NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature
of Operations:
Digital
Ally, Inc. and subsidiary (collectively, “Digital Ally,” “Digital,” 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 recently added a line of disinfectants manufactured by a third party for use
against viruses and bacteria and is offering such products to its law enforcement and commercials customers beginning in the second
quarter 2020. 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.
Basis
of Presentation:
The
condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in
the United States for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly,
they do not include all the information and footnotes required by generally accepted accounting principles in the United States
for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2020 are not
necessarily indicative of the results that may be expected for the year ending December 31, 2020.
The
balance sheet at December 31, 2019 has been derived from the audited financial statements at that date, but does not include all
the information and footnotes required by generally accepted accounting principles in the United States for complete financial
statements.
For
further information, refer to the financial statements and footnotes included in the Company’s annual report on Form 10-K
for the year ended December 31, 2019.
COVID-19
pandemic:
The
World Health Organization has declared the outbreak of Covid-19, or coronavirus, which began in December 2019, a pandemic and
the U.S. federal government has declared it a national emergency. The Covid-19 pandemic had a negative impact our revenues in
the first quarter 2020 and we expect it will adversely affect our business and operations during the remainder of 2020 and while
its full and continued impact cannot be determined at present, however it will have a material adverse effect on our future business,
financial condition, results of operations, or cash flows. The global spread of Covid-19 has already created significant volatility,
uncertainty and economic disruption in the markets in which we operate. Governments, public institutions, and other organizations
in countries and localities where cases of Covid-19 have been detected are taking certain emergency measures to mitigate its spread,
including implementing travel restrictions and closing factories, schools, public buildings, and businesses. We are closely monitoring
the spread of Covid-19 and continually assessing its potential effects on our business.
The
extent to which our future results are affected by COVID-19 will largely depend on future developments that cannot be accurately
predicted, including the duration and scope of the pandemic, governmental and business responses to the pandemic and the impact
on the global economy, our customers’ demand for our products and services, and our ability to provide our products and
services, particularly as result of our employees working remotely and/or the closure of certain offices and facilities. While
these factors are uncertain, the COVID-19 pandemic or the perception of its effects will have a material adverse effect on our
business, financial condition, results of operations, or cash flows.
Management’s
Liquidity Plan and Going Concern:
The
accompanying unaudited condensed 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 for the three months ended March 31, 2020 and for the year ended December 31, 2019 primarily due to reduced revenues and
gross margins caused by a variety of factors, including the Covid-19 pandemic and its related effects on our customers and our
supply chain, 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 $2.3 million during the three months ended March 31,
2020 and $10.0 million for the year ended December 31, 2019 and it had an accumulated deficit of $89.7 million as of March 31,
2020. During 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 3. 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 $2.5 million in an underwritten public offering of common stock and $389,000 in unsecured promissory
notes and detachable warrants during the three months ended March 31, 2020. In addition, 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, it
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 3.
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.
On
April 4, 2020, the Company entered into a promissory note providing for a loan of $1,418,900 (the “PPP Loan”) pursuant
to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”).
The PPP Loan has a two-year term and bears interest at a rate of 0.98% per annum. Monthly principal and interest payments are
deferred for six months after the date of disbursement. The PPP Loan may be prepaid at any time prior to maturity with no prepayment
penalties. The promissory note contains events of default and other provisions customary for a loan of this type. The Paycheck
Protection Program provides that the PPP Loan may be partially or wholly forgiven if the funds are used for certain qualifying
expenses as described in the CARES Act. The Company intends to use the majority of the PPP Loan amount for qualifying expenses
and to apply for forgiveness of the loan in accordance with the terms of the CARES Act.
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 8, “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
2020 and 2019, 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. The extent to which
our future operating results are affected by COVID-19 will largely depend on future developments which cannot be accurately predicted,
including the duration and scope of the pandemic, governmental and business responses to the pandemic and the impact on the global
economy, our customers’ demand for our products and services, and our ability to provide our products and services, particularly
as result of our employees working remotely and/or the closure of certain offices and facilities. While these factors are uncertain,
the COVID-19 pandemic or the perception of its effects will have a material adverse effect on our business, financial condition,
results of operations, or cash flows.
