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Edited Transcript of DGLY earnings conference call or presentation 15-Aug-19 3:15pm GMT

Q2 2019 Digital Ally Inc Earnings Call

Overland Park Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Digital Ally Inc earnings conference call or presentation Thursday, August 15, 2019 at 3:15:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Stanton E. Ross

Digital Ally, Inc. - Chairman, President & CEO

* Thomas J. Heckman

Digital Ally, Inc. - CFO, VP, Treasurer & Secretary

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Conference Call Participants

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* Brian D. Rockowitz

Madison Global Partners, LLC - MD

* Bryan Preston Lubitz

Aegis Capital Corporation, Research Division - VP of Investments

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Presentation

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Operator [1]

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Good morning, and welcome to the Digital Ally 2019 Second Quarter Results Conference Call. (Operator Instructions)

I will now turn the call over to Stan Ross, CEO. Please go ahead, sir.

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [2]

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Good morning, everybody. Thanks for joining us. I have with me today, Tom Heckman, the company's CFO, which will do a little recap of last quarter's numbers, and then I'll touch on some of the highlights that we had last quarter and also give you a little insight to what we see as the remainder of 2019 for the future.

Tom?

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Thomas J. Heckman, Digital Ally, Inc. - CFO, VP, Treasurer & Secretary [3]

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Okay. Thank you, Stan, and welcome, everyone. Appreciate you joining us. I do want to let you know that we filed our Form 10-Q yesterday evening, and hopefully, you've had a chance to look at it. It will be a more detailed analysis of the quarterly operating results that I'll go through here. I will discuss a few of the major events and initiatives that happened during the second quarter, which we believe will also continue for the rest of 2019 and beyond in a good way.

So let's look at some of those major events. First of all, in a litigation aspect, we had 2 major events. Number one, the WatchGuard settlement, which has been out there, and we've done press releases. So hopefully, everyone's in tune with what happened there. We did receive $6 million cash in settlement of that litigation. And more importantly, they have until December 2023 to design a workaround and implement a workaround, where we can reinstitute a lawsuit at that time. So it's a $6 million settlement that we received during the second quarter and obviously, had a big impact to our financials.

The second area, and not so good a impact, was a summary judgment motion was granted by the judge in the Axon case. I would tell you that: number one, it's unexpected; number two, it's unfortunate; but number three, it is reversible on appeal. We have appealed it, and we fully, fully believe that it will be reversed as an error in judgment by the judge on granting that. So we're very optimistic on the results of that. The problem is it has delayed the lawsuit in us getting in front of a judge and jury with Axon for a number of months. I can't give you exact time line, but we're looking at least 6-, 8-, maybe 9-months delay in what we had anticipated in a trial date with Axon.

The other thing that impacted us in a indirect way was the increase in the BKI obligation. BKI is a litigation financing, and if you recall, they were paid out of the proceeds of our litigation with both WatchGuard and Axon. So obviously, we received $6 million in the WatchGuard settlement, so that went against the obligation. And then, the delay in the Axon case, due to this unfortunate decision by the judge, also has increased the valuation of the obligation. So we do fair value that in our financial statements, and unfortunately, the valuation experts view that as very positive developments during the quarter and increased the obligation by $3 million, which was a noncash charge in the nonoperating expenses, noncash charge during the quarter. So if you -- on a macro level, we settled for $6 million with WatchGuard, but we gave back $3 million of it in an increase -- noncash increase in the expected obligation to the litigation financiers. So kind of an offset to the overall good settlement with WatchGuard.

In a related matter, the settlement with WatchGuard stopped the legal spend on the WatchGuard case, and the appeal has also slowed the march towards the trial date. So it slowed our legal spend in the second quarter. And in fact, we were $200,000 less in legal spend than in the prior year. We do expect that the lower spending in litigation costs will continue through the end of the year until the appeal is heard and hopefully reversed. And then probably next year, it'll pick back up as we march towards trial with Axon.

The second major area is the new product that we announced and launched late in the second quarter, the EVO-HD, which is a law enforcement-styled in-car video system, really a leapfrog in technology. We believe it is the only 5G offering on the market right now. So we've definitely caught up and surpassed our competitors in terms of features and technology. We launched that and began deliveries late, late in the June 30 quarter. So it really didn't have a lot of effect on our -- direct effect on our revenues. We did get some revenue units out, but we did see that customers delayed their purchasing decisions for that launch, so that they had time to review the features and how it worked. And we hope that we'll see renewed spending and increased market share in the second half 2019 because of the EVO-HD launch. In reality, it is a high-technology leader in our law enforcement market, especially compared to our competitors, but what it does for us also, since it is connected, it's fully connected all the time 5G, it will substantially reduce our support cost. So whenever there are troubleshooting needed or new firmware that comes out, we can push that centrally and remotely to all the deployed units. So it will really help us in terms of the cost of supporting that new product. So we're happy with the EVO-HD, and we're -- we look forward to seeing that take on some new market share for us in second half of the year.

