Part
I
Item
1. Business.
Overview
Digital
Ally produces digital video imaging and storage products for use in law enforcement, security and commercial applications. Our
current products are an in-car digital video/audio recorder contained in a rear-view mirror for use in law enforcement and commercial
fleets, a system that provides our law enforcement customers with audio/video surveillance from multiple vantage points and hands-free
automatic activation of body-worn cameras and in-car video systems; a weather-resistant mobile digital video recording system
for use on motorcycles, ATV’s and boats, a miniature digital video system designed to be worn on an individual’s body;
a hand-held laser speed detection device that it is offering primarily to law enforcement agencies; and cloud storage solutions.
We have active research and development programs to adapt its technologies to other applications. We have the ability to integrate
electronic, radio, computer, mechanical, and multi-media technologies to create unique solutions to address needs in a variety
of other industries and markets, including mass transit, school bus, taxi cab and the military. We sell our products to law enforcement
agencies and other security organizations, and consumer and commercial fleet operators through direct sales domestically and third-party
distributors internationally. We have several new and derivative products in research and development that we anticipate will
begin commercial production during 2017.
Corporate
History
We
were incorporated in Nevada on December 13, 2000 as Vegas Petra, Inc. From that date until November 30, 2004, when we entered
into a Plan of Merger with Digital Ally, Inc., a Nevada corporation which was formerly known as Trophy Tech Corporation (the “Acquired
Company”), we had not conducted any operations and were a closely-held company. In conjunction with the merger, we were
renamed Digital Ally, Inc.
The
Acquired Company, which was incorporated on May 16, 2003, engaged in the design, development, marketing and sale of bow hunting-related
products. Its principal product was a digital video recording system for use in the bow hunting industry. It changed its business
plan in 2004 to adapt its digital video recording system for use in the law enforcement and security markets. We began shipments
of our in-car digital video rear view mirror in March 2006.
On
January 2, 2008, we commenced trading on the NASDAQ Capital Market under the symbol “DGLY.” We conduct our business
from 9705 Loiret Boulevard, Lenexa, Kansas 66219. Our telephone number is (913) 814-7774.
Products
We
produce and sell digital audio/video recording, storage and other products in law enforcement and commercial applications. These
product series have been used primarily in law enforcement and private security applications, both of which use the core competency
of our technology in digital video compression, recording and storage. During 2011, we completed the launch of several derivative
products as “event recorders” that can be used in taxi cab, limousine, ambulance and other commercial fleet vehicle
applications which served to greatly diversify our addressable market. We have launched additional derivative products during
2012 through 2016 that address law enforcement, private security and commercial fleet applications. We also intend to produce
and sell other digital video products in the future that will continue to expand our reach beyond the traditional law enforcement,
private security and commercial fleet applications. We have developed and continue to develop both local server and cloud based
storage, archiving and search capabilities that provide customers with innovative, useful and secure methods to store and maintain
their audio/video data. These products incorporate our standards-based digital compression capability that allows the recording
of significant time periods on a chip and circuit board which can be designed into small forms and stored. The following describes
our product portfolio.
In-Car
Digital Video Mirror System for law enforcement – DVM-100, DVM-400, DVM-750, DVM-800 and DVM-800 HD
In-car
video systems for patrol cars are now a necessity and have generally become standard. Current systems are primarily digital based
systems with cameras mounted on the windshield and the recording device generally in the trunk, headliner, dashboard, console
or under the seat of the vehicle. Most manufacturers have already developed and transitioned completely to digital video, but
some have not transitioned totally to a fully solid-state digital system and continue to rely on hard-drive or DVD based systems
which are less reliable and susceptible to heat, cold and vibration.
Our
digital video rear view mirror unit is a self-contained video recorder, microphone and digital storage system that is integrated
into a rear-view mirror, with a monitor, GPS and 900 MHz audio transceiver. Our system is more compact and unobtrusive than certain
of our competitors because it requires no recording equipment to be located in other parts of the vehicle.
Our
in-car digital video rear view mirror has the following features:
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wide
angle zoom color camera;
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standards-based
video and audio compression and recording;
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system
is concealed in the rear view mirror, replacing factory rear view mirror;
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monitor
in rear-view mirror is invisible when not activated;
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eliminates
need for analog tapes to store and catalogue;
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easily
installs in any vehicle;
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ability
to integrate with body-worn cameras including auto-activation of either system;
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archives
audio/video data to the cloud, computers (wirelessly) and to compact flash memory, or file servers;
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900
MHz audio transceiver with automatic activation;
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marks
exact location of incident with integrated GPS;
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playback
using Windows Media Player;
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optional
wireless download of stored video evidence;
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proprietary
software protects the chain of custody;
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and
records to rugged and durable solid state memory.
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Compact
HD Quality In-Car Digital Video (not in a rear-view mirror)- MicroVu HD for law enforcement
The
MicroVu is a compact in-car video system that is mobile (not mounted in a rear-view mirror) which provides up to 1080p HD video
recording. The MicroVu is very compact as the complete system is only 4” long by 1” high. The MicroVu is designed
for simple installation and features advanced automatic login (RFID log-in) and interoperability with our body cameras through
our VuLink products. The primary user of the MicroVu system is law enforcement although derivative models may appeal to the commercial
fleet market in particular the over the road trucking market.
In-Car
Digital Video “Event Recorder” System –DVM-250 Plus for Commercial Fleets
Digital
Ally provides commercial fleets and commercial fleet managers with the digital video tools they need to increase driver safety,
track assets in real-time and minimize the company’s liability risk all while enabling fleet managers to operate the fleet
at an optimal level. We market a product designed to address these commercial fleet markets with our DVM-250 Plus event recorders
that provides all types of commercial fleets with features and capabilities that are fully-customizable, consistent with their
specific application and inherent risks. The DVM-250 Plus is a rear-view mirror based digital audio and video recording system
with many, but not all of, the features of our DVM-800 law enforcement mirror systems at a lower price point. The DVM-250 Plus
is designed to capture “events,” such as wrecks and erratic driving or other abnormal occurrences, for evidentiary
or training purposes. These markets may find our units attractive from both a feature and cost perspective, compared to other
providers. Our marketing efforts indicate that these commercial fleets are adopting this technology, in particular the ambulance
and taxi-cab markets.
Digital
Ally offers a suite of data management web-based tools to assist fleet managers in the organization, archival, and management
of videos and telematics information. Within the suite, there are powerful mapping and reporting tools that help optimize efficiency,
serve as excellent training tools for teams on safety and ultimately generate a significant return on investment for the organization.
Miniature
Body-Worn Digital Video System – FirstVU HD for law enforcement and private security
This
system is also a derivative of our in-car video systems, but is much smaller and lighter and more rugged and water-resistant to
handle a hostile outdoor environment. These systems can be used in many applications in addition to law enforcement and private
security and are designed specifically to be clipped to an individual’s pocket or other outer clothing. The unit is self-contained
and requires no external battery or storage devices. Current systems offered by competitors are digital based, but generally require
a battery pack and/or storage device to be connected to the camera by wire or other means. We believe that our FirstVU HD product
is more desirable for potential users than our competitors’ offerings because of its video quality, small size, shape and
lightweight characteristics
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Our FirstVU HD integrates with our in-car video systems through our patented VuLink system
allowing for automatic activation of both systems.
VuLink,
VuVault.net and FleetVU Manager
The
VuLink system provides our law enforcement customers with audio/video surveillance from multiple vantage points in order to more
fully capture an event and it allows the operator to quickly and easily reassemble the various recording devices. The VuLink enables
body cameras and in-car video systems to be automatically or manually activated simultaneously.
VuVault.net
is a cost-effective, fully expandable, law enforcement cloud storage solution powered by Amazon Web Services that provides CJIS
compliant redundant, and security-enhanced storage of all uploaded videos.
FleetVU
Manager is our web-based software for commercial fleet tracking and monitoring that features and manages video captured by our
Video Event Data Recorders of incidents that require attention, such as accidents. This software solution features our cloud-based
web portal that utilizes many of the features of our VUVault.NET law-enforcement cloud-based storage solution.
Hand-Held
Speed Detection System – Laser Ally
This
system is a lightweight, hand-held speed detection device that uses LIDAR (Light Detection and Ranging) technology rather than
the traditional radar systems, which use sound waves. LIDAR systems are used in high congestion traffic areas that require extreme
accuracy and identification of the subject vehicles. This system uses new technology that prevents the Laser Ally from being detected
by current detectors or jammed by current jamming devices. This system was developed and manufactured by a third party vendor
for us.
Other
Products
During
the last year, we have focused our research and development efforts to meet the varying needs of our customers, enhance our existing
products and commence development of new products and product categories. Our research and development efforts are intended to
maintain and enhance our competitiveness in the market niche we have carved out, as well as positioning us to compete in diverse
markets outside of law enforcement.
Market
and Industry Overview
Historically,
our primary market has been domestic and international law enforcement agencies. In 2012, we expanded our scope by pursuing the
commercial fleet vehicle and mass transit markets. In the future, given sufficient capital and market opportunity, we may address
markets for private security, homeland security, mass transit, healthcare, general retail, general consumer and other commercial
markets. We have made inroads into certain commercial fleet and the ambulance service provider market, confirming that our DVM-250
Plus product and FleetVU Manager can become a significant revenue producer for us.
Law
Enforcement
We
believe that law enforcement already recognizes a valuable use of our various digital audio/video products for the recording of
roadside sobriety tests. Without some form of video or audio recording, court proceedings usually consist of the police officer’s
word against that of the suspect. Records show that conviction rates increase substantially where there is video evidence to back
up officer testimony. Video evidence also helps to protect police departments against frivolous lawsuits.
The
largest source of police video evidence today is in-car video. Unfortunately, some police cars still do not have in-car video,
and in those that do, the camera usually points forward rather than to the side of the road where the sobriety test takes place.
The in-car video is typically of little use for domestic violence investigations, burglary or theft investigations, disorderly
conduct calls or physical assaults. In all of these cases, the FirstVU HD may provide recorded evidence of the suspect’s
actions and reactions to police intervention.
Additionally,
motorcycle patrolmen rarely have video systems. We have developed the DVM-440 Ultra as a mobile application of our digital video
recording system that can be used by motorcycle police and water patrol.
Crime
scene investigations, including detailed photography, are typically a large part of the budgets of metropolitan police forces.
The FirstVU may record a significant portion of such evidence at a much lower cost for gathering, analyzing and storing data and
evidence.
Commercial
and Other Markets
There
are numerous potential applications for our digital audio/video camera products. We believe that other markets for our digital
video systems, including the derivatives currently being developed, include private investigators, SWAT team members, over-the-road
trucking fleets, airport security, municipal fire departments, and the U.S. military. Other commercial markets for our digital
video systems include real estate appraisers, plumbers and electricians.
Schools
We
believe our products and offerings may be of benefit in kindergarten through twelve grade school systems. We are currently assessing
our entry into this potential market through several pilot tests. Preliminary results have been positive and we believe this new
market will represent a substantial new addressable market for our mobile audio/video recording products in 2017.
Medical
applications
We
believe our products and offerings may be of benefit in hospital and other medical services delivery systems. We are currently
assessing our entry into this potential market.
Private
Security Companies
There
are thousands of private security agencies in the United States employing a large number of guards. Police forces use video systems
for proof of correct conduct by officers, but private security services usually have no such tool. We believe that the FirstVU
HD is an excellent management tool for these companies to monitor conduct and timing of security rounds. In addition to the FirstVU
HD, the digital video security camera can provide fill-in security when guards have large areas to cover or in areas that do not
have to be monitored around the clock.
