Digital Ally(DGLY) - 2020 Q4 - Annual Report

Part I Business Digital Ally, Inc. designs and manufactures digital video imaging and storage products for law enforcement, security, and commercial sectors, expanding into new product lines like ThermoVu™ and Shield™ in response to the COVID-19 pandemic Overview and COVID-19 Pandemic Impact Digital Ally produces digital video products for law enforcement and commercial use, and recently introduced ThermoVu™ temperature monitors and Shield™ disinfectants in response to market needs, while implementing cost-saving measures due to decreased demand from the COVID-19 pandemic - The company's core business is digital video imaging and storage for law enforcement and commercial applications[15] - In response to the COVID-19 pandemic, the company launched two new product lines in Q2 2020: ThermoVu™ temperature monitoring stations and Shield™ disinfectants and cleansers[15] - The pandemic led to decreased demand from law enforcement and commercial customers during 2020[21][22] - The company implemented a COVID-19 mitigation plan in April 2020, including work hour and salary reductions for senior management, to reduce operating expenses[28] Our Products The company's product portfolio includes in-car digital video systems, body-worn cameras, commercial fleet event recorders, and cloud-based evidence management solutions, with new additions like ThermoVu and Shield addressing pandemic-related safety needs - The EVO-HD, launched in Q2 2019, is the company's next-generation in-car video platform, offering multiple HD cameras and built-in patented VuLink auto-activation technology[29][34][36] - The FirstVU HD is a miniature, rugged, and water-resistant body-worn camera that integrates with in-car systems via the patented VuLink ecosystem for automatic, coordinated recording[40][42] - The company offers cloud storage solutions powered by Amazon Web Services (AWS): VuVault.net for law enforcement and FleetVU Manager for commercial fleets[43][44] - New products launched in 2020 include ThermoVu, a non-contact temperature screening instrument, and Shield, a line of disinfectants and cleansers[45][46] Market, Manufacturing, and Sales Digital Ally's primary market is law enforcement, but it is expanding into commercial fleets, event security, and schools, with manufacturing outsourced to contract partners globally and sales conducted through a direct force domestically and distributors internationally - The company's primary market is law enforcement, but it is actively expanding into commercial, event security, school, and private security sectors[49][57] - Manufacturing of key components and products is outsourced to contract manufacturers in the US, Philippines, and South Korea, with final assembly and quality control in Lenexa, Kansas[59][60] - The sales strategy utilizes a direct employee sales force for domestic markets and independent distributors for international sales[61] Competition, Intellectual Property, and Human Capital The company operates in a highly competitive market, facing larger competitors like Axon Enterprises, and relies heavily on protecting its proprietary technology through patents, notably for its VuLink auto-activation technology, while employing 86 full-time staff as of December 31, 2020 - Primary competitors in the law enforcement market include Axon Enterprises, Inc. and WatchGuard Video. In the commercial fleet sector, competitors include Lytx, Inc. and SmartDrive Systems[64][65] - The company relies on patent protection, particularly for its VuLink product, as well as trade secrets and know-how to compete[66][68][70] - As of December 31, 2020, the company had approximately 86 full-time employees[71] Risk Factors The company has indicated that this section is not applicable as per the filing - The company has indicated that this section is not applicable[75] Properties As of June 2020, the company's principal executive office is a 16,531 square foot leased facility in Lenexa, Kansas, with plans to purchase a 71,361 square foot building in the same city for approximately $5.3 million by May 2021 - The company leases its principal executive office, a 16,531 sq. ft. facility in Lenexa, KS, with the lease ending in December 2026[78] - On February 24, 2021, the company contracted to purchase a 71,361 sq. ft. building in Lenexa, KS for approximately $5.3 million, intended to serve future office and warehouse needs[79] Legal Proceedings The company is involved in various legal proceedings, including the dismissal of a patent infringement lawsuit against Axon and a settlement with WatchGuard in May 2019, which included a $6.0 million payment and a patent license grant - The patent infringement lawsuit against Axon was dismissed by the U.S. District Court. The company's appeal was denied in April 2020, and it has abandoned any further appeals in this matter[86][87] - In May 2019, the company settled its patent infringement lawsuit against WatchGuard. As part of the settlement, Digital Ally received a one-time payment of $6,000,000[88][89] - As part of the WatchGuard settlement, Digital Ally granted WatchGuard a license to the '292 and '452 patents through December 31, 2023[90] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the Nasdaq Capital Market under "DGLY", with