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”) produce
digital video imaging and storage products for use in law enforcement, security and commercial applications. Its products are
an in-car digital video/audio recorder contained in a rear-view mirror for use in law enforcement and commercial fleets; a system
that provides its law enforcement customers with audio/video surveillance from multiple vantage points and hands-free automatic
activation of body-worn cameras and in-car video systems; a miniature digital video system designed to be worn on an individual’s
body; and cloud storage solutions. The Company has active research and development programs to adapt its technologies to other
applications. It can integrate electronic, radio, computer, mechanical, and multi-media technologies to create unique solutions
to address needs in a variety of other industries and markets, including mass transit, school bus, taxicab and the military. The
Company sells its products to law enforcement agencies and other security organizations and consumer and commercial fleet operators
through direct sales domestically and third-party distributors internationally.
The
Company was originally incorporated in Nevada on December 13, 2000 as Vegas Petra, Inc. and had no operations until 2004. On November
30, 2004, Vegas Petra, Inc. entered into a Plan of Merger with Digital Ally, Inc., at which time the merged entity was renamed
Digital Ally, Inc.
Adoption
of New Accounting Pronouncement:
In
February 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-02,
Leases
(“Topic 842”).
The guidance requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in
a manner similar to today’s accounting. Lessees initially recognize a lease liability for the obligation to make lease payments
and a right-of-use asset for the right to use the underlying asset for the lease term. The lease liability is measured at the
present value of the lease payments over the lease term. The right-of-use asset is measured at the lease liability amount, adjusted
for lease prepayments, lease incentives received and the lessee’s initial direct costs. The standard is effective for public
business entities for annual reporting periods beginning after December 15, 2018, and interim periods within that reporting period,
which is the first quarter of 2019 for the Company.
The
Company adopted the new guidance on January 1, 2019 using the optional transitional method and elected to use the package of three
practical expedients which allows the Company not to reassess whether contracts are or contain leases, lease classification and
whether initial direct costs qualify for capitalization. The Company has completed its assessment of the impact of the standard
and determined that the only lease that the Company held was an operating lease for its office and warehouse space. Upon adoption
of the standard, the Company recorded operating lease right of use (ROU) assets of approximately $501,000 and lease
liabilities of approximately $582,000 related to it office and warehouse space operating leases. The Company also removed deferred
rent of approximately $81,000 when adopting the new guidance.
Management’s
Liquidity Plan
The
Company incurred substantial operating losses in the three months ended March 31, 2019 and for the year ended December 31, 2018
primarily due to reduced revenues and gross margins caused by competitors’ willful infringement of its patents, specifically
the auto-activation of body-worn and in-car video systems, and by competitors’ introduction of newer products with more
features than those of the Company and significant price cutting of their products. The Company incurred net losses of approximately
$3.2 million for the three months ended March 31, 2019 and $15.5 million during the year ended December 31, 2018 and it had an
accumulated deficit of $80.6 million as of March 31, 2019. In recent years the Company has accessed the public and private capital
markets to raise funding through the issuance of debt and equity. In that regard, the Company raised funding in the form of subordinated
debt, secured debt and proceeds investment agreements totaling $16,500,000, and net proceeds of $7,324,900 from an underwritten
public offering of common stock during the year ended December 31, 2018. The Company issued common stock with detachable common
stock purchase warrants for $2,776,332 and raised funding from subordinated and secured debt totaling $1,608,500 during the year
ended December 31, 2017. During 2016, the Company raised $4.0 million of funding in the form of convertible debentures and common
stock purchase warrants. These debt and equity raises were utilized to fund its operations and management expects to continue
this pattern until it achieves positive cash flows from operations, although it can offer no assurance in this regard.
The
Company retired all interest-bearing debt outstanding during the year ended December 31, 2018. The only long-term obligations
outstanding as of March 31, 2019 are associated with the proceeds investment agreement that the Company entered into during July
2018, as more fully described in Note 7.
The
Company settled its lawsuit with the PGA Tour and the case was dismissed by the Plaintiff with prejudice on April 17, 2019. See
Note 15, “Subsequent Events,” for the details respecting the settlement.
The
Company will have to restore positive operating cash flows and profitability over the next year and/or raise additional capital
to fund its operational plans, meet its customary payment obligations and otherwise execute its business plan. There can be no
assurance that it will be successful in restoring positive cash flows and profitability, or that it can raise additional financing
when needed, and obtain it on terms acceptable or favorable to the Company.
The
Company has implemented an enhanced quality control program to detect and correct product issues before they result in significant
rework expenditures affecting its gross margins and has seen progress in that regard. In addition, the Company undertook a number
of cost reduction initiatives in 2018, including a reduction of its workforce by approximately 40%, restructuring its direct sales
force and cutting other selling, general and administrative costs. The Company has increased its addressable market to non-law
enforcement customers and obtained new non-law enforcement contracts in 2018, which contracts include recurring revenue during
the period 2019 to 2020. The Company believes that its quality control, headcount reduction and cost cutting initiatives, expansion
to non-law enforcement sales channels and new product introduction will eventually restore positive operating cash flows and profitability,
although it can offer no assurances in this regard.
In
addition to the initiatives described above, the Board of Directors is conducting a review of a full range of strategic alternatives
to best position the Company for the future including, but not limited to, monetizing its patent portfolio and related patent
infringement litigation against Axon Enterprise, Inc. (“Axon” formerly Taser International, Inc.) and Enforcement
Video, LLC d/b/a WatchGuard Video (“WatchGuard”), the sale of all or certain assets, properties or groups of properties
or individual businesses or merger or combination with another company. The result of this review may also include the continued
implementation of the Company’s business plan. The Company retained Roth Capital Partners (“Roth”) in 2018 to
assist in this process and the capital raises/fundings completed in 2018 were part of this strategic alternatives review. While
such funding addressed the Company’s near-term liquidity needs, it continues to consider strategic alternatives to address
longer-term liquidity needs and operational issues. There can be no assurance that any additional transactions or financings will
result from this process.
Based
on the uncertainties described above, the Company believes its business plan does not alleviate the existence of substantial doubt
about its ability to continue as a going concern within one year from the date of the issuance of these condensed consolidated
interim financial statements.
The
following is a summary of the Company’s Significant Accounting Policies:
Basis
of Consolidation:
The
accompanying financial statements include the consolidated accounts of Digital Ally and its wholly-owned subsidiary, Digital Ally
International, Inc. All intercompany balances and transactions have been eliminated during consolidation.
The
Company formed Digital Ally International, Inc. during August 2009 to facilitate the export sales of its products.
Fair
Value of Financial Instruments:
The
carrying amounts of financial instruments, including cash and cash equivalents, accounts receivable and accounts payable approximate
fair value because of the short-term nature of these items. The Company accounts for its proceeds investment agreement on a fair
value basis.
Revenue
Recognition:
The
Company applies the provisions of Accounting Standards Codification (ASC) 606-10,
Revenue from Contracts with Customers
,
and all related appropriate guidance. The Company recognizes revenue under the core principle to depict the transfer of control
to its customers in an amount reflecting the consideration to which it expects to be entitled. In order to achieve that core principle,
the Company applies the following five-step approach: (1) identify the contract with a customer, (2) identify the performance
obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations
in the contract, and (5) recognize revenue when a performance obligation is satisfied.
