DIGITAL ALLY, INC. This quarterly report on Form 10-Q ofDigital Ally, Inc. (the "Company", "we", "us", or "our") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The words "believe," "expect," "anticipate," "intend," "estimate," "may," "should," "could," "will," "plan," "future," "continue," and other expressions that are predictions of or indicate future events and trends and that do not relate to historical matters identify forward-looking statements. These forward-looking statements are based largely on our expectations or forecasts of future events, can be affected by inaccurate assumptions, and are subject to various business risks and known and unknown uncertainties, a number of which are beyond our control. Therefore, actual results could differ materially from the forward-looking statements contained in this document, and readers are cautioned not to place undue reliance on such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. A wide variety of factors could cause or contribute to such differences and could adversely impact revenues, profitability, cash flows and capital needs. There can be no assurance that the forward-looking statements contained in this document will, in fact, transpire or prove to be accurate. Factors that could cause or contribute to our actual results differing materially from those discussed herein or for our stock price to be adversely affected include, but are not limited to: (1) our losses in recent years, including during the six months endedJune 30, 2020 and the 2019 fiscal year; (2) economic and other risks for our business from the effects of the COVID-19 pandemic, including the impacts on our law-enforcement and commercial customers, suppliers and employees and on our ability to raise capital as required; (3) our ability to increase revenues, increase our margins and return to consistent profitability in the current economic and competitive environment; (4) our operation in developing markets and uncertainty as to market acceptance of our technology and new products; (5) the availability of funding from federal, state and local governments to facilitate the budgets of law enforcement agencies, including the timing, amount and restrictions on such funding; (6) our ability to deliver our new product offerings as scheduled in 2020, such as the Shield™ disinfectant/sanitizers products and ThermoVU™ temperature screening systems, whether such new products perform as planned or advertised and whether they will help increase our revenues; (7) whether we will be able to increase the sales, domestically and internationally, for our products in the future; (8) our ability to maintain or expand our share of the market for our products in the domestic and international markets in which we compete, including increasing our international revenues; (9) our ability to produce our products in a cost-effective manner; (10) competition from larger, more established companies with far greater economic and human resources; (11) our ability to attract and retain quality employees; (12) risks related to dealing with governmental entities as customers; (13) our expenditure of significant resources in anticipation of sales due to our lengthy sales cycle and the potential to receive no revenue in return; (14) characterization of our market by new products and rapid technological change; (15) our dependence on sales of our EVO-HD, DVM-800, FirstVU HD and DVM-250 products; (16) potential that stockholders may lose all or part of their investment if we are unable to compete in our markets and return to profitability; (17) defects in our products that could impair our ability to sell our products or could result in litigation and other significant costs; (18) our dependence on key personnel; (19) our reliance on third-party distributors and sales representatives for part of our marketing capability; (20) our dependence on a few manufacturers and suppliers for components of our products and our dependence on domestic and foreign manufacturers for certain of our products; (21) our ability to protect technology through patents and to protect our proprietary technology and information as trade secrets and through other similar means; (22) our ability to generate more recurring cloud and service revenues; (23) risks related to our license arrangements; (24) our revenues and operating results may fluctuate unexpectedly from quarter to quarter; (25) sufficient voting power by coalitions of a few of our larger stockholders, including directors and officers, to make corporate governance decisions that could have significant effect on us and the other stockholders; (26) sale of substantial amounts of our common stock, par value$0.001 per share that may have a depressive effect on the market price of the outstanding shares of our common stock; (27) possible issuance of common stock subject to options and warrants that may dilute the interest of stockholders; (28) our nonpayment of dividends and lack of plans to pay dividends in the future; (29) future sale of a substantial number of shares of our common stock that could depress the trading price of our common stock, lower our value and make it more difficult for us to raise capital; (30) our additional securities available for issuance, which, if issued, could adversely affect the rights of the holders of our common stock; (31) the likely high volatility of our stock price due to a number of factors, including a relatively limited public float; (32) whether the litigation against Axon will achieve its intended objectives and result in monetary recoveries for us; (33) whether the USPTO rulings will curtail, eliminate or otherwise have an effect on the actions of Axon and other competitors respecting us, our products and customers; (34) whether our patented VuLink technology will become the de-facto "standard" for agencies engaged in deploying state-of-the-art body-worn and in-car camera systems and will increase our revenues; (35) whether such technology will have a significant impact on our revenues in the long-term and (36) indemnification of our officers and directors.
Current Trends and Recent Developments for the Company
Overview We produce digital video imaging, storage products and disinfectant and related safety products for use in law enforcement, security and commercial applications. Our current products include in-car digital video/audio recorders 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. We have active research and development programs to adapt our technologies to other applications. We sell our 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. 30 We supply technology-based products utilizing our portable digital video and audio recording capabilities, for the law enforcement and security industries and for the commercial fleet and mass transit markets. We have the ability to integrate electronic, radio, computer, mechanical, and multi-media technologies to create unique solutions to address needs in a variety of other industries and markets, including mass transit, school bus, taxicab and the military. Our products include the DVM-800 in-car digital video mirror systems for use by law enforcement; the FirstVU and the FirstVU HD which are body-worn cameras, our patented VuLink product, which integrates our body-worn cameras with our in-car systems by providing hands-free automatic activation and which we supply to both law enforcement and commercial markets; the DVM-250 and DVM-250 Plus, a commercial line of digital video mirrors that serve as "event recorders" for the commercial fleet and mass transit markets; and FleetVU and VuLink, which are cloud-based evidence management systems. We introduced the EVO-HD product in lateJune 2019 and began full-scale deliveries in the third quarter 2019. It is designed and built on a new and highly advanced technology platform that we expect to become the platform for a new family of our in-car video solution products for the law enforcement and commercial markets. We believe that the launch of these new products will help to reinvigorate our in-car and body-worn systems revenues while diversifying and broadening the market for our product offerings as circumstances normalize in a post-COVID-19 economy, although we can offer no assurance in this regard. The Company has recently added two new lines of branded products: (1) the ThermoVu™ which is a line of self-contained temperature monitoring stations that provides alerts and controls facility access when an individual's temperature exceeds a pre-set threshold and (2) our Shield™ disinfectants and cleansers which are for use against viruses and bacteria and began offering such products to its law enforcement and commercials customers beginning late in the second quarter 2020. We are ramping up our supply chain for both of these new product lines, which are manufactured by third-parties. We experienced operating losses for all of our fiscal quarters during 2020 and 2019 except for the second quarter of 2019, as a result of a patent litigation settlement. The following is a summary of our recent operating results on a
quarterly basis:
June 30, March 31, December 31, September 30, June 30,
2020 2020 2019 2019 2019
Total revenue $ 1,732,192 $ 2,425,745 $ 2,420,437 $ 2,923,148 $ 2,546,983
Gross profit (loss) 392,758 1,265,028 (88,185 ) 1,188,262 950,812
Gross profit margin % 22.7 % 52.2 % (3.6 )% 40.7 % 37.3 %
Total selling, general
and administrative
expenses 2,535,912 3,192,396 3,145,633 3,468,709 (1,616,830 )
Operating income (loss) (2,143,154 ) (1,927,368 ) (3,233,819 ) (2,280,447 ) 2,567,642
Operating income (loss)
% (123.7 )% (79.5 )% (133.6 )% (78.0 )% 100.8 %
Net loss $ (497,894 ) $ (2,334,110 ) $ (3,426,984 ) $ (2,985,825 ) $ (387,730 ) Our business is subject to substantial fluctuations on a quarterly basis as reflected in the significant variations in revenues and operating results in the above table. These variations result from various factors, including but not limited to: (1) the timing of large individual orders; (2) the traction gained by newer products, such as the recently released EVO-HD, the ThermoVU™ and the Shield™ line; (3) production, quality and other supply chain issues affecting our cost of goods sold; (4) unusual increases in operating expenses, such as the timing of trade shows and bonus compensation; (5) the timing of patent infringement litigation settlements, such as the$6.0 settlement we obtained from WatchGuard during the second quarter of 2019 and (5) the impact of patent infringement and other litigation including all related obligations and expenses respecting such litigation and (6) most recently, the impact of COVID-19 on
the economy and our business. 31
Off-Balance Sheet Arrangements
We do not have any off-balance sheet debt, nor did we have any transactions, arrangements, obligations (including contingent obligations) or other relationships with any unconsolidated entities or other persons that may have material current or future effect on our financial conditions, changes in the financial conditions, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenue or expenses.
