Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition
and Results of Operation.
This quarterly report on Form
10-Q (the “Report”) of Digital Ally, Inc. (the “Company”, “we”, “us”, or “our”)
contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities
Act”), 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 fiscal 2020 and 2019; (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) 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, such as trade secrets, 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 a significant
effect on us and the other stockholders; (26) the sale of substantial amounts of our common stock, par value $0.001 per share (the “Common
Stock”), that may have a depressive effect on the market price of the outstanding shares of our Common Stock; (27) the 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 such technology will have a significant
impact on our revenues in the long-term; and (33) indemnification of our officers and directors.
27
Current Trends and Recent Developments for the
Company
Overview
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 positive solutions to our customers’ requests. Our products include: the DVM-800 and DVM-800 Lite, which
are in-car digital video mirror systems for law enforcement; the FirstVU and the FirstVU HD, which are body-worn cameras; our patented
and revolutionary VuLink product, which integrates our body-worn cameras with our in-car systems by providing hands-free automatic activation
for both law enforcement and commercial markets; the DVM-250 and DVM-250 Plus, which are our 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 our
cloud-based evidence management systems. We introduced the EVO-HD product in the second quarter of 2019 and began full-scale deliveries
in the third quarter 2019, which continued through 2020 and into 2021. The EVO-HD is designed and built on a new and highly advanced
technology platform that will become the platform for a new family of 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. Additionally, we introduced 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.
We began offering our Shield™ disinfectants and cleansers to our law enforcement and commercial customers late in the second quarter
of 2020. We have entered the revenue cycle management (“RCM”) business in the second quarter of 2021 with the formation
of the Company’s wholly owned subsidiary, Digital Ally Healthcare, Inc. and its majority-owned subsidiary Nobility Healthcare,
LLC. Nobility Healthcare, LLC completed its first acquisition on June 30, 2021 when it acquired Elite. The Elite acquisition had little
effect on the second quarter 2021 operating results but is expected to make positive contributions to the Company’s operating results
in future quarters.
We experienced operating losses
for the first and second quarters of 2021 and all quarters during 2020. The following is a summary of our recent operating results on
a quarterly basis:
June 30, 2021
March 31, 2021
December 31,
2020
September 30,
2020
June 30, 2020
Total revenue
$
2,493,671
$
2,535,829
$
2,798,291
$
3,558,640
$
1,732,192
Gross profit
1,260,800
811,882
1,182,160
1,222,648
392,758
Gross profit margin %
50.6
%
32.0
%
43.0
%
34.1
%
22.7
%
Total selling, general and administrative expenses
3,877,684
3,677,575
2,931,334
3,066,606
2,535,912
Operating income (loss)
(2,616,884
)
(2,865,693
)
(1,749,174
)
(1,843,958
)
(2,143,154
)
Operating income (loss) %
(105.0
)%
(113.0
)%
(63.2
)%
(51.4
)%
(123.7
)%
Net income (loss)
$
(5,382,487
)
$
21,721,858
$
(321,318
)
$
527,442
$
(497,894
)
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 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 stock-based and bonus compensation; (5) the timing of patent infringement litigation settlements; (5) ongoing patent and other litigation
and related expenses respecting outstanding lawsuits; and (6) most recently, the impact of COVID-19 on the economy and our business.
We reported a net loss of $5,382,487 on revenues of $2,493,671 for the second quarter of 2021. The income recognized in
the first quarter 2021, and in the third quarter 2020 ended a series of quarterly losses resulting from competitive pressures, supply
chain problems, increases in inventory reserves as our current product suite ages, product quality control issues, product warranty issues,
and litigation expenses relating to patent infringement claims.
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 a material current or future effect on financial conditions, changes in the
financial conditions, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenue
or expenses other than the following:
We are a party to operating leases
and license agreements that represent commitments for future payments (described in Note 8, “Operating Leases,” to
our condensed consolidated financial statements) and we have issued purchase orders in the ordinary course of business that represent
commitments to future payments for goods and services.
28
For the Three Months Ended June 30, 2021 and
2020
Results of Operations
Summarized immediately below and
discussed in more detail in the subsequent subsections is an analysis of our operating results for the three months ended June 30, 2021
and 2020, represented as a percentage of total revenues for each such quarter:
Three Months Ended
June 30,
2021
2020
Revenue
100
%
100
%
Cost of revenue
49
%
77
%
Gross profit
51
%
23
%
Selling, general and administrative expenses:
Research and development expense
18
%
21
%
Selling, advertising and promotional expense
35
%
28
%
General and administrative expense
102
%
98
%
Total selling, general and administrative expenses
156
%
147
%
Operating loss
(105
)%
(124
)%
Change in fair value of proceeds investment agreement
—
%
149
%
Change in fair value of secured convertible notes
—
%
(51
)%
Change in fair value of derivative liabilities
(114
)%
—
%
Other income and interest expense, net
4
%
(3
)%
Income (loss) before income tax benefit
(216
)%
(29
)%
Income tax (provision)
—
%
—
%
Net loss
(216
)%
(29
)%
Net loss per share information:
Basic
$
(0.10
)
$
(0.03
)
Diluted
$
(0.10
)
$
(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.
●
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 is recognized upon shipment of the repair parts and acceptance of the service or materials by the end customer.
29
We may discount our prices on
specific orders based upon the size of the order, the specific customer and the competitive landscape.
The
COVID-19 pandemic had an impact on our revenues in the second quarter 2021 and we expect it to adversely affect our revenues during the
remainder of 2021. The COVID-19 pandemic had a negative impact generally on our legacy products and, in particular our commercial event
recorder hardware (DVM-250 Plus) and in-car hardware for law enforcement (DVM-800) during the quarter. The COVID-19 pandemic had a positive
impact generally on our new Shield disinfectant/sanitizer and ThermoVU product lines.
Revenues for the second quarter of 2021 and 2020 were
derived from the following sources:
Three months ended June 30,
2021
2020
DVM-800 and DVM 800HD
18
%
21
%
ThermoVu TM
2
%
—
%
Shield TM disinfectants/sanitizers
1
%
—
%
FirstVu HD
12
%
13
%
DVM-250 Plus
2
%
6
%
Cloud service revenue
10
%
16
%
Extended warranty revenue
9
%
—
%
VuLink
1
%
1
%
EVO-HD
25
%
9
%
Repair and service
2
%
23
%
Accessories and other revenues
18
%
11
%
100
%
100
%
Product revenues for the three
months ended June 30, 2021 and 2020 were $1,719,332 and $1,053,581 respectively, an increase of $665,751 (63%), due to
the following factors:
●
The Company generated revenues totaling over
$64,598 during the three months ended June 30, 2021, compared to $-0- for the same period in 2020 from its new product lines.
Late in 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 late in the second quarter of 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.
30
●
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 our recent financial condition. 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 but sales in 2020 were
hampered due to the COVID-19 pandemic. 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. We experienced substantial increases
in EVO-HD revenues during the second quarter of 2021 and believe that customers are recognizing and are attracted to its advanced
features.
●
The COVID-19 pandemic has continued to delay
the shipment of law enforcement orders since the first quarter of 2020 as police forces and governments deal with its impact. In
addition, our salesmen were generally unable to meet with and demonstrate our products to our law enforcement 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 important in order to obtain new customers or upgrade existing customers. Our product sales to
law enforcement increased in the second quarter of 2021 compared to the same period in 2020, as the impact of the COVID-19
pandemic was at its peak.
The COVID-19 pandemic impact has begun to
lessen, although the shipment of commercial orders in the second quarter of 2021 remain slow, as cruise lines,
taxi cabs, paratransit and other commercial customers continue to deal with its impact. In addition, our salesmen were generally
unable to meet with and demonstrate our products to our 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 to commercial customers increased in the second
quarter of 2021 compared to the same period in 2020 despite the impact of the COVID-19 pandemic.
