Stan Ross - CEO Tom Heckman - CFO

Brian Kinstlinger - Maxim Group Ishfaque Faruk - WestPark Capital Bryan Lubitz - Aegis Capital

Good morning and welcome to the Digital Ally's First Quarter 2017 Operating Results Conference Call. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. Statements made on today's call will include forward-looking statements including statements regarding our expectations, beliefs, intentions, or strategies regarding the future including statements around projected spending. We intend that such forward-looking statements to be subject to the Safe Harbor provided by the Private Securities Litigation Reform Act of 1995. The forward-looking statements information is based on current information and expectations regarding Digital Ally Incorporated. These estimates and statements speak only as of the date on which they are made and are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. All forward-looking statements that are made on today's call are subject to risks and uncertainties that could cause our actual results to differ materially. These risks are discussed in our press releases we issued earlier today and in greater detail in our quarterly report on Form 10-Q for first quarter 2017 filed with SEC under the caption Risk Factors. You may find this and our other SEC filings on our website at www.digitalallyinc.com. Please note this event is being recorded. I would now like to turn the conference over to Stan Ross, CEO of Digital Ally Inc., and Tom Heckman, CFO of Digital Ally Inc. Thank you. Please go ahead.

Thanks, Darla. Thanks everybody for joining us today. Tom is going to do a brief recap of the numbers and give you a little insight on where things are going. I think one of the things that stands out in this quarter that we have been mentioning for sometime is the ability for us to continue to conform the company to take advantage tremendous amount of opportunities that are in the commercial market and that is evident by our numbers, evident by some of the press releases that you've seen to-date and will be evident by some of the future business that you will see coming down the pipeline. So we're excited about how the revenues spike up like they did and look forward to this hopefully trend continuing as we finish out 2017 and continue to move forward with our expansion in the commercial markets. Tom?

