NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature
of Business:
Digital
Ally, Inc. and subsidiary (collectively, “Digital Ally,” “Digital,” and the “Company”) produces
digital video imaging and storage products for use in law enforcement, security and commercial applications. Its products are
an in-car digital video/audio recorder contained in a rear-view mirror for use in law enforcement and commercial fleets; a system
that provides its law enforcement customers with audio/video surveillance from multiple vantage points and hands-free automatic
activation of body-worn cameras and in-car video systems; a miniature digital video system designed to be worn on an individual’s
body; and cloud storage solutions. The Company has active research and development programs to adapt its technologies to other
applications. It can integrate electronic, radio, computer, mechanical, and multi-media technologies to create unique solutions
to address needs in a variety of other industries and markets, including mass transit, school bus, taxicab and the military. The
Company sells its products to law enforcement agencies, private security customers and organizations and consumer and commercial
fleet operators through direct sales domestically and third-party distributors internationally.
The
Company was originally incorporated in Nevada on December 13, 2000 as Vegas Petra, Inc. and had no operations until 2004. On November
30, 2004, Vegas Petra, Inc. entered into a Plan of Merger with Digital Ally, Inc., at which time the merged entity was renamed
Digital Ally, Inc.
Management’s
Liquidity Plan and Going Concern
The
accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization
of assets and the satisfaction of liabilities in the normal course of business. The Company incurred operating losses in the year
ended December 31, 2019 and substantial operating losses for the year ended December 31, 2018 primarily due to reduced revenues
and gross margins caused by competitors’ willful infringement of its patents, specifically the auto-activation of body-worn
and in-car video systems, and by competitors’ introduction of newer products with more advanced features together with significant
price cutting of their products. The Company incurred net losses of approximately $10.0 million for the year ended December 31,
2019 and $15.5 million during the year ended December 31, 2018 and it had an accumulated deficit of $87.4 million as of December
31, 2019. During the year ended December 31, 2019, the Company settled one of its patent infringement cases and received a lump
sum payment of $6.0 million, which was used to pay its obligations under its Proceeds Investment Agreement as more fully described
in Note 12. In recent years the Company has accessed the public and private capital markets to raise funding through the issuance
of debt and equity. In that regard, the Company raised $1,564,000 in the year ended December 31, 2019 from the exercise of warrants,
the Company borrowed $300,000 pursuant to a short-term promissory note payable on December 23, 2019 with detachable warrants to
purchase 107,000 shares of common stock and on August 5, 2019, the Company raised funds from the issuance of $2.78 million principal
balance of secured convertible notes with detachable warrants to purchase 571,248 shares of common stock with the net proceeds
being used for working capital purposes as more fully described in Note 6. Additionally, the Company raised funding in the form
of subordinated debt, secured debt and Proceeds Investment Agreement totaling $16,500,000 and net proceeds of $7,324,900 from
an underwritten public offering of common stock during the year ended December 31, 2018. These debt and equity raises were utilized
to fund its operations and management expects to continue this pattern until it achieves positive cash flows from operations,
although it can offer no assurance in this regard.
The
Company settled its lawsuit with the PGA Tour and the case was dismissed by the Plaintiff with prejudice on April 17, 2019. Additionally,
the Company settled its lawsuit with WatchGuard on May 13, 2019 and the case was dismissed. See Note 12, “Contingencies”
for the details respecting the settlements.
The
Company will have to restore positive operating cash flows and profitability over the next year and/or raise additional capital
to fund its operational plans, meet its customary payment obligations and otherwise execute its business plan. There can be no
assurance that it will be successful in restoring positive cash flows and profitability, or that it can raise additional financing
when needed, and obtain it on terms acceptable or favorable to the Company.
The
Company has increased its addressable market to non-law enforcement customers and obtained new non-law enforcement contracts in
2019 and 2018, which contracts include recurring revenue during the period 2020 to 2023. The Company believes that its quality
control and cost cutting initiatives, expansion to non-law enforcement sales channels and new product introduction will eventually
restore positive operating cash flows and profitability, although it can offer no assurances in this regard.
In
addition to the initiatives described above, the Board of Directors is conducting a review of a full range of strategic alternatives
to best position the Company for the future including, but not limited to, monetizing its patent portfolio and related patent
infringement litigation against Axon Enterprise, Inc. (“Axon” formerly Taser International, Inc.), the sale of all
or certain assets, properties or groups of properties or individual businesses or merger or combination with another company.
The result of this review may also include the continued implementation of the Company’s business plan. The Company’s
August 5, 2019 issuance of $2.78 million principal balance of convertible notes was part of this strategic alternatives review.
The Company has an active shelf registration statement on Form S-3, which it utilized to raise $2.9 million in gross proceeds
through the issuance of 2,521,740 common shares in an underwritten public offering at $1.15 per share on March 3, 2020. While
such funding addressed the Company’s near-term liquidity needs, it continues to consider strategic alternatives to address
longer-term liquidity needs and operational issues. There can be no assurance that any additional transactions or financings will
result from this process.
Based
on the uncertainties described above, the Company believes its business plan does not alleviate the existence of substantial doubt
about its ability to continue as a going concern within one year from the date of the issuance of these consolidated financial
statements. The accompanying consolidated financial statements do not include any adjustments related to the recoverability and
classification of asset amounts or the classification of liabilities that might be necessary should the Company be unable to continue
as a going concern.
The
following is a summary of the Company’s Significant Accounting Policies:
Basis
of Consolidation:
The
accompanying financial statements include the consolidated accounts of Digital Ally and its wholly-owned subsidiaries, Digital
Ally International, Inc. All intercompany balances and transactions have been eliminated during consolidation.
The
Company formed Digital Ally International, Inc. during August 2009 to facilitate the export sales of its products.
Fair
Value of Financial Instruments:
The
carrying amounts of financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and subordinated
notes payable approximate fair value because of the short-term nature of these items. The Company accounts for its derivative
liabilities, secured convertible debentures and proceeds investment agreement on a fair value basis.
Revenue
Recognition:
The
Company applies the provisions of Accounting Standards Codification (ASC) 606-10, Revenue from Contracts with Customers,
and all related appropriate guidance. The Company recognizes revenue under the core principle to depict the transfer of control
to its customers in an amount reflecting the consideration to which it expects to be entitled. In order to achieve that core principle,
the Company applies the following five-step approach: (1) identify the contract with a customer, (2) identify the performance
obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations
in the contract, and (5) recognize revenue when a performance obligation is satisfied.
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:
|
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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.
|
|
|
|
|
|
|
●
|
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.
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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 accrued expenses in the accompanying balance sheets
until payments are remitted.
Service
and other revenue is comprised of revenues from extended warranties, repair services, cloud revenue and software revenue. Revenue
is recognized upon shipment of the product and acceptance of the service or materials by the end customer for repair services.
Revenue for extended warranty, cloud service or other software-based products is over the term of the contract warranty or service
period. A time-elapsed method is used to measure progress because the Company transfers control evenly over the contractual period.
Accordingly, the fixed consideration related to these revenues is generally recognized on a straight-line basis over the contract
term, as long as the other revenue recognition criteria have been met.
Contracts
with some of the Company’s customers contain multiple performance obligations that are distinct and accounted for separately.
The transaction price is allocated to the separate performance obligations on a relative standalone selling price (“SSP”).
The Company determined SSP for all the performance obligations using observable inputs, such as standalone sales and historical
pricing. SSP is consistent with the Company’s overall pricing objectives, taking into consideration the type of service
being provided. SSP also reflects the amount the Company would charge for the performance obligation if it were sold separately
in a standalone sale. Multiple performance obligations consist of product, software, cloud subscriptions and extended warranties.
The
Company’s multiple performance obligations may include future in-car or body-worn camera devices to be delivered at defined
points within a multi-year contract, and in those arrangements, the Company allocates total arrangement consideration over the
life of the multi-year contract to future deliverables using management’s best estimate of selling price.
Contract
liabilities consist of deferred revenue and include payments received in advance of performance under the contract and are reported
separately as current liabilities and non-current liabilities in the Consolidated Balance Sheets. Such amounts consist of extended
warranty contracts, prepaid cloud services and prepaid installation services and are generally recognized as the respective performance
obligations are satisfied. During the year ended December 31, 2018, the Company recognized revenue of $1.7 million related to
its contract liabilities at January 1, 2018. Total contract liabilities consist of the following: Contract liabilities
consist of deferred revenue and include payments received in advance of performance under the contract and are reported separately
as current liabilities and non-current liabilities in the Consolidated Balance Sheets. Such amounts consist of extended warranty
contracts, prepaid cloud services and prepaid installation services and are generally recognized as the respective performance
obligations are satisfied. Total contract liabilities consist of the following:
|
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
Contract liabilities, current
|
|
$
|
1,707,943
|
|
|
$
|
1,748,789
|
|
|
Contract liabilities, non-current
|
|
|
1,803,143
|
|
|
|
1,991,091
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contract liabilities
|
|
$
|
3,511,086
|
|
|
$
|
3,739,880
|
|
Sales
returns and allowances aggregated $134,825 and $132,477 for the years ended December 31, 2019 and 2018, respectively. Obligations
for estimated sales returns and allowances are recognized at the time of sales on an accrual basis. The accrual is determined
based upon historical return rates adjusted for known changes in key variables affecting these return rates.
Revenues
for the years ended December 31, 2019 and 2018 were derived from the following sources:
|
|
|
Year
ended December 31,
|
|
|
|
|
2019
|
|
|
2018
|
|
|
DVM-800
|
|
$
|
3,756,544
|
|
|
$
|
5,090,804
|
|
|
Repair
and service
|
|
|
1,505,849
|
|
|
|
1,466,845
|
|
|
FirstVu
HD
|
|
|
1,264,457
|
|
|
|
1,386,737
|
|
|
DVM-250
Plus
|
|
|
1,133,557
|
|
|
|
757,676
|
|
|
Cloud
service revenue
|
|
|
754,586
|
|
|
|
693,653
|
|
|
DVM-750
|
|
|
—
|
|
|
|
403,390
|
|
|
VuLink
|
|
|
140,392
|
|
|
|
190,951
|
|
|
EVO
|
|
|
287,012
|
|
|
|
—
|
|
|
Laser
Ally
|
|
|
—
|
|
|
|
79,155
|
|
|
DVM-100
& DVM-400
|
|
|
7,890
|
|
|
|
75,421
|
|
|
Accessories
and other revenues
|
|
|
1,591,077
|
|
|
|
1,146,777
|
|
|
|
|
$
|
10,441,364
|
|
|
$
|
11,291,409
|
|
Use
of Estimates:
The
preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues
and expenses during the reporting period. Actual results could differ from those estimates. Management utilizes various other
estimates, including but not limited to determining the estimated lives of long-lived assets, determining the potential impairment
of long-lived assets, the fair value of warrants, options, proceeds investment agreement and convertible debt, the recognition
of revenue, inventory valuation reserve, the valuation allowance for deferred tax assets and other legal claims and contingencies.
The results of any changes in accounting estimates are reflected in the financial statements in the period in which the changes
become evident. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the period
that they are determined to be necessary.
Cash
and cash equivalents:
Cash
and cash equivalents include funds on hand, in bank and short-term investments with original maturities of ninety (90) days or
less.
Cash
and cash equivalents that are restricted as to withdrawal or use under the terms of the secured convertible debentures are presented
as restricted cash separate from cash and cash equivalents on the accompanying balance sheet.
Accounts
Receivable:
Accounts
receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding
amounts on a weekly basis. The Company determines the allowance for doubtful accounts by regularly evaluating individual customer
receivables and considering a customer’s financial condition, credit history, and current economic conditions. Trade receivables
are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.
A
trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than thirty (30)
days beyond terms. No interest is charged on overdue trade receivables.
Inventories:
Inventories
consist of electronic parts, circuitry boards, camera parts and ancillary parts (collectively, “components”), work-in-process
and finished goods, and are carried at the lower of cost or market, with cost determined by standard cost methods, which approximate
the first-in, first-out method. Inventory costs include material, labor and manufacturing overhead. Service inventories that exceed
the estimated requirements for the next 12 months based on recent usage levels are reported as other long-term assets. Management
has established inventory reserves based on estimates of excess and/or obsolete current and non-current inventory.