●
Management has been focusing on migrating customers, from a “hardware sale” to a service fee model. Therefore, we expect a reduction in hardware sales 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 of 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 continues to hold traction, resulting in recurring revenues over a span of three to five years.
Service and other revenues for
the three months ended June 30, 2021 and 2020 were $774,339 and $678,611, respectively, an increase of $95,728 (14%), due
to the following factors:
●
Cloud
revenues were $247,085 and $281,008 for the three months ended June 30, 2021 and 2020, respectively, a decrease
of $33,923 (12%). 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 affected
our commercial customers usage of cloud services and lessened cloud revenues.
●
Revenues
from extended warranty services were $232,614 and $334,705 for the three months
ended June 30, 2021 and 2020, respectively, a decrease of $102,091 (31%). We
have many customers that have purchased extended warranty packages, primarily in our DVM-800
premium service program. However, the affects from the COVID-19 pandemic and related restrictions
on travel adversely affected our sales of DVM-800 hardware systems resulting in a decrease
in their sales over the three months ended June 30, 2021 compared to the same
period in 2020.
31
●
Installation
service revenues were $30,029 and $49,776 for the three months ended June
30, 2021 and 2020, respectively, a decrease of $19,747 (40%). Installation revenues
tend to vary more than other service revenue types and are dependent on larger customer implementations.
The decrease in installation revenues in the three months ended June 30, 2021
compared to the same period 2020 was attributable to the continued effects related
to the COVID-19 pandemic. Additionally, our newer products require less installation services,
as the products are further along in the set-up process prior to leaving the warehouse.
●
Revenues
from building rental income were $146,185 and $-0- for the three months ended June 30, 2021
and 2020, respectively, an increase of $146,185 (100%). The Company completed the purchase
of an office/warehouse building during the three months ended June 30, 2021, in which current tenants were
under a lease agreement. The agreement concludes at the end of August 2021.
Total revenues for the three
months ended June 30, 2021 and 2020 were $2,493,671 and $1,732,192, respectively, an increase of $761,479 (44%),
due to the reasons noted above.
Cost of Revenue
Cost of product revenue on
units sold for the three months ended June 30, 2021 and 2020 was $1,017,659 and $1,165,528, respectively, a decrease
of $147,869 (13%). The decrease in cost of goods sold for products is due to numerous factors in the period
during 2020 that were not relevant to the same period in 2021. In the 2020 period, the Company experienced a
move to its new warehouse facility, and a significant manufacturing slow down caused by the COVID-19 pandemic causing
unfavorable overhead and labor variances for production in the second quarter of 2020, which management had decided to
expense as a period cost. For the same period in 2021, the Company did not experience these factors, but further reduced
the inventory reserve. Additionally, RMA returns as a percentage of product revenues was 10% for the three months ended
June 30, 2021 compared to 32% for the three months ended June 30, 2020.
Cost of service and other revenues
for the three months ended June 30, 2021 and 2020 was $215,212 and $173,906, respectively, an increase of $41,306
(24%). The increase in service and other cost of goods sold is primarily due to the 14% decrease in service and other
revenues for the three months ended June 30, 2021.
Total cost of sales as a percentage
of revenues was 51% for the three months ended June 30, 2021 compared to 77% for the three months ended June 30, 2020. We believe
our gross margins will improve during the remainder of 2021 if we can increase revenues (in particular service and other revenues),
shipping costs moderate and continue to reduce product warranty issues.
We had $2,321,788 and
$1,960,351 in reserves for obsolete and excess inventories at June 30, 2021 and December 31, 2020, respectively. Total raw materials
and component parts were $3,184,707 and $3,186,426 at June 30, 2021 and December 31, 2020, respectively, a decrease of $1,719
(1%). Finished goods balances were $8,737,310 and $6,974,291 at June 30, 2021 and December 31, 2020, respectively,
an increase of $1,943,019 (29%). The increase in the inventory reserve is primarily due to the aging of older version inventory
component parts that were mostly or fully reserved during the three months ended June 30, 2021. 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, 2021.
Gross Profit
Gross profit for the three months
ended June 30, 2021 and 2020 was $1,260,800 and $392,758, respectively, an increase of $868,042 (221%). The increase
is commensurate with the increase in product and service revenues during the three months ended June 30, 2021
compared to the same period in 2020. 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 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 efficient management of our supply chain through outsourcing production, quantity
purchases and more effective purchasing practices.
32
Selling, General and Administrative Expenses
Selling, general and administrative
expenses were $3,877,684 and $2,535,912 for the three months ended June 30, 2021 and 2020, respectively, an increase of $1,341,772
(53%). The increase was fueled by an increase in travel expenses as COVID-19 restrictions begin to ease, increased promotional
and advertising expenses, along with increased legal and broker fees for the quarter ended June 30, 2021. The significant
components of selling, general and administrative expenses are as follows:
Three months ended
June 30,
2021
2020
Research and development expense
$
460,999
$
359,697
Selling, advertising and promotional expense
870,183
486,649
Professional fees and expense
620,346
217,726
Executive, sales, and administrative staff payroll
674,008
510,872
Other
1,252,148
960,968
Total
$
3,877,684
$
2,535,912
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 $460,999 and $359,697 for the three months ended June 30, 2021 and 2020, respectively,
an increase of $101,302 (28%). Most of our engineers are dedicated to research and development activities for new products,
primarily the ThermoVu TM , Shield TM , EVO-HD and non-mirror based DVM-250 that can be located in multiple places
in a vehicle. We expect our research and development activities will continue to trend higher in future quarters as we continue to expand
our product offerings based on our new EVO-HD product platform and as we outsource more development projects. We consider our research
and development capabilities and new product focus to be a competitive advantage and intend to 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 $870,183 and $486,649 for the three months
ended June 30, 2021 and 2020, respectively, an increase of $383,534 (79%). Salesman salaries and commissions represent
the primary components of these costs and were $496,215 and $374,882 for the three months ended June 30, 2021 and 2020, respectively,
an increase of $383,616 (79%). The effective commission rate was 19.9% for the three months ended June 30, 2021,
compared to 21.6% for the three months ended June 30, 2020. This increase directly correlates with the increase in total
sales for the three months ended June 30, 2021 compared to the same period in 2020.
Promotional and advertising expenses
totaled $373,968 during the three months ended June 30, 2021, compared to $111,767 during the three months ended June 30, 2020,
an increase of $262,201 (235%). The increase is primarily attributable to NASCAR and IndyCar seasons resuming in the 2021, as
they were conversely suspended during the same period in 2020. Additionally, trade shows are beginning to take place in the second
quarter of 2021, compared to the second quarter of 2020, when they were suspended as a result of the COVID-19 pandemic.
Professional fees and expense .
Professional fees and expenses totaled $620,346 and $217,726 for the three months ended June 30, 2021 and 2020, respectively,
an increase of $402,620 (185%). The increase in professional fees is primarily attributable to increased legal
and broker fees associated with the Company’s acquisition of Elite Medical Billing Specialists, paired with other current due diligence
items and opportunities the Company is exploring. Additionally, increased board fees, audit fees, and service fees attribute
to this increase.
