Digital Ally Inc. - The Need To Dilute Shareholders Appears Inevitable

Aug.20.14 | About: Digital Ally, (DGLY)

Summary

More dilution for current shareholders in the near future appears inevitable, as $2.34 million is due in May 2015 and the company rapidly is burning through its low cash balance.

DGLY’s largest shareholder sold most of his position, at around $7.50, on July 11 and recently filed a lawsuit against members of the Board.

Last week, DGLY announced a significant decrease in revenue and earnings after the company failed to receive any significant orders from state police or other potential customers.

For the past five years, DGLY has been unable to generate earnings leading to an accumulated deficit of $17.6 million, which is more than the company’s current, inflated market cap.

Introduction

Despite the recent meteoric rise in price of Digital Ally Inc. (NASDAQ:DGLY) stock, it has failed to generate revenue growth and desperately needs cash in order to alleviate the company's need to fund operations. In our opinion, DGLY is nothing more than a low-float stock that is easily manipulated and currently is trading well above its fair value. Stephan Gans, who was the company's largest shareholder, sold most of his position, and you should too. 3D Analytics has completed a thorough review of DGLY and determined the stock is likely to fall back to $3 in the coming days, a result of the hype wearing off and investors realizing that revenues are on a sharp decline and that the company needs to raise cash in the near future.

More dilution for current shareholders in the near future seems inevitable, with $2.34 million due in May 2015 and the company rapidly burning through its low cash balance

On July 1, 2014, DGLY filed an S-3 stating that 434,095 shares of common stock were being offered by a private holder of a convertible note and warrant that were issued in March. DGLY currently has only 2,295,553 shares issued and outstanding, so this offering has the potential to dilute current shareholders by almost 20 percent.

On July 11, 2014, in order to encourage this private holder to convert the note to equity, DGLY announced a voluntary agreement to lower the conversion price of shares issued in March from $8.55 to $6.25 for a period from July 11-14, 2014. The convertible note holds a maturity date of March 24, 2016, so it is our opinion DGLY is taking advantage of the recent rise in its stock price to meet its upcoming debt obligation at the expense of current shareholders. On July 17, 2014, DGLY filed an 8-K stating that the holder converted $1,777,777.76 principal amount and $2,963.04 accrued interest on the Note into 284,928 shares of common stock of the Company and the Conversion Price returned to $8.55 per share.

The S-3 also states, "Our articles of incorporation authorize the issuance of 9,375,000 shares of our common stock. The common stock can be issued by our board of directors without stockholder approval. In addition, we are anticipating seeking approval from our shareholders at our next annual meeting for an amendment to our Articles of Incorporation in order to increase the number of shares of common stock available for issuance and to approve the authorization of blank check preferred stock. Any future issuances of equity would further dilute the percentage ownership of us held by our public shareholders."

From this, one could deduce the company is expecting that it may need to heavily dilute shareholders in the future, a move that would put downward pressure on the stock price.

In 2011, DGLY borrowed $2.5 million under an agreement that requires monthly interest-only payments until the maturity date in May 2015. The company's most recent S-3 states, "We have no revolving credit facility to fund our operating needs should it become necessary. It will be difficult to obtain an institutional line of credit facility given our recent operating losses, the current banking environment and the existence of the Convertible Note, which may adversely affect our ability to finance our business, grow or be profitable. Further, even if we could obtain a new credit facility, in all likelihood would may not be on terms favorable to us." In the latest 10-Q, DGLY reported a cash balance of $676,634 but had burned more than $1.35 million in cash during 2014 for operating activities. This is why the company needed to issue the convertible note and warrant to raise $2 million. Otherwise, DGLY would have been out of cash. With the $2.34 million of the borrowed $2.5 million still due in May 2015 under terms of the 2011 loan, DGLY, in our opinion, will have no choice but to continue to dilute shareholders in the near future in order to continue operating. DGLY currently has 2.47 million shares outstanding.

DGLY's largest shareholder sold most of his position, at around $7.50, on July 11 and recently filed a lawsuit against members of the Board for breach of fiduciary duties to the company and its stockholders.

On July 11, 2014, Stephan Gans disposed 381,087 shares of DGLY in the open market at an average sale price of $7.5079. Previously, he had been DGLY's largest shareholder, with around 17-percent ownership. On June 4, 2014, Gans urged shareholders to vote against the 807-percent increase in the company's authorized shares and the creation of a class of blank-check preferred stock which has the potential to be highly dilutive for the current shareholders. He also filed a stockholder-derivative lawsuit against the other members of the Board for breach of fiduciary duties to the company and its stockholders. The alleged breach was connected to the convertible-debt transaction and failure to provide information regarding allocation of resources between the company and Infinity Energy Resources, Inc.

Last week, DGLY announced a significant decrease in revenue and earnings after the company failed to receive any significant orders from state police or other potential customers

On Aug. 13, 2014, DGLY announced a 32-percent decrease in revenues with a net loss of $988,089 ($0.43 per share) during the second quarter. Management said, "We had no single order or shipment in excess of $100,000," a fact which suggests the new product offerings are failing to be adopted by state police or other potential customers.

For the past five years, DGLY has been unable to generate earnings leading to an accumulated deficit of $17.6 million, which is more than the company's current, inflated market cap.

DGLY continues to lose money year after year. This has led to an accumulated deficit of $17.6 million, which is more than the company's current inflated market cap. In addition, revenues continue to decline as DGLY's competitors continue to dominate.

Conclusion

Investors in DGLY should take advantage of this unwarranted increase and sell shares before more dilution comes. The company continues to lose money year after year and has an accumulated deficit greater than its current, inflated market cap. Stephan Gans sold most of his position, and you should too. 3D Analytics believes the stock is likely to fall back to $3 in the coming days, a result of the hype wearing off and investors realizing that revenues are on a sharp decline and that the company needs to raise cash in the near future.

Disclosure: The author is short DGLY.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

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