Yes. Thank you, Stan. Welcome everyone. I appreciate you joining us today. Do want to remind you that we did file our Form 10-Q with the SEC earlier this morning. Its available on EDGAR website with the SEC and I encourage everybody to take a look at that, that will be a much more expansive look at what went on in the first quarter 2017. My remarks here will be brief, I know there will probably a lot of questions at the end and I want to leave a lot of time for that. So I will be brief but I will try and hit some of the more significant changes for the quarter. Overall on a macro-basis the first 2017 was pretty darn good, especially compared to the last several quarters we have endured and actually all the way through 2016. In particular from a revenue perspective we hit 5.2 million or in excess of 5.2 million in revenue first time in a couple of years that we have hit that higher revenue figure for quarterly basis that represented 18.7% higher than the prior year quarter as well as 52% over what we experienced in Q4, 2016. So sequential was a market change in the revenue figures. Gross margins we recovered a 44% versus 42% in the year ago quarter so slight improvement from a year ago, but a huge improvement sequentially from the fourth quarter of 2016 where we only reported a 4% margin on sales in the Q4 2016. SG&A was slightly down about 3% versus prior year which is encouraging. Although we did have some very good things happen to us in the first quarter. We did report an operating loss of 1.8 million for the quarter but we do see the turn in our numbers based on some of the new strategy that we have implemented with the company in the last year. I will start digging into the new strategy and a little bit more into the numbers that we reported in our 10-Q. As Stan mentioned, our strategy is to shift more to a recurring revenue basis, in other words we want to get recurring revenue over a period of time that we can rely upon and not be so not rely as much on individuals sales and significant product sales, we want the recurring revenue over the longer term. In that regard we did have a couple of announcements in the first quarter. The first one was AMR, American Medical Response which is a division of Envision Healthcare. In fact they are the largest ambulance service provider in the United States. We reported $8.3 million contract over three year period, recurring revenue basis so that was a very nice win for us and I will say that that is the minimum that contract will yield, what we're finding is that they are buying add-ons in particular to asset tracking units which will increase our revenue generated from that contract by about $20 to $25 per month per unit, so that’s a very nice contract for us, of course we're happy to have it. The second one was the airport shuttle. The company that we have done business with for a number of years, they decided to go a 100% to the cloud and that contract will yield 400,000 over three years all on recurring basis where we have the assets already deployed, the event recorder is already deployed in the shuttles and we're moving them to our fleet view cloud offering. We're actively seeking to move more law and commercial customers to our cloud based offerings. We're unveiling several new marketing programs, in particular for our law enforcement to encourage our law customers to go away from the local storage into the cloud storage which would be a generator of recurring service revenue for us and actually relieve the law agencies of the internal costs infrastructure, costs of dealing with their own IT and storage demands. So we're actively seeking to do that. Quite frankly we see the strategy working in moving the company more to a recurring revenue stream and we think that the first quarter 2017 was really the first quarter that we saw the pronounced change based on that strategy shift. Gross margins are recovering, the quality issues we believe are behind us. We're still dealing with some of the older inventories especially the older PCB boards that we have in inventory, we're going through those, but for the most part our quality issues are behind us especially with respect to the body-worn camera. We continue to believe that 60% overall gross margins in the future is a realistic and achievable goal of ours although we've got a ways to go. We did improve quite a bit over last year and also over 2016 fourth quarter margins. SG&A, we did see a small decline over a year ago levels but our professional fees and costs continue to run high. They were totaled around 425,000 for the quarter. Obviously that's a lot to do with the litigation we have going on in regards to the patent cases we have with both Taser and WatchGuard. So we do believe that those costs will continue throughout 2017 unless there is some major shift in the litigation. So beyond the legal and professional fee line we are implementing cost containment measures that we hope will help us be more efficient from an SG&A expense perspective. Some of the new initiatives we have for 2017 and beyond we've already talked about how we're trying to expand a recurring service revenue in the commercial and law business and we're already seeing some results of those efforts. We're trying to expand our international law business especially from a cloud perspective and we talked last time that there was a very nice niche that we could carve out internationally where countries require the data storage to be stored within the territorial boundaries of a country. We believe we've developed a cloud offering that will accomplish that. So we believe we've got a unique and very big opportunity from an international law perspective. We're also trying to expand our commercial event recorder business given that we do have the fleet view cloud offering which is a very powerful cloud offering. I wouldn't say that it's probably the class of the market channel right now and we're seeing AMR and other analysts providers go to that gravitate towards that as well as the airport shuttle business. I expect taxi cabs, limos, ride shares all those industries to follow us into the cloud with the fleet view offering. We've also over the last year have really dwelled into the other non-law enforcement market channels. We've taken a non-traditional approach there where we've really gone after the distribution channel and have the marketing aspects to determine these new markets that we're going to go after and then talk to and develop products using our audio video technology to solve some of the older problems that these people have. And right now that we believe that those markets are vastly under served and at their ripe for new technological improvements that we can provide with our systems. So we've gone out and we developed several of those new market channels and I hope to have some progress to report here in the next quarter or two in terms of winning some significant market share and new customers within those markets. We believe the innovative solutions we can provide will catch on quickly in these new markets. We do believe it's huge opportunities there. Overall the first quarter 2017 was a pivotal quarter for us where we saw some very big strides in the right direction both profitability, sales and these new markets and we believe that if we continue this and we hope we do that they will return to profitability later in 2017. These new markets will be a big part of that as well that we're chasing after. Again thanks for everyone's patience in joining us today. With that I'll turn it back Stan.

Thanks a lot Tom. I too would just reiterate and stress the things that we've done in regards to continuing to diversify this company, the law enforcement market has been great to us, continues to be great to us. We have a very large percentage of the overall industry that buys from us for their video solutions. We will keep them as good long term customers as long as we continue to provide quality products and services to them which I'm confident that will happen. So really the big expansion that you will see is going to be outside of law enforcement and while you're just now starting to see some of the news I assure that we anticipate quite a bit more in 2017 some probably even in areas that you may not have thought that there may been such a large need for video solutions. So I'm pretty excited about where that's going on. We also have a lot that’s going to be happening here in the second quarter and in the near future in regards to our litigation just in regards to timing of certain events that we know that are on the horizon unless there is some type of rescheduling some of this litigation expense hopefully will start come to an end and there will be some resolution on where our patents and the industry stance concerning happen to observe our patents. So Darla I think we're at a point we'd like to go ahead and open this back up to Q&A.

[Operator Instructions]. We do have a question from Brian Kinstlinger with Maxim.

So great job on AMRT contractor in the quarter and getting the revenues there, can you talk about what's left in terms of deliveries this year and then can you remind us what percentage of that AMR revenue is recurring as you mention it's per unit per month?

We've delivered about 1550 units, well we will deliver about 1550 units in 2017 .We're doing them about a clip of 40 per week and we're also doing the installation as we go and that's been the bottleneck if you will in terms of getting those out. Now in terms of the monthly revenue I think I managed to mention during my prepared remarks that that will many, in fact I think all of the local locations that are adopting this technology have gone ahead and gone with the asset tracking unit. The asset tracking unit piece of that alone is about $23, $25 a month per unit per month. On top of that you've got the fleet view which is about $15 to $20 per month depending on some of the configurations of -- they would elect to do. So you're talking $40 to $50 per month of recurring revenue for those that are taking both the ATU and asset tracking unit and the fleet. So it's a significant number.