The
Company considers customer purchase orders, which in some cases are governed by master sales agreements, to be the contracts with
the customer. In situation where sales are to a distributor, the Company had concluded its contracts are with the distributor
as the Company holds a contract bearing enforceable rights and obligations only with the distributor. As part of part of its consideration
for the contract, the Company evaluates certain factors including the customers’ ability to pay (or credit risk). For each
contract, the Company considers the promise to transfer products, each of which is distinct, to be the identified performance
obligations. In determining the transaction price, the Company evaluates whether the price is subject to refund or adjustment
to determine the net consideration to which it expects to be entitled. As the Company’s standard payment terms are less
than one year, it has elected the practical expedient under ASC 606-10-32-18 to not assess whether a contract has a significant
financing component. The Company allocates the transaction price to each distinct product based on its relative standalone selling
price. The product price as specified on the purchase order is considered the standalone selling price as it is an observable
input which depicts the price as if sold to a similar customer in similar circumstances. Revenue is recognized when control of
the product is transferred to the customer (i.e. when the Company’s performance obligations is satisfied), which typically
occurs at shipment. Further in determining whether control has been transferred, the Company considers if there is a present right
to payment and legal title, along with risks and rewards of ownership having transferred to the customer. Customers do not have
a right to return the product other than for warranty reasons for which they would only receive repair services or replacement
product. The Company has also elected the practical expedient under ASC 340-40-25-4 to expense commissions for product sales when
incurred as the amortization period of the commission asset the Company would have otherwise recognized is less than one year.
The
Company sells its products and services to law enforcement and commercial customers in the following manner:
|
●
|
Sales
to domestic customers are made direct to the end customer (typically a law enforcement agency or a commercial customer) through
its sales force, which is composed of its employees. Revenue is recorded when the product is shipped to the end customer.
|
|
|
|
|
●
|
Sales
to international customers are made through independent distributors who purchase products from the Company at a wholesale
price and sell to the end user (typically law enforcement agencies or a commercial customer) at a retail price. The distributor
retains the margin as its compensation for its role in the transaction. The distributor generally maintains product inventory,
customer receivables and all related risks and rewards of ownership. Accordingly, upon application of steps one through five
above, revenue is recorded when the product is shipped to the distributor consistent with the terms of the distribution agreement.
|
|
|
|
|
●
|
Repair
parts and services for domestic and international customers are generally handled by its inside customer service employees.
Revenue is recognized upon shipment of the repair parts and acceptance of the service or materials by the end customer.
|
Sales
taxes collected on products sold are excluded from revenues and are reported as accrued expenses in the accompanying balance sheets
until payments are remitted.
Service
and other revenue is comprised of revenues from extended warranties, repair services, cloud revenue and software revenue. Revenue
is recognized upon shipment of the product and acceptance of the service or materials by the end customer for repair services.
Revenue for extended warranty, cloud service or other software-based products is over the term of the contract warranty or service
period. A time-elapsed method is used to measure progress because the Company transfers control evenly over the contractual period.
Accordingly, the fixed consideration related to these revenues is generally recognized on a straight-line basis over the contract
term, as long as the other revenue recognition criteria have been met.
Contracts
with some of the Company’s customers contain multiple performance obligations that are distinct and accounted for separately.
The transaction price is allocated to the separate performance obligations on a relative standalone selling price (“SSP”).
The Company determined SSP for all the performance obligations using observable inputs, such as standalone sales and historical
pricing. SSP is consistent with the Company’s overall pricing objectives, taking into consideration the type of service
being provided. SSP also reflects the amount the Company would charge for the performance obligation if it were sold separately
in a standalone sale. Multiple performance obligations consist of product, software, cloud subscriptions and extended warranties.
The
Company’s multiple performance obligations may include future in-car or body-worn camera devices to be delivered at defined
points within a multi-year contract, and in those arrangements, the Company allocates total arrangement consideration over the
life of the multi-year contract to future deliverables using management’s best estimate of selling price.
Contract
liabilities consist of deferred revenue and include payments received in advance of performance under the contract and are reported
separately as current liabilities and non-current liabilities in the Condensed Consolidated Balance Sheets. Such amounts consist
of extended warranty contracts, prepaid cloud services and prepaid installation services and are generally recognized as the respective
performance obligations are satisfied. Total contract liabilities consist of the following:
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
Contract liabilities, current
|
|
$
|
1,663,009
|
|
|
$
|
1,748,789
|
|
Contract liabilities,
non-current
|
|
|
1,912,599
|
|
|
|
1,991,091
|
|
|
|
|
|
|
|
|
|
|
Total contract
liabilities
|
|
$
|
3,575,608
|
|
|
$
|
3,739,880
|
|
Sales
returns and allowances aggregated $69,780 and $20,019 for the three months ended March 31, 2019 and 2018, respectively. Obligations
for estimated sales returns and allowances are recognized at the time of sales on an accrual basis. The accrual is determined
based upon historical return rates adjusted for known changes in key variables affecting these return rates.
Revenues
for first quarter 2019 and first quarter 2018 were derived from the following sources:
|
|
Three
months ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
DVM-800
|
|
$
|
1,084,208
|
|
|
$
|
1,082,146
|
|
Repair and service
|
|
|
357,123
|
|
|
|
299,952
|
|
FirstVu HD
|
|
|
418,202
|
|
|
|
266,364
|
|
DVM-250 Plus
|
|
|
191,321
|
|
|
|
180,306
|
|
Cloud service revenue
|
|
|
179,464
|
|
|
|
145,322
|
|
Other service revenue
|
|
|
54,780
|
|
|
|
35,127
|
|
DVM-750
|
|
|
69,890
|
|
|
|
63,970
|
|
VuLink
|
|
|
47,025
|
|
|
|
39,636
|
|
Laser Ally
|
|
|
15,540
|
|
|
|
15,050
|
|
DVM-100 & DVM-400
|
|
|
3,390
|
|
|
|
48,043
|
|
Accessories and
other revenues
|
|
|
129,853
|
|
|
|
295,597
|
|
|
|
$
|
2,550,796
|
|
|
$
|
2,471,513
|
|
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.
Accounts
Receivable:
Accounts
receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding
amounts on a weekly basis. The Company determines the allowance for doubtful accounts by regularly evaluating individual customer
receivables and considering a customer’s financial condition, credit history, and current economic conditions. Trade receivables
are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.
A
trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than thirty (30)
days beyond terms. No interest is charged on overdue trade receivables.
Inventories:
Inventories
consist of electronic parts, circuitry boards, camera parts and ancillary parts (collectively, “components”), work-in-process
and finished goods, and are carried at the lower of cost (First-in, First-out Method) or market value. The Company determines
the estimate for the reserve for slow moving or obsolete inventories by regularly evaluating individual inventory levels, projected
sales and current economic conditions.
Furniture,
fixtures and equipment:
Furniture,
fixtures and equipment is stated at cost net of accumulated depreciation. Additions and improvements are capitalized while ordinary
maintenance and repair expenditures are charged to expense as incurred. Depreciation is recorded by the straight-line method over
the estimated useful life of the asset, which ranges from three to ten years. Amortization expense on capitalized leases is included
with depreciation expense.
