
|
Agreement
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2017
|
|
$
|
16,816
|
|
|
$
|
3,262,807
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,279,623
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal
payments made on debentures
|
|
|
—
|
|
|
|
(3,250,000
|
)
|
|
|
(6,600,000
|
)
|
|
|
—
|
|
|
|
(9,850,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New
secured convertible debentures
|
|
|
—
|
|
|
|
—
|
|
|
|
4,565,749
|
|
|
|
—
|
|
|
|
4,565,749
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New
proceeds investment agreement
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
9,067,513
|
|
|
|
9,067,513
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion
of secured convertible debentures
|
|
|
—
|
|
|
|
—
|
|
|
|
(275,000
|
)
|
|
|
—
|
|
|
|
(275,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock purchase warrants exercised
|
|
|
(335,921
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
(335,921
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in fair value of secured convertible debentures and proceeds investment agreement
|
|
|
—
|
|
|
|
(12,807)
|
|
|
|
2,309,251
|
|
|
|
98,487
|
|
|
|
2,394,931
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in fair value of warrant derivative
|
|
|
319,105
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
319,105
|
|
Balance,
September 30, 2018
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,166,000
|
|
|
$
|
9,166,000
|
|
NOTE
8. ACCRUED EXPENSES
Accrued
expenses consisted of the following at September 30, 2018 and December 31, 2017:
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
Accrued
warranty expense
|
|
$
|
186,766
|
|
|
$
|
325,001
|
|
Accrued
sales commissions
|
|
|
29,221
|
|
|
|
19,500
|
|
Accrued
payroll and related fringes
|
|
|
320,716
|
|
|
|
242,508
|
|
Accrued
insurance
|
|
|
119,450
|
|
|
|
53,888
|
|
Accrued
rent
|
|
|
95,301
|
|
|
|
134,684
|
|
Accrued
sales returns and allowances
|
|
|
35,038
|
|
|
|
17,936
|
|
Other
|
|
|
374,954
|
|
|
|
446,912
|
|
|
|
$
|
1,161,446
|
|
|
$
|
1,240,429
|
|
Accrued
warranty expense was comprised of the following for the nine months ended September 30, 2018:
|
|
2018
|
|
Beginning
balance
|
|
$
|
325,001
|
|
Provision
for warranty expense
|
|
|
98,643
|
|
Charges
applied to warranty reserve
|
|
|
(236,878
|
)
|
|
|
|
|
|
Ending balance
|
|
$
|
186,766
|
|
NOTE
9. INCOME TAXES
The
effective tax rate for the nine months ended September 30, 2018 and 2017 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 September 30, 2018 primarily because of the Company’s
history of operating losses.
NOTE
10. COMMITMENTS AND CONTINGENCIES
Operating
Leases.
The Company has a non-cancelable long-term operating lease agreement for office and warehouse space that expires
during April 2020. It has also entered into month-to-month leases for equipment and facilities. Rent expense was $99,431 and $99,431
for the three months ended September 30, 2018 and 2017, respectively, and $298,293 and $298,293, for the nine months September
30, 2018 and 2017, respectively. Following are the minimum lease payments for each year and in total.
Year
ending December 31:
|
|
|
|
2018
(period from October 1, 2018 to December 31, 2018)
|
|
$
|
113,572
|
|
2019
|
|
|
457,327
|
|
2020
|
|
|
154,131
|
|
|
|
|
|
|
|
|
$
|
725,030
|
|
License
agreements.
The Company had several license agreements under which it had been assigned the rights to certain licensed
materials used in its products. Certain of these agreements required 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 $6,250 for the three months ended September 30, 2018 and 2017, respectively, and $2,083 and $14,938 for the nine months
ended September 30, 2018 and 2017, respectively.
Litigation.
The Company is subject to various legal proceedings arising from normal business operations. Although there can be no
assurances, based on the information currently available, management believes that it is probable that the ultimate outcome of
each of the actions will not have a material adverse effect on the Consolidated Financial Statements of the Company. However,
an adverse 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
addition to the infringement claims, the Company brought claims alleging that Axon conspired to keep the Company out of the marketplace
by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Axon bribed officials and otherwise conspired
to secure no-bid contracts for its products in violation of both state law and federal antitrust law. The Company’s lawsuit
also seeks monetary and injunctive relief, including treble damages, for these alleged violations.
Axon
filed an answer, which denied the patent infringement allegations on April 1, 2016. In addition, Axon filed a motion to dismiss
all allegations in the complaint on March 4, 2016 for which the Company filed an amended complaint on March 18, 2016 to address
certain technical deficiencies in the pleadings. Digital amended its complaint and Axon renewed its motion to seek dismissal of
the allegations that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation
of both state law and federal antitrust law on April 1, 2016. Formal discovery commenced on April 12, 2016 with respect to the
patent related claims. In January 2017, the Court granted Axon’s motion to dismiss the portion of the lawsuit regarding
claims that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state
law and federal antitrust law. On May 2, 2018, the Federal Circuit affirmed the District Court’s ruling and on October 1,
2018 the Supreme Court denied Digital Ally’s petition for review.
In
December 2016 and January 2017, Axon filed two petitions for
Inter Partes
Review (“IPR”) against the ‘452
Patent. The United States Patent and Trademark Office (“USPTO”) rejected both of Axon’s petitions. Axon is now
statutorily precluded from filing any more IPR petitions against the ‘452 Patent.
The
District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on November
17, 2017, the Federal District Court of Kansas rejected Axon’s request to maintain the stay. With this significant ruling,
the parties will now proceed towards trial. Since litigation has resumed, the Court has issued a claim construction order (also
called a
Markman
Order) where it sided with the Company on all disputes and denied Axon’s attempts to limit the scope
of the claims. Following the
Markman
Order, the Court set all remaining deadlines in the case. Fact discovery closed on
October 8, 2018, and the Final Pretrial Conference has been set for January 16, 2019.
WatchGuard
On
May 27, 2016 the Company filed suit against WatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent infringement based on
WatchGuard’s VISTA Wifi and 4RE In-Car product lines.
The
USPTO has granted multiple patents to the Company with claims covering numerous features, such as automatically activating all
deployed cameras in response to the activation of just one camera. Additionally, Digital Ally’s patent claims cover automatic
coordination as well as digital synchronization between multiple recording devices. It also has patent coverage directed to the
coordination between a multi-camera system and an officer’s smartphone, which allows an officer to more readily assess an
event on the scene while an event is taking place or immediately after it has occurred.
The
Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car product
lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the U.S Patent No.
8,781,292 (the “ ‘292 Patent”) and ‘452 Patents and U.S. Patent No. 9,325,950 the (“ ‘950
Patent”). The Company is aggressively challenging WatchGuard’s infringing conduct, seeking both monetary damages,
as well as seeking a permanent injunction preventing WatchGuard from continuing to sell its VISTA Wifi and 4RE In-Car product
lines using Digital Ally’s own technology to compete against it. On May 8, 2017, WatchGuard filed a petition seeking IPR
of the ‘950 Patent. The Company opposed that petition and on December 4, 2017, The Patent Trial and Appeal Board (“PTAB”)
rejected the request of WatchGuard Video to institute an IPR on the ‘950 Patent. The lawsuit also involves the ‘292
Patent and the ‘452 Patent, the ‘452 Patent being the same patent asserted against Axon. The ‘292 Patent previously
was subject to the IPR process with the USPTO, but in June 2018 the PTO found the ‘292 Patent valid and rejected Axon’s
arguments. WatchGuard had previously agreed to be bound by Axon’s IPRs and, as such, WatchGuard is now statutorily barred
from any further IPR’s challenges with respect to the ‘950, ‘452, and ‘292 Patents. Since the defeat of
Axon’s ‘292 Patent IPR, the Court has lifted the stay and set a schedule moving the case towards trial. Discovery
will close on December 17, 2018, and the Final Pretrial Conference will take place on April 9, 2019.
Utility
Associates, Inc.
On
October 25, 2013, the Company filed a complaint in the United States District Court for the District of Kansas (2:13-cv-02550-SAC)
to eliminate threats by a competitor, Utility Associates, Inc. (“Utility”), of alleged patent infringement regarding
U.S. Patent No. 6,831,556 (the “ ‘556 Patent”). Specifically, the lawsuit seeks a declaration that the Company’s
mobile video surveillance systems do not infringe any claim of the ‘556 Patent. The Company became aware that Utility had
mailed letters to current and prospective purchasers of its mobile video surveillance systems threatening that the use of such
systems purchased from third parties not licensed to the ‘556 Patent would create liability for them for patent infringement.
In
addition, the Company began proceedings to invalidate the ‘556 Patent through a request for IPR of the ‘556 patent
at the USPTO. On July 27, 2015, the USPTO invalidated key claims in Utility’s ‘556 Patent. The Final Decision from
the USPTO significantly curtailed Utility’s ability to threaten law enforcement agencies, municipalities, and others with
infringement of the ‘556 Patent. Utility appealed this decision to the United States Court of Appeals for the Federal Circuit.
The United States Court of Appeals for the Federal affirmed the ruling of the USPTO summarily thus concluding the matter.
On
June 6, 2014 the Company filed a separate Unfair Competition lawsuit against Utility in the United States District Court for the
District of Kansas. In that lawsuit it contended that Utility has disparaged the Company and illegally interfered with its contracts,
customer relationships and business expectancies by falsely asserting to its customers and others that its products violate the
‘556 Patent, of which Utility claims to be the holder. In addition to damages, the Company sought permanent injunctive relief,
prohibiting Utility from continuing to threated or otherwise interfere with the Company’s customers. On March 4, 2015, an
initial hearing was held upon the Company’s request for injunctive relief.
Based
upon facts revealed at a March 4, 2015 injunction hearing, on March 16, 2015, the Company sought leave to amend its Complaint
in the unfair competition suit to assert additional claims against Utility. Those new claims included claims of actual or attempted
monopolization, in violation of § 2 of the Sherman Act, claims arising under a new Georgia statute that prohibits threats
of patent infringement in “bad faith,” and additional claims of unfair competition/false advertising in violation
of § 63(a) of the Lanham Act. The Court concluded its injunction hearing on April 22, 2015, and allowed the Company leave
to add these claims, but denied its preliminary injunction. Subsequent to the injunction hearing, Utility withdrew from the market
the in-car video recording device that it had sold in competition with the Company’s own products of similar function and
which Utility had attempted to market using threats of patent infringement. After discovery closed, Utility filed a Motion for
Summary Judgment and the Company filed a Motion for Partial Summary Judgment. On March 30, 2017, the Court entered its order granting
Utility’s motion and denying the Company’s motion for summary judgment. The Company believed the District Court had
made several errors when ruling on the motions for summary judgment, and filed an appeal to the United States Court of Appeals
for the Tenth Circuit (10
th
Circuit”). While the appeal was pending, Utility filed a motion for the recovery
from the Company of some $800,000 in alleged attorney’s fees as provided, purportedly, under the Lanham Patent and Uniform
Trade Secrets Act. That motion was denied in its entirety by final judgement of the District Court entered February 14, 2018.
On February 16, 2018, the 10
th
Circuit issued its decision affirming the decision of the District Court. The Company
filed a petition for rehearing by the panel and en banc, which was denied. Thereafter, Utility its own motion for the recovery
of attorney fees, on appeal in the alleged amount of $125,000. That motion was denied by the 10th Circuit. In the District Court,
Utility failed or declined to file any request for the recovery of costs and the time for the award thereof, as well as for any
further appeal by either party, has now expired.
The
Company is also involved as a plaintiff and defendant in ordinary, routine litigation and administrative proceedings incidental
to its business from time to time, including customer collections, vendor and employment-related matters. The Company believes
the likely outcome of any other pending cases and proceedings will not be material to its business or its financial condition.
VieVu
acquisition by Axon.
On May 4, 2018, Axon announced that it had acquired 100% ownership of VieVu, LLC in a deal that includes
cash, stock and a stock earn-out. On July 27, 2018, the Company and VieVu, LLC mutually agreed to and executed a termination of
the supply and distribution agreement which provided for the return of all confidential information and the survival of certain
provisions regarding non-disclosure of proprietary information. Effective July 27, 2018 VieVu, LLC discontinued all sales and
marketing efforts involving the Company’s patented VuLink product.
Sponsorship.
On April 16, 2015 the Company entered into a Title Sponsorship Agreement (the “Agreement”) under which it
became the title sponsor for a Web.com Tour golf tournament (the “Tournament”) held annually in the Kansas City Metropolitan
area. The Agreement provides the Company with naming rights and other benefits for the 2015 through 2019 annual Tournament in
exchange for the following sponsorship fee:
Year
|
|
Sponsorship
fee
|
|
2015
|
|
$
|
375,000
|
|
2016
|
|
$
|
475,000
|
|
2017
|
|
$
|
475,000
|
|
2018
|
|
$
|
500,000
|
|
2019
|
|
$
|
500,000
|
|
The
Company has the right to sell and retain the proceeds from the sale of additional sponsorships, including but not limited to a
presenting sponsorship, a concert sponsorship and founding partnerships for the Tournament. The Company recorded a net sponsorship
expense of $0 and $263,047 for the nine months ended September 30, 2018 and 2017. The Company is negotiating with the Web.com
Tour golf tournament officials to terminate the Agreement and the sponsorship fee commitments for the 2018 and 2019 Tournaments.
There can be no assurance that it will be successful in negotiating the termination of this sponsorship agreement or that if successful
in such negotiations, on terms acceptable or favorable to the Company.
401
(k) Plan.
In July 2008, the Company amended and restated its 401(k) retirement savings plan. The amended plan requires
the Company to provide 100% matching contributions for employees who elect to contribute up to 3% of their compensation to the
plan and 50% matching contributions for employee’s elective deferrals on the next 2% of their contributions. The Company
has made matching contributions totaling $26,680 and $43,455 for the three months ended September 30, 2018 and 2017, respectively,
and $85,028 and $137,781 for the nine months ended September 30, 2018 and 2017, 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 paid amounts to the LLC as advances against commissions ranging from $5,000 to $6,000 per month plus necessary and
reasonable expenses for the period through June 30, 2017, which can be automatically extended based on the LLC achieving minimum
sales quotas. The agreement was renewed in January 2017 for a period of three years, subject to yearly minimum sales thresholds
that would allow the Company to terminate the contract if such minimums are not met. As of September 30, 2018, the Company had
advanced a total of $280,807 pursuant to this agreement and established an allowance reserve of $85,835 for a net advance of $194,212.
The minimum sales threshold has not been met, and the Company has discontinued all advances, although the contract has not been
formally 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.