Homeland
Security Market
In
addition to the government, U.S. corporations are spending heavily for protection against the potential of terrorist attacks.
Public and private-sector outlays for antiterrorism measures and for protection against other forms of violence are significant.
These are potential markets for our products.
Manufacturing
We
have entered into contracts with manufacturers for the assembly of the printed circuit boards used in our products. Dedicated
circuit board manufacturers are well-suited to the assembly of circuit boards with the complexity found in our products. Dedicated
board manufacturers can spread the extensive capital equipment costs of circuit board assembly among multiple projects and customers.
Such manufacturers also have the volume to enable the frequent upgrade to state-of-the-art equipment. We have identified multiple
suppliers who meet our quality, cost, and performance criteria. We also use more than one source for circuit board assembly to
ensure a reliable supply over time. We use contract manufacturers to manufacture our component subassemblies and may eventually
use them to perform final assembly and testing. Due to the complexity of our products, we believe that it is important to maintain
a core of knowledgeable production personnel for consistent quality and to limit the dissemination of sensitive intellectual property
and will continue this practice. In addition, such technicians are valuable in our service and repair business to support our
growing installed customer base.
We
also contract with two manufacturers that have manufacturing facilities in Asia for the production of our DVM-100, DVM-400, DVM-250
Plus, DVM-800 and DVM-800 HD products. The contracts are general in nature addressing confidentiality and other matters, have
no minimum purchase requirements and require the acceptance of specific purchase orders to support any product supply acquisitions.
We have started using additional contract manufacturers based in the United States for these product lines to further mitigate
any supply disruption risk and ensure competitive pricing. We typically perform final assembly, testing and quality control functions
for these products in our Lenexa, Kansas facility.
License
Arrangements
We
have entered into several agreements, including agreements with Sasken-Ingenient Technologies, Inc. (“Sasken”), Lead
Technologies (“Lead”) and Pixel Forensics, Inc. (“Pixel), to license certain software products to be used in
our video products. The licensors have written certain software for specific Texas Instrument chips which are included in our
products or media analytics such as face redaction software. The licenses generally require upfront payments and contain automatic
renewal provisions unless either party notifies the other of its intent to not renew prior to expiration or unless the agreement
is terminated due to a material breach by the other party.
The
following is a summary of our license agreements as of December 31, 2016:
License
Type
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Effective
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Expiration
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Terms
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Production
software license agreement
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April
2005
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April
2017
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Automatically
renews for one year periods unless terminated by either party.
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Software
sublicense agreement
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October
2007
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October
2017
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Automatically
renews for one year periods unless terminated by either party.
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Software
development and software services agreement
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June
2015
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June
2017
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Renewable
by mutual agreement of the parties unless terminated by Digital Ally for convenience.
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Sales
and Marketing
In
recent years, we have changed principally to an employee-based, direct sales force for domestic selling efforts that enables us
to control and monitor its daily activities. In this connection, we have reduced the size of certain territories and consequently
increased the sales personnel and changed the number of domestic sales territories to 21 in order to better penetrate the market.
The direct territory sales team is supported by a team of eight inside sales coordinators, and a telesales specialist and a pre-sales
solution design team. We have also added a bid specialist to coordinate large bid opportunities. We believe our employee-based
model encourages our sales personnel in lower performing territories to improve their efforts and, consequently, their sales results.
Our executive team also supports sales agents with significant customer opportunities by providing pricing strategies and customer
presentation assistance. Our technical support personnel may also provide sales agents with customer presentations and product
specifications in order to facilitate sales activities.
We
use our direct sales force and international distributors to market our products. Our key promotional activities include:
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attendance
at industry trade shows and conventions;
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direct
sales, with a force of industry-specific sales individuals who identify, call upon and build on-going relationships with key
purchasers and targeted industries;
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support
of our direct sales with passive sales systems, including inside sales and e-commerce;
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print
advertising in journals with specialized industry focus;
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direct
mail campaigns targeted to potential customers;
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web
advertising, including supportive search engines and website and registration with appropriate sourcing entities;
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public
relations, industry-specific venues, as well as general media, to create awareness of our brand and our products, including
membership in appropriate trade organizations; and
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brand
identification through trade names associated with us and our products.
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Competition
The
law enforcement and security surveillance markets are extremely competitive. Competitive factors in these industries include ease
of use, quality, portability, versatility, reliability, accuracy and cost. There are direct companies with competitive technology
and products in the law enforcement and surveillance markets for all of our products and those we have in development. Many of
these competitors have significant advantages over us, including greater financial, technical, marketing and manufacturing resources,
more extensive distribution channels, larger customer bases and faster response times to adapt new or emerging technologies and
changes in customer requirements. Our primary competitors include L-3 Mobile-Vision, Inc., Coban Technologies, Inc., Watchguard,
Kustom Signals, Panasonic System Communications Company, International Police Technologies, Inc. and a number of other competitors
who sell or may in the future sell in-car video systems to law enforcement agencies. Our primary competitors in the body-worn
camera market include TASER International, Inc. (“Taser”), Reveal Media and VieVU, Inc. We face similar and intense
competitive factors for our event recorders in the mass transit markets as we do in the law enforcement and security surveillance
markets. We will also compete with any company making surveillance devices for commercial use. There can be no assurance that
we will be able to compete successfully in these markets. Further, there can be no assurance that new and existing companies will
not enter the law enforcement and security surveillance markets in the future.
The
commercial fleet security and surveillance markets likewise are also very competitive. There are direct competitors for our DVM-250
Plus “event recorders,” which several may have greater financial, technical marketing, and manufacturing resources
than we do. Our primary competitors in the commercial fleet sector include Lytx, Inc. (previously DriveCam, Inc.) and SmartDrive
Systems.
Intellectual
Property
Our
ability to compete effectively will depend on our success in protecting our proprietary technology, both in the United States
and abroad. We have filed for patent protection in the United States and certain other countries to cover certain design aspects
of our products. However, we license the critical technology on which our products are based from third parties, including Sasken-Ingenient
Technologies, Inc., Pixel Forensics and Lead Technologies.
Some
of our patent applications are still under review by the U.S. Patent Office and, therefore, we have not yet been issued all of
the patents that we applied for in the United States. We were issued several patents in recent years, including a patent on our
VuLink product which provides automatic bi-directional triggering of our body-worn camera and our in-car video systems. No assurance
can be given which, or any, of the patents relating to our existing technology will be issued from the United States or any foreign
patent offices. Additionally, no assurance can be given that we will receive any patents in the future based on our continued
development of our technology, or that our patent protection within and/or outside of the United States will be sufficient to
deter others, legally or otherwise, from developing or marketing competitive products utilizing our technologies.
We
have entered into supply and distribution agreements with several companies that produce certain of our products, including our
DVM-100, DVM-250, DVM-400, DVM-800 and DVM-800 HD products. These supply and distribution agreements contain certain confidentiality
provisions that protect our proprietary technology, as well as that of the third party manufacturers.
In
addition to seeking patent protection, we rely on trade secrets, know-how and continuing technological advancement to seek to
achieve and thereafter maintain a competitive advantage. Although we have entered into or intend to enter into confidentiality
and invention agreements with our employees, consultants and advisors, no assurance can be given that such agreements will be
honored or that we will be able to effectively protect our rights to our unpatented trade secrets and know-how. Moreover, no assurance
can be given that others will not independently develop substantially equivalent proprietary information and techniques or otherwise
gain access to our trade secrets and know-how.
Taser,
a competitor in our body-camera market, requested that the United States Patent & Trademark Office (“USPTO”) commence
an
ex parte
reexamination of our U.S. Patent No. 8,781,292 (‘292 Patent). The USPTO granted this request and has
completed its reexamination. The USPTO has confirmed the validity of our ‘292 patent which relates to our auto-activation
technology for law enforcement body cameras. We have filed suit in the U.S. District Court for the District of Kansas against
Taser, alleging willful patent infringement against Taser’s Axon body camera product line. On February 2, 2016, we received
notification that the USPTO has issued another patent relating to our auto-activation technology for law enforcement cameras.
U.S. Patent No. 9,253,452 (“the ‘452 patent”) generally covers the automatic activation and coordination of
multiple recording devices in response to a triggering event, such as a law enforcement officer activating the light bar on the
vehicle. We have added Taser’s willful infringement of the ‘452 patent to our existing lawsuit. Taser has recently
requested that the USPTO institute new
Inter Partes Reviews
(“IPR”) of our ‘292 patent and we have filed
an objection to the USPTO instituting the IPR.
Despite
the USPTO’s recognition of the validity of the ‘292 patent and ‘452 patent, TASER continues to offer for sale,
sell, and market its Axon technology in disregard of our federally protected patent rights. As a result, we are aggressively challenging
Taser’s infringing conduct in our lawsuit against it, seeking both monetary damages and a permanent injunction preventing
Taser from continuing to sell its Axon Signal technology.
On
May 27, 2016 we filed suit against Enforcement Video, LLC d/b/a WatchGuard Video (“WatchGuard”), alleging patent infringement
of our ‘292 patent based on WatchGuard’s VISTA Wifi and 4RE In-Car product lines. We intend to aggressively challenge
Watchguard’s infringing conduct in our lawsuit against it, seeking both monetary damages and a permanent injunction preventing
Watchguard from continuing to sell its auto-activation technology embodied within its body-worn and in-car video systems. The
Company is reviewing other competitors products for possible infringement of the ‘292’ patent but have not commenced
any additional actions at this point in time.
We
believe the outcome of these infringement lawsuits, and in particular the Taser lawsuit will have meaningful effects upon the
entire body-worn camera market within the United States over the foreseeable future. The auto-activation technology protected
by our ‘292 patent is quickly becoming standard within the industry, therefore if we are successful in challenging Taser
and Watchguard’s infringing conduct, it will have a substantial and positive impact upon our future revenue streams.
Employees
We
had 154 full-time employees as of December 31, 2016. Our employees are not covered by any collective bargaining agreement and
we have never experienced a work stoppage. We believe that our relations with our employees are good.
Item
1A.
Risk Factors.
Not
applicable.
Item
1B. Unresolved Staff Comments.
None.
Item
2. Properties.
We
entered into a non-cancellable, long-term facility lease in September 2012 to combine all of our operations into one location,
commencing in November 2012. Our facility contains approximately 33,776 square feet and is located at 9705 Loiret Boulevard, Lenexa,
Kansas 66219. The lease will terminate on April 1, 2020. The monthly rent ranges from $35,634 to $38,533 over the term.
Item
3. Legal Proceedings.
The
Company is subject to various legal proceedings arising from normal business operations. Although there can be no assurances,
based on the information currently available, management believes that it is probable that the ultimate outcome of each of the
actions will not have a material adverse effect on the consolidated financial 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.
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.
The Company rejected Utility’s assertion and is vigorously defending the right of end-users to purchase such systems from
providers other than Utility. The United States District Court for the District of Kansas dismissed the lawsuit because it decided
that Kansas was not the proper jurisdictional forum for the dispute. The District Court’s decision was not a ruling on the
merits of the case. The Company appealed the decision and the Federal Circuit affirmed the District Court’s previous decision.