For the Three Months Ended
Results of Operations
Summarized immediately below and discussed in more detail in the subsequent sub-sections is an analysis of our operating results for the three months endedJune 30, 2020 and 2019, represented as a percentage of total revenues for each respective year: Three months ended June 30, 2020 2019 Revenue 100 % 100 % Cost of revenue 77 % 63 % Gross profit 23 % 37 %
Selling, general and administrative expenses:
Research and development expense 21 %
23 %
Selling, advertising and promotional expense 28 %
48 %
Stock-based compensation expense 22 %
23 %
General and administrative expense 76 %
78 %
Patent litigation settlement - %
(236 )%
Total selling, general and administrative expenses 147 % (64 )% Operating income (loss) (124 )% 101 %
Change in fair value of proceeds investment agreement 149 %
(116 )%
Change in fair value of secured convertible notes (51 )%
- %
Other income and interest expense, net (3 )%
- %
Loss before income tax benefit (29 )% (15 )% Income tax (provision) - % - % Net loss (29 )% (15 )%
Net loss per share information:
Basic$ (0.03 ) $ (0.03 ) Diluted$ (0.03 ) $ (0.03 ) Revenues
We sell our products and services to law enforcement and commercial customers in the following manner:
? Sales to domestic customers are made directly to the end customer (typically a
law enforcement agency or a commercial customer) through our sales force,
comprised of our employees. Revenue is recorded when the product is shipped to
the end customer.
32
? Sales to international customers are made through independent distributors who
purchase products from us at a wholesale price and sell to the end user
(typically law enforcement agencies or a commercial customer) at a retail
price. The distributor retains the margin as its compensation for its role in
the transaction. The distributor generally maintains product inventory,
customer receivables and all related risks and rewards of ownership. Revenue
is recorded when the product is shipped to the distributor consistent with the
terms of the distribution agreement.
? Repair parts and services for domestic and international customers are
generally handled by our inside customer service employees. Revenue isrecognized upon shipment of the repair parts and acceptance of the service or
materials by the end customer.
We may discount our prices on specific orders based upon the size of the order, the specific customer and the competitive landscape.
Revenues for each of the second quarters of 2020 and 2019 were derived from the
following sources:
Three months ended June 30,
2020 2019
DVM-800 21 % 35 %
Repair and service 23 % 15 %
DVM-250 Plus 6 % 9 %
FirstVu HD 13 % 12 %
Cloud service revenue 16 % 7 %
EVO-HD 9 % 3 %
VuLink 1 % 1 %
Accessories and other revenues 11 % 18 %
100 % 100 %
The COVID-19 pandemic had a negative impact on our revenues in the second quarter 2020 and we expect it to adversely affect our revenues during the remainder of 2020.
Product revenues for the three months ended
? In general, we have experienced pressure on our revenues as our in-car and
body-worn systems are facing increased competition because our competitors
have released new products with advanced features. Additionally, our law
enforcement revenues declined over the prior period due to price-cutting and
competitive actions by our competitors, adverse marketplace effects related to
our patent litigation proceedings and supply chain issues. We introduced our
EVO-HD late in the second quarter of 2019 with the goal of enhancing our
product line features to meet these competitive challenges and we started to
see traction in late 2019. We expect customers and potential customers to
review and test the EVO-HD prior to committing to this new product platform,
all of which has been delayed due to the COVID-19 pandemic.
? The COVID-19 pandemic delayed the shipment of orders in the second quarter
2020 as police forces and governments dealt with its impact. In addition, our
salesmen were generally unable to meet with and demonstrate our products to
our law enforcement and commercial customers because of travel and other
restrictions imposed by cities and states due to the COVID-19 pandemic. In
person demonstration of our products to potential customers is generally
required in order to obtain new customers or upgrade existing customers. Our
product sales decreased substantially in the second quarter 2020 compared to
2019 primarily due to the impact of the COVID-19 pandemic.
33
? Management has been focusing on migrating customers, in particular commercial
customers, from a "hardware sale" to a service fee model. Therefore, we expect
a reduction in commercial hardware sales (principally DVM-250's and FirstVU's)
as we convert these customers to a service model under which we provide the
hardware as part of a recurring monthly service fee. In that respect, we
introduced a monthly subscription agreement plan for our body worn cameras and
related equipment during the second quarter 2020 that allowed law enforcement
agencies to pay a monthly service fee to obtain body worn cameras without
incurring a significant upfront capital outlay. This program has gained some
traction, resulting in decreased product revenues and increasing our service
revenues.
? Our international revenues decreased to
during the three months ended
product revenues) during the three months ended
pandemic delayed the shipment of orders in the second quarter 2020 as police
forces and governments dealt with its impact. In addition, our salesmen were
generally unable to meet with and demonstrate our products to our
international law enforcement and commercial customers because of travel and
other restrictions imposed by the various countries. In person demonstration
of our products to potential customers is generally required in order to
obtain new customers or upgrade existing customers. Our international sales
decreased substantially in the second quarter 2020 compared to 2019 primarily
due to the impact of the COVID-19 pandemic. We believe that would have seen an
uptick in our international sales activity in 2020 as a result of the recent
award of a contract for our FirstVU HD by a sovereign nation's national police
force which was suspended because of the COVID-19 pandemic. The status of this
large international contract is unsettled at present.
? During the second quarter of 2020, the Company launched two product lines in
direct response to the increased safety precautions that organizations and
individuals are taking due to the COVID-19 pandemic. ThermoVu™ was launched as
a non-contact temperature-screening instrument that measures temperature
through the wrist and controls entry to facilities when temperature
measurements exceed pre-determined parameters. ThermoVu™ has optional features
such as facial recognition to improve facility security by restricting access
based on temperature and/or facial recognition reasons. ThermoVu™ provides an
instant pass/fail audible tone with its temperature display and controls
access to facilities based on such results. We believe that it can be widely
applied in schools, office buildings, subway stations, airports and other
public venues. The Company also launched its Shield™ disinfectant/sanitizer
product lines to fulfill demand by current customers and others for a
disinfectant and sanitizer that is less harsh than many of the traditional
products now widely distributed. The Shield™ Cleanser product line contains a
cleanser with no harsh chemicals or fumes.
The Company began offering the Shield™ line of disinfecting products to its
first responder customers including police, fire and paramedics during the
second quarter 2020. 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. The Company is hopeful that its law enforcement and commercial
customers will adopt this new product offering to combat the spread of the
COVID-19 virus as well as other bacteria and viruses.
Service and other revenues for the three months ended June 30, 2020 and 2019
were $678,611 and $601,259 , respectively, an increase of $77,352 (13%), dueto the following factors:
? Cloud revenues were
June 30, 2020 and 2019, respectively, an increase of$111,134 (65%). We have experienced increased interest in our cloud solutions for law enforcement primarily due to the deployment of our new cloud-based EVO-HD in-car system; however, the fallout from the COVID-19 pandemic and related business shut-downs adversely affected our commercial customers usage of cloud services and offset increases in cloud revenues. 34
? Revenues from extended warranty services were
three months ended
(3%). We have a number of customers that have purchased extended warranty
packages, primarily in our DVM-800 premium service program.
? Installation service revenues were
ended
Installation revenues tend to vary more than other service revenue types and
are dependent on larger customer implementations. The decrease in installation
revenues in 2020 compared to 2019 was attributable to the COVID-19 pandemic
lock-down, which prevented our technicians from completing on-site
installations during the 2020 period.
? Software revenue, non-warranty repair and other revenues were
decrease of
ended
2019 and non-warranty repairs were
2020 compared to
security event fees were
compared to $-0 - during the three months ended June 30, 2019 .
Total revenues for the three months ended June 30, 2020 and 2019 were $1,732,192
and $2,546,983 , respectively, a decrease of $814,791 (32%), due to the reasons
noted above.
Cost of Revenue
Cost of product revenue on units sold for the three months ended June 30, 2020
and 2019 was $1,165,528 and $1,468,828 , respectively, a decrease of $303,300
(21%). The decrease in cost of goods sold for products is primarily due to the
46% decrease in product revenues offset by an increase in the cost of goods sold
for products as a percentage of product revenues to 111% for the three months
ended June 30, 2020 compared to 75% for the three months ended June 30, 2019 .
During the second quarter of 2020 the Company moved to new and smaller warehouse
facilities and during the move sorted through its entire inventory and disposed
of all excess and obsolete inventory rather than moving it to the new location,
which contributed to the increase in the cost of goods sold for products as a
percentage of product revenues to 111% for the three months ended June 30, 2020 .
In addition, the move to a new facility coupled with the manufacturing slow down
caused by the COVID-19 pandemic caused significant unfavorable overhead and
labor variances for production in the second quarter of 2020, which management
decided to expense as a period cost rather than apply to finished good andwork in process inventory.
