Our business is subject to substantial fluctuations on a quarterly basis as reflected in the significant variations in revenues and operating results in the above table. These variations result from various factors, including but not limited to: 1) the timing of large individual orders andorders; 2) the traction gained by our new products, such as the FirstVU HD, MicroVU HD, FleetVU and DVM-800. We reported an operating loss of $2,700,529 on revenues of $5,051,119 for fourth quarter 2015 compared to an operating loss of $2,140,785 on revenues of $5,096,088 for third quarter 2015, an operating loss of $816,962 on revenues of $5,634,237 for second quarter 2015, and an operating loss of $1,963,195 on revenues of $4,248,764 for first quarter 2015. Our fourth quarter 2015 revenues decreased slightly from third quarter 2015. Our gross margin percentage decreased to 31.0% in the fourth quarter from 40.0% in the third quarter 2015 and 54.9% in the second quarter 2015. During the third quarter 2015, we decided to upgrade the connectors contained in the camera cable assembly on our FirstVU HD product to improve functionality and reliability. This upgrade was applied to all deployed units in the field as well as in our inventory, which required us to rework the camera assemblies and scrap a portion of the original cable assembly. Total scrap costs recognized in third and fourth quarter 2015 approximated $1,615,000, which adversely affected our gross margins and other operating results. Management believes the FirstVU HD connector upgrade implemented to all deployed units during the third and fourth quarter 2015 will resolve the cable assembly issue and that gross margins should return to more normal levels in future quarters. Our selling, general and administrative (“SG&A”) expenses were higher in the fourth quarter 2015 compared to the first three quarters of 2015. The primary reason for the increased SG&A expenses in the fourth quarter 2015 over the three prior quarters of 2015 was the addition of technical support staff to handle field inquiries and installation matters because our installed customer base has expanded and additional technical support staff required for our newnewer products, such as the FirstVU HD and DVM-800. ManyFleetVU; 3) production, quality and other supply chain issues affecting our cost of goods sold; 4) unusual increases in operating expenses, such as our sponsorship of the Digital Ally Open golf tournament, the timing of trade shows and bonus compensation; and 5) litigation and related expenses respecting outstanding lawsuits. We reported an operating loss of $3,787,960 on revenues of $2,877,661 for fourth quarter 2017, which continued a series of quarterly losses resulting from competitive pressures, increases in inventory reserves as our current product suite ages, product quality control issues, product warranty issues, infringement of our customers require extensive information technology infrastructure planningpatents by direct competitors such as Axon and WatchGuard that reduced our revenues, litigation expenses relating to managethe patent infringement and store the audio/video evidence gathered byreduction of our systems, which often requires new and larger data servers. Our international revenues during 2015 decreased to $148,667 from $961,763 in 2014.gross margins.

There have been a number ofThe factors and trends affecting our recent performance which include:

Off-Balance Sheet Arrangements

We do not have any off-balance sheet debt nor did we have any transactions, arrangements, obligations (including contingent obligations) or other relationships with any unconsolidated entities or other persons that may have material current or future effect on financial conditions, changes in the financial conditions, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenue or expenses.

We are a party to operating leases, title sponsorship, and license agreements that represent commitments for future payments (described in Note 1211 to our consolidated financial statements) and we have issued purchase orders in the ordinary course of business that represent commitments to future payments for goods and services.

For the Years Ended December 31, 20152017 and 20142016

Results of Operations

Summarized immediately below and discussed in more detail in the subsequent sub-sections is an analysis of our operating results for the years ended December 31, 20152017 and 2014,2016, represented as a percentage of total revenues for each respective year:

Revenues

Our current product offerings include the following:

We sell our products and services to law enforcement and commercial customers in the following manner:

We may discount our prices on specific orders when consideringbased upon the size of the order, the specific customer and the competitive landscape. We believe that our systems are cost competitive compared to our principal competitors and generally are lower priced when considering comparable features and capabilities.

Revenues for the years ended December 31, 20152017 and 20142016 were derived from the following sources:

We experienced a change in the sales mix of our products for the year ended December 31, 2015 compared to the year ended December 31, 2014. Our newer products, the DVM-800 and the FirstVU HD, contributed 56% of total sales for the twelve months ended December 31, 2015, compared to 51% for the comparable period ending December 31, 2014. We expect the sales mix will continue to transition from our legacy M-500 Plus and DVM -750 product lines to the newer products during 2016. In addition, our commercial event recorders (DVM-250 Plus) increased from 5%7% to 10%9% of total revenues. We expect thisrevenues, which trend is expected to continue because of the appeal of our new FleetVU cloud-based driver management and monitoring tool.