Then another area that we've gone into and we've talked about for some time is moving more aggressively to our service line and especially in the commercial area. And what we've launched is an event solutions category for us. And really, what -- if you step back and look at it on a macro level, there's a lot of single regular events, maybe infrequent, but regular events, take, for instance, football teams. NFL teams played, what, 16 regular season games at a minimum and then probably only half of them at home. So they are a huge market for us, but they have infrequent needs for our services. So what we designed is a full turnkey solution that these teams and event organizers do not have to actually buy our body cameras. What they're doing is buying our servers. So we would provide the body cameras, the servers, the pipe up to the cloud, storage, management, batteries, all that stuff for each one of the events. And it seems they've been taking off. Now we did announce a multiyear agreement with the Kansas City Chiefs here in our hometown, which we're very proud of. And obviously, with the football season upon us, we expect some good revenues to be generated by that.

We also announced that we were awarded a very prestigious award for a similar product offering that we featured at MetLife Stadium, which is in East Rutherford, New Jersey, and which is a home of the New York Giants and Jets. So we believe that this is a growing area for us, and it's innovative use of our technology, and more importantly, it will generate a lot of service revenues for us on a go-forward basis.

We also announced that we entered into a 2-year agreement with Rahal Letterman Lanigan Racing team, which, for you racing fans, is -- you probably know who they are. For those that are not, they are very well-known Indy series racing team and the Letterman in there is David Letterman from the Late Night show. But anyway, it's a 2-year agreement where we are providing the first-ever live streaming video from their garages. And I think they got 3 or 4 cars in most of the Indy series races. So we're live streaming from their garages. And this past Indy 500 was our first time doing that, and the initial results were very encouraging. The number of hits and the people had tuned in on -- from the streaming broadcast was higher than our expectations. And again, this is a 2-year agreement. So we'll see how it goes next year, and potentially, that could develop into some more areas of service revenues for us.

We also, just recently, in fact, last week, announced a partnership with KMC Brands. KMC Brands is a very well-known company here in the Kansas City area. And for those that don't know Kansas, the State of Kansas approved or is now allowing industrial hemp to be grown in the state and processed and sold. So we're working with KMC Brands to develop a video documentation validation program, in addition to security, obviously, for the industrial hemp that's grown in the state. In other words, what we want to do is provide security for hemp growers within that Kansas and other states that have approved hemp and then also be able to validate where it was grown, how it was processed and how it got to the dispensary. So from start to finish, we'd be able to provide video documentation validation for that. And with the number of states that are now allowing marijuana as well as industrial hemp to be grown and processed, we really view this as a growth industry for us because there is an obvious need for video documentation and our solutions, especially our body cameras. So we believe that'll be a good area of growth for us.

So as you can tell, I'm getting -- I'm very excited and we're moving very aggressively into the commercial markets and especially the service revenues, anything that will generate recurring service revenues for us. And the reason why is, obviously, if you look at our financials, service revenues generate roughly 80% margins -- gross margins, very high gross margin for us, and it's grown substantially pretty much every year. It's now up to 25% of our total revenues as compared to 16% in the prior year. And we believe that, that percentage of total revenues will continue to increase, especially with our event solutions and our industrial hemp offerings. Needless to say, we're going to continue to be aggressive, and we're looking for new commercial areas to grow our business.

During the quarter, our SG&A expenses, excluding the $6 million litigation settlement, which showed up in our operating expenses as a negative expense or a income item, was up significantly. And if you look at it, really, there is 2 areas that generated that increase in SG&A expense. Number one, we had increased R&D, research and development spend as we finalized the development and launch of the EVO-HD. I believe that we'll see a reduction in the coming quarters to more historical levels on the R&D basis because we've now actually launched the EVO-HD. Our selling and advertising expenses were up significantly, primarily due to our NASCAR sponsorship. So we -- the NASCAR race was in the second quarter, hit us in the second quarter. So we don't see that happening again for the rest of the year.

