Digital Ally Q3 Earnings: Revenues Down on a Halted Contract

Small cap police body cam stockDigital Ally, Inc (NASDAQ: DGLY) reportedQ3 2017 earnings after the market closed on Tuesday. Media generated police controversies have helpedpolice body cam players like Digital Ally,theclosest thing to a pure play police body cam stock. However, Digital Ally and body cam competitor Axon Enterprise (NASDAQ: AAXN), formerly known as TASER International, Inc (NASDAQ: TASR), have also been embroiled in messy patent infringement lawsuits.

Total revenue decreased 31.2% to approximately $3.0 million with the primary reason for the revenue decrease was the halt of deliveries under the AMR contract, which was expected to generate significant revenues in the third quarter. In the third quarter 2016, the Company generated revenues in excess of $760,000 on one contract with a large international customer that did not recur in 2017. Additionally, law enforcement revenues declined over the prior period due to price-cutting and other actions by competitors and adverse marketplace effects related to the patent litigation. The net loss of was $3,493,306 versus a net loss of $3,255,579. The CEO made extensive comments that included:

We were disappointed with our third quarter 2017 revenues, which were down 31% from prior year levels and 14% on a sequential basis. We were expecting significant deliveries with AMR in third quarter 2017, but they were placed on hold after they experienced two catastrophic accidents involving the loss of life in vehicles equipped with our DVM-250s. AMR alleged that the DVM-250 units in those vehicles failed to record the accidents. We met with AMR representatives in the third quarter 2017 to discuss the accidents and the performance of our equipment including a plan to re-start the contract deliveries. We have proposed to AMR that it update and upgrade its existing equipment and resume deliveries under the contract, including a roll out to new locations in the first quarter of 2018. AMR has yet to approve our proposal, but we are encouraged by the dialogue we have had with AMR and are hopeful that deliveries will resume under the contract during first quarter 2018, although we can offer no assurances in this regard. Additionally, our law enforcement revenues declined over the prior period due to price-cutting and other actions by our competitors and adverse marketplace effects related to the patent litigation. Finally, in the third quarter 2016 we generated revenues in excess of $760,000 on one contract with a large international customer that did not recur in 2017.

We had significant decisions in our favor from the USPTO in July and August. On July 6, 2017, the USPTO denied institution of Axons first IPR action on the 452 Patent, finding that Axon had not established even a reasonable likelihood that the challenged claims would be found unpatentable after completion of an IPR trial. On August 3, 2017, the USPTO issued a decision denying institution of Axons second IPR request on the 452 Patent. Axon has twice unsuccessfully attempted to invalidate claims in the 452 Patent and is now statutorily barred from filing any further IPRs against the 452 Patent, as well as against the 292 Patent.In the four IPRs that Axon filed against Digital Allys 292 and 452 Patents, Axon has lost on three of the IPR petitions by failing to persuade the USPTO to even institute a hearing. The result of the fourth IPR, which only challenges certain claims of the 292 Patent, has yet to be decided by the USPTO, with a decision expected to be rendered approximately during the first quarter of 2018. For the fourth and only remaining IPR, we are vigorously defending Axons claims of unpatentability and are looking forward to confirming the uniqueness of our innovation. We have dropped the 292 Patent from the Axon litigation. Because the 452 Patent has been validated by the USPTO, we are now seeking to lift the stay and proceed with our lawsuit in District Court against Axon to a trial where the question of infringement and damages can be addressed.

We are pursuing several new market channels that do not involve our traditional law enforcement and private security customers and utilize our core technology of mobile audio/video recording equipment together with our cloud storage and archiving services. These new market channels do not effectively utilize the power of audio/video recordings, which could represent large untapped addressable markets for our products and services. If successful, we believe that these new market channels could yield increased recurring service revenues for us in the future, Mr. Ross continued. We are promoting a new revenue model that bundles our product offerings, including the long-term lease of our body-worn and/or in-car audio/video hardware, together with a monthly subscription for our cloud storage, search and archiving services for the underlying audio and video material. We believe this revenue service model may appeal to our customers, in particular our commercial and other non-law enforcement customers because it reduces the capital outlay up front and eliminates repairs and maintenance in exchange for level monthly payments for the utilization of the equipment, data storage and management services.

We are excited to enter into the supply agreement with VIEVU and are appreciative of it acknowledging the strength of our patent and choice to enter into this agreement. This agreement will provide a clear path forward for VIEVUs customers to realize the value of a complete solution with automatic activation and help clarify to our competitors and to the entire law enforcement community which offerings will be available exclusively with our patented technology. We believe that our revenues in 2018 will be significantly and favorably impacted by this contract and our other strategies for monetizing this important auto-activation patent.

We recently announced the launch of the DVM-800 HD in-car video system, which we believe will be disruptive in the market and will lead to an expansion of our overall market share in the law enforcement channel. The DVM-800 HD system provides full 1080P high definition video at a cost-effective price point, which we believe is a competitive market advantage for us.

Our international revenues decreased to $236,524 in third quarter 2017 compared to $827,452 during 2016. Our third quarter 2017 international revenues were disappointing; however, the international sales cycle generally takes longer than domestic business and we have a number of bids outstanding to international customers.

We had approximately $4.7 million in net working capital available at September 30, 2017, including $1.9 million of accounts receivable and $10.1 million of inventory. We raised $3.0 million in a registered direct offering of our common stock and purchase warrants with three investors on August 23, 2017. We also had $650,000 principal amount of unsecured subordinated notes with two private, third party lenders at September 30, 2017. The Secured Convertible Debentures (the Debentures) we issued in December 2016 mature in March 2018 unless converted by their holders at $5.00 per share before such date. We made payments of $750,000 against the Debentures in September 2017. The Debentures and the outstanding notes in the principal amount of $650,000 represent current liabilities as of September 30, 2017. Our goal is to reduce inventory levels in the ensuing quarters to provide additional working capital and improve our operating results to generate the funds to retire the subordinated notes and Debentures. We may also pursue the raise of additional capital if required.

A technical chart for Digital Ally shows shares falling for much of the year now:

A long term performance chart shows Digital Ally drifting lower while still outperforming video management software stockVicon Industries, Inc (NYSEMKT: VII) whiledirect competitorAxon Enterprise and security stock Napco Security Technologies Inc (NASDAQ: NSSC) have maintained their gains:

Finally, here is a quick recap of small cap Digital Allys recent earnings history along with EPS estimate trends from the Yahoo! Finance analyst estimates page going into the current earnings report:

Earnings History9/29/201612/30/20163/30/20176/29/2017
EPS Est. -0.23 -0.2 -0.28 -0.23
EPS Actual -0.61 -0.8 -0.36 -0.41
Difference -0.38 -0.6 -0.08 -0.18
Surprise % -165.20% -300.00% -28.60% -78.30%
EPS TrendCurrent Qtr. (Sep 2017)Next Qtr. (Dec 2017)Current Year (2017)Next Year (2018)
Current Estimate -0.32 -0.24 -1.31 -0.27
7 Days Ago -0.32 -0.24 -1.31 -0.27
30 Days Ago -0.35 -0.24 -1.35 -0.3
60 Days Ago -0.29 -0.26 -1.32 -0.2
90 Days Ago -0.24 -0.18 -1.04 -0.2

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