RevenuesProduct revenues for the years ended December 31, 20152017 and 20142016 were $20,030,208$12,773,560 and $17,444,419,$15,014,647, respectively, an increasea decrease of $2,585,789$2,241,087 (15%), due to the following factors:

Service and other revenues for the years ended December 31, 2017 and 2016 were $1,804,040 and $1,559,844, respectively, an increase of $244,196 (16%), due to the following factors:

Total revenues for the years ended December 31, 2017 and 2016 were $14,577,600 and $16,574,491, respectively, a decrease of $1,996,891 (12%), due to the reasons noted above.

Cost of Revenue

Cost of product revenue on units sold for the yearyears ended December 31, 20152017 and 20142016 was $11,680,853$8,771,474 and $7,521,626,$10,461,064, respectively, an increasea decrease of $4,159,227 (55%$1,689,590 (16%). The increasedecrease in product cost of goods sold is partiallycommensurate with the 15% decrease in product revenues coupled with product cost of sales as a percentage of revenues decreasing to 69% in 2017 from 70% in 2016. We increased the reserve for obsolete and excess inventories by approximately $991,000 during the year ended December 31, 2017 due to the 15% increase in revenues. In addition, we encountered printed circuit board issues in our FirstVU HD body-worn cameras early in 2015 and in response upgraded the entire installed base of FirstVUs in the third and fourth quarter 2015. The upgrade involved the replacement of a connector contained in the camera cable assembly on our FirstVU HD product that dramatically increased rework and scrap rates on our FirstVU HD. Our scrap costs were approximately $1,615,000 for third and fourth quarter 2015. We also increased our inventory reserve in 2015 due to changes in the sales mix to the DVM-800 platform, which has resulted in a higher levellevels of excess component parts of older versions of PCB boards, used trade-in inventory requiring refurbishment and the phase-out of our DVM-750 and LaserAlly legacy products.

Cost of service and other revenue for the years ended December 31, 2017 and 2016 was $1,261,153 and $812,194, respectively, an increase of $448,959 (55%). The increase in service and other cost of goods sold is commensurate with the 14% increase in service and other revenues coupled with service cost of sales increasing to 70% from 52% for the year ended December 31, 2017 compared to December 31, 2016. The primary reason for the increase was the growth in the use of certain technical support personnel to generate direct installation and other service revenues in the year ended December 31, 2017 compared to December 31, 2016. A larger number of our commercial and law enforcement customers have engaged us to install our equipment, such as our contract with AMR. Installation services typically generate lower margins than our cloud storage and FleetVU cloud-based driver management and monitoring tool. This trend has served to increase the cost of service revenue in 2017 compared to 2016.

Total cost of sales as a percentage of revenues increased to 58%69% during the year ended December 31, 20152017 compared to 43%68% for the year ended December 31, 2014.2016. We believe that the FirstVU HD connector upgrade implemented to all deployed units during the third and fourth quarter 2015 will resolve the cable assembly issue and thatour gross margins should return to more normalwill increase if we improve revenue levels in 2016. Our goal is to maintain cost of sales as a percentage of revenues at 40% or less during 2016. We expect that our newerand reduce product offerings, in particular the DVM-800, VuLink and FirstVU HD, should improve our cost of goods sold as a percentage of sales in the longer term. We do not expect to incur significant capital expenditures to ramp up production of our current products because our internal process is largely assembling subcomponents, testing and shipping of completed products or we use contract manufacturers. We rely on our subcontractors to produce finished circuit boards that represent the primary components of our products, thereby reducing our need to purchase capital equipment.warranty issues.

We had $1,202,411recorded $2,990,702 and $600,578$1,999,920 in reserves for obsolete and excess inventories at December 31, 20152017 and December 31, 2014,2016, respectively. Total raw materials and component parts were $3,833,873$4,621,704 and $2,987,124$4,015,170 at December 31, 20152017 and December 31, 2014,2016, respectively, an increase of $846,749 (28%$606,534 (15%). The increase in raw materials and componentwas mostly in refurbished parts is primarily attributable tofor our forecasts of sales for the FirstVU HD and VuLink and the need to secure long lead component inventory items in advance of production.product. Finished goods balances were $7,895,663$6,964,624 and $6,576,480$7,215,346 at December 31, 20152017 and December 31, 2014,2016, respectively, an increasea decrease of $1,319,183 (20%$250,722 (3%). The increase in finished goods was primarily for the DVM-750 product for anticipated international customer orders and additional cameras for our various products. Finished goods at December 31, 2015 consist primarily of the Laser Ally products and our DVM-500 Plus and DVM-750 products for expected orders. The increase in the inventory reserve is primarily due to the change in sales mix of our products, which has resulted in a higher level of excess component parts of the older versions of our PCB boards and the phase out of our DVM-750 and LaserAlly legacy products. Additionally, we increased our reserves on selected refurbished and items requiring repair during the year ended December 31, 2017. We believe the reserves are appropriate given our inventory levels at December 31, 2015.2017.