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 unaudited condensed consolidated
financial statements. The accompanying unaudited condensed 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.
Basis
of Consolidation:
The
accompanying financial statements include the consolidated accounts of Digital Ally and its wholly-owned subsidiary, Digital Ally
International, Inc. All intercompany balances and transactions have been eliminated during consolidation.
The
Company formed Digital Ally International, Inc. during August 2009 to facilitate the export sales of its products.
Segments
of Business:
Management
has determined that its operations are comprised of one reportable segment: the sale of digital audio and video recording and
speed detection devices. For the three months ended March 31, 2020 and 2019, sales by geographic area were as follows:
|
|
Three
Months Ended
March 31,
|
|
|
|
2020
|
|
|
2019
|
|
Sales by geographic area:
|
|
|
|
|
|
|
|
|
United
States of America
|
|
$
|
2,371,687
|
|
|
$
|
2,514,342
|
|
Foreign
|
|
|
54,058
|
|
|
|
36,454
|
|
|
|
$
|
2,425,745
|
|
|
$
|
2,550,796
|
|
Sales
to customers outside of the United States are denominated in U.S. dollars. All Company assets are physically located within the
United States.
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 was 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.
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 such debt was outstanding. 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 will not be required 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 implemented the revised disclosure requirements upon adoption of ASU 2018-13.
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. The adoption of this standard did not have a significant impact on the Company’s financial position and
results of operations.
NOTE
2. INVENTORIES
Inventories
consisted of the following at March 31, 2020 and December 31, 2019:
|
|
March
31,
2020
|
|
|
December
31, 2019
|
|
Raw material and component
parts
|
|
$
|
4,312,384
|
|
|
$
|
4,481,611
|
|
Work-in-process
|
|
|
60,862
|
|
|
|
35,858
|
|
Finished goods
|
|
|
4,881,662
|
|
|
|
4,906,956
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
9,254,908
|
|
|
|
9,424,425
|
|
Reserve for excess
and obsolete inventory
|
|
|
(4,117,022
|
)
|
|
|
(4,144,013
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
5,137,886
|
|
|
$
|
5,280,412
|
|
Finished
goods inventory includes units held by potential customers and sales agents for test and evaluation purposes. The cost of such
units totaled $124,557 and $80,711 as of March 31, 2020 and December 31, 2019, respectively.
NOTE
3. DEBT OBLIGATIONS
Debt
obligations is comprised of the following:
|
|
March
31,
2020
|
|
|
December
31, 2019
|
|
2019 Secured convertible
notes, at fair value
|
|
$
|
—
|
|
|
$
|
1,593,809
|
|
2018 Proceeds investment agreement,
at fair value
|
|
|
6,193,000
|
|
|
|
6,500,000
|
|
Unsecured promissory notes payable,
less unamortized discount of $-0- and $66,061 at March 31, 2020 and December 31, 2019, respectively
|
|
|
300,000
|
|
|
|
233,939
|
|
Unsecured promissory
notes payable – Related party
|
|
|
289,000
|
|
|
|
—
|
|
Debt obligations
|
|
$
|
6,782,000
|
|
|
$
|
8,327,748
|
|
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.
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
|
|
During
the three months ended March 31, 2020, the holders of the 2019 Convertible Notes exercised their right to convert principal balances
aggregating $1,259,074 into equity. In addition, the Company paid regular monthly principal payments totaling $172,839 during
the three months ended March 31, 2020 and on March 3, 2020, the Company exercised its right to prepay in cash the remaining outstanding
principal balance aggregating $574,341. There remains no outstanding 2019 Convertible notes as of March 31, 2020 as a result of
these conversions and prepayments.