Cost of service and other revenues for the three months endedJune 30, 2020 and 2019 was$173,906 and$127,343 , respectively, an increase of$46,563 (37%). The increase in service and other cost of goods sold is primarily due to the 13% increase in service and other revenues coupled with an increase in the cost of service and other revenues sold for products as a percentage of service and other revenues to 26% for the three months endedJune 30, 2020 compared to 21% for the three months endedJune 30, 2019 . Total cost of sales as a percentage of revenues was 77% for the three months endedJune 30, 2020 compared to 63% for the three months endedJune 30, 2019 . We believe our gross margins will improve during the remainder of 2020 if we can increase revenues (in particular service and other revenues) in light of the COVID-19 pandemic and continue to reduce product warranty issues. We had$2,000,412 and$4,144,013 in reserves for obsolete and excess inventories atJune 30, 2020 andDecember 31, 2019 , respectively. Total raw materials and component parts were$2,575,710 and$4,481,611 atJune 30, 2020 andDecember 31, 2019 , respectively, a decrease of$1,905,901 (43%). DuringJune 2020 the Company moved to a new and smaller warehouse facilities and during the move sorted through its entire inventory and disposed of all excess and obsolete inventory rather than moving it to the new location which contributed to the significant decrease in the cost. We scrapped older version inventory component parts that were mostly or fully reserved during the three months endedJune 30, 2020 , which was the primary cause for the decrease in total raw materials and component parts. Finished goods balances were$4,146,308 and$4,906,956 atJune 30, 2020 andDecember 31, 2019 , respectively, a decrease of$760,648 (16%). The decrease in the inventory reserve is primarily due to the scrapping of older version legacy products that were mostly or fully reserved during the three months endedJune 30, 2020 as a result of moving our warehouse and office location. The remaining reserve for inventory obsolescence is generally provided for the level of component parts of the older versions of our printed circuit boards and the phase out of our DVM-750, DVM-500 Plus and LaserAlly legacy products. We believe that the reserves are appropriate given our inventory levels atJune 30, 2020 . 35 Gross Profit
Gross profit for the three months endedJune 30, 2020 and 2019 was$392,758 and$950,812 , respectively, a decrease of$558,054 (59%). The decrease is commensurate with the 32% decrease in total revenues and the gross margin percentage decline to 23% during the three months endedJune 30, 2020 , from 37% during the three months endedJune 30, 2019 . Our goal is to improve our margins to 60% over the longer-term based on the expected margins of our EVO-HD, DVM-800, VuLink, FirstVU HD, ThermoVU™, Shield™ disinfectants and our cloud evidence storage and management offering, if they gain traction in the marketplace and subject to a normalizing economy in the wake of the COVID-19 pandemic. In addition, if revenues from these products increase, we will seek to further improve our margins from them through economies of scale and more efficiently utilizing fixed manufacturing overhead components. We plan to continue our initiative to more efficiently manage our supply chain through outsourcing production, quantity purchases and more effective purchasing practices.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were$2,535,912 and$(1,616,830) for the three months endedJune 30, 2020 and 2019, respectively, an increase of$4,152,742 (257%). The significant increase was attributable to the patent litigation settlement of$6.0 million that we received in the second quarter of 2019. Exclusive of the patent litigation settlement, overall selling, general and administrative expenses would have decreased by 42% in the second quarter 2020 compared to the same period in 2019. The significant components of selling, general and administrative expenses are as follows: Three months ended June 30, 2020 2019 Research and development expense$ 359,697 $
582,905
Selling, advertising and promotional expense 486,649
1,237,947
Stock-based compensation expense 376,738
585,195
Professional fees and expense 217,726
228,476
Executive, sales, and administrative staff payroll 510,872 1,090,868 Other 584,230 657,779 Patent litigation proceeds - (6,000,000 ) Total$ 2,535,912 $ (1,616,830 ) Research and development expense. We continue to focus on bringing new products to market, including updates and improvements to current products. Our research and development expenses totaled$359,697 and$582,905 for the three months endedJune 30, 2020 and 2019, respectively, a decrease of$223,208 (38%). Most of our engineers are dedicated to research and development activities for new products primarily the EVO-HD, which was launched in late second quarter of 2019 and a non-mirror based DVM-250 that can be located in multiple places in a vehicle. We expect our research and development activities will decrease in future quarters as we reduce our engineering headcount to reflect lower activity on our EVO-HD product platform. We consider our research and development capabilities and new product focus to be a competitive advantage and will continue to invest in this area on a prudent basis and consistent with our financial resources. Selling, advertising and promotional expenses. Selling, advertising and promotional expense totaled$486,649 and$1,237,847 for the three months endedJune 30, 2020 and 2019, respectively, a decrease of$751,198 (61%). The significant decrease was primarily attributable to our sponsorship of aNASCAR race inMay 2019 and other related sponsorship opportunities that did not recur in 2020. Salesman salaries and commissions represent the primary components of these costs and were$374,882 and$727,155 for the three months endedJune 30, 2020 and 2019, respectively, a decrease of$352,273 (48%). The effective commission rate was 21.6% for the three months endedJune 30, 2020 compared to 28.5% for the three months endedJune 30, 2019 . We reduced the number of salesmen in our law enforcement and commercial channels beginning in the first quarter of 2020, which had a full effect on the second quarter 2020. 36 Promotional and advertising expenses totaled$111,767 during the three months endedJune 30, 2020 compared to$510,792 during the three months endedJune 30, 2019 , a decrease of$399,025 (78%). The decrease is primarily attributable to our sponsorship of theNASCAR race inMay 2019 , the suspension of the 2020NASCAR season late in the first quarter 2020 and a reduction in attendance at trade shows as a result of the COVID-19 pandemic. Stock-based compensation expense. Stock based compensation expense totaled$376,738 and$585,195 for the three months endedJune 30, 2020 and 2019, respectively, a decrease of$208,457 (36%). The decrease is primarily due to the decreased amortization during the three months endedJune 30, 2020 related to the restricted stock granted at a lower market price per share during 2020 and 2019 to our officers, directors, and other employees. We relied more on stock-based compensation during 2020 and 2019 as we reduced cash expenses for liquidity reasons. Professional fees and expense. Professional fees and expenses totaled$217,726 and$228,476 for the three months endedJune 30, 2020 and 2019, respectively, a decrease of$10,750 (5%). The decrease in professional fees is primarily attributable to legal fees and expenses related to the Axon lawsuit and the resolution of the WatchGuard and PGA lawsuits. We resolved the PGA lawsuit onApril 17, 2019 and the WatchGuard lawsuit was settled on May13, 2019. OnJune 17, 2019 , theU.S. District Court granted Axon's Motion for Summary Judgment and accepted Axon's position that it did not infringe on ourU.S. Patent No. 9,253,452 and dismissed the lawsuit in its entirety. We appealed theU.S. District Court's ruling and onApril 22, 2020 , a three-judge panel of theUnited States Court of Appeals for the Tenth Circuit denied our appeal and affirmed theU.S. District Court's previous decision to grant Axon summary judgment. The Company filed a motion requesting a rehearing in front of theCourt of Appeals which motion was also denied onJune 9, 2020 . The Company has untilNovember 7, 2020 to decide whether it will appeal theU.S. District Court's andCourt of Appeals' decisions to theUnited States Supreme Court . Our spending on legal fees on the Axon case has slowed during 2020 as we waited for the appeal to be heard. The Company's decision on whether it will appeal the decisions to theUnited States Supreme Court will impact the trend of legal expenses for the balance of 2020. Executive, sales and administrative staff payroll. Executive, sales and administrative staff payroll expenses totaled$510,872 and$1,090,868 for the three months endedJune 30, 2020 and 2019, respectively, a decrease of$579,996 (53%). The primary reason for the decrease in executive, sales and administrative staff payroll was a reduction in our technical support staffing in response to the COVID-19 pandemic and the Company expects such reductions to continue to reduce related staff expenses during the balance of 2020. The COVID-19 pandemic has significantly impacted the Company's new event security business channel in the second quarter of 2020 as many sporting venues were closed including those served by these service technicians. Other. Other selling, general and administrative expenses totaled$584,230 and$657,779 for the three months endedJune 30, 2020 and 2019, respectively, a decrease of$73,549 (11%). The decrease in other expenses during the three months endedJune 30, 2020 compared to the same period in 2019 is primarily attributable to lower contract employee expenses and travel costs resulting