33
Executive, sales and administrative
staff payroll. Executive, sales and administrative staff payroll expenses totaled $674,008 and $510,872 for the three
months ended June 30, 2021 and 2020, respectively, an increase of $163,136 (31%). The primary reason for the increase
in executive, sales and administrative staff payroll was the return to regular staff levels compared to the same period
in 2020, during which period the Company experienced a reduction in technical support staffing in response to the COVID-19 pandemic during the
second quarter of 2020, as the COVID-19 pandemic had 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 $1,252,148 and $960,968 for the three months ended June 30, 2021 and 2020,
respectively, an increase of $291,180 (30%). The increase in other expenses in the three months ended June 30, 2021 compared
to the same period in 2020 is primarily attributable to an increase in travel costs as COVID-19 restrictions begin to ease, as well as
substantially increased insurance costs compared to the same period in 2020. The increased insurance costs are primarily in general liability
and related coverages which premiums have been increased to address exposure to the COVID-19 pandemic.
Operating Loss
For the reasons stated above,
our operating loss was $2,616,884 and $2,143,154 for the three months ended June 30, 2021 and 2020, respectively, a decrease
of $473,730 (22%). Operating loss as a percentage of revenues bettered to 105% in the three months ended June
30, 2021 from 124% in the same period in 2020.
Interest Income
Interest income increased to
$90,774 for the three months ended June 30, 2021, from $15,609 in the same period of 2020, which reflected our increase in cash
and cash equivalent levels in the second quarter of 2021 compared to the second quarter of 2020. The Company completed two registered
direct offerings in the first quarter of 2021 which yielded net proceeds of approximately $66.4 million which balances have earned increased
interest income when compared to the first quarter of 2020 Additionally, this increase is a result of interest incurred on debt that
the Company has issued, as well as interest incurred on leased products.
Interest Expense
We incurred interest expense
of $1,365 and $25,636 during the three months ended June 30, 2021 and 2020, respectively. The decrease was attributable to utilizing
a portion of the net proceeds from the registered direct offerings to eliminate substantially all interest-bearing debt balances outstanding
in the three months ended June 30, 2021 as compared to the same period in 2020. On May 12, 2020, the Company received $150,000 in additional
loan funding under the Economic Injury Disaster Loans (“EIDL”) program administered by the Small Business Administration
(“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. The EIDL loan represent the Company’s only interest-bearing
debt outstanding as of June 30, 2021.
Secured Convertible Notes Issuance Expenses
We recognized secured convertible
notes issuance expense totaling $-0- and $34,906 during the three months ended June 30, 2021 and 2020, respectively.
We elected to account for
and record our $1.667 million principal amount of the 2020 Convertible Notes issued in April 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 ended June 30, 2020. The issuance costs primarily included related legal and accounting fees.
No similar debt issuances occurred during the three months ended June 30, 2021.
Gain on Extinguishment of debt
We recognized a gain on extinguishment
of debt totaling $10,000 and $-0- during the three months ended June 30, 2021 and 2020, respectively. During the three months ended June
30, 2021 the Company was notified that its $10,000 EIDL advance received with the PPP Loan was fully forgiven,
Change in Fair Value of Secured Convertible
Notes
We recognized a loss on change
in fair value of Secured Convertible Notes totaling $-0- and $887,807 during the three months ended June 30, 2021 and 2020, respectively.
We elected to account for
the secured convertible notes that were issued on April 17, 2020 on their fair value basis. Therefore, we determined the fair value of
the secured convertible notes as of their issuance date of April 17, 2020 and through June 12, 2020, when they were paid in full. The
change in fair value from their issuance date of April 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 ended June 30, 2020.
Change in Fair Value of Proceeds Investment
Agreement
We recognized a gain on change
in fair value of proceeds investment agreement totaling $-0- and $2,578,000 during the three months ended June 30, 2021 and 2020, respectively.
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 of June 30, 2020, and March 31, 2020 to be $3,615,000 and $6,193,000, respectively. The change in fair value from March 31, 2020 to
June 30, 2020 was $2,578,000, which was recognized as a gain in the Condensed Consolidated Statement of Operations for the three months
ended June 30, 2020.
Change in Fair Value of Short-Term Investments
We recognized a loss on change
in fair value of short-term investments totaling $1,590 and $-0- during the three months ended June 30, 2021 and 2020, respectively.
Such short-term investments are included in cash and cash equivalents as they contain original maturities of ninety (90) days or less.
Change in Fair Value of Derivative Liabilities
During the first quarter of 2021,
the Company issued detachable warrants to purchase a total of 42,500,000 shares of Common Stock in association with the two registered
direct offerings previously described. The underlying warrant agreement terms provide for net cash settlement outside the control of
the Company in the event of tender offers under certain circumstances. As such, the Company is required to treat these warrants as derivative
liabilities which are valued at their estimated fair value at their issuance date and at each reporting date with any subsequent changes
reported in the condensed consolidated statement of operations as the change in fair value of warrant derivative liabilities. The change
in fair value of the warrant derivative liabilities from March 31, 2021 to June 30, 2021 totaled $2,863,422 which was recognized
as a loss in the second quarter of 2021. The Company determined the fair value of such warrants as of their issuance date, and
as of June 30, 2021, to be $51,216,058 and $29,527,224, respectively.
34
Income/(Loss) before Income Tax Benefit
As a result of the above results
of operations, we reported an income/(loss) before income tax benefit of ($5,382,487) and ($497,894) for the three months ended
June 30, 2021 and 2020, respectively, a decrease of $4,884,593 (981%).
Income Tax Benefit
We did not record an income tax
expense related to our income for the three months ended June 30, 2021 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 of June 30, 2021. We had approximately
$76,070,000 of net operating loss carryforwards and $1,795,000 of research and development tax credit carryforwards as of June 30, 2021
available to offset future net taxable income.
Net Income/(Loss)
As a result of the above results
of operations, we reported net income/(loss) of ($5,382,487) and ($497,894) for the three months ended June 30, 2021 and 2020,
respectively, a decrease of $4,884,593 (981%).
Basic and Diluted Income/(Loss) per Share
The basic and diluted income/(loss)
per share was ($0.10) and ($0.03) for the three months ended June 30, 2021 and 2020, respectively. Basic income (loss) per share
is based upon the weighted average number of common shares outstanding during the period. For the three months ended June 30, 2021 and
2020, all shares issuable upon conversion of convertible debt and the exercise
of outstanding stock options and warrants were antidilutive, and, therefore, not included in the computation of diluted income (loss)
per share.
For
the Six Months Ended June 30, 2021 and 2020
Results
of Operations
Summarized
immediately below and discussed in more detail in the subsequent subsections is an analysis of our operating results for the six months
ended June 30, 2021 and 2020, represented as a percentage of total revenues for each respective year:
Six
Months Ended
June
30,
2021
2020
Revenue
100 %
100 %
Cost of revenue
59 %
60 %
Gross profit
41 %
40 %
Selling, general and administrative expenses:
Research and development expense
18 %
20 %
Selling, advertising and promotional expense
29 %
28 %
General and administrative expense
103 %
90 %
Total selling, general and administrative expenses
150 %
138 %
Operating loss
(109 )%
(98 )%
Change in fair value of proceeds investment agreement
— %
69 %
Change in fair value of secured convertible notes
— %
(31 )%
Change in fair value of derivative liabilities
431 %
— %
Other income and interest expense, net
3 %
(8 )%
Income (loss) before income tax benefit
325 %
(68 )%
Income tax (provision)
— %
— %
Net income/(loss)
325 %
(68 )%
Net income/(loss) per share information:
Basic
$ 0.34
$ (0.17 )
Diluted
$ 0.34
$ (0.17 )
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.
●
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
is recognized 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.
35
The
COVID-19 pandemic had an impact on our revenues during the six months ended June 30, 2021 and we expect it to adversely affect our revenues
during the remainder of 2021; however, the impact is beginning to lessen. The COVID-19 pandemic had a negative impact generally on our
legacy products and, in particular our commercial event recorder hardware (DVM-250 Plus) and in-car hardware for law enforcement (DVM-800)
during the quarter. The COVID-19 pandemic had a positive impact generally on our new Shield disinfectant/sanitizer and ThermoVU product
lines.