As of September 30, 2018, the Company had advanced a total of $37,360 pursuant to this agreement.
NOTE
11. STOCK-BASED COMPENSATION
The
Company recorded pretax compensation expense related to the grant of stock options and restricted stock issued of $669,480 and
$478,863 for the three months ended September 30, 2018 and 2017 and $1,757,227 and $981,652 for the nine months ended September
30, 2018 and 2017, respectively.
As
of September 30, 2018, the Company had adopted seven separate stock option and restricted stock plans: (i) the 2005 Stock Option
and Restricted Stock Plan (the “2005 Plan”), (ii) the 2006 Stock Option and Restricted Stock Plan (the “2006
Plan”), (iii) the 2007 Stock Option and Restricted Stock Plan (the “2007 Plan”), (iv) the 2008 Stock Option
and Restricted Stock Plan (the “2008 Plan”), (v) the 2011 Stock Option and Restricted Stock Plan (the “2011
Plan”), (vi) the 2013 Stock Option and Restricted Stock Plan (the “2013 Plan”), (vii) the 2015 Stock Option
and Restricted Stock Plan (the “2015 Plan”) and (vii) the 2018 Stock Option and Restricted Stock Plan (the “2018
Plan”). The 2005 Plan, 2006 Plan, 2007 Plan, 2008 Plan, 2011 Plan, 2013 Plan, 2015 Plan and 2018 Plan are referred to as
the “Plans.”
These
Plans permit the grant of stock options or restricted stock to its employees, non-employee directors and others for up to a total
of 3,425,000 shares of common stock. The 2005 Plan terminated during 2015 with 4,616 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2005 Plan that remain unexercised and outstanding
as of September 30, 2018 total 23,125. The 2006 Plan terminated during 2016 with 21,087 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 September 30, 2018 total 46,387. The 2007 Plan terminated during 2017 with 82,151 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2007 Plan that remain unexercised and outstanding
as of September 30, 2018 total 12,500. The 2008 Plan terminated during 2018 with 5,624 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 September 30, 2018 total 32,875.
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 577,926 shares remained available for awards under the various
Plans as of September 30, 2018.
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 nine months ended September 30, 2018 was $284,384.
Activity
in the various Plans during the nine months ended September 30, 2018 is reflected in the following table:
Options
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
Outstanding
at January 1, 2018
|
|
|
350,269
|
|
|
$
|
13.44
|
|
Granted
|
|
|
160,000
|
|
|
|
2.20
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
(75,632
|
)
|
|
|
(45.69
|
)
|
Outstanding
at September 30, 2018
|
|
|
434,637
|
|
|
$
|
4.65
|
|
Exercisable
at September 30, 2018
|
|
|
274,637
|
|
|
$
|
6.07
|
|
The
fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. There were 160,000
stock options issued during the nine months ended September 30, 2018.
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 nine months ended September 30, 2018.
At
September 30, 2018, the aggregate intrinsic value of options outstanding was approximately $104,000 and the aggregate intrinsic
value of options exercisable was approximately $-0-. No options were exercised in the nine months ended September 30, 2018.
As
of September 30, 2018, the unrecognized portion of stock compensation expense on all existing stock options was $213,288.
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 September 30, 2018:
|
|
|
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
|
|
|
|
293,500
|
|
|
8.9
years
|
|
|
133,500
|
|
|
|
8.0
years
|
|
$
|
3.50
to $4.99
|
|
|
|
67,625
|
|
|
5.5
years
|
|
|
67,625
|
|
|
|
5.5
years
|
|
$
|
5.00
to $6.49
|
|
|
|
—
|
|
|
—years
|
|
|
—
|
|
|
|
—years
|
|
$
|
6.50
to $7.99
|
|
|
|
9,312
|
|
|
3.1
years
|
|
|
9,312
|
|
|
|
3.1
years
|
|
$
|
8.00
to $9.99
|
|
|
|
2,500
|
|
|
2.7
years
|
|
|
2,500
|
|
|
|
2.7
years
|
|
$
|
10.00
to $19.99
|
|
|
|
55,450
|
|
|
1.8
years
|
|
|
55,450
|
|
|
|
1.8
years
|
|
$
|
20.00
to $24.99
|
|
|
|
5,625
|
|
|
0.9
years
|
|
|
5,625
|
|
|
|
0.9
years
|
|
$
|
25.00
to $27.50
|
|
|
|
625
|
|
|
0.1
years
|
|
|
625
|
|
|
|
0.1
years
|
|
|
|
|
|
|
434,637
|
|
|
7.2
years
|
|
|
274,637
|
|
|
|
5.7
years
|
|
Restricted
stock grants.
The Board of Directors has granted restricted stock awards under the Plans. Restricted stock awards are
valued on the date of grant and have no purchase price for the recipient. Restricted stock awards typically vest over nine months
to four years corresponding to anniversaries of the grant date. Under the Plans, unvested shares of restricted stock awards may
be forfeited upon the termination of service to or employment with the Company, depending upon the circumstances of termination.
Except for restrictions placed on the transferability of restricted stock, holders of unvested restricted stock have full stockholder’s
rights, including voting rights and the right to receive cash dividends.
A
summary of all restricted stock activity under the equity compensation plans for the nine months ended September 30, 2018 is as
follows:
|
|
Number
of
Restricted
shares
|
|
|
Weighted
average
grant date
fair
value
|
|
Nonvested
balance, January 1, 2018
|
|
|
791,725
|
|
|
$
|
4.37
|
|
Granted
|
|
|
484,500
|
|
|
|
2.27
|
|
Vested
|
|
|
(408,250
|
)
|
|
|
(3.59
|
)
|
Forfeited
|
|
|
(33,900
|
)
|
|
|
(4.04
|
)
|
Nonvested
balance, September 30, 2018
|
|
|
834,075
|
|
|
$
|
3.56
|
|
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 September 30, 2018, there were $1,038,275 of total unrecognized compensation costs related to all remaining non-vested restricted
stock grants, which will be amortized over the next 27 months in accordance with the respective vesting scale.
The
nonvested balance of restricted stock vests as follows:
Year
ended December 31,
|
|
Number
of
shares
|
|
|
|
|
|
2018
(October 1, 2018 to December 31, 2018)
|
|
|
61,925
|
|
2019
|
|
|
757,025
|
|
2020
|
|
|
15,125
|
|
NOTE
12. COMMON STOCK PURCHASE WARRANTS
The
Company has issued common stock purchase warrants in conjunction with various debt and equity issuances. The warrants are either
immediately exercisable, or have a delayed initial exercise date, no more than nine months from issue date, and allow the holders
to purchase up to 4,699,645 shares of common stock at $2.60 to $16.50 per share as of September 30, 2018. The warrants expire
from December 3, 2018 through July 31, 2023 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 provisions have now been exercised.
|
|
Warrants
|
|
|
Weighted
average
exercise price
|
|
Vested
Balance, January 1, 2018
|
|
|
3,233,466
|
|
|
$
|
6.57
|
|
Granted
|
|
|
1,478,379
|
|
|
|
2.90
|
|
Warrant
reset
|
|
|
159,538
|
|
|
|
0.52
|
|
Exercised
|
|
|
(171,738)
|
|
|
|
(0.52)
|
|
Cancelled
|
|
|
—
|
|
|
|
—
|
|
Vested
Balance, September 30, 2018
|
|
|
4,699,645
|
|
|
$
|
5.54
|
|
The
total intrinsic value of all outstanding warrants aggregated $151,428 as of September 30, 2018 and the weighted average remaining
term is 36 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 September 30, 2018:
|
|
|
Outstanding
and exercisable warrants
|
Exercise
price
|
|
|
Number
of options
|
|
|
Weighted
average
remaining
contractual life
|
$
|
2.60
|
|
|
|
565,712
|
|
|
4.5
years
|
$
|
2.75
|
|
|
|
100,000
|
|
|
4.0
years
|
$
|
3.00
|
|
|
|
916,667
|
|
|
4.5
years
|
$
|
3.25
|
|
|
|
180,000
|
|
|
2.9
years
|
$
|
3.36
|
|
|
|
880,000
|
|
|
3.8
years
|
$
|
3.50
|
|
|
|
36,000
|
|
|
0.4
years
|
$
|
3.65
|
|
|
|
200,000
|
|
|
3.7
years
|
$
|
3.75
|
|
|
|
94,000
|
|
|
3.9
years
|
$
|
5.00
|
|
|
|
800,000
|
|
|
3.2
years
|
$
|
8.50
|
|
|
|
42,500
|
|
|
0.2
years
|
$
|
13.43
|
|
|
|
879,766
|
|
|
2.3
years
|
$
|
16.50
|
|
|
|
5,000
|
|
|
1.8
years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,699,645
|
|
|
3.0
years
|
NOTE
13. 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. is 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.
Nasdaq
Listing
- On April 17, 2018 the Company received a letter from The Nasdaq Stock Market (“Nasdaq”) indicating
that it was not compliant with the minimum stockholders’ equity requirement under Nasdaq Listing Rule 5550(b)(1) for continued
listing on The Nasdaq Capital Market because its stockholders’ equity, as reported in its Annual Report on Form 10-K for
the year ended December 31, 2017, was below the required minimum of $2.5 million. Further, as of April 17, 2018, the Company did
not meet the alternative compliance standards relating to the market value of listed securities or net income from continuing
operations. This notice of noncompliance had no immediate impact on the continued listing or trading of the Company’s common
stock on The Nasdaq Capital Market.
Under
Nasdaq Listing Rule 5810(c)(2), the Company had until June 1, 2018 to submit a plan to regain compliance. The Company submitted
its compliance plan and on June 27, 2018 Nasdaq granted it an extension until September 30, 2018 to provide evidence of compliance
with Rule 5550(b)(1).
On
September 28, 2018, the Company announced that it had completed a firm commitment underwritten public offering (the “Offering”)
for 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 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. The
net proceeds from the Offering were approximately
$7.32 million
including the partial exercise of the over-allotment option of 200,000 shares, after deducting underwriting
discounts and commissions and estimated expenses payable.
The
Company expects additional gross proceeds of $488,000 if the balance of the over-allotment option of 160,000 shares is exercised
in full by the underwriters. The Company
intends
to use the net proceeds for working capital and general corporate purposes.
The
Company has reported total stockholders’ equity of $3,337,125 as of September 30, 2018 and therefore the Company
believes it is now in compliance with the continued listing standard under Rule 5550(b) having stockholders’ equity of not
less than $2.5 million.
Increase
in shares authorized
– On July 5, 2018, at the Company’s annual meeting, the Company’s stockholders
approved an increase in the number of authorized shares of capital stock from 25,000,000 to 50,000,000, all of which are classified
as common shares.
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
14. NET LOSS PER SHARE
The
calculations of the weighted average number of shares outstanding and loss per share outstanding for the three and nine months
ended September 30, 2018 and 2017 are as follows:
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Numerator
for basic and diluted income per share – Net loss
|
|
$
|
(4,665,580
|
)
|
|
$
|
(3,493,306
|
)
|
|
$
|
(10,216,702
|
)
|
|
$
|
(7,852,784
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for basic loss per share – weighted average shares outstanding
|
|
|
7,725,877
|
|
|
|
6,249,116
|
|
|
|
7,295,098
|
|
|
|
5,851,428
|
|
Dilutive
effect of shares issuable under stock options and warrants outstanding
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for diluted loss per share – adjusted weighted average shares outstanding
|
|
|
7,725,877
|
|
|
|
6,249,116
|
|
|
|
7,295,098
|
|
|
|
5,851,428
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
(loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.60
|
)
|
|
$
|
(0.56
|
)
|
|
$
|
(1.40
|
)
|
|
$
|
(1.34
|
)
|
Diluted
|
|
$
|
(0.60
|
)
|
|
$
|
(0.56
|
)
|
|
$
|
(1.40
|
)
|
|
$
|
(1.34
|
)
|
Basic
loss per share is based upon the weighted average number of common shares outstanding during the period. For the three and nine
months ended September 30, 2018 and 2017, all outstanding stock options to purchase common stock were antidilutive, and, therefore,
not included in the computation of diluted net loss per share.
*************************************
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
This
Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. The words “believe,” “expect,” “anticipate,” “intend,”
“estimate,” “may,” “should,” “could,” “will,” “plan,”
“future,” “continue,” and other expressions that are predictions of or indicate future events and trends
and that do not relate to historical matters identify forward-looking statements. These forward-looking statements are based largely
on our expectations or forecasts of future events, can be affected by inaccurate assumptions, and are subject to various business
risks and known and unknown uncertainties, a number of which are beyond our control. Therefore, actual results could differ materially
from the forward-looking statements contained in this document, and readers are cautioned not to place undue reliance on such
forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as
a result of new information, future events or otherwise. A wide variety of factors could cause or contribute to such differences
and could adversely impact revenues, profitability, cash flows and capital needs. There can be no assurance that the forward-looking
statements contained in this document will, in fact, transpire or prove to be accurate.
Factors
that could cause or contribute to our actual results differing materially from those discussed herein or for our stock price to
be adversely affected include, but are not limited to: (1) our losses in recent years, including the three months and nine months
ended September 30, 2018 and fiscal 2017; (2) macro-economic risks from the effects of the decrease in budgets for the law-enforcement
community; (3) our ability to increase revenues, increase our margins and return to consistent profitability in the current economic
and competitive environment, including whether deliveries will resume under the AMR contract; (4) our operation in developing
markets and uncertainty as to market acceptance of our technology and new products; (5) the availability of funding from federal,
state and local governments to facilitate the budgets of law enforcement agencies, including the timing, amount and restrictions
on such funding; (6) our ability to deliver our new product offerings as scheduled in 2019, 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 to their historical
levels; (9) our ability to produce our products in a cost-effective manner; (10) competition from larger, more established companies
with far greater economic and human resources; (11) our ability to attract and retain quality employees; (12) risks related to
dealing with governmental entities as customers; (13) our expenditure of significant resources in anticipation of sales due to
our lengthy sales cycle and the potential to receive no revenue in return; (14) characterization of our market by new products
and rapid technological change; (15) our dependence on sales of our DVM-800, DVM-800 HD, First VU HD and DVM-250 products; (16)
potential that stockholders may lose all or part of their investment if we are unable to compete in our markets and return to
profitability; (17) defects in our products that could impair our ability to sell our products or could result in litigation and
other significant costs; (18) our dependence on key personnel; (19) our reliance on third-party distributors and sales representatives
for part of our marketing capability; (20) our dependence on a few manufacturers and suppliers for components of our products
and our dependence on domestic and foreign manufacturers for certain of our products; (21) our ability to protect technology through
patents and to protect our proprietary technology and information as trade secrets and through other similar means; (22) our ability
to generate more recurring cloud and service revenues; (23) risks related to our license arrangements; (24) our revenues and operating
results may fluctuate unexpectedly from quarter to quarter; (25) sufficient voting power by coalitions of a few of our larger
stockholders, including directors and officers, to make corporate governance decisions that could have significant effect on us
and the other stockholders; (26) sale of substantial amounts of our common stock that may have a depressive effect on the market
price of the outstanding shares of our common stock; (27) possible issuance of common stock subject to options and warrants that
may dilute the interest of stockholders; (28) our nonpayment of dividends and lack of plans to pay dividends in the future; (29)
future sale of a substantial number of shares of our common stock that could depress the trading price of our common stock, lower
our value and make it more difficult for us to raise capital; (30) our additional securities available for issuance, which, if
issued, could adversely affect the rights of the holders of our common stock; (31) our stock price is likely to be highly volatile
due to a number of factors, including a relatively limited public float; (32) whether the litigation against Axon and WatchGuard
will achieve their intended objectives and result in monetary recoveries for the Company; (33) whether the USPTO rulings will
curtail, eliminate or otherwise have an effect on the actions of Axon and WatchGuard respecting us, our products and customers;
(34) whether the remaining two claims under the ‘556 Patent have applicability to us or our products; and (35) whether our
patented VuLink technology is becoming the
de-facto
“standard” for agencies engaged in deploying state-of-the-art
body-worn and in-car camera systems and will increase our revenues; (36) whether such technology will have a significant impact
on our revenues in the long-term; and (37) indemnification of our officers and directors.