from the COVID-19 pandemic. Patent litigation settlement. The income attributable to our patent litigation settlement was$-0 - and$6,000,000 for the three months endedJune 30, 2020 and 2019, respectively. OnMay 13, 2019 we reached a resolution of the pending patent infringement litigation with WatchGuard and executed a settlement agreement that resulted in the dismissal of this case. As part of such agreement, we received a one-time$6,000,000 payment and granted WatchGuard a perpetual covenant to not sue WatchGuard if its products incorporate agreed-upon modified recording functionality. Additionally, we granted WatchGuard a license to the '292 Patent and '452 Patent throughDecember 31, 2023 . As part of the settlement, we and WatchGuard agreed that WatchGuard was making no admission that it had infringed any of our patents. See Note 9 - "Commitments and Contingencies" to the Company's condensed consolidated financial statements, included in Part I, Item 1 of this quarterly report on Form 10-Q (the "June 30, 2020 Financial Statements"), for the details respecting the settlement. 37 Operating Loss
For the reasons stated above, our operating loss was
Interest Income Interest income increased to$15,609 for the three months endedJune 30, 2020 from$5,628 in 2019, which reflected our higher cash and cash equivalent levels in the second quarter of 2020 compared to the second quarter of 2019. The Company raised significant amounts of cash through the closing of two underwritten public offerings and the exercise of outstanding common stock purchase warrants duringJune 2020 , which will generate interest income in
future quarters. Interest Expense
We incurred interest expense of
The Company issued an aggregate of$1.667 million principal amount of secured convertible notes onApril 17, 2020 which bore interest at 8% per annum on the outstanding principal balance. During the three months endedJune 30, 2020 , the holders of the secured convertible notes exercised their right to convert principal balances aggregating$1.666 million into equity. In addition, the Company exercised its right to prepay in cash the remaining outstanding principal balance aggregating$1,000 . Such secured convertible notes are no longer outstanding as ofJune 30, 2020 as a result of these conversions and prepayments. The Company issued an unsecured promissory note in an aggregate principal amountof$300,000 payable onDecember 23, 2019 which bore interest at 8% per annum on the outstanding principal balance which has been repaid in full as ofJune 30, 2020 . In addition, during 2020 we issued an unsecured note payable with a related party in the principal amount of$319,000 which bore interest at 6% per annum, which has been repaid in full as ofJune 30, 2020 . OnApril 4, 2020 , the Company entered into a promissory note providing for a PPP Loan of$1,418,900 . The PPP Loan has a two-year term and bears interest at a rate of 1.0% per annum. Monthly principal and interest payments are deferred for six months after the date of disbursement and total$79,850.57 per month thereafter. OnMay 12, 2020 the Company received$150,000 in additional loan funding under the EIDL program administered by the SBA. Under the terms of the EIDL promissory note, interest accrues on the outstanding principal at the rate of 3.75% per annum. The term of the EIDL promissory note is thirty years and monthly principal and interest payments are deferred for twelve months after the date of disbursement and total$731.00 per month thereafter.
Secured Convertible Notes Issuance Expenses
We elected to account for and record our$1.667 million principal amount of the 2020 Convertible Notes issued inApril 2020 on a fair value basis. Accordingly, we were required to expense the related issuance costs to other expense in the condensed consolidated statements of operations. Such costs totaled$34,906 for the three months endedJune 30, 2020 . The issuance costs primarily included related legal and accounting fees. No similar debt issuances occurred during the three months endedJune 30, 2019 .
Change in Fair Value of Proceeds Investment Agreement
We elected to account for the PIA that we entered into with BKI in July of 2018 on its fair value basis. Therefore, we determined the fair value of the 2018 PIA as ofJune 30, 2020 , andMarch 31, 2020 to be$3,615,000 and$6,193,000 , respectively. The change in fair value fromMarch 31, 2020 toJune 30, 2020 was$2,578,000 , which was recognized as a gain in the Condensed Consolidated Statement of Operations for the three months endedJune 30, 2020 . The change in fair value fromMarch 31, 2019 toJune 30, 2019 was$(2,961,000) , which was recognized as a loss in the Condensed Consolidated Statement of Operations for the three months endedJune 30, 2019 . 38
Change in Fair Value of Secured Convertible Notes
We elected to account for the secured convertible notes that were issued onApril 17, 2020 on their fair value basis. Therefore, we determined the fair value of the secured convertible notes as of their issuance date ofApril 17, 2020 and throughJune 12, 2020 , when they were paid in full. The change in fair value from their issuance date ofApril 17, 2020 to their pay-off date was$887,807 , which was recognized as a charge in the Condensed Consolidated Statement of Operations for the three months endedJune 30, 2020 .
Loss before Income Tax Benefit
As a result of the above, we reported a loss before income tax benefit of
Income Tax Benefit
We did not record an income tax related to our losses for the three months endedJune 30, 2020 due to our overall net operating loss carryforwards available. We have further determined to continue providing a full valuation reserve on our net deferred tax assets as ofJune 30, 2020 . We had approximately$66,925,000 of net operating loss carryforwards and$1,795,000 of research and development tax credit carryforwards as determined onDecember 31, 2019 available to offset
future net taxable income. Net Loss As a result of the above, we reported net losses of$497,894 and$387,730 for the three months endedJune 30, 2020 and 2019, respectively, a deterioration of$110,164 (28%).
Basic and Diluted Loss per Share
The basic and diluted loss per share was ($0.03 ) and ($0.03 ) for the three months endedJune 30, 2020 and 2019, respectively, for the reasons previously noted. All outstanding stock options, warrants and convertible securities were considered antidilutive and therefore excluded from the calculation of diluted loss per share for the three months endedJune 30, 2020 and 2019 because of the net loss reported for each of such period.
For the Six months ended
Results of Operations
Summarized immediately below and discussed in more detail in the subsequent sub-sections is an analysis of our operating results for the six months endedJune 30, 2020 and 2019, represented as a percentage of total revenues for each respective year: Six months ended June 30, 2020 2019 Revenue 100 % 100 % Cost of revenue 60 % 58 % Gross profit 40 % 42 %
Selling, general and administrative expenses:
Research and development expense 20 % 21 %
Selling, advertising and promotional expense 28 % 39 %
Stock-based compensation expense 17 % 26 %
General and administrative expense 73 % 84 %
Patent litigation settlement - % (118 )%
Total selling, general and administrative expenses 138 % 52 %
Operating income (loss) (98 )% (10 )%
Change in fair value of proceeds investment agreement 69 %
(60 )%
Change in fair value of secured convertible notes (31 )% - %
Other income and interest expense, net (8 )% - %
Loss before income tax benefit (68 )%
(70 )%
Income tax (provision) - % - %
Net loss (68 )% (70 )%
Net loss per share information:
Basic $ (0.17 ) $ (0.32 )
Diluted $ (0.17 ) $ (0.32 )
39
Revenues
We sell our products and services to law enforcement and commercial customers as noted earlier in this quarterly report on Form 10-Q.
We may discount our prices on specific orders based upon the size of the order, the specific customer and the competitive landscape.
Revenues for each of the six months endedJune 30, 2020 and 2019 were derived from the following sources: Six months ended June 30, 2020 2019 DVM-800 29 % 39 % Repair and service 19 % 14 % DVM-250 Plus 5 % 8 % FirstVu HD 14 % 15 % Cloud service revenue 13 % 7 % EVO-HD 8 % 1 % VuLink 2 % 2 % Accessories and other revenues 10 % 14 % 100 % 100 % 40
The COVID-19 pandemic had a negative impact on our revenues during the six
months ended
Product revenues for the six months ended
? In general, we have experienced pressure on our revenues as our in-car and
body-worn systems are facing increased competition because our competitors
have released new products with advanced features. Additionally, our law
enforcement revenues declined over the prior period due to price-cutting and
competitive actions by our competitors, adverse marketplace effects related to
our patent litigation proceedings and supply chain issues. We introduced our
EVO-HD late in second quarter of 2019 with the goal of enhancing our product
line features to meet these competitive challenges and we started to see
traction in late 2019. We expect customers and potential customers to review
and test the EVO-HD prior to committing to this new product platform, all of
which has been delayed due to the COVID-19 pandemic.
? Our salesmen were generally unable to meet with and demonstrate our products
to our law enforcement and commercial customers because of travel and other
restrictions imposed by cities and states due to the COVID-19 pandemic. In
person demonstration of our products to potential customers is generally
required in order to obtain new customers or upgrade existing customers. Our
product sales decreased substantially in the first half of 2020 compared to
2019 primarily due to the impact of the COVID-19 pandemic.
? In addition, the COVID-19 pandemic delayed the shipment of orders late in the
first quarter of 2020 as police forces and governments dealt with its impact.