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 condensed consolidated
statement of operations. Following is an analysis of the activity in the secured convertible notes during the three months ended
March 31, 2020:
|
|
Amount
|
|
Balance at December 31, 2019
|
|
$
|
1,593,809
|
|
Principal repaid
during the period by issuance of common stock
|
|
|
(1,259,074
|
)
|
Principal repaid
during the period by payment of cash
|
|
|
(747,180
|
)
|
Change in fair value
of secured convertible note during the period
|
|
|
412,445
|
|
|
|
|
|
|
Balance at March 31, 2020
|
|
$
|
—
|
|
Following
is a range of certain estimates and assumptions utilized as of December 31, 2019 to determine the fair value of secured convertible
notes:
|
|
December
31, 2019
|
|
|
|
Assumptions
|
|
Volatility – range
|
|
|
115
|
%
|
Risk-free rate
|
|
|
1.60
|
%
|
Contractual term
|
|
|
0.6
years
|
|
Calibrated stock price
|
|
$
|
1.06
|
|
Debt yield
|
|
|
123.6
|
%
|
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 March 31, 2020 and December 31, 2019 to
probability weighted present value of expected patent asset proceeds for the litigation involving both Axon and WatchGuard:
|
|
|
March
31, 2020
|
|
|
|
December
31, 2019
|
|
Discount
rate
|
|
|
3.6%
- 21.3
|
%
|
|
|
3.0%
- 16.6
|
%
|
Expected
term to patent asset proceeds payment
|
|
|
0.33
years – 3.75 years
|
|
|
|
0.58
years - 4 years
|
|
Probability
of success
|
|
|
5.9%
- 38.5
|
%
|
|
|
5.9%
- 38.5
|
%
|
Estimated
minimum return payable to BKI
|
|
$
|
21
million
|
|
|
$
|
21
million
|
|
Negotiation
discount
|
|
|
43.3
|
%
|
|
|
43.3
|
%
|
In
May 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 8. 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
following represents activity in the PIA during the three months ended March 31, 2020:
Beginning balance as of December 31, 2019
|
|
$
|
6,500,000
|
|
Repayment of obligation
|
|
|
—
|
|
Change in the
fair value during the period
|
|
|
(307,000
|
)
|
Ending balance as of March 31,
2020
|
|
$
|
6,193,000
|
|
Unsecured
Promissory Notes 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 (this note was repaid in full on May 6, 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 was amortized to interest expense ratably over the term of the promissory note
which approximates the effective interest method. The amortization of discount resulted in $66,061 of the discount amortized to
interest expense during the three months ended March 31, 2020.
On
January 17, 2020, the Company, borrowed $100,000 under an unsecured note payable to a private, third-party lender. The promissory
note bore interest at the rate of 8% per annum with principal and accrued interest payable on or before its maturity date of April
17, 2020. The Company granted the lender warrants exercisable to purchase a total of 35,750 shares of its common stock at an exercise
price of $1.40 per share until January 17, 2025. The Company allocated $20,806 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 note was repaid
in full on March 12, 2020 and the discount was amortized to interest expense through the date of payment. The amortization of
discount resulted in $20,806 of the discount amortized to interest expense during the three months ended March 31, 2020.
Unsecured
Promissory Notes Payable – Related party
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. Total interest accrued through March 31, 2020 on this promissory note was $2,067.
NOTE
4. FAIR VALUE MEASUREMENT
In
accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC 820”), the Company utilizes
the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other
relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets
or liabilities, such as a business.
ASC
820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three
broad levels. The following is a brief description of those three levels:
●
|
Level
1 — Quoted prices in active markets for identical assets and liabilities
|
|
|
●
|
Level
2 — Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities)
|
|
|
●
|
Level
3 — Significant unobservable inputs (including the Company’s own assumptions in determining the fair value)
|
The
following table represents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a
recurring basis as of March 31, 2020 and December 31, 2019:
|
|
March
31, 2020
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured convertible
debentures
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Proceeds
investment agreement
|
|
|
—
|
|
|
|
—
|
|
|
|
6,193,000
|
|
|
|
6,193,000
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6,193,000
|
|
|
$
|
6,193,000
|
|
|
|
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
|
|
The
following table represents the change in Level 3 tier value measurements:
|
|
2019
|
|
|
|
|
|
|
|
|
|
Secured
|
|
|
Proceeds
|
|
|
|
|
|
|
Convertible
|
|
|
Investment
|
|
|
|
|
|
|
Notes
|
|
|
Agreement
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2019
|
|
$
|
1,593,809
|
|
|
$
|
6,500,000
|
|
|
$
|