Current
Trends and Recent Developments for the Company
Overview
We
supply technology-based products utilizing our portable digital video and audio recording capabilities, for the law enforcement
and security industries and for the commercial fleet and mass transit markets. We have the ability to integrate electronic, radio,
computer, mechanical, and multi-media technologies to create unique solutions to our customers’ requests. We began shipping
our flagship digital video mirror product in March 2006. We have developed additional products to complement our original in-car
digital video products, including the DVM-800 and DVM-800 HD, both in-car digital video mirror products, and body-worn camera,
including the FirstVU and the FirstVU HD products designed for law enforcement usage. In recent years we launched the patented
and revolutionary VuLink product which integrates our body-worn cameras with our in-car systems by providing hands-free automatic
activation; and a commercial line of digital video mirrors (the DVM-250 and DVM-250 Plus) that serve as “event recorders”
for the commercial fleet and mass transit markets in order to expand our customer base beyond the traditional law enforcement
agencies. We have additional research and development projects that we anticipate will result in several new product launches
in 2019 and beyond involving in-car and body-worn systems for both the law enforcement and commercial markets, as well as expanding
our cloud-based evidence management systems. We believe that the launch of these new products will help to reinvigorate our in-car
and body-worn systems revenues while diversifying and broadening the market for our product offerings.
We
experienced operating losses for all quarters during 2018 and 2017. The following is a summary of our recent operating results
on a quarterly basis:
|
|
September
30,
|
|
|
June
30,
|
|
|
March
31,
|
|
|
December
31,
|
|
|
September
30,
|
|
|
June
30,
|
|
|
March
31,
|
|
|
|
2018
|
|
|
2018
|
|
|
2018
|
|
|
2017
|
|
|
2017
|
|
|
2017
|
|
|
2017
|
|
Total
revenue
|
|
$
|
2,878,059
|
|
|
$
|
3,563,550
|
|
|
$
|
2,471,513
|
|
|
$
|
2,877,661
|
|
|
$
|
2,983,577
|
|
|
$
|
3,486,502
|
|
|
$
|
5,229,860
|
|
Gross
profit
|
|
|
1,177,289
|
|
|
|
1,618,467
|
|
|
|
1,109,394
|
|
|
|
86,295
|
|
|
|
1,008,613
|
|
|
|
1,173,216
|
|
|
|
2,276,849
|
|
Gross
profit margin percentage
|
|
|
40.9
|
%
|
|
|
45.4
|
%
|
|
|
44.9
|
%
|
|
|
3.0
|
%
|
|
|
33.8
|
%
|
|
|
33.7
|
%
|
|
|
43.5
|
%
|
Total
selling, general and administrative expenses
|
|
|
3,087,005
|
|
|
|
3,055,776
|
|
|
|
3,082,710
|
|
|
|
3,874,255
|
|
|
|
4,125,308
|
|
|
|
3,665,813
|
|
|
|
4,079,062
|
|
Operating
loss
|
|
|
(1,909,716
|
)
|
|
|
(1,437,309
|
)
|
|
|
(1,973,316
|
)
|
|
|
(3,787,960
|
)
|
|
|
(3,116,695
|
)
|
|
|
(2,492,597
|
)
|
|
|
(1,802,213
|
)
|
Operating
loss percentage
|
|
|
(66.4
|
)%
|
|
|
(40.3
|
)%
|
|
|
(79.8
|
)%
|
|
|
(131.6
|
)%
|
|
|
(104.5
|
)%
|
|
|
(71.5
|
)%
|
|
|
(34.5
|
)%
|
Net
loss
|
|
$
|
(4,665,580
|
)
|
|
$
|
(2,962,890
|
)
|
|
$
|
(2,588,232
|
)
|
|
$
|
(4,399,673
|
)
|
|
$
|
(3,493,306
|
)
|
|
$
|
(2,326,523
|
)
|
|
$
|
(2,032,955
|
)
|
Our
business is subject to substantial fluctuations on a quarterly basis as reflected in the significant variations in revenues and
operating results in the above table. These variations result from various factors, including but not limited to: 1) the timing
of large individual orders; 2) the traction gained by our newer products, such as the FirstVU HD, VuLink and FleetVU; 3) production,
quality and other supply chain issues affecting our cost of goods sold; 4) unusual increases in operating expenses, such as our
sponsorship of the Digital Ally Open golf tournament, the timing of trade shows and bonus compensation; and 5) litigation and
related expenses respecting outstanding lawsuits. We reported an operating loss of $1,909,716 on revenues of $2,878,059 for third
quarter 2018, which continued a series of quarterly losses resulting from competitive pressures, supply chain problems, increases
in inventory reserves as our current product suite ages, product quality control issues, product warranty issues, infringement
of our patents by direct competitors such as Axon and WatchGuard that reduced our revenues, litigation expenses relating to the
patent infringement and the reduction of our gross margins.
A
number of factors and trends affected our recent performance, which include:
|
●
|
Revenues
decreased in third quarter 2018 to $2,878,059 compared to the previous quarters. The primary reason for the revenue decreases
in the third quarter 2018 is that we continued to rectify supply chain issues that had prevented us from shipping our revenue
backlog during the June 30, 2018 quarter and we continued to carry approximately $265,000 in backlog as of September 30, 2018
which caused our third quarter 2018 revenues to be less than expected. Further, our in-car and body-worn systems continued
to face increased competition as our competitors have released new products with advanced features and have maintained their
product price cuts. We expect to introduce a new product platform specifically for in-car systems to be in production by second
quarter 2019 to address our competitors’ new product features. This new product platform will utilize advanced chipsets
that will generate new and highly advanced products for our law enforcement and commercial customers. Our law enforcement
revenues also declined over the prior period due to price-cutting, willful infringement of our patents and other actions by
our competitors and adverse marketplace effects related to the patent litigation. For example, one of our competitors introduced
a body-camera including cloud storage free for one year that disrupted the market during 2017 and 2018 and has continued to
pressure our revenues.
|
|
●
|
Recognizing
a critical limitation in law enforcement camera technology, during 2014 we pioneered the development of our VuLink ecosystem
that provided intuitive auto-activation functionality as well as coordination between multiple recording devices. The USPTO
has recognized these pioneering efforts by granting us multiple patents with claims covering numerous features, such as automatically
activating an officer’s cameras when the light bar is activated or when a data-recording device such as a smart weapon
is activated. Additionally, our patent claims cover automatic coordination between multiple recording devices. Prior to this
innovation, officers were forced to manually activate each device while responding to emergency scenarios - a requirement
that both decreased the usefulness of the existing camera systems and diverted officers’ attention during critical moments.
We believe law enforcement agencies have recognized the value of our VuLink technology and that a trend 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, WatchGuard and others has substantially
and negatively impacted revenues that otherwise would have been generated by our VuLink system and indirectly our body-worn
and in-car systems. We believe that the results of the current patent litigation will largely set the competitive landscape
for body-worn and in-car systems for the foreseeable future. We are seeking other ways to monetize our VuLink patents, which
may include entering into license agreements or supply and distribution agreements with competitors. We expect that this technology
will have a significant positive impact on our revenues in the long-term, particularly if we are successful in our prosecution
of the patent infringement litigation pending with Axon and WatchGuard, and we can successfully monetize the underlying patents,
although we can make no assurances in this regard.
|
|
|
|
|
●
|
We
recently announced a multi-year official partnership with NASCAR, naming us “A Preferred Technology Provider of NASCAR.”
As part of the new 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 race track, as well as enhancing its officiating
process through technology. We believe this new partnership with NASCAR will demonstrate the flexibility of our product offerings
and help expand the appeal of our products and service capabilities to new commercial markets.
|
|
|
|
|
●
|
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 $174,000 in Q-3 2018, an increase of $56,000 (47%)
over the comparable quarter in 2017. Additionally, revenues from extended warranties have also been increasing and were approximately
$279,000 for the three months ended September 30, 2018, compared to $237,000 for the prior year period for an increase of
$42,000 (18%). We are pursuing several new market channels that do not involve our traditional law enforcement and private
security customers, such as our NASCAR affiliation, 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. We are testing a new revenue model that involves the long-term lease of our body-worn and/or
in-car hardware, together with a monthly subscription for our cloud storage, search and archiving services for the underlying
audio and video material. The goal of this new service revenue model is to positively impact our revenues and improve the
stability of our quarter-to-quarter revenues and operating results, although we can make no assurances in this regard. We
believe this service revenue model may appeal to our customers, in particular our commercial and other non-law enforcement
customers, because it reduces the initial capital outlay and eliminates repairs and maintenance in exchange for making level
monthly payments for the utilization of the equipment, data storage and management services.
|
|
●
|
Our
international revenues decreased to $300,570 (3% of total revenues) during the nine months ended September 30, 2018, compared
to $326,370 (3% of total revenues) during the nine months ended September 30, 2017. We are marketing our newer products, including
the FleetVu driver monitoring and management service, the VuLink and the FirstVU HD internationally.
|
|
|
|
|
●
|
The
Company has undertaken a program in recent quarters to substantially reduce selling, general and administrative (“SG&A”)
expenses through headcount reductions and other SG&A cost reduction measures. Our operating results reflect significant
reductions in overall SG&A expenses compared to previous quarters. Management expects this trend to continue throughout
2018.
|
Off-Balance
Sheet Arrangements
We
do not have any off-balance sheet debt nor did we have any transactions, arrangements, obligations (including contingent obligations)
or other relationships with any unconsolidated entities or other persons that may have material current or future effect on financial
conditions, changes in the financial conditions, results of operations, liquidity, capital expenditures, capital resources, or
significant components of revenue or expenses.
We
are a party to operating leases, title sponsorship, and license agreements that represent commitments for future payments (described
in Note 10 to our condensed 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 Three Months Ended September 30, 2018 and 2017
Results
of Operations
Summarized
immediately below and discussed in more detail in the subsequent sub-sections is an analysis of our operating results for the
three months ended September 30, 2018 and 2017, represented as a percentage of total revenues for each respective year:
|
|
Three
Months Ended
September
30,
|
|
|
|
2018
|
|
|
2017
|
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost
of revenue
|
|
|
59
|
%
|
|
|
66
|
%
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
41
|
%
|
|
|
34
|
%
|
Selling,
general and administrative expenses:
|
|
|
|
|
|
|
|
|
Research
and development expense
|
|
|
11
|
%
|
|
|
28
|
%
|
Selling,
advertising and promotional expense
|
|
|
25
|
%
|
|
|
35
|
%
|
Stock-based
compensation expense
|
|
|
23
|
%
|
|
|
16
|
%
|
General
and administrative expense
|
|
|
48
|
%
|
|
|
59
|
%
|
|
|
|
|
|
|
|
|
|
Total
selling, general and administrative expenses
|
|
|
107
|
%
|
|
|
138
|
%
|
|
|
|
|
|
|
|
|
|
Operating
loss
|
|
|
(66
|
)%
|
|
|
(104
|
)%
|
Change
in fair value of secured convertible debentures
|
|
|
(51
|
)%
|
|
|
(1
|
)%
|
Change
in fair value of proceeds investment agreement
|
|
|
(3
|
)%
|
|
|
—
|
|
Loss
on the extinguishment of secured convertible debentures
|
|
|
(4
|
)%
|
|
|
—
|
%
|
Other
income and interest expense, net
|
|
|
(38
|
)%
|
|
|
(12
|
)%
|
|
|
|
|
|
|
|
|
|
Loss
before income tax benefit
|
|
|
(162
|
)%
|
|
|
(117
|
)%
|
Income
tax (provision)
|
|
|
—
|
%
|
|
|
—
|
%
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
(162
|
)%
|
|
|
(117
|
)%
|
|
|
|
|
|
|
|
|
|
Net loss per
share information:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.60
|
)
|
|
$
|
(0.56
|
)
|
Diluted
|
|
$
|
(0.60
|
)
|
|
$
|
(0.56
|
)
|
Revenues
Our
current product offerings include the following:
Product
|
|
Description
|
|
Retail
Price
|
|
DVM-750
|
|
An
in-car digital audio/video system that is integrated into a rear view mirror primarily designed for law enforcement customers.
We offer local storage as well as cloud storage solutions to manage the recorded evidence. We charge a monthly storage fee
for our cloud storage option and a one-time fee for the local storage option. This product is being discontinued and phased
out of our product line.
|
|
$
|
2,995
|
|
DVM-100
|
|
An
in-car digital audio/video system that is integrated into a rear view mirror primarily designed for law enforcement customers.
This system uses an integrated fixed focus camera. This product is being discontinued and phased out of our product line.
|
|
$
|
1,895
|
|
DVM-400
|
|
An
in-car digital audio/video system that is integrated into a rear view mirror primarily designed for law enforcement customers.
This system uses an external zoom camera. This product is being discontinued and phased out of our product line.
|
|
$
|
2,795
|
|
DVM-250
Plus
|
|
An
in-car digital audio/video system that is integrated into a rear view mirror primarily designed for commercial fleet customers.