Yes, correct me if I'm wrong, Tom, but we also have -- there is upfront expense as well that are that they're paying that's more for the hardware right off the bat. So there is a combination Brian, as I didn't want to -- there is a sort of a combination of acquiring the hardware along with the ongoing with the cloud services and asset tracking that we have there.

Now with that said, since you are 40 per week right now for much of the year as well as the recurring piece, do you expect Digital Ally is going to sustain or better than first quarterly revenue I mean or be there about especially as maybe international begins to recover?

You know the biggest thing is, I mean right now we're feeling pretty confident that we have the supply channel to continue to is to support those kind of numbers coming in on and so we don't anticipate any drawback there. The biggest thing is just and we do have a well laid out plan on where to be, when to be there, when they're going to have the vehicles available to us to and do all these installations. So there is a little bit of a combination, not trying to avoid your question but there is it's important that we -- the timing for both parties continues to work real well with each other even to the point where we could accelerate this. So as long as everything stays the course its going and there's no hiccups on either of our parts in regards to being able to provide product or them to be able to provide us the locations to get to. We should have a pretty good and favorable second quarter.

And then in terms of percentages, what percentage of revenue in the quarter was related to body cameras?

Hang on a second, I will give you the exact. First use represented 13% of our total sales, now it was a reduction from the prior year but I think I think given the difficulties we've had with some of the performance issues on the first few because of quality deals and all that, I think that we will rebound down the road. We fought a lot of fires both comparatively with the patent infringement and so on and so forth and some of the press releases that were out there so we've been swimming upstream if you will with the first few for the last couple of quarters.

In the quarter can you in this past quarter even up till now can you speak to the performance of those first use [ph], is the inventory issues all behind you and so now is it normal margins?

Very large number, I mean we really have been out there doing the replacing all the products and everything else and what we're seeing is a very high quality of the units that are out there today are working as advertised. We haven't found any real pickups out there. So I would say the reliability and the stability of the product is really strong so the margin should start to increase from that perspective as well.

Last question, you know you mentioned in the second quarter we may see some news on the patent lawsuit. Can you describe what the next event is and when you think that might happen if there's no delays?

Yes, so there's a couple things and you've got to realize there's two different channels that some of the stuff is going down. One, we have litigation going on against Taser and Taser really is the fighting us in the court room, they're fighting us again in the patent office which this is their second round of attempting to do this. So we know that in the second quarter at some point the patent office has to say okay we're going -- you guys have done this was, we're going to be one more shot you're going to have your day to get in front of the panel and try to explain to us why you think -- why you taken the direction you're taken or it's possible that the patent office says, look we've already been through this exercise you haven't shown us anything worthy enough to giving you your day in court so therefore no and if that should happen which that that would be sort of rare I mean they're going to want to react on it and be cautious going into just because of the impact that this would have on the industry. So they will probably get the ability to get in front of the panel but by chance they don't then that sends a signal throughout the industry that the watch guards and the other companies that we put on notice will have to be dealing with this because all of them have been in some fashion or form we believe violating those patents as well. The second avenue is one of the companies, there's three different patents again around our ecosystem of auto-activation and that particular company called WatchGuard, different court, different judge. It continues to move forward and we may see some yet this quarter understanding the position that the courts taking yet this quarter from that perspective which would bleed over to Taser as well that very suddenly it does happen but I mean I think one judge is going to look at the other judges work, they are either going to pine on it or there had to be a big mistake one way or another. So those two key events we look to have happened this quarter at least some rumblings of the position this quarter. If by chance Taser would get their day in court to try to explain why they believe that in the position they're taking I think that has a nine month deadline on it. So the product is scheduled within the first 3 to 6 months, we would all get in front of the panel and say this is why we believe they violated, this is why we believe what they're presenting for us does not come into play and hopefully you could have a ruling and technically you would have a ruling within the nine months but hopefully would have sooner than that. The WatchGuard situation right now we'll just see what the judges say on that on how quick that’s going to be. That's probably it and that's all Brian.

Your next question is from is from Ishfaque Faruk, WestPark Capital.

Do you guys have any similar contracts in the pipeline like the AMR one, that one was a huge win for you guys. I mean like do you have similar negotiations in place right now?

You know I'll tell you this there are clearly entities that we're talking to that a contract of that magnitude is possible.

All right. Okay. And a couple of along the same lines, your software service revenues have been growing significantly and going forward do you expect Stan or Tom them to be like growing much faster from these levels considering like that AMR contract has like a lot of software revenues from asset tracking as well as fleet?