approximately 158 shareholders of record as of March 31, 2021, and no cash dividends anticipated as earnings are retained for operations, while equity compensation plans authorize 5,675,000 shares for issuance - The company's common stock trades on the Nasdaq Capital Market under the symbol "DGLY"[101] - The company has never declared or paid cash dividends and intends to retain future earnings for business operations[102] - Equity Compensation Plan Information | Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) | Weighted-average exercise price of outstanding options, warrants and rights (b) | Number of securities remaining available for future issuance under equity compensation plans (c) | | :--- | :--- | :--- | :--- | | Equity compensation plans approved by stockholders | 833,313 | $3.15 | 1,064,346 | | Equity compensation plans not approved by stockholders | 5,000 | $11.36 | — | | Total all plans | 838,313 | $3.20 | 1,064,346 | Management's Discussion and Analysis of Financial Condition and Results of Operations In fiscal year 2020, Digital Ally's total revenue remained flat at $10.5 million, with new product lines offsetting declines in legacy sales, leading to a 26% increase in gross profit and a significantly reduced net loss of $2.6 million, while liquidity improved with $4.4 million in cash and an additional $66.5 million raised in early 2021 Overview and Recent Developments The company experienced operating losses in most quarters of 2019 and 2020, with exceptions due to a patent litigation settlement and new product launches, while focusing on expanding recurring service revenue and leveraging partnerships, despite a decline in international revenues - The company experienced operating losses for all quarters in 2020 and 2019, except for Q3 2020 (aided by new product launches) and Q2 2019 (aided by a patent litigation settlement)[131] - A Proceeds Investment Agreement with Brickell Key Investments was terminated in July 2020, resulting in a $5.25 million positive change in fair value for the year[134] - Recurring cloud storage revenue increased by 25% in 2020, reaching approximately $937,000, up from $750,000 in 2019[136] - International revenues decreased from approximately 2% of total revenues in 2019 to less than 1% in 2020[139] Results of Operations (2020 vs. 2019) For the year ended December 31, 2020, total revenues increased slightly by 1% to $10.5 million, driven by new product lines, leading to a 26% rise in gross profit and a significant 74% reduction in net loss to $2.6 million, primarily due to non-operating gains - Financial Performance Summary | Financial Metric | 2020 | 2019 | Change | | :--- | :--- | :--- | :--- | | Total Revenue | $10,514,868 | $10,441,364 | +1% | | Product Revenue | $8,029,457 | $7,732,796 | +3% | | Service Revenue | $2,485,411 | $2,708,568 | -8% | | Gross Profit | $4,062,594 | $3,232,629 | +26% | | Gross Margin | 39% | 31% | +8 p.p. | | Operating Loss | ($7,663,651) | ($6,032,781) | +27% | | Net Loss | ($2,625,881) | ($10,005,713) | -74% | | Loss Per Share (Basic & Diluted) | ($0.12) | ($0.87) | -86% | - New product lines (ThermoVu and Shield) generated over $1.64 million in revenue in 2020, offsetting declines in legacy products impacted by COVID-19 and competition[151] - The improvement in net loss was primarily driven by a $5.25 million gain from the change in fair value of the proceeds investment agreement and a $1.42 million gain on the extinguishment of a PPP loan[187][194][195] Liquidity and Capital Resources The company significantly improved its liquidity, ending 2020 with $4.4 million in cash after raising $18.8 million from financing activities, and further strengthening its position with approximately $66.5 million in net proceeds from offerings in early 2021, which management believes provides adequate funding for the foreseeable future - Cash and cash equivalents increased from $359,685 at year-end 2019 to $4,361,758 at year-end 2020[221] - In 2020, the company raised $18.8 million from financing activities, including $12.8 million from underwritten public offerings and $5.2 million from the exercise of common stock purchase warrants[202][223] - Subsequent to year-end, in January and February 2021, the company raised approximately $29.0 million and $37.4 million in net proceeds, respectively, from two registered direct offerings[206][209] - Management believes it has adequate funding for the foreseeable future as a result of the capital raised in early 2021[211] - The company successfully regained compliance with Nasdaq's minimum stockholders' equity and minimum bid price requirements during 2020[242][243] Critical Accounting Policies The company's critical accounting policies involve significant management judgment and estimates, including Revenue Recognition, Allowance for Excess and Obsolete Inventory, Warranty Reserves, Stock-based Compensation, and Accounting for Income Taxes, with a full valuation allowance maintained against deferred tax assets due to recurring operating losses - Key critical accounting policies include Revenue Recognition, Allowance for Excess and Obsolete Inventory, Warranty Reserves, Stock-based Compensation Expense, and Accounting for Income Taxes[248][253] - The reserve for excess and obsolete inventory was $1.96 million at