Manufacturing
inventory is reviewed for obsolescence and excess quantities on a quarterly basis, based on estimated future use of quantities
on hand, which is determined based on past usage, planned changes to products and known trends in markets and technology. Changes
in support plans or technology could have a significant impact on obsolescence.
To
support our world-wide service operations, we maintain service spare parts inventory, which consists of both consumable and repairable
spare parts. Consumable service spare parts are used within our service business to replace worn or damaged parts in a system
during a service call and are generally classified in current inventory as our stock of this inventory turns relatively quickly.
However, if there has been no recent usage for a consumable service spare part, but the part is still necessary to support systems
under service contracts, the part is considered to be non-current and included within non-current inventories within our consolidated
balance sheet. Consumables are charged to cost of goods sold when issued during the service call.
As
these service parts age over the related product group’s post-production service life, we reduce the net carrying value
of our repairable spare part inventory on the consolidated balance sheet to account for the excess that builds over the service
life. The post-production service life of our systems is generally seven to twelve years and, at the end of twelve years, the
carrying value for these parts in our consolidated balance sheet is reduced to zero. We also perform periodic monitoring of our
installed base for premature end of service life events and expense, through cost of sales, the remaining net carrying value of
any related spare parts inventory in the period incurred.
Furniture,
fixtures and equipment:
Furniture,
fixtures and equipment is stated at cost net of accumulated depreciation. Additions and improvements are capitalized while ordinary
maintenance and repair expenditures are charged to expense as incurred. Depreciation is recorded by the straight-line method over
the estimated useful life of the asset, which ranges from three to ten years. Amortization expense on capitalized leases is included
with depreciation expense. The cost and accumulated depreciation related to assets sold or retired are removed from the accounts
and any gain or loss is credited or charged to income.
Intangible
assets:
Intangible
assets include deferred patent costs and license agreements. Legal expenses incurred in preparation of patent application have
been deferred and will be amortized over the useful life of granted patents. Costs incurred in preparation of applications that
are not granted will be charged to expense at that time. The Company has entered into several sublicense agreements under which
it has been assigned the exclusive rights to certain licensed materials used in its products. These sublicense agreements generally
require upfront payments to obtain the exclusive rights to such material. The Company capitalizes the upfront payments as intangible
assets and amortizes such costs over their estimated useful life on a straight-line method.
Leases:
The
Company determines if an arrangement contains a lease at inception. For arrangements where the Company is the lessee, the Company
will evaluate whether to account for the lease as an operating or finance lease. Operating leases are included in the right of
use assets (ROU) and operating lease liabilities on the consolidated balance sheet as of December 31, 2019. Finance leases would
be included in furniture, fixtures and equipment, net and long-term debt and finance lease obligations on the balance sheet. The
Company had operating leases for copiers and its office and warehouse space at December 31, 2019 but no financing leases.
ROU
assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term
at commencement date. The Company uses its incremental borrowing rate based on the information available at the commencement date
in determining the operating lease liabilities if the operating lease does not provide an implicit rate. Lease terms may include
the option to extend when Company is reasonably certain that the option will be exercised. Lease expense for operating leases
is recognized on a straight-line basis over the lease term.
The
Company elected to apply the short-term lease measurement and recognition exemption in which ROU assets and lease liabilities
are not recognized for short term leases.
Secured
convertible debentures:
The
Company has elected to record its debentures at fair value. Accordingly, the debentures are marked-to-market at each reporting
date with the change in fair value reported as a gain (loss) in the Consolidated Statement of Operations. All issuance costs related
to the debentures were expensed as incurred in the Consolidated Statement of Operations.
Proceeds
investment agreement:
The
Company has elected to record its proceeds investment agreement at its fair value. Accordingly, the proceeds investment agreement
will be marked-to-market at each reporting date with the change in fair value reported as a gain (loss) in the Consolidated Statement
of Operations. All issuance costs related to the proceeds investment agreement were expensed as incurred in the Consolidated Statement
of Operations.
Senior
Convertible Notes:
The
Company has elected to record its senior convertible notes at its fair value. Accordingly, the senior convertible notes will be
marked-to-market at each reporting date with the change in fair value reported as a gain (loss) in the Consolidated Statement
of Operations. All issuance costs related to the senior convertible notes were expensed as incurred in the Consolidated Statement
of Operations.
Long-Lived
Assets:
Long-lived
assets such as furniture, fixtures and equipment and purchased intangible assets subject to amortization are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances
require a long-lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows
expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or
asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying
value exceeds its fair value. Fair value is determined through various valuation techniques, including discounted cash flow models,
quoted market values and third-party appraisals, as considered necessary.
Warranties:
The
Company’s products carry explicit product warranties that extend up to two years from the date of shipment. The Company
records a provision for estimated warranty costs based upon historical warranty loss experience and periodically adjusts these
provisions to reflect actual experience. Accrued warranty costs are included in accrued expenses. Extended warranties are offered
on selected products and when a customer purchases an extended warranty the associated proceeds are treated as contract liabilities
and recognized over the term of the extended warranty.
Shipping
and Handling Costs:
Shipping
and handling costs for outbound sales orders totaled $65,312 and $66,053 for the years ended December 31, 2019 and 2018, respectively.
Such costs are included in general and administrative expenses in the Consolidated Statements of Operations.
Advertising
Costs:
Advertising
expense includes costs related to trade shows and conventions, promotional material and supplies, and media costs. Advertising
costs are expensed in the period in which they are incurred. The Company incurred total advertising expense of approximately $1,019,707
and $384,113 for the years ended December 31, 2019 and 2018, respectively. Such costs are included in selling, advertising and
promotional expenses in the Consolidated Statements of Operations.
Income
Taxes:
Deferred
taxes are provided for by the liability method in which deferred tax assets are recognized for deductible temporary differences
and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences.
Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion
or all the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes
in tax laws and rates on the date of enactment.
The
Company applies the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) No. 740 - Income Taxes that provides a framework for accounting for uncertainty in income taxes and provided
a comprehensive model to recognize, measure, present, and disclose in its financial statements uncertain tax positions taken or
expected to be taken on a tax return. It initially recognizes tax positions in the financial statements when it is more likely
than not the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently
measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with
the tax authority assuming full knowledge of the position and all relevant facts. Application requires numerous estimates based
on available information. The Company considers many factors when evaluating and estimating its tax positions and tax benefits,
and it recognized tax positions and tax benefits may not accurately anticipate actual outcomes. As it obtains additional information,
the Company may need to periodically adjust its recognized tax positions and tax benefits. These periodic adjustments may have
a material impact on its Consolidated Statements of Operations.
The
Company’s policy is to record estimated interest and penalties related to the underpayment of income taxes as income tax
expense in the Consolidated Statements of Operations. There was no interest expense related to the underpayment of estimated taxes
during the years ended December 31, 2019 and 2018. There were no penalties in 2019 and 2018.
The
Company is subject to taxation in the United States and various states. As of December 31, 2019, the Company’s tax returns
filed for 2016, 2017, and 2018 and to be filed for 2019 are subject to examination by the relevant taxing authorities. With few
exceptions, as of December 31, 2018, the Company is no longer subject to Federal, state, or local examinations by tax authorities
for years before 2016.
Research
and Development Expenses:
The
Company expenses all research and development costs as incurred. Development costs of computer software to be sold, leased, or
otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established
and ending when a product is available for general release to customers. In most instances, the Company’s products are released
soon after technological feasibility has been established. Costs incurred subsequent to achievement of technological feasibility
were not significant, and software development costs were expensed as incurred during 2019 and 2018.
Common
Stock Purchase Warrants:
The
Company has common stock purchase warrants that are accounted for as liabilities under the caption of derivative liabilities on
the consolidated balance sheet and recorded at fair value due to the warrant agreements containing anti-dilution provisions. The
change in fair value is being recorded in Consolidated Statement of Operations.
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
|
|
|
|
|
|
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●
|
Forfeitures
are accounted for as they occur.
|
Segments
of Business:
The
Company has determined that its operations are comprised of one reportable segment: the sale of digital audio and video recording
and speed detection devices. For the year ended December 31, 2019 and 2018, sales by geographic area were as follows:
|
|
|
Year ended December 31,
|
|
|
|
|
2019
|
|
|
2018
|
|
|
Sales by geographic area:
|
|
|
|
|
|
|
|
|
|
United States of America
|
|
$
|
10,251,259
|
|
|
$
|
10,929,071
|
|
|
Foreign
|
|
|
190,105
|
|
|
|
362,338
|
|
|
|
|
$
|
10,441,364
|
|
|
$
|
11,291,409
|
|
Sales
to customers outside of the United States are denominated in U.S. dollars. All Company assets are physically located within the
United States.
Reclassification
of Prior Year Presentation
Certain
prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect
on the reported results of operations.
Recently
Adopted Accounting Standards
In
February 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-02, Leases (“Topic 842”).
The guidance requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in
a manner similar to today’s accounting. Lessees initially recognize a lease liability for the obligation to make lease payments
and a right-of-use asset for the right to use the underlying asset for the lease term. The lease liability is measured at the
present value of the lease payments over the lease term. The right-of-use asset is measured at the lease liability amount, adjusted
for lease prepayments, lease incentives received and the lessee’s initial direct costs. The standard is effective for public
business entities for annual reporting periods beginning after December 15, 2018, and interim periods within that reporting period,
which is the first quarter of 2019 for the Company.
The
Company adopted the new guidance on January 1, 2019 using the optional transitional method and elected to use the package of three
practical expedients which allows the Company not to reassess whether contracts are or contain leases, lease classification and
whether initial direct costs qualify for capitalization. The Company has completed its assessment of the impact of the standard
and determined that the only lease that the Company held was an operating lease for its office and warehouse space. Upon adoption
of the standard, the Company recorded Right of Use (ROU) assets of approximately $501,000 and lease liabilities of approximately
$582,000 related to it office and warehouse space operating leases. The Company also removed deferred rent of approximately $81,000
when adopting the new guidance.
For
financial liabilities measured using the fair value option in ASC 825, ASU 2016-01, Financial Instruments — Overall (Subtopic
825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, issued in January 2016, requires entities
to recognize the changes in fair value of liabilities caused by a change in instrument specific credit risk (own credit risk)
in other comprehensive income. The ASU is effective for calendar-year public business entities beginning in 2018. For all other
calendar-year entities, it is effective for annual periods beginning in 2019 and interim periods beginning in 2020. Entities can
early adopt certain provisions of the new standard, including this provision related to financial liabilities measured under the
fair value option. We have considered this guidance and its impact on this debt accounted for at fair value. Based on discussions
with our valuation expert and knowledge of the Company there was no change in valuation caused by a change in the Company’s
credit risk during the period from August 5, 2019 to December 31, 2019.
ASU
2018-09, Codification improvements, clarifies the accounting for a debt extinguishment when the fair value option is elected.
Upon extinguishment an entity shall include in net income the cumulative amount of the gain or loss previously recorded in other
comprehensive income for the extinguished debt that resulted from changes in instrument-specific credit risk. The ASU is effective
for calendar-year public business entities beginning in 2019. For all other calendar-year entities, it is effective for annual
periods beginning in 2020 and interim periods beginning in 2021. Early adoption is permitted for any fiscal year or interim period
for which an entity’s financial statements have not yet been issued or have not been made available to be issued. We have
considered this guidance and its impact on this debt accounted for at fair value. Based on discussions with our valuation expert
and knowledge of the Company there was no change in valuation caused by a change in the Company’s credit risk during the
period from August 5, 2019 to December 31, 2019. Since there is no change accounted for as a change in Credit Risk (included in
other comprehensive income/loss) there is no impact to the Company’s financial statements from this new guidance.
In
June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses” to improve information on credit
losses for financial assets and net investment in leases that are not accounted for at fair value through net income. ASU 2016-13
replaces the current incurred loss impairment methodology with a methodology that reflects expected credit losses. In April 2019
and May 2019, the FASB issued ASU No. 2019-04, “Codification Improvements to Topic 326, Financial Instruments-Credit Losses,
Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments” and ASU No. 2019-05, “Financial Instruments-Credit
Losses (Topic 326): Targeted Transition Relief” which provided additional implementation guidance on the previously issued
ASU. In November 2019, the FASB issued ASU 2019-10, “Financial Instruments - Credit Loss (Topic 326), Derivatives and Hedging
(Topic 815), and Leases (Topic 842),” which defers the effective date for public filers that are considered small reporting
companies (“SRC”) as defined by the Securities and Exchange Commission to fiscal years beginning after December 15,
2022, including interim periods within those fiscal years. Since the Company is an SRC, implementation is not needed until January
1, 2023. The Company will continue to evaluate the effect of adopting ASU 2016-13 will have on the Company’s consolidated
financial statements.
