Digital Ally Inc (DGLY) 2011 Q3 法說會逐字稿

Hello and welcome to the Digital Ally, Inc. third-quarter 2011 conference call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (Operator Instructions).

Yesterday Digital Ally, Inc. issued a press release that included certain cautionary language with respect to forward-looking statements. The Company would ask you to review the language in the press release regarding forward-looking statements as they are equally applicable to any forward-looking statements made during this conference call.

(Operator Instructions). Please also note, this conference is being recorded. Now I would like to turn the conference over to Stanton Ross, CEO. Mr. Ross?

Thanks, Rocco. Thanks, everybody, for joining us today. With me is Tom Heckman, the Company's CFO. Tom will be going over the highlights of the numbers and explaining a little bit of our current financial situation and the outlook that we have in regards to the remainder of the year and obviously going into 2012.

As you can see, a lot of the things that we've been talking about since late last year have started to come to fruition. We have gotten through a lot of our inventory that was higher cost inventory, we have continued to do a good job in regards to the cuts that were necessary on the SG&A side of things to get us back to not quite where we want to be, but back to a positive cash situation, and Tom will go over that with you.

But the important thing to recognize is that there's still more room for improvement and we will continue those improvements the remainder of this year and going into 2012, along with a tremendous amount of new products that we'll finally start to be adding to the revenue side of the Company here in the fourth quarter. So I will elaborate in more detail on that after Tom is through going over the numbers. Tom?

Thank you, Stan, and thanks to everyone for joining us here today. We did file our Form 10-Q this morning earlier today and I would hope everyone would have a chance to look at that for a more complete discussion of the Company's financial position and results of operations for the three and nine months ended September 30. So please refer to that.

My remarks here will be brief and really just hit the highlights rather than doing any kind of deep discussion. We will have a Q&A session at the end of this call. So if questions come up that I don't address, please bear with me and ask it at the end of the meeting here.

I guess from an overall standpoint the third quarter was very encouraging on many fronts for the Company. We reversed the number of negative trends that had been persisting from the last couple quarters. Most notably our operating profits improved. Although there was an operating loss of $92,000, it was much improved over the previous quarters going back into 2010.

We did have and did show positive EBITDA of roughly $450,000, which we have not had for a number of quarters as well. Our balance sheet was strengthened during the quarter. Our gross margins improved dramatically which is what we expected, but we wanted to -- we certainly did enjoy seeing that occur in the third quarter and become very apparent.

Okay, now let's discuss a little more of the details behind these improvements. Revenues improved from Q2, but were less than prior year. If you dig into that, the international revenues were $1.2 million for the quarter or almost 21% of our total revenues for the quarter. So our international revenues did show some rebound. That was actually more than double the total international sales for Q1 and Q2 of 2011 combined. So we really had a strong showing from our international customers.

Now bear in mind that international revenues are very sporadic and when they do occur they usually occur in chunks. We had probably four or five shipments internationally so this was a nice swing for us, a nice improvement in international revenues. But it was not widespread to the whole world.

We did see a marked improvement in Central America, in particular Mexico, we had several orders from several different agencies in Mexico that was very nice to see. And of course we had the Turkey Gendarmerie order that occurred in the first month of the third quarter. So those areas of the world have been strong for us. We are looking at other parts of the world where we have strong distributors and hopefully we'll generate some more international revenues in the future there.

Our domestic revenues, however, remain challenged. They were basically flat with the previous quarter. We're really seeing some headwinds there as it relates to municipal budgets and the constraints that put on police budgets and the ability for agencies to buy our equipment.

What we've done to combat that is we've entered in newer and lower cost DVM-100 and 400 products. We believe that's appealing to our cash strapped customers where they cannot afford DVM-500s or 750s, but they sure can afford the lower cost DVM-100s and 400s. Now the features are not as robust in those units, but on a cash basis, on a cost basis it seems to be a pretty beneficial product for our cash strapped customers.

Roughly 12% of our revenues for the third quarter were in the form of new products, in particular the DVM-250 and the 100. We're seeing a nice trend in the 250 as it relates to our ambulance providers. In fact, we're seeing trends in the ambulance industry where the contracting agency, whether it be the municipality or county, are beginning to require video of events that happen in the ambulances.