8,093,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of secured convertible debentures
|
|
|
(1,259,074
|
)
|
|
|
—
|
|
|
|
(1,259,074
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repayment of 2019 secured convertible
notes
|
|
|
(747,180
|
)
|
|
|
|
|
|
|
(747,180
|
)
|
Change in fair
value of secured convertible debentures and proceeds investment agreement
|
|
|
412,445
|
|
|
|
(307,000
|
)
|
|
|
105,445
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2020
|
|
$
|
—
|
|
|
$
|
6,193,000
|
|
|
$
|
6,193,000
|
|
NOTE
5. ACCRUED EXPENSES
Accrued
expenses consisted of the following at March 31, 2020 and December 31, 2019:
|
|
March
31,
2020
|
|
|
December
31,
2019
|
|
Accrued warranty expense
|
|
$
|
17,008
|
|
|
$
|
17,838
|
|
Accrued litigation costs
|
|
|
250,000
|
|
|
|
295,000
|
|
Accrued sales commissions
|
|
|
25,631
|
|
|
|
28,480
|
|
Accrued payroll and related fringes
|
|
|
390,550
|
|
|
|
233,254
|
|
Accrued insurance
|
|
|
20,812
|
|
|
|
78,579
|
|
Accrued sales returns and allowances
|
|
|
5,542
|
|
|
|
18,258
|
|
Accrued sales taxes
|
|
|
49,503
|
|
|
|
50,136
|
|
Other
|
|
|
115,318
|
|
|
|
124,336
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
874,364
|
|
|
$
|
845,881
|
|
Accrued
warranty expense was comprised of the following for the three months ended March 31, 2020:
|
|
|
|
Beginning balance
|
|
$
|
17,838
|
|
Provision for warranty expense
|
|
|
26,095
|
|
Charges applied
to warranty reserve
|
|
|
(26,925
|
)
|
|
|
|
|
|
Ending balance
|
|
$
|
17,008
|
|
NOTE
6. INCOME TAXES
The
effective tax rate for the three months ended March 31, 2020 and 2019 varied from the expected statutory rate due to the Company
continuing to provide a 100% valuation allowance on net deferred tax assets. The Company determined that it was appropriate to
continue the full valuation allowance on net deferred tax assets as of March 31, 2020 primarily because of the Company’s
history of operating losses.
The
Company has incurred operating losses in recent years and it continues to be in a three-year cumulative loss position at March
31, 2020. 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 continue to provide a 100% valuation allowance on its net deferred tax assets. 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.
The Company has available to it approximately $67 million in net operating loss carryforwards to offset future taxable income
as of March 31, 2020.
NOTE
7. 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 March 31, 2020 was one month. The Company has
entered into a lease for new office and warehouse space: See NOTE 13. SUBSEQUENT EVENTS.
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 March 31, 2020 was 43 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 $98,836 for the three months ended March 31, 2020.
The
discount rate implicit within the Company’s operating leases was not generally determinable and therefore the Company determined
the discount rate based on its incremental borrowing rate on the information available at commencement date. As of commencement
date, the operating lease liabilities reflect a weighted average discount rate of 8%.
The
following sets forth the operating lease right of use assets and liabilities as of March 31, 2020:
Assets:
|
|
|
|
Operating lease right of
use assets
|
|
$
|
94,449
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Operating lease obligations-current
portion
|
|
$
|
49,828
|
|
Operating lease
obligations-less current portion
|
|
$
|
44,620
|
|
Total operating
lease obligations
|
|
$
|
94,448
|
|
The
components of lease expense were as follows for the three months ended March 31, 2020:
Selling,
general and administrative expenses
|
|
$
|
98,836
|
|
Following
are the minimum lease payments for each year and in total.
Year
ending December 31:
|
|
|
|
2020
|
|
$
|
52,915
|
|
2021
|
|
|
19,176
|
|
2022
|
|
|
19,176
|
|
2023
|
|
|
15,980
|
|
Total undiscounted minimum future lease
payments
|
|
|
107,247
|
|
Imputed interest
|
|
|
(12,799
|
)
|
Total
operating lease liability
|
|
$
|
94,448
|
|
NOTE
8. CONTINGENCIES
COVID-19
pandemic
The
World Health Organization has declared the outbreak of COVID-19, or coronavirus, which began in December 2019, a pandemic and
the U.S. federal government has declared it a national emergency. Our business and operations could be materially and adversely
affected by the effects of COVID-19. The global spread of COVID-19 has already created significant volatility, uncertainty and
economic disruption in the markets in which we operate. Governments, public institutions, and other organizations in countries
and localities where cases of COVID-19 have been detected are taking certain emergency measures to mitigate its spread, including
implementing travel restrictions and closing factories, schools, public buildings, and businesses. While the full impact of this
outbreak is not yet known, we are closely monitoring the spread of COVID-19 and continually assessing its potential effects on
our business.