Intangible
assets:
Intangible
assets include deferred patent costs and license agreements. Legal expenses incurred in preparation of patent application have
been deferred and will be amortized over the useful life of granted patents. Costs incurred in preparation of applications that
are not granted will be charged to expense at that time. The Company has entered into several sublicense agreements under which
it has been assigned the exclusive rights to certain licensed materials used in its products. These sublicense agreements generally
require upfront payments to obtain the exclusive rights to such material. The Company capitalizes the upfront payments as intangible
assets and amortizes such costs over their estimated useful life on a straight-line method.
Leases:
The
Company determines if an arrangement contains a lease at inception. For arrangements where the Company is the lessee, the Company
will evaluate whether to account for the lease as an operating or finance lease. Operating leases are included in the right of
use assets (ROU) and operating lease liabilities on the condensed consolidated balance sheet as of March 31, 2019. Finance leases
would be included in furniture, fixtures and equipment, net and long-term debt and finance lease obligations on the condensed
balance sheet. The Company had an operating lease for office and warehouse space at March 31, 2019 but no financing leases.
ROU
assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term
at commencement date. The Company uses its incremental borrowing rate based on the information available at the commencement date
in determining the operating lease liabilities if the operating lease does not provide an implicit rate. Lease terms may include
the option to extend when Company is reasonable certain that the option will be exercised. Lease expense for operating leases
is recognized on a straight line basis over the lease term
The
Company elected to apply the short-term lease measurement and recognition exemption in which ROU assets and lease liabilities
are not recognized for short term leases.
Proceeds
investment agreement:
The
Company has elected to record its proceeds investment agreement at its fair value. Accordingly, the proceeds investment agreement
will be marked-to-market at each reporting date with the change in fair value reported as a gain (loss) in the Consolidated Statement
of Operations. All issuance costs related to the proceeds investment agreement were expensed as incurred in the Consolidated Statement
of Operations.
Long-Lived
Assets:
Long-lived
assets such as furniture, fixtures and equipment and purchased intangible assets subject to amortization are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances
require a long-lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows
expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or
asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying
value exceeds its fair value. Fair value is determined through various valuation techniques, including discounted cash flow models,
quoted market values and third-party appraisals, as considered necessary.
Warranties:
The
Company’s products carry explicit product warranties that extend up to two years from the date of shipment. The Company
records a provision for estimated warranty costs based upon historical warranty loss experience and periodically adjusts these
provisions to reflect actual experience. Accrued warranty costs are included in accrued expenses. Extended warranties are offered
on selected products and when a customer purchases an extended warranty the associated proceeds are treated as contract liabilities
and recognized over the term of the extended warranty.
Shipping
and Handling Costs:
Shipping
and handling costs for outbound sales orders totaled $18,476 and $13,967 for the three months ended March 31, 2019 and 2018, respectively.
Such costs are included in selling, general and administrative expenses in the Condensed Consolidated Statements of Operations.
Advertising
Costs:
Advertising
expense includes costs related to trade shows and conventions, promotional material and supplies, and media costs. Advertising
costs are expensed in the period in which they are incurred. The Company incurred total advertising expense of approximately $124,015
and $79,569 for the three months ended March 31, 2019 and 2018, respectively. Such costs are included in selling, general and
administrative expenses in the Condensed Consolidated Statements of Operations.
Income
Taxes:
Deferred
taxes are provided for by the liability method in which deferred tax assets are recognized for deductible temporary differences
and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences.
Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion
or all the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes
in tax laws and rates on the date of enactment.
The
Company applies the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) No. 740 - Income Taxes that provides a framework for accounting for uncertainty in income taxes and provided
a comprehensive model to recognize, measure, present, and disclose in its financial statements uncertain tax positions taken or
expected to be taken on a tax return. It initially recognizes tax positions in the financial statements when it is more likely
than not the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently
measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with
the tax authority assuming full knowledge of the position and all relevant facts. Application requires numerous estimates based
on available information. The Company considers many factors when evaluating and estimating its tax positions and tax benefits,
and it recognized tax positions and tax benefits may not accurately anticipate actual outcomes. As it obtains additional information,
the Company may need to periodically adjust its recognized tax positions and tax benefits. These periodic adjustments may have
a material impact on its Consolidated Statements of Operations.
The
Company’s policy is to record estimated interest and penalties related to the underpayment of income taxes as income tax
expense in the consolidated statements of operations. There was no interest expense related to the underpayment of estimated taxes
during the three months ended March 31, 2019 and 2018. There have been no penalties in the three months ended March 31, 2019 and
2018.
The
Company is subject to taxation in the United States and various states. As of March 31, 2019, the Company’s tax returns
filed for 2015, 2016, and 2017 and to be filed for 2018 are subject to examination by the relevant taxing authorities. With few
exceptions, as of March 31, 2019, the Company is no longer subject to Federal, state, or local examinations by tax authorities
for years before 2015.
Research
and Development Expenses:
The
Company expenses all research and development costs as incurred. Development costs of computer software to be sold, leased, or
otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established
and ending when a product is available for general release to customers. In most instances, the Company’s products are released
soon after technological feasibility has been established. Costs incurred subsequent to achievement of technological feasibility
were not significant, and software development costs were expensed as incurred during the three months ended March 31, 2019 and
2018.
Common
Stock Purchase Warrants:
The
Company has common stock purchase warrants that are accounted for as equity based on their relative fair value and are not subject
to re-measurement.
Stock-Based
Compensation:
The
Company grants stock-based compensation to its employees, board of directors and certain third-party contractors. Share-based
compensation arrangements may include the issuance of options to purchase common stock in the future or the issuance of restricted
stock, which generally are subject to vesting requirements. The Company records stock-based compensation expense for all stock-based
compensation granted based on the grant-date fair value. The Company recognizes these compensation costs on a straight-line basis
over the requisite service period of the award.
The
Company estimates the grant-date fair value of stock-based compensation using the Black-Scholes valuation model. Assumptions used
to estimate compensation expense are determined as follows:
|
●
|
Expected
term is determined using the contractual term and vesting period of the award;
|
|
|
|
|
●
|
Expected
volatility of award grants made in the Company’s plan is measured using the weighted average of historical daily changes
in the market price of the Company’s common stock over the period equal to the expected term of the award;
|
|
|
|
|
●
|
Expected
dividend rate is determined based on expected dividends to be declared;
|
|
|
|
|
●
|
Risk-free
interest rate is equivalent to the implied yield on zero-coupon U.S. Treasury bonds with a maturity equal to the expected
term of the awards; and
|
|
|
|
|
●
|
Forfeitures
are accounted for as they occur.
|
Segments
of Business:
The
Company has determined that its operations are comprised of one reportable segment: the sale of digital audio and video recording
and speed detection devices. For the three months ended March 31, 2019 and 2018, sales by geographic area were as follows:
|
|
Three
months ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Sales by geographic area:
|
|
|
|
|
|
|
|
|
United
States of America
|
|
$
|
2,514,342
|
|
|
$
|
2,438,788
|
|
Foreign
|
|
|
36,454
|
|
|
|
32,725
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,550,796
|
|
|
$
|
2,471,513
|
|
Sales
to customers outside of the United States are denominated in U.S. dollars. All Company assets are physically located within the
United States.