In
August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-13, Fair Value Measurement (Topic
820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, to improve the effectiveness
of disclosures. The amendments remove, modify, and add certain disclosure requirements in Topic 820, “Fair Value Measurement.”
The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used
to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively
for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should
be applied retrospectively to all periods presented upon their effective date. The amendments are effective for fiscal years beginning
after December 15, 2019. Early adoption is permitted, including adoption in an interim period. Furthermore, an entity is permitted
to early adopt any removed or modified disclosures upon issuance of the update and delay adoption of the additional disclosures
until their effective date. The Company is currently evaluating the effects the adoption of ASU 2018-13 will have on the disclosures.
In
August 2018, the FASB issued ASU No. 2018-15, Intangible-Goodwill and Other Internal-Use Software (Subtopic 350-40), or
ASU 2018-15. ASU 2018-15 updates guidance regarding accounting for implementation costs associated with a cloud computing arrangement
that is a service contract. The amendments under ASU 2018-15 are effective for interim and annual fiscal periods beginning after
December 15, 2019, with early adoption permitted. The Company does not expect the adoption of ASU 2018-15 to have a material impact
on its financial statements.
In
December 2019, the FASB issued ASU No. 2019-12, Income Taxes - simplifying the accounting for income taxes (Topic 740), which
is meant to simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740, Income
Taxes. The amendment also improves consistent application and simplify GAAP for other areas of Topic 740 by clarifying and amending
existing guidance. We do not expect the adoption of this standard to have a significant impact on our financial position and results
of operations.
NOTE
2. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
Financial
instruments that potentially subject the Company to concentrations of credit risk consist of accounts receivable. Sales to domestic
customers are typically made on credit and the Company generally does not require collateral while sales to international customers
require payment before shipment or backing by an irrevocable letter or credit. The Company performs ongoing credit evaluations
of its customers’ financial condition and maintains an allowance for estimated losses. Accounts are written off when deemed
uncollectible and accounts receivable are presented net of an allowance for doubtful accounts. The allowance for doubtful accounts
totaled $123,224 as of December 31, 2019 and $70,000 as of December 31, 2018.
The
Company uses primarily a network of unaffiliated distributors for international sales and employee-based direct sales force for
domestic sales. No international distributor individually exceeded 10% of total revenues and no customer receivable balance exceeded
10% of total accounts receivable for the years ended December 31, 2019 and 2018.
The
Company purchases finished circuit boards and other proprietary component parts from suppliers located in the United States and
on a limited basis from Asia. Although the Company obtains certain of these components from single source suppliers, it generally
owns all tooling and management has located alternative suppliers to reduce the risk in most cases to supplier problems that could
result in significant production delays. The Company has not historically experienced significant supply disruptions from any
of its principal vendors and does not anticipate future supply disruptions. The Company acquires most of its components on a purchase
order basis and does not have long-term contracts with its suppliers.
NOTE
3. ACCOUNTS RECEIVABLE – ALLOWANCE FOR DOUBTFUL ACCOUNTS
The
allowance for doubtful accounts receivable was comprised of the following for the years ended December 31, 2019 and 2018:
|
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
Beginning balance
|
|
$
|
70,000
|
|
|
$
|
70,000
|
|
|
Provision for bad debts
|
|
|
60,000
|
|
|
|
—
|
|
|
Charge-offs to allowance, net of recoveries
|
|
|
(6,776
|
)
|
|
|
—
|
|
|
Ending balance
|
|
$
|
123,224
|
|
|
$
|
70,000
|
|
NOTE
4. INVENTORIES
Inventories
consisted of the following at December 31, 2019 and 2018:
|
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
Raw material and component parts
|
|
$
|
4,481,611
|
|
|
$
|
4,969,786
|
|
|
Work-in-process
|
|
|
35,858
|
|
|
|
351,451
|
|
|
Finished goods
|
|
|
4,906,956
|
|
|
|
4,965,594
|
|
|
Subtotal
|
|
|
9,424,425
|
|
|
|
10,286,831
|
|
|
Reserve for excess and obsolete inventory
|
|
|
(4,144,013
|
)
|
|
|
(3,287,771
|
)
|
|
Total inventories
|
|
$
|
5,280,412
|
|
|
$
|
6,999,060
|
|
Finished
goods inventory includes units held by potential customers and sales agents for test and evaluation purposes. The cost of such
units totaled $80,711 and $115,456 as of December 31, 2019 and 2018, respectively.
NOTE
5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture,
fixtures and equipment consisted of the following at December 31, 2019 and 2018:
|
|
|
Estimated Useful Life
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
Office furniture, fixtures and equipment
|
|
3-10 years
|
|
$
|
397,795
|
|
|
$
|
802,681
|
|
|
Warehouse and production equipment
|
|
3-5 years
|
|
|
210,700
|
|
|
|
526,932
|
|
|
Demonstration and tradeshow equipment
|
|
2-5 years
|
|
|
252,001
|
|
|
|
426,582
|
|
|
Leasehold improvements
|
|
2-5 years
|
|
|
163,171
|
|
|
|
160,198
|
|
|
Rental equipment
|
|
1-3 years
|
|
|
93,923
|
|
|
|
124,553
|
|
|
Total cost
|
|
|
|
|
1,117,591
|
|
|
|
2,040,946
|
|
|
Less: accumulated depreciation and amortization
|
|
|
|
|
(920,528
|
)
|
|
|
(1,793,405
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net furniture, fixtures and equipment
|
|
|
|
$
|
197,063
|
|
|
$
|
247,541
|
|
Depreciation
and amortization of furniture, fixtures and equipment aggregated $254,491 and $385,104 for the years ended December 31, 2019 and
2018, respectively. The cost and accumulated depreciation related to assets sold or retired are removed from the accounts and
any gain or loss is credited or charged to income. The Company retired fixed assets during 2019 totaling $1,127,368, all of which
were fully depreciated resulting in no gain or loss for the year ended December 31, 2019.
NOTE
6. INTANGIBLE ASSETS
Intangible
assets consisted of the following at December 31, 2019 and 2018:
|
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
Gross value
|
|
|
Accumulated amortization
|
|
|
Net carrying value
|
|
|
Gross value
|
|
|
Accumulated amortization
|
|
|
Net carrying value
|
|
|
Amortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses
|
|
$
|
73,893
|
|
|
$
|
41,785
|
|
|
$
|
32,108
|
|
|
$
|
73,893
|
|
|
$
|
31,228
|
|
|
$
|
42,665
|
|
|
Patents and Trademarks
|
|
|
542,420
|
|
|
|
326,220
|
|
|
|
216,200
|
|
|
|
452,599
|
|
|
|
273,586
|
|
|
|
179,013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
616,313
|
|
|
|
368,005
|
|
|
|
248,308
|
|
|
|
526,492
|
|
|
|
304,814
|
|
|
|
221,678
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Patents and trademarks pending
|
|
|
164,960
|
|
|
|
—
|
|
|
|
164,960
|
|
|
|
265,119
|
|
|
|
—
|
|
|
|
265,119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
781,273
|
|
|
$
|
368,005
|
|
|
$
|
413,268
|
|
|
$
|
791,611
|
|
|
$
|
304,814
|
|
|
$
|
486,797
|
|
Patents
and trademarks pending will be amortized beginning at the time they are issued by the appropriate authorities. If issuance of
the final patent or trademark is denied, then the amount deferred will be immediately charged to expense.
Amortization
expense for the years ended December 31, 2019 and 2018 was $135,660 and $115,073, respectively. Estimated amortization for intangible
assets with definite lives for the next five years ending December 31 and thereafter is as follows:
|
Year ending December 31:
|
|
|
|
|
2020
|
|
$
|
97,502
|
|
|
2021
|
|
|
87,967
|
|
|
2022
|
|
|
62,399
|
|
|
2023
|
|
|
440
|
|
|
2024
|
|
|
—
|
|
|
|
|
$
|
248,308
|
|
NOTE
7. DEBT OBLIGATIONS
Debt
obligations is comprised of the following:
|
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
2019 Secured convertible notes, at fair value
|
|
$
|
1,593,809
|
|
|
$
|
—
|
|
|
2018 Proceeds investment agreement, at fair value
|
|
|
6,500,000
|
|
|
|
9,142,000
|
|
|
Unsecured promissory note payable, less unamortized discount of $66,061 at December 31, 2019
|
|
|
233,939
|
|
|
|
—
|
|
|
Debt obligations
|
|
$
|
8,327,748
|
|
|
$
|
9,142,000
|
|
2019
Secured Convertible Notes.
On
August 5, 2019, the Company, entered into a securities purchase agreement with several accredited investors providing for the
issuance of (i) the Company’s 8% secured convertible notes due August 4, 2020 with a principal face amount of $2,777,777.78,
which convertible notes are, subject to certain conditions, convertible into 1,984,126 shares of the Company’s common stock,
at a price per share of $1.40; (ii) five-year warrants to purchase an aggregate of 571,428 shares of Common Stock at an exercise
price of $1.8125, which warrants are immediately exercisable upon issuance and on a cashless basis if the Warrants have not been
registered 180 days after the date of issuance; and (iii) the issuance of shares of common stock equal to 5% of the aggregate
purchase price of the convertible notes, with an aggregate value of $125,000 (the “Commitment Shares”). The accredited
investors purchased the foregoing securities for an aggregate cash purchase price of $2,500,000.
Pursuant
to the purchase agreement, an aggregate of $1,153,320 in principal amount of convertible notes (the “Registered Notes”),
the conversion shares underlying the Registered Notes and all of the Commitment Shares were issued to the accredited investors
in a registered direct offering pursuant to a prospectus supplement to the Company’s currently effective shelf registration
statement on Form S-3. Accordingly, $1,153,320 in original principal amount of our convertible notes were issued as Registered
Notes pursuant to the shelf registration statement and therefore freely tradable.
In
a related transaction and in accordance with the purchase agreement, the Company issued to the accredited investors in a concurrent
private placement pursuant to an exemption from the registration requirements of the Securities Act provided in Section 4(a)(2)
of the Securities Act and/or Regulation D promulgated thereunder, (1) the remaining aggregate of $1,624,457.78 in principal amount
of convertible notes, (2) the shares of common stock issuable from time to time upon conversion of such convertible notes, and
(3) the common shares underlying the common stock purchase warrants. On September 5, 2019, the Company filed a Registration Statement
on Form S-1 covering the securities issued in the concurrent private placement including an aggregate of $1,624,457.78 in principal
amount of previously non-registered convertible notes, the shares of common stock issuable from time to time upon conversion of
such non-registered convertible notes and the common stock underlying the common stock purchase warrants. Such Registration Statement
on Form S-1 was declared effective by the Securities and Exchange Commission on September 12, 2019.
In
connection with the purchase agreement, the Company and its subsidiary entered into a security agreement, dated as of August 5,
2019, with the investors, pursuant to which the Company and its subsidiary granted a security interest in, among other items,
the Company and its subsidiary’s accounts, chattel paper, documents, equipment, general intangibles, instruments and inventory,
and all proceeds, as set forth in the security agreement. In addition, pursuant to an intellectual property security agreement,
dated as of August 5, 2019, the Company granted a continuing security interest in all of the Company’s right, title and
interest in, to and under certain of the Company’s trademarks, copyrights and patents. In addition, the Company’s
subsidiary jointly and severally agreed to guarantee and act as surety for the Company’s obligation to repay the convertible
notes pursuant to a subsidiary guarantee.
Under
the purchase agreement, the convertible notes and warrants contain provisions whereby the accredited investors are prohibited
from exercising their rights to convert the notes or exercise the warrants if, as a result of such conversion or exercise, such
holder, together with its affiliates, would own more than 4.99% of the total number of shares of the Company’s common stock
outstanding immediately after giving effect to such exercise. However, the investors may increase or decrease such percentage
to any other percentage not in excess of 9.99%, provided that any increase in such percentage shall not be effective until 61
days after such notice to the Company.