year-end 2020, down from $4.14 million in 2019, primarily due to scrapping older inventory during a warehouse move[261][263] - Due to a history of operating losses, the company maintained a full valuation allowance of $24.6 million against its net deferred tax assets as of December 31, 2020[270] Controls and Procedures Based on evaluations as of December 31, 2020, the company's principal executive and financial officers concluded that disclosure controls and procedures were effective, and management assessed internal control over financial reporting as effective, with no material changes reported during the year - Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of December 31, 2020[281] - Management assessed internal control over financial reporting using the 2013 COSO framework and concluded it was effective as of December 31, 2020[284] Part III Directors, Executive Compensation, Security Ownership, and Principal Accountant Fees Information required for Items 10 through 14, covering Directors, Executive Officers, Corporate Governance, Executive Compensation, Security Ownership, Certain Relationships and Related Transactions, Director Independence, and Principal Accountant Fees and Services, is incorporated by reference from the company's definitive proxy statement, expected to be filed within 120 days of the fiscal year-end - Information regarding directors, executive officers, corporate governance, executive compensation, security ownership, and principal accountant fees is incorporated by reference from the company's 2021 Proxy Statement[290][292][293][295][296] Part IV Exhibits and Financial Statement Schedules This section lists the documents filed as part of the Annual Report on Form 10-K, including consolidated financial statements and a comprehensive list of exhibits such as corporate governance documents, material contracts, and officer certifications, with financial statement schedules omitted as they are not applicable or included elsewhere - This section provides a list of all exhibits filed with the Form 10-K, including corporate governance documents, material contracts, equity plans, and officer certifications[301] - All financial statement schedules were omitted because they were not applicable or the required information was included within the consolidated financial statements or notes[300] Financial Statements and Notes Report of Independent Registered Public Accounting Firm The independent auditor, RBSM LLP, issued an unqualified opinion on the consolidated financial statements for 2020 and 2019, affirming fair presentation in conformity with U.S. GAAP, while identifying the valuation of inventories as a critical audit matter due to significant management estimates - The auditor issued an unqualified opinion, stating the financial statements are presented fairly in accordance with U.S. GAAP[317] - A Critical Audit Matter was identified related to the valuation of inventories, specifically the reserve for excess and obsolete inventory, due to the high degree of subjective judgment required[322][323] Consolidated Financial Statements The consolidated financial statements present the company's financial position and performance for fiscal years 2020 and 2019, showing a significant increase in total assets and a shift to stockholders' equity, a reduced net loss, and a net increase in cash from financing activities despite cash used in operations - Balance Sheet (Year-End) | Balance Sheet (Year-End) | 2020 | 2019 | | :--- | :--- | :--- | | Total Assets | $20,797,527 | $8,916,875 | | Total Liabilities | $6,441,021 | $15,234,254 | | Total Stockholders' Equity (Deficit) | $14,356,506 | ($6,317,379) | - Statement of Operations (Year Ended) | Statement of Operations (Year Ended) | 2020 | 2019 | | :--- | :--- | :--- | | Total Revenue | $10,514,868 | $10,441,364 | | Gross Profit | $4,062,594 | $3,232,629 | | Operating Loss | ($7,663,651) | ($6,032,781) | | Net Loss | ($2,625,881) | ($10,005,713) | - Statement of Cash Flows (Year Ended) | Statement of Cash Flows (Year Ended) | 2020 | 2019 | | :--- | :--- | :--- | | Net Cash Used in Operating Activities | ($13,284,715) | ($1,124,373) | | Net Cash Used in Investing Activities | ($1,499,189) | ($266,144) | | Net Cash Provided by (Used in) Financing Activities | $18,775,977 | ($1,848,605) | Notes to Consolidated Financial Statements The notes provide detailed explanations of the company's accounting policies and financial data, including the adoption of new accounting standards, details on debt obligations like the forgiven PPP loan and terminated Proceeds Investment Agreement, legal proceedings, stock-based compensation, and significant capital raises in early 2021 - The company adopted new accounting standards for revenue recognition (ASC 606) and leases (ASC 842)[346][397] - In 2020, the company received a $1.4 million PPP loan which was fully forgiven, resulting in a gain on extinguishment of debt[419] - The Proceeds Investment Agreement (PIA) was terminated in July 2020 upon a payment of $1.25 million, extinguishing a liability carried at $6.5 million at the end of 2019[443][446] - Subsequent to year-end, the company raised approximately $29.0 million (January 2021) and $37.6 million (February 2021) in net proceeds from underwritten public offerings[547][553]