We offer a web-based, driver management and monitoring analytics package for a monthly service fee that is available for our
DVM-250 customers.
|
|
$
|
1,295
|
|
DVM-800
HD
|
|
An
in-car digital audio/video system which records in full 1080P high definition video that is integrated into a rear view mirror
primarily designed for law enforcement customers. This system can use an internal fixed focus camera or two external cameras
for a total of four video streams. This system also includes the Premium Package which has an additional warranty. We offer
local storage as well as cloud storage solutions to manage the recorded evidence. We charge a monthly storage fee for our
cloud storage option and a one-time fee for the local storage option.
|
|
$
|
4,795
|
|
DVM-800
|
|
An
in-car digital audio/video system which records in 480P standard definition video that is integrated into a rear view mirror
primarily designed for law enforcement customers. This system can use an internal fixed focus camera or two external cameras
for a total of four video streams. This system also includes the Premium Package which has additional warranty. We offer local
storage as well as cloud storage solutions to manage the recorded evidence. We charge a monthly storage fee for our cloud
storage option and a one-time fee for the local storage option.
|
|
$
|
3,995
|
|
DVM-800
Lite
|
|
An
in-car digital audio/video system which records in 480P standard definition video that is integrated into a rear view mirror
primarily designed for law enforcement customers. This system can use an internal fixed focus camera or two external cameras
for a total of four video streams. This system also includes the Premium Package which has additional warranty. We offer local
storage as well as cloud storage solutions to manage the recorded evidence. We charge a monthly storage fee for our cloud
storage option and a one-time fee for the local storage option. This system is replacing the DVM-100 and DVM-400 product offerings
and allows the customer to configure the system to their needs.
|
|
|
Various
based on configuration
|
|
FirstVU
HD
|
|
A
body-worn digital audio/video camera system primarily designed for law enforcement customers. We also offer a cloud based
evidence storage and management solution for our FirstVU HD customers for a monthly service fee.
|
|
$
|
595
|
|
VuLink
|
|
An
in-car device that enables an in-car digital audio/video system and a body worn digital audio/video camera system to automatically
and simultaneously start recording.
|
|
$
|
495
|
|
We
sell our products and services to law enforcement and commercial customers in the following manner:
|
●
|
Sales
to domestic customers are made directly to the end customer (typically a law enforcement agency or a commercial customer)
through our sales force, comprised of our employees. Revenue is recorded when the product is shipped to the end customer.
|
|
|
|
|
●
|
Sales
to international customers are made through independent distributors who purchase products from us at a wholesale price and
sell to the end user (typically law enforcement agencies or a commercial customer) at a retail price. The distributor retains
the margin as its compensation for its role in the transaction. The distributor generally maintains product inventory, customer
receivables and all related risks and rewards of ownership. Revenue is recorded when the product is shipped to the distributor
consistent with the terms of the distribution agreement.
|
|
|
|
|
●
|
Repair
parts and services for domestic and international customers are generally handled by our inside customer service employees.
Revenue is recognized upon shipment of the repair parts and acceptance of the service or materials by the end customer.
|
We
may discount our prices on specific orders based upon the size of the order, the specific customer and the competitive landscape.
We believe that our systems are at least comparable to those of our principal competitors and are generally lower priced when
considering comparable features and capabilities.
Revenues
for the three months ended September 30, 2018 and 2017 were derived from the following sources:
|
|
Three
months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
DVM-800
|
|
|
38
|
%
|
|
|
47
|
%
|
FirstVu
HD
|
|
|
15
|
%
|
|
|
12
|
%
|
Repair
and service
|
|
|
13
|
%
|
|
|
12
|
%
|
DVM-250 Plus
|
|
|
9
|
%
|
|
|
6
|
%
|
Cloud
service revenue
|
|
|
6
|
%
|
|
|
4
|
%
|
DVM-750
|
|
|
6
|
%
|
|
|
8
|
%
|
VuLink
|
|
|
—
|
%
|
|
|
1
|
%
|
DVM-100 &
DVM-400
|
|
|
—
|
%
|
|
|
2
|
%
|
Accessories
and other revenues
|
|
|
13
|
%
|
|
|
8
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Product
revenues for the three months ended September 30, 2018 and 2017 were $2,334,863 and $2,521,663, respectively, a decrease of $186,800
(7%), due to the following factors:
|
●
|
In
general, our revenues were pressured as our in-car and body-worn systems are facing increased competition because our competitors
have released new products with advanced features. We have projects that we believe will address this issue by developing
a new product platform specifically for in-car systems, which we expect to be in production by second quarter 2019. This new
product platform will utilize advanced chipsets that will generate new and highly advanced products for our law enforcement
and commercial customers. Our law enforcement revenues also 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
shipped two individual orders in excess of $100,000 for a total of approximately $369,005 in revenue and deferred revenue
for the three months ended September 30, 2018 compared to one individual order in excess of $100,000, for a total of approximately
$153,000 in revenue and deferred revenue, for the three months ended September 30, 2017. Our average order size decreased
to approximately $2,085 in the three months ended September 30, 2018 from $2,410 during the three months ended September 30,
2017. 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 $90,441 (3% of total revenues) during third quarter 2018, compared to $236,524 (8% of
total revenues) during third quarter 2017. The international sales cycle generally takes longer than domestic business and
we have provided bids to a number of international customers. We are marketing our newer products, including the FleetVu driver
monitoring and management service, the DVM-800 HD and the FirstVU HD internationally.
|
Service
and other revenues for the three months ended September 30, 2018 and 2017 were $543,196 and $461,914, respectively, an increase
of $81,282 (18%), due to the following factors:
|
●
|
Cloud
revenues were $173,564 and $118,016 for the three months ended September 30, 2018 and 2017, respectively, an increase of $55,548
(47%). We have experienced increased interest in our cloud solutions for law enforcement and a growing number of our commercial
customers has implemented our FleetVU cloud-based driver management/monitoring tool and asset tracking solutions, which contributed
to our increased cloud revenues in 2018. We expect this trend to continue in 2018 and throughout 2019 as we restarted the
American Medical Response (“AMR”) contract during 2018 and the migration from local storage to cloud storage continues
in our customer base.
|
|
|
|
|
●
|
Revenues
from extended warranty services were $278,935 and $236,628 the three months ended September 30, 2018 and 2017, respectively,
an increase of $42,307 (18%). 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 in 2018 and throughout
2019.
|
|
|
|
|
●
|
Installation
service revenues were $29,115 and $14,458 for the three months ended September 30, 2018 and 2017, respectively, an increase
of $14,657 (101%). Installation revenues tend to vary more than other service revenue types and are dependent on larger customer
implementations.
|
Total
revenues for the three months ended September 30, 2018 and 2017 were $2,878,059 and $2,983,577, respectively, a decrease of $105,518
(4%), due to the reasons noted above.
Cost
of Revenue
Cost
of product revenue on units sold for the three months ended September 30, 2018 and 2017 was $1,592,072 and $1,709,046, respectively,
a decrease of $116,974 (7%). The decrease in cost of goods sold is commensurate with the 7% decrease in product revenues for the
three months ended September 30, 2018 compared to 2017.
Cost
of service and other revenues for the three months ended September 30, 2018 and 2017 was $108,698 and $265,918, respectively,
a decrease of 157,220 (59%). The decrease in service and other cost of goods sold is primarily due to the Company reducing its
staff in the service installation and warranty repair departments in 2018 versus 2017.
Total
cost of sales as a percentage of revenues decreased to 59% during the three months ended September 30, 2018 compared to 66% for
the three months ended June 30, 2017. We believe our gross margins will continue to improve during the remainder of 2018 and beyond
if we can increase revenues, continue to reduce product warranty issues and continue to shift revenues to the higher margin cloud
services.
We
had $2,689,973 and $2,990,702 in reserves for obsolete and excess inventories at September 30, 2018 and December 31, 2017, respectively.
Total raw materials and component parts were $4,462,562 and $4,621,704 at September 30, 2018 and December 31, 2017, respectively,
a decrease of $159,142 (3%). The decrease in raw materials was mostly in parts for FirstVU HD products. Finished goods balances
were $5,329,099 and $6,964,624 at September 30, 2018 and December 31, 2017, respectively, a decrease of $1,635,525 (23%). The
decrease in finished goods was primarily related to reductions in our DVM-750 product line, and test and evaluation and replacement
inventory. The decrease in the inventory reserve is primarily due to the reduction of test and evaluation and replacement inventory
levels, which were partially reserved. We believe the reserves are appropriate given our inventory levels at September 30, 2018.
Gross
Profit
Gross
profit for the three months ended September 30, 2018 and 2017 was $1,177,289 and $1,008,613, respectively, an increase of $168,676
(17%). The increase is primarily the result of improvement in our cost of sales as a percentage of revenues which decreased to
59% during the three months ended September 30, 2018 from 66% for the three months ended September 30, 2017. We believe that gross
margins will improve during 2018 and beyond if we improve revenue levels, 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 DVM-800, DVM-800 HD, 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 2018. In addition, if revenues from these
products increase, we will seek to further improve our margins from them through economies of scale and more efficiently utilizing
fixed manufacturing overhead components. We plan to continue our initiative on more efficient management of our supply chain through
outsourcing production, quantity purchases and more effective purchasing practices.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses were $3,087,005 and $4,125,308 for the three months ended September 30, 2018 and 2017, respectively,
a decrease of $1,038,303 (25%). Management has implemented a plan to significantly to reduce overall selling, general and administrative
expenses in late 2017 and 2018 which has shown considerable success. Overall selling, general and administrative expenses as a
percentage of sales decreased to 107% in third quarter 2018 from 138% in the same period in 2017. The significant components of
selling, general and administrative expenses are as follows:
|
|
Three
Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Research
and development expense
|
|
$
|
323,981
|
|
|
$
|
831,573
|
|
Selling,
advertising and promotional expense
|
|
|
711,506
|
|
|
|
1,048,334
|
|
Stock-based
compensation expense
|
|
|
669,480
|
|
|
|
478,863
|
|
Professional
fees and expense
|
|
|
356,856
|
|
|
|
411,945
|
|
Executive,
sales and administrative staff payroll
|
|
|
426,291
|
|
|
|
694,475
|
|
Other
|
|
|
598,891
|
|
|
|
660,118
|
|
Total
|
|
$
|
3,087,005
|
|
|
$
|
4,125,308
|
|
Research
and development expense.
We continue to focus on bringing new products to market, including updates and improvements to
current products; however, we are now relying more on contracted engineering services on an “as-needed” basis. Our
research and development expenses totaled $323,981 and 831,573 for the three months ended September 30, 2018 and 2017, respectively,
a decrease of $507,592 (61%). We employed 12 engineers at September 30, 2018 compared to 32 engineers at September 30, 2017. These
headcount reductions were part of our strategy to reduce SG&A expenses and were the primary factor in the 61% reduction in
research and development in Q-3 2018 compared to Q-3 2017. Research and development expenses as a percentage of total revenues
were 11% for the three months ended September 30, 2018 compared to 28% for the three months ended September 30, 2017. Although
we significantly reduced our engineering headcount in early 2018, we still consider our research and development capabilities
and new product focus to be a competitive advantage and will continue to invest in this area on a prudent basis and consistent
with our financial resources.
Selling,
advertising and promotional expenses.
Selling, advertising and promotional expense totaled $711,506 and $1,048,334 for
the three months ended September 30, 2018 and 2017, respectively, a decrease of $336,828 (32%). The decrease was primarily attributable
to the reduction of salesman in the law enforcement channel in late 2017. Salesmen salaries and commissions represent the primary
components of these costs and were $607,111 and $701,399 for the three months ended September 30, 2018 and 2017, respectively,
a decrease of $94,288 (13%). The effective commission rate was 21.0% for the three months ended September 30, 2018 compared to
23.5% for the three months ended September 30, 2017.
Promotional
and advertising expenses totaled $104,395 during the three months ended September 30, 2018 compared to $346,935 for the three
months ended September 30, 2017, a decrease of $242,540 (70%). The decrease is primarily attributable to the Company not serving
as the title sponsor for the 2018 Web.com Tour golf tournament. In third quarter 2017 we incurred net promotional expenses of
$263,047 for the 2017 Web.com golf tournament. Additionally, we have reduced the number of trade shows we attended during 2018
as management questioned the efficiency and effectiveness of many of the lesser attended trade shows and eliminated them from
the schedule. This reduction in promotional and advertising expenses was also a component of our strategy to reduce SG&A expenses.
Stock-based
compensation expense.
Stock-based compensation expense totaled $669,480 and $478,863 for the three months ended September
30, 2018 and 2017, respectively, an increase of $190,617 (40%). The increase is primarily due to the increased amortization during
the three months ended September 30, 2018 related to the restricted stock granted during 2018 and 2017 to our officers, directors,
and other employees. In 2018 we granted 484,500 shares of restricted stock to employees and officers and in 2017, we granted 100,000
stock options and 522,000 shares of restricted stock to employees, officers and directors for which the grant date fair-value
amounts were amortized to expense. We relied more on stock-based compensation during 2018 and 2017 resulting in increased stock-based
compensation as we attempted to reduce cash expenses for liquidity reasons.
Professional
fees and expense
. Professional fees and expenses totaled $356,856 and $411,945 for the three months ended September 30,
2018 and 2017, respectively, a decrease of $55,089 (13%). Professional fees for both periods are primarily related to litigation
expenses related to the ongoing Axon and WatchGuard lawsuits. The Axon and WatchGuard case stays have now been lifted and both
lawsuits are now proceeding towards trial. The legal fees related to both the Axon and WatchGuard litigation are expected to ramp
up during the remainder of 2018 and into 2019 as we proceed to trial. We intend to pursue recovery from Axon, WatchGuard, their
insurers and other responsible parties as appropriate.
Executive,
sales and administrative staff payroll.
Executive, sales and administrative staff payroll expenses totaled $426,291 and
$694,475 for the three months ended September 30, 2018 and 2017, respectively, a decrease of $268,184 (39%). The primary reason
for the decrease in executive, sales and administrative staff payroll was a significant reduction of workforce that was effective
in mid-January 2018. We had approximately 159 total employees at September 30, 2017 compared to approximately 83 at September
30, 2018. This reduction in executive, sales and administrative staff payroll headcount and related expenses were a primary component
of our strategy to reduce SG&A expenses.
Other
.
Other selling, general and administrative expenses totaled $598,891 and $660,118 for the three months ended September 30, 2018
and 2017, respectively, a decrease of $61,227 (9%). The decrease in other expenses in the third quarter 2018 compared to the third
quarter 2017 is primarily attributable to decreased health insurance premiums and unemployment taxes for our employees as a result
of the headcount reduction related to our strategy to reduce SG&A expenses.