Revenues
for the six months ended June 30, 2021 and 2020 were derived from the following sources:
Six months ended June 30,
2021
2020
DVM-800 and DVM 800HD
23 %
29 %
ThermoVu TM
3 %
— %
Shield TM disinfectants/sanitizers
1 %
— %
FirstVu HD
13 %
14 %
DVM-250 Plus
3 %
5 %
Cloud service revenue
10 %
13 %
Extended warranty revenue
10 %
— %
VuLink
1 %
2 %
EVO-HD
19 %
8 %
Repair and service
3 %
19 %
Accessories and other revenues
14 %
10 %
100 %
100 %
Product
revenues for the six months ended June 30, 2021 and 2020 were $3,631,910 and $2,820,116 respectively, an increase of $811,794 (29%),
due to the following factors:
●
The
Company generated revenues totaling over $205,907 during the six months ended June 30, 2021,
compared to $53,663 for the same period in 2020 from its new product lines. Late in 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 late in the second quarter of 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.
●
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 our recent financial condition. 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 but sales in 2020 were hampered due to the COVID-19 pandemic. 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. We experienced
substantial increases in EVO-HD revenues during the six months ended June 30, 2021 and believe that customers are recognizing and are
attracted to its advanced features.
36
●
The
COVID-19 pandemic has continued to delay the shipment of law enforcement orders since the
first quarter of 2020 as police forces and governments deal with its impact. In addition,
our salesmen were generally unable to meet with and demonstrate our products to our law enforcement
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
important in order to obtain new customers or upgrade existing customers. Our product sales
to law enforcement increased during the six months ended June 30, 2021 compared to the same
period in 2020, as the impact of the COVID-19 pandemic was at its peak.
The
COVID-19 pandemic impact has begun to lessen, although the shipment of commercial orders during the six months ended June 30, 2021
remain slow, as cruise lines, taxi cabs, paratransit and other commercial customers continue to deal with its impact. In addition,
our salesmen were generally unable to meet with and demonstrate our products to our 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 to commercial customers increased
in the second quarter of 2021 compared to the same period in 2020 despite the impact of the COVID-19 pandemic.
●
Management
has been focusing on migrating customers, from a “hardware sale” to a service fee model. Therefore, we expect a reduction
in hardware sales 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 of 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 continues to hold traction, resulting in recurring revenues
over a span of three to five years.
Service
and other revenues for the six months ended June 30, 2021 and 2020 were $1,397,591 and $1,337,820, respectively, an increase of $59,771
(4%), due to the following factors:
●
Cloud
revenues were $488,738 and $508,132 for the six months ended June 30, 2021 and 2020, respectively, a decrease of $19,394 (4%). 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 affected our commercial customers
usage of cloud services and lessened cloud revenues.
●
Revenues
from extended warranty services were $487,307 and $668,073 for the six months ended June 30, 2021 and 2020, respectively, a decrease
of $180,766 (27%). We have many customers that have purchased extended warranty packages, primarily in our DVM-800 premium service
program. However, the affects from the COVID-19 pandemic and related restrictions on travel adversely affected our sales of DVM-800
hardware systems resulting in a decrease in their sales over the six months ended June 30, 2021 compared to the same period in 2020.
●
Installation
service revenues were $119,531 and $86,632 for the six months ended June 30, 2021 and 2020, respectively, an increase of $32,900
(38%). Installation revenues tend to vary more than other service revenue types and are dependent on larger customer implementations.
The increase in installation revenues in the six months ended June 30, 2021 compared to the same period 2020 was attributable to
the resumption of previous projects pending install due to the effects related to the COVID-19 pandemic.
●
Revenues
from building rental income were $146,185 and $-0- for the six months ended June 30, 2021 and 2020, respectively, an increase of
$146,185 (100%). The Company completed the purchase of an office/warehouse building during the six months ended June 30, 2021, in which current
tenants were under a lease agreement. The agreement concludes at the end of August 2021.
37
Total
revenues for the six months ended June 30, 2021 and 2020 were $5,029,501 and $4,157,936, respectively, an increase of $871,565 (21%),
due to the reasons noted above.
Cost
of Revenue
Cost
of product revenue on units sold for the six months ended June 30, 2021 and 2020 was $2,578,969 and $2,154,774, respectively, an increase
of $424,195 (20%). The increase in cost of goods sold for products is primarily due to a significant increase in inbound freights costs
for the six months ended June 30, 2021 compared to the same period in 2020, as the Company received several large shipments from oversees
during the period due to the expanded product line. Furthermore, the Company increased its inventory reserve during the period, thus
increasing the cost of sales for the period.
Cost
of service and other revenues for the six months ended June 30, 2021 and 2020 was $377,849 and $345,374, respectively, an increase of
$32,475 (9%). The increase in service and other cost of goods sold is primarily due to the 4% increase in service and other revenues
for the six months ended June 30, 2021.
Total
cost of sales as a percentage of revenues was 59% for the six months ended June 30, 2021 compared to 60% for the six months ended June
30, 2020. We believe our gross margins will improve during the remainder of 2021 if we can increase revenues (in particular service and
other revenues), shipping costs moderate and continue to reduce product warranty issues.
We
had $2,321,788 and $1,960,351 in reserves for obsolete and excess inventories at June 30, 2021 and December 31, 2020, respectively. Total
raw materials and component parts were $3,184,707 and $3,186,426 at June 30, 2021 and December 31, 2020, respectively, a decrease of
$1,719 (1%). Finished goods balances were $8,737,310 and $6,974,291 at June 30, 2021 and December 31, 2020, respectively, an increase
of $1,943,019 (29%). The increase in the inventory reserve is primarily due to the aging of older version inventory component parts that
were mostly or fully reserved during the six months ended June 30, 2021. 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, 2021.
Gross
Profit
Gross
profit for the six months ended June 30, 2021 and 2020 was $2,072,683 and $1,657,788, respectively, an increase of $414,895 (25%). The
increase is commensurate with the increase in product and service revenues during the six months ended June 30, 2021 compared to the
same period in 2020. 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 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 efficient management of our supply chain through outsourcing production, quantity purchases and more
effective purchasing practices.
Selling,
General and Administrative Expenses
Selling, general and administrative
expenses were $7,555,261 and $5,728,307 for the six months ended June 30, 2021 and 2020, respectively, an increase of $1,826,954 (32%).
The increase was fueled by an increase in travel expenses as COVID-19 restriction begin to ease, increased promotional and advertising
expenses, along with increased legal and broker fees for the six months ended June 30, 2021. The significant components of selling, general
and administrative expenses are as follows:
Six
months ended
June
30,
2021
2020
Research and development expense
$ 909,964
$ 845,445
Selling, advertising and promotional expense
1,466,938
1,169,030
Professional fees and expense
852,923
557,318
Executive, sales, and administrative staff
payroll
1,358,168
1,231,650
Other
2,967,268
1,924,864
Total
$ 7,555,261
$ 5,728,307
38
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 $909,964 and $845,445 for the six months ended June 30, 2021 and 2020, respectively,
an increase of $64,519 (8%). Most of our engineers are dedicated to research and development activities for new products, primarily the
ThermoVu TM , Shield TM , EVO-HD and non-mirror based DVM-250 that can be located in multiple places in a vehicle.
We expect our research and development activities will continue to trend higher in future quarters as we continue to expand our product
offerings based on our new EVO-HD product platform and as we outsource more development projects. We consider our research and development
capabilities and new product focus to be a competitive advantage and intend to 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 $1,466,938 and $1,169,030 for the
six months ended June 30, 2021 and 2020, respectively, an increase of $297,908 (25%). Salesman salaries and commissions represent the
primary components of these costs and were $895,767 and $952,832 for the six months ended June 30, 2021 and 2020, respectively, a decrease
of $57,065 (6%). The effective commission rate was 17.8% for the six months ended June 30, 2021, compared to 22.9% for the six months
ended June 30, 2020.