So that's a nice trend, we have a good product for that market. We're seeing some very good traction in the ambulance industry as well as some other industries for the 250, but that is certainly promising for us.

We are in the process of launching the DVM-400 and the DVM-400 is really an improved feature DVM-100 with an external camera. So we're launching that in the fourth quarter and we, of course, announced our new MDT Command product that probably -- will maybe be introduced in the fourth quarter, but more likely early 2012. So we're continuing to introduce new products for our customers.

Gross margins improved 51% in the third quarter, that's almost 10% higher than both Q2 and Q1 2011 levels. What we're seeing is the positive impact to our supply-chain initiative that we announced earlier this year, the DVM-500 Plus is really leading the way in these lower cost of sales or higher margins. Our DVM Plus is our number one seller, over 80% of our mirrors sales are in the DVM-500 Plus category. With that said, the 500 Plus inventory and the supply-chain supplying the DVM-500 Plus product is well matured.

We're seeing very good cost reductions in our component costs and are very pleased with that. The DVM-750, however, is -- we're probably a quarter or two away from seeing some real contributions to improved margins from the 750 as we continue to burn off some of the inventory that we had from prior years. But we look for Q4 possibly, but more probably Q1, Q2 2012 to see some margin improvements on that product.

With the burn through of the DVM-500 inventory we're now seeing the overhead management reductions that we did earlier in the year show up in our gross margins. As we increase our production obviously we're getting more efficiencies from our overhead and management of production resources.

Also contributing to the improved gross margin was our sales mix. As I said before, we had 12% of our revenues approximately were with the newer products, in particular the DVM-250 and 100. Those products have higher gross margins than our traditional markets or traditional products. So that helped our margins for the quarter. We are continuing to increase or DVM-500 Plus production which will again lead to an increase in efficiencies down the road. And we also expect the DVM-400 and eventually the MDT product, when they're introduced, to help our margins.

From an SG&A standpoint, we remain at our reduced level of around $3 million a quarter; that's the successful results of our cost-cutting initiative that we introduced earlier this year. Our selling costs were impacted negatively by the cost of developing our new commercial fleet channel to sell the DVM-250 and related products.

We now have six direct salesman in that channel and two support personnel, so we're developing that channel, we're spending the money to develop it and we believe we'll see the results -- good results from that down the road.

As far as the law enforcement sales channel, we continue to evaluate and revamp and restructure our sales channel in that respect. And we will have probably changes down the road in the way we sell things and the way we compensate our salesmen there.

Overall from a P&L standpoint our number one priority go-forward is dealing with the sluggishness and the headwinds that we're seeing in the domestic market for law enforcement products. The way around that, we believe, are these new products, the DVM-100 and 400 which are lower price points and more appealing to the cost conscious consumers we have in our law-enforcement agencies in the US right now.

Also international markets, we're seeing rebounds there which we discussed earlier. Hopefully we can see that continue to improve. But again, that is very spotty; they're very large and chunky when they happen. So we're not protecting, we're not building inventory in anticipation of international sales, but we are very hopeful that that will improve down the road.

Our gross margins, they are improved to 51% in the third quarter. We believe there's quite a bit of room for additional improvement especially as we burn through the DVM-750 inventory and get more traction and higher level of sales from our new products which do yield higher margins. And also, we are going to continue on our SG&A cost initiative. It's more of a cost containment initiative at this point, but we believe it's important to keep the costs in line from an SG&A standpoint.

As we said before, EBITDA turned positive. We generated $450,000 of cash during the quarter -- first time in a number of quarters -- which led to our improved liquidity which is apparent on our balance sheet. On our balance sheet we showed $1.3 million in cash at the end of the third quarter, much improved over prior quarters and year end 2010.

Our goal has been to maintain cash balances in excess of our note payable balance. As you're aware, we have a $1.5 million subordinated note outstanding. We're not quite there yet; we've got $1.3 million sitting on the balance sheet, but we're going to -- our goal is to accumulate cash at least enough to where if need be we could pay that subordinated off -- the subordinated note off.

From a working capital standpoint we're in a very strong position, $9.1 million at the end of the quarter. Of that $9.1 million, $6.7 million is inventory, that's a reduction of over $3.3 million from the end of the year. As we have talked about in previous quarters, number one focus of management, or at least myself anyway, is to get these inventory levels down. We've been successful in doing that and we don't see any reason we can't continue that trend.