Yes I do expect service revenues to increase. I wouldn’t say exponentially but significantly throughout '17 and beyond and here's one reason for that, the AMR contract was announced early in the first quarter but we had to get the supply chain in order we had to get the units in place and we had to get our install team there to turn that revenue on. So there was very little revenue generated from that AMR contract that hit our books in the first quarter of 2017 other than the product revenue, the hardware revenue. So I would think that the second quarter just from that alone would be a significant increase just from the AMR revenues generated. Secondly, the airport shuttle contract will kick in the second quarter now it will take us most of the quarter to get it all turned on. They have a number of locations but it too will generate revenues in the second quarter that it generated zero service revenues in the first quarter. So just those two contracts alone will have a significant impact on the quarterly results as well as we are undertaking several new promotional campaigns to move law customers to the cloud and generate additional recurring service revenues as well as old fleet customers that don't utilize the fleet view cloud service for their commercial event recorders. We're enticing them if you will to go to the cloud as well because believe me and Stan can pipe in as well but I think that fleet view cloud service is the class of the industry right now and I think once they see it, use it, feel it they're not going to go back to the local service. So yes I do believe that second quarter 2017 will show market improvement as well as throughout the rest of '17 and beyond in service revenues.

Okay. And my last question, could you guys give us some update on the litigation against [indiscernible]. There was supposed to be ruling in the court at end of March or early April if I'm going by memory here. And what are like the next steps regarding that?

Yes, Ish, I think what you're talking about is -- and jump in and correct me if I'm wrong but I think what you're talking about in March originally the courts had a. Marksman's hearing scheduled for this. Is that what you're talking about?

Yes.

So what happened there is the judge when Taser acts on who we want to call him now they basically said, hey the patent office has taken a look at this and a tremendous amount of our argument is going to be relevant from how the patent office responds, therefore would you stay in other words reschedule this meeting for a later date so that we would have more information at that point in time and the courts awarded them that additional time. So again I think what we're hoping to see is the patent office to continue to move forward and come up with a decision whether or not they're going even allow them an opportunity to get in front of the panel or if they're going to just you know you've already done this once and what you showed us today hasn't changed our minds therefore we're not even going to give you the hearing that would be pretty devastating to them and the others. Just because that sort of supports the reasons that we were awarded the patents to begin with. So that’s where exactly the courts pushed it back and rescheduled.

Your next question is from Bryan Lubitz with Aegis Capital.

I want to specifically focus on the margins. As you guys know I have been buying your stock for very long time, and a 5.2 million quarter is a pretty significant quarter for the first quarter that I can remember. Margins up a 43.5%, you guys continuously focus on trying to get to 60% gross margins. Hypothetically we're at 55% gross margins or even 50% gross margins with this number with a 5.2 number. How close are we to being profitable with that revenue?

Bryan as we said before our goal is 60%, we've exceeded that in the past and I think given the change in our revenue mix to a more service recurring service model that should be a very good goal for us that is attainable in the near term. The math is pretty simple you know you do a 5.3 million quarter you add 16% to that that’s a significant number, 800,000 or 900,000 and then secondly you take the litigation expenses out or reduced significantly which really is an operating, it's in our view an investment in the patents and in protecting our proprietary rights. So you've fixed the margin, you're getting pretty darn close to breakeven on an EBITDA basis, you get up to the upper 50% to 60% you're going to be very close as well as watching the SG&A line and controlling the litigations spend as well, that would fix a lot of things and obviously you take out the non-cash charges, the stock compensation, the depreciation, the amortization, that sort of stuff. Hopefully that gives you to a breakeven type quarter given the revenues that we generate.

Okay. So that being said when we're building up our service business, the residual business is sticky business, the stuff you guys are getting from the VuVault and obviously the asset tracking etcetera. If that continues to build and snowball and gets momentum like you guys are saying that's what's going to correct margins or obviously some of the other issues we've had in the past we've knocked out those being completely knocked out that will get us to that number.

Well Bryan its Tom again, we clearly had some lingering issues with the products in the first quarter. We increased our ops [ph] lessons reserve in that and quite frankly we reserve for everything we know about at a point in time, and at the end of the quarter. We thought we had that done at the end of December but there was some products that came in after the quarter closed that needed to be replaced in that. So as of now we think we've fixed the quality problems or reserve for, we do have some reserves for some couple of customers that we're going to take care of. So that by itself that’s 600,000 to 800,000 damage to the first quarter. So you add that back to it and then beyond that you get the service revenue which if you look at the financials we generated service another revenue of 545,000 and only had costs to goods sold of 178,000 so that by itself gets you well over 60%. So it's a combination of the two, I mean obviously we've got to get our product quality behind us, issues behind us which I think we have and we've appropriately reserved [indiscernible] in the quarter and then you couple that with the recurring service model that's in place now. I think we've got the makings of a pretty good gross margin.