The
extent to which our results are affected by COVID-19 will largely depend on future developments which cannot be accurately predicted,
including the duration and scope of the pandemic, governmental and business responses to the pandemic and the impact on the global
economy, our customers’ demand for our products and services, and our ability to provide our products and services, particularly
as result of our employees working remotely and/or the closure of certain offices and facilities. While these factors are uncertain,
the COVID-19 pandemic or the perception of its effects will have a material adverse effect on our business, financial condition,
results of operations, or cash flows.
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 filed an appeal to this ruling asking 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 overturned the summary judgment ruling, a new judge would be assigned to handle
the litigation with Axon due to the 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. On April 22, 2020, a three-judge panel of the United
States Court of Appeals denied the Company’s appeal and affirmed the District Court’s previous decision to grant Axon
summary judgment. The Company is evaluating its alternatives including whether to file a motion requesting a rehearing
in front of the three-judge panel or the entire Court of Appeals.
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 was dismissed by Plaintiff with prejudice on April 17,
2019.
NASDAQ
LISTING.
Our
Common Stock is 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. NASDAQ has not provided any guidance whether the extension until June 30, 2020 will be affected by the Covid-19
pandemic.
NOTE
9. STOCK-BASED COMPENSATION
The
Company recorded pretax compensation expense related to the grant of stock options and restricted stock issued of $311,677 and
$725,198 for the three months ended March 31, 2020 and 2019, respectively.
As
of March 31, 2020, 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 March 31, 2020 total 8,063. The 2006 Plan terminated during 2016 with 27,412 shares not awarded or underlying options, which
shares are now unavailable for issuance. Stock options granted under the 2006 Plan that remain unexercised and outstanding as
of March 31, 2020 total 40,062. The 2007 Plan terminated during 2017 with 89,651 shares not awarded or underlying options, which
shares are now unavailable for issuance. Stock options granted under the 2007 Plan that remain unexercised and outstanding as
of March 31, 2020 total 5,000. The 2008 Plan terminated during 2018 with 9,249 shares not awarded or underlying options, which
shares are now unavailable for issuance. Stock options granted under the 2008 Plan that remain unexercised and outstanding as
of March 31, 2020 total 31,250.
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 121,636 shares remained available for awards under the various
Plans as of March 31, 2020.
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 three months ended March 31, 2020:
Options
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
Outstanding at December 31, 2019
|
|
|
589,125
|
|
|
$
|
3.74
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
(5,000
|
)
|
|
|
(9.40
|
)
|
Outstanding at March 31, 2020
|
|
|
584,125
|
|
|
$
|
3.69
|
|
Exercisable at March 31, 2020
|
|
|
539,125
|
|
|
$
|
3.75
|
|
The
fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. The total estimated
grant date fair value stock options issued during the three months ended March 31, 2020 was $-0- as there were no grants during
that period.
The
Plans allow for the cashless exercise of stock options. This provision allows the option holder to surrender/cancel options with
an intrinsic value equivalent to the purchase/exercise price of other options exercised. There were no shares surrendered pursuant
to cashless exercises during the three months ended March 31, 2020 and 2019.
At
March 31, 2020, the aggregate intrinsic value of options outstanding was approximately $-0- and the aggregate intrinsic value
of options exercisable was approximately $-0-. No options were exercised in the three months ended March 31, 2020 and 2019.