NOTE
2. BASIS OF PRESENTATION
The
condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in
the United States for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly,
they do not include all the information and footnotes required by generally accepted accounting principles in the United States
for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2019 are not
necessarily indicative of the results that may be expected for the year ending December 31, 2019.
The
balance sheet at December 31, 2018 has been derived from the audited financial statements at that date but does not include all
the information and footnotes required by generally accepted accounting principles in the United States for complete financial
statements.
For
further information, refer to the financial statements and footnotes included in the Company’s annual report on Form 10-K
for the year ended December 31, 2018.
NOTE
3. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
Financial
instruments that potentially subject the Company to concentrations of credit risk consist of accounts receivable. Sales to domestic
customers are typically made on credit and the Company generally does not require collateral while sales to international customers
require payment before shipment or backing by an irrevocable letter or credit. The Company performs ongoing credit evaluations
of its customers’ financial condition and maintains an allowance for estimated losses. Accounts are written off when deemed
uncollectible and accounts receivable are presented net of an allowance for doubtful accounts. The allowance for doubtful accounts
totaled $70,000 as of March 31, 2019 and December 31, 2018.
The
Company uses primarily a network of unaffiliated distributors for international sales and employee-based direct sales force for
domestic sales. No international distributor individually exceeded 10% of total revenues and no customer receivable balance exceeded
10% of total accounts receivable for the three months ended March 31, 2019 and 2018
The
Company purchases finished circuit boards and other proprietary component parts from suppliers located in the United States and
on a limited basis from Asia. Although the Company obtains certain of these components from single source suppliers, it generally
owns all tooling and management has located alternative suppliers to reduce the risk in most cases to supplier problems that could
result in significant production delays. The Company has not historically experienced significant supply disruptions from any
of its principal vendors and does not anticipate future supply disruptions. The Company acquires most of its components on a purchase
order basis and does not have long-term contracts with its suppliers.
NOTE
4. INVENTORIES
Inventories
consisted of the following at March 31, 2019 and December 31, 2018:
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
Raw material and component
parts
|
|
$
|
5,079,868
|
|
|
$
|
4,969,786
|
|
Work-in-process
|
|
|
284,112
|
|
|
|
351,451
|
|
Finished goods
|
|
|
5,081,980
|
|
|
|
4,965,594
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
10,445,960
|
|
|
|
10,286,831
|
|
Reserve for excess
and obsolete inventory
|
|
|
(3,450,627
|
)
|
|
|
(3,287,771
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
6,995,333
|
|
|
$
|
6,990,060
|
|
Finished
goods inventory includes units held by potential customers and sales agents for test and evaluation purposes. The cost of such
units totaled $135,583 and $115,456 as of March 31, 2019 and December 31, 2018, respectively.
NOTE
5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture,
fixtures and equipment consisted of the following at March 31, 2019 and December 31, 2018:
|
|
Estimated
Useful Life
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
Office furniture, fixtures
and equipment
|
|
3-10 years
|
|
$
|
810,937
|
|
|
$
|
802,681
|
|
Warehouse and production equipment
|
|
3-5 years
|
|
|
536,374
|
|
|
|
526,932
|
|
Demonstration and tradeshow equipment
|
|
2-5 years
|
|
|
466,394
|
|
|
|
426,582
|
|
Leasehold improvements
|
|
2-5 years
|
|
|
161,966
|
|
|
|
160,198
|
|
Rental equipment
|
|
1-3
years
|
|
|
124,553
|
|
|
|
124,553
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost
|
|
|
|
|
2,100,224
|
|
|
|
2,040,946
|
|
Less: accumulated
depreciation and amortization
|
|
|
|
|
(1,868,172
|
)
|
|
|
(1,793,405
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net furniture,
fixtures and equipment
|
|
|
|
$
|
232,052
|
|
|
$
|
247,541
|
|
Depreciation
and amortization of furniture, fixtures and equipment aggregated $74,766 and $116,550 for the three months ended March 31, 2019
and 2018, respectively.
NOTE
6. DEBT OBLIGATIONS
Proceeds
investment agreement is comprised of the following:
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
2018 Proceeds investment
agreement, at fair value
|
|
$
|
9,279,000
|
|
|
$
|
9,142,000
|
|
Less: Current
portion
|
|
|
(6,000,000
|
)
|
|
|
—
|
|
2018 Proceeds
investment agreement at fair value-less current portion
|
|
$
|
3,279,000
|
|
|
$
|
9,142,000
|
|
2018
Proceeds Investment Agreement
.
On
July 31, 2018, the Company entered into a Proceeds Investment Agreement (the “PIA Agreement”) with Brickell Key Investments
LP (“BKI”), pursuant to which BKI funded an aggregate of $500,000 (the “First Tranche”) to be used (i)
to fund the Company’s litigation proceedings relating to the infringement of certain patent assets listed in the PIA Agreement
and (ii) to repay the Company’s existing debt obligations and for certain working capital purposes set forth in the PIA
Agreement. Pursuant to the PIA Agreement, BKI was granted an option to provide the Company with an additional $9.5 million, at
BKI’s sole discretion (the “Second Tranche”). On August 21, 2018, BKI exercised its option on the Second Tranche
for $9.5 million which completed the $10 million funding.
Pursuant
to the PIA Agreement and in consideration for the $10 million in funding, the Company agreed to assign to BKI (i) 100% of all
gross, pre-tax monetary recoveries paid by any defendant(s) to the Company or its affiliates agreed to in a settlement or awarded
in judgment in connection with the patent assets, plus any interest paid in connection therewith by such defendant(s) (the “Patent
Assets Proceeds”), up to the minimum return (as defined in the Agreement) and (ii) if BKI has not received its minimum return
by the earlier of a liquidity event (as defined in the Agreement) and July 31, 2020, then the Company agreed to assign to BKI
100% of the Patent Asset Proceeds until BKI has received an amount equal to the minimum return on $4.0 million.
Pursuant
to the PIA Agreement, the Company granted BKI (i) a senior security interest in the Patent Assets, the claims (as defined in the
Agreement) and the Patent Assets Proceeds until such time as the minimum return is paid, in which case, the security interest
on the patent assets, the claims and the Patent Assets Proceeds will be released, and (ii) a senior security interest in all other
assets of the Company until such time as the minimum return is paid on $4.0 million, in which case, the security interest on such
other assets will be released.
The
security interest is enforceable by BKI if the Company is in default under the PIA Agreement which would occur if (i) the Company
fails, after five (5) days’ written notice, to pay any due amount payable to BKI under the PIA Agreement, (ii) the Company
fails to comply with any provision of the PIA Agreement or any other agreement or document contemplated under the PIA Agreement,
(iii) the Company becomes insolvent or insolvency proceedings are commenced (and not subsequently discharged) with respect to
the Company, (iv) the Company’s creditors commence actions against the Company (which are not subsequently discharged) that
affect material assets of the Company, (v) the Company, without BKI’s consent, incurs indebtedness other than immaterial
ordinary course indebtedness up to $500,000, (vi) the Company fails, within five (5) business days following the closing of the
second tranche, to fully satisfy its obligations to certain holders of the Company’s senior secured convertible promissory
notes listed in the PIA Agreement and fails to obtain unconditional releases from such holders as to the Company’s obligations
to such holders and the security interests in the Company held by such holders or (vii) there is an uncured non-compliance of
the Company’s obligations or misrepresentations by the Company under the PIA Agreement.