So at a net-net basis, we recorded a net loss of $387,000 for Q2 2019. That's compared to a $3 million loss in the prior year. So quite an improvement year-over-year. But more importantly, our operating cash flow has turned positive. We are $1.3 million positive operating cash flow year-to-date and $2.9 million, almost $3 million, for just the second quarter. So some very good improvement in the operating cash flows.

A couple of subsequent events that have recently been occurred. We issued $2.5 million -- roughly $2.5 million of principal balance in convertible debentures at $1.40 per share to provide us some liquidity. That closed about a week or 2 ago. And then we were just recently notified of the pending issuance of our breath analyzer patent, which was announced a year or 2 ago that we filed for this patent. What we're doing is integrating the breathalyzer, if you will, into our video systems for better documentation for the court, obviously. We're looking at ways to take that to market. There are some well-known and very established breath test kit providers out there, and that may be an avenue we go. But we're just now exploring how to take that thing to market. But we believe that's going to be a game changer in how the breathalyzer market is approached.

I guess at the end of the day, neither Stan or I or the Board are really satisfied with our operating results year-to-date in Q2, but we are optimistic that the new commercial service revenues, coupled with the new EVO-HD law enforcement product that's out there, will improve revenues for the second half of 2019 and beyond.

So with that, Stan, I'll turn it back to you.

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [4]

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Yes. Thanks a lot, Tom. And it was great sort of recap and also a good insight to where we see things developing over the next few months and quarters. I'm very excited not to maximize the understanding of the most recent notice that we received in regards to the breathalyzer patent. And that began as a total new market that we'll be able to enter into that should enhance our ability to get in front of different law enforcement departments and other areas outside, even in the commercial side of things. It was a big utilization for breathalyzers outside law enforcement.

So that along with some of the other patents and we're pretty optimistic that are coming down the pipeline that could give us a leg up in numerous areas. I think you will see a couple of new partnerships that will be announced between now and the end of the year. So I agree with Tom, and I think the whole Board does, that we have a very exciting outlook in regards to the remainder of this year and clearly going into next year on how these products could really get a lot of traction and continue to grow.

So I think what we'll do now is go ahead and open up the floor for some Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question is from [Donald DeFilippo].

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [2]

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Let's jump to the next one.

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Operator [3]

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Your next question is from Bryan Lubitz.

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Bryan Preston Lubitz, Aegis Capital Corporation, Research Division - VP of Investments [4]

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Questions about the patents that you guys have just referenced, Tom had referenced, in terms of breath analyzer patent. Did you guys say you were looking for ways to monetary -- to monetize that into the product? Or are you already marketing that? What's the end result in terms of what that can do in terms of bringing sales to the actual product?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [5]

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Yes. So Brian, this is Stan. The technology and the patent surrounding the breathalyzer, we've got a couple of different options. One is flat go out and try to reinvent the wheel a little bit and design our own product and announce it or we just sit there, in which it's a much quicker path, and partner up with one of a half a dozen breathalyzer companies that are out there that would be able to have sort of the exclusivity in this particular patent. And that way, if they've got a real and/or a large customer base, the video side of it would allow us to come into sort of their market area as well. So we're either going to -- and I have to tell you, we're leaning towards partnering up with someone more than anything in regards to implementing our technology into theirs, their breathalyzers, and then having that coupled with our video solutions.

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Bryan Preston Lubitz, Aegis Capital Corporation, Research Division - VP of Investments [6]

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Okay. Also this past quarter, out of the U.S. Patent Office, you guys were granted, if I'm remembering correctly, a patent on the stun gun. Can you elaborate on that?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [7]

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Yes. So the wireless taser, basically, is what we call it in short, we did receive a patent on it. There is clearly a uniqueness about what its capabilities are able to do surrounding the patent. Again, it is a -- quite a bit more of a little bit of a challenge as far as how to implement that versus, say, the most recent patent that we got on the breathalyzer, but is definitely something that is in the queue in regards to our research and development and figuring out how to bring that to market.

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Bryan Preston Lubitz, Aegis Capital Corporation, Research Division - VP of Investments [8]

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When you say challenge, what exactly are you talking about? Do you mean taser?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [9]

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Yes. Exactly. I mean again, you got to look at this. This is a pretty cool device. Instead of the standard stun guns that are out there now utilizing wires to connect to probes that create the energy that stuns the individual, this would be a wireless device. And so you're actually launching a module that would hit the individual and then be able to deliver the stun, and there's also a situation that you can regulate the intensity of the stun as well. So it's a little more of a challenge in the development than like I'm saying on the other breathalyzer technology.