As
of March 31, 2020, the unrecognized portion of stock compensation expense on all existing stock options was $72,703 and will be
recognized over the next two 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 March 31, 2020:
|
|
|
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
|
|
|
8.1
years
|
|
|
425,313
|
|
|
|
8.0
years
|
|
$
|
3.50
to $4.99
|
|
|
|
64,000
|
|
|
4.1
years
|
|
|
64,000
|
|
|
|
4.1
years
|
|
$
|
5.00
to $6.49
|
|
|
|
—
|
|
|
—
years
|
|
|
—
|
|
|
|
—
years
|
|
$
|
6.50
to $7.99
|
|
|
|
7,562
|
|
|
1.6
years
|
|
|
7,562
|
|
|
|
1.6
years
|
|
$
|
8.00
to $9.99
|
|
|
|
2,500
|
|
|
1.2
years
|
|
|
2,500
|
|
|
|
1.2
years
|
|
$
|
10.00
to $19.99
|
|
|
|
39,750
|
|
|
0.8
years
|
|
|
39,750
|
|
|
|
0.8
years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
584,125
|
|
|
7.1
years
|
|
|
539,125
|
|
|
|
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 three months ended March 31, 2020 is as follows:
|
|
Number
of
Restricted
shares
|
|
|
Weighted
average
grant date
fair
value
|
|
Nonvested
balance, January 1, 2020
|
|
|
514,875
|
|
|
$
|
2.97
|
|
Granted
|
|
|
530,050
|
|
|
|
1.08
|
|
Vested
|
|
|
(274,925
|
)
|
|
|
(2.74
|
)
|
Forfeited
|
|
|
(22,500
|
)
|
|
|
(1.92
|
)
|
Nonvested
balance, March 31, 2020
|
|
|
747,500
|
|
|
$
|
1.75
|
|
The
Company estimated the fair market value of these restricted stock grants based on the closing market price on the date of grant.
As of March 31, 2020, there were $706,239 of total unrecognized compensation costs related to all remaining non-vested restricted
stock grants, which will be amortized over the next 21 months in accordance with their respective vesting scale.
The
nonvested balance of restricted stock vests as follows:
Years
ended
|
|
Number
of
shares
|
|
|
|
|
|
2020
(April 1, 2020 through December 31, 2020)
|
|
|
13,125
|
|
2021
|
|
|
488,750
|
|
2022
|
|
|
245,625
|
|
NOTE
10. 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 4,860,323 shares of common stock at $1.40 to $16.50 per share as of March 31, 2020. The warrants
expire from July 15, 2020 through January 17, 2025 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 three months ended March 31,
2020:
|
|
Warrants
|
|
|
Weighted
average
exercise
price
|
|
Vested
Balance, January 1, 2020
|
|
|
4,824,573
|
|
|
$
|
5.15
|
|
Granted
|
|
|
35,750
|
|
|
|
1.40
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Cancelled
|
|
|
—
|
|
|
|
—
|
|
Vested
Balance, March 31, 2020
|
|
|
4,860,323
|
|
|
$
|
5.12
|
|
The
total intrinsic value of all outstanding warrants aggregated $-0- as of March 31, 2020 and the weighted average remaining term
is 30.4 months.
The
following table summarizes the range of exercise prices and weighted average remaining contractual life for outstanding and exercisable
warrants to purchase common shares as of March 31, 2020:
|
|
|
Outstanding
and exercisable warrants
|
|
Exercise
price
|
|
|
Number
of warrants
|
|
|
Weighted
average
remaining
contractual life
|
|
$
|
1.40
|
|
|
|
142,750
|
|
|
|
4.7
years
|
|
$
|
1.81
|
|
|
|
571,428
|
|
|
|
4.4
years
|
|
$
|
2.60
|
|
|
|
465,712
|
|
|
|
3.3
years
|
|
$
|
3.00
|
|
|
|
701,667
|
|
|
|
3.0
years
|
|
$
|
3.25
|
|
|
|
120,000
|
|
|
|
2.7
years
|
|
$
|
3.36
|
|
|
|
680,000
|
|
|
|
1.9
years
|
|
$
|
3.36
|
|
|
|
200,000
|
|
|
|
2.9
years
|
|
$
|
3.65
|
|
|
|
200,000
|
|
|
|
2.2
years
|
|
$
|
3.75
|
|
|
|
94,000
|
|
|
|
2.4
years
|
|
$
|
5.00
|
|
|
|
800,000
|
|
|
|
1.8
years
|
|
$
|
13.43
|
|
|
|
879,766
|
|
|
|
0.8
years
|
|
$
|
16.50
|
|
|
|
5,000
|
|
|
|
0.3
years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,860,323
|
|
|
|
2.5
years
|
|
NOTE
11. STOCKHOLDERS’ EQUITY
Underwritten
Public Offering - On March 3, 2020, the Company entered into an underwriting agreement with Aegis Capital Corp., 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 2,521,740 shares of the Company’s
common stock, par value $0.001 per share at a public price of $1.15 per share. The Company also granted the underwriters a forty-five
(45)-day option to purchase up to an additional 378,261 shares of common stock to cover over-allotments, if any. 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.