Promotional
and advertising expenses totaled $571,171 during the six months ended June 30, 2021, compared to $216,198 during the six months ended
June 30, 2020, an increase of $354,973 (164%). The increase is primarily attributable to NASCAR and IndyCar seasons resuming in the 2021,
as they were conversely suspended during the same period in 2020. Additionally, trade shows are beginning to take place in the second
quarter of 2021, compared to the second quarter of 2020, when they were suspended as a result of the COVID-19 pandemic.
Professional fees and
expense . Professional fees and expenses totaled $852,923 and $557,318 for the six months ended June 30, 2021 and 2020, respectively,
an increase of $295,605 (53%). The increase in professional fees is primarily attributable to increased legal fees surrounding the two
registered direct offerings during the six months ended June 30, 2021, along with increased legal and broker fees associated with the
Company’s acquisition of Elite Medical Billing Specialists, paired with other current due diligence items and opportunities the
Company is exploring. Additionally, increased board fees, audit fees, and service fees attribute to this increase.
Executive,
sales and administrative staff payroll. Executive, sales and administrative staff payroll expenses totaled $1,358,168 and $1,231,650
for the six months ended June 30, 2021 and 2020, respectively, an increase of $126,518 (10%). The primary reason for the increase in
executive, sales and administrative staff payroll was due to the return to regular staff levels compared to the same period in 2020,
in which the Company experienced a reduction in technical support staffing in response to the COVID-19 pandemic during the second quarter
of 2020, as the COVID-19 pandemic had 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 $2,967,268 and $1,924,864 for the six months ended June 30, 2021 and 2020,
respectively, an increase of $1,042,404 (54%). The increase in other expenses in the six months ended June 30, 2021 compared to the same
period in 2020 is primarily attributable to an increase in travel costs as COVID-19 restrictions begin to ease, as well as substantially
increased insurance costs compared to the same period in 2020. The increased insurance costs are primarily in general liability and related
coverages which premiums have been increased to address exposure to the COVID-19 pandemic.
Operating
Loss
For
the reasons stated above, our operating loss was $5,482,578 and $4,070,519 for the six months ended June 30, 2021 and 2020, respectively,
a decrease of $1,412,059 (35%). Operating loss as a percentage of revenues worsened to 109% in the six months ended June 30, 2021 from
98% in the same period in 2020.
Interest
Income
Interest
income increased to $132,461 for the six months ended June 30, 2021, from $21,869 in the same period of 2020, which reflected our increase
in cash and cash equivalent levels in the six months ended June 30, 2021 compared to the same period in 2020. The Company completed two
registered direct offerings in the six months ended June 30, 2021 which yielded net proceeds of approximately $66.4 million which balances
have earned increased interest income when compared to the same period in 2020 Additionally, this increase is a result of interest incurred
on debt that the Company has issued, as well as interest incurred on leased products.
39
Interest
Expense
We
incurred interest expense of $2,793 and $333,196 during the six months ended June 30, 2021 and 2020, respectively. The decrease was attributable
to utilizing a portion of the net proceeds from the registered direct offerings to eliminate substantially all interest-bearing debt
balances outstanding in the six months ended June 30, 2021 as compared to the same period in 2020. On May 12, 2020, the Company received
$150,000 in additional loan funding under the Economic Injury Disaster Loans (“EIDL”) program administered by the Small Business
Administration (“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. The EIDL loan represent the Company’s
only interest-bearing debt outstanding as of June 30, 2021.
Secured Convertible Notes Issuance Expenses
We recognized secured convertible
notes issuance expense totaling $-0- and $34,906 during the six months ended June 30, 2021 and 2020, respectively.
We elected to account for
and record our $1.667 million principal amount of the 2020 Convertible Notes issued in April 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 ended June 30, 2020. The issuance costs primarily included related legal and accounting fees.
No similar debt issuances occurred during the three months ended June 30, 2021.
Gain on Extinguishment of debt
We recognized a gain on extinguishment
of debt totaling $10,000 and $-0- during the six months ended June 30, 2021 and 2020, respectively. During the six months ended June
30, 2021 the Company was notified that its $10,000 EIDL advance received with the PPP Loan was fully forgiven,
Change in Fair Value of Secured Convertible
Notes
We recognized a loss on change
in fair value of Secured Convertible Notes totaling $-0- and $1,300,252 during the six months ended June 30, 2021 and 2020, respectively.
We elected to account for
the secured convertible notes that were issued on April 17, 2020 on their fair value basis. Therefore, we determined the fair value of
the secured convertible notes as of their issuance date of April 17, 2020 and through June 12, 2020, when they were paid in full. The
change in fair value from their issuance date of April 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 ended June 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 on December 31, 2019 until they were paid in full on March 3, 2020. The change
in fair value from December 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 ended June 30, 2020.
Change in Fair Value of Proceeds Investment
Agreement
We recognized a gain on change
in fair value of proceeds investment agreement totaling $-0- and $2,885,000 during the three months ended June 30, 2021 and 2020, respectively.
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 of June 30, 2020, and December 31, 2019 to be $3,615,000 and $6,500,000, respectively. The change in fair value from December 31,
2019 to June 30, 2020 was $2,885,000, which was recognized as a gain in the Condensed Consolidated Statement of Operations for the six
months ended June 30, 2020.
Change in Fair Value of Short-Term Investments
We recognized a loss on change
in fair value of short-term investments totaling $6,554 and $-0- during the six months ended June 30, 2021 and 2020, respectively. Such
short-term investments are included in cash and cash equivalents as they contain original maturities of ninety (90) days or less.
Change
in Fair Value of Derivative Liabilities
During
the six months ended June 30, 2021, the Company issued detachable warrants to purchase a total of 42,500,000 shares of Common Stock in
association with the two registered direct offerings previously described. The underlying warrant agreement terms provide for net cash
settlement outside the control of the Company in the event of tender offers under certain circumstances. As such, the Company is required
to treat these warrants as derivative liabilities which are valued at their estimated fair value at their issuance date and at each reporting
date with any subsequent changes reported in the condensed consolidated statement of operations as the change in fair value of warrant
derivative liabilities. The change in fair value of the warrant derivative liabilities from their issuance date to June 30, 2021 totaled
$21,688,835 which was recognized as a gain in the period ended June 30, 2021. The Company determined the fair value of such warrants
as of their issuance date, and as of June 30, 2021, to be $51,216,058 and $29,527,224, respectively.
Income/(Loss)
before Income Tax Benefit
As
a result of the above results of operations, we reported an income/(loss) before income tax benefit of $16,339,371 and ($2,832,004) for
the six months ended June 30, 2021 and 2020, respectively, an increase of $19,171,375 (677%).
Income
Tax Benefit
We
did not record an income tax expense related to our income for the six months ended June 30, 2021 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
of June 30, 2021. We had approximately $76,070,000 of net operating loss carryforwards and $1,795,000 of research and development tax
credit carryforwards as of June 30, 2021 available to offset future net taxable income.
Net
Income/(Loss)
As
a result of the above results of operations, we reported net income/(loss) of $16,339,371 and ($2,832,004) for the six months ended June
30, 2021 and 2020, respectively, an increase of $19,171,375 (677%).
Basic
and Diluted Income/(Loss) per Share
The
basic and diluted income/(loss) per share was $0.34 and ($0.17) for the six months ended June 30, 2021 and 2020, respectively. Basic
income (loss) per share is based upon the weighted average number of common shares outstanding during the period. For the six months
ended June 30, 2021 and 2020, all shares issuable upon conversion of convertible debt and the exercise of outstanding stock options and
warrants were antidilutive, and, therefore, not included in the computation of diluted income (loss) per share.