In
addition, the Company began proceedings to invalidate the ‘556 Patent through a request for
inter partes review
of
the ‘556 patent at the United States Patent and Trademark Office (“USPTO”). On July 27, 2015, the USPTO invalidated
key claims in Utility’s ‘556 Patent. The Final Decision from the USPTO significantly curtails 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
Circuit denied Utility’s appeal and therefore confirmed the ruling of the USPTO. This denial of Utility’s appeal finalized
the USPTO’s ruling in Digital’s favor and the matter is now concluded as it relates to the USPTO.
On
June 6, 2014 the Company filed an Unfair Competition lawsuit against Utility Associates, Inc. (“Utility”) in the United
States District Court for the District of Kansas. In the lawsuit it contends that Utility has defamed 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.
The
suit also includes claims against Utility for tortious interference with contract and violation of the Kansas Uniform Trade Secrets
Act (KUSTA), arising out of Utility’s employment of the Company’s employees, in violation of that employee’s
Non-Competition and Confidentiality agreements with the Company. In addition to damages, the Company seeks temporary, preliminary,
and permanent injunctive relief, prohibiting Utility from, among other things, continuing to threaten or otherwise interfere with
the Company’s customers. On March 4, 2015, an initial hearing was held upon the Company’s request for injunctive relief.
Based
upon facts revealed at the March 4, 2015 hearing, on March 16, 2015, the Company sought leave to amend its Complaint in the Kansas
suit to assert additional claims against Utility. Those new claims include 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. As
these statutes expressly provide, the Company will seek treble damages, punitive damages and attorneys’ fees as well as
injunctive relief. The Court concluded its hearing on April 22, 2015, and allowed the Company leave to amend its complaint, but
denied its preliminary injunction. The discovery stage of the lawsuit expired in May 2016. Both parties have filed summary judgment
motions, which are currently under review and consideration by the court. The jury trial date is scheduled for June 2017. The
Company believes that the USPTO’s final decision issued on July 27, 2015 will provide it with substantial basis to pursue
its claims either through summary judgment motions prior to trial or the jury trial itself and it intends to pursue recovery from
Utility, its insurers and other parties, as appropriate.
On
September 13, 2014, Utility filed suit in the United States District Court for the Northern District of Georgia against the Company
alleging infringement of the ‘556 Patent. The suit was served on the Company on September 20, 2014. As alleged in the Company’s
first filed lawsuit described above, the Company believes that the ‘556 Patent is both invalid and not infringed. Further,
the USPTO has issued its final decision invalidating 23 of the 25 claims asserted in the ‘556 Patent, as noted above. The
Company believes that the suit filed by Utility is without merit and is vigorously defending the claims asserted against the Company.
An adverse resolution of the foregoing litigation or patent proceedings could have a material adverse effect on the Company’s
business, prospects, results of operations, financial condition, and liquidity. The Court stayed all proceedings with respect
to this lawsuit pending the outcome of the patent review performed by the USPTO and the appellate court. Based on the USPTO’s
final decision to invalidate substantially all claims contained in the ‘556 Patent and the United States Court of Appeals
for the Federal Circuit full denial of Utility’s appeal, the Company intends to file for summary judgment in its favor if
Utility does not request outright dismissal.
The
Company received notice in April 2015 that Taser, one of its competitors, had commenced an action in the USPTO for a re-examination
of its U.S. Patent No. 8,781,292 (the “ ‘292 Patent”). A re-examination is essentially a request that the USPTO
review whether the patent should have issued in its present form in view of the “prior art,” e.g., other patents in
the same technology field. The prior art Taser used to request the re-examination is a patent application that never issued into
a patent was assigned to an unrelated third party and was not the result of any of Taser’s own research and development
efforts.
The
Company owns the ‘292 Patent, which is directed to a system that determines when a recording device, such as a law enforcement
officer’s body camera or in-car video recorder, begins recording and automatically instructs other recording devices to
begin recording. The technology described in the ‘292 Patent is incorporated in the Company’s VuLink product.
On
August 17, 2015 the USPTO issued a first, non-final action rejecting all 20 claims of the ‘292 Patent respecting its ‘292
Patent under an
ex parte
re-examination. The Company was provided the opportunity to discuss the merits of the prior art
and the scope of the patent claims with the patent Examiner handling the reexamination and to amend the patent claims. On January
14, 2016 the USPTO ultimately rejected Taser’s efforts and confirmed the validity of the ‘292 Patent with 59 claims
covering various aspects of the Company’s auto-activation technology. On February 2, 2016 the USPTO issued another patent
relating to the Company’s auto-activation technology for law enforcement cameras. U.S. Patent No. 9,253,452 (the “
‘452 Patent”) generally covers the automatic activation and coordination of multiple recording devices in response
to a triggering event, such as a law enforcement officer activating the light bar on the vehicle.
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
Taser, alleging willful patent infringement against Taser’s Axon body camera product line. The lawsuit was initiated after
the USPTO reconfirmed the validity of the ‘292 Patent, which covers various aspects of auto-activation and multiple camera
coordination for body-worn cameras and in-car video systems. The ‘292 Patent previously was subject to attack by Taser,
which tried to invalidate it at the USPTO. The USPTO ultimately rejected Taser’s efforts and confirmed the validity of the
‘292 Patent with 59 claims covering various aspects of this valuable auto-activation technology. On February 2, 2016 the
USPTO issued another patent relating to the Company’s auto-activation technology for law enforcement cameras. This ‘452
Patent generally covers the automatic activation and coordination of multiple recording devices in response to a triggering event
such as a law enforcement officer activating the light bar on the vehicle. The Company added the ‘452 patent to its existing
lawsuit against Taser seeking both monetary damages and a permanent injunction against Taser for infringement of both the ‘452
and ‘292 Patents.
In
addition to the infringement claims, the Company added a new set of claims to the lawsuit alleging that Taser conspired to keep
the Company out of the marketplace by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Taser
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.
The
Company filed an amended complaint and Taser filed an answer which denied the patent infringement allegations on April 1, 2016.
In addition, Taser 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. Taser amended and renewed its
motion to seek dismissal of the allegations that it had bribed officials and otherwise conspired to secure no-bid contracts for
its products in violation of both state law and federal antitrust law on April 1, 2016. Formal discovery commenced on April 12,
2016 with respect to the patent related claims. In January 2017 the Court granted Taser’s motion to dismiss the portion
of the lawsuit regarding claims that it had bribed officials and otherwise conspired to secure no-bid contracts for its products
in violation of both state law and federal antitrust law. The Company has appealed this decision to the United States Court of
Appeals for the Federal Circuit and is awaiting its decision.
In
December 2016, Taser announced that it had commenced an action in the USPTO for
inter partes review
of the Company’s
‘292 Patent. Previously Taser had attempted to invalidate the ‘292 Patent through a re-examination procedure at the
USPTO. On January 14, 2016 the USPTO ultimately rejected Taser’s efforts and confirmed the validity of the ‘292 Patent
with 59 claims covering various aspects of the Company’s auto-activation technology. The USPTO fully rejected all of Taser’s
previous arguments, concluding all 59 claims in Digital Ally’s ‘292 patent were valid and non-obvious. Taser is again
attempting through its recently filed
inter partes review
to convince the USPTO that Digital Ally’s patents lack
patentability. The USPTO is taking the request under consideration and has not decided whether it will institute the
inter
partes review.
In addition, Taser has requested that the patent infringement lawsuit filed by Digital Ally in the U.S. District
Court for the District of Kansas (Case No: 2:16-cv-02032) against Taser, be stayed while its
inter partes review
is being
considered by the USPTO. Digital Ally has filed a motion to deny the stay and both motions. On March 20, 2017 the Court granted
Taser’s motion to stay in part and temporarily stayed the proceedings until the Patent Trial and Appeal Board (“PTAB”)
issues its initial decisions with respect to Taser’s petitions for
inter partes review
. The PTAB is scheduled to
issue its initial decisions with respect to whether it will institute the requested
inter partes reviews
between June 2017
and August 2017.
On
May 27, 2016 the Company filed suit against Enforcement Video, LLC d/b/a WatchGuard Video (“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 and simultaneously
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. Digital Ally also has patent
coverage directed to the coordination between a multi-camera system and an officer’s smartphone, which allows an officer
to more readily assess an event on the scene while an event is taking place or immediately after it has occurred.
The
Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car product
lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the ‘292 and
‘452 Patents and U.S. Patent No. 9,325,950. 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. The lawsuit is in the early
stages of discovery.
The
Company is also involved as a plaintiff and defendant in ordinary, routine litigation and administrative proceedings incidental
to its business from time to time, including customer collections, vendor and employment-related matters. The Company believes
the likely outcome of any other pending cases and proceedings will not be material to its business or its financial condition.
Item
4. Mine Safety Disclosures.
Not
applicable.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
Nature of Business:
Digital Ally, Inc. and
subsidiaries (collectively, “Digital Ally,” “Digital,” the “Company,” “we,” “ours”
and “us”) produces digital video imaging and storage products for use in law enforcement, security and commercial applications.
Its products are an in-car digital video/audio recorder contained in a rear-view mirror for use in law enforcement and commercial
fleets; a system that provides its law enforcement customers with audio/video surveillance from multiple vantage points and hands-free
automatic activation of body-worn cameras and in-car video systems; a miniature digital video system designed to be worn on an
individual’s body; a weather-resistant mobile digital video recording system for use on motorcycles, ATV’s and boats;
a hand-held laser speed detection device that it is offering primarily to law enforcement agencies; and cloud storage solutions.
The Company has active research and development programs to adapt its technologies to other applications. It can integrate electronic,
radio, computer, mechanical, and multi-media technologies to create unique solutions to address needs in a variety of other industries
and markets, including mass transit, school bus, taxi cab and the military. The Company sells its products to law enforcement agencies
and other security organizations, 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.
The following is a summary of the Company’s
Significant Accounting Policies:
Basis of Consolidation:
The accompanying financial
statements include the consolidated accounts of Digital Ally and its wholly-owned subsidiaries, Digital Ally International, Inc.,
MP Ally, LLC, and Medical Devices Ally, LLC. All intercompany balances and transactions have been eliminated during consolidation.
The Company formed Digital
Ally International, Inc. during August 2009 to facilitate the export sales of its products. In addition, Medical Devices Ally,
LLC was formed in July 2014 and MP Ally, LLC was formed in July 2015, both of which have been inactive since formation.
Fair Value of Financial Instruments:
The carrying amounts
of financial instruments, including cash and cash equivalents, accounts receivable and accounts payable approximate fair value
because of the short-term nature of these items. The Company accounts for its derivative liabilities and its secured convertible
debentures on a fair value basis.
Revenue Recognition:
Revenues from the sale
of products are recorded when the product is shipped, title and risk of loss have transferred to the purchaser, payment terms are
fixed or determinable and payment is reasonably assured. Customers do not have a right to return the product other than for warranty
reasons for which they would only receive repair services or replacement product.
The Company sells its
products and services to law enforcement and commercial customers in the following manner:
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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.
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Sales to international customers are made through independent distributors who purchase products from the Company at a wholesale price and sell to the end user (typically law enforcement agencies or a commercial customer) at a retail price. The distributor retains the margin as its compensation for its role in the transaction. The distributor generally maintains product inventory, customer receivables and all related risks and rewards of ownership. Revenue is recorded when the product is shipped to the distributor consistent with the terms of the distribution agreement.
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●
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Repair parts and services for domestic and international customers are generally handled by its inside customer service employees. Revenue is recognized upon shipment of the repair parts and acceptance of the service or materials by the end customer.
|
Sales taxes collected
on products sold are excluded from revenues and are reported as an accrued expense in the accompanying balance sheets until payments
are remitted.