Operating
Loss
For
the reasons stated, our operating loss was $(1,909,716) and $(3,116,695) for the three months ended September 30, 2018 and 2017,
respectively, an improvement of $1,206,979 (39%). Operating loss as a percentage of revenues decreased to 66% in 2018 from 104%
in 2017.
Interest
Income
Interest
income increased to $2,206 for the three months ended September 30, 2018 from $1,761 in 2017 which reflected our overall higher
cash and cash equivalent levels in 2018 compared to 2017.
Interest
Expense
We
incurred interest expense of $1,083,317 and $375,048 during the three months ended September 30, 2018 and 2017. The increase is
primarily attributable to the $6.875 million principal amount of the 2018 Debentures we issued in April and May 2018, which bore
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.
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. We were required to treat the warrants as derivative
liabilities because of their anti-dilution and down-round provisions. Accordingly, we estimated the fair value of such warrants
as of their respective date of issuance and recorded a corresponding derivative liability in the balance sheet. Upon exercise
of the warrants we recognized a gain/loss based on the closing market price of the underlying common stock on the date of exercise.
In addition, the warrant derivative liability is adjusted to the estimated fair value of any unexercised warrants as of December
31, 2017 and September 30, 2018. There remained warrants outstanding exercisable to purchase 12,200 shares of common stock at
December 31, 2017 and there were no associated warrants outstanding as of September 30, 2018. Certain common stock purchase warrants
issued in August 2014 contained anti-dilution provisions that triggered a reset to their exercise price and number of warrants
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 three months
ended September 30, 2018 at the reset exercise price of $0.52 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 three months
ended September 30, 2018 of $9,799.
The
changes in the fair value of the warrant derivatives related to unexercised warrants resulted in a gain of $3,628 for the three
months ended September 30, 2017.
Loss
on Extinguishment of Secured Convertible Debentures
We
closed the Private Placement of $6.875 million of 2018 Debentures and warrants exercisable to purchase 916,667 shares of common
stock on April 3, 2018. The Private Placement resulted in gross proceeds of $6.25 million before placement agent fees and other
expenses associated with the transaction. We used a portion of the proceeds to repay in full the 2016 Debentures, 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 2016 Debentures totaling $100,000 for the three months ended September 30, 2018. There was no similar extinguishment of
debentures in 2017.
Change
in Fair Value of Secured Convertible Debentures
We
elected to account for the $6.875 million principal amount of the 2018 Debentures issued in April and May 2018 on their fair value
basis. Therefore, we determined the fair value of the 2018 Debentures which yielded an estimated fair value of $4,565,749 including
their embedded derivatives as of their origination date. We also determined the estimated fair value of $5,354,803 for the 2018
Debentures including their embedded derivatives as of June 30, 2018. We paid the 2018 Debentures in full on August 21, 2018 and
the change in fair value from June 30, 2018 until August 21, 2018 was $1,466,467, which was recognized as a loss in the Condensed
Consolidated Statement of Operations.
Change
in fair value of Proceeds Investment Agreement
We
elected to account for the Proceeds Investment Agreement that was entered into July of 2018 on its fair value basis. Therefore,
we determined the fair value of the 2018 PIA Agreement which yielded an estimated fair value of $9,067,513 as of its origination date. We also determined the estimated fair value of $9,166,000 for the PIA Agreement s of September 30, 2018
. The change in fair value from origination date until September 30,2018
was $98,487, which was recognized as a loss in the Condensed Consolidated Statement of Operations.
Loss
before Income Tax Benefit
As
a result of the above, we reported a loss before income tax benefit of $4,665,580 and $3,493,306 for the three months ended
September 30, 2018 and 2017, respectively, a deterioration of $1,172,274 (34%).
Income
Tax Benefit
We
did not record an income tax benefit related to our losses for the three months ended September 30, 2018 due to our overall net
operating loss carryforwards available. We have further determined to continue providing a full valuation reserve on our net deferred
tax assets as of September 30, 2018.
We
had approximately $41,715,000 of net operating loss carryforwards and $2,007,000 of research and development tax credit carryforwards
as of December 31, 2017 available to offset future net taxable income.
Net
Loss
As
a result of the above, we reported net losses of $4,665,580 and $3,493,306 for the three months ended September 30, 2018
and 2017, respectively, a deterioration of $1,172,274 (34%).
Basic
and Diluted Loss per Share
The
basic and diluted loss per share was $0.59 and $0.56 for the three months ended September 30, 2018 and 2017, respectively, for
the reasons previously noted. All outstanding stock options were considered antidilutive and therefore excluded from the calculation
of diluted loss per share for the three months ended September 30, 2018 and 2017 because of the net loss reported for each period.
For
the Nine Months Ended September 30, 2018 and 2017
Results
of Operations
Summarized
immediately below and discussed in more detail in the subsequent subsections is an analysis of our operating results for the nine
months ended September 30, 2018 and 2017, represented as a percentage of total revenues for each respective year:
|
|
Nine
Months Ended
September
30,
|
|
|
|
2018
|
|
|
2017
|
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost
of revenue
|
|
|
56
|
%
|
|
|
62
|
%
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
44
|
%
|
|
|
38
|
%
|
Selling,
general and administrative expenses:
|
|
|
|
|
|
|
|
|
Research
and development expense
|
|
|
12
|
%
|
|
|
21
|
%
|
Selling,
advertising and promotional expense
|
|
|
24
|
%
|
|
|
26
|
%
|
Stock-based
compensation expense
|
|
|
20
|
%
|
|
|
8
|
%
|
General
and administrative expense
|
|
|
48
|
%
|
|
|
46
|
%
|
|
|
|
|
|
|
|
|
|
Total
selling, general and administrative expenses
|
|
|
104
|
%
|
|
|
101
|
%
|
|
|
|
|
|
|
|
|
|
Operating
loss
|
|
|
(60
|
)%
|
|
|
(63
|
)%
|
Change
in fair value of secured convertible debentures
|
|
|
(26
|
)%
|
|
|
—
|
%
|
Change
in fair value of proceeds investment agreement
|
|
|
(1
|
)%
|
|
|
—
|
%
|
Loss
on the extinguishment of secured convertible debentures
|
|
|
(7
|
)%
|
|
|
—
|
%
|
Change
in warrant derivative liabilities
|
|
|
(4
|
)%
|
|
|
—
|
%
|
Secured
convertible debentures issuance expense
|
|
|
(2
|
)%
|
|
|
—
|
%
|
Other
income and interest expense, net
|
|
|
(15
|
)%
|
|
|
(4
|
)%
|
Loss
before income tax benefit
|
|
|
(115
|
)%
|
|
|
(67
|
)%
|
Income
tax benefit
|
|
|
—
|
%
|
|
|
—
|
%
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
(115
|
)%
|
|
|
(67
|
)%
|
|
|
|
|
|
|
|
|
|
Net loss per
share information:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(1.40
|
)
|
|
$
|
(1.34
|
)
|
Diluted
|
|
$
|
(1.40
|
)
|
|
$
|
(1.34
|
)
|
Revenues
for the nine months ended September 30, 2018 and 2017 were derived from the following sources:
|
|
Nine
months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
DVM-800
|
|
|
44
|
%
|
|
|
48
|
%
|
FirstVu
HD
|
|
|
12
|
%
|
|
|
12
|
%
|
Repair
and service
|
|
|
12
|
%
|
|
|
10
|
%
|
DVM-250 Plus
|
|
|
7
|
%
|
|
|
10
|
%
|
Cloud
service revenue
|
|
|
6
|
%
|
|
|
2
|
%
|
DVM-750
|
|
|
4
|
%
|
|
|
3
|
%
|
VuLink
|
|
|
2
|
%
|
|
|
2
|
%
|
DVM-100 &
DVM-400
|
|
|
1
|
%
|
|
|
2
|
%
|
Accessories
and other revenues
|
|
|
12
|
%
|
|
|
11
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Product
revenues for the nine months ended September 30, 2018 and 2017 were $7,319,676 and $10,263,833, respectively, a decrease of $2,944,157
(29%), 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
as our competitors have released new products with advanced features. We have development projects that we believe will address
this issue by introducing a new product platform specifically for in-car systems, which we expect to be in production by second
quarter 2019. This new product platform will utilize advanced chipsets that will generate new and highly advanced products
for our law enforcement and commercial customers. Additionally, our law enforcement revenues declined over the prior period
due to price-cutting, willful infringement of our patents and other actions by our competitors, adverse marketplace effects
related to the patent litigation and supply chain issues.
|
|
|
|
|
●
|
In
addition, product revenues for the nine months ended September 30, 2017 included approximately $680,000 in revenues related
to the AMR contract compared to approximately $90,000 in 2018. In early 2017 we were awarded the AMR contract for 1,550 DVM-250
systems, as well as FleetVU manager cloud storage and system implementation, which had a positive impact on first quarter
2017 revenues. We had expected increases in our commercial event recorder revenues given the AMR contract, but in summer 2017
AMR halted deliveries under the contract after it experienced two catastrophic accidents involving the loss of life in vehicles
equipped with our DVM-250’s. AMR alleged that the DVM-250 units in those vehicles failed to record the accidents. We
met with AMR representatives in the late 2017 to discuss the accidents and the performance of our equipment including a plan
to re-start the contract deliveries. We agreed upon a plan to update and upgrade our existing equipment and resume deliveries
under the contract with AMR, including the potential roll out to new locations in 2018 and 2019. The parties have completed
the implementation of the updates/upgrades of equipment, including the installation of ATU’S, which will increase recurring
revenue generated under the current contract for 2018 and beyond. We are hopeful that full-scale deliveries will resume under
the contract in early 2019, although we can offer no assurances in this regard.
|
|
|
|
|
●
|
We
shipped five individual orders in excess of $100,000, for a total of approximately $862,000 in revenue and deferred revenue
for the nine months ended September 30, 2018 compared to nine individual orders in excess of $100,000, for a total of approximately
$2,331,000 in revenue and deferred revenue for the nine months ended September 30, 2017. Our average order size decreased
to approximately $2,170 in the nine months ended September 30, 2018 from $2,740 during the nine months ended September 30,
2017. 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 $300,570 (3% of total revenues) during the nine months ended September 30, 2018, compared
to $326,370 (3% of total revenues) during the nine months ended September 30, 2017. The international sales cycle generally
takes longer than domestic business and we have provided bids to a number of international customers. We are marketing our
newer products, including the FleetVu driver monitoring and management service, the DVM-800 HD and the FirstVU HD internationally.
|
Service
and other revenues for the nine months ended September 30, 2018 and 2017 were $1,593,446 and $1,436,106, respectively, an increase
of $157,340 (11%), due to the following factors:
|
●
|
Cloud
revenues were $500,305 and $259,962 for the nine months ended September 30, 2018 and 2017, respectively, an increase of $240,343
(92%). We have experienced increased interest in our cloud solutions for law enforcement and an increasing number of our commercial
customers have implemented our FleetVU cloud-based driver management/monitoring tool and asset tracking solutions, which contributed
to our increased cloud revenues in 2018. We expect this trend to continue for the remainder of 2018 and throughout 2019 as
we restart the AMR contract and the migration from local storage to cloud storage continues in our customer base.
|
|
|
|
|
●
|
Installation
service revenues were $75,680 and $161,408 for the nine months ended September 30, 2018 and 2017, respectively, a decrease
of $85,728 (53%). In early 2017 we were awarded the AMR contract for the installation of 1,550 three camera DV-250 systems
which resulted in the higher installation services in 2017. We did not have any similar large customer installations in 2018.
Installation revenues tend to vary more than other service revenue types and are dependent on larger customer implementations.
|
|
|
|
|
●
|
Revenues
from extended warranty services were $805,068 and $638,982 for the nine months ended September 30, 2018 and 2017, respectively,
an increase of $166,086 (26%). We have many customers that 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 for the remainder of
2018 and into 2019.
|
Total
revenues for the nine months ended September 30, 2018 and 2017 were $8,913,122 and $11,699,939, respectively, a decrease of $2,786,817
(24%), due to the reasons noted above.
Cost
of Revenue
Cost
of product revenue on units sold for the nine months ended September 30, 2018 and 2017 was $4,672,432 and $6,450,570, respectively,
a decrease of $1,778,138 (28%). The decrease in cost of goods sold is primarily due to the 28% decrease in product revenues for
the nine months ended September 30, 2018 compared to 2017.
Cost
of service and other revenues for the nine months ended September 30, 2018 and 2017 was $335,540 and $790,691, respectively, a
decrease of $455,151 (58%). The decrease in service and other cost of goods sold is primarily due to the additional staffing we
had related to the AMR contract in the service installation and warranty repair departments in 2017 compared to 2018.
Total
cost of sales as a percentage of revenues decreased to 56% during the nine months ended September 30, 2018 compared to 62% for
the nine months ended September 30, 2017. We believe our gross margins will continue to improve if we improve revenue levels,
continue to reduce product warranty issues and add higher margin revenues from cloud-based services.
Gross
Profit
Gross
profit for the nine months ended September 30, 2018 and 2017 was $3,905,150 and $4,458,678, respectively, a decrease of $553,528
(12%). The decrease is primarily attributable to the 24% decrease in revenues for the nine months ended September 30, 2018 compared
to 2017 offset by cost of sales as a percentage of revenues decreasing to 56% from 62% for the same periods We believe that gross
margins will continue to improve in 2018 over 2017 because we have corrected the quality control and other warranty related issues
affecting our FirstVU HD product during recent quarters. Our goal is to improve our margins to 60% over the longer-term based
on the expected margins of our newer products, in particular the DVM-800, VuLink, DVM-800 HD, FirstVU HD and cloud-based evidence
storage and management offering, as they continue to gain traction in the marketplace and we increase our commercial market penetration
in 2018. In addition, as revenues from these products increase, we will seek to further improve our margins from them through
economies of scale and more efficiently utilizing fixed manufacturing overhead components. We plan to continue our initiative
on more efficient management of our supply chain through outsourcing production, quantity purchases and more effective purchasing
practices.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses were $9,225,491 and $11,870,183 for the nine months ended September 30, 2018 and 2017, respectively,
a decrease of $2,646,692 (22%). Management has implemented a plan to significantly reduce overall selling, general and administrative
expenses in late 2017 and 2018 which has shown considerable success. Selling, general and administrative expenses as a percentage
of sales increased to 104% in 2018 from 101% in 2017. The significant components of selling, general and administrative expenses
are as follows:
|
|
Nine
Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Research
and development expense
|
|
$
|
1,097,861
|
|
|
$
|
2,495,924
|
|
Selling,
advertising and promotional expense
|
|
|
2,097,919
|
|
|
|
3,036,168
|
|
Stock-based
compensation expense
|
|
|
1,757,227
|
|
|
|
981,652
|
|
Professional
fees and expense
|
|
|
1,167,761
|
|
|
|
1,187,435
|
|
Executive,
sales and administrative staff payroll
|
|
|
1,380,209
|
|
|
|
2,065,327
|
|
Other
|
|
|
1,724,514
|
|
|
|
2,103,677
|
|
Total
|
|
$
|
9,225,491
|
|
|
$
|
11,870,183
|
|
Research
and development expense.