The
Company elected to account for the secured convertible notes on the fair value basis. Therefore, the Company determined the fair
value of the (1) secured convertible notes, (2) the Commitment Shares and (3) the common stock purchase warrants which yielded
estimated fair values of the secured convertible notes including their embedded derivatives, the Commitment Shares and the detachable
common stock purchase warrants. The following represents the resulting fair value as determined on August 5, 2019, the date of
origination:
|
Secured convertible notes
|
|
$
|
1,845,512
|
|
|
Common stock issued as Commitment Shares
|
|
|
118,749
|
|
|
Common stock purchase warrants
|
|
|
535,739
|
|
|
|
|
|
|
|
|
Gross cash proceeds
|
|
$
|
2,500,000
|
|
Under
the fair value basis, the Company determines the fair value of the secured convertible notes and adjusts the carrying value of
the secured convertible notes at each reporting date with the resulting charge or credit being reflected in the consolidated statement
of operations. Following is an analysis of the activity in the secured convertible notes during the year ended December 31, 2019:
|
|
|
Amount
|
|
|
Balance at December 31, 2018
|
|
$
|
—
|
|
|
Issuance of convertible notes on August 5, 2019, at fair value
|
|
|
1,845,512
|
|
|
Principal repaid during the period by issuance of common stock
|
|
|
(648,067
|
)
|
|
Principal repaid during the period by payment of cash
|
|
|
(123,457
|
)
|
|
Change in fair value of secured convertible note during the period
|
|
|
519,821
|
|
|
|
|
|
|
|
|
Balance at December 31, 2019
|
|
$
|
1,593,809
|
|
Following is a range
of certain estimates and assumptions utilized as of December 31, 2019 and August 5. 2019 (inception date) to determine the
fair value of secured convertible notes:
|
|
|
December 31, 2019
|
|
|
August 5, 2019
|
|
|
|
|
Assumptions
|
|
|
Assumptions
|
|
|
Volatility – range
|
|
|
115
|
%
|
|
|
110
|
%
|
|
Risk-free rate
|
|
|
1.60
|
%
|
|
|
1.78
|
%
|
|
Contractual term
|
|
|
0.6
years
|
|
|
|
0.9
years
|
|
|
Calibrated stock price
|
|
$
|
1.06
|
|
|
$
|
0.86
|
|
|
Debt yield
|
|
|
123.6
|
%
|
|
|
88.6
|
%
|
Under
the fair value basis, legal, accounting and miscellaneous costs directly related to the issuance of the secured convertible notes
are charged to expense as incurred. A total of $89,148 of such issuance costs were charged to operations during the year ended
December 31, 2019.
2018
Proceeds Investment Agreement.
On
July 31, 2018, the Company entered into a Proceeds Investment Agreement (the “PIA Agreement”) with Brickell Key Investments
LP (“BKI”), pursuant to which BKI funded an aggregate of $500,000 (the “First Tranche”) to be used (i)
to fund the Company’s litigation proceedings relating to the infringement of certain patent assets listed in the PIA Agreement
and (ii) to repay the Company’s existing debt obligations and for certain working capital purposes set forth in the PIA
Agreement. Pursuant to the PIA Agreement, BKI was granted an option to provide the Company with an additional $9.5 million, at
BKI’s sole discretion (the “Second Tranche”). On August 21, 2018, BKI exercised its option on the Second Tranche
for $9.5 million which completed the $10 million funding.
Pursuant
to the PIA Agreement and in consideration for the $10 million in funding, the Company agreed to assign to BKI (i) 100% of all
gross, pre-tax monetary recoveries paid by any defendant(s) to the Company or its affiliates agreed to in a settlement or awarded
in judgment in connection with the patent assets, plus any interest paid in connection therewith by such defendant(s) (the “Patent
Assets Proceeds”), up to the minimum return (as defined in the Agreement) and (ii) if BKI has not received its minimum return
by the earlier of a liquidity event (as defined in the Agreement) and July 31, 2020, then the Company agreed to assign to BKI
100% of the Patent Asset Proceeds until BKI has received an amount equal to the minimum return on $4.0 million.
Pursuant
to the PIA Agreement, the Company granted BKI (i) a senior security interest in the Patent Assets, the claims (as defined in the
Agreement) and the Patent Assets Proceeds until such time as the minimum return is paid, in which case, the security interest
on the patent assets, the claims and the Patent Assets Proceeds will be released, and (ii) a senior security interest in all other
assets of the Company until such time as the minimum return is paid on $4.0 million, in which case, the security interest on such
other assets will be released.
The
security interest is enforceable by BKI if the Company is in default under the PIA Agreement which would occur if (i) the Company
fails, after five (5) days’ written notice, to pay any due amount payable to BKI under the PIA Agreement, (ii) the Company
fails to comply with any provision of the PIA Agreement or any other agreement or document contemplated under the PIA Agreement,
(iii) the Company becomes insolvent or insolvency proceedings are commenced (and not subsequently discharged) with respect to
the Company, (iv) the Company’s creditors commence actions against the Company (which are not subsequently discharged) that
affect 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
Company utilized a probability weighted present value of expected patent asset proceeds for the litigation involving both Axon
and WatchGuard (see Note 12 – Commitments and Contingencies) which involved estimates of the amount and timing of the expected
patent asset proceeds from the alleged patent infringement. The fair value of the PIA is updated for actual and estimated activity
affecting the probability weighted present value of expected patent asset proceeds at each reporting date with the change charged/credited
to operations. Following is a range of certain estimates and assumptions utilized as of December 31, 2019 and 2018 to probability
weighted present value of expected patent asset proceeds for the litigation involving both Axon and WatchGuard:
|
|
|
|
December
31, 2019
|
|
|
|
December
31, 2018
|
|
|
Discount rate
|
|
|
3.0%
- 16.6
|
%
|
|
|
4.7%
- 21.75
|
%
|
|
Expected term to patent asset proceeds payment
|
|
|
0.58
years - 4 years
|
|
|
|
0.93
years - 1.1 years
|
|
|
Probability of success
|
|
|
5.9%
- 38.5
|
%
|
|
|
17.7%
- 77.0
|
%
|
|
Estimated minimum return payable to BKI
|
|
$
|
21
million
|
|
|
$
|
22.5
million
|
|
|
Negotiation discount
|
|
|
43.3
|
%
|
|
|
54.4
|
%
|
During
the year ended December 31, 2019, the Company settled its patent infringement litigation with WatchGuard whereby it received a
lump-sum payment of $6.0 million as further described in Note 12. In accordance with the terms of the PIA, the Company remitted
the $6.0 as a principal payment toward its minimum return payment obligations under the PIA. The Company recorded the receipt
of the $6,000,000 settlement as Patent litigation settlement income in the accompanying condensed consolidated statement of operations.
The
following represents activity in the PIA during the year ended December 31, 2019 and 2018:
|
Beginning balance as of January 1, 2018
|
|
$
|
-
|
|
|
Origination date at fair value of the Debentures
|
|
|
9,067,513
|
|
|
Change in the fair value during the period
|
|
|
74,487
|
|
|
Ending balance as of December 31, 2018
|
|
$
|
9,142,000
|
|
|
|
|
|
|
|
|
Beginning balance as of January 1, 2019
|
|
$
|
9.142,000
|
|
|
Repayment of obligation
|
|
|
(6,000,000
|
)
|
|
Change in the fair value during the period
|
|
|
3,358,000
|
|
|
Ending balance as of December 31, 2019
|
|
$
|
6,500,000
|
|
Unsecured
Promissory Note Payable.
On
December 23, 2019, the Company, borrowed $300,000 under an unsecured note payable to a private, third-party lender. The promissory
note bears interest at the rate of 8% per annum with principal and accrued interest payable on or before its maturity date of
March 31, 2020. The Company granted the lender warrants exercisable to purchase a total of 107,000 shares of its common stock
at an exercise price of $1.40 per share until December 23, 2024. The Company allocated $71,869 of the proceeds of the promissory
note to additional paid-in-capital, which represented the grant date relative fair value of the warrants issued to the lender.
The discount will be amortized to interest expense ratably over the term of the promissory note which approximates the effective
interest method. The amortization of discount resulted in $5,808 of the discount amortized to interest expense during the year
ended December 31, 2019.
2018
Secured Convertible Debentures.
On
April 3, 2018, and May 11, 2018, the Company completed a private placement (the “2018 Private Placement”) of $6.875
million in principal amount of senior secured convertible promissory notes (the “2018 Debentures”) and warrants to
purchase 916,667 shares of common stock of the Company (the “2018 Warrants”) to institutional investors. The 2018
Debentures and 2018 Warrants were issued pursuant to a securities purchase agreement between the Company and the purchasers’
signatory thereto. Additionally, a portion of the 2018 Debentures and 2018 Warrants were issued to two institutional investors
pursuant to their respective participation rights under a securities purchase agreement, dated August 21, 2017. One of the institutional
investors that participated in the 2017 common stock issuance closed its tranche with the Company on May 11, 2018. The 2018 Private
Placement resulted in gross cash proceeds of $6.25 million ($6.875 million par value) before placement agent fees and other expenses
associated with the transaction. The proceeds were used primarily for full repayment of the 2016 Debentures described above, other
outstanding subordinated debt of the Company, working capital and general corporate purposes.
The
Company elected to account for the 2018 Debentures on the fair value basis. Therefore, the Company determined the fair value of
the 2018 Debentures and 2018 Warrants which yielded estimated fair values of the 2018 Debentures including their embedded derivatives
and the detachable 2018 Warrants as follows:
|
Secured
convertible debentures
|
|
$
|
4,565,749
|
|
|
Common
stock purchase warrants
|
|
|
1,684,251
|
|
|
|
|
|
|
|
|
Gross
cash proceeds
|
|
$
|
6,250,000
|
|
The
Company paid the remaining balances of the 2018 Debentures on August 21, 2018 from proceeds of the 2018 proceeds investment agreement
described below. The change in fair value of the 2018 Debentures was $2,309,251 for the year ended December 31, 2018.
The
following represents activity in the 2018 Debentures during the year ended December 31, 2018:
|
Beginning
balance as of January 1, 2018
|
|
$
|
-
|
|
|
Origination
date at fair value of the Debentures
|
|
|
4,565,749
|
|
|
Conversions
exercised during the period
|
|
|
(275,000
|
)
|
|
Principal
payments made on Debentures
|
|
|
(6,600,000
|
)
|
|
Change
in the fair value during the period
|
|
|
2,309,251
|
|
|
Ending
balance as of December 31, 2018
|
|
$
|
-
|
|
2016
Secured Convertible Debentures.
On
December 30, 2016, the Company completed a private placement (the “2016 Private Placement”) of $4.0 million in principal
amount of the secured convertible debentures (the “2016 Debentures”) and common stock warrants (the “2016 Warrants”)
to two institutional investors. The 2016 Debentures and 2016 Warrants were issued pursuant to a Securities Purchase Agreement
between the Company and the purchasers’ signatory thereto. The 2016 Private Placement resulted in gross proceeds of $4.0
million before placement agent fees and other expenses associated with the transaction totaling $281,570, which was expensed as
incurred.
The
Company elected to account for the 2016 Debentures on the fair value basis. Therefore, the Company determined the fair value of
the 2016 Debentures utilizing Monte Carlo simulation models which yielded an estimated fair value of $4.0 million for the Debentures
including their embedded derivatives as of the origination date. No value was allocated to the detachable 2016 Warrants as of
the origination date because of the relative fair value of the 2016 Debentures including their embedded derivative features approximated
the gross proceeds of the financing transaction. The Company made principal payments of $750,000 on August 24, 2017 on the 2016
Debentures.
The
Company paid the remaining balance of the 2016 Debentures on April 3, 2018 from proceeds of the 2018 secured convertible debentures
described below. The Company recorded debt extinguishment costs of $600,000 during the year ended December 31, 2018 related to
the repayment and extinguishment of the 2016 Debentures.
The
change in fair value of the 2016 Debentures was $-0- and $(12,807) for the years ended December 31, 2019 and 2018, respectively.
Unsecured
Promissory Notes Payable.