Service and other revenue
is comprised of revenues from extended warranties, repair services, cloud revenue and software revenue. Revenue is recognized upon shipment of the product and acceptance of the service or materials by the
end customer for repair services. Revenue for extended warranty, cloud service or other software-based are treated as deferred
revenue and recognized over the term of the contracted warranty or service period on a straight line method.
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 on a straight line method.
Multiple element arrangements
consisting of product, software, cloud and extended warranties are offered to our customers. Revenue arrangements with multiple
deliverables are divided into separate units and revenue is allocated using the relative selling price method based upon vendor-specific
objective evidence of selling price or third-party evidence of the selling prices if vendor-specific objective evidence of selling
prices does not exist. If neither vendor-specific objective evidence nor third-party evidence exists, management uses its best
estimate of selling price. The majority of the Company’s allocations of arrangement consideration under multiple element
arrangements are performed using vendor-specific objective evidence by utilizing prices charged to customers for deliverables when
sold separately. The Company’s multiple element arrangements may include future in-car or body-worn camera devices to be
delivered at defined points within a multi-year contract, and in those arrangements, the Company allocates total arrangement consideration
over the life of the multi-year contract to future deliverables using management’s best estimate of selling price. The Company
has not utilized third-party evidence of selling price
Sales returns and allowances
aggregated $494,790 and $712,872 for the years ended December 31, 2016 and 2015, respectively. Obligations for sales returns and
allowances are recognized at the time of sales on an accrual basis. The accrual is determined based upon historical return rates
adjusted for known changes in key variables affecting these return rates.
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 secured convertible debentures at their fair value. Accordingly, the secured convertible debentures
will be marked-to-market at each reporting date with the change in fair value reported as a gain (loss) in the statement of
operations. All issuance costs related to the secured convertible debentures are 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 $93,685 and $92,081 for the years ended December 31, 2016 and 2015, respectively. Such
costs are included in selling, general and administrative expenses in the Consolidated Statements of Operations.
Advertising Costs:
Advertising expense includes
costs related to trade shows and conventions, promotional material and supplies, and media costs. Advertising costs are expensed
in the period in which they are incurred. The Company incurred total advertising expense of approximately $1,147,219 and $848,671
for the years ended December 31, 2016 and 2015, respectively. Such costs are included in selling, general and administrative expenses
in the Consolidated Statements of Operations.
Income Taxes:
Deferred taxes are provided
for by the liability method wherein 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 of the deferred
tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates
on the date of enactment.
The Company applies the
provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)
No. 740 - Income Taxes that provides a framework for accounting for uncertainty in income taxes and provided a comprehensive model
to recognize, measure, present, and disclose in its financial statements uncertain tax positions taken or expected to be taken
on a tax return. It initially recognizes tax positions in the financial statements when it is more likely than not the position
will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently measured as the largest
amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming
full knowledge of the position and all relevant facts. Application requires numerous estimates based on available information.
The Company considers many factors when evaluating and estimating its tax positions and tax benefits, and it recognized tax positions
and tax benefits may not accurately anticipate actual outcomes. As it obtains additional information, the Company may need to periodically
adjust its recognized tax positions and tax benefits. These periodic adjustments may have a material impact on its consolidated
statements of operations.
The Company’s policy
is to record estimated interest and penalties related to the underpayment of income taxes as income tax expense in the consolidated
statements of operations. There was no interest expense related to the underpayment of estimated taxes during the years ended December
31, 2016 and 2015. There have been no penalties in 2016 and 2015.
The Company is subject
to taxation in the United States and various states. As of December 31, 2016, the Company’s tax returns filed for 2013, 2014,
and 2015 and to be filed for 2016 are subject to examination by the relevant taxing authorities. With few exceptions, as of December
31, 2016, the Company is no longer subject to Federal, state, or local examinations by tax authorities for years before 2013.
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 2016 and 2015.
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:
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Expected term is determined using the contractual term and vesting period of the award;
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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;
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Expected dividend rate is determined based on expected dividends to be declared;
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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
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Forfeitures are based on the history of cancellations of awards granted and management’s analysis of potential forfeitures.
|
Segments of Business:
Management has determined that its operations
are comprised of one reportable segment: the sale of speed detection and digital audio and video recording devices. For the year
ended December 31, 2016 and 2015, sales by geographic area were as follows:
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Year ended December 31,
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2016
|
|
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2015
|
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Sales by geographic area:
|
|
|
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United States of America
|
|
$
|
15,383,479
|
|
|
$
|
19,881,541
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|
Foreign
|
|
|
1,191,012
|
|
|
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148,667
|
|
|
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$
|
16,574,491
|
|
|
$
|
20,030,208
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|
Sales to customers outside of the United States
are denominated in U.S. dollars. All Company assets are physically located within the United States.
Reclassification of Prior Year Presentation:
Certain prior year amounts
have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported
results of operations.
Recent Accounting Pronouncements:
In May 2014, the FASB
issued Accounting Standard Update (“ASU”) No. 2014-09,
“Revenue from Contracts with Customers”
(“ASU
2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer
of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when
it becomes effective. The standard is effective for interim and annual periods beginning after December 15, 2017 and permits the
use of either the retrospective or cumulative effect transition method. The Company has not yet selected a transition method and
is currently evaluating the standard and the impact on its consolidated financial statements and footnote disclosures.
In August 2014, the FASB
issued 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.
This ASU requires management to evaluate whether there are conditions
or events, considered in the aggregate, that should raise substantial doubt about the entity’s ability to continue as a going
concern within one year after the date that the financial statements are issued. When management identifies conditions or events
that raise substantial doubt about an entity’s ability to continue as a going concern, management should consider whether
its plans that are intended to mitigate those relevant conditions or events will alleviate the substantial doubt. This ASU was
effective for the Company for the year ended December 31, 2016. There was no effect related to the Company’s adoption of
this guidance on its consolidated financial statements.
In July 2015, the FASB
issued ASU 2015-11, Inventory (Topic 330):
Simplifying the Measurement of Inventory
. The amendments in the ASU require entities
that measure inventory using the first-in, first-out or average cost methods to measure inventory at the lower of cost and net
realizable value. Net realizable value is defined as estimated selling price in the ordinary course of business less reasonably
predictable costs of completion, disposal and transportation. ASU 2015-11 is effective for financial statements issued for fiscal
years, and interim periods within those fiscal years, beginning after December 15, 2016 on a prospective basis. This ASU will be
effective for the Company for fiscal years beginning after December 15, 2016. The Company
is currently evaluating the effects adoption of this guidance will have on its consolidated financial statements.
In April 2015, the FASB
issued ASU 2015-03, Interest—
Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance
Costs.
This ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet
as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective
for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.
The Company adopted this ASU on January 1, 2016. The adoption of this standard did not have any impact on the financial statements.
In November 2015,
the FASB issued ASU 2015-17,
Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes
. This ASU
simplifies the presentation of deferred income taxes by eliminating the requirement for entities to separate deferred tax
liabilities and assets into current and noncurrent amounts in classified balance sheets. Instead, it requires deferred tax
assets and liabilities be classified as noncurrent in the balance sheet. ASU 2015-17 is effective for financial statements
issued for annual periods beginning after December 15, 2016 and interim periods within those annual periods. Early adoption
is permitted, and this ASU may be applied either prospectively to all deferred tax liabilities and assets or retrospectively
to all periods presented. The adoption of this standard is not expected to have a material impact on the Company’s
consolidated financial statements.
In February 2016, the
FASB issued ASU No. 2016-02,
Leases
(Topic 842). The objective of ASU 2016-02 is to recognize lease assets and lease liabilities
by lessees for those leases classified as operating leases under previous U.S. GAAP. ASU 2016-02 is effective for fiscal years
beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of ASU 2016-02 is permitted.
The Company is currently evaluating the effects adoption of this guidance will have on its consolidated financial statements.
In March 2016, the FASB
issued ASU No. 2016-09,
Compensation-Stock Compensation (Topic 718)
. The objective of ASU 2016-09 is to reduce the complexity
of certain aspects of the accounting for employee share-based payment transactions. As a result of this ASU, there are changes
to minimum statutory withholding requirements, accounting for forfeitures, and accounting for income taxes. The ASU is effective
for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The adoption of this standard is not expected to have a material impact on the Company’s
consolidated financial statements.
In August 2016, the FASB
issued ASU 2016-15,
Clarification on Classification of Certain Cash Receipts and Cash Payments on the Statement of Cash Flows
,
to create consistency in the classification of eight specific cash flow items. This standard is effective for calendar-year SEC
registrants beginning in 2018. The Company is currently evaluating the effects adoption of this guidance will have on its consolidated
financial statements.
In November 2016, the
FASB issued ASU 2016-18,
Statement of Cash Flows - Restricted Cash (Topic 230),
which amends the existing guidance relating
to the disclosure of restricted cash and restricted cash equivalents on the statement of cash flows. ASU 2016-18 is effective
for the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, and early adoption is permitted.
The Company is currently in the process of evaluating the impact of adoption of ASU 2016-18 on its Consolidated Statements of
Cash Flows.
NOTE 2. CONCENTRATION OF CREDIT RISK AND
MAJOR CUSTOMERS
Financial instruments
that potentially subject the Company to concentrations of credit risk consist of accounts receivable. Sales to domestic customers
are typically made on credit and the Company generally does not require collateral while sales to international customers require
payment before shipment or backing by an irrevocable letter of 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 and $74,997
as of December 31, 2016 and December 31, 2015, respectively.
The Company sells through
a network of unaffiliated distributors for international sales and employee-based sales agents for domestic sales. No international
distributor individually exceeded 10% of total revenues and no customer receivable balance exceeded 10% of total accounts receivable
for the years ended December 31, 2016 and 2015.
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, the Company generally owns all
tooling and management has located or is in process of locating 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 any significant supply
disruptions from any of its principal vendors and does not anticipate future supply disruptions. The Company acquires most of its
components on a purchase order basis and does not have long-term contracts with its suppliers.
NOTE 3. ACCOUNTS RECEIVABLE – ALLOWANCE
FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts receivable
was comprised of the following for the years ended December 31, 2016 and 2015:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Beginning balance
|
|
$
|
74,997
|
|
|
$
|
65,977
|
|
Provision for bad debts
|
|
|
2,224
|
|
|
|
46,864
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Charge-offs to allowance, net of recoveries
|
|
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(7,221
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)
|
|
|
(37,844
|
)
|
Ending balance
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$
|
70,000
|
|
|
$
|
74,997
|
|
NOTE 4. INVENTORIES
Inventories consisted of the following at December
31, 2016 and 2015:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Raw material and component parts
|
|
$
|
4,015,170
|
|
|
$
|
3,833,873
|
|
Work-in-process
|
|
|
355,715
|
|
|
|
134,641
|
|
Finished goods
|
|
|
7,215,346
|
|
|
|
7,895,663
|
|
Subtotal
|
|
|
11,586,231
|
|
|
|
11,864,177
|
|
Reserve for excess and obsolete inventory
|
|
|
(1,999,920
|
)
|
|
|
(1,202,411
|
)
|
Total
|
|
$
|
9,586,311
|
|
|
$
|
10,661,766
|
|
Finished goods inventory
includes units held by potential customers and sales agents for test and evaluation purposes. The cost of such units totaled $634,059
and $651,004 as of December 31, 2016 and December 31, 2015, respectively.
