
PART I – FINANCIAL INFORMATION This part presents the company's unaudited condensed consolidated financial information for the period ended September 30, 2019 Financial Statements This section presents Digital Ally, Inc.'s unaudited condensed consolidated financial statements, including balance sheets, statements of operations, stockholders' deficit, and cash flows, for the period ended September 30, 2019 Condensed Consolidated Balance Sheets The balance sheet as of September 30, 2019, shows a decrease in total assets and a widening of the total stockholders' deficit Condensed Consolidated Balance Sheet Highlights (Unaudited) | Account | Sep 30, 2019 | Dec 31, 2018 | | :--- | :--- | :--- | | Total Current Assets | $10,407,072 | $13,302,171 | | Cash and cash equivalents | $1,272,935 | $3,598,807 | | Inventories, net | $6,381,713 | $6,999,060 | | Total Assets | $11,601,085 | $14,338,655 | | Total Current Liabilities | $6,711,996 | $4,617,744 | | Total Liabilities | $14,959,467 | $15,750,835 | | Total Stockholders' Deficit | ($3,358,382) | ($1,412,180) | Condensed Consolidated Statements of Operations The statements of operations show a slight revenue increase for Q3 2019 but a decrease for the nine-month period, with a narrowed net loss for both periods Statement of Operations Highlights (Unaudited) | Metric | Q3 2019 | Q3 2018 | Nine Months 2019 | Nine Months 2018 | | :--- | :--- | :--- | :--- | :--- | | Total Revenue | $2,923,148 | $2,878,059 | $8,020,927 | $8,913,122 | | Gross Profit | $1,188,262 | $1,177,289 | $3,320,814 | $3,905,150 | | Operating Loss | ($2,280,447) | ($1,909,716) | ($2,798,963) | ($5,320,341) | | Net Loss | ($2,985,825) | ($4,665,580) | ($6,578,729) | ($10,216,702) | | Net Loss Per Share (Basic & Diluted) | ($0.26) | ($0.60) | ($0.58) | ($1.40) | Condensed Consolidated Statements of Stockholders' Equity (Deficit) The stockholders' deficit widened significantly due to net losses, partially offset by capital raised from warrant exercises and convertible notes - The total stockholders' deficit grew to $3.36 million by September 30, 2019, from a deficit of $1.41 million at December 31, 201817 - During the nine months ended September 30, 2019, the company issued common stock upon exercise of warrants for $1.56 million and upon conversion of secured notes and interest for $698,06717 Condensed Consolidated Statements of Cash Flows Cash flows for the nine months ended September 30, 2019, show net cash used in operating, investing, and financing activities, resulting in a significant decrease in cash Cash Flow Summary for Nine Months Ended Sep 30 (Unaudited) | Activity | 2019 | 2018 | | :--- | :--- | :--- | | Net cash used in operating activities | ($170,958) | ($4,077,492) | | Net cash (used) provided by investing activities | ($129,766) | $469,099 | | Net cash (used in) provided by financing activities | ($2,025,148) | $11,142,731 | | Net (decrease) increase in cash | ($2,325,872) | $7,534,338 | | Cash at end of period | $1,272,935 | $7,589,050 | - Key financing activities in 2019 included receiving $2.5 million from secured convertible notes and $1.56 million from warrant exercises, offset by a $6.0 million payment on the proceeds investment agreement21 Notes to the Condensed Consolidated Financial Statements Notes detail accounting policies, business nature, liquidity issues, going concern doubts, revenue recognition, debt obligations, fair value measurements, and legal contingencies - The company produces digital video imaging and storage products for law enforcement, security, and commercial applications, including in-car systems, body-worn cameras, and cloud storage solutions24 - The company incurred a net loss of approximately $6.6 million for the nine months ended September 30, 2019, with an accumulated deficit of $84.0 million, raising substantial doubt about its ability to continue as a going concern3137 - In May 2019, the company settled its patent infringement litigation with WatchGuard, receiving a one-time lump-sum payment of $6.0 million used to pay down Proceeds Investment Agreement (PIA) obligations97135 - On August 5, 2019, the company issued $2.78 million in 8% secured convertible notes and warrants, raising $2.5 million in cash for working capital purposes99 Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial performance, key trends, and strategic initiatives, covering results of operations, revenue challenges, the impact of a patent settlement, recurring revenue growth, liquidity concerns, and critical accounting policies Overview and Recent Developments This section covers recent operating losses, the impact of a patent settlement, competitive revenue pressures, new product launches, and strategic focus on recurring service revenue and patent monetization - The company reported an operating loss of $2.3 million in Q3 2019, contrasting with $2.6 million operating income in Q2 2019, driven by a $6.0 million patent litigation settlement172 - The company introduced the new EVO-HD product platform in late June 2019 to counter competitors' advanced features and price cuts174 - Recurring service revenue is a key focus, with extended warranty revenue growing 36% YoY to $379,989 and cloud storage revenue growing 12% YoY to $194,661 in Q3 2019176 - The patent infringement lawsuit against Axon was dismissed via summary judgment in June 2019, with the company appealing the ruling178 Results of Operations - Three