Specifically, we were unable to ship the initial purchase orders under a
substantial contract awarded by a foreign country for the expected deployment
of body cameras to its entire national police force. The contract was expected
to include up to 5,000 body cameras with our web-based software infrastructure
service over a three-year period. The contract was suspended pending the
government's decision to freeze the planned deployment until such time as the
pandemic is contained within its population. The initial purchase order was
expected to ship during the first quarter 2020 and we believed that it would
have made a substantial impact on our product revenues for such quarter. At
this point, we are unable to forecast if and when this major project will be
restarted or how it may be modified as a result of the pandemic. Upon
completion, the original contract would have been the largest body camera
deployment in our history and the largest contract for recurring service
revenues for our web-based software related to the Company's body cameras.
? Management has been focusing on migrating customers, in particular commercial
customers from a "hardware sale" to a service fee model. Therefore, we expect
a reduction in commercial hardware sales (principally DVM-250's and FirstVU's)
as we convert these customers to a service model under which we provide the
hardware as part of a recurring monthly service fee. In that respect, we
introduced a monthly subscription agreement plan for our body worn cameras and
related equipment during the second quarter 2020 which allowed law enforcement
agencies to pay a monthly service fee to obtain body worn cameras without
incurring a significant upfront capital outlay. This program has gained some
traction which is resulting in decreased product revenues and increasing our
service revenues.
? Our international revenues decreased to
during the six months ended
product revenues) during the six months ended
pandemic delayed the shipment of orders in the second quarter 2020 as police
forces and governments dealt with its impact. In addition, our salesmen were
generally unable to meet with and demonstrate our products to our
international law enforcement and commercial customers because of travel and
other restrictions imposed by the various countries. In person demonstration
of our products to potential customers is generally required in order to
obtain new customers or upgrade existing customers. Our international sales
decreased substantially in the second quarter of 2020 compared to 2019
primarily due to the impact of the COVID-19 pandemic. We believe that we would
have seen an uptick in our international sales activity in 2020 as a result of
the recent award of a contract for our FirstVU HD by a sovereign nation's
national police force, which was suspended because of the COVID-19 pandemic as
noted above.
41
? During the second quarter 2020, the Company launched ThermoVuä and Shieldä
Disinfectant/Sanitizer products, two product lines in direct response to the
increased safety precautions that organizations and individuals are taking due
to the COVID-19 pandemic, as discussed earlier in this quarterly report on
Form 10-Q.
Service and other revenues for the six months endedJune 30, 2020 and 2019 were$1,337,820 and$1,231,591 , respectively, an increase of$106,229 (9%), due
to the following factors:
? Cloud revenues were
2020 and 2019, respectively, an increase of
experienced increased interest in our cloud solutions for law enforcement
primarily due to the deployment of our new cloud-based EVO-HD in-car system;
however, the fallout from the COVID-19 pandemic and related business
shut-downs adversely affected our commercial customers usage of cloud services
and offset increases in cloud revenues.
? Revenues from extended warranty services were
six months ended
(0%). We have a number of customers that have purchased extended warranty
packages, primarily in our DVM-800 premium service program.
? Installation service revenues were
ended
Installation revenues tend to vary more than other service revenue types and
are dependent on larger customer implementations. The decrease in installation
revenues in 2020 compared to 2019 was attributable to the COVID-19 pandemic
lock-down, which prevented our technicians from completing on-site
installations during the 2020 period.
? Software revenue, non-warranty repair and other revenues were
decrease of
months ended
non-warranty repairs were
compared to
period.
Total revenues for the six months ended June 30, 2020 and 2019 were $4,157,936
and $5,097,779 , respectively, a decrease of $939,843 (18%), due to the reasons
noted above.
42
Cost of Revenue
Cost of product revenue on units sold for the six months ended June 30, 2020 and
2019 was $2,154,774 and $2,731,899 , respectively, a decrease of $577,125 (21%).
The decrease in cost of goods sold for products is primarily due to the 27%
decrease in product revenues coupled with an increase in the cost of goods sold
for products as a percentage of product revenues to 76% for the six months ended
June 30, 2020 compared to 71% for the six months ended June 30, 2019 . During
June 2020 the Company moved to new and smaller warehouse facilities and during
the move sorted through its entire inventory and disposed of all excess and
obsolete inventory rather than moving it to the new location, which contributed
to the increase in the cost of goods sold for products as a percentage of
product revenues to 76% for the six months ended June 30, 2020 . In addition, the
move to a new facility coupled with the manufacturing slow down caused by the
COVID-19 pandemic caused significant unfavorable overhead and labor variances
for production in the first half of 2020, which management decided to expense as
a period cost rather than apply to finished good and work in process inventory.
Cost of service and other revenues for the six months ended June 30, 2020 and
2019 was $345,374 and $233,328 , respectively, an increase of $112,046 (48%). The
increase in service and other cost of goods sold is primarily due to the 9%
increase in service and other revenues coupled with an increase in the cost of
service and other revenues sold for products as a percentage of service and
other revenues to 26% for the six months ended June 30, 2020 compared to 19% for
the six months ended June 30, 2019 .
Total cost of sales as a percentage of revenues was 60% for the six months ended
June 30, 2020 compared to 58% for the six months ended June 30, 2019 . We believe
our gross margins will improve during the remainder of 2020 if we can increase
revenues (in particular service and other revenues) and continue to reduce
product warranty issues.
We had $2,000,412 and $4,144,013 in reserves for obsolete and excess inventories
at June 30, 2020 and December 31, 2019 , respectively. Total raw materials and
component parts were $2,575,710 and $4,481,611 at June 30, 2020 and December 31,
2019 , respectively, a decrease of $1,905,901 (43%). During the six months ended
June 30, 2020 the Company moved to a new and smaller warehouse facilities and
during the move sorted through its entire inventory and disposed of all excess
and obsolete inventory rather than moving it to the new location which
contributed to the significant decrease in the cost. We scrapped older version
inventory component parts that were mostly or fully reserved during the six
months ended June 30, 2020 , which was the primary cause for the decrease in
total raw materials and component parts. Finished goods balances were $4,146,308
and $4,906,956 at June 30, 2020 and December 31, 2019 , respectively, a decrease
of $760,648 (16%). The decrease in the inventory reserve is primarily due to the
scrapping of older version legacy products that were mostly or fully reserved
during the six months ended June 30, 2020 , as a result of moving our warehouse
and office location. The remaining reserve for inventory obsolescence is
generally provided for the level of component parts of the older versions of our
PCB boards and the phase out of our DVM-750, DVM-500 Plus and LaserAlly legacy
products. We believe the reserves are appropriate given our inventory levels at
June 30, 2020 .
Gross Profit
Gross profit for the six months endedJune 30, 2020 and 2019 was$1,657,788 and$2,132,552 , respectively, a decrease of$474,764 (22%). The decrease is commensurate with the 18% decrease in total revenues and the gross margin percentage decrease to 40% during the six months endedJune 30, 2020 , from 42% during the six months endedJune 30, 2019 . Our goal is to improve our margins to 60% over the longer-term based on the expected margins of our EVO-HD, DVM-800, VuLink and FirstVU HD ThermoVuä products, Shieldä disinfectant/sanitizer products and our cloud evidence storage and management offering, if they gain traction in the marketplace and subject to a normalizing economy in the wake of the COVID-19 pandemic. In addition, if revenues from these products increase, we will seek to further improve our margins from them through economies of scale and more efficiently utilizing fixed manufacturing overhead components. We plan to continue our initiative to more efficiently manage of our supply chain through outsourcing production, quantity purchases and more effective purchasing practices. 43
Selling, General and Administrative Expenses
Selling, general and administrative expenses were$5,728,307 and$2,651,068 for the six months endedJune 30, 2020 and 2019, respectively, an increase of$3,077,239 (116%). The significant increase was attributable to the patent litigation settlement of$6.0 million that we received in 2019. Exclusive of the patent litigation settlement, overall selling, general and administrative expenses would have decreased by$922,761 (11%) in the first half of 2020 compared to the same period in 2019. The significant components of selling, general and administrative expenses are as follows: Six months ended June 30, 2020 2019 Research and development expense$ 845,445 $
1,045,076
Selling, advertising and promotional expense 1,169,030
1,993,936
Stock-based compensation expense 688,415
1,310,393
Professional fees and expense 557,318
1,169,452
Executive, sales, and administrative staff payroll 1,231,650 1,705,289 Other 1,236,449 1,426,922 Patent litigation proceeds - (6,000,000 ) Total$ 5,728,307 $ 2,651,068 Research and development expense. We continue to focus on bringing new products to market, including updates and improvements to current products. Our research and development expenses totaled$845,445 and$1,045,076 for the six months endedJune 30, 2020 and 2019, respectively, a decrease of$199,631 (19%). Most of our engineers are dedicated to research and development activities for new products primarily the EVO-HD, which was launched late in the second quarter of 2019 and a non-mirror based DVM-250 that can be located in multiple places in a vehicle. We expect our research and development activities will decrease in future quarters as we reduce our engineering headcount to reflect lower activity on our EVO-HD product platform. We consider our research and development capabilities and new product focus to be a competitive advantage and will continue to invest in this area on a prudent basis and consistent with our financial resources. Selling, advertising and promotional expenses. Selling, advertising and promotional expense totaled$1,169,030 and$1,993,936 for the six months endedJune 30, 2020 and 2019, respectively, a decrease of$824,906 (41%). Salesman salaries and commissions represent the primary components of these costs and were$952,832 and$1,359,129 for the six months endedJune 30, 2020 and 2019, respectively, a decrease of$406,297 (30%). The effective commission rate was 22.9% for the six months endedJune 30, 2020 compared to 26.7% for the six months endedJune 30, 2019 . We reduced the number of salesmen in our law enforcement and commercial channels in 2020. We expect continued reductions in salesman commissions and travel for the balance of 2020 while the effects of the COVID-19 pandemic continue.