NOTE 5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consisted
of the following at December 31, 2016 and 2015:
|
|
Estimated
Useful Life
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Office furniture, fixtures and equipment
|
|
3-10 years
|
|
$
|
1,074,533
|
|
|
$
|
905,124
|
|
Warehouse and production equipment
|
|
3-5 years
|
|
|
643,250
|
|
|
|
532,339
|
|
Demonstration and tradeshow equipment
|
|
2-5 years
|
|
|
451,750
|
|
|
|
451,750
|
|
Leasehold improvements
|
|
2-5 years
|
|
|
153,828
|
|
|
|
153,828
|
|
Rental equipment
|
|
1-3 years
|
|
|
60,354
|
|
|
|
—
|
|
Total cost
|
|
|
|
|
2,383,715
|
|
|
|
2,043,041
|
|
Less: accumulated depreciation and amortization
|
|
|
|
|
(1,509,813
|
)
|
|
|
(978,855
|
)
|
Net furniture, fixtures and equipment
|
|
|
|
$
|
873,902
|
|
|
$
|
1,064,186
|
|
Depreciation and amortization of furniture,
fixtures and equipment aggregated $530,958 and $498,810 for the years ended December 31, 2016 and 2015, respectively.
NOTE 6. INTANGIBLE ASSETS
Intangible assets consisted of the following
at December 31, 2016 and 2015:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
|
|
Gross value
|
|
|
Accumulated amortization
|
|
|
Net carrying value
|
|
|
Gross value
|
|
|
Accumulated amortization
|
|
|
Net carrying value
|
|
Amortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses
|
|
$
|
73,892
|
|
|
$
|
10,115
|
|
|
$
|
63,777
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Patents and Trademarks
|
|
|
374,348
|
|
|
|
80,093
|
|
|
|
294,255
|
|
|
|
96,418
|
|
|
|
47,086
|
|
|
|
49,331
|
|
|
|
$
|
448,240
|
|
|
$
|
90,208
|
|
|
$
|
358,032
|
|
|
$
|
96,418
|
|
|
$
|
47,086
|
|
|
$
|
49,331
|
|
Unamortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
73,893
|
|
|
$
|
—
|
|
|
$
|
73,893
|
|
Patents and trademarks pending
|
|
|
109,144
|
|
|
|
—
|
|
|
|
109,144
|
|
|
|
287,036
|
|
|
|
—
|
|
|
|
287,036
|
|
|
|
|
109,144
|
|
|
|
—
|
|
|
|
109,144
|
|
|
|
360,929
|
|
|
|
—
|
|
|
|
360,929
|
|
Total
|
|
$
|
557,384
|
|
|
$
|
90,208
|
|
|
$
|
467,176
|
|
|
$
|
457,347
|
|
|
$
|
47,086
|
|
|
$
|
410,261
|
|
Patents and trademarks
pending will be amortized beginning at the time they are issued by the appropriate authorities. If issuance of the final patent
or trademark is denied, then the amount deferred will be immediately charged to expense.
Amortization expense for
the years ended December 31, 2016 and 2015 was $43,122 and $31,313, respectively. Estimated amortization for intangible assets
with definite lives for the next five years ending December 31 and thereafter is as follows:
Year ending December 31:
|
|
|
|
2017
|
|
$
|
121,835
|
|
2018
|
|
|
104,750
|
|
2019
|
|
|
99,339
|
|
2020
|
|
|
10,556
|
|
2021
|
|
|
10,556
|
|
thereafter
|
|
|
10,996
|
|
|
|
$
|
358,032
|
|
NOTE 7. SECURED CONVERTIBLE DEBENTURES AND
CAPITAL LEASE OBLIGATIONS
2014 Secured Convertible Note Payable
Between February 13 and
25, 2015 the holder of the $4.0 million Secured Convertible Note exercised its right to convert the remaining principal of $3,963,780
into 655,738 shares of common stock and 5,475 shares for accrued interest at the conversion price of $7.32 per share. The increase
in fair market value of these 655,213 shares over the $3,963,780 principal retired was $4,434,383 representing the increase in
our stock price over the conversion rate as of the conversion dates. Such amount was recognized as a charge to the Consolidated
Statement of Operations during the year ended December 31, 2015 and included in change in fair value of secured convertible notes
payable.
On March 24, 2015 the holder
exercised part of its Warrant to purchase 212,295 shares of common stock with the change in value of the warrant derivative totaling
$340,722 being recognized as income in the Consolidated Statement of Operations representing the change in the Company’s
stock price compared to the exercise price at the respective exercise date. On April 9, 2015 the holder exercised part of its Warrant
to purchase 37,800 shares of common stock with the change in value of the warrant derivative totaling $127,951 being recognized
as income in the Consolidated Statement of Operations representing the change in the Company’s stock price compared
to the exercise price at the respective exercise date. The changes in fair value of the warrant derivative related to the unexercised
warrants resulted in a loss of $97,667 for the twelve months ended December 31, 2015 compared to a gain of $33,977 for the twelve
months ended December 31, 2016. The net change in warrant derivative liabilities resulted in a net gain of $33,076 and $371,006
for the twelve months ended December 31, 2016 and 2015, respectively.
As of December 31, 2016
and 2015, the remaining Warrant was exercisable to purchase 12,200 common shares and was recorded as a liability at its fair value
in the amount of $33,076 and $67,053, respectively, on the Condensed Consolidated Balance Sheet.
2016 Secured Convertible Debentures
.
Secured Convertible Debentures is comprised of the following:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Secured convertible debentures, at fair value
|
|
$
|
4,000,000
|
|
|
$
|
—
|
|
Less: Current maturities of long-term debt, at fair value
|
|
|
—
|
|
|
|
—
|
|
Secured convertible debentures, at fair value-long-term
|
|
$
|
4,000,000
|
|
|
$
|
—
|
|
On December 30, 2016, Digital
Ally, Inc. (the “Company”) completed a private placement (the “Private Placement”) of $4.0 million in principal
amount of 8% Secured Convertible Debentures (the “Debentures”) and common stock warrants (the “Warrants”)
to two institutional investors. The Debentures and Warrants were issued pursuant to a Securities Purchase Agreement (the “Purchase
Agreement”) between the Company and the purchasers signatory thereto (the “Holders”). The Private Placement resulted
in gross proceeds of $4.0 million before placement agent fees and other expenses associated with the transaction which totaled
$281,570 which was expensed as incurred.
The Company
elected to account for the Debentures on the fair value basis. Therefore, the Company determined the fair value of the
Debentures utilizing Monte Carlo simulation models which yielded an estimated fair value of $4.0 million for the
convertible notes including their embedded derivatives as of the origination date.
No
value was allocated to the detachable Warrants as of the origination date because of the relative fair value of the
convertible note including its embedded derivative features approximated the gross proceeds of the financing
transaction.
There was no change in the fair value of
the secured convertible debentures between the date of origination (December 30, 2016) and December 31, 2016.
Prior to the maturity date,
the Debentures bear interest at 8% per annum with interest payable in cash quarterly in arrears on the first business day of each
calendar quarter following the issuance date. The Debentures rank senior to the Company’s existing and future indebtedness
of the Company and are secured by substantially all tangible and certain intangible assets of the Company.
The Debentures are convertible
at any time six months after their date of issue at the option of the holders into shares of the Company’s common stock at
$5.00 per share (the “Conversion Price”). The Debentures mature on March 30, 2018. The Warrants are exercisable to
purchase up to an aggregate of 800,000 shares of the Company’s common stock commencing on the date of issuance at an exercise
price of $5.00 per share (the “Exercise Price”). The Warrants will expire on the fifth anniversary of their date of
issuance. The Conversion Price and Exercise Price are subject to adjustment upon stock splits, reverse stock splits, and similar
capital changes.
The Company has the right,
subject to certain limitations, to redeem the Debenture with 30 days advance notice with the redemption amount determined as the
sum of (a) 112% of the then outstanding principal amount of the Debenture, (b) accrued but unpaid interest and (c) all liquidated
damages and other amounts due in respect of the Debenture, if any.
Additionally, if following
the six-month anniversary of the Original Issue Date, the VWAP (volume weighted average price), for each of any ten (10) consecutive
trading days exceeds $7.50 per share, the Company has the right, subject to certain limitations, to provide written notice to the
Holders which forces the Holders to convert all or part of the then outstanding principal amount of the Debenture plus accrued
but unpaid interest
Upon the occurrence of
an event of default under the Debentures, the Debentures bear interest at 18% per annum and a Debenture holder may require the
Company to redeem all or a portion of its Debenture. The Company has agreed to maintain cash balance of $500,000 while the Debentures
are outstanding, which is reflected as restricted cash in the accompanying balance sheet. The Holders have agreed to beneficial
conversion limitation which effectively blocks either Holder from converting the Debenture or exercise the Warrant to the extent
that such conversion or exercise would result in the Holder being the beneficial owner in excess of 4.99% (or, upon election of
purchaser, 9.99%), which beneficial ownership limitation may be increased or decreased up to 9.99% upon notice to the Company,
provided that any increase in such limitation will not be effective until 61 days following notice to the Company.
Capital Leases
. Future minimum
lease payments under non-cancelable capital leases having terms in excess of one year are as follows:
Year ending December 31:
|
|
|
|
2017
|
|
$
|
34,298
|
|
2018
|
|
|
8,574
|
|
Total future minimum lease payments
|
|
|
42,872
|
|
Less amount representing interest
|
|
|
1,588
|
|
Present value of minimum lease payments
|
|
|
41,284
|
|
Less current portion
|
|
|
32,792
|
|
Capital lease obligations, less current portion
|
|
$
|
8,492
|
|
Assets under capital leases are included in
furniture, fixtures and equipment as follows:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Office furniture, fixtures and equipment
|
|
$
|
382,928
|
|
|
$
|
382,928
|
|
Less: accumulated amortization
|
|
|
(294,895
|
)
|
|
|
(224,089
|
)
|
Net furniture, fixtures and equipment
|
|
$
|
88,033
|
|
|
$
|
158,839
|
|
NOTE 8. Fair Value Measurement
In accordance with ASC
Topic 820 —
Fair Value Measurements and Disclosures
(“ASC 820”), the Company utilizes the market approach
to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information
generated by market transactions involving identical or comparable assets, liabilities or a group of assets or liabilities, such
as a business.