Under
the PIA Agreement, the Company issued BKI a warrant to purchase up to 465,712 shares of the Company’s common stock, par
value $0.001 per share (the “PIA Warrant”), at an exercise price of $2.60 per share provided that the holder of the
PIA Warrant will be prohibited from exercising the PIA Warrant if, as a result of such exercise, such holder, together with its
affiliates, would own more than 4.99% of the total number of shares of the Company’s common stock outstanding immediately
after giving effect to such exercise. However, such holder may increase or decrease such percentage to any other percentage not
in excess of 9.99%, provided that any increase in such percentage shall not be effective until 61 days after such notice to the
Company. The PIA Warrant is exercisable for five years from the date of issuance and is exercisable on a cashless exercise basis
if there is no effective registration statement. No contractual registration rights were given.
The
Company elected to account for the PIA on the fair value basis. Therefore, the Company determined the fair value of the PIA and
PIA Warrants which yielded estimated fair values of the PIA including their embedded derivatives and the detachable PIA Warrants
as follows:
Proceeds investment agreement
|
|
$
|
9,067,513
|
|
Common stock
purchase warrants
|
|
|
932,487
|
|
|
|
|
|
|
Gross cash proceeds
|
|
$
|
10,000,000
|
|
The
following represents activity in the PIA during the Three months ended March 31, 2019:
Beginning balance as of January 1, 2019
|
|
$
|
9,142,000
|
|
Repayment of obligation
|
|
|
—
|
|
|
|
|
|
|
Change in the
fair value during the period
|
|
|
137,000
|
|
Ending balance as of March 31,
2019
|
|
$
|
9,279,000
|
|
The
estimated fair value of the obligation under the PIA Agreement is complex and involves the use of a valuation model that is subject
to a number of inputs, many of which are estimates. As of March 31, 2019, the Company classified a portion of the obligation
under the PIA Agreement as current within the condensed consolidated balance sheet to the extent the development of the WatchGuard
legal matter indicated a more than remote possibility of the receipt of proceeds within the next 12 months, which would in turn
require the Company to make payments on the obligation under the PIA Agreement. As a matter of consistency with the disclosed
WatchGuard settlement, the Company have classified $6 million of the obligation as current at March 31, 2019. It should
be noted that the subsequent WatchGuard settlement agreement contains certain information that was unknown at March 31, 2019 and
was therefore not reflected in the estimated fair value of our obligation under the PIA Agreement as of that date; however, this
information will be reflected in subsequent valuations of this obligation on and after the settlement date and may give rise to
subsequent changes in the estimated fair value of this obligation.
NOTE
7. FAIR VALUE MEASUREMENT
In
accordance with ASC Topic 820 —
Fair Value Measurements and Disclosures
(“ASC 820”), the Company utilizes
the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other
relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets
or liabilities, such as a business.
ASC
820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three
broad levels. The following is a brief description of those three levels:
●
|
Level
1 — Quoted prices in active markets for identical assets and liabilities
|
|
|
●
|
Level
2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
|
|
|
●
|
Level
3 — Significant unobservable inputs (including the Company’s own assumptions in determining the fair value)
|
The
following table represents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a
recurring basis as of March 31, 2019 and December 31, 2018.
|
|
March
31, 2019
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds
investment agreement
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,279,000
|
|
|
$
|
9,279,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2018
|
|
|
|
|
Level
1
|
|
|
|
Level
2
|
|
|
|
Level
3
|
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds
investment agreement
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,142,000
|
|
|
$
|
9,142,000
|
|
The
following table represents the change in Level 3 tier value measurements:
|
|
Proceeds
Investment Agreement
|
|
December 31, 2018
|
|
$
|
9,142,000
|
|
|
|
|
|
|
Change in fair
value
|
|
|
137,000
|
|
|
|
|
|
|
March 31, 2019
|
|
$
|
9,279,000
|
|
NOTE
8. ACCRUED EXPENSES
Accrued
expenses consisted of the following at March 31, 2019 and December 31, 2018:
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
Accrued warranty expense
|
|
$
|
138,496
|
|
|
$
|
195,135
|
|
Accrued litigation costs
|
|
|
896,265
|
|
|
|
1,119,445
|
|
Accrued sales commissions
|
|
|
30,000
|
|
|
|
25,750
|
|
Accrued payroll and related fringes
|
|
|
327,552
|
|
|
|
186,456
|
|
Accrued insurance
|
|
|
22,484
|
|
|
|
71,053
|
|
Accrued rent
|
|
|
—
|
|
|
|
81,160
|
|
Accrued sales returns and allowances
|
|
|
28,689
|
|
|
|
13,674
|
|
Other
|
|
|
217,486
|
|
|
|
387,994
|
|
|
|
$
|
1,660,972
|
|
|
$
|
2,080,667
|
|
Accrued
warranty expense was comprised of the following for the three months ended March 31, 2019:
|
|
2019
|
|
Beginning balance
|
|
$
|
195,135
|
|
Provision for warranty expense
|
|
|
15,161
|
|
Charges applied
to warranty reserve
|
|
|
(71,800
|
)
|
Ending balance
|
|
$
|
138,496
|
|
NOTE
9. INCOME TAXES
The
effective tax rate for the three months ended March 31, 2019 and 2018 varied from the expected statutory rate due to the Company
continuing to provide a 100% valuation allowance on net deferred tax assets. The Company determined that it was appropriate to
continue the full valuation allowance on net deferred tax assets as of March 31, 2019 primarily because of the Company’s
history of operating losses.
NOTE
10. OPERATING LEASE
The
Company entered into an operating lease with a third party in September 2012 for office and warehouse space in Lenexa, Kansas.
The terms of the lease include monthly payments ranging from $38,026 to $38,533 with a maturity date of April 2020. The Company
has the option to renew for an additional three years beyond the original expiration date, which may be exercised at the Company’s
sole discretion. The Company evaluated the renewal option at the adoption of ASC 842 to determine if it is reasonably certain
the exercise the option and concluded that it is not reasonably certain that any options will be exercised The weighted average
remaining lease term for the Company’s operating lease as of March 31, 2019 was 1.08 years.
Expense
related to the office space operating lease was recorded on a straight line basis over the lease term. Lease expense under the
operating lease was approximately $114,078 for the three months ended March 31, 2019.
The
discount rate implicit within the Company’s operating lease was not generally determinable and therefore the Company determined
the discount rate based on its incremental borrowing rate on the information available at commencement date. As of March 31, 2019,
the operating lease liabilities reflect a weighted average discount rate of 8%.
The
following sets forth the operating lease right of use assets and liabilities as of March 31, 2019:
Assets:
|
|
|
|
Operating lease right
of use assets
|
|
$
|
387,426
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Operating lease obligations-current
portion
|
|
$
|
433,007
|
|
Operating
lease obligations-less current portion
|
|
|
35,580
|
|
Total operating
lease obligations
|
|
$
|
468,587
|
|
Following
are our minimum lease payments for each year and in total.