Promotional and advertising expenses totaled$216,198 during the six months endedJune 30, 2020 compared to$634,807 during the six months endedJune 30, 2019 , a decrease of$19,584 (16%). The decrease is primarily attributable to our sponsorship of the 2019NASCAR race inKansas City and the suspension of the 2020NASCAR season in 2020 and a reduction in attendance at trade shows as a result of the COVID-19 pandemic. Stock-based compensation expense. Stock based compensation expense totaled$688,415 and$1,310,393 for the six months endedJune 30, 2020 and 2019, respectively, a decrease of$621,978 (47%). The decrease is primarily due to the decreased amortization during the six months endedJune 30, 2020 related to the restricted stock granted at a lower market price per share during 2020 and 2019 to our officers, directors, and other employees. We relied more on stock-based compensation during 2020 and 2019 as we attempted to reduce cash expenses for liquidity reasons. 44 Professional fees and expense. Professional fees and expenses totaled$557,318 and$1,169,452 for the six months endedJune 30, 2020 and 2019, respectively, a decrease of$612,134 (52%). The decrease in professional fees is primarily attributable to legal fees and expenses related to the Axon lawsuit and the resolution of the WatchGuard and PGA lawsuits. We resolved the PGA lawsuit onApril 17, 2019 and the WatchGuard lawsuit was settled on May13, 2019. OnJune 17, 2019 , theU.S. District Court granted Axon's motion for summary judgment and accepted Axon's position that it did not infringe on our '452 Patent and dismissed the lawsuit in its entirety. We appealed the U.S District Court's ruling and onApril 22, 2020 , a three-judge panel of theUnited States Court of Appeals denied our appeal and affirmed theU.S. District Court's previous decision to grant Axon summary judgment. The Company filed a motion requesting a rehearing in front of theCourt of Appeals which was denied onJune 9, 2020 . The Company has untilNovember 7, 2020 to decide whether it will appeal theU.S. District Court's andCourt of Appeals' decisions to theUnited States Supreme Court . Our spending on legal fees on the Axon case has slowed during 2020 as we waited for the appeal to be heard. The Company's decision on whether it will appeal the decisions to theUnited States Supreme Court will impact the trend of legal expenses for the balance of 2020. Executive, sales and administrative staff payroll. Executive, sales and administrative staff payroll expenses totaled$1,231,650 and$1,705,289 for the six months endedJune 30, 2020 and 2019, respectively, a decrease of$473,639 (28%). The primary reason for the decrease in executive, sales and administrative staff payroll was a reduction in our technical support staffing in response to the COVID-19 pandemic and we expect such reductions to continue to reduce related staff expenses during the balance of 2020. The COVID-19 pandemic has significantly impacted the Company's new event security business channel in 2020 as many sporting venues were closed including those served
by these service technicians. Other. Other selling, general and administrative expenses totaled$1,236,449 and$1,426,922 for the six months endedJune 30, 2020 and 2019, respectively, a decrease of$190,473 (13%). The decrease in other expenses during the six months endedJune 30, 2020 compared to the 2019 period is primarily attributable to lower contract employee expenses and travel costs, a result of the COVID-19 pandemic. Patent litigation settlement. The income attributable to our patent litigation settlement was$-0 - and$6,000,000 for the six months endedJune 30, 2020 and 2019, respectively. OnMay 13, 2019 we reached a resolution of the pending patent infringement litigation with WatchGuard and executed a settlement agreement that resulted in the dismissal of this case. As part of such agreement, we received a one-time$6,000,000 payment and granted WatchGuard a perpetual covenant to not sue WatchGuard if its products incorporate agreed-upon modified recording functionality. Additionally, we granted WatchGuard a license to the '292 Patent and '452 Patent throughDecember 31, 2023 . As part of the settlement, we and WatchGuard agreed that WatchGuard was making no admission that it had infringed any of our patents. See Note 9 -- "Commitments and Contingencies" to theJune 30, 2020 Financial Statements, for the details respecting the settlement. Operating Loss For the reasons stated above, our operating loss was$4,070,519 and$518,516 for the six months endedJune 30, 2020 and 2019, respectively, a deterioration of$3,552,003 (685%). Operating loss as a percentage of revenues improved to 82% in 2020, from 121% in 2019. Interest Income
Interest income increased to$21,869 for the six months endedJune 30, 2020 from$23,612 in the 2019 period, which reflected our lower cash and cash equivalent levels in 2020 compared to first quarter 2019. The Company raised significant amounts of cash through the closing of two underwritten public offerings and the exercise of outstanding common stock purchase warrants duringJune 2020 , which will generate interest income in future quarters. 45 Interest Expense
We incurred interest expense of
The Company issued an aggregate of$1.667 million principal amount of secured convertible notes onApril 20, 2020 which bore interest at 8% per annum on the outstanding principal balance. During the six months endedJune 30, 2020 , the holders of the secured convertible notes exercised their right to convert principal balances aggregating$1.666 million into equity. In addition, the Company exercised its right to prepay in cash the remaining outstanding principal balance aggregating$1,000 . Such secured convertible notes are no longer outstanding as ofJune 30, 2020 , as a result of these conversions and prepayments. The Company issued an aggregate of$2.778 million principal amount of secured convertible notes onAugust 5, 2019 which bore interest at 8% per annum on the outstanding principal balance. During the six months endedJune 30, 2020 , the holders of the secured 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 six months endedJune 30, 2020 and onMarch 3, 2020 , the Company exercised its right to prepay in cash the remaining outstanding principal balance aggregating$574,341 . Such secured convertible notes are no longer outstanding as ofJune 30, 2020 , as a result of these conversions and prepayments. The Company issued an unsecured promissory note in an aggregate principal amountof$300,000 onDecember 23, 2019 which bore interest at 8% per annum on the outstanding principal balance and which has been repaid in full as ofJune 30, 2020 . In addition, during 2020 we issued an unsecured note payable with a related party in the principal amount of$319,000 which bore interest at 6% per annum and which has been repaid in full as ofJune 30, 2020 and we issued an aggregate of$100,000 principal amount of unsecured promissory note payable which bore interest at 8% per annum on the outstanding principal balance which remained outstanding until it was paid in full as ofJune 30, 2020 . OnApril 4, 2020 , the Company entered into a promissory note providing for a PPP Loan of$1,418,900 . The PPP Loan has a two-year term and bears interest at a rate of 1.0% per annum. Monthly principal and interest payments are deferred for six months after the date of disbursement and total$79,850.57 per month thereafter. OnMay 12, 2020 the Company received$150,000 in additional loan funding under the EIDL program administered by the SBA. Under the terms of the EIDL promissory note, interest accrues on the outstanding principal at the rate of 3.75% per annum. The term of the EIDL promissory note is thirty years and monthly principal and interest payments are deferred for twelve months after the date of disbursement and total$731.00 per month thereafter.
Secured Convertible Notes Issuance Expenses
We elected to account for and record our$1.667 million principal amount of the 2020 Convertible Notes issued inApril 2020 on a fair value basis. Accordingly, we were required to expense the related issuance costs to other expense in the condensed consolidated statements of operations. Such costs totaled$34,906 for the six months endedJune 30, 2020 . The issuance costs primarily included related legal and accounting fees. No similar debt issuances occurred during the six months endedJune 30, 2019 .