ASC 820 utilizes a fair
value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following
is a brief description of those three levels:
●
|
Level 1 — Quoted prices in active markets for identical assets and liabilities
|
|
|
●
|
Level 2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
|
|
|
●
|
Level 3 — Significant unobservable
inputs (including the Company’s own assumptions in determining the fair value)
|
The following table represents the Company’s
hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 and 2015.
|
|
|
|
|
December 31, 2016
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured convertible debentures
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
4,000,000
|
|
|
$
|
4,000,000
|
|
Warrant derivative liability
|
|
|
—
|
|
|
|
—
|
|
|
|
33,076
|
|
|
|
33,076
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
4,033,076
|
|
|
$
|
4,033,076
|
|
|
|
December 31, 2015
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant derivative liability
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
67,053
|
|
|
$
|
67,053
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
67,053
|
|
|
$
|
67,053
|
|
The following table represents the change in
level 3 tier value measurements:
|
|
Warrant
derivative
liability
|
|
|
Secured
convertible
debentures
|
|
|
Total
|
|
December 31, 2015
|
|
$
|
67,053
|
|
|
$
|
—
|
|
|
$
|
67,053
|
|
Fair value at origination
|
|
|
—
|
|
|
|
4,000,000
|
|
|
|
4,000,000
|
|
Change in fair value
|
|
|
(33,977
|
)
|
|
|
—
|
|
|
|
(33,977
|
)
|
December 31, 2016
|
|
$
|
33,076
|
|
|
$
|
4,000,000
|
|
|
$
|
4,033,076
|
|
NOTE 9. ACCRUED EXPENSES
Accrued expenses consisted
of the following at December 31, 2016 and 2015:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Accrued warranty expense
|
|
$
|
374,597
|
|
|
$
|
159,838
|
|
Accrued Senior Convertible Note issuance costs
|
|
|
204,000
|
|
|
|
—
|
|
Accrued sales commissions
|
|
|
36,389
|
|
|
|
100,295
|
|
Accrued payroll and related fringes
|
|
|
270,781
|
|
|
|
247,984
|
|
Accrued insurance
|
|
|
81,610
|
|
|
|
34,926
|
|
Accrued rent
|
|
|
182,409
|
|
|
|
224,393
|
|
Accrued sales returns and allowances
|
|
|
215,802
|
|
|
|
72,456
|
|
Other
|
|
|
177,141
|
|
|
|
96,435
|
|
|
|
$
|
1,542,729
|
|
|
$
|
936,327
|
|
Accrued warranty expense
was comprised of the following for the years ended December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Beginning balance
|
|
$
|
159,838
|
|
|
$
|
247,082
|
|
Provision for warranty expense
|
|
|
343,142
|
|
|
|
5,317
|
|
Charges applied to warranty reserve
|
|
|
(128,383
|
)
|
|
|
(92,561
|
)
|
Ending balance
|
|
$
|
374,597
|
|
|
$
|
159,838
|
|
NOTE 10. INCOME TAXES
The components of income
tax (provision) benefit for the years ended December 31, 2016 and 2015 are as follows:
|
|
|
2016
|
|
|
|
2015
|
|
Current taxes:
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
—
|
|
|
$
|
—
|
|
State
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Total current taxes
|
|
|
—
|
|
|
|
—
|
|
Deferred tax (provision) benefit
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Income tax (provision) benefit
|
|
$
|
—
|
|
|
$
|
—
|
|
A reconciliation of the
income tax (provision) benefit at the statutory rate of 34% for the years ended December 31, 2016 and 2015 to the Company’s
effective tax rate is as follows:
|
|
2016
|
|
|
2015
|
|
U.S. Statutory tax rate
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
State taxes, net of Federal benefit
|
|
|
3.5
|
%
|
|
|
6.2
|
%
|
Executive compensation
|
|
|
(1.3
|
)%
|
|
|
—
|
|
Federal Research and development tax credits
|
|
|
1.6
|
%
|
|
|
1.5
|
%
|
Stock based compensation
|
|
|
(2.1
|
)%
|
|
|
0.6
|
%
|
Common stock issued upon conversion of promissory note and related common stock purchase warrants
|
|
|
—
|
%
|
|
|
3.3
|
%
|
Change in valuation reserve on deferred tax assets
|
|
|
(34.2
|
)%
|
|
|
(45.0
|
)%
|
Other, net
|
|
|
(1.5
|
)%
|
|
|
(0.6
|
)%
|
|
|
|
|
|
|
|
|
|
Income tax (provision) benefit
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
Significant components
of the Company’s deferred tax assets (liabilities) as of December 31, 2016 and 2015 are as follows:
|
|
2016
|
|
|
2015
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
$
|
1,615,000
|
|
|
$
|
1,623,000
|
|
Start-up costs
|
|
|
175,000
|
|
|
|
180,000
|
|
Inventory reserves
|
|
|
785,000
|
|
|
|
480,000
|
|
Uniform capitalization of inventory costs
|
|
|
110,000
|
|
|
|
150,000
|
|
Allowance for doubtful accounts receivable
|
|
|
30,000
|
|
|
|
30,000
|
|
Other reserves
|
|
|
5,000
|
|
|
|
2,000
|
|
Equipment depreciation
|
|
|
40,000
|
|
|
|
—
|
|
Deferred revenue
|
|
|
1,165,000
|
|
|
|
903,000
|
|
Derivative liabilities
|
|
|
15,000
|
|
|
|
26,000
|
|
Accrued expenses
|
|
|
340,000
|
|
|
|
210,000
|
|
Net operating loss carryforward
|
|
|
15,755,000
|
|
|
|
12,295,000
|
|
Research and development tax credit carryforward
|
|
|
1,955,000
|
|
|
|
1,747,000
|
|
Alternative minimum tax credit carryforward
|
|
|
90,000
|
|
|
|
90,000
|
|
State jobs credit carryforward
|
|
|
230,000
|
|
|
|
230,000
|
|
State research and development credit carryforward
|
|
|
280,000
|
|
|
|
280,000
|
|
Charitable contributions carryforward
|
|
|
60,000
|
|
|
|
50,000
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
22,650,000
|
|
|
|
18,296,000
|
|
Valuation reserve
|
|
|
(22,455,000
|
)
|
|
|
(18,105,000
|
)
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
195,000
|
|
|
|
191,000
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Equipment depreciation
|
|
|
—
|
|
|
|
(6,000
|
)
|
Domestic international sales company
|
|
|
(195,000
|
)
|
|
|
(185,000
|
)
|
Total deferred tax liabilities
|
|
|
(195,000
|
)
|
|
|
(191,000
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets (liability)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax asset (liability) are classified in our consolidated balance sheets as follows:
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
—
|
|
|
$
|
—
|
|
Non-current
|
|
$
|
—
|
|
|
$
|
—
|
|
The valuation allowance
on deferred tax assets totaled $22,455,000 and $18,105,000 as of December 31, 2016 and December 31, 2015, respectively. We record
the benefit we will derive in future accounting periods from tax losses and credits and deductible temporary differences as “deferred
tax assets.” In accordance with Accounting Standards Codification (ASC) 740, “Income Taxes,” we record a valuation
allowance to reduce the carrying value of our deferred tax assets if, based on all available evidence, it is more likely than not
that some or all of the deferred tax assets will not be realized.
The Company has incurred
operating losses in 2016 and 2015 and we continue to be in a three-year cumulative loss position at December 31, 2016 and 2015.
Accordingly, we determined there was not sufficient positive evidence regarding our potential for future profits to outweigh the
negative evidence of our three-year cumulative loss position under the guidance provided in ASC 740. Therefore, we determined to
increase our valuation allowance by $4,350,000 to continue to fully reserve our deferred tax assets at December 31, 2016. 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.
At December 31, 2016, the
Company had available approximately $40,100,000 of net operating loss carryforwards available to offset future taxable income generated.
Such tax net operating loss carryforwards expire between 2026 and 2036. In addition, the Company had research and development tax
credit carryforwards totaling $1,955,000 available as of December 31, 2016, which expire between 2023 and 2036.
The Internal Revenue Code
contains provisions under Section 382 which limit a company’s ability to utilize net operating loss carry-forwards in the
event that it has experienced a more than 50% change in ownership over a three-year period. Current estimates prepared by the Company
indicate that due to ownership changes which have occurred, approximately $765,000 of its net operating loss and $175,000 of its
research and development tax credit carryforwards are currently subject to an annual limitation of approximately $1,151,000, but
may be further limited by additional ownership changes which may occur in the future. As stated above, the net operating loss and
research and development credit carryforwards expire between 2023 and 2036, allowing the Company to potentially utilize all of
the limited net operating loss carry-forwards during the carryforward period.
As discussed in Note 1,
“Summary of Significant Accounting Policies,” tax positions are evaluated in a two-step process. The Company first
determines whether it is more likely than not that a tax position will be sustained upon examination. If a tax position meets the
more-likely-than-not recognition threshold, it is then measured to determine the amount of benefit to recognize in the financial
statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon
ultimate settlement. Management has identified no tax positions taken that would meet or exceed these thresholds and therefore
there are no gross interest, penalties and unrecognized tax expense/benefits that are not expected to ultimately result in payment
or receipt of cash in the consolidated financial statements.
The effective tax rate
for the years ended December 31, 2016 and 2015 varied from the expected statutory rate due to the Company continuing to provide
a 100% valuation allowance on net deferred tax assets. The Company determined that it was appropriate to continue the full valuation
allowance on net deferred tax assets as of December 31, 2016 primarily because of the current year operating losses.
NOTE 11. COMMITMENTS AND CONTINGENCIES
Operating Leases.
The Company had a non-cancelable long-term operating lease agreement for office and warehouse space that expires during April 2020.
The Company also entered into month-to-month leases for equipment and storage facilities. Rent expense for the years ended December
31, 2016 and 2015 was $397,724 and $401,845, respectively, related to these leases. Following are the minimum lease payments for
each year and in total.
Year ending December 31:
|
|
|
|
2017
|
|
$
|
445,449
|
|
2018
|
|
|
451,248
|
|
2019
|
|
|
457,327
|
|
2020
|
|
|
154,131
|
|
|
|
$
|
1,508,155
|
|
License agreements.
The Company has several license agreements under which it has been assigned the rights to certain licensed materials used
in its products. Certain of these agreements require the Company to pay ongoing royalties based on the number of products shipped
containing the licensed material on a quarterly basis. Royalty expense related to these agreements aggregated $25,161 and $26,454
for the years ended December 31, 2016 and 2015, 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.
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. The Company rejected Utility’s
assertion and is vigorously defending the right of end-users to purchase such systems from providers other than Utility. The United
States District Court for the District of Kansas dismissed the lawsuit because it decided that Kansas was not the proper jurisdictional
forum for the dispute. The District Court’s decision was not a ruling on the merits of the case. The Company appealed the
decision and the Federal Circuit affirmed the District Court’s previous decision.
In addition, the Company
began proceedings to invalidate the ‘556 Patent through a request for
inter partes review
of the ‘556 patent
at the United States Patent and Trademark Office (“USPTO”). On July 27, 2015, the USPTO invalidated key claims in Utility’s
‘556 Patent. The Final Decision from the USPTO significantly curtails 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 Circuit denied Utility’s appeal
and therefore confirmed the ruling of the USPTO. This denial of Utility’s appeal finalized the USPTO’s ruling in Digital’s
favor and the matter is now concluded.
On June 6, 2014 the Company
filed an Unfair Competition lawsuit against Utility Associates, Inc. (“Utility”) in the United States District Court
for the District of Kansas. In the lawsuit it contends that Utility has defamed 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.
The suit also includes
claims against Utility for tortious interference with contract and violation of the Kansas Uniform Trade Secrets Act (KUSTA), arising
out of Utility’s employment of the Company’s employees, in violation of that employee’s Non-Competition and Confidentiality
agreements with the Company. In addition to damages, the Company seeks temporary, preliminary, and permanent injunctive relief,
prohibiting Utility from, among other things, continuing to threaten or otherwise interfere with the Company’s customers.
On March 4, 2015, an initial hearing was held upon the Company’s request for injunctive relief.
Based upon facts revealed
at the March 4, 2015 hearing, on March 16, 2015, the Company sought leave to amend its Complaint in the Kansas suit to assert additional
claims against Utility. Those new claims include 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. As these statutes
expressly provide, the Company will seek treble damages, punitive damages and attorneys’ fees as well as injunctive relief.