On
September 29, 2017, the Company borrowed $300,000 under an unsecured note payable with a private, third party lender. Such note
bore interest at 8% per annum and was due and payable in full on November 30, 2017. The note was unsecured and subordinated to
all existing and future senior indebtedness, as such term was defined in the note. The Company issued warrants to the lender exercisable
to purchase 100,000 shares of common stock for $2.75 per share until September 30, 2022. The Company allocated $117,000 of the
proceeds of the note to additional paid-in-capital, which represented the grant date relative fair value of the warrants issued
to the lender. The discount was amortized to interest expense ratably over the terms of the note. On December 29, 2017 the Company
borrowed an additional $350,000 with the same private, third party lender and combined the existing note payable plus accrued
interest into a new note (the “Secured Note”) for $658,500 that was due and payable in full on March 1, 2018 and could
be prepaid without penalty. The Secured Note was secured by the Company’s intellectual property portfolio, as such term
is defined in the security agreement relating to the Secured Note. In connection with issuance of the Secured Note, the Company
issued warrants to the lender exercisable to purchase 120,000 shares of common stock for $3.25 per share until December 28, 2022.
The Company treated the issuance and extension of this debt as an extinguishment for financial accounting purposes. Accordingly,
the estimated fair value of the warrants granted totaled $244,379, which was recorded as additional paid-in-capital and a loss
on extinguishment of subordinated notes payable.
The
Company paid the remaining balances of the Secured Note and subordinated note with an aggregate principal balance of $1,008,500
on April 3, 2018.
On
March 7, 2018 the Company borrowed $250,000 under a secured note payable with a private, third party lender (the “March
Note”). The March Note bears interest at 12% per annum and contained an original maturity date of June 7, 2018. The Company
negotiated an extension of the maturity date to September 30, 2018. The March Note was secured by the inventory of the Company
and junior to senior liens held by the holders of the 2018 Debentures and subordinated to all existing and future senior indebtedness,
as such term was defined in the March Note. Such Note was convertible at any time after its date of issue at the option of the
holder into shares of the Company’s common stock at a conversion price of $3.25 per share. The conversion price and exercise
price were subject to adjustment upon stock splits, reverse stock splits, and similar capital changes. The Company issued warrants
to the lender exercisable to purchase 36,000 shares of common stock for $3.50 per share until March 7, 2019. The Company allocated
$15,287 of the proceeds of the note to additional paid-in-capital, which represented the grant date relative fair value of the
warrants issued to the lender. The discount was amortized to interest expense ratably over the terms of the note. The Company
made a principal payment of $100,000 on August 21, 2018 on the March Note. The holder converted the remaining principal and outstanding
interest of the March Note into 47,319 shares of the Company’s common stock on September 20, 2018.
The
discount amortized to interest expense totaled $-0- and $47,657 for the years ended December 31, 2019, and 2018, respectively.
NOTE
8. FAIR VALUE MEASUREMENT
In
accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC 820”), the Company utilizes
the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other
relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets
or liabilities, such as a business.
ASC
820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three
broad levels. The following is a brief description of those three levels:
|
●
|
Level
1 — Quoted prices in active markets for identical assets and liabilities
|
|
|
|
|
●
|
Level
2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
|
|
|
|
|
●
|
Level
3 — Significant unobservable inputs (including the Company’s own assumptions in determining the fair value)
|
The
following table represents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a
recurring basis as of December 31, 2019 and 2018.
|
|
|
December 31, 2019
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured convertible debentures
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,593,809
|
|
|
$
|
1,593,809
|
|
|
Proceeds investment agreement
|
|
|
—
|
|
|
|
—
|
|
|
|
6,500,000
|
|
|
|
6,500,000
|
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
8,093,809
|
|
|
$
|
8,093,809
|
|
|
|
|
December 31, 2018
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured convertible debentures
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Proceeds investment agreement
|
|
|
—
|
|
|
|
—
|
|
|
|
9,142,000
|
|
|
|
9,142,000
|
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,142,000
|
|
|
$
|
9,142,000
|
|
The
following table represents the change in Level 3 tier value measurements:
|
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
Secured
|
|
|
Proceeds
|
|
|
|
|
|
|
|
Convertible
|
|
|
Investment
|
|
|
|
|
|
|
|
Notes
|
|
|
Agreement
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2018
|
|
$
|
—
|
|
|
$
|
9,142,000
|
|
|
$
|
9,142,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal payments made on debentures
|
|
|
—
|
|
|
|
(6,000,000
|
)
|
|
|
(6,000,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New secured convertible debentures
|
|
|
1,845,512
|
|
|
|
—
|
|
|
|
1,845,512
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of secured convertible debentures
|
|
|
(648,067
|
)
|
|
|
—
|
|
|
|
(648,067
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repayment of 2019 secured convertible notes
|
|
|
(123,457
|
)
|
|
|
|
|
|
|
(123,457
|
)
|
|
Change in fair value of secured convertible debentures and proceeds investment agreement
|
|
|
519,821
|
|
|
|
3,358,000
|
|
|
|
3,877,821
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2019
|
|
$
|
1,593,809
|
|
|
$
|
6,500,000
|
|
|
$
|
8,093,809
|
|
NOTE
9. ACCRUED EXPENSES5
Accrued
expenses consisted of the following at December 31, 2019 and 2018:
|
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
Accrued warranty expense
|
|
$
|
17,838
|
|
|
$
|
195,135
|
|
|
Accrued litigation costs
|
|
|
295,000
|
|
|
|
1,119,445
|
|
|
Accrued sales commissions
|
|
|
28,480
|
|
|
|
25,750
|
|
|
Accrued payroll and related fringes
|
|
|
233,254
|
|
|
|
186,456
|
|
|
Accrued insurance
|
|
|
78,579
|
|
|
|
71,053
|
|
|
Accrued rent
|
|
|
—
|
|
|
|
81,160
|
|
|
Accrued sales returns and allowances
|
|
|
18,258
|
|
|
|
13,674
|
|
|
Other
|
|
|
174,472
|
|
|
|
387,994
|
|
|
|
|
$
|
845,881
|
|
|
$
|
2,080,667
|
|
Accrued
warranty expense was comprised of the following for the years ended December 31, 2019 and 2018:
|
|
|
2019
|
|
|
2018
|
|
|
Beginning balance
|
|
$
|
195,135
|
|
|
$
|
325,001
|
|
|
Provision for warranty expense
|
|
|
47,355
|
|
|
|
181,826
|
|
|
Charges applied to warranty reserve
|
|
|
(224,651
|
)
|
|
|
(311,692
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance
|
|
$
|
17,838
|
|
|
$
|
195,135
|
|
NOTE
10. INCOME TAXES
The
components of income tax provision (benefit) for the years ended December 31, 2019 and 2018 are as follows:
|
|
|
|
2019
|
|
|
|
2018
|
|
|
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 21% for the years ended December 31, 2019 and 2018
to the Company’s effective tax rate is as follows:
|
|
|
2019
|
|
|
2018
|
|
|
U.S. Statutory tax rate
|
|
|
21.0
|
%
|
|
|
21.0
|
%
|
|
State taxes, net of Federal benefit
|
|
|
5.1
|
%
|
|
|
5.1
|
%
|
|
Federal Research and development tax credits
|
|
|
—
|
%
|
|
|
—
|
%
|
|
Stock based compensation
|
|
|
(2.6
|
)%
|
|
|
(3.0
|
)%
|
|
Revaluation of deferred tax assets based on changes in enacted tax laws
|
|
|
—
|
%
|
|
|
—
|
%
|
|
Change in valuation reserve on deferred tax assets
|
|
|
(22.4
|
)%
|
|
|
(22.1
|
)%
|
|
Other, net
|
|
|
(1.1
|
)%
|
|
|
(1.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
Income tax (provision) benefit
|
|
|
—
|
%
|
|
|
—
|
%
|
Significant
components of the Company’s deferred tax assets (liabilities) as of December 31, 2019 and 2018 are as follows:
|
|
|
2019
|
|
|
2018
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
$
|
605,000
|
|
|
$
|
650,000
|
|
|
Start-up costs
|
|
|
115,000
|
|
|
|
115,000
|
|
|
Inventory reserves
|
|
|
1,080,000
|
|
|
|
860,000
|
|
|
Uniform capitalization of inventory costs
|
|
|
85,000
|
|
|
|
90,000
|
|
|
Allowance for doubtful accounts receivable
|
|
|
90,000
|
|
|
|
45,000
|
|
|
Equipment depreciation
|
|
|
240,000
|
|
|
|
140,000
|
|
|
Deferred revenue
|
|
|
915,000
|
|
|
|
975,000
|
|
|
Debt and PIA obligations carried at fair value
|
|
|
1,045,000
|
|
|
|
225,000
|
|
|
Accrued expenses
|
|
|
110,000
|
|
|
|
385,000
|
|
|
Net operating loss carryforward
|
|
|
17,515,000
|
|
|
|
16,080,000
|
|
|
Research and development tax credit carryforward
|
|
|
1,795,000
|
|
|
|
1,795,000
|
|
|
State jobs credit carryforward
|
|
|
230,000
|
|
|
|
230,000
|
|
|
Charitable contributions carryforward
|
|
|
55,000
|
|
|
|
50,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
23,880,000
|
|
|
|
21,640,000
|
|
|
Valuation reserve
|
|
|
(23,740,000
|
)
|
|
|
(21,500,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
140,000
|
|
|
|
140,000
|
|
|
Domestic international sales company
|
|
|
(140,000
|
)
|
|
|
(140,000
|
)
|
|
Total deferred tax liabilities
|
|
|
(140,000
|
)
|
|
|
(140,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets (liability)
|
|
$
|
—
|
|
|
$
|
—
|
|
The
valuation allowance on deferred tax assets totaled $23,740,000 and $21,500,000 as of December 31, 2019 and 2018, respectively.
The Company records the benefit it will derive in future accounting periods from tax losses and credits and deductible temporary
differences as “deferred tax assets.” In accordance with ASC 740, “Income Taxes,” the Company records
a valuation allowance to reduce the carrying value of our deferred tax assets if, based on all available evidence, it is more
likely than not that some or all of the deferred tax assets will not be realized.
On
December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Act”). The Act, which is also commonly referred
to as “U.S. tax reform,” significantly changes U.S. corporate income tax laws by, among other things, reducing the
U.S. corporate income tax rate to 21% starting in 2018. Under the Act, corporations are no longer subject to the AMT, effective
for taxable years beginning after December 31, 2017. However, where a corporation has an AMT Credit from a prior taxable year,
the corporation still carries it forward and may use a portion of it as a refundable credit in any taxable year beginning after
2017 but before 2022. Generally, 50% of the corporation’s AMT Credit carried forward to one of these years starting in 2018
will be claimable and refundable for that year. In tax years beginning in 2021, however, the entire remaining carryforward generally
will be refundable.
The
Company has incurred operating losses in 2019 and 2018 and it continues to be in a three-year cumulative loss position at December
31, 2019 and 2018. Accordingly, the Company determined there was not sufficient positive evidence regarding its potential for
future profits to outweigh the negative evidence of our three-year cumulative loss position under the guidance provided in ASC
740. Therefore, it determined to increase our valuation allowance by $2,240,000 to continue to fully reserve its deferred tax
assets at December 31, 2019. The Company expects to continue to maintain a full valuation allowance until it determines that it
can sustain a level of profitability that demonstrates its ability to realize these assets. To the extent the Company determines
that the realization of some or all of these benefits is more likely than not based upon expected future taxable income, a portion
or all of the valuation allowance will be reversed. Such a reversal would be recorded as an income tax benefit and, for some portion
related to deductions for stock option exercises, an increase in shareholders’ equity.
At
December 31, 2019, the Company had available approximately $67,100,000 of Federal net operating loss carryforwards available to
offset future taxable income generated. Such tax net operating loss carryforwards expire between 2026 and 2039. In addition, the
Company had research and development tax credit carryforwards totaling $1,795,000 available as of December 31, 2019, which expire
between 2023 and 2037.
The
Internal Revenue Code contains provisions under Section 382 which limit a company’s ability to utilize net operating loss
carry-forwards in the event that it has experienced a more than 50% change in ownership over a three-year period. Current estimates
prepared by the Company indicate that due to ownership changes which have occurred, approximately $765,000 of its net operating
loss and $175,000 of its research and development tax credit carryforwards are currently subject to an annual limitation of approximately
$1,151,000, but may be further limited by additional ownership changes which may occur in the future. As stated above, the net
operating loss and research and development credit carryforwards expire between 2023 and 2038, allowing the Company to potentially
utilize all of the limited net operating loss carry-forwards during the carryforward period.