Change in Fair Value of Proceeds Investment Agreement
We elected to account for the PIA on its fair value basis. Therefore, we determined the fair value of the 2018 PIA as ofJune 30, 2020 andDecember 31, 2020 to be$3,615,000 and$6,500,000 , respectively. The change in fair value fromDecember 31, 2020 toJune 30, 2020 was$2,885,000 , which was recognized as a gain in the Condensed Consolidated Statement of Operations for the six months endedJune 30, 2020 . The change in fair value fromDecember 31, 2018 toJune 30, 2019 was$(3,098,000) , which was recognized as a loss in the Condensed Consolidated Statement of Operations for the six months endedJune 30, 2019 . 46
Change in Fair Value of Secured Convertible Notes
We elected to account for the secured convertible notes that were issued onApril 17, 2020 on their fair value basis. Therefore, we determined the fair value of the secured convertible notes as of their issuance date ofApril 17, 2020 and throughJune 12, 2020 , when they were paid in full. The change in fair value from their issuance date ofApril 17, 2020 to their pay-off date was$887,807 , which was recognized as a charge in the Condensed Consolidated Statement of Operations for the six months endedJune 30, 2020 . We elected to account for the secured convertible notes that were issued in August of 2019 on their fair value basis. Therefore, we determined the fair value of the secured convertible notes as of their issuance date onDecember 31, 2019 until they were paid in full onMarch 3, 2020 . The change in fair value fromDecember 31, 2019 to their pay-off date was$412,445 , which was recognized as a charge in the Condensed Consolidated Statement of Operations for the six months endedJune 30, 2020 .
Loss before Income Tax Benefit
As a result of the above, we reported a loss before income tax benefit of
Income Tax Benefit We did not record an income tax related to our losses for the six months endedJune 30, 2020 due to our overall net operating loss carryforwards available. We have further determined to continue providing a full valuation reserve on our net deferred tax assets as ofJune 30, 2020 . We had approximately$66,925,000 of net operating loss carryforwards and$1,795,000 of research and development tax credit carryforwards as determined onDecember 31, 2019 available to offset
future net taxable income. Net Loss As a result of the above, we reported net losses of$2,832,004 and$3,592,904 for the six months endedJune 30, 2020 and 2019, respectively, an improvement of$760,900 (21%).
Basic and Diluted Loss per Share
The basic and diluted loss per share was ($0.17 ) and ($0.32 ) for the six months endedJune 30, 2020 and 2019, respectively, for the reasons previously noted. All outstanding stock options, warrants and convertible securities were considered antidilutive and therefore excluded from the calculation of diluted loss per share for the six months endedJune 30, 2020 and 2019 because of the net loss reported for such periods.
Liquidity and Capital Resources and Going Concern
Overall:
Management's Liquidity Plan and Going Concern. TheJune 30, 2020 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 six months endedJune 30, 2020 and for the year endedDecember 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$2.8 million during the six months endedJune 30, 2020 and$10.0 million for the year endedDecember 31, 2019 and it had an accumulated deficit of$90.2 million as ofJune 30, 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 4 - "Proceeds Investment Agreement Obligation" to theJune 30, 2020 Financial Statements. 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$12.8 million in underwritten public offerings of common stock,$5.2 million through the exercise of common stock purchase warrants and options,$1.6 million through the issuance of promissory notes under the SBA's PPP and EIDL programs, raised$1.5 million through the issuance of secured convertible notes and$419,000 in unsecured promissory notes and detachable warrants during the six months endedJune 30, 2020 . In addition, the Company raised$1,564,000 in the year endedDecember 31, 2019 from the exercise of warrants, borrowed$300,000 pursuant to a short-term promissory note payable onDecember 23, 2019 with detachable warrants to purchase 107,000 shares of common stock and onAugust 5, 2019 , and 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 used for working capital purposes as more fully described in Note 3-"Debt Obligations" to theJune 30, 2020 Financial Statements. These debt and equity raises were utilized to fund the Company's operations and management expects to continue this pattern until the Company achieves positive cash flows from operations, although it can offer no assurance in this regard. 47 OnApril 4, 2020 , the Company issued a promissory note in connection with the receipt of a loan of$1,418,900 (the "PPP Loan") under the SBA's PPP 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. Such promissory note contains events of default and other provisions customary for a loan of this type. The PPP 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. As ofJune 30, 2020 , the Company has used the entirety of the PPP Loan proceeds for purposes consistent with the PPP and has not taken any actions that it believes will reduce the amount eligible for forgiveness. As such, the Company believes that the entire amount of the PPP Loan will be forgiven. However, to the extent any portion of the PPP Loan is determined to be ineligible for forgiveness, we will be required to repay any portion of the outstanding principal that is not forgiven, along with accrued interest, and we cannot provide any assurance that we will be eligible for loan forgiveness or that any amount of the PPP Loan will ultimately be forgiven by the SBA. OnApril 23, 2020 , the SBA issued guidance stating that it is unlikely that a public company with substantial market value and access to capital markets will be able to make the certification required to obtain a PPP loan in good faith. The lack of clarity regarding loan eligibility under the CARES Act PPP has resulted in significant media coverage and controversy with respect to public companies applying for and receiving loans. If, despite our good-faith belief that we satisfied all eligible requirements for the PPP Loan, we are later determined to have violated any of the laws or governmental regulations that apply to us in connection with the PPP Loan, such as the False Claims Act, or it is otherwise determined that we were ineligible to receive the PPP Loan, we may be subject to penalties, including significant civil, criminal and administrative penalties, and could be required to repay the PPP Loan in its entirety. In addition, our receipt of the PPP Loan may result in adverse publicity and damage to our reputation, and a review or audit by the SBA or other government entity or claims under the False Claims Act could consume significant financial and management resources. OnJuly 2, 2020 theSEC declared the Company's Shelf Registration Statement effective. The Shelf Registration Statement will provide the Company with access to liquidity from the public markets should it decide to utilize it for such purposes. The Shelf Registration Statement allows the Company to offer and sell, from time to time in one or more offerings, any combination of our common stock, debt securities, debt securities convertible into common stock or other securities in any combination thereof, rights to purchase shares of common stock or other securities in any combination thereof, warrants to purchase shares of common stock or other securities in any combination thereof or units consisting of common stock or other securities in any combination thereof having an aggregate initial offering price not exceeding$125,000,000 . 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 from 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, we believe that the COVID-19 pandemic or the perception of its effects will have a material adverse effect on our business, financial condition, results of operations and cash flows. 48 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. Cash, cash equivalents: As ofJune 30, 2020 , we had cash and cash equivalents with an aggregate balance of$16,165,550 , an increase from a balance of$359,685 atDecember 31, 2019 . Summarized immediately below and discussed in more detail in the subsequent subsections are the main elements of the$15,805,865 net increase in cash during the six months endedJune 30, 2020 :
? Operating
activities: in operating activities was
30, 2020 and net cash provided by operations of $1,269,447 for the
six months ended June 30, 2019 , a deterioration of
deterioration was attributable to the net loss incurred for 2020
and the usage of cash to decrease accounts payable during the six
months ended June 30, 2020 compared to 2019.
? Investing $163,109 of net cash used in investing activities. Cash used in
activities: investing activities was $163,109 and $100,589 for the six months
ended June 30, 2020 and 2019 respectively. In 2020, we incurred
costs for the build out of the new office and warehouse space, for
the tooling of new products, an integrated display system and for
patent applications on our proprietary technology utilized in our
new products and included in intangible assets.
? Financing $20,025,977 of net cash provided by financing activities. Cash
activities: provided by financing activities was $20,025,977 for the six
months ended June 30, 2020 and net cash used in financing
activities was $4,436,000 for the six months ended June 30, 2019 .
We closed several underwritten public offerings of our common
stock in 2020 which generated $12.8 million of cash, we received
total proceeds of $5.2 million from the exercise of common stock
purchase warrants and we received a total of $1.6 million in
borrowings under the PPP and EIDL programs administered by the SBA
in 2020. In April 2020 , we received net proceeds of $1,500,000
from the issuance of the convertible notes with detachable common
stock purchase warrants. In addition, we received $419,000 in
proceeds from the issuance of unsecured promissory notes payable
during the six months ended June 30, 2020 . These 2020 financing
cash inflows were offset by the repayment of principal on the
secured convertible notes and unsecured promissory notes. During
2019 we also received $1,564,000 of proceeds from the exercise of
common stock purchase warrants offset by the $6 million payment on
the PIA.