Months Ended Q3 2019 saw a 2% total revenue increase driven by service revenue growth, flat gross profit, a 12% rise in SG&A expenses, and an improved net loss due to fair value changes in debt instruments Revenue Comparison (Three Months Ended Sep 30) | Revenue Type | 2019 | 2018 | Change | % Change | | :--- | :--- | :--- | :--- | :--- | | Product | $2,173,257 | $2,334,863 | ($161,606) | (7%) | | Service and other | $749,891 | $543,196 | $206,695 | 38% | | Total | $2,923,148 | $2,878,059 | $45,089 | 2% | - Gross profit margin remained stable at 41% for Q3 2019 and Q3 2018183 - SG&A expenses increased by $381,704 (12%) YoY, driven by higher R&D, selling/promotional costs, and payroll, partially offset by decreases in professional fees and stock-based compensation200 Results of Operations - Nine Months Ended Nine-month results show a 10% total revenue decrease, a 15% gross profit decline, and a reported 34% decrease in SG&A expenses primarily due to a $6.0 million patent settlement Revenue Comparison (Nine Months Ended Sep 30) | Revenue Type | 2019 | 2018 | Change | % Change | | :--- | :--- | :--- | :--- | :--- | | Product | $6,039,445 | $7,319,676 | ($1,280,231) | (17%) | | Service and other | $1,981,482 | $1,593,446 | $388,036 | 24% | | Total | $8,020,927 | $8,913,122 | ($892,195) | (10%) | - A $6.0 million patent litigation settlement with WatchGuard was recorded, significantly reducing reported SG&A expenses and operating loss for the nine-month period241249 - Excluding the settlement, SG&A expenses increased due to higher R&D (+42%), selling/promotional costs (+37%), professional fees (+15%), and payroll (+77%)241 Liquidity and Capital Resources The company faces substantial doubt about its going concern ability due to historical losses, declining cash, and reliance on capital markets despite recent funding and a patent settlement - The company's business plan does not alleviate substantial doubt about its ability to continue as a going concern279 - Cash and cash equivalents decreased from $3.60 million at December 31, 2018, to $1.27 million at September 30, 2019281 - Net cash used in financing activities was $2.03 million, reflecting $4.06 million in proceeds from debt and warrants, offset by a $6.0 million repayment of the PIA283 Critical Accounting Policies This section outlines critical accounting policies requiring significant management judgment, including revenue recognition, inventory allowances, warranty reserves, stock-based compensation, income taxes, fair value determination, and going concern analysis - Key critical accounting policies include Revenue Recognition, Allowance for Excess and Obsolete Inventory, Warranty Reserves, Stock-based Compensation, Accounting for Income Taxes, Fair Value Determination, and Going Concern Analysis311 - The company maintains a full valuation allowance of $21.5 million on its net deferred tax assets due to a history of operating losses, indicating it does not expect to realize these tax benefits331 - The reserve for excess and obsolete inventory was $3.34 million, or 34.3% of the gross inventory balance, as of September 30, 2019324 Quantitative and Qualitative Disclosures About Market Risk This item is not applicable, indicating no significant exposure to market risks requiring disclosure - Not applicable342 Controls and Procedures Management concluded that disclosure controls and procedures were effective as of September 30, 2019, with no material changes to internal control over financial reporting during the quarter - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of September 30, 2019344 - No material changes were made to internal controls over financial reporting during the quarter345 PART II - OTHER INFORMATION This part provides additional information beyond the financial statements, including legal proceedings, equity sales, and other disclosures Legal Proceedings This section details significant legal matters, including the appealed dismissal of the Axon patent lawsuit, the $6.0 million settlement of the WatchGuard patent lawsuit, and the dismissal of the PGA Tour breach of contract suit - Axon Lawsuit: The District Court granted summary judgment in favor of Axon, dismissing the patent infringement case, which Digital Ally has appealed356357 - WatchGuard Lawsuit: The case was settled on May 13, 2019, with WatchGuard paying Digital Ally a one-time, lump-sum settlement of $6.0 million, leading to dismissal of the litigation358359 - PGA Tour, Inc. Lawsuit: A breach of contract suit filed by the PGA was resolved and dismissed with prejudice on April 17, 2019365 Unregistered Sales of Equity Securities and Use of Proceeds On August 5, 2019, the company issued $1.62 million in 8% secured convertible notes and warrants in a private placement to accredited investors under registration exemptions - The company conducted a private placement on August 5, 2019, issuing convertible notes and warrants to accredited investors366 Defaults Upon Senior Securities This item is not applicable - Not applicable368 Mine Safety Disclosures This item is not applicable - Not applicable370 Other Information This item is not applicable - Not applicable372 Exhibits This section lists exhibits filed with Form 10-Q, including CEO and CFO certifications required by the Securities and Exchange Act of 1934 - Exhibits include CEO and CFO certifications as required by the Securities and Exchange Act of 1934374380