The Court concluded its hearing on April 22, 2015, and allowed the Company leave to amend its complaint, but denied its preliminary
injunction. The discovery stage of the lawsuit expired in May 2016. Both parties have filed summary judgment motions, which are
currently under review and consideration by the court. The jury trial date is scheduled for June 2017. The Company believes that
the USPTO’s final decision issued on July 27, 2015 will provide it with substantial basis to pursue its claims either through
summary judgment motions prior to trial or the jury trial itself and it intends to pursue recovery from Utility, its insurers and
other parties, as appropriate.
On September 13, 2014,
Utility filed suit in the United States District Court for the Northern District of Georgia against the Company alleging infringement
of the ‘556 Patent. The suit was served on the Company on September 20, 2014. As alleged in the Company’s first filed
lawsuit described above, the Company believes that the ‘556 Patent is both invalid and not infringed. Further, the USPTO
has issued its final decision invalidating 23 of the 25 claims asserted in the ‘556 Patent, as noted above. The Company believes
that the suit filed by Utility is without merit and is vigorously defending the claims asserted against the Company. An adverse
resolution of the foregoing litigation or patent proceedings could have a material adverse effect on the Company’s business,
prospects, results of operations, financial condition, and liquidity. The Court stayed all proceedings with respect to this lawsuit
pending the outcome of the patent review performed by the USPTO and the appellate court. Based on the USPTO’s final decision
to invalidate substantially all claims contained in the ‘556 Patent and the United States Court of Appeals for the Federal
Circuit full denial of Utility’s appeal, the Company intends to file for summary judgment in its favor if Utility does not
request outright dismissal.
The Company received notice
in April 2015 that Taser, one of its competitors, had commenced an action in the USPTO for a re-examination of its U.S. Patent
No. 8,781,292 (the “ ‘292 Patent”). A re-examination is essentially a request that the USPTO review whether the
patent should have issued in its present form in view of the “prior art,” e.g., other patents in the same technology
field. The prior art Taser used to request the re-examination is a patent application that never issued into a patent was assigned
to an unrelated third party and was not the result of any of Taser’s own research and development efforts.
The Company owns the ‘292
Patent, which is directed to a system that determines when a recording device, such as a law enforcement officer’s body camera
or in-car video recorder, begins recording and automatically instructs other recording devices to begin recording. The technology
described in the ‘292 Patent is incorporated in the Company’s VuLink product.
On August 17, 2015 the USPTO
issued a first, non-final action rejecting all 20 claims of the ‘292 Patent respecting its ‘292 Patent under an
ex
parte
re-examination. The Company was provided the opportunity to discuss the merits of the prior art and the scope of the
patent claims with the patent Examiner handling the reexamination and to amend the patent claims. On January 14, 2016 the USPTO
ultimately rejected Taser’s efforts and confirmed the validity of the ‘292 Patent with 59 claims covering various aspects
of the Company’s auto-activation technology. On February 2, 2016 the USPTO issued another patent relating to the Company’s
auto-activation technology for law enforcement cameras. U.S. Patent No. 9,253,452 (the “ ‘452 Patent”) generally
covers the automatic activation and coordination of multiple recording devices in response to a triggering event, such as a law
enforcement officer activating the light bar on the vehicle.
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 Taser, alleging willful
patent infringement against Taser’s Axon body camera product line. The lawsuit was initiated after the USPTO reconfirmed
the validity of the ‘292 Patent, which covers various aspects of auto-activation and multiple camera coordination for body-worn
cameras and in-car video systems. The ‘292 Patent previously was subject to attack by Taser, which tried to invalidate it
at the USPTO. The USPTO ultimately rejected Taser’s efforts and confirmed the validity of the ‘292 Patent with 59 claims
covering various aspects of this valuable auto-activation technology. On February 2, 2016 the USPTO issued another patent relating
to the Company’s auto-activation technology for law enforcement cameras. This ‘452 Patent generally covers the automatic
activation and coordination of multiple recording devices in response to a triggering event such as a law enforcement officer activating
the light bar on the vehicle. The Company added the ‘452 patent to its existing lawsuit against Taser seeking both monetary
damages and a permanent injunction against Taser for infringement of both the ‘452 and ‘292 Patents.
In addition to the infringement
claims, the Company added a new set of claims to the lawsuit alleging that Taser conspired to keep the Company out of the marketplace
by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Taser 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.
The Company filed an amended
complaint and Taser filed an answer which denied the patent infringement allegations on April 1, 2016. In addition, Taser 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. Taser amended and renewed its motion to seek dismissal of
the allegations that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of
both state law and federal antitrust law on April 1, 2016. Formal discovery commenced on April 12, 2016 with respect to the patent
related claims. In January 2017 the Court granted Taser’s motion to dismiss the portion of the lawsuit regarding claims that
it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state law and
federal antitrust law. The Company has appealed this decision to the United States Court of Appeals for the Federal Circuit and
is awaiting its decision.
In December 2016, Taser
announced that it had commenced an action in the USPTO for
inter partes review
of the Company’s ‘292 Patent.
Previously Taser had attempted to invalidate the ‘292 Patent through a re-examination procedure at the USPTO. On January
14, 2016 the USPTO ultimately rejected Taser’s efforts and confirmed the validity of the ‘292 Patent with 59 claims
covering various aspects of the Company’s auto-activation technology. The USPTO fully rejected all of Taser’s previous
arguments, concluding all 59 claims in Digital Ally’s ‘292 patent were valid and non-obvious. Taser is again attempting
through its recently filed
inter partes review
to convince the USPTO that Digital Ally’s patents lack patentability.
The USPTO is taking the request under consideration and has not decided whether it will institute the
inter partes review.
In addition, Taser has requested that the patent infringement lawsuit filed by Digital Ally in the U.S. District Court for the
District of Kansas (Case No: 2:16-cv-02032) against Taser, be stayed while its
inter partes review
is being considered by
the USPTO. Digital Ally has filed a motion to deny the stay and both motions. On March 20, 2017 the Court granted Taser’s
motion to stay in part and temporarily stayed the proceedings until the Patent Trial and Appeal Board (“PTAB”) issues
its initial decisions with respect to Taser’s petitions for
inter partes review
. The PTAB is scheduled to issue its
initial decisions with respect to whether it will institute the requested
inter partes reviews
between June 2017 and August
2017.
On May 27, 2016 the Company
filed suit against Enforcement Video, LLC d/b/a WatchGuard Video (“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 and simultaneously 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. Digital Ally also has patent coverage directed to the coordination
between a multi-camera system and an officer’s smartphone, which allows an officer to more readily assess an event on the
scene while an event is taking place or immediately after it has occurred.
The Company’s lawsuit
alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car product lines without its permission.
Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the ‘292 and ‘452 Patents and U.S. Patent
No. 9,325,950. 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. The lawsuit is in the early stages of discovery.
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 under which it became the title sponsor for a Web.com Tour
golf tournament (the “Tournament”) held annually in the Kansas City Metropolitan area. Such Agreement provides the
Company with naming rights and other benefits for the annual Tournament for the years 2015 through 2019 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 $499,313
and $172,623 for the years ended December 31, 2016 and 2015, respectively. Such expense was included in sales and promotional expense
in the accompanying statement of operations.
Stock Repurchase
Program
. On August 25, 2015, the Board of Directors approved a program that authorizes the repurchase of up to $2.5 million
of the Company’s common stock in the open market, or in privately negotiated transactions. The repurchases, if and when made,
will be subject to market conditions, applicable rules of the Securities and Exchange Commission and other factors. The repurchase
program will be funded using a portion of cash and cash equivalents, along with cash flow from operations. Purchases may be commenced,
suspended or discontinued at any time. The Company had not repurchased any shares under this program as of December 31, 2016.
401 (k) Plan.
The
Company sponsors a 401(k) retirement savings plan for the benefit of our employees. The plan, as amended, requires it to provide
100% matching contributions for employees, who elect to contribute up to 3% of their compensation to the plan and 50% matching
contributions for employee’s elective deferrals on the next 2% of their contributions. The Company made matching contributions
totaling $184,642 and $163,227 for the years ended December 31, 2016 and 2015, respectively. Each participant is 100% vested at
all times in employee and employer matching contributions.
Consulting and Distributor
Agreements.
The Company has entered into two agreements that require it to make monthly payments which will be applied
to future commissions and/or consulting fees to be earned by the provider:
|
●
|
The first agreement is with an individual who provides consulting services for international sales opportunities for both our law enforcement and commercial product lines primarily in Europe. This individual is paid a monthly fee ranging from $4,000 to $6,000 per month plus necessary and reasonable expenses for a period of one year beginning March 23, 2016, which can be extended by mutual agreement of the parties. In addition to the monthly fee, the provider can earn a success fee based upon the amount of sales generated by his activities. As of December 31, 2016, the Company had advanced a total of $47,781 pursuant to this agreement.
|
|
|
|
|
●
|
The second agreement is with a limited liability company (“LLC”) that is partially owned by a relative of the Company’s chief financial officer. Under the agreement, dated January 15, 2016, 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 pays the LLC an advance against commissions ranging from $5,000 to $6,000 per month plus necessary and reasonable expenses for a period of one year beginning January 2016, which agreement can be automatically extended based on the LLC achieving certain minimum sales quotas. The agreement was renewed in January 2017 for a period of three years. As of December 31, 2016, the Company had advanced a total of $169,048 pursuant to this agreement.
|
NOTE 12. STOCK-BASED COMPENSATION
The Company recorded pretax
compensation expense related to the grant of stock options and restricted stock issued of $1,592,365 and $1,623,033, for the year
ended December 31, 2016 and 2015, respectively.
As of December 31, 2016,
the Company has adopted seven separate stock option and restricted stock plans: (i) the 2005 Stock Option and Restricted Stock
Plan (the “2005 Plan”), (ii) the 2006 Stock Option and Restricted Stock Plan (the “2006 Plan”), (iii) the
2007 Stock Option and Restricted Stock Plan (the “2007 Plan”), (iv) the 2008 Stock Option and Restricted Stock Plan
(the “2008 Plan”), (v) the 2011 Stock Option and Restricted Stock Plan (the “2011 Plan”), (vi) the 2013
Stock Option and Restricted Stock Plan (the “2013 Plan”) and (vii) the 2015 Stock Option and Restricted Stock Plan
(the “2015 Plan”), which was amended in May 2016. These Plans permit the grant of stock options or restricted stock
to its employees, non-employee directors and others totaling 1,925,000 shares of common stock. The 2005 Plan expired during 2015
with 28 shares reserved for awards but unissued which are now unavailable for issuance and the 2006 Plan expired in 2016 with 30
shares reserved for awards but unissued which are now unavailable for issuance. The Company believes that such awards better align
the interests of its employees with those of its shareholders. Option awards have been granted with an exercise price equal to
the market price of the Company’s 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 provide for accelerated vesting if there is a
change in control (as defined in the Plans) or the death or disability of the holder. The Company has registered all shares of
common stock that are issuable under its Plans with the SEC. A total of 200,772 shares remained available for grant under the various
Plans as of December 31, 2016.
In addition to the Stock
Option and Restricted Stock Plans described above, the Company has issued other options outside of these Plans to non-employees
for services rendered that are subject to the same general terms as the Plans, of which 1,250 options are fully vested and remain
outstanding as of December 31, 2016.
The fair value of each
option award is estimated on the date of grant using a Black-Scholes option valuation model. There were 40,000 stock options issued
during 2016.