Liquidity and Capital Resources
Overall:
Management’s
Liquidity Plan. The Company has historically raised capital in the form of equity and debt instruments from private and public
sources to supplement its needs for funds to support its business operational and strategic plans. 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 had raised
net proceeds of approximately $66.4 million in registered direct offerings of Common Stock, pre-funded warrants and warrants during the
six months ended June 30, 2021. Furthermore, the Company’s only remaining interest-bearing debt at June 30, 2021 is $500,000
remaining due on the promissory notes under the EIDL program, and the Elite contingent consideration promissory note.
The net proceeds of the registered direct offerings are sufficient to fund our operations during the remainder of 2021 and management
believes that it now has adequate liquidity for the foreseeable future from the recently completed registered direct offerings in 2021.
Such offerings were completed through utilization of the Company’s shelf-registration statement on Form S-3 (File No. 333-239419),
which was initially filed with the U.S. Securities and Exchange Commission (the “SEC) on June 25, 2020 and was declared effective
on July 2, 2020 (the “Shelf Registration Statement”).
Shelf
Registration Statement on Form S-3 - The Shelf Registration Statement allows the Company to offer and sell, from time to time in
one or more offerings, any combination of our shares of 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 utilized the
Shelf Registration Statement for two recent offerings of its securities, as more fully described in Note 12 of the notes to the
Company’s condensed consolidated financial statements, “Stockholders’ Equity”, raising approximately $66.4 million
in net proceeds during the six months ended June 30, 2021.
40
Management
believes that it has adequate funding to support its business operations for the foreseeable future as a result of the funds raised through
these Offerings.
Cash, cash equivalents:
As of June 30, 2021, we had cash and cash equivalents with an aggregate balance of $58,276,178, an increase from a balance of
$4,361,758 at December 31, 2020. Summarized immediately below and discussed in more detail in the subsequent subsections are the main
elements of the $53,914,420 net increase in cash during the six months ended June 30, 2021:
●
Operating activities :
$6,149,773
of net cash used in operating activities. Net cash used in operating
activities was $6,149,773 and $4,057,003 for the six months ended June 30, 2021 and 2020, respectively, an increase of $2,092,770.
The increase was primarily the result of increased inventory levels and various deposits included in other assets during
the six months ended June 30, 2021 compared to the same period of 2020.
●
Investing activities :
$6,506,407
of net cash used in investing activities. Cash used in investing
activities was $6,506,407 and $163,109 for the six months ended June 30, 2021 and 2020 respectively. The increase was primarily
the result of the office/warehouse building purchase the Company completed during the six months ended June 30, 2021.
Along with the acquisition of Elite, which was closed during the six months ended June 30, 2021.
●
Financing activities :
$66,570,600 of net cash provided by financing activities. Cash provided by financing activities was $66,570,600 and $20,025,977 for the six months ended June 30, 2021 and 2020, respectively. During January 2021, we received net proceeds of $28,941,000 ($29,013,000 upon full exercise of the prefunded warrants) from the issuance of shares of common stock, warrants and pre-funded warrants through a registered direct offering. In addition, during February 2021, we received net proceeds of $37,447,100 ($37,557,600 upon full exercise of the prefunded warrants) from the issuance of shares of common stock, warrants and pre-funded warrants through a registered direct offering.
The net result of these activities
was an increase in cash of $53,914,420 to $58,276,178 for the six months ended June 30, 2021.
Commitments:
We had $58,276,178 of
cash and cash equivalents and net positive working capital $40,209,734 as of June 30, 2021. Accounts receivable balances represented
$2,683,931 of our net working capital at June 30, 2021. We believe we be able to collect our outstanding receivables on a timely
basis and reduce the overall level during the balance of 2021, which would provide positive cash flow to support our operations during
2021. Inventory represents $9,615,759 of our net working capital at June 30, 2021, and finished goods represented $8,737,310
of total inventory at June 30, 2021. We are actively managing the level of inventory and our goal is to reduce such level during
the balance of 2021 by our sales activities, thereby increasing cash flow to help support our operations during 2021.
Capital
Expenditures . On April 30, 2021 the Company closed on the purchase and sale
agreement to acquire a 71,361 square feet commercial office /warehouse building located
in Lenexa, Kansas which is intended to serve as the Company’s future office and warehouse needs. The building contains
approximately 30,000 square feet of office space and the remainder warehouse space. The total purchase price was approximately $5.3
million, the Company funded the purchase price with cash on hand, without the addition of external debt or other financing. The
Company will be incurring capital expenditures to renovate the building to suit its office/warehouse needs during the balance of
2021.
In
addition, the Company has completed the Elite business acquisition for a total purchase price of approximately $1.4 million during the
six months ended June 30, 2021. The Elite purchase price includes a contingent consideration promissory note payable to the sellers with
an estimated fair value of $350,000 as of June 30, 2021. Management expects to continue its roll-up strategy in the RCM (medical billing
services) industry during the balance of 2021 and beyond.
Lease commitments. On
May 13, 2020, the Company entered into an operating lease for new warehouse and office space, which will serve as its new principal executive
office and primary business location. The original lease agreement was amended on August 28, 2020 to correct the footage under lease and
monthly payment amounts resulting from such correction. The lease terms, as amended include no base rent for the first nine months and
monthly payments ranging from $12,398 to $14,741 thereafter, with a termination date of December 2026. The Company is responsible for
property taxes, utilities, insurance and its proportionate share of common area costs related to its new location. The Company took possession
of the leased facilities on June 15, 2020. The remaining lease term for the Company’s office and warehouse operating lease as of
June 30, 2021 was sixty-six months.
41
The Company entered into an operating
lease with a third party in October 2019 for copiers used for office and warehouse purposes. The terms of the lease include 48 monthly
payments of $1,598 with a maturity date of October 2023. The Company has the option to purchase such equipment at maturity for its estimated
fair market value at that point in time. The remaining lease term for the Company’s copier operating lease as of June 30, 2021 was
28 months.
Lease expense related to the
office space and copier operating leases was recorded on a straight-line basis over the lease term. Total lease expense under the two
operating leases was approximately $65,953 for the six months ended June 30, 2021.
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 June 30, 2021:
Assets:
Operating
lease right of use assets
$
722,843
Liabilities:
Operating
lease obligations-current portion
$
123,356
Operating
lease obligations-less current portion
$
672,216
Total operating
lease obligations
$
795,572
The components of lease expense
were as follows for the six months ended June 30, 2021:
Selling, general and administrative expenses
$
65,953
Following are the minimum lease
payments for each year and in total.
Year ending December 31:
2021(July 1, 2021 to December 31, 2021)
$
91,272
2022
184,145
2023
184,241
2024
171,642
2025 & beyond
348,446
Total undiscounted minimum future lease payments
979,746
Imputed interest
(184,174
)
Total operating lease liability
$
795,572
Debt obligations –
Outstanding debt obligations comprises the following:
June 30, 2021
Economic injury disaster loan (EIDL)
$
150,000
Elite contingent consideration promissory note
350,000
Debt obligations
$
500,000
42
Debt obligations mature as follows as of June 30,
2021:
June 30,
2021
2021 (July 1, 2021 to December 31, 2021)
$
1,482
2022
143,049
2023
143,166
2024
73,286
2025
3,412
2026 and thereafter
135,605
Total
$
500,000
2020 Small Business Administration Notes .
On May 4, 2020, the Company issued
a promissory note in connection with the receipt of the Paycheck Protection Program (“PPP”) loan of $1,418,900 (the “PPP
Loan”) under the SBA’s PPP Program under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”).