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Bryan Preston Lubitz, Aegis Capital Corporation, Research Division - VP of Investments [10]

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So manufacturing part of it is where you think you see a hurdle? Is that what you're trying to say?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [11]

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All -- yes, all of the above. We got more work to do.

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Bryan Preston Lubitz, Aegis Capital Corporation, Research Division - VP of Investments [12]

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All right. Now you guys have mentioned that you had a couple of different partnerships that you started this past quarter, KMC Brands, the racecar company and obviously, Kansas City and MetLife. Do we expect to see revenue generated out of these partnerships that should allow us to go profitable in the future?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [13]

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Yes. I mean it's just -- you can definitely see the avenues that we're going down and the situation of security side of things in the business, like Tom said, I mean, we're up to 25% of our revenue is now reoccurring revenue. And so it continues to grow, and we continue to have relationships that we're building upon, and these are nice contracts, 3-year contracts. And they're filling us out a little bit as we are what their needs are. But I think you'll see additional -- not only partnerships come into the sectors we've already discussed, but I think you're going to see some new areas, where our video solution will come into play that we'll be able to announce that we have not dabbled in, in the past.

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Bryan Preston Lubitz, Aegis Capital Corporation, Research Division - VP of Investments [14]

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So you're expecting more partnerships to arise out of, I guess, NASCAR and your relationships there?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [15]

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Absolutely. That NASCAR relationship, the Indy relationship, the B2B that has been developed through those groups is priceless. I mean it's -- we're getting in front of the right people to be able to talk to them about how to deliver the right solution for their needs. And as you know, the engineering capabilities that we have and support, we can adapt to pretty much meet all their needs.

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Bryan Preston Lubitz, Aegis Capital Corporation, Research Division - VP of Investments [16]

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Okay. So that brings me to my last question for you guys. A couple of months ago, right before -- or a month ago -- right before you guys released EVO, you had a press release saying that the presale orders were well ahead of expectations. If you were to comment, Stan, on your pilot programs right now and the amount of, I guess, people that you're working with, companies that you're working with on these pilot programs, what would you say in terms of based upon the amount you're working with today as compared to the history of the company?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [17]

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The EVO product has absolutely lived up to expectations. I mean that is the bottom line. And so now, if we've got a department that has a need, has the capital, and we're able to go in there and show them what all this product is capable of doing, we really, really are looked upon very favorably to go -- for them to come our direction. And they're not pilots programs anymore. And we're looking at orders coming in, and it's starting to happen. I mean they love the product.

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Bryan Preston Lubitz, Aegis Capital Corporation, Research Division - VP of Investments [18]

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So you had pilot programs a month-or-so ago and now you're actually converting those into contracts is what you're saying?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [19]

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Correct.

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Operator [20]

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(Operator Instructions) And you do have a follow-up from [Donald DeFilippo].

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Unidentified Participant, [21]

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Now I have 1 question and 1 comment. My question is in regard to the appellate court, which it provides a form for an opportunity to not to try the case again but to get a type of review of: one, de novo, which is new; or two, a clear error of the court, which tries to identify a clear error. It will not substitute its own judgment about what the right decision should have been made. Now can you tell me what the lawyers have come up with where the error was made by the original court?

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Thomas J. Heckman, Digital Ally, Inc. - CFO, VP, Treasurer & Secretary [22]

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[Donald], this is Tom. I'll try and answer that. And I'll preface this by saying I'm not a lawyer, not an attorney. But from what I understand, this is a de novo case where they'll rehear it and come to their judgment. We believe that the judge misinterpreted the claims in the actual patent. And it was, in our view, a very clear error. So I guess, what you're asking is if we believe it was a clear error that's reversible and that he did not read the claim correctly and it's completely reversible. So number one, it is de novo. It's a new hearing in front of the appellate judges on that specific issue and understand that the judge only ruled on that issue, the summary judgment. He did not say our patent was invalid. What he said was that Axon did not infringe because of that 1 claim, the way he interpreted it. So we're very optimistic about the outcome of this appeal.

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [23]

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Yes, [Donald], this is Stan. I'll just chime in real quick and because we actually just met with them yesterday, the attorneys, and we still all are sort of shaking our head because you would have thought that there may be some areas that maybe he could have misinterpreted. But this one, in our opinion, was so clear. It was the last thing that we thought he would hang his hat on because we feel very, very confident that he just misinterpreted it.