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. The net proceeds to the Company from the Offering totaled approximately $2,502,136, 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 forty-five (45) 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 forty-five (45)-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.
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.
NOTE
12. NET LOSS PER SHARE
The
calculation of the weighted average number of shares outstanding and loss per share outstanding for the three months ended March
31, 2020 and 2019 are as follows:
|
|
Three
months ended
March
31,
|
|
|
|
2020
|
|
|
2019
|
|
Numerator
for basic and diluted income per share – Net loss
|
|
$
|
(2,334,110
|
)
|
|
$
|
(3,205,174
|
)
|
|
|
|
|
|
|
|
|
|
Denominator
for basic loss per share – weighted average shares outstanding
|
|
|
13,888,438
|
|
|
|
10,941,856
|
|
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
|
|
|
13,888,438
|
|
|
|
10,941,856
|
|
|
|
|
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.17
|
)
|
|
$
|
(0.29
|
)
|
Diluted
|
|
$
|
(0.17
|
)
|
|
$
|
(0.29
|
)
|
Basic
loss per share is based upon the weighted average number of common shares outstanding during the period. For the three months
ended March 31, 2020 and 2019, 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
13. SUBSEQUENT EVENTS
Wholesale
Distribution Agreement — Effective April 3, 2020, the Company entered into a distribution agreement with Trust Think,
LLC, under which it has been engaged to service, promote, and sell certain Danolyte® disinfecting products, which
are manufactured and distributed by Trust Think to certain first responder and commercial customers with whom the Company has
existing relationships. Danolyte® has been listed on the United States Environmental Protection Agency’s
List N: Disinfectants for Use Against SARS-CoV-2, the virus that causes COVID-19. The Company will receive a percentage of the
sales sold through its distribution channels.
The
Company will offer the disinfecting products to its first responder customers including police, fire and paramedics. Commercial
customers such as cruise lines, taxi-cab and para transit may also be good candidates for the products. The Company is considering
enhancing the line of disinfectant products for additional related products including hardware to efficiently and effectively
dispense the disinfectants and temperature measuring devices.
Issuance
of Restricted Common Stock. On April 17, 2020, the Compensation Committee of the Board of Directors of the Company determined
that the cash portion of the annual base salaries of Stanton E. Ross, President and Chief Executive Officer, and Thomas J. Heckman,
Chief Financial Officer, Treasurer and Secretary, shall be reduced to annual rates of $150,000 each for the balance of 2020 commencing
May 1, 2020.
The
Committee also decided that the balance of the annual salaries of Messrs. Ross and Heckman for 2020, which are $69,230.76 and
$55,384.00, respectively, as of May 1, 2020 will be paid through the issuance of shares of restricted stock under the 2018 Stock
Option and Restricted Stock Plan with the Company paying the applicable federal and state taxes on such amounts. The Company issued
Messrs. Ross and Heckman 75,250 shares and 60,200 shares, respectively, effective April 17, 2020 based on a closing price of $0.92
per share on such date.
2020
Secured Convertible Notes. On April 17, 2020, the Company entered into a securities purchase agreement with two accredited
investors providing for the issuance of (i) the Company’s 8% Senior Secured Convertible Promissory Notes due April 16, 2021
with an aggregate principal face amount of $1,666,666, which are, subject to certain conditions, convertible into an aggregate
of 1,650,164 shares of the Company’s common stock, par value $0.001 per share at a price per share of $1.01 and (ii) five-year
warrants to purchase an aggregate of up to 1,237,624 shares of common stock at an exercise price of $1.31, subject to customary
adjustments. Such 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. The closing of the offering occurred on April 17, 2020 whereby the investors purchased the
securities for an aggregate purchase price of $1,500,000.