The following is the
assumptions used in the Black-Scholes option valuation model:
|
|
2016
|
|
|
|
|
|
Expected term of options
|
|
|
5.5 years
|
|
Expected volatility
|
|
|
115%
|
|
Expected dividends
|
|
|
0
|
|
Risk free rates
|
|
|
1.29%
|
|
Activity in the various Plans during the year ended December 31, 2016 is reflected in the following
table:
Options
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
Outstanding at January 1, 2016
|
|
|
328,690
|
|
|
$
|
20.43
|
|
Granted
|
|
|
40,000
|
|
|
|
3.92
|
|
Exercised
|
|
|
(5,050
|
)
|
|
|
(3.77
|
)
|
Forfeited
|
|
|
(1,200
|
)
|
|
|
(3.63
|
)
|
Outstanding at December 31, 2016
|
|
|
362,440
|
|
|
$
|
18.46
|
|
Exercisable at December 31, 2016
|
|
|
315,690
|
|
|
$
|
21.00
|
|
Weighted-average fair value for options granted during the period at fair value
|
|
|
40,000
|
|
|
$
|
3.25
|
|
The Plans allow for the
cashless exercise of stock options. This provision allows the option holder to surrender/cancel options with an intrinsic value
equivalent to the purchase/exercise price of other options exercised. There were no shares surrendered pursuant to cashless exercises
during the year ended December 31, 2016.
At December 31, 2016,
the aggregate intrinsic value of options outstanding was approximately $66,069, and the aggregate intrinsic value of options exercisable
was approximately $48,627. The aggregate intrinsic value of options exercised during the year ended December 31, 2016 was $10,898.
The aggregate intrinsic value of options exercised during the year ended December 31, 2015 was $281,792.
As of December 31, 2016, the unamortized portion
of stock compensation expense on all existing stock options was $42,666, which will be recognized over the next 9 months.
The following table summarizes
the range of exercise prices and weighted average remaining contractual life for outstanding and exercisable options under the
Company’s option plans as of December 31, 2016:
|
|
|
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 $3.99
|
|
|
|
100,374
|
|
|
7.5 years
|
|
|
61,174
|
|
|
6.6 years
|
$
|
4.00 to $6.99
|
|
|
|
34,125
|
|
|
5.7 years
|
|
|
27,450
|
|
|
5.5 years
|
$
|
7.00 to $9.99
|
|
|
|
19,069
|
|
|
4.7 years
|
|
|
18,194
|
|
|
4.7 years
|
$
|
10.00 to $12.99
|
|
|
|
52,808
|
|
|
0.4 years
|
|
|
52,808
|
|
|
0.4 years
|
$
|
13.00 to $15.99
|
|
|
|
51,439
|
|
|
3.7 years
|
|
|
51,439
|
|
|
3.7 years
|
$
|
16.00 to $18.99
|
|
|
|
1,250
|
|
|
0.5 years
|
|
|
1,250
|
|
|
0.5 years
|
$
|
19.00 to $29.99
|
|
|
|
6,500
|
|
|
2.6 years
|
|
|
6,500
|
|
|
2.6 years
|
$
|
30.00 to $55.00
|
|
|
|
96,875
|
|
|
0.9 years
|
|
|
96,875
|
|
|
0.9 years
|
|
|
|
|
|
362,440
|
|
|
3.7 years
|
|
|
315,690
|
|
|
3.0 years
|
Restricted stock
grants.
The Board of Directors has granted restricted stock awards under the Plans. Restricted stock awards are valued
on the date of grant and have no purchase price for the recipient. Restricted stock awards typically vest over nine months to four
years corresponding to anniversaries of the grant date. Under the Plans, unvested shares of restricted stock awards may be forfeited
upon the termination of service to or employment with the Company, depending upon the circumstances of termination. Except for
restrictions placed on the transferability of restricted stock, holders of unvested restricted stock have full stockholder’s
rights, including voting rights and the right to receive cash dividends.
A summary of all restricted
stock activity under the equity compensation plans for the year ended December 31, 2016 is as follows:
|
|
Number
of Restricted shares
|
|
|
Weighted average
grant date fair
value
|
|
Nonvested balance, January 1, 2016
|
|
|
354,500
|
|
|
$
|
8.43
|
|
Granted
|
|
|
290,000
|
|
|
|
4.79
|
|
Vested
|
|
|
(144,600
|
)
|
|
|
(10.35
|
)
|
Forfeited
|
|
|
(4,600
|
)
|
|
|
(7.72
|
)
|
Nonvested balance, December 31, 2016
|
|
|
495,300
|
|
|
$
|
5.75
|
|
The Company estimated the
fair market value of these restricted stock grants based on the closing market price on the date of grant. As of December 31, 2016,
there were $1,462,224 of total unrecognized compensation costs related to all remaining non-vested restricted stock grants, which
will be amortized over the next 47 months in accordance with the respective vesting scale.
The nonvested balance
of restricted stock vests as follows:
Year ended December 31,
|
|
Number of
shares
|
|
|
|
|
|
2017
|
|
|
194,450
|
|
2016
|
|
|
186,650
|
|
2018
|
|
|
91,700
|
|
2019
|
|
|
22,500
|
|
NOTE 13. COMMON STOCK PURCHASE WARRANTS
The Company has issued
common stock purchase warrants (the “Warrants”) in conjunction with various debt and equity issuances. The Warrants
are immediately exercisable and allow the holders to purchase up to 2,379,290 shares of common stock at $5.00 to $16.50 per share
as of December 31, 2016. The Warrants expire from July 22, 2017 through December 30, 2021 and allow for cashless exercise.
|
|
Warrants
|
|
|
Weighted
average
exercise price
|
|
Vested Balance, January 1, 2016
|
|
|
1,599,290
|
|
|
$
|
13.26
|
|
Granted
|
|
|
800,000
|
|
|
|
5.00
|
|
Exercised
|
|
|
(20,000
|
)
|
|
|
5.00
|
|
Cancelled
|
|
|
—
|
|
|
|
—
|
|
Vested Balance, December 31, 2016
|
|
|
2,379,290
|
|
|
$
|
10.47
|
|
The total intrinsic value
of all outstanding Warrants aggregated $-0- as of December 31, 2016 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 December 31, 2016:
|
|
|
Outstanding and exercisable warrants
|
Exercise price
|
|
|
Number of options
|
|
|
Weighted average
remaining
contractual life
|
|
|
|
|
|
|
|
|
|
$
|
5.00
|
|
|
|
12,200
|
|
|
2.6 years
|
$
|
5.00
|
|
|
|
800,000
|
|
|
5.0 years
|
$
|
8.50
|
|
|
|
42,500
|
|
|
1.9 years
|
$
|
13.43
|
|
|
|
639,824
|
|
|
0.5 years
|
$
|
13.43
|
|
|
|
879,766
|
|
|
4.1 years
|
$
|
16.50
|
|
|
|
5,000
|
|
|
3.5 years
|
|
|
|
|
|
2,379,290
|
|
|
3.0 years
|
NOTE 14. PREFERRED STOCK
The Company held its annual
meeting of the shareholders (the “Annual Meeting”) on May 12, 2016. The shareholders approved an amendment to the Company’s
Articles of Incorporation to increase the number of authorized shares of its capital stock that the Company may issue from 25,000,000
to 35,000,000, of which 25,000,000 shares classified as common stock and 10,000,000 classified as preferred stock. The newly authorized
preferred stock has a par value of $0.001 per share. There have been no preferred shares issued as of December 31, 2016.
The Board of Directors
is authorized, to provide for the issuance of the shares of preferred stock in series, and by filing a certificate pursuant to
the applicable law of the State of Nevada, to establish from time to time the number of shares to be included in each such series,
and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations
and restrictions thereof. The authority of the Board of Directors with respect to each series of Preferred Stock will include,
but not be limited to, the rights to determine the following:
|
●
|
The number of shares constituting that series of Preferred Stock and the distinctive designation of that series, which may be a distinguishing number, letter or title;
|
|
|
|
|
●
|
The dividend rate on the shares of that series of Preferred Stock, whether dividends will be cumulative, and if so, from which date(s), and the relative rights of priority, if any, of payment of dividends on shares of that series;
|
|
|
|
|
●
|
Whether that series of Preferred Stock will have voting rights, in addition to the voting rights provided by law, and, if so, the terms of such voting rights;
|
|
●
|
Whether that series of Preferred Stock will have conversion privileges and, if so, the terms and conditions of such conversion, including provision for adjustment of the conversion rate in such events as the Board of Directors determines;
|
|
|
|
|
●
|
Whether or not the shares of that series of Preferred Stock will be redeemable and, if so, the terms and conditions of such redemption, including the date or date upon or after which they are redeemable, and the amount per share payable in case of redemption, which amount may vary under different conditions and at different redemption dates;
|
|
|
|
|
●
|
Whether that series of Preferred Stock will have a sinking fund for the redemption or purchase of shares of that series and, if so, the terms and amount of such sinking fund;
|
|
|
|
|
●
|
The rights of the shares of that series of Preferred Stock in the event of voluntary or involuntary liquidation, dissolution or winding up of the Company, and the relative rights of priority, if any, of payment of shares of that series; and any other relative rights, preferences and limitations of that series of Preferred Stock; and any other relative rights, preferences and limitations of that series of Preferred Stock
|
NOTE 15. NET LOSS PER SHARE
The calculation of the weighted average number
of shares outstanding and loss per share outstanding for the years ended December 31, 2016 and 2015 are as follows:
|
|
Year ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Numerator for basic and diluted income per share – Net loss
|
|
$
|
(12,710,688
|
)
|
|
$
|
(12,037,892
|
)
|
Denominator for basic loss per share – weighted average shares outstanding
|
|
|
5,347,042
|
|
|
|
4,340,012
|
|
Dilutive effect of shares issuable under stock options and warrants outstanding
|
|
|
—
|
|
|
|
—
|
|
Denominator for diluted loss per share – adjusted weighted average shares outstanding
|
|
|
5,347,042
|
|
|
|
4,340,012
|
|
|
|
|
Year ended December 31,
|
|
|
|
|
2016
|
|
|
|
2015
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(2.38
|
)
|
|
$
|
(2.77
|
)
|
Diluted
|
|
$
|
(2.38
|
)
|
|
$
|
(2.77
|
)
|
Basic loss per share
is based upon the weighted average number of common shares outstanding during the period. For the years ended December 31, 2016
and 2015, all outstanding stock options to purchase common stock were antidilutive, and, therefore, not included in the computation
of diluted income (loss) per share.
NOTE 16. SUBSEQUENT EVENT
In December 2016, Taser announced that it had
commenced an action in the USPTO for i
nter partes review
of the Company’s ‘292 Patent. Taser is again attempting
through its recently filed
inter partes review
to convince the USPTO that Digital Ally’s patents lack patentability.
The USPTO is taking the request under consideration and has not decided whether it will institute the
inter partes review.
In
addition, Taser has requested that the patent infringement lawsuit filed by Digital Ally in the U.S. District Court for the District
of Kansas (Case No: 2:16-cv-02032) against Taser, be stayed while its
inter partes review
is being considered by the USPTO.
Digital Ally has filed a motion to deny the stay and both motions. On March 20, 2017 the Court granted Taser’s motion to
stay in part and temporarily stayed the proceedings until the Patent Trial and Appeal Board (“PTAB”) issues its initial
decisions with respect to Taser’s petitions for
inter partes review
. The PTAB is scheduled to issue its initial decisions
with respect to whether it will institute the requested
inter partes reviews
between June 2017 and August 2017.