AR, Accounts Receivable is down to $4 million, that's a reduction of $800,000 from year end. We're going to continue to focus on improving our liquidity through collection and receivables as well. Because we generated so much cash we have reduced accounts payable by over $1.9 million from year end, almost $2 million from year end. So our trade vendors are happy with us and our working capital position is very strong.

To sum up the balance sheet, we have the working capital necessary to invest in our new products, to build our new commercial fleet sales channel, to complete the revamping of our current law enforcement sales channel, and if necessary pay off the subordinated note when it matures in May of 2012. So at this time I'll send it back to Stan so he can provide some further comments.

Thanks, Tom. One of the things I'd like to comment on is recently, earlier in the week we attended the International Associations Chief of Police, the largest law enforcement conference that we have each year. And what was exciting for me to see is while the attendance was a little higher than maybe what our expectations were -- so that was a nice bright spot -- was going around and looking at the competition.

I mean we were one of the few companies out there that had a whole area set up for new products. So while a lot of people are just trying to weather the storm; we have not only weathered the storm, I think we've done a great job of improving our numbers. But we also delivered several new products that were out there that were totally different than our competition.

I think that while the market may be a little soft I do believe that we have the ability to get additional market share that may make up for the difference. I do know that in talking with our international salesman at this show that he still is optimistic that the trends that we've seen in the third quarter can carry over into the fourth quarter and on into the next year.

We've done a great job and it's taken a lot of time to get our foot in the door in some new countries that have started buying small quantities. And I think you will notice in the third quarter we never did a press release of any real large international order. I mean they were just nice orders they continued to come in and we believe that trend can continue.

We also, as I said in my opening remarks, the new products -- and I'm, I guess, leaning more towards the commercial products that we have introduced and will now have out in the marketplace in some of these pilot programs that have been doing the testing should start to come into play a lot more in the fourth quarter and definitely have an impact in 2012. I wouldn't be surprised that maybe this 25% or even higher number in regards to our commercial side of our business as far as in 2012.

So I'm excited the fact that the Company is back into a growth mode. We do look to continue to bring on additional salesmen to help us with our new products on the commercial side of our business. We will continue to bring on additional sales reps and defined territories and ways of going about marketing in the tough law enforcement side of things. But we have definitely -- have a leg up on that I think on some of our competition. We've noticed that a few of our -- quite a few resumes from our competition have showed up on our doorstep.

So we're pleased with the progress and the turnaround that is finally starting to take hold, we will continue this throughout the year and into 2012. This is also our longest stretch that we will have without being able to communicate with our shareholders. So we hope that you guys will ask a lot of questions and we can address any issues that you may have outstanding here in the remainder of our call. Rocco, I'd like to open up the floor for the Q&A session.

(Operator Instructions). Steve Shaw, Sidoti & Company.

Can you guys provide some brief color on the LIDARCam and that DragonCam that you mentioned, just about the basics of the product and what they are and how they work.

Yes, the LIDAR itself that we introduced a while back, obviously laser speed detection, had some very unique features in it. It's one of the only units that's out there that radar detectors are unable to detect. It is unable to be jammed and it actually can detect if you're trying to jam it. It has other features as well.

Now it is a sort of the higher end of the LIDAR family, so we've done a pretty good job of introducing this product, we have a lot of units that are being evaluated internationally in regards to the LIDAR and jumping through the hoops to get them certified in certain countries. So we're optimistic that it's going to finish strong this year and have a good year next year.

That being said, we've enhanced it because a lot of countries, including here in the states, now like the video associated with the speed detection. And so that was the latest feature that we just added to where not only are they out there clocking you, they're actually video recording you as they're catching your speed. So it's just a little more evidence that they have in regards to validating that you were the one that they caught speeding versus the competition.

So it's a nice feature and some of your European markets that's quite standard. As a matter of fact, they will go ahead and detect your speed and record you, take a shot or do the video and send you your speeding ticket versus going ahead and coming after you and pulling you over. So there's a lot of upside on that we believe.

So are those separate attachments that somebody could buy if they already have the LIDAR or is that just one piece?

They're added features that they can add on, correct.

Okay. And then when you mentioned the boost in international sales, was that mainly event recorders or was the LIDAR included in that or was it a chunk of that?