In
accordance with the securities purchase agreement, an aggregate of $500,000 in principal amount of notes, and the conversion shares
underlying such notes, were issued to the investors in a registered direct offering pursuant to a prospectus supplement to the
Company’s currently effective registration statement on Form S-3 (File No. 333-225227), which was initially filed with the
SEC on May 25, 2018, and was declared effective on June 6, 2018.
In
accordance with the securities purchase agreement, the Company also issued to the 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 the remaining aggregate of $1,166,666 in principal amount of other notes, the shares of common stock issuable
from time to time upon conversion of such other notes, and warrants.
In
connection with the securities purchase agreement, the Company and its subsidiary entered into a security agreement, dated as
of April 17, 2020, with the investors, pursuant to which the Company and its subsidiary granted to the investors 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 April 17, 2020, the Company granted to the investors 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.
Promissory
Note Under the Paycheck Protection Program. On April 4, 2020, the Company entered into a promissory note with a bank,
which provides for a loan in the amount of $1,418,900 (the “PPP Loan”) pursuant to the Paycheck Protection Program
under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The PPP Loan has a two-year term and
bears interest at a rate of 1% per annum. Monthly principal and interest payments are deferred for six months after the
date of disbursement. The PPP Loan may be prepaid at any time prior to maturity with no prepayment penalties. The promissory note
contains events of default and other provisions customary for a loan of this type. The Paycheck Protection Program provides that
the PPP Loan may be partially or wholly forgiven if the funds are used for certain qualifying expenses as described in the CARES
Act. The Company intends to use the majority of the PPP Loan amount for qualifying expenses and to apply for forgiveness of the
loan in accordance with the terms of the CARES Act.
Warehouse and
Office Building Lease. On May 13, 2020, the Company entered into a lease agreement for new warehouse and office space
which will serve as the company’s new principal executive office and primary business location. The terms of the lease include
no base rent for the first six months and monthly payments ranging from $12,398 to $13,693 thereafter, with a maturity date of
December 2026. The Company is responsible for property taxes, utilities, insurance and its proportionate share of common area
costs related to its new location. The Company will move to and occupy the new space after certain improvements are completed
landlord which is expected to be in June 2020.
NASDAQ
Listing - On April 22, 2020, the Company received a written notification from the Nasdaq indicating that the Company was
not in compliance with Nasdaq Listing Rule 5550(a)(2), as the Company’s closing bid price for its common stock, par value
$0.001 per share, was below $1.00 per share for the last thirty (30) consecutive business days.
Pursuant
to Nasdaq Listing Rule 5810(c)(3)(A), the Company has been granted a 180-calendar day compliance period to regain compliance with
the minimum bid price requirement. However, the 180-day grace period to regain compliance with the Minimum Bid Price Requirement
under applicable Nasdaq rules has been extended due to the global market impact caused by COVID-19. More specifically, Nasdaq
has stated that the compliance periods for any company previously notified about non-compliance will be suspended effective April
16, 2020, through June 30, 2020. On July 1, 2020, companies would receive the balance of any pending compliance period exception
to come back into compliance with the applicable Minimum Bid Price Requirement. As a result of this extension, the Company has
until December 28, 2020, to regain compliance with the Minimum Bid Price Requirement.
During
the compliance period, the Company’s shares of common stock will continue to be listed and traded on the Nasdaq Capital
Market. To regain compliance, the closing bid price of the Company’s shares of common stock must meet or exceed $1.00 per
share for at least ten (10) consecutive business days during the 180-calendar day compliance period. Management continues to believe
that adherence to its current operating and business plan will enable the Company to regain compliance.
If
the Company is not in compliance by December 28, 2020, the Company may be afforded a second 180-calendar day compliance period.
To qualify for this additional time, the Company will be required to meet the continued listing requirement for market value of
publicly held shares and all other initial listing standards for Nasdaq with the exception of the minimum bid price requirement.
If
the Company does not regain compliance within the allotted compliance period(s), including any extensions that may be granted
by Nasdaq, Nasdaq will provide notice that the Company’s shares of common stock will be subject to delisting and may potentially
be traded on the OTC market thereafter.
*************************************