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Unidentified Participant, [24]

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I see. And now you say that this new court hearing might take up to 9 months. Is it possible to speed things up?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [25]

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So here's what we know, and this is sort of the format, and like I said, we met with them yesterday, so we'll be a little more informed on -- for this call. What will happen is that they will -- we'll file our brief on the 26th of this month. So we're right around the corner. So we'll have that filed, and then we were told that, I believe, it was 40 days that they have to respond, and then we'll have a short period of time to respond after that. Then they will actually schedule -- once we file, they will actually schedule the -- what I'll say, the oral argument where we'll actually be in D.C. in front of the panel. And it won't be just one. It will be a panel. And we'll be able to both talk on the subject, and then they normally rule within 90 days. So you could say that if everything clicked along pretty nicely, you're looking at probably end of ruling could be as early as 6 months, but realistically, you're looking -- probably 6 to 9 is the window.

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Unidentified Participant, [26]

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Okay. Very good. Now I have 1 comment concerning the bonuses you paid to the officers and yourself. Is it possible you could rescind those bonuses based on current financial condition of the company?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [27]

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I don't know about rescinding. But I received your letter the other day, and I very much appreciated it. It's something that the Board is clearly looking at, what we have to do, whatever it's going to take for us to get back to profitability. And so everything is on the table to be looked at, for sure.

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Unidentified Participant, [28]

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Well, that's what everyone is looking for, profitability, whether it would be $0.02 or $0.03 a quarter, whatever, but as long as it's positive.

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [29]

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We totally agree with you.

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Operator [30]

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Your next question is from Brian Rockowitz of Madison Global Partners.

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Brian D. Rockowitz, Madison Global Partners, LLC - MD [31]

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Tough quarter for you guys. I wish you tremendous success in this appeal process and going forward with some new business models that you guys are looking to do regarding your new patents. Over the last 8 quarters, 6 of them have seen declines in revenue. Do you attribute any of those declines over the last 6 -- those 6 quarters to companies switching over from using your products, law enforcement agencies that you've already had onboard that have gone to whether it's VIEVU, whether it's Axon or anybody?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [32]

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As far as the -- there's obviously a couple of products that we have. But as far as the in-car systems, I don't know that, that was a dramatic loss on some of -- in that area. Obviously, the way that Axon has approached the body camera side of the business and basically buying the business and given a product away for a year free, that clearly was something that we couldn't have weathered that storm, I mean. And they know that. And so they took that kind of tactic. And while we think there's some real issues there and after they used their product and see the real costs associated with it, I think those -- they may not continue down that path. But that clearly had an impact on our body camera side of things. The commercial side, again, like Tom mentioned, we're still seeing good growth there. And you have to realize, Brian, that when we're talking law enforcement, they're making big purchases, okay? And so you get that upfront flush of money when it comes to the in-car systems and even some of the body cameras to where these contracts that we have on the reoccurring revenue, it is a monthly fee that we're bringing in or even a yearly fee that we're bringing in. So you don't see the immediate impact, but the fact that it's continuing to grow, we're very, very pleased with that.

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Brian D. Rockowitz, Madison Global Partners, LLC - MD [33]

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Okay. And just as a follow-up to the other gentleman's question about those executive bonuses, of $1.6 million that you had in SG&A, I guess, last quarter, is that accurate, $1.6 million?

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Thomas J. Heckman, Digital Ally, Inc. - CFO, VP, Treasurer & Secretary [34]

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Yes. Brian, the $1.6 million is after the $6 million patent litigation settlement credit, if you will. So real SG&A expense was like $7.6 million.

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Brian D. Rockowitz, Madison Global Partners, LLC - MD [35]

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And of that, how much of that was contributed to executive bonuses?

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [36]

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No idea. Don't remember that off the top of my head.

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Thomas J. Heckman, Digital Ally, Inc. - CFO, VP, Treasurer & Secretary [37]

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About $450,000.

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Brian D. Rockowitz, Madison Global Partners, LLC - MD [38]

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Okay. All right, gentlemen. Listen, I wish you guys the best of luck with this appeal.

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Stanton E. Ross, Digital Ally, Inc. - Chairman, President & CEO [39]

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Thank you, Brian. I would like to thank everybody for calling in today, listening in today. And again, we are very optimistic and excited about the remainder of the year and going into next year because of the new product launches, the continued increase in reoccurring revenue growth and also the patents, the technology that continues to be innovative in the industry, and stay tuned. I'm sure you guys will see some new and exciting partnerships that we have to announce. So thank you, everybody, for attending today.

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Operator [40]

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Thank you. This does conclude today's conference call. You may now disconnect.