We continue to focus on bringing new products to market, including updates and improvements to
current products; however, we are now relying more on contracted engineering services on an “as-needed” basis. Our
research and development expenses totaled $1,097,861 and $2,495,924 for the nine months ended September 30, 2018 and 2017, respectively,
a decrease of $1,398,063 (56%). We employed 12 engineers at September 30, 2018 compared to 32 engineers at September 30, 2017,
most of whom are dedicated to research and development activities for new products. These headcount reductions were part of our
strategy to reduce SG&A expenses and were the primary factor in the 56% reduction in research and development in the nine
months ended September 30, 2018 compared the same period 2017. Research and development expenses as a percentage of total revenues
were 12% for the nine months ended September 30, 2018 compared to 21% for the nine months ended September 30, 2017. Although we
significantly reduced our engineering headcount in early 2018, we still consider our research and development capabilities and
new product focus to be a competitive advantage and will continue to invest in this area on a prudent basis and consistent with
our financial resources.
Selling,
advertising and promotional expenses.
Selling, advertising and promotional expense totaled $2,097,919 and $3,036,168 for
the nine months ended September 30, 2018 and 2017, respectively, a decrease of $938,249 (31%), which is commensurate with the
24% decline in revenues. Salesman salaries and commissions represent the primary components of these costs and were $1,802,278
for the nine months ended September 30, 2018 compared to $2,418,904 for the nine months ended September 30, 2017, a decrease of
$616,626 (25%). We reduced the number of salesman in our law enforcement channel in late 2017. The overall effective commission
rate was 20.2% for the nine months ended September 30, 2018 and 20.7% for the nine months ended September 30, 2017.
Promotional
and advertising expenses totaled $295,641 during the nine months ended September 30, 2018 compared to $617,264 during the nine
months ended September 30, 2017, a decrease of $321,623 (52%). The decrease is primarily attributable to us not serving as the
title sponsor for the 2018 Web.com Tour golf tournament. In third quarter 2017 we incurred net promotional expenses of $263,047
for the 2017 Web.com golf tournament. Additionally, we have reduced the number of trade shows we attended during 2018 as management
questioned the efficiency and effectiveness of many of the lesser attended trade shows and eliminated them from the schedule.
This reduction in promotional and advertising expenses were also a component of our strategy to reduce SG&A expenses. The
decrease is primarily attributable reducing the number of trade shows we attended during 2018 as management questioned the efficiency
and effectiveness of many of the lesser attended trade shows and eliminated them from the schedule. This reduction in promotional
and advertising expenses was also a component of our strategy to reduce SG&A expenses.
Stock-based
compensation expense.
Stock-based compensation expense totaled $1,757,227 and $981,652 for the nine months ended September
30, 2018 and 2017, respectively, an increase of $775,575 (79%). The increase is primarily due to increased amortization during
the nine months ended September 30, 2018 related to the restricted stock granted during 2018 and 2017 to our officers, directors,
and other employees. We relied more on stock-based compensation during 2018 and 2017 resulting in increased stock-based compensation
as we attempted to reduce cash expenses for liquidity reasons.
Professional
fees and expense
. Professional fees and expenses totaled $1,167,761 and $1,187,435 for the nine months ended September
30, 2018 and 2017, respectively, a decrease of $19,674 (2%). The professional fees are primarily attributable to legal fees and
expenses related to the ongoing Axon and WatchGuard lawsuits. The Axon and WatchGuard case stays have now been lifted and both
lawsuits are now proceeding towards trial. The legal fees related to both the Axon and WatchGuard litigation are expected to ramp
up during the remainder of 2018 and into 2019 as we proceed to trial. We intend to pursue recovery from Axon, WatchGuard, their
insurers and other responsible parties as appropriate.
Executive,
sales and administrative staff payroll.
Executive, sales and administrative staff payroll expenses totaled $1,380,209
and $2,065,327 for the nine months ended September 30, 2018 and 2017, respectively, a decrease of $685,118 (33%). The primary
reason for the decrease in executive, sales and administrative staff payroll was a significant reduction of workforce that was
effective in mid-January 2018. We had approximately 159 total employees at September 30, 2017 compared to approximately 83 at
September 30, 2018. This reduction in executive, sales and administrative staff payroll headcount and related expenses was a primary
component of our strategy to reduce SG&A expenses.
Other
.
Other selling, general and administrative expenses totaled $1,724,514 and $2,103,677 for the nine months ended September 30, 2018
and 2017, respectively, a decrease of $379,163 (18%). The decrease in other expenses in 2018 compared to 2017 is primarily attributable
to decreased health insurance premiums and unemployment taxes for our employees as a result of the headcount reduction related
to our strategy to reduce SG&A expenses.
Operating
Loss
For
the reasons previously stated, our operating loss was $(5,320,341) and $(7,411,505) for the nine months ended September 30, 2018
and 2017, respectively, an improvement of $2,091,164 (28%). Operating loss as a percentage of revenues increased to 113% for the
first nine months of 2018 from 63% for the same period in 2017.
Interest
Income
Interest
income decreased to $4,506 for the nine months ended September 30, 2018 from $10,619 in 2017.
Interest
Expense
We
incurred interest expense of $1,366,520 and $536,035 during the nine months ended September 30, 2018 and 2017. The increase is
primarily attributable to the $6.875 million principal amount of the 2018 Debentures we issued in April and May 2018, which bore
interest at the rate of 8% per annum on the outstanding principal balance. The 2018 Debentures were paid off on August 21, 2018
and the Company was required to pay off the remaining 12 months of guaranteed interest on the Debentures which included a 10%
premium since they were not paid off before August 1, 2018.
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.
In addition, the warrant derivative liability is adjusted to the estimated fair value of any unexercised warrants as of December
31, 2017 and September 30, 2018. There remained warrants outstanding exercisable to purchase 12,200 shares of common stock at
December 31, 2017 and there were no associated warrants outstanding as of September 30, 2018. 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 their option to purchase common stock for all remaining outstanding warrants during the nine
months ended September 30, 2018 at the 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 nine months
ended September 30, 2018 of $319,105.
The
changes in the fair value of the warrant derivatives related to unexercised warrants resulted in a gain of $17,347 for the nine
months ended September 30, 2017. There remained no associated warrants outstanding exercisable to purchase common shares at September
30, 2018 therefore the respective warrant derivative liability balance was $0 at September 30, 2018.
Secured
Convertible Debentures Issuance Expenses
We
elected to account for and record the $6.875 million 2018 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 $220,312 for the nine months ended September 30, 2018. The issuance costs included a $150,000 placement agent fee and
the remainder was primarily legal fees. No similar debt issuances occurred in 2017.
Loss
on Extinguishment of Secured Convertible Debentures
We
closed the Private Placement of $6.875 million of 2018 Debentures and warrants exercisable to purchase 916,667 shares of common
stock on April 3, 2018. The Private Placement resulted in gross proceeds of $6.25 million before placement agent fees and other
expenses associated with the transaction. We used a portion of the proceeds to repay in full the 2016 Debentures, 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 2016 Debentures totaling $600,000 for the nine months ended September 30, 2018. There was no similar extinguishment of
debentures in 2017.
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 nine months ended September 30, 2018, which was recognized
as a gain in the Condensed Consolidated Statement of Operations. We paid these Debentures on April 3, 2018.
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 $2,309,250, which was recognized
as a loss in the Condensed Consolidated Statement of Operations.
The
net charge to change in fair value of secured debentures for the nine months ended September 30, 2018 was $2,296,443 compared
to a gain of $66,790 for the nine months ended September 30, 2017.
Change
in fair value of proceeds investment agreement
We
elected to account for the Proceeds Investment Agreement that was entered into July of 2018 on its fair value basis. Therefore,
we determined the fair value of the 2018 PIA Agreement which yielded an estimated fair value of $9,067,513 as of its origination date. We also determined the estimated fair value of $9,166,000 for the PIA Agreement as of September 30, 2018
. The change in fair value from origination date until September 30,2018
was $98,487, which was recognized as a loss in the Condensed Consolidated Statement of Operations.
Loss
before Income Tax Benefit
As
a result of the above, we reported a loss before income tax benefit of $10,216,702 and $7,852,784 for the nine months ended
September 30, 2018 and 2017, respectively, a deterioration of $2,363,918 (30%).
Income
Tax Benefit
We
did not record an income tax benefit related to our losses for the nine months ended September 30, 2018 due to our overall net
operating loss carryforwards available. We have further determined to continue providing a full valuation reserve on our net deferred
tax assets as of September 30, 2018.
We
had approximately $41,715,000 of net operating loss carryforwards and $2,007,000 of research and development tax credit carryforwards
as of December 31, 2017 available to offset future net taxable income.
Net
Loss
As
a result of the above, we reported net losses of $10,216,702 and $7,852,784 for the nine months ended September 30, 2018
and 2017, respectively, a deterioration of $2,363,918 (30%).
Liquidity
and Capital Resources
Overall
Management’s
Liquidity Plan -
The Company incurred substantial operating losses in the nine months ended September 30, 2018 and for
the year ended December 31, 2017 due to the factors cited elsewhere in this Report. In recent years and including 2018, the Company
has accessed the public and private capital markets to raise funding through the issuance of debt and equity. In that regard,
it raised funding in the form of subordinated debt, secured debt and proceeds investment agreements totaling $16,500,000, and
net proceeds of $7,324,900 from an underwritten public offering of common stock during the nine months ended September 30, 2018.
The Company issued common stock and detachable common stock purchase warrants totaling $2,776,332 and raised funding from subordinated
and secured debt totaling $1,608,500 during the year ended December 31, 2017. During 2016, it raised $4.0 million of funding in
the form of convertible debentures and common stock purchase warrants.
The
Company has retired all interest-bearing debt outstanding during the nine months ended September 30, 2018 and has no interest-bearing
debt outstanding as of September 30, 2018. The only long-term obligations outstanding as of September 30, 2018 is associated with
the proceeds investment agreement which the Company entered into during July 2018 which is more fully described in Note 6.
The
Company will have to restore positive operating cash flows and profitability over the next twelve months and/or raise additional
capital to fund its operational plans, meet its customary payment obligations and otherwise execute its business plan. There can
be no assurance that it will be successful in restoring positive cash flows and profitability, or that it can raise additional
debt or equity financing when needed and obtain it on terms acceptable or favorable to the Company.
The
Company has implemented an enhanced quality control program to detect and correct product issues before they result in significant
rework expenditures affecting the Company’s gross margins and has seen progress in that regard. In addition, the Company
has undertaken a number of cost reduction initiatives, including a reduction of its workforce by approximately 40%, restructuring
its direct sales force and cutting other selling, general and administrative costs. In 2017 it introduced a new full high definition
in-car video system (DVM-800 HD), which is intended to help it regain market share and improve revenues in its law enforcement
division. The Company has increased its addressable market to non-law enforcement customers and obtained new non-law enforcement
contracts in 2017 and the first nine months of 2018, which contracts include recurring revenue during the period 2018 to 2020.
It believes that its quality control, headcount reduction and cost cutting initiatives, introduction of the DVM-800 HD for law
enforcement and expansion to non-law enforcement sales channels will restore positive operating cash flows and profitability during
the next year, although it can offer no assurances in this regard.
Strategic
Alternatives -
The Company’s Board of Directors has initiated a review of strategic alternatives to best position
the Company for the future, including, but not limited to, monetizing its patent portfolio and related patent infringement litigation
against Axon and WatchGuard, the sale of all or certain assets, properties or groups of properties or individual businesses or
merger or combination with another company. The result of the strategic review may also include the continued implementation of
the Company’s business plan with additional debt or equity financing. The Company retained Roth to assist in this review
and process. Thus, the Company is considering alternatives to address its near-term and long-term liquidity and operational issues.
There can be no assurance that a transaction or financing will result from this process. As part of this overall strategic alternatives
process, the Board of Directors approved the Proceeds Investment Agreement and underwritten public offering, which are more fully
described below.
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 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, the PIA Warrant 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 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.
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.
Underwritten
Public Offering
- On September 26, 2018, the Company entered into an underwriting agreement with Roth, as the representative
of the underwriters and sole book-running manager, under 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
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.
Discussion
of Liquidity and Capital Resources:
On
December 30, 2016, the Company completed a private placement of $4.0 million principal amount of 2016 Debentures with two institutional
investors. The 2016 Debentures bear interest at 8% per annum payable in cash on a quarterly basis and are secured by substantially
all our tangible and certain intangible assets. In addition, we issued the investors warrants to acquire 800,000 shares of common
stock at $5.00 per share. The Company made payments of $750,000 against the 2016 Debentures on August 24, 2017. The 2016 Debentures
matured on March 30, 2018 and were convertible at any time six months after their date of issue at the option of the holders into
shares of common stock at $5.00 per share. In addition, the Company could elect to redeem the Debentures at 112% of their outstanding
principal balance and could force conversion by the holders if the market price exceeds $7.50 per share for ten consecutive trading
days. The Company used the proceeds of this private placement for general working capital purposes. It retired the 2016 Debentures
with part of the proceeds of the 2018 Debentures issued in April 2018.
On
June 30, 2017, the Company borrowed an aggregate of $700,000 under notes (the “June Notes”) with two private, third-party
lenders. The unsecured Notes bore interest of 8% per annum with all principal and accrued interest due on or before their September
30, 2017 maturity date. In connection with the issuance of the June Notes the Company issued the lenders warrants exercisable
to purchase a total of 200,000 shares of common stock at an exercise of $3.65 per share and an expiration date of June 29, 2022.
On September 30, 2017 the Company negotiated an extension of the maturity date of one of the June Notes to December 31, 2017 and
then an extension to March 31, 2018. In connection with the first extension, the Company issued warrants exercisable to purchase
100,000 shares of common stock at $2.60 per share until November 15, 2022. In connection with the second extension, the Company
issued warrants exercisable to purchase 60,000 shares of common stock at $3.25 per share until March 15, 2019. The Company retired
the second June Note which had a principal balance of $350,000.