Year
ending December 31:
|
|
|
|
2019 (period from April
1, 2019 to December 31, 2019)
|
|
$
|
343,249
|
|
2020
|
|
|
154,131
|
|
|
|
$
|
497,380
|
|
Discount
|
|
|
(28,793
|
)
|
Operating
lease obligation
|
|
$
|
468,587
|
|
NOTE
11. CONTINGENCIES
Litigation.
From
time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy to
not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After
carefully assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded,
we vigorously defend any lawsuit filed against us. We record a liability when losses are deemed probable and reasonably estimable.
When losses are deemed reasonably possible but not probable, we determine whether it is possible to provide an estimate of the
amount of the loss or range of possible losses for the claim, if material for disclosure. In evaluating matters for accrual and
disclosure purposes, we take into consideration factors such as our historical experience with matters of a similar nature, the
specific facts and circumstances asserted, the likelihood of our prevailing, the availability of insurance, and the severity of
any potential loss. We reevaluate and update accruals as matters progress over time.
While
the ultimate resolution is unknown we do not expect that these lawsuits will individually, or in the aggregate, have a material
adverse effect to our results of operations, financial condition or cash flows. However, the outcome of any litigation is inherently
uncertain and there can be no assurance that any expense, liability or damages that may ultimately result from the resolution
of these matters will be covered by our insurance or will not be in excess of amounts recognized or provided by insurance coverage
and will not have a material adverse effect on our operating results, financial condition or cash flows.
Axon
The
Company owns U.S. Patent No. 9,253,452 (the ” ’452 Patent”), which generally covers the automatic activation
and coordination of multiple recording devices in response to a triggering event, such as a law enforcement officer activating
the light bar on the vehicle.
The
Company filed suit on January 15, 2016 in the U.S. District Court for the District of Kansas (Case No: 2:16-cv-02032) against
Axon, alleging willful patent infringement against Axon’s body camera product line and Signal auto-activation product. The
Company is seeking both monetary damages and a permanent injunction against Axon for infringement of the ’452 Patent.
In
addition to the infringement claims, the Company brought claims alleging that Axon conspired to keep the Company out of the marketplace
by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Axon bribed officials and otherwise conspired
to secure no-bid contracts for its products in violation of both state law and federal antitrust law. The Company’s lawsuit
also seeks monetary and injunctive relief, including treble damages, for these alleged violations.
Axon
filed an answer, which denied the patent infringement allegations on April 1, 2016. In addition, Axon filed a motion to dismiss
all allegations in the complaint on March 4, 2016 for which the Company filed an amended complaint on March 18, 2016 to address
certain technical deficiencies in the pleadings. Digital amended its complaint and Axon renewed its motion to seek dismissal of
the allegations that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation
of both state law and federal antitrust law on April 1, 2016. Formal discovery commenced on April 12, 2016 with respect to the
patent related claims. In January 2017, the Court granted Axon’s motion to dismiss the portion of the lawsuit regarding
claims that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state
law and federal antitrust law. On May 2, 2018, the Federal Circuit affirmed the District Court’s ruling and on October 1,
2018 the Supreme Court denied Digital Ally’s petition for review.
In
December 2016 and January 2017, Axon filed two petitions for
Inter Partes
Review (“IPR”) against the ’452
Patent. The United States Patent and Trademark Office (“USPTO”) rejected both of Axon’s petitions. Axon is now
statutorily precluded from filing any more IPR petitions against the ’452 Patent.
The
District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on November
17, 2017, the Federal District Court of Kansas rejected Axon’s request to maintain the stay. With this significant ruling,
the parties will now proceed towards trial. Since litigation has resumed, the Court has issued a claim construction order (also
called a
Markman
Order) where it sided with the Company on all disputes and denied Axon’s attempts to limit the scope
of the claims. Following the
Markman
Order, the Court set all remaining deadlines in the case. Fact discovery closed on
October 8, 2018, and a Final Pretrial Conference took place on January 16, 2019. The parties filed motions for summary judgment
on January 31, 2019. The parties are awaiting a ruling from the Court on the summary judgment motions. The Court will set a trial
date once summary judgment matters are resolved.
WatchGuard
On
May 27, 2016 the Company filed suit against WatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent infringement based on
WatchGuard’s VISTA Wifi and 4RE In-Car product lines.
The
USPTO has granted multiple patents to the Company with claims covering numerous features, such as automatically activating all
deployed cameras in response to the activation of just one camera. Additionally, Digital Ally’s patent claims cover automatic
coordination as well as digital synchronization between multiple recording devices. It also has patent coverage directed to the
coordination between a multi-camera system and an officer’s smartphone, which allows an officer to more readily assess an
event on the scene while an event is taking place or immediately after it has occurred.
The
Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car product
lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the U.S Patent No.
8,781,292 (the ” ’292 Patent”) and ’452 Patents and U.S. Patent No. 9,325,950 the (” ’950
Patent”). The Company is aggressively challenging WatchGuard’s infringing conduct, seeking both monetary damages,
as well as seeking a permanent injunction preventing WatchGuard from continuing to sell its VISTA Wifi and 4RE In-Car product
lines using Digital Ally’s own technology to compete against it. On May 8, 2017, WatchGuard filed a petition seeking IPR
of the ’950 Patent. The Company opposed that petition and on December 4, 2017, The Patent Trial and Appeal Board (“PTAB”)
rejected the request of WatchGuard Video to institute an IPR on the ’950 Patent. The lawsuit also involves the ’292
Patent and the ’452 Patent, the ’452 Patent being the same patent asserted against Axon. The ’292 Patent previously
was subject to the IPR process with the USPTO, but in June 2018 the PTO rejected Axon’s arguments and did not invalidate
the ’292 Patent. WatchGuard had previously agreed to be bound by Axon’s IPRs and, as such, WatchGuard is now statutorily
barred from any further IPR’s challenges with respect to the ’950, ’452, and ’292 Patents. Since the defeat
of Axon’s ’292 Patent IPR, the Court has lifted the stay and set a schedule moving the case towards trial. Discovery
is ongoing and will close on May 2, 2019. The parties will then proceed with expert reports and summary judgment. No trial date
has been set. As of March 31, 2019, the parties were in active settlement discussions which resulted in the signing of a
non-binding term sheet that may resolve the matter. See Note 15, “Subsequent Events,” for the details respecting the
settlement terms and timing.
PGA
Tour, Inc.
On
January 22, 2019 the PGA Tour, Inc. (the “PGA”) filed suit against the Company in the Federal District Court for the
District of Kansas (Case No. 2:19-cv-0033-CM-KGG) alleging breach of contract and breach of implied covenant of good faith and
fair dealing relative to the Web.com Tour Title Sponsor Agreement (the “Agreement”). The contract was executed on
April 16, 2015 by and between the parties. Under the Agreement, Digital Ally would be a title sponsor of and receive certain naming
and other rights and benefits associated with the Web.com Tour for 2015 through 2019 in exchange for Digital Ally’s payment
to Tour of annual sponsorship fees.