As
discussed in Note 1, “Summary of Significant Accounting Policies,” tax positions are evaluated in a two-step process.
The Company first determines whether it is more likely than not that a tax position will be sustained upon examination. If a tax
position meets the more-likely-than-not recognition threshold, it is then measured to determine the amount of benefit to recognize
in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of
being realized upon ultimate settlement. Management has identified no tax positions taken that would meet or exceed these thresholds
and therefore there are no gross interest, penalties and unrecognized tax expense/benefits that are not expected to ultimately
result in payment or receipt of cash in the consolidated financial statements.
The
effective tax rate for the years ended December 31, 2019 and 2018 varied from the expected statutory rate due to the Company continuing
to provide a 100% valuation allowance on net deferred tax assets. The Company determined that it was appropriate to continue the
full valuation allowance on net deferred tax assets as of December 31, 2019 primarily because of the current year operating losses.
The
Company’s federal and state income tax returns are closed for examination purposes by relevant statute and by examination
for 2015 and all prior tax years.
NOTE
11. OPERATING LEASE
The
Company entered into an operating lease with a third party in September 2012 for office and warehouse space in Lenexa, Kansas.
The terms of the lease include monthly payments ranging from $38,026 to $38,533 with a maturity date of April 2020. The Company
has the option to renew for an additional three years beyond the original expiration date, which may be exercised at the Company’s
sole discretion. The Company evaluated the renewal option at the lease commencement date to determine if it is reasonably certain
the exercise the option and concluded that it is not reasonably certain that any options will be exercised. The weighted average
remaining lease term for the Company’s office and warehouse operating lease as of December 31, 2019 was four months.
The
Company entered into an operating lease with a third party in October 2019 for copiers used for office and warehouse purposes.
The terms of the lease include 48 monthly payments of $1,598 with a maturity date of October 2023. The Company has the option
to Purchase the equipment at maturity for its estimated fair market value at that point in time. The remaining lease term for
the Company’s copier operating lease as of December 31, 2019 was 46 months.
Lease
expense related to the office space and copier operating leases were recorded on a straight-line basis over their respective lease
terms. Total lease expense under the two operating leases was approximately $400,920 for the year ended December 31, 2019.
The
discount rate implicit within the Company’s operating leases was not generally determinable and therefore the Company determined
the discount rate based on its incremental borrowing rate on the information available at commencement date. As of commencement
date, the operating lease liabilities reflect a weighted average discount rate of 8%.
The cash outflows
from operating leases for the year ended December 31, 2019 was $400,920. The weighted average remaining lease term and the weighted
average discount rate for operating leases at December 31, 2019 were 5.6 months and 8%, respectively.
The
following sets forth the operating lease right of use assets and liabilities as of December 31, 2019:
|
Assets:
|
|
|
|
|
|
Operating lease right of use assets
|
|
$
|
122,459
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
Operating lease obligations-current portion
|
|
$
|
159,160
|
|
|
Operating lease obligations-less current portion
|
|
$
|
44,460
|
|
|
Total operating lease obligations
|
|
$
|
203,620
|
|
The
components of lease expense were as follows for the year ending December 31, 2019:
|
Selling,
general and administrative expenses
|
|
$
|
400,920
|
|
Following
are the minimum lease payments for each year and in total.
|
Year ending December 31:
|
|
|
|
|
2020
|
|
$
|
173,307
|
|
|
2021
|
|
|
19,176
|
|
|
2022
|
|
|
19,176
|
|
|
2023
|
|
|
15,980
|
|
|
Total undiscounted minimum future lease payments
|
|
|
227,639
|
|
|
Imputed interest
|
|
|
(24,019
|
)
|
|
Total operating lease liability
|
|
$
|
203,620
|
|
NOTE
12. COMMITMENTS AND CONTINGENCIES
License
agreements. The Company has several license agreements under which it has been assigned the rights to certain licensed
materials used in its products. Certain of these agreements require the Company to pay ongoing royalties based on the number of
products shipped containing the licensed material on a quarterly basis. Royalty expense related to these agreements aggregated
$0 and $2,083 for the years ended December 31, 2019 and 2018, respectively.
Litigation.
From
time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy to
not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After
carefully assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded,
we vigorously defend any lawsuit filed against us. We record a liability when losses are deemed probable and reasonably estimable.
When losses are deemed reasonably possible but not probable, we determine whether it is possible to provide an estimate of the
amount of the loss or range of possible losses for the claim, if material for disclosure. In evaluating matters for accrual and
disclosure purposes, we take into consideration factors such as our historical experience with matters of a similar nature, the
specific facts and circumstances asserted, the likelihood of our prevailing, the availability of insurance, and the severity of
any potential loss. We reevaluate and update accruals as matters progress over time.
While
the ultimate resolution is unknown, based on the information currently available, we do not expect that these lawsuits will individually,
or in the aggregate, have a material adverse effect to our results of operations, financial condition or cash flows. However,
the outcome of any litigation is inherently uncertain and there can be no assurance that any expense, liability or damages that
may ultimately result from the resolution of these matters will be covered by our insurance or will not be in excess of amounts
recognized or provided by insurance coverage and will not have a material adverse effect on our operating results, financial condition
or cash flows.
Axon
The
Company owns U.S. Patent No. 9,253,452 (the “ ‘452 Patent”), which generally covers the automatic activation
and coordination of multiple recording devices in response to a triggering event, such as a law enforcement officer activating
the light bar on the vehicle.
The
Company filed suit on January 15, 2016 in the U.S. District Court for the District of Kansas (Case No: 2:16-cv-02032) against
Axon, alleging willful patent infringement against Axon’s body camera product line and Signal auto-activation product. The
Company is seeking both monetary damages and a permanent injunction against Axon for infringement of the ‘452 Patent.
In
December 2016 and January 2017, Axon filed two petitions for Inter Partes Review (“IPR”) against the ‘452
Patent. The United States Patent and Trademark Office (“USPTO”) rejected both of Axon’s petitions. Axon is now
statutorily precluded from filing any more IPR petitions against the ‘452 Patent.
The
District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on November
17, 2017, the Federal District Court of Kansas rejected Axon’s request to maintain the stay. With this significant ruling,
the parties will now proceed towards trial. Since litigation has resumed, the Court has issued a claim construction order (also
called a Markman Order) where it sided with the Company on all disputes and denied Axon’s attempts to limit the scope
of the claims. Following the Markman Order, the Court set all remaining deadlines in the case. Fact discovery closed on
October 8, 2018, and a Final Pretrial Conference took place on January 16, 2019. The parties filed motions for summary judgment
on January 31, 2019.
On
June 17, 2019, the Court granted Axon’s motion for summary judgment that Axon did not infringe on the Company’s patent
and dismissed the case. Importantly, the Court’s ruling did not find that Digital’s ‘452 Patent was invalid.
It also did not address any other issue, such as whether Digital’s requested damages were appropriate, and it did not impact
the Company’s ability to file additional lawsuits to hold other competitors accountable for patent infringement. This ruling
solely related to an interpretation of the claims as they relate to Axon and was unrelated to the supplemental briefing Digital
recently filed on its damages claim and the WatchGuard settlement. Those issues are separate and the judge’s ruling on summary
judgment had nothing to do with Digital’s damages request. The Company has filed an appeal to this ruling and has asked
the appellate court to reverse this decision.
The
Company filed its Opening Appeal Brief on August 26, 2019 and Axon filed its Responsive Brief on November 6, 2019 and the Company
filed its Reply Brief responding to Axon on November 27, 2019. The United States Court of Appeals for the Federal Circuit scheduled
oral argument on the Company’s appeal of the district court’s summary judgment order on April 6, 2020. This appeal
will address the incorrect and mistaken dismissal of Digital Ally’s claims against Axon by Judge Carlos Murguia in the
U.S. District Court of Kansas litigation. If the Court of Appeals overturns the summary judgment ruling, a new judge will be assigned
to handle the litigation with Axon due to the recent resignation of Judge Murguia. On March 12, 2020, the panel of judges for
the United States Court of Appeals issued an order cancelling the oral arguments previously set for April 6, 2020 having determined
that they will decide the appeal based on the parties’ briefs without oral argument.
WatchGuard
On
May 27, 2016, the Company filed suit against WatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent infringement based on
WatchGuard’s VISTA Wifi and 4RE In-Car product lines.
On
May 13, 2019, the parties resolved the dispute and executed a settlement agreement in the form of a Release and License Agreement.
The litigation has been dismissed as a result of this settlement.
The
Release and License Agreement encompasses the following key terms:
|
|
●
|
WatchGuard
paid Digital Ally a one-time, lump settlement payment of $6,000,000.
|
|
|
|
|
|
|
●
|
Digital
Ally granted WatchGuard a perpetual covenant not to sue if WatchGuard’s products incorporate agreed-upon modified recording
functionality. Digital Ally also granted WatchGuard a license to the ‘292 Patent and the ‘452 Patent (and related
patents, now existing and yet-to-issue) through December 31, 2023. The parties agreed to negotiate in good faith to attempt
to resolve any alleged infringement that occurs after the license period expires.
|
|
|
|
|
|
|
●
|
The
parties further agreed to release each other from all claims or liabilities pre-existing the settlement.
|
|
|
|
|
|
|
●
|
As
part of the settlement, the parties agreed that WatchGuard made no admission that it infringed any of Digital Ally’s
patents.
|
Upon
receipt of the $6,000,000 the parties filed a joint motion to dismiss the lawsuit which the Judge granted.
PGA
Tour, Inc.
On
January 22, 2019 the PGA Tour, Inc. (the “PGA”) filed suit against the Company in the Federal District Court for the
District of Kansas (Case No. 2:19-cv-0033-CM-KGG) alleging breach of contract and breach of implied covenant of good faith and
fair dealing relative to the Web.com Tour Title Sponsor Agreement (the “Agreement”). The contract was executed on
April 16, 2015 by and between the parties. Under the Agreement, Digital Ally would be a title sponsor of and receive certain naming
and other rights and benefits associated with the Web.com Tour for 2015 through 2019 in exchange for Digital Ally’s payment
to Tour of annual sponsorship fees. The suit was resolved and the case has been dismissed by Plaintiff with prejudice on April
17, 2019.
401
(k) Plan. The Company sponsors a 401(k) retirement savings plan for the benefit of its employees. The plan, as amended,
requires it to provide 100% matching contributions for employees, who elect to contribute up to 3% of their compensation to the
plan and 50% matching contributions for employee’s elective deferrals on the next 2% of their contributions. The Company
made matching contributions totaling $108,688 and $112,622 for the years ended December 31, 2019 and 2018, respectively. Each
participant is 100% vested at all times in employee and employer matching contributions.
Consulting
and Distributor Agreements. The Company entered into an agreement that required it to make monthly payments that will
be applied to future commissions and/or consulting fees to be earned by the provider. The agreement is with a limited liability
company (“LLC”) that is minority owned by a relative of the Company’s chief financial officer. Under the agreement,
dated January 15, 2016 and as amended on February 13, 2017, the LLC provides consulting services for developing a new distribution
channel outside of law enforcement for its body-worn camera and related cloud storage products to customers in the United States.
The Company advanced amounts to the LLC against commissions ranging from $5,000 to $6,000 per month plus necessary and reasonable
expenses for the period through June 30, 2017, which can be automatically extended based on the LLC achieving minimum sales quotas.
The agreement was renewed in January 2017 for a period of three years, subject to yearly minimum sales thresholds that would allow
the Company to terminate the contract if such minimums are not met. As of December 31, 2019, the Company had advanced a total
of $274,731 pursuant to this agreement and established an allowance reserve of $224,731 for a net advance of $50,000. The minimum
sales threshold was not met, and the Company discontinued all advances, although the contract has not been formally terminated.
However, the exclusivity provisions of the agreement have been terminated.