The net result of these activities was an increase in cash of
Commitments: We had$16,165,550 of cash and cash equivalents and net positive working capital$14,777,559 as ofJune 30, 2020 . Accounts receivable balances represented$1,619,234 of our net working capital atJune 30, 2020 . We intend to collect our outstanding receivables on a timely basis and reduce the overall level during the balance of 2020, which would help to provide cash to support our operations during 2020. Inventory represented$4,752,285 of our net working capital atJune 30, 2020 and finished goods represented$4,146,308 of total inventory atJune 30, 2020 . We are actively managing the level of inventory and our goal is to reduce such level during the balance of 2020 by our sales activities. 49
Capital Expenditures. We had no material commitments for capital expenditures at
Lease commitments. OnMay 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 termination date ofDecember 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 took possession of the leased facilities onJune 15, 2020 . The remaining lease term for the Company's office and warehouse operating lease as ofJune 30, 2020 was seventy-eight months. The Company's previous office and warehouse space lease expired inApril 2020 and the Company paid holdover rent for the time period until it moved to and commenced occupying the new space onJune 15, 2020 . The Company entered into an operating lease with a third party inOctober 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 ofOctober 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 ofJune 30, 2020 was 40 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 was
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
Assets:
Operating lease right of use assets $ 769,635
Liabilities:
Operating lease obligations-Long-term portion $ 731,334
Operating lease obligations-Current portion $ 44,308
Total operating lease obligations $ 775,642
The components of lease expense were as follows for the six months ended June
30, 2020 :
Selling, general and administrative expenses $ 252,290 Following are the minimum lease payments for each year and in total.
Year ending December 31 :
2020 (July 1, to December 31, 2020) $ 21,986
2021 169,691
2022 172,666
2023 172,542
2024 159,703
Thereafter 310,259
Total undiscounted minimum future lease payments 1,006,847
Imputed interest (231,205 )
Total operating lease liability $ 775,642
50
Debt obligations is comprised of the following:
June 30,
2020 December 31, 2019
PPP Loan $ 1,418,900 $ -
EIDL Loan 150,000 -2019 secured convertible notes, at fair value -
1,593,809
Unsecured promissory notes payable, less unamortized discount of$-0 - and$66,061 atJune 30, 2020 andDecember 31, 2019 , respectively -
233,939
Debt obligations 1,568,900
1,827,748
Less: current maturities of debt obligations 552,258
1,827,748
Debt obligations, long-term $ 1,016,642 $ -
Debt obligations mature as follows as of
June 30,
2020
2020 (July 1, 2020 to December 31, 2020) $ 68,241
2021 948,391
2022 401,321
2023 3,166
2024 3,286
2025 and thereafter 144,495
Total $ 1,568,900 The PIA obligation comprises of the following:
June 30, 2020 December 31, 2019
Proceeds investment agreement, at fair value$ 3,615,000 $
6,500,000
Less: Current portion (3,615,000 ) - Proceeds investment agreement, at fair value - Long-term $ - $ 6,500,000
OnJuly 20, 2020 , the Company and BKI executed a Termination Agreement and Mutual Release. Under the terms of the Termination Agreement the parties agreed to terminate the PIA and to release one another from any further liability under the PIA's obligation. See Note 4 -- Proceeds Investment Agreement Obligation to theJune 30, 2020 Financial Statements. Under the terms of the Agreement, upon payment of$1,250,000 by the Company to BKI both parties agreed to terminate the PIA and to release each other from any further liability thereunder. Such$1,250,000 payment was made onJuly 22, 2020 . In addition to the$1,250,000 payment, the Company further agreed to pay BKI the following: (a) a contingent payment in the amount of$2,750,000 following the closing of an asset purchase, membership interest purchase, or similar transaction between the Company and a specified third-party (the "Purchase Transaction") and (b) any and all future proceeds received from WatchGuard and its successors and assigns by the Company for WatchGuard's use of the '292 and '452 patents. For clarity, the parties further agreed that the payment of the contingent payment would only be due and payable upon the closing of the specified Purchase Transaction and the relevant contingent payment portion of the Agreement, and any obligations stemming therefrom, would automatically terminate if the specified Purchase Transaction is abandoned prior to its closing, including its failure to close within three years from the date of the Agreement. The specified Purchase Transaction has not yet occurred and there is no binding agreement to complete such Purchase Transaction. 51 Inflation and Seasonality
Inflation has not materially affected us during the past fiscal year. We do not believe that our business is seasonal in nature; however, we usually generate higher revenues during the second half of the calendar year than in the first half.
Potential Impacts of the COVID-19 Pandemic on Our Business and Operations
The COVID-19 pandemic represents a fluid situation that presents a wide range of potential impacts of varying durations for different global geographies, including locations where we have offices, employees, customers, vendors and other suppliers and business partners. Like most US-based businesses, the COVID-19 pandemic and efforts to mitigate the same began to have impacts on our business inMarch 2020 . By that time, much of our first fiscal quarter was completed. During the quarter endedJune 30, 2020 , we have observed recent decreases in demand from certain customers, primarily our law-enforcement and commercial customers. Given the fact that our products are sold through a variety of distribution channels, we expect our sales will experience more volatility as a result of the changing and less predictable operational needs of many customers as a result of the COVID-19 pandemic. We are aware that many companies, including many of our suppliers and customers, are reporting or predicting negative impacts from COVID-19 on future operating results. Although we observed significant declines in demand for our products from certain customers during the three months endedJune 30, 2020 , we believe that it remains too early for us to know the exact impact COVID-19 will have on the long-term demand for our products. We also cannot be certain how demand may shift over time as the impacts of the COVID-19 pandemic may go through several phases of varying severity and duration. In light of broader macro-economic risks and already known impacts on certain industries that use our products and services, we have taken and are taking targeted steps to lower our operating expenses because of the COVID-19 pandemic. We continue to monitor the impacts of COVID-19 on our operations closely and this situation could change based on a significant number of factors that are not entirely within our control and are discussed in this and other sections of this quarterly report on Form 10-Q. We do not expect there to be material changes to our assets on our balance sheet or our ability to timely account for those assets. Further, in connection with the preparation of this quarterly report on Form 10-Q and the interim financial statements contained herein, we reviewed the potential impacts of the COVID-19 pandemic on goodwill and intangible assets and have determined there to be no material impact at this time. We have also reviewed the potential impacts on future risks to the business as it relates to collections, returns and other business-related items. To date, travel restrictions and border closures have not materially impacted our ability to obtain inventory or manufacture or deliver products or services to customers. However, if such restrictions become more severe, they could negatively impact those activities in a way that would harm our business over the long term. Travel restrictions impacting people can restrain our ability to assist our customers and distributors as well as impact our ability to develop new distribution channels, but at present we do not expect these restrictions on personal travel to be material to our business operations or financial results. We have taken steps to restrain and monitor our operating expenses and therefore we do not expect any such impacts to materially change the relationship between costs and revenues. Like most companies, we have taken a range of actions with respect to how we operate to assure we comply with government restrictions and guidelines as well as best practices to protect the health and well-being of our employees and our ability to continue operating our business effectively. To date, we have been able to operate our business effectively using these measures and to maintain all internal controls as documented and posted. We also have not experienced challenges in maintaining business continuity and do not expect to incur material expenditures to do so. However, the impacts of COVID-19 and efforts to mitigate the same have remained unpredictable and it remains possible that challenges may arise in the future. 52
The actions we have taken so far during the COVID-19 pandemic include, but are not limited to:
? requiring all employees who can work from home to work from home;
? increasing our IT networking capability to best assure employees can work
effectively outside the office; and
? for employees who must perform essential functions in one of our offices:
? Having employees maintain a distance of at least six feet from other employees
whenever possible;
? Having employees work in dedicated shifts to lower the risk all employees who
perform similar tasks might become infected by COVID-19;
? Having employees stay segregated from other employees in the office with whom
they require no interaction; and
? Requiring employees to wear masks while they are in the office whenever
possible.
We currently believe revenue for the three months endedSeptember 30, 2020 may decline year over year due to the conditions noted. InApril 2020 , we implemented a COVID-19 mitigation plan designed to further reduce our operating expenses for the three months endingJune 30, 2020 . Actions taken to date include work hour and salary reductions for senior management. These cost reductions are in addition to the significant restructuring actions we initiated in the first quarter of 2020. Based on our current cash position, our projected cash flow from operations and our cost reduction and cost containment efforts to date, we believe that we will have sufficient capital and or have access to sufficient capital through public and private equity and debt offerings to sustain operations for a period of one year following the date of this filing. If business interruptions resulting from COVID-19 were to be prolonged or expanded in scope, our business, financial condition, results of operations and cash flows would be negatively impacted. We will continue to actively monitor this situation and will implement actions necessary to maintain business continuity.
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