On
August 23, 2017, the Company closed a $3.0 million offering of our common stock and common stock purchase warrants in a registered
direct offering. At the closing, it sold to institutional investors in a registered direct offering an aggregate of 940,000 shares
of its common stock at a price of $3.00 per share and Series B Warrants, for gross offering proceeds of $3.0 million. For each
share of common stock purchased, investors received two registered warrants, each with an exercise price of $3.36 per share (the
“Series A-1 Warrant” and the “Series A-2 Warrant”). The Series A-1 Warrants are exercisable to purchase
up to 680,000 shares of common stock and have a term of five years commencing six months following the closing date. The Series
A-2 warrants are immediately exercisable to purchase a 200,000 shares of common stock and have a term of five years commencing
on the closing date. Additionally, the Company issued to certain of the investors, in lieu of shares of common stock at closing,
Series B Warrants that are immediately exercisable (the “Series B Warrant”) to purchase 60,000 shares of common stock
for which the investors paid $2.99 per share at the closing and will pay $0.01 per share upon exercise of the Series B Warrant
so that such investors’ beneficial ownership interest would not exceed 9.9% of the issued and outstanding shares of common
stock. The Series B Warrants terminate upon exercise in full. After placement agent fees and other estimated offering expenses,
the net offering proceeds to us totaled approximately $2.8 million. The foregoing warrants issued in this transaction did not
contain terms that would require us to record derivative warrant liabilities that could affect our financial statements. Proceeds
of the offering were used to pay a portion of the outstanding principal balance of the Debentures, retire one of the June Notes
and for working capital purposes.
On
September 29, 2017, the Company borrowed $300,000 under an unsecured promissory note with a private, third-party lender. Such
note bore interest of 8% per annum with all principal and accrued interest due on or before its November 30, 2017 maturity date.
In connection with the note the Company issued the lender warrants exercisable to purchase a total of 100,000 shares common stock
at an exercise of $2.75 per share and an expiration date of September 30, 2022.
On
December 29, 2017 the Company borrowed an additional $350,000 with the same private, third party lender and combined the existing
note issued in September 2017 into a new note (the “Secured Note”) with a principal balance of $658,500 that was due
and payable in full on March 1, 2018 and may be prepaid without penalty. The Secured Note was secured by the Company’s intellectual
property portfolio, as such term is defined in the Secured Note. In connection with issuance of the Secured Note the Company issued
warrants to the lender exercisable to purchase 120,000 shares of common stock for $3.25 per share until December 28, 2022. The
Company used the proceeds of the foregoing note transactions for general working capital purposes. The Secured Note was retired
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 bore interest at 12% per annum and was due and payable in full on June 7, 2018. The note is secured
by the inventory of the Company and junior to senior liens held by the holders of the 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 March Note matured on June 7, 2018 and was extended to September 30, 2018. The conversion price and exercise price were subject
to adjustment upon stock splits, reverse stock splits, and similar capital changes. The Company made principal payments 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.
On
April 3, 2018, and May 11, 2018, the Company completed the 2018 Private Placement of $6.875 million of principal amount of the
2018 Debentures and warrants to purchase 916,667 shares of common stock of the Company 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, as discussed below. One
of the institutional investors that participated pursuant to 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 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 paid the
remaining balances of the 2018 Debentures on August 21, 2018 from proceeds of the PIA Financing.
On
September 26, 2018, the Company entered into an underwriting agreement with Roth under 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.
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.
If
we must further supplement our liquidity to support our operations in 2018, given our recent history of net operating losses and
negative cash flows, we do not believe that traditional banking indebtedness would be available to us given our recent operating
history. Our 2019 operating plan could include raising additional capital through an asset sale, a public offering or a private
placement of debt or equity, all of which are under consideration as part of our strategic alternatives. We have demonstrated
our ability to raise new debt or equity capital in recent years and most recently by the underwritten public offering in September
and PIA Financing in August 2018. If necessary, we believe that we could raise additional capital during the next 12 months if
required, but we can offer no assurances in this regard.
Further,
we had warrants outstanding exercisable to purchase 4,699,645 shares of common stock at a weighted average exercise price $5.54
per share outstanding as of September 30, 2018. In addition, there are common stock options outstanding exercisable to purchase
434,637 shares at an average price of $6.07 per share. We could potentially use such outstanding warrants to provide near-term
liquidity if and could induce their holders to exercise their warrants by adjusting/lowering the exercise price on a temporary
or permanent basis if the exercise price was below the then market price of our common stock, although we can offer no assurances
in this regard. Ultimately, we must restore profitable operations and positive cash flows to provide liquidity to support our
operations and, if necessary, to raise capital on commercially reasonable terms in 2019, although we can offer no assurances in
this regard.
Based
on the uncertainties described above, we believe our business plan does not alleviate the existence of substantial doubt about
our ability to continue as a going concern within one year after the date that the financial statements in this Report.
We
had $7,589,050 of available cash and equivalents and net working capital of $13,557,997 as of September 30, 2018. Net working
capital as of September 30, 2018 includes approximately $2.0 million of accounts receivable and $7.4 million of inventory.
Cash
and cash equivalents balances:
As of September 30, 2018, we had cash and cash equivalents with an aggregate balance of $7,589,050,
an increase from a balance of $54,712 at December 31, 2017. Summarized immediately below and discussed in more detail in the subsequent
subsections are the main elements of the $7,534,338 net increase in cash during the nine months ended September 30, 2018:
|
●
|
Operating
activities:
|
$4,077,492
of net
cash
used in
operating activities. Net cash used in operating activities was $4,077,492 and $5,763,948 for the nine
months ended September 30, 2018 and 2017, respectively, an improvement of $1,762,723. The improvement was primarily the result
of increases in non-cash charges such as changes in fair value of secured convertible debt and warrant derivative liabilities,
stock based compensation and decreases in inventory and increases in contract liabilities. Our goal is to increase revenues,
return to profitability and decrease our inventory levels during the remainder of 2018, thereby providing positive cash flows
from operations, although there can be no assurances that we will be successful in this regard.
|
|
|
|
|
|
●
|
Investing
activities:
|
$469,099
of net
cash
provided by
investing activities. Cash provided by investing activities was $469,099 for the nine months ended
September 30, 2018 compared to cash used in investing activities of $455,516 for the nine months ended September 30, 2017.
We satisfied the requirements to maintain a minimum cash balance of $500,000 on March 30, 2018 as defined in the Secured Convertible
Debenture (see Note 6) and the restriction was lifted and the funds became available for working capital needs. In 2018 and
2017, 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:
|
$11,142,731
of net
cash provided by
financing activities. Cash provided by financing activities was $11,142,731 and $2,652,514
for the nine months ended September 30, 2018 and 2017, respectively. On September 28, we received net proceeds of $7,324,900
from the common stock underwriting, which will be used for working capital and general corporate purposes. On July 31 and
August 21, 2018 we received $10,000,000 from the proceeds investment agreement which was used to repay the 2018 Debentures
and for general corporate purposes. On April 3, 2018 and May 11, 2018 we received proceeds of $6,250,000 from the 2018 Debentures
and warrants primarily for full repayment of the 2016 Debentures issued in December 2016 and other outstanding debt of the
company, working capital and general corporate purposes. On March 7, 2018, we received $250,000 of proceeds from the issuance
of the March Note for general working capital purposes. During 2015 we acquired capital equipment financed through capital
lease obligations and payments on such obligations represented the cash used in financing activities.
|
The
net result of these activities was an increase in cash of $7,534,338 to $7,589,050 for the nine months ended September 30, 2018.
Commitments:
We
had $7,589,050 of cash and cash equivalent balances and net working capital of $13,557,997 as of September 30, 2018. Accounts
receivable balances represented $2,006,116 of our net working capital at September 30, 2018. We intend to collect our outstanding
receivables on a timely basis during 2018, which would help to provide positive cash flow to support our operations during the
balance of 2018. Inventory represented $7,370,677 of our net working capital at September 30, 2018 and finished goods represented
$5,329,099 of total inventory. We are actively managing the overall level of inventory and our goal is to reduce such levels during
the balance of 2018 and in 2019 by our sales activities, which should provide additional cash flow to help support our operations
during 2018 and 2019.
Capital
Expenditures
.
We had no material commitments for capital expenditures at September 30, 2018.
Lease
Commitments-Operating Leases
. We have a non-cancelable long-term operating lease agreement for office and warehouse space
that expires in April 2020. We have also entered into month-to-month leases for equipment and facilities. Rent expense related
to these leases was $198,862 for the nine months ended September 30, 2018 and 2017. Following are our minimum lease payments for
each year and in total.
Year
ending December 31:
|
|
|
|
2018
(period from October 1, 2018 to December 31, 2018)
|
|
$
|
113,572
|
|
2019
|
|
|
457,327
|
|
2020
|
|
|
154,131
|
|
|
|
$
|
725,030
|
|
License
agreements.
We had several license agreements under which we had been assigned the rights to certain materials used in
our products. Certain of these agreements required 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 $6,250 for the three
months ended September 30, 2018 and 2017, respectively, and $2,083 and $14,938 for the nine months ended September 30, 2018 and
2017, respectively.
Litigation.
The
Company is subject to various legal proceedings arising from normal business operations. Although there can be no assurances,
based on the information currently available, management believes that it is probable that the ultimate outcome of each of the
actions will not have a material adverse effect on the consolidated financial statements of the Company. However, an adverse 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
addition to the infringement claims, the Company brought claims alleging that Axon conspired to keep the Company out of the marketplace
by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Axon bribed officials and otherwise conspired
to secure no-bid contracts for its products in violation of both state law and federal antitrust law. The Company’s lawsuit
also seeks monetary and injunctive relief, including treble damages, for these alleged violations.
Axon
filed an answer, which denied the patent infringement allegations on April 1, 2016. In addition, Axon filed a motion to dismiss
all allegations in the complaint on March 4, 2016 for which the Company filed an amended complaint on March 18, 2016 to address
certain technical deficiencies in the pleadings. Digital amended its complaint and Axon renewed its motion to seek dismissal of
the allegations that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation
of both state law and federal antitrust law on April 1, 2016. Formal discovery commenced on April 12, 2016 with respect to the
patent related claims. In January 2017, the Court granted Axon’s motion to dismiss the portion of the lawsuit regarding
claims that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state
law and federal antitrust law. On May 2, 2018, the Federal Circuit affirmed the District Court’s ruling and on October 1,
2018 the Supreme Court denied Digital Ally’s petition for review.
In
December 2016 and January 2017, Axon filed two petitions for
Inter Partes
Review (“IPR”) against the ‘452
Patent. The United States Patent and Trademark Office (“USPTO”) rejected both of Axon’s petitions. Axon is now
statutorily precluded from filing any more IPR petitions against the ‘452 Patent.
The
District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on November
17, 2017, the Federal District Court of Kansas rejected Axon’s request to maintain the stay. With this significant ruling,
the parties will now proceed towards trial. Since litigation has resumed, the Court has issued a claim construction order (also
called a
Markman
Order) where it sided with the Company on all disputes and denied Axon’s attempts to limit the scope
of the claims. Following the
Markman
Order, the Court set all remaining deadlines in the case. Fact discovery closed on
October 8, 2018, and the Final Pretrial Conference has been set for January 16, 2019.
WatchGuard
On
May 27, 2016 the Company filed suit against WatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent infringement based on
WatchGuard’s VISTA Wifi and 4RE In-Car product lines.
The
USPTO has granted multiple patents to the Company with claims covering numerous features, such as automatically activating all
deployed cameras in response to the activation of just one camera. Additionally, Digital Ally’s patent claims cover automatic
coordination as well as digital synchronization between multiple recording devices. It also has patent coverage directed to the
coordination between a multi-camera system and an officer’s smartphone, which allows an officer to more readily assess an
event on the scene while an event is taking place or immediately after it has occurred.
The
Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car product
lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the U.S Patent No.
8,781,292 (the “ ‘292 Patent”) and ‘452 Patents and U.S. Patent No. 9,325,950 the (“ ‘950
Patent”). The Company is aggressively challenging WatchGuard’s infringing conduct, seeking both monetary damages,
as well as seeking a permanent injunction preventing WatchGuard from continuing to sell its VISTA Wifi and 4RE In-Car product
lines using Digital Ally’s own technology to compete against it. On May 8, 2017, WatchGuard filed a petition seeking IPR
of the ‘950 Patent. The Company opposed that petition and on December 4, 2017, The Patent Trial and Appeal Board (“PTAB”)
rejected the request of WatchGuard Video to institute an IPR on the ‘950 Patent. The lawsuit also involves the ‘292
Patent and the ‘452 Patent, the ‘452 Patent being the same patent asserted against Axon. The ‘292 Patent previously
was subject to the IPR process with the USPTO, but in June 2018 the PTO found the ‘292 Patent valid and rejected Axon’s
arguments. WatchGuard had previously agreed to be bound by Axon’s IPRs and, as such, WatchGuard is now statutorily barred
from any further IPR’s challenges with respect to the ‘950, ‘452, and ‘292 Patents. Since the defeat of
Axon’s ‘292 Patent IPR, the Court has lifted the stay and set a schedule moving the case towards trial. Discovery
will close on December 17, 2018, and the Final Pretrial Conference will take place on April 9, 2019.
Utility
Associates, Inc.
On
October 25, 2013, the Company filed a complaint in the United States District Court for the District of Kansas (2:13-cv-02550-SAC)
to eliminate threats by a competitor, Utility Associates, Inc. (“Utility”), of alleged patent infringement regarding
U.S. Patent No. 6,831,556 (the “ ‘556 Patent”). Specifically, the lawsuit seeks a declaration that the Company’s
mobile video surveillance systems do not infringe any claim of the ‘556 Patent. The Company became aware that Utility had
mailed letters to current and prospective purchasers of its mobile video surveillance systems threatening that the use of such
systems purchased from third parties not licensed to the ‘556 Patent would create liability for them for patent infringement.
In
addition, the Company began proceedings to invalidate the ‘556 Patent through a request for IPR of the ‘556 patent
at the USPTO. On July 27, 2015, the USPTO invalidated key claims in Utility’s ‘556 Patent. The Final Decision from
the USPTO significantly curtailed Utility’s ability to threaten law enforcement agencies, municipalities, and others with
infringement of the ‘556 Patent. Utility appealed this decision to the United States Court of Appeals for the Federal Circuit.
The United States Court of Appeals for the Federal affirmed the ruling of the USPTO summarily thus concluding the matter.