The PPP Loan had a two-year term and bore interest at a rate of 1.0% per annum. Monthly principal and interest payments were deferred
for nine months after the date of disbursement and totaled $79,850 per month thereafter. The PPP Loan could have been prepaid at any
time prior to maturity with no prepayment penalties. The promissory note contained 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 used the majority of the PPP Loan amount for qualifying expenses and to apply for
forgiveness of the PPP Loan in accordance with the terms of the CARES Act. The Company applied for forgiveness of the PPP Loan and December
10, 2020, the Company was fully forgiven of its $1,418,900 PPP Loan. Additionally, the Company was fully forgiven, during the three
months ended June 30, 2021, of its $10,000 EIDL advance received with the PPP Loan.
On May 12, 2020, the Company received
$150,000 in loan funding from the SBA under the EIDL program administered by the SBA, which program was expanded pursuant to the CARES
Act. The EIDL is evidenced by a secured promissory note, dated May 8, 2020, in the original principal amount of $150,000 with the SBA,
the lender.
Under the terms of the note issued
under the EIDL program, interest accrues on the outstanding principal at the rate of 3.75% per annum. The term of such note is thirty
years, though it may be payable sooner upon an event of default under such note. Monthly principal and interest payments are deferred
for twelve months after the date of disbursement and total $731 per month thereafter. Such note may be prepaid in part or in full, at
any time, without penalty. The Company granted the secured party a continuing interest in and to any and all collateral, including but
not limited to tangible and intangible personal property.
Elite Medical Billing Specialists Contingent
Consideration Promissory Note Payable .
On June 30, 2021, Nobility
Healthcare, LLC, a subsidiary of the Company, issued a Contingent Consideration Promissory Note (the “Note”) in connection
with the Stock Purchase Agreement between Nobility and Elite Medical Billing Specialists (“Elite”) of $350,000. The note
has a three-year term and bears interest at a rate of 3.00% per annum. Quarterly principal and interest payments are deferred for six
months and is due in equal quarterly installments on the seventh business day of each quarter. The principal amount of the Note is subject
to an earn-out adjustment, being the difference between the $975,000 (the “Projected Revenue”) and the cash basis revenue
(the “Measurement Period Revenue”) collected by Elite in its normal course of business from the clients existing on June
30, 2021, during the period from October 1, 2021 through September 30, 2022 (the “Measurement Period”) measured an a quarterly
basis and annualized as of the relevant period. If the Measurement Period Revenue is less than the Projected Revenue, such amount will
be subtracted from the principal balance of this Note on a dollar-for-dollar basis. If the Measurement Period Revenue is more than the
Projected Revenue, such amount will be added to the principal balance of this Note on a dollar-for-dollar basis. In no event will the
principal balance of this Note become a negative number. The maximum downward earn-out adjustment to the principal balance will be to
zero. There are no limits to the increases to the principal balance of the Note as a result of the earn-out adjustments.
The contingent consideration
Promissory Note is considered to be additional purchase price, therefore the estimated fair value of the contingent liability is recorded
as a liability at the acquisition date and the fair value is considered part of the consideration paid for the acquisition. Management
has recorded the Contingent Consideration Promissory Note at its estimated fair value of $350,000 at the acquisition date. Management
will continue to estimate the fair value of this Note at each reporting date with the change, if any recorded as a gain or loss in the
statement of operations during the relevant period.
Critical Accounting Policies
Our significant accounting policies
are summarized in Note 1, “Nature of Business and Summary of Significant Accounting Policies ,” to our consolidated
financial statements. While the selection and application of any accounting policy may involve some level of subjective judgments and
estimates, we believe the following accounting policies are the most critical to our financial statements, potentially involve the most
subjective judgments in their selection and application, and are the most susceptible to uncertainties and changing conditions:
●
Revenue Recognition / Allowance for Doubtful Accounts;
●
Allowance for Excess and Obsolete Inventory;
●
Warranty Reserves;
●
Fair value of warrant derivative liabilities;
●
Stock-based Compensation Expense; and
●
Accounting for Income Taxes.
43
Revenue Recognition / Allowances
for Doubtful Accounts. Revenue is recognized for the shipment of products or delivery of service when all five of the following
conditions are met:
(i)
Identify the contract with the customer;
(ii)
Identify the performance obligations in the contract;
(iii)
Determine the transaction price;
(iv)
Allocate the transaction price to the performance obligations in the contract; and
(v)
Recognize revenue when a performance obligation is satisfied.
We consider the terms and conditions
of the contract and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract when
the customer order is approved, we can identify each party’s rights regarding the services to be transferred, we can identify the
payment terms for the services, we have determined the customer has the ability and intent to pay and the contract has commercial substance.
At contract inception we evaluate whether the contract includes more than one performance obligation. We apply judgment in determining
the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment
experience or, in the case of a new customer, credit and financial information pertaining to the customer.
Performance obligations promised
in a contract are identified based on the services and the products that will be transferred to the customer that are both capable of
being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily
available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the services and the
products is separately identifiable from other promises in the contract. Our performance obligations consist of (i) products, (ii) professional
services, and (iii) extended warranties.
The transaction price is determined
based on the consideration to which we expect to be entitled in exchange for transferring services to the customer. Variable consideration
is included in the transaction price if, in our judgment it is probable that a significant future reversal of cumulative revenue under
the contract will not occur. None of our contracts contain a significant financing component.
If the contract contains a single
performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple
performance obligations require an allocation of the transaction price to each performance obligation based on the relative standalone
selling price (“SSP”).
Revenue is recognized at the
time the related performance obligation is satisfied by transferring the control of the promised service to a customer. Revenue is recognized
when control of the service is transferred to the customer, in an amount that reflects the consideration that we expect to receive in
exchange for our services. We generate all our revenue from contracts with customers.
We review all significant, unusual
or nonstandard shipments of product or delivery of services as a routine part of our accounting and financial reporting process to determine
compliance with these requirements. Extended warranties are offered on selected products, and when a customer purchases an extended warranty
the associated proceeds are treated as contract liability and recognized over the term of the extended warranty.
Our principal customers are
state, local and federal law enforcement agencies, which historically have been low risks for uncollectible accounts. However, we have
commercial customers and international distributors that present a greater risk for uncollectible accounts than such law enforcement
customers and we consider a specific reserve for bad debts based on their individual circumstances. Our historical bad debts have been
negligible, with less than $258,000 charged off as uncollectible on cumulative revenues of $241.4 million since we commenced deliveries
during 2006. As of June 30, 2021, and December 31, 2020, we had provided a reserve for doubtful accounts of $123,224 and $123,224, respectively.
44
We periodically perform a specific
review of significant individual receivables outstanding for risk of loss due to uncollectability. Based on such review, we consider our
reserve for doubtful accounts to be adequate as of June 30, 2021. However, should the balance due from any significant customer ultimately
become uncollectible then our allowance for bad debts will not be sufficient to cover the charge-off and we will be required to record
additional bad debt expense in our statement of operations.
Allowance for Excess and
Obsolete Inventory. We record valuation reserves on our inventory for estimated excess or obsolete inventory items. The amount
of the reserve is equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about
future demand and market conditions. On a quarterly basis, management performs an analysis of the underlying inventory to identify reserves
needed for excess and obsolescence. Management uses its best judgment to estimate appropriate reserves based on this analysis. In addition,
we adjust the carrying value of inventory if the current market value of that inventory is below its cost.