On
June 1, 2018 the Company entered into an agreement with an individual that required it to make monthly payments that will be applied
to future commissions and/or consulting fees to be earned by the provider. Under the agreement, the individual provides consulting
services for developing new distribution channels both inside and outside of law enforcement for its in-car and body-worn camera
systems and related cloud storage products to customers within and outside the United States. The Company was required to advance
amounts to the individual as an advance against commissions of $7,000 per month plus necessary and reasonable expenses for the
period through August 31, 2018, which was extended to December 31, 2018 by mutual agreement of the parties at $6,000 per month.
The parties have mutually agreed to further extend the arrangement on a monthly basis at $5,000 per month. As of December 31,
2019, the Company had advanced a total of $53,332 pursuant to this agreement.
NOTE
13. STOCK-BASED COMPENSATION
The
Company recorded pretax compensation expense related to the grant of stock options and restricted stock issued of $2,112,090 and
$2,272,656 for the years ended December 31, 2019 and 2018, respectively.
As
of December 31, 2019, the Company had adopted seven separate stock option and restricted stock plans: (i) the 2005 Stock Option
and Restricted Stock Plan (the “2005 Plan”), (ii) the 2006 Stock Option and Restricted Stock Plan (the “2006
Plan”), (iii) the 2007 Stock Option and Restricted Stock Plan (the “2007 Plan”), (iv) the 2008 Stock Option
and Restricted Stock Plan (the “2008 Plan”), (v) the 2011 Stock Option and Restricted Stock Plan (the “2011
Plan”), (vi) the 2013 Stock Option and Restricted Stock Plan (the “2013 Plan”), (vii) the 2015 Stock Option
and Restricted Stock Plan (the “2015 Plan”) and (vii) the 2018 Stock Option and Restricted Stock Plan (the “2018
Plan”). The 2005 Plan, 2006 Plan, 2007 Plan, 2008 Plan, 2011 Plan, 2013 Plan, 2015 Plan and 2018 Plan are referred to as
the “Plans.”
These
Plans permit the grant of stock options or restricted stock to its employees, non-employee directors and others for up to a total
of 4,175,000 shares of common stock. The 2005 Plan terminated during 2015 with 19,678 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2005 Plan that remain unexercised and outstanding
as of December 31, 2019 total 8,063. The 2006 Plan terminated during 2016 with 24,662 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2006 Plan that remain unexercised and outstanding
as of December 31, 2019 total 42,812. The 2007 Plan terminated during 2017 with 88,401 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2007 Plan that remain unexercised and outstanding
as of December 31, 2019 total 6,250. The 2008 Plan terminated during 2018 with 8,249 shares not awarded or underlying options,
which shares are now unavailable for issuance. Stock options granted under the 2008 Plan that remain unexercised and outstanding
as of December 31, 2019 total 32,250.
The
Company believes that such awards better align the interests of our employees with those of its stockholders. Option awards have
been granted with an exercise price equal to the market price of its stock at the date of grant with such option awards generally
vesting based on the completion of continuous service and having ten-year contractual terms. These option awards typically provide
for accelerated vesting if there is a change in control (as defined in the Plans). The Company has registered all shares of common
stock that are issuable under its Plans with the SEC. A total of 629,186 shares remained available for awards under the various
Plans as of December 31, 2019.
The
fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model.
Activity
in the various Plans during the years ended December 31, 2019 and 2018 is reflected in the following table:
|
Options
|
|
Number of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
|
Outstanding at January 1, 2018
|
|
|
350,269
|
|
|
$
|
13.44
|
|
|
Granted
|
|
|
160,000
|
|
|
|
2.20
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
Forfeited
|
|
|
(76,257
|
)
|
|
|
(45.52
|
)
|
|
Outstanding at December 31, 2018
|
|
|
434,012
|
|
|
$
|
4.62
|
|
|
Exercisable at December 31, 2018
|
|
|
354,012
|
|
|
$
|
5.17
|
|
|
Options
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
|
Outstanding
at January 1, 2019
|
|
|
434,012
|
|
|
$
|
4.62
|
|
|
Granted
|
|
|
180,000
|
|
|
|
3.01
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
Forfeited
|
|
|
(24,887
|
)
|
|
|
(13.78
|
)
|
|
Outstanding
at December 31, 2019
|
|
|
589,125
|
|
|
$
|
3.74
|
|
|
Exercisable
at December 31, 2019
|
|
|
499,125
|
|
|
$
|
3.87
|
|
The
fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. The total estimated
grant date fair value stock options issued during the year ended December 31, 2019 and 2018 was $436,217 and $284,384, respectively.
The
Company has utilized the following assumptions in its Black-Scholes option valuation model to calculate the estimated grant date
fair value of the options during the years ended December 31, 2019 and 2018:.
|
|
|
2019
|
|
|
2018
|
|
|
|
|
Assumptions
|
|
|
Assumptions
|
|
|
Volatility – range
|
|
|
107.6
|
%
|
|
|
107.5
|
%
|
|
Risk-free rate
|
|
|
2.23
|
%
|
|
|
2.74
|
%
|
|
Contractual term
|
|
|
5.5 years
|
|
|
|
5.5 years
|
|
|
Exercise price
|
|
$
|
3.01
|
|
|
$
|
2.20
|
|
The
Plans allow for the cashless exercise of stock options. This provision allows the option holder to surrender/cancel options with
an intrinsic value equivalent to the purchase/exercise price of other options exercised. There were no shares surrendered pursuant
to cashless exercises during the years ended December 31, 2019 and 2018.
At
December 31, 2019 and 2018, the aggregate intrinsic value of options outstanding was approximately $-0- and $76,800, respectively,
and the aggregate intrinsic value of options exercisable was approximately $-0- and $76,800, respectively. No options were exercised
in the years ended December 31, 2019 and 2018.
As
of December 31, 2019, the unrecognized portion of stock compensation expense on all existing stock options was $181,757 and will
be recognized over the next five months.
The
following table summarizes the range of exercise prices and weighted average remaining contractual life for outstanding and exercisable
options under the Company’s option plans as of December 31, 2019:
|
|
|
|
Outstanding
options
|
|
Exercisable
options
|
|
Exercise
price
range
|
|
|
Number
of
options
|
|
|
Weighted
average
remaining
contractual life
|
|
Number
of
options
|
|
|
Weighted
average
remaining
contractual life
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.01
to $3.49
|
|
|
|
470,313
|
|
|
8.4
years
|
|
|
380,313
|
|
|
|
8.1
years
|
|
|
$
|
3.50
to $4.99
|
|
|
|
66,875
|
|
|
4.3
years
|
|
|
66,875
|
|
|
|
4.3
years
|
|
|
$
|
5.00
to $6.49
|
|
|
|
—
|
|
|
—
years
|
|
|
—
|
|
|
|
—
years
|
|
|
$
|
6.50
to $7.99
|
|
|
|
8,437
|
|
|
1.8
years
|
|
|
8,437
|
|
|
|
1.8
years
|
|
|
$
|
8.00
to $9.99
|
|
|
|
2,500
|
|
|
1.4
years
|
|
|
2,500
|
|
|
|
1.4
years
|
|
|
$
|
10.00
to $19.99
|
|
|
|
39,750
|
|
|
1.0
years
|
|
|
39,750
|
|
|
|
1.0
years
|
|
|
$
|
20.00
to $24.99
|
|
|
|
1,250
|
|
|
0.1
years
|
|
|
1,250
|
|
|
|
0.1
years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
589,125
|
|
|
7.3
years
|
|
|
499,125
|
|
|
|
6.9
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 one to four
years corresponding to anniversaries of the grant date. Under the Plans, unvested shares of restricted stock awards may be forfeited
upon the termination of service to or employment with the Company, depending upon the circumstances of termination. Except for
restrictions placed on the transferability of restricted stock, holders of unvested restricted stock have full stockholder’s
rights, including voting rights and the right to receive cash dividends.
A
summary of all restricted stock activity under the equity compensation plans for the years ended December 31, 2019 and 2018 is
as follows:
|
|
|
Number of
Restricted
shares
|
|
|
Weighted
average
grant date
fair
value
|
|
|
Nonvested balance, January 1, 2018
|
|
|
791,725
|
|
|
$
|
4.37
|
|
|
Granted
|
|
|
484,500
|
|
|
|
2.27
|
|
|
Vested
|
|
|
(470,175
|
)
|
|
|
(3.83
|
)
|
|
Forfeited
|
|
|
(33,900
|
)
|
|
|
(4.04
|
)
|
|
Nonvested balance, December 31, 2018
|
|
|
772,150
|
|
|
$
|
3.40
|
|
|
|
|
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
|
|
|
(774,015
|
)
|
|
|
(3.35
|
)
|
|
Forfeited
|
|
|
(5,370
|
)
|
|
|
(3.46
|
)
|
|
Nonvested balance, December 31, 2019
|
|
|
514,875
|
|
|
$
|
2.97
|
|
The
Company estimated the fair market value of these restricted stock grants based on the closing market price on the date of grant.
As of December 31, 2019, there were $379,623 of total unrecognized compensation costs related to all remaining non-vested restricted
stock grants, which will be amortized over the next 12 months in accordance with their respective vesting scale.
The
nonvested balance of restricted stock vests as follows:
|
Years ended
|
|
Number of
shares
|
|
|
|
|
|
|
|
2020
|
|
|
264,750
|
|
|
2021
|
|
|
250,125
|
|
NOTE
14. COMMON STOCK PURCHASE WARRANTS
The
Company has issued common stock purchase warrants in conjunction with various debt and equity issuances. The warrants are either
immediately exercisable, or have a delayed initial exercise date, no more than six months from their respective issue date and
allow the holders to purchase up to 4,824,573 shares of common stock at $1.40 to $16.50 per share as of December 31, 2019. The
warrants expire from July 15, 2020 through December 23, 2024 and allow for cashless exercise.
Certain
common stock purchase warrants issued in August 2014 contained anti-dilution provisions that triggered a reset as a result of
the April 2018 financing transaction. The reset provisions resulted in the 12,200 warrants held at an exercise price of $7.32
per share increased by 159,538 warrants resulting in a final reset to 172,038 warrants at an exercise price of $0.52 per share.
All warrants subject to the reset provision have now been exercised.
The
following table summarizes information about shares issuable under warrants outstanding during the years ended December 31, 2019
and 2018:
|
|
|
Warrants
|
|
|
Weighted
average
exercise price
|
|
|
Vested Balance, January 1, 2018
|
|
|
3,233,466
|
|
|
$
|
6.57
|
|
|
Granted
|
|
|
1,478,379
|
|
|
|
2.90
|
|
|
Warrant reset
|
|
|
159,538
|
|
|
|
0.52
|
|
|
Exercised
|
|
|
(171,738
|
)
|
|
|
(0.52
|
)
|
|
Cancelled
|
|
|
(42,500
|
)
|
|
|
(8.50
|
)
|
|
Vested Balance, December 31, 2018
|
|
|
4,657,145
|
|
|
$
|
5.54
|
|
|
|
|
Warrants
|
|
|
Weighted
average
exercise price
|
|
|
Vested Balance, January 1, 2019
|
|
|
4,693,145
|
|
|
$
|
5.40
|
|
|
Granted
|
|
|
678,428
|
|
|
|
1.75
|
|
|
Exercised
|
|
|
(529,000
|
)
|
|
|
(2.96
|
)
|
|
Cancelled
|
|
|
(18,000
|
)
|
|
|
(3.50
|
)
|
|
Vested Balance, December 31, 2019
|
|
|
4,824,573
|
|
|
$
|
5.15
|
|
The
total intrinsic value of all outstanding warrants aggregated $-0- as of December 31, 2019 and the weighted average remaining term
is 33.2 months.