What I wanted to ask in regards to AMR, in our past calls we've discussed a potential of expansion there. Are we to assume that the potential for expansion of what I'm talking about is EMTs etcetera, that would not really be signed unless we fulfill the remainder of the contract in terms of the 6500 ambulances?

Well there's several things, they are actually already have been looking at additional equipment that they have been adding to their package. So over and above the pre-announced numbers that we threw out there and they are a very aggressive growing company so we could see them saying and we made an acquisition and/or additional growth therefore we need to add another x-amount of units into the mix and this has been working out really well for us. Is there any way we can figure out a way that to double up on the amount of units and installations on a weekly/monthly basis. So all of that could happen -- we bit off about as much as we both parties were comfortable in handling in the short term but as we start to get a little rhythm and want to try to double up or duplicate it to a higher number that could be a possibility Bryan.

Just to add a couple of things, first of all the AMR has committed to a full fleet deployment with us and they are very acquisitive. They acquire locations left and right and as they acquire those things we will obviously bring our units into those, that will be organic growth with AMR. But secondly I think you may have been hinting at is they do have upwards to two EMTs per imbalance and obviously they've got event recorders or in vehicle event recorders and it might make some sense at some-time down the future to put a body camera on EMTs and that would be a very, very logical extension of that contract. So yes there's a lot of opportunity to grow that that relationship and the major thing is that they've committed to us as a long term vendor, supplier of audio video technology to them and it may come in several different forms. Body cameras, event recorders maybe even stationary cameras, there's lot of growth potential there.

So you were saying roughly two EMTs per each ambulance if they were to sign for that essentially could double the size of that contract?

Yes I mean especially if they continue to do the cloud type of solution everything else, that would probably a good number.

Okay. So it seems that obviously you're getting a lot of traction with the residual business. Your gross margins are improving. We have a couple of nice contracts in the pipeline. The one thing that I noticed in your stats that seem to be going up is that your short percentage of float is now approaching 15%. This will be my last question for you guys. If you address your short shareholders what would you say to them?

Well they are probably bunch of Taser shareholders, they are banking on quite a bit but, like we really are pretty excited about I guess sort of the diversification this company is continuing to evolve into and the continued support from our existing customer base. As we continue to see new markets come in and continue to see the new recurring model develop and grow it's got to make them think twice and if we would be fortunate enough to get through this litigation and it plays out like we hope it can they will have their hands full trying to cover.

Your next question is from [indiscernible].

I just want to understand the timeline, make sure I understand it clearly, the patent office will decide if they want to hear the arguments again from Exxon and WatchGuard here in the June quarter and then from there we have a nine month window we will get to final resolution. I want to make sure I understand that and then my the second part of that question is the nine month window is that clock's already started at the end of March or does that start after the patent office makes its decisions. Thanks.

So George, I will deliver this best I can. Obviously we get our updates from our counsel and obviously like Marksman's hearing I was excited about having our day in front of a judge back in March and of course they get pushed back but my understanding this is how I understand it is that the IPR request that Taser has filed, the patent office will make a decision whether or not they want to hear the request here in the second quarter. If they agree to hear it then I believe it to be a nine month window that is when it will be scheduled and ruled upon and completed and so that's my understanding. So let's say that it's the end of quarter they sit there and say okay, we're going to give you your day in court, it's too important, let's just everyone come up here and speak, tell you story Then I believe it to be another three quarter sometime in that window that the decision has to be made from the patent office and that's how I best understood it. I don’t know if you've got a buddy that’s a patent attorney but best to my knowledge as I recall that that is sort of the scenario in that regards concerning the IPR request. If they are awarded the time it doesn't really mean anything one way or the other and regards to who's right, who's wrong it just means that they are going to get their day in court to explain their story.

And there are no further questions at this time. I would like to hand back to the presenters for any closing remarks.

Well again both on behalf of Tom and I, we both want to thank everybody for joining us today and I know it's one of those when you have -- your year-end call about 30 days about and then you get your first quarter following riding behind it, there's not a lot of things that develop that are new that you didn't get to hear about on the call but we do appreciate everyone's participation and look forward to visiting again with you in about 90 days. Thank you all.

This concludes the Digital Ally First Quarter 2017 Operating Results Conference Call. You may now disconnect your lines.