The
suit has been resolved and the case has been dismissed by Plaintiff with prejudice on April 17, 2019. See Note 15, “Subsequent
Events,” for the details respecting the settlement.
401
(k) Plan.
The Company sponsors a 401(k) retirement savings plan for the benefit of its employees. The plan, as amended,
requires it to provide 100% matching contributions for employees, who elect to contribute up to 3% of their compensation to the
plan and 50% matching contributions for employee’s elective deferrals on the next 2% of their contributions. The Company
had made matching contributions totaling $26,442 and $29,375 for the three months ended March 31, 2019 and 2018, respectively.
Each participant is 100% vested at all times in employee and employer matching contributions.
Consulting
and Distributor Agreements.
The Company entered into an agreement that required it to make monthly payments that will
be applied to future commissions and/or consulting fees to be earned by the provider. The agreement is with a limited liability
company (“LLC”) that is minority owned by a relative of the Company’s chief financial officer. Under the agreement,
dated January 15, 2016 and as amended on February 13, 2017, the LLC provides consulting services for developing a new distribution
channel outside of law enforcement for its body-worn camera and related cloud storage products to customers in the United States.
The Company advanced amounts to the LLC against commissions ranging from $5,000 to $6,000 per month plus necessary and reasonable
expenses for the period through June 30, 2017, which can be automatically extended based on the LLC achieving minimum sales quotas.
The agreement was renewed in January 2017 for a period of three years, subject to yearly minimum sales thresholds that would allow
the Company to terminate the contract if such minimums are not met. As of March 31, 2019, the Company had advanced a total of
$278,241 pursuant to this agreement and established an allowance reserve of $104,140 for a net advance of $174,101. The minimum
sales threshold has not been met and the Company has discontinued all advances, although the contract has not been formally terminated.
However, the exclusivity provisions of the agreement have been terminated.
On
June 1, 2018 the Company entered into an agreement with an individual that required it to make monthly payments that will be applied
to future commissions and/or consulting fees to be earned by the provider. Under the agreement, the individual provides consulting
services for developing new distribution channels both inside and outside of law enforcement for its in-car and body-worn camera
systems and related cloud storage products to customers within and outside the United States. The Company was required to advance
amounts to the individual as an advance against commissions of $7,000 per month plus necessary and reasonable expenses for the
period through August 31, 2018, which was extended to December 31, 2018 by mutual agreement of the parties at $6,000 per month.
The parties have mutually agreed to further extend the arrangement on a monthly basis at $5,000 per month. As of March 31, 2019,
the Company had advanced a total of $77,841 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 $725,198 and
$493,519 for the three months ended 2019 and 2018, respectively.
As
of December 31, 2019, the Company had adopted seven separate stock option and restricted stock plans: (i) the 2005 Stock Option
and Restricted Stock Plan (the “2005 Plan”), (ii) the 2006 Stock Option and Restricted Stock Plan (the “2006
Plan”), (iii) the 2007 Stock Option and Restricted Stock Plan (the “2007 Plan”), (iv) the 2008 Stock Option
and Restricted Stock Plan (the “2008 Plan”), (v) the 2011 Stock Option and Restricted Stock Plan (the “2011
Plan”), (vi) the 2013 Stock Option and Restricted Stock Plan (the “2013 Plan”), (vii) the 2015 Stock Option
and Restricted Stock Plan (the “2015 Plan”) and (vii) the 2018 Stock Option and Restricted Stock Plan (the “2018
Plan”). The 2005 Plan, 2006 Plan, 2007 Plan, 2008 Plan, 2011 Plan, 2013 Plan, 2015 Plan and 2018 Plan are referred to as
the “Plans.”
These
Plans permit the grant of stock options or restricted stock to its employees, non-employee directors and others for up to a total
of 3,425,000 shares of common stock. The 2005 Plan terminated during 2015 with 7,116 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2005 Plan that remain unexercised and outstanding
as of March 31, 2019 total 20,625. The 2006 Plan terminated during 2016 with 23,399 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2006 Plan that remain unexercised and outstanding
as of March 31, 2019 total 44,075. The 2007 Plan terminated during 2017 with 85,276 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2007 Plan that remain unexercised and outstanding
as of March 31, 2019 total 9,375. The 2008 Plan terminated during 2018 with 8,249 shares not awarded or underlying options, which
shares are now unavailable for issuance. Stock options granted under the 2008 Plan that remain unexercised and outstanding as
of March 31, 2019 total 32,250.
The
Company believes that such awards better align the interests of our employees with those of its stockholders. Option awards have
been granted with an exercise price equal to the market price of its stock at the date of grant with such option awards generally
vesting based on the completion of continuous service and having ten-year contractual terms. These option awards typically provide
for accelerated vesting if there is a change in control (as defined in the Plans). The Company has registered all shares of common
stock that are issuable under its Plans with the SEC. A total of 56,316 shares remained available for awards under the various
Plans as of March 31, 2019.
The
fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. The total estimated
grant date fair value stock options issued during the three months ended March 31, 2019 was $-0-.
Activity
in the various Plans during the three months ended March 31, 2019 is reflected in the following table:
Options
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
Outstanding at January 1, 2019
|
|
|
434,012
|
|
|
$
|
4.62
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
(7,937
|
)
|
|
|
(10.16
|
)
|
Outstanding at March 31, 2019
|
|
|
426,075
|
|
|
$
|
4.52
|
|
Exercisable at March 31, 2019
|
|
|
386,075
|
|
|
$
|
4.76
|
|
The
fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. There were no
stock options issued during the three months ended March 31, 2019.
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 three months ended 2019.
At
March 31, 2019, the aggregate intrinsic value of options outstanding was approximately $332,295 and the aggregate intrinsic value
of options exercisable was approximately $271,495. No options were exercised in the three months ended March 31, 2019.
As
of March 31, 2019, the unrecognized portion of stock compensation expense on all existing stock options was $71,096.
The
following table summarizes the range of exercise prices and weighted average remaining contractual life for outstanding and exercisable
options under the Company’s option plans as of December 31, 2019:
|
|
|
Outstanding
options
|
|
Exercisable
options
|
|
Exercise
price
range
|
|
|
Number
of
options
|
|
|
Weighted
average
remaining
contractual life
|
|
Number
of
options
|
|
|
Weighted
average
remaining
contractual life
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.01
to $3.49
|
|
|
|
291,625
|
|
|
8.5
years
|
|
|
251,625
|
|
|
|
8.4
years
|
|
$
|
3.50
to $4.99
|
|
|
|
67,625
|
|
|
5.0
years
|
|
|
67,625
|
|
|
|
5.0
years
|
|
$
|
5.00
to $6.49
|
|
|
|
—
|
|
|
—years
|
|
|
—
|
|
|
|
—years
|
|
$
|
6.50
to $7.99
|
|
|
|
8,875
|
|
|
2.6
years
|
|
|
8,875
|
|
|
|
2.6
years
|
|
$
|
8.00
to $9.99
|
|
|
|
2,500
|
|
|
2.2
years
|
|
|
2,500
|
|
|
|
2.2
years
|
|
$
|
10.00
to $19.99
|
|
|
|
49,825
|
|
|
1.4
years
|
|
|
49,825
|
|
|
|
1.4
years
|
|
$
|
20.00
to $24.99
|
|
|
|
5,625
|
|
|
0.4
years
|
|
|
5,625
|
|
|
|
0.4
years
|
|
|
|
|
|
|
426,075
|
|
|
6.8
years
|
|
|
386,075
|
|
|
|
6.6
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 three months ended 2019 is as follows:
|
|
Number
of
Restricted
shares
|
|
|
Weighted
average
grant date
fair
value
|
|
Nonvested
balance, January 1, 2019
|
|
|
772,150
|
|
|
$
|
3.40
|
|
Granted
|
|
|
522,110
|
|
|
|
2.91
|
|
Vested
|
|
|
(297,790
|
)
|
|
|
(4.32
|
)
|
Forfeited
|
|
|
(2,500
|
)
|
|
|
(2.30
|
)
|
Nonvested
balance, March 31, 2019
|
|
|
993,970
|
|
|
$
|
2.90
|
|
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 March 31, 2019, there were 1,453,782 of total unrecognized compensation costs related to all remaining non-vested restricted
stock grants, which will be amortized over the next 21 months in accordance with the respective vesting scale.