It was mainly -- actually it was mainly the law enforcement, not even so much the event recorder. It was the DVM-500s I think was the majority of the international stuff. So it was more law enforcement not even getting into the -- like you said, the event recorder, the DVM-250 or the LIDAR at this point.

Okay. And then in regards to the new commercial fleet channel, I think you said you had six reps. How many do you plan on adding to that?

I can see that number more than doubling. We will continue to bring them on probably two to three per quarter. It's just such a large market. Obviously it's much larger than law enforcement. And what we have done is allowed some of our law enforcement reps to call upon the low hanging fruit that may be in their territories at this point in time. But easily I could see us bringing on maybe three per quarter, getting them trained, getting them out in the field and I think that's a nice growth rate.

And did you guys hire a sales manager yet?

We're on the road right now visiting with a few possible candidates.

Okay. Thanks, guys. That's all I have.

(Operator Instructions). [Martin Rembly], private investor.

Good morning, gentlemen. I saw reports a little while ago that says if the stock trades below $1 there's a possibility of being excluded from the -- I believe the stock exchange. And can you expand on that and give us more detail on that?

Yes, Martin, that is a situation. Typically what happens is in a process where if your stock is trading below $1 for very long, I think it's 30 days or whatever, NASDAQ will send you a notice that you have the -- potentially to be delisted. Tom, help me out, but I think you've got --

180.

-- 180 days; if your stock gets back above $1 for a period of time then you've overcome that hurdle. You also have the ability to submit a request of why you shouldn't be delisted and ask for additional time. I think we've got another quarter or so before that --.

Yes, the initial 180-day period, Martin, runs in March of 2012 and then there's a possibility or maybe even some people would say probability that at that time if we haven't fixed the $1 bid/ask price then we could request a 180-day extension, which I think gets you into September sometime to review and propose a plan to recover the stock price.

So there is some time yet. We hope that just some positive operating results such as what we've done today and some additional large orders when they're announced hopefully will improve our stock price above that $1 and it doesn't -- it resolves itself that way. But of course we're not relying upon that at this point.

Yes, but if -- since there won't be any more communications possibly before March, if the stock was still trading below $1 before about 180 days do you have a plan. Are you going to re-buy stock to increase the market value or do you already have thought about an action plan that would avoid going through that route?

We have -- we have had several considerations and thoughts about what to do. We will actually be back I want to say it's in February, should have our year-end numbers out and we'll be communicating with you and give you a lot more color on that situation at that point in time.

But, yes, there's been several things that have been revisited and things that we ought to look at. The bottom line is a though there's nothing that's going to be more beneficial than just positive numbers and news out there. So that's the first and primary goal that we have out there.

Thank you.

Austin Hopper, AWH Capital.

You talked about some of the headwinds that you're dealing with, I think it's in the domestic market, with cash straps in municipalities and putting out product at lower price points. Can you just help me understand the pricing difference and like what that newer products are or what the lower prices are versus the higher prices?

Yes, I'd be glad to. Where we're at right now, I mean you could go as low as even the event recorder which sales for less than $1000 to our higher end units that -- with features added to it and could go as high as about $5,500. So what we now have is a real situation and I think we've got it even in our 10-Q as far as the pricing of the products if you have a chance to look online.

But we really have a scenario to where if they only can afford let's say $1,800 per vehicle we can provide that product. We have another one that's around 2,700, another one close to $3,900 and $4,900. So we have roughly four different -- if you add the event recorder, five different products that they can utilize depending with the features and the functionalities that they'd like to meet their budgets and their needs.

I guess what I'm asking, so $1,800 -- pardon me, and I'll look at your 10-Q -- the $1,800 product or $2,700 product, is that comparable to the $5,500 product, I mean in basic functionality, or is it a different type of product?

Well they have -- okay, first of all they all have higher margins, those lower ones are the newer products that we've talked about. As far as comparability, the DVM-500 and the 750 are still a lot more feature-rich than the two that you just mentioned. So it just really depends on what the department wants.

I they may think that I just don't need those features, and that future may be as simple as simultaneous recording. He said you may just want to make sure it's recording either what's out front or he has no problem saying I'm going to use my external camera and I don't have problems doing that manually. So there is definitely feature differences so they will not be cannibalizing each other.