Inventories consisted of the
following at June 30, 2021 and 2020:
June 30, 2021
December 31,
2020
Raw material and component parts
$
3,184,707
$
3,186,426
Work-in-process
15,530
1,907
Finished goods
8,737,310
6,974,291
Subtotal
11,937,547
10,162,625
Reserve for excess and obsolete inventory
(2,321,788
)
(1,960,351
)
Total inventories
$
9,615,759
$
8,202,274
We balance the need to maintain
strategic inventory levels to ensure competitive delivery performance to our customers against the risk of inventory obsolescence due
to changing technology and customer requirements. As reflected above, our inventory reserves represented 19.4% of the gross inventory
balance at June 30, 2021, compared to 19.3% of the gross inventory balance at December 31, 2020. We had $2,321,788 and $1,960,351
in reserves for obsolete and excess inventories at June 30, 2021 and December 31, 2020, respectively. Total raw materials and component
parts were $3,184,707 and $3,186,426 at June 30, 2021 and December 31, 2020, respectively, a decrease of $1,719 (1%). Finished goods
balances were $8,737,547 and $6,974,291 at June 30, 2021 and December 31, 2020, respectively, an increase of $1,763,019 (25%).
The increase in finished goods was primarily attributable to accumulating inventory for the new and expending Shield and ThermoVU
product lines. The slight increase in the inventory reserve is primarily due to older version legacy products continuing to receive growing
reserves as they age during 2021. 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 the reserves are appropriate given our inventory levels at June 30, 2021.
If actual future demand or market
conditions are less favorable than those projected by management or significant engineering changes to our products that are not anticipated
and appropriately managed, additional inventory write-downs may be required in excess of the inventory reserves already established.
Warranty
Reserves. We generally provide up to a two-year parts and labor standard warranty on our products to our customers. Provisions
for estimated expenses related to product warranties are made at the time products are sold. These estimates are established using historical
information on the nature, frequency, and average cost of claims. We actively study trends of claims and take action to improve product
quality and minimize claims. Our warranty reserves were decreased to $11,562 as of June 30, 2021 compared to $31,845 as of December
31, 2020 as we begin to slow our warranty exposures through the roll-off of DVM-750 and DVM-800 units from warranty coverage. Standard
warranty exposure on the DVM-800 and DVM-250plus are the responsibility of the contract manufacturers which reduced our overall warranty
exposure as these are very popular products in our line. There is a risk that we will have higher warranty claim frequency rates and
average cost of claims than our history has indicated on our legacy mirror products on our new products for which we have limited experience.
Actual experience could differ from the amounts estimated requiring adjustments to these liabilities in future periods.
45
Warrant derivative liabilities.
On January 14, 2021 and February 1, 2021, the Company issued warrants to purchase a total of 42,550,000 shares of Common Stock. The warrant
terms provide for net cash settlement outside the control of the Company under certain circumstances in the event of tender offers. As
such, the Company is required to treat these warrants as derivative liabilities which are valued at their estimated fair value at their
issuance date and at each reporting date with any subsequent changes reported in the consolidated statements of operations as the change
in fair value of warrant derivative liabilities. Furthermore, the Company revalues the fair value of warrant derivative liability as of
the date the warrant is exercised with the resulting warrant derivative liability transitioned to equity.
The Company has utilized the following
assumptions in its Black-Scholes option valuation model to calculate the estimated fair value of the warrant derivative liabilities as
of their date of issuance and as of June 30, 2021:
Issuance date assumptions
June 30, 2021 assumptions
Volatility - range
106.6 – 166.6
%
107.5
%
Risk-free rate
0.08 - 0.49
%
0.87
%
Dividend
0
%
0
%
Remaining contractual term
0.01 - 5 years
4.6 years
Exercise price
$
2.80 - 3.25
$
3.25
Common stock issuable under the warrants
42,550,000
24,300,000
During the six months ended June
30, 2021, holders of pre-funded warrants exercised a total of 18,250,000 warrants which were fair valued at $1,817,549 at their date of
issuance and recorded as a derivative warrant liability. On the date of exercise such pre-funded warrants were fair valued at zero, which
was transitioned to permanent equity during the six months ended June 30, 2021. The Company reported the $1,817,549 change in fair value
from their issuance date to their exercise date in the condensed statements of operations as the change in fair value of warrant derivative
liabilities.
Stock-based Compensation
Expense . We grant stock options to our employees and directors and such benefits provided are share-based payment awards which
require us to make significant estimates related to determining the value of our share-based compensation. Our expected stock-price volatility
assumption is based on historical volatilities of the underlying stock that are obtained from public data sources and there were no stock
options granted during the six months ended June 30, 2021.
If factors change and we develop
different assumptions in future periods, the compensation expense that we record in the future may differ significantly from what we have
recorded in the current period. There is a high degree of subjectivity involved when using option pricing models to estimate share-based
compensation. Changes in the subjective input assumptions can materially affect our estimates of fair values of our share-based compensation.
Certain share-based payment awards, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value compared
to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, values may be realized
from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our
financial statements. Although the fair value of employee share-based awards is determined using an established option pricing model,
that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction. In addition, we account
for forfeitures as they occur.
Accounting for Income Taxes.
Accounting for income taxes requires significant estimates and judgments on the part of management. Such estimates and judgments
include, but are not limited to, the effective tax rate anticipated to apply to tax differences that are expected to reverse in the future,
the sufficiency of taxable income in future periods to realize the benefits of net deferred tax assets and net operating losses currently
recorded and the likelihood that tax positions taken in tax returns will be sustained on audit.
46
As required by authoritative
guidance, we record deferred tax assets or liabilities based on differences between financial reporting and tax bases of assets and liabilities
using currently enacted rates that will be in effect when the differences are expected to reverse. Authoritative guidance also requires
that deferred tax assets be reduced by a valuation allowance if it is more likely than not that all or some portion of the deferred tax
asset will not be realized. As of December 31, 2020, cumulative valuation allowances in the amount of $24,595,000 were recorded in connection
with the net deferred income tax assets. We determined that it was appropriate to continue to provide a full valuation reserve on our
net deferred tax assets as of December 31, 2020 because of the overall net operating loss carryforwards available. We expect to continue
to maintain a full valuation allowance until we determine that we can sustain a level of profitability that demonstrates our ability to
realize these assets. To the extent we determine that the realization of some or all of these benefits is more likely than not based upon
expected future taxable income, a portion or all of the valuation allowance will be reversed. Such a reversal would be recorded as an
income tax benefit and, for some portion related to deductions for stock option exercises, an increase in shareholders’ equity.
As required by authoritative
guidance, we have performed a comprehensive review of our portfolio of uncertain tax positions in accordance with recognition standards
established by the FASB, an uncertain tax position represents our expected treatment of a tax position taken in a filed tax return or
planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes.
We have no recorded liability as of December 31, 2020 representing uncertain tax positions.
We have generated substantial
deferred income tax assets related to our operations primarily from the charge to compensation expense taken for stock options, certain
tax credit carryforwards and net operating loss carryforwards. For us to realize the income tax benefit of these assets, we must generate
sufficient taxable income in future periods when such deductions are allowed for income tax purposes. In some cases where deferred taxes
were the result of compensation expense recognized on stock options, our ability to realize the income tax benefit of these assets is
also dependent on our share price increasing to a point where these options have intrinsic value at least equal to the grant date fair
value and are exercised. In assessing whether a valuation allowance is needed in connection with our deferred income tax assets, we have
evaluated our ability to generate sufficient taxable income in future periods to utilize the benefit of the deferred income tax assets.
We continue to evaluate our ability to use recorded deferred income tax asset balances. If we fail to generate taxable income for financial
reporting in future years, no additional tax benefit would be recognized for those losses, since we will not have accumulated enough positive
evidence to support our ability to utilize net operating loss carryforwards in the future. Therefore, we may be required to increase our
valuation allowance in future periods should our assumptions regarding the generation of future taxable income not be realized.
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.
Item 3. Quantitative and Qualitative Disclosures
about Market Risk.
Not Applicable.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.