The
nonvested balance of restricted stock vests as follows:
Years
ended
|
|
Number
of
shares
|
|
|
|
|
|
2019
(April 1, 2019 to December 31, 2019)
|
|
|
477,525
|
|
2020
|
|
|
265,785
|
|
2021
|
|
|
250,660
|
|
NOTE
13. COMMON STOCK PURCHASE WARRANTS
The
Company has issued common stock purchase warrants in conjunction with various debt and equity issuances. The warrants are either
immediately exercisable, or have a delayed initial exercise date, no more than nine months from issue date, and allow the holders
to purchase up to 4,532,145 shares of common stock at $2.60 to $16.50 per share as of March 31, 2019. The warrants expire from
July 15, 2020 through July 31, 2023 and allow for cashless exercise.
|
|
Warrants
|
|
|
Weighted
average
exercise price
|
|
Vested
Balance, January 1, 2019
|
|
|
4,693,145
|
|
|
$
|
5.40
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
Exercised
|
|
|
(161,000
|
)
|
|
|
(3.20)
|
)
|
Cancelled
|
|
|
—
|
|
|
|
—
|
|
Vested
Balance, March 31, 2019
|
|
|
4,532,145
|
|
|
$
|
5.46
|
|
The
total intrinsic value of all outstanding warrants aggregated $1,730,998 as of March 31, 2019 and the weighted average remaining
term is 32 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 March 31, 2019:
|
|
|
Outstanding
and exercisable warrants
|
Exercise
price
|
|
|
Number
of warrants
|
|
|
Weighted
average
remaining contractual life
|
$
|
2.60
|
|
|
|
565,712
|
|
|
4.2
years
|
$
|
2.75
|
|
|
|
100,000
|
|
|
3.5
years
|
$
|
3.00
|
|
|
|
851,667
|
|
|
4.0
years
|
$
|
3.25
|
|
|
|
120,000
|
|
|
3.7
years
|
$
|
3.36
|
|
|
|
880,000
|
|
|
3.7
years
|
$
|
3.50
|
|
|
|
36,000
|
|
|
0.3
years
|
$
|
3.65
|
|
|
|
200,000
|
|
|
3.2
years
|
$
|
3.75
|
|
|
|
94,000
|
|
|
3.4
years
|
$
|
5.00
|
|
|
|
800,000
|
|
|
2.8
years
|
$
|
13.43
|
|
|
|
879,766
|
|
|
1.8
years
|
$
|
16.50
|
|
|
|
5,000
|
|
|
1.3
years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,532,145
|
|
|
2.7
years
|
NOTE
14. NET LOSS PER SHARE
The
calculation of the weighted average number of shares outstanding and loss per share outstanding for the three months ended March
31, 2019 and 2018 are as follows:
|
|
Three
months ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Numerator
for basic and diluted income per share – Net loss
|
|
$
|
(3,205,174
|
)
|
|
$
|
(2,588,232
|
)
|
|
|
|
|
|
|
|
|
|
Denominator for basic loss per share – weighted average
shares outstanding
|
|
|
10,941,856
|
|
|
|
7,030,809
|
|
|
|
|
|
|
|
|
|
|
Dilutive effect
of shares issuable under stock options and warrants outstanding
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted loss per
share – adjusted weighted average shares outstanding
|
|
|
10,941,856
|
|
|
|
7,030,809
|
|
|
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.29
|
)
|
|
$
|
(0.37
|
)
|
Diluted
|
|
$
|
(0.29
|
)
|
|
$
|
(0.37
|
)
|
Basic
loss per share is based upon the weighted average number of common shares outstanding during the period. For the three months
ended March 31, 2019 and 2018, all outstanding stock options to purchase common stock were antidilutive, and, therefore, not included
in the computation of diluted net loss per share.
NOTE
15. SUBSEQUENT EVENTS
WatchGuard
As
described in Note 11, “Contingencies,” the parties have signed a non-binding term sheet which may resolve the Company’s
lawsuit against WatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent infringement based on WatchGuard’s VISTA Wifi
and 4RE In-Car product lines. On April 29, 2019 the parties
notified the Court that they
had reached an agreement to settle the litigation and jointly move to stay the litigation for two weeks, during which time the
parties formalized the settlement and filed dismissal papers.
On
May 14, 2019 the Company and WatchGuard announced that they had reached a resolution of the pending patent infringement litigation.
On May 26, 2016, the Company initiated a patent lawsuit in the U.S. District Court for the District of Kansas against WatchGuard
for alleged infringement of the ’292 Patent, the ’452 Patent and the ’950 Patent. On May 13, 2019, the parties
resolved the dispute and executed a settlement agreement in the form of a Release and License Agreement. The litigation has been
dismissed as a result of this settlement.
The
resolution of the dispute centers includes the following key terms:
|
●
|
WatchGuard will pay Digital Ally
a one-time, lump sum settlement payment of six (6) million dollars.
|
|
●
|
Digital Ally has granted WatchGuard
a perpetual covenant not to sue if WatchGuard’s products incorporate agreed-upon modified recording functionality.
|
|
●
|
Digital Ally has also granted
WatchGuard a license to the ’292 Patent and the ’452 Patent (and related patents, now existing and yet-to-issue)
through December 31, 2023. The parties have agreed to negotiate in good faith to attempt to resolve any alleged infringement
that occurs after the license period expires.
|
|
●
|
The Parties have further agreed
to release each other from all claims or liabilities pre-existing the settlement.
|
|
●
|
As part of the settlement, the
parties agreed that WatchGuard is making no admission that it has infringed any of Digital Ally’s patents.
|
PGA
Tour, Inc.
As
described in Note 11, “Contingencies,” the lawsuit has been settled and the case was dismissed by Plaintiff with prejudice
on April 17, 2019. This development dismisses and resolves the PGA’s lawsuit against the Company in the Federal District
Court for the District of Kansas (Case No. 2:19-cv-0033-CM-KGG) which alleged breach of contract and breach of implied covenant
of good faith and fair dealing relative to the Web.com Tour Title Sponsor Agreement.
*************************************