Okay, but the 100 and 400 are essentially -- do similar things just fewer features and lower price?

Yes, just dummied down versions, correct.

And is the 400 out now? I thought you said -- did you sell it in the quarter or is that coming out? Maybe I missed that.

No, the 400 was introduced at the IACP conference which occurred last week and we are getting production quantities in the fourth quarter. So it will be ready and available for sale in the fourth quarter.

And that one is $2,700?

Correct.

Okay, great. Thank you.

George Whiteside, US Financial (sic).

Good morning. Earlier in your summation you commented on the fact that you had gotten your gross margin up to 51%. My recollection is at times in the past you had an objective of getting up to 60%. Do you think that is an achievable target for the future?

George, I think depending on your time horizon it is very achievable. The new products that we're introducing have higher margins than 60%. So, yes, it is achievable. Realistically though we need to burn through the overhang of inventory we have on the DVM-750 before we get into the lower cost components that we've contracted with.

So we need to burn that out. And I think according to current projections we're going to burn that out either late in the fourth quarter, early first quarter 2012. So I think after that 60% is definitely achievable, but there's a number of factors obviously going into that including sales mix.

Totally understandable. Well, if you're able to have an improvement in profit margin say for the fourth quarter and you have a really good quarter, is there any possibility that you might be profitable for the entire year?

Yes, George, and here I am forecasting a little bit, but we hit $5.8 million in revenue in the third quarter and at 51% gross margins we had a $92,000 operating loss. So if you extrapolate that, and I know there's a lot of ifs and ands about that, but if you extrapolate that to $6 million or $6.25 million we're breakeven there just at the 51% margin.

So if we're able to move that margin needle up a couple of points, then obviously our breakeven point will go down. We believe we do have SG&A costs contained, so we're merely dealing with gross margin percentages and sales dollars.

I guess, George, and again trying to clarify, I think was your question also will we -- can we have a strong enough fourth quarter to where we can overcome the losses we had in the first two quarters, was that also what you were hitting on?

You have read my mind.

Again, I would think that we would have to have substantial contributions from maybe some international stuff to come in play for that to occur. And I'm not going to say that there isn't speculation and talk that that could happen, but you would definitely see -- if you've seen some press releases of larger international orders we'd have a shot at it.

Alright, I just burned up my two questions. I'll get back into the queue.

Martin Rembly, private investor.

You said a few times this year that you thought your breakeven point was about $6 million per quarter, which seems to be pretty accurate based on the result of Q3. Now at the beginning of the year you thought $6 million in sales per quarter would be a fairly easy target to reach -- maybe not easy, but you were confident you would get $6 million per quarter, $24 million for the year and anything above that would bring money to the bottom line.

Now having reached $6 million in sales for a while in the quarter except for Q3 is very close and [asset consolidations], your estimates on the breakeven point were right on. Do you think you can now sustain $6 million per quarter in sales where you thought that FY'11 would be fairly easy to reach? Do you see that (multiple speakers)?

Yes, we're hopeful. I mean (multiple speakers) tell you, Martin, the trade winds in regards to the law enforcement side and municipalities and states and stuff is challenging and there's just only so much out there. So what we're looking at and we do believe will occur is some of the new products will come into play and really help us out in hitting that number.

So we to believe that we can get to that number and improve on that and also that some of the marketshare we could start taking over as well. I wish -- my confidence level is not as high as you would like to hear right now and I just don't know what to say. I have not seen trade winds like this in the law enforcement and Ken McCoy is one -- our Vice President of Marketing is one that we rely on a lot in regards to this and he too has said this is some tough times.

But we do see the new products strongly contributing and that contribution will be in the fourth quarter because you started to see a little bit in the third. So fourth quarter we think is there. So we're optimistic, but we don't think it's going to be because of law enforcement, as far as domestic, law enforcement is going to be the driving factor on it.

Thank you.

Mr. Whiteside.

You mentioned what positives you saw in your meeting -- your conference. And I wonder what your thinking is in terms of your competition and the possibility of consolidation in the industry. And have you seen any signs of any of your competition being acquired by another firm?

George, we haven't seen anything yet. I mean, obviously you know that there is a casualty earlier in the year with a company that went under and someone bought them out of bankruptcy or the assets out of bankruptcy and they're still out there trying to do something with that product. But we haven't seen any real consolidation of any of the bigger players that are in the market.