The
following table summarizes the range of exercise prices and weighted average remaining contractual life for outstanding and exercisable
warrants to purchase common shares as of December 31, 2019:
|
|
|
|
Outstanding and exercisable warrants
|
|
Exercise price
|
|
|
Number of warrants
|
|
|
Weighted average
remaining
contractual life
|
|
$
|
1.40
|
|
|
|
107,000
|
|
|
5.0 years
|
|
$
|
1.81
|
|
|
|
571,428
|
|
|
4.6 years
|
|
$
|
2.60
|
|
|
|
465,712
|
|
|
3.6 years
|
|
$
|
3.00
|
|
|
|
701,667
|
|
|
3.3 years
|
|
$
|
3.25
|
|
|
|
120,000
|
|
|
3.0 years
|
|
$
|
3.36
|
|
|
|
680,000
|
|
|
2.2 years
|
|
$
|
3.36
|
|
|
|
200,000
|
|
|
3.2 years
|
|
$
|
3.65
|
|
|
|
200,000
|
|
|
2.5 years
|
|
$
|
3.75
|
|
|
|
94,000
|
|
|
2.6 years
|
|
$
|
5.00
|
|
|
|
800,000
|
|
|
2.0 years
|
|
$
|
13.43
|
|
|
|
879,766
|
|
|
1.1 years
|
|
$
|
16.50
|
|
|
|
5,000
|
|
|
0.5 years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,824,573
|
|
|
2.8 years
|
NOTE
15. STOCKHOLDERS’ EQUITY
Underwritten
Public Offering - On September 26, 2018, the Company entered into an underwriting agreement with Roth Capital Partners,
LLC, as the representative of the underwriters and sole book-running manager, pursuant to which the Company agreed to sell to
the underwriters in a firm commitment underwritten public offering (the “Offering”) an aggregate of 2,400,000 shares
of the Company’s common stock, par value $0.001 per share at a public price of $3.05 per share. The Company also granted
the Underwriters a forty-five (45)-day option to purchase up to an additional 360,000 shares of common stock to cover over-allotments,
if any. Aegis Capital Corp. was a co-manager for the Offering. The Offering was registered and the common stock was issued pursuant
to the Company’s effective shelf registration statement on Form S-3 (File No. 333-225227), which was initially filed with
the Securities and Exchange Commission on May 25, 2018 and was declared effective on June 6, 2018.
On
September 28, 2018, the underwriter exercised its over-allotment option to acquire an additional 200,000 shares at $3.05 per share.
The partial exercise of the over-allotment option resulted in additional gross proceeds of $610,000. The net proceeds to the Company
from the Offering totaled approximately $7,324,900 including the partial exercise of the over-allotment option, after deducting
underwriting discounts and commissions and estimated expenses payable by the Company.
Under
the underwriting agreement the Company agreed not to contract to issue or announce the issuance or proposed issuance of any Common
Stock or Common Stock equivalents for sixty (60) days following the closing of the Offering, subject to certain exclusions as
set forth therein. The Company’s executive officers and directors have entered into sixty (60)-day Lock-Up Agreements with
the Representative pursuant to which they have agreed not to sell, transfer, assign or otherwise dispose of the shares of the
Company’s common stock owned by them, subject to certain exclusions as set forth therein.
Approval
of the 2018 Stock Option Plan and Restricted Stock Plan - On July 5, 2018 at the Company’s annual meeting, the Company’s
stockholders approved the 2018 Digital Ally, Inc. Stock Option and Restricted Stock Plan and reserving 1,000,000 shares for issuance
under such Plan.
NOTE
16. NET LOSS PER SHARE
The
calculation of the weighted average number of shares outstanding and loss per share outstanding for the years ended December 31,
2019 and 2018 are as follows:
|
|
|
Year ended December 31,
|
|
|
|
|
2019
|
|
|
2018
|
|
|
Numerator for basic and diluted income per share – Net loss
|
|
$
|
(10,005,713
|
)
|
|
$
|
(15,544,551
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic loss per share – weighted average shares outstanding
|
|
|
11,478,618
|
|
|
|
8,073,257
|
|
|
Dilutive effect of shares issuable upon conversion of convertible debt and the exercise of stock options and warrants outstanding
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted loss per share – adjusted weighted average shares outstanding
|
|
|
11,478,618
|
|
|
|
8,073,257
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.87
|
)
|
|
$
|
(1.93
|
)
|
|
Diluted
|
|
$
|
(0.87
|
)
|
|
$
|
(1.93
|
)
|
Basic
loss per share is based upon the weighted average number of common shares outstanding during the period. For the years ended December
31, 2019 and 2018, all shares issuable upon conversion of convertible debt and the exercise of outstanding stock options and warrants
were antidilutive, and, therefore, not included in the computation of diluted income (loss) per share.
Note
17 - Subsequent events
2020
Issuance of Restricted Common Stock.- On January 3, 2020, the board of directors approved the grant of
530,050 restricted common shares to officers and employees of the Company. Such shares will generally vest one-half on January
2, 2021 and one half on January 2, 2022, provided that each grantee remains an officer or employee on such dates.
2019
Secured Convertible Notes.- Subsequent to December 31, 2019, the holders of the 2019 Convertible Notes exercised their
right to convert principal balances aggregating $1,259,074 into equity. In addition, the Company exercised their right to prepay
in cash the remaining outstanding principal balance aggregating $574,341. Their remain no outstanding 2019 Convertible notes
as a result of these conversions and prepayments.
Underwritten
public offering - On March 3, 2020, the Company consummated an underwritten public offering of 2,521,740 shares of common
stock (the Offering”). The Offering was conducted pursuant to an underwriting agreement, dated February 27, between the
Company and Aegis Capital Corp. (the “Underwriters”). The common stock in the Offering was sold at a public offering
price of $1.15 per share. The Company has granted the Underwriters a 45-day option to purchase up to an additional 378,261 additional
shares of common stock at the public offering price, less underwriting discounts and commissions, to cover over-allotments, if
any.
The
common stock in the Offering was issued pursuant to the Company’s effective shelf registration statement on Form S-3 (File
No. 333-225227). The underwriting agreement contained customary representations, warranties and agreements by the Company, customary
conditions to closing, indemnification obligations of the Company and the Underwriters. The
Underwriters received discounts and commissions of seven percent (7%) of the gross cash proceeds received by the Company from
the sale of the common shares in the Offering. In addition, the Company agreed to pay the Underwriters (a) a non-accountable
expense reimbursement of 1% of the gross proceeds received and (b) “road show” expenses, diligence fees and the fees
and expenses of the Underwriters’ legal counsel not to exceed $50,000.
Under
the underwriting agreement, the Company and its officers and directors executed lock-up agreements whereby, (a) the Company has
agreed not to engage in the following for a period of 45 days from the date of the pricing of the Offering, (1) offer, sell or
otherwise transfer or dispose of, directly or indirectly, any shares of capital stock of the Company, or (2) file or caused to
be filed any registration statement with the SEC relating to the offering of any shares of the Company’s capital stock or
any securities convertible into or exercisable or exchangeable for shares of the Company’s capital stock, and (b) the Company’s
executive officers and directors, as of the pricing date of the Offering, have agreed, subject to certain exceptions, not to offer,
issue, sell, contract to sell, encumber, grant any option for the sale of or otherwise dispose of any securities of the Company
without the prior written consent of the Underwriters, for a period of 45 days from the date of the offering.
The
gross proceeds to the Company from the offering, before deducting underwriting discounts and commissions and other estimated offering
expenses, and assuming the Underwriters do not exercise their option to purchase the option shares, are approximately $2.9 million.
The net proceeds to the Company from the offering, after deducting underwriting discounts
and commissions and the non-accountable expense reimbursement, but before deducting other
expenses in connection with the offering, and assuming the Underwriters do not exercise their option to purchase the option
Shares, are approximately $2.67 million. The Company intends to use the net proceeds
from this offering to fund the repayment of debt and for general corporate purposes.
Debt
Financing:- The Company entered two debt instruments subsequent to December 31, 2019 as follows:
|
|
●
|
During
February 2020, the Company borrowed a total of $289,000 from the Company’s Chairman, CEO & President under an unsecured
promissory note bearing interest at 6% through its May 28, 2020 maturity date. The proceeds from the note were used for general
corporate purposes.
|
|
|
|
|
|
|
●
|
On
January 17, 2020, the Company borrowed a total of $100,000 from an individual under an unsecured promissory note bearing interest
at 8% through its April 17, 2020 maturity date. In connection with the loan, the Company issued the individual a warrant for
the purchase of 35,750 shares of common stock at $1.40 per share for a period of five years from the date of the note. The
proceeds from the note were used for general corporate purposes.
|
NASDAQ
Listing - Our Common Stock is currently listed on The Nasdaq Capital Market
(“Nasdaq”). In order to maintain that listing, we must satisfy minimum financial and other continued listing
requirements and standards, including those regarding director independence and independent committee requirements, minimum stockholders’
equity, minimum share price, and certain corporate governance requirements. There can be no assurances that we will be able to
comply with the applicable listing standards.
If
our Common Stock is delisted from Nasdaq and is not eligible for quotation on another
market or exchange, trading of our Common Stock could be conducted in the over-the-counter market or on an electronic bulletin
board established for unlisted securities such as the Pink Sheets or the OTC Bulletin Board. In such event, it could become more
difficult to dispose of, or obtain accurate price quotations for, our Common Stock, and there would likely also be a reduction
in our coverage by securities analysts and the news media. Also, it may be difficult for us to raise additional capital if we
are not listed on Nasdaq or a major exchange.
On
July 11, 2019, Nasdaq notified us that, for the previous 30 consecutive business days, the minimum Market Value of Listed Securities
(the “MVLS”) for our Common Stock was below the $35 million minimum MVLS requirement for continued listing on Nasdaq
under Nasdaq Listing Rule 5550(b)(2) (the “MVLS Rule”). In accordance with Nasdaq Listing Rule 5810(c)(3)(C),
we had 180 calendar days, or until January 7, 2020, to regain compliance with the MVLS Rule. To regain compliance with the MVLS
Rule, the minimum MVLS for our Common Stock must have been at least $35 million for a minimum of ten consecutive business days
at any time during this 180-day period. If we failed to regain compliance with such rule by January 7, 2020, we were subject to
being be delisted from Nasdaq. If we were delisted from The
Nasdaq Capital Market, our Common Stock may lose liquidity, increase volatility, and lose market maker support.
On
January 8, 2020, we received a determination letter from the staff of Nasdaq stating that we had not regained compliance with
the MVLS Standard, since our Common Stock was below the $35 million minimum MVLS requirement for continued listing on Nasdaq under
the MLVS Rule and had not been at least $35 million for a minimum of ten consecutive business days at any time during the 180-day
grace period granted to us. Pursuant to the letter, unless we requested a hearing to appeal this determination by January 15,
2020, our Common Stock would be delisted from Nasdaq and trading of our Common Stock would have been suspended at the opening
of business on January 17, 2020.
On
January 13, 2020, we requested a hearing before the Nasdaq Hearings Panel to appeal the Letter and the Staff of Nasdaq notified
us that a hearing was scheduled for February 20, 2020. We were asked to provide the Panel with a plan to regain compliance with
the minimum MLVS requirement under the MLVS Rule, which needed to include a discussion of the events that we believe will enable
us to timely regain compliance with the minimum MLVS requirement. On January 21, 2020, we submitted such a compliance plan.
On March 6, 2020, we received
notice from the NASDAQ hearing panel that the Company has been granted an extension until June 30, 2020 to regain compliance with
Rule 5550(b), which requires us to have at least i) $2.5 million in shareholder equity; or ii) $35 million in market value of
listed securities, or iii) net income from continuing operations of at least $500,000 in the most recently completed fiscal year
or in two of the last three fiscal years. Our goal is to meet the $2.5 million minimum shareholder equity requirement for continued
listing on NASDAQ. There can be no assurance that we will regain compliance with the NASDAQ’s Listing Rule
regarding our $2.5 million minimum shareholder equity requirement on or prior to the June 30, 2020 required date. Furthermore,
even if we regain compliance on or prior to such date, we must thereafter continue to maintain compliance the
continued listing rule.
COVID – 19 Pandemic
- The accompanying consolidated financial statements as well as the
Notes to the Consolidated Financial Statements, unless otherwise indicated, principally reflect the status of our business and
the results of our operations as of December 31, 2019. Since that date, economies throughout the world have been severely disrupted
by the effects of the quarantines, business closures and the reluctance of individuals to leave their homes as a result of the
outbreak of the coronavirus (COVID-19). Although we remain open as an “essential business,” our supply chain has been
disrupted and our customers and in particular our commercial customers have been significantly impacted which has in turn reduced
our operations and activities. In addition, the capital markets have been disrupted and our efforts to raise necessary capital
will likely be adversely impacted by the outbreak of the virus and we cannot forecast with any certainty when the disruptions caused
by it will cease to impact our business and the results of our operations. In reading the our consolidated financial statements,
including our discussion of our ability to continue as a going concern set forth herein, in each case, consider the additional
uncertainties caused by the outbreak of COVID - 19.
*************************************