On
June 6, 2014 the Company filed a separate Unfair Competition lawsuit against Utility in the United States District Court for the
District of Kansas. In that lawsuit it contended that Utility has disparaged the Company and illegally interfered with its contracts,
customer relationships and business expectancies by falsely asserting to its customers and others that its products violate the
‘556 Patent, of which Utility claims to be the holder. In addition to damages, the Company sought permanent injunctive relief,
prohibiting Utility from continuing to threated or otherwise interfere with the Company’s customers. On March 4, 2015, an
initial hearing was held upon the Company’s request for injunctive relief.
Based
upon facts revealed at a March 4, 2015 injunction hearing, on March 16, 2015, the Company sought leave to amend its Complaint
in the unfair competition suit to assert additional claims against Utility. Those new claims included claims of actual or attempted
monopolization, in violation of § 2 of the Sherman Act, claims arising under a new Georgia statute that prohibits threats
of patent infringement in “bad faith,” and additional claims of unfair competition/false advertising in violation
of § 63(a) of the Lanham Act. The Court concluded its injunction hearing on April 22, 2015, and allowed the Company leave
to add these claims, but denied its preliminary injunction. Subsequent to the injunction hearing, Utility withdrew from the market
the in-car video recording device that it had sold in competition with the Company’s own products of similar function and
which Utility had attempted to market using threats of patent infringement. After discovery closed, Utility filed a Motion for
Summary Judgment and the Company filed a Motion for Partial Summary Judgment. On March 30, 2017, the Court entered its order granting
Utility’s motion and denying the Company’s motion for summary judgment. The Company believed the District Court had
made several errors when ruling on the motions for summary judgment, and filed an appeal to the United States Court of Appeals
for the Tenth Circuit (10
th
Circuit”). While the appeal was pending, Utility filed a motion for the recovery
from the Company of some $800,000 in alleged attorney’s fees as provided, purportedly, under the Lanham Patent and Uniform
Trade Secrets Act. That motion was denied in its entirety by final judgement of the District Court entered February 14, 2018.
On February 16, 2018, the 10
th
Circuit issued its decision affirming the decision of the District Court. The Company
filed a petition for rehearing by the panel and en banc, which was denied. Thereafter, Utility its own motion for the recovery
of attorney fees, on appeal in the alleged amount of $125,000. That motion was denied by the 10th Circuit. In the District Court,
Utility failed or declined to file any request for the recovery of costs and the time for the award thereof, as well as for any
further appeal by either party, has now expired.
The
Company is also involved as a plaintiff and defendant in ordinary, routine litigation and administrative proceedings incidental
to its business from time to time, including customer collections, vendor and employment-related matters. The Company believes
the likely outcome of any other pending cases and proceedings will not be material to its business or its financial condition.
Sponsorship.
On April 16, 2015 the Company entered into a Title Sponsorship Agreement (the “Agreement”) under which it
became the title sponsor for a Web.com Tour golf tournament (the “Tournament”) held annually in the Kansas City Metropolitan
area. The Agreement provides the Company with naming rights and other benefits for the 2015 through 2019 annual Tournament in
exchange for the following sponsorship fee:
Year
|
|
|
Sponsorship
fee
|
|
|
2015
|
|
|
$
|
375,000
|
|
|
2016
|
|
|
$
|
475,000
|
|
|
2017
|
|
|
$
|
475,000
|
|
|
2018
|
|
|
$
|
500,000
|
|
|
2019
|
|
|
$
|
500,000
|
|
The
Company has the right to sell and retain the proceeds from the sale of additional sponsorships, including but not limited to a
presenting sponsorship, a concert sponsorship and founding partnerships for the Tournament. The Company recorded a net sponsorship
expense of $0 and $6,595 for the six months ended June 30, 2018 and 2017. The Company is negotiating with the Web.com Tour golf
tournament officials to terminate the Agreement and the sponsorship fee commitments for the 2018 and 2019 Tournaments. There can
be no assurance that it will be successful in negotiating the termination of this sponsorship agreement or that if successful
in such negotiations, on terms acceptable or favorable to the Company.
401
(k) Plan.
In July 2008, the Company amended and restated its 401(k) retirement savings plan. The amended plan requires
the Company to provide 100% matching contributions for employees who elect to contribute up to 3% of their compensation to the
plan and 50% matching contributions for employee’s elective deferrals on the next 2% of their contributions. The Company
has made matching contributions totaling $26,680 and $43,455 for the three months ended September 30, 2018 and 2017, respectively,
and $85,028 and $137,781 for the nine months ended September 30, 2018 and 2017, 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 paid amounts to the LLC as advance against commissions ranging from $5,000 to $6,000 per month plus necessary and
reasonable expenses for the period through June 30, 2017, which can be automatically extended based on the LLC achieving minimum
sales quotas. The agreement was renewed in January 2017 for a period of three years, subject to yearly minimum sales thresholds
that would allow the Company to terminate the contract if such minimums are not met. As of September 30, 2018, the Company had
advanced a total of $280,807 pursuant to this agreement and established an allowance reserve of $85,835 for a net advance of $194,212.
The minimum sales threshold has not been met, and the Company has discontinued all advances, although the contract has not been
formally 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.
As of September 30, 2018, the Company had advanced a total of $37,360 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;
|
|
|
|
|
●
|
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.
We recognize revenue under the core principle to depict the transfer of
control our customers in an amount reflecting the consideration to which we expect to be entitled. In order to achieve that core
principle, we apply the following five –step approach:
|
(i)
|
Identify
the contract with the customer;
|
|
|
|
|
(ii)
|
Identify
the performance obligations in the contract;
|
|
|
|
|
(iii)
|
Determine
the transaction price;
|
|
|
|
|
(iv)
|
Allocate
the transaction price to the performance obligations in the contract; and
|
|
|
|
|
(v)
|
Recognize
revenue when a performance obligation is satisfied.
|
We
consider the terms and conditions of the contract and our customary business practices in identifying our contracts under ASC
606. We determine we have a contract when the customer order is approved, we can identify each party’s rights regarding
the services to be transferred, we can identify the payment terms for the services, we have determined the customer has the ability
and intent to pay and the contract has commercial substance. At contract inception we evaluate whether the contract includes more
than one performance obligation. We apply judgment in determining the customer’s ability and intent to pay, which is based
on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit
and financial information pertaining to the customer.
Performance
obligations promised in a contract are identified based on the services and the products that will be transferred to the customer
that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with
other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby
the transfer of the services and the products is separately identifiable from other promises in the contract. Our performance
obligations consist of (i) products, (ii) professional services, and (iii) extended warranties.
The
transaction price is determined based on the consideration to which we expect to be entitled in exchange for transferring services
to the customer. Variable consideration is included in the transaction price if, in our judgment it is probable that a significant
future reversal of cumulative revenue under the contract will not occur. None of our contracts contain a significant financing
component.
If
the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation.
Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation
based on the relative standalone selling price (“SSP”).
Revenue
is recognized at the time the related performance obligation is satisfied by transferring the control of the promised service
to a customer. Revenue is recognized when control of the service is transferred to the customer, in an amount that reflects the
consideration that we expect to receive in exchange for our services. We generate all our revenue from contracts with customers.
We
review all significant, unusual or nonstandard shipments of product or delivery of services as a routine part of our accounting
and financial reporting process to determine compliance with these requirements. Extended warranties are offered on selected products
and when a customer purchases an extended warranty the associated proceeds are treated as contract liability and recognized over
the term of the extended warranty.
Our
principal customers are state, local and federal law enforcement agencies, which historically have been low risks for uncollectible
accounts. However, we do 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
$226.0 million since we commenced deliveries during 2006. As of September 30, 2018 and December 31, 2017, we had provided a reserve
for doubtful accounts of $70,000.
We
periodically perform a specific review of significant individual receivables outstanding for risk of loss due to uncollectibility.
Based on such review, we consider our reserve for doubtful accounts to be adequate as of September 30, 2018. 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 September 30, 2018 and December 31, 2017:
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
Raw
material and component parts
|
|
$
|
4,462,562
|
|
|
$
|
4,621,704
|
|
Work-in-process
|
|
|
268,989
|
|
|
|
155,087
|
|
Finished
goods
|
|
|
5,329,099
|
|
|
|
6,964,624
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
10,060,650
|
|
|
|
11,741,415
|
|
Reserve
for excess and obsolete inventory
|
|
|
(2,689,973
|
)
|
|
|
(2,990,702
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
7,370,677
|
|
|
$
|
8,750,713
|
|
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 26.7% of the gross inventory balance at September 30, 2018, compared to 25.5% of the gross inventory balance at December
31, 2017. We had $2,689,973 and $2,990,702 in reserves for obsolete and excess inventories at September 30, 2018 and December
31, 2017, respectively. Total raw materials and component parts were $4,462,562 and $4,621,704 at September 30, 2018 and December
31, 2017, respectively, a decrease of $159,142 (3%). The decrease in raw materials was mostly in parts for FirstVU HD products.
Finished goods balances were $5,329,099 and $6,964,624 at September 30, 2018 and December 31, 2017, respectively, a decrease of
$1,635,525 (23%). The decrease in finished goods was primarily in our DVM-750 product line, test and evaluation and replacement
inventory. The decrease in the inventory reserve is primarily due to the reduction of test and evaluation and replacement inventory
levels which were partially reserved. We believe the reserves are appropriate given our inventory levels at September 30, 2018.
If
actual future demand or market conditions are less favorable than those projected by management or significant engineering changes
to our products that are not anticipated and appropriately managed, additional inventory write-downs may be required in excess
of the inventory reserves already established.
Warranty
Reserves.
We generally provide up to a two-year parts and labor warranty on our products to our customers. Provisions
for estimated expenses related to product warranties are made at the time products are sold. These estimates are established using
historical information on the nature, frequency, and average cost of claims. We actively study trends of claims and take action
to improve product quality and minimize claims. Our warranty reserves were decreased to $186,766 as of September 30, 2018 compared
to $325,001 as of December 31, 2017 primarily for expected replacements associated with select FirstVU HD customers. We have limited
experience with the FirstVU HD and DVM-800 and will monitor our reserve for all warranty claims related to these two newer products.
There is a risk that we will have higher warranty claim frequency rates and average cost of claims than our history has indicated
on our legacy mirror products on our new products for which we have limited experience. Actual experience could differ from the
amounts estimated requiring adjustments to these liabilities in future periods.
Stock-based
Compensation Expense
.
We grant stock options to our employees and directors and such benefits provided are share-based
payment awards which require us to make significant estimates related to determining the value of our share-based compensation.
Our expected stock-price volatility assumption is based on historical volatilities of the underlying stock which are obtained
from public data sources and there were not any options granted during the nine months ended September 30, 2018.
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, 2017, cumulative valuation
allowances in the amount of $18,070,000 were recorded in connection with the net deferred income tax assets. Based on a review
of our deferred tax assets and recent operating performance, we determined that it was appropriate to continue to provide a full
valuation reserve on our net deferred tax assets as of September 30, 2018 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 September 30, 2018 representing uncertain tax positions.
We
have generated substantial deferred income tax assets related to our operations primarily from the charge to compensation expense
taken for stock options, certain tax credit carryforwards and net operating loss carryforwards. For us to realize the income tax
benefit of these assets, we must generate sufficient taxable income in future periods when such deductions are allowed for income
tax purposes. In some cases where deferred taxes were the result of compensation expense recognized on stock options, our ability
to realize the income tax benefit of these assets is also dependent on our share price increasing to a point where these options
have intrinsic value at least equal to the grant date fair value and are exercised. In assessing whether a valuation allowance
is needed in connection with our deferred income tax assets, we have evaluated our ability to generate sufficient taxable income
in future periods to utilize the benefit of the deferred income tax assets. We continue to evaluate our ability to use recorded
deferred income tax asset balances. If we fail to generate taxable income for financial reporting in future years, no additional
tax benefit would be recognized for those losses, since we will not have accumulated enough positive evidence to support our ability
to utilize net operating loss carryforwards in the future. Therefore, we may be required to increase our valuation allowance in
future periods should our assumptions regarding the generation of future taxable income not be realized.
Determination
of Fair Value for Financial Instruments and Derivatives.
During 2018 and 2016 we issued Secured Convertible Debentures
with detachable warrants to purchase common stock and in 2014 in two separate transactions we issued a total of $6.0 million of
Secured Convertible Notes with detachable warrants to purchase common stock. Additionally, in July and August 2018 we entered
into the proceeds investment agreement (PIA). We elected to record the PIA, 2018 and 2016 Debentures and 2014 Secured Convertible
Notes on their fair value basis. In addition, the warrants to purchase common stock issued in conjunction with the 2014 Secured
Convertible Notes contained anti-dilution provisions that required them to be accounted for as derivative liabilities. We were
required to determine the fair value of these financial instruments outstanding as of September 30, 2018 for financial reporting
purposes. The entire principal balance of the Secured Convertible Notes issued in 2014 has been converted to equity and all warrants
have been exercised Additionally, the 2018 and 2016 Secured Debentures have been paid off or converted to equity. 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 September 30, 2018.
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds
investment agreement
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
9,166,000
|
|
|
$
|
9,166,000
|
|
Going
Concern Analysis.
In
accordance with ASU 2014-15,
Presentation of Financial Statements- Going Concern
(Subtopic 205-40) – Disclosure of
Uncertainties about an Entity’s Ability to Continue as a Going Concern, we are required to evaluate whether there are conditions
or events, considered in the aggregate, that raise substantial doubt about our ability to continue as a going concern within one
year after the date that our financials are issued. When management identifies conditions or events that raise substantial doubt
about their ability to continue as a going concern it should consider whether its plans to mitigate those relevant conditions
or events will alleviate the substantial doubt. If conditions or events raise substantial doubt about an entity’s ability
to continue as a going concern, but the substantial doubt is alleviated as a result of management’s plans, the entity should
disclose information that enables user of financial statements to understand the principal events that raised the substantial
doubt, management’s evaluation of the significance of those conditions or events, and management’s plans that alleviated
substantial doubt about the entity’s ability to continue as a going concern.
We
performed the analysis and our overall assessment was there were conditions or events, considered in the aggregate as of September
30, 2018, which raised substantial doubt about our ability to continue as a going concern within the next twelve months but such
doubt was not adequately mitigated by our plans to address the substantial doubt as disclosed in Note 1: Management’s Liquidity
Plan.
Inflation
and Seasonality
Inflation
has not materially affected us during the past fiscal year. We do not believe that our business is seasonal in nature however;
we usually generate higher revenues during the second half of the calendar year than in the first half.