And as we mentioned, we've got the -- we feel like there's three or four competitors that we have out there that we consider key competitors and all of us are still out there just swinging at it by ourselves at this point in time. The only thing that -- again, we still have a strong R&D budget in regards to new products that we're continuing to introduce.

And that was the biggest thing that I recognize is a lot of the competitors didn't have anything really new that they were showing at the show and honestly I think the question -- maybe it was Steve that asked it in regards to our national sales manager, we've actually received quite a few resumes from our competitors in regards to some of the people that they've laid off recently. So maybe there's a good reason why they were let go, so you've always got to be looking into that.

George, this is Tom. I would add it's apparent from our P&L that we do invest in R&D, we are generating new products, we've seen the impact of those new products on our revenue in the third quarter. We've got the DVM-400 coming out in the fourth quarter and the MDT unit coming out. And that's not it, we've got other projects in the R&D hopper.

I think where we differ from our competition is that we are reinvesting in R&D dollars and my sense is that they are not -- or not certainly to the extent that we are and it's showing up in the marketplace. Our products are coming out in rapid fire succession and the competitors are not coming out with much of anything new. And eventually we're going to take market share because of that.

Totally understandable. Well also at the show with your new LIDAR products, were you able to sign any contracts at the show or have strong expression of interest?

Yes, I mean, very seldom -- I mean very seldom, George, do you actually write many contracts at these shows. What you really are doing is really generating the leads in which they would like one of our sales representatives to come up there and so they can sit there and touch and feel and evaluate the product for maybe as much as a week or even 30 days.

So lead generation -- I was there for two of the three days and I know they had in excess of 350 leads after just the first two days which was a number larger than what we were seeing from last year's show. So that's why we again continue to be encouraged by the way our product -- it's either the products or maybe the market is turning a little bit.

But I believe it's because of our new products more than anything is the reason we're having so many leads. Again also realize this is just law enforcement, so some of the shows, which we're attending one out today out in San Francisco, are more commercial oriented and we're starting to get a lot of leads off of that as well.

Well, that sounds awfully encouraging to have 300 leads. That would -- what you said earlier, I'm sure a portion of that is a result of the lack of new product from your competition.

Yes, I agree with you George. I think there's a lot of interest in several of our new products. And again, we used to be sort of a one trick pony with just having in car video systems. But now we've got a variety of different products that we can call upon existing customers and also go into markets where they may already have a video system, whether it be ours or not, and look at selling them LIDAR systems or other products that we have.

It sounds as though -- sort of a second item -- it sounds as though in terms of having -- offering some downscale or less feature rich product that you might have an opportunity to upgrade with those same customers when more money is available, budgets are less constrained, etc. Is that (multiple speakers)?

Absolutely, we'll work with those municipalities and counties and states as well. We are very proud of our products and if they came in and bought maybe one of the lower end units now because that's all they could afford, we'd be glad to work with them on exchanges and going ahead and upgrading them with some of the other products as the money comes available. Because we will continue to have markets for those products that we can go ahead and refurbish and go ahead and get out there and remarket again.

Sounds like a plan.

George, thanks for your questions. Appreciate it, and your interest.

We show no further questions at this time. I'd like to turn the conference back over to management for any closing remarks.

Well again, thanks, everybody, for tuning in. And again, we're very appreciative of all the efforts that our employees have done over the course of this year that have gotten us back to this point. And I know they too have put forth a lot of effort in making today happen and we'll continue to push forward to having some stronger numbers going forward. Tom, any final comments?

Yes, I think the important thing is that we reversed a number of trends in the third quarter and hopefully that reversal continues. We believe we've got plans in place that do that. I will caution everybody that the headwinds are strong in the domestic law enforcement market. But some of the changes we've made to diversify the business and diversify our sales channels, particularly in the DVM-250, I think will reap benefits for the Company in the near future.

Thanks a lot, everybody.

And we thank you for your time, gentlemen. To access a digital replay of this conference you may dial 1-877-344-7529 or 1-412-317-0088 beginning at 1 p.m. Eastern Time today. You will be prompted to enter a conference number which will be 1000-5798. Please record your name and company when joining. The conference is now concluded and we thank you for attending today's presentation. You may now disconnect your line.