Gross Profit

Gross profit for the years ended December 31, 20152017 and 20142016 was $8,349,355$4,544,973 and $9,922,793,$5,301,233, respectively, a decrease of $1,573,438 (16%$756,260 (14%). The decrease is a result ofcommensurate with the 12% decline in revenues for the year ended December 31, 2017 and the cost of sales as a percentage of revenues increasing to 58%69% during the year ended December 31, 20152017 from 43%68% for the year ended December 31, 2014 offset by the 15% increase in sales for the year ended December 31, 2015.2016. We believe that gross margins will improve during 2018 and beyond if we improve revenue levels and reduce product warranty issues. Our goal is to improve our margins to 60% over the longer term based on the expected margins of our newer products, in particular the DVM-800, DVM-800 HD, VuLink and FirstVU HD, asif they continue to gain traction in the marketplace and we are able to increase our commercial productionmarket penetration in 2016.2018. In addition, asif revenues increase from these products increase, we will seek to further improve our margins from them through economies of scale and more efficiently utilizing fixed manufacturing overhead components. We plan to continue our initiative on more efficient management of our supply chain through outsourcing production, quantity purchases and more effective purchasing practices.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $15,970,826$15,744,438 and $12,811,987$17,787,421 for the years ended December 31, 20152017 and 2014,2016, respectively, an increasea decrease of $3,158,839 (25%$2,042,983 (11%). Selling, general and administrative expenses as a percentage of sales increased to 80%108% in 20152017 from 74%107% in 2014.2016. The significant components of selling, general and administrative expenses are as follows:

The significant components of selling, general and administrative expenses are as follows:

Research and development expense.We continue to focus on bringing new products to market, including updates and improvements to current products. Our research and development expenses totaled $2,980,807$3,149,011 and $2,905,407$3,186,137 for the years ended December 31, 20152017 and 2014,2016, respectively, an increase of $75,400 (3%$37,126 (1%). We employed a total of 2524 engineers at December 31, 20152017 compared to 2232 engineers at December 31, 2014,2016, most of whom are dedicated to research and development activities for new products. We are increasingIn prior years we had increased our engineering staff of web-based developers as we expandexpanded our offerings to include, among other items, cloud-based evidence storage and management for our law enforcement customers (VuVault.net) and our web-based commercial fleet driver monitoring and management tool (FleetVU)(FleetVU Manager). Research and development expenses as a percentage of total revenues were 15% in 201522% for the year ended December 31, 2017 compared to 17%19% for the year ended December 31, 2016. Although we reduced our engineering headcount in 2014. We have active research and development projects on several new products, as well as upgrades to our existing product lines. Weearly 2018, we still consider our research and development capabilities and new product focus to be a competitive advantage and will continue to invest in this area on a prudent basis.basis and consistent with our financial resources.

Selling, advertising and promotional expenses.Selling, advertising and promotional expense totaled $3,965,400$3,873,091 and $3,340,764$4,238,895 for the years ended December 31, 20152017 and 2014,2016, respectively, an increasea decrease of $624,636 (19%$365,804 (9%). SalariesThe decrease was primarily attributable to the 15% decline in revenues in 2017 compared to 2016 and the reduction in promotional and advertising expenses. Salesman salaries and commissions to our sales personnel represent the primary components of these costs and were $3,116,729$3,111,435 and $2,729,589$3,091,676 for the years ended December 31, 20152017 and 2014,2016, respectively, an increase of $387,140 (14%$19,759 (1%), which is commensurate with. We increased the number of salesman in 2017 compared to 2016, in our 15% increasecommercial sales channel recognizing the increased commercial market opportunities while reducing the number of salesman in revenues.our law enforcement channel. The effective commission rate was 15.6%21.3% for the yearsyear ended December 31, 2015 and 2014, respectively.2017 compared to 18.6% for the year ended December 31, 2016.

Promotional and advertising expenses totaled $848,671$761,656 during the year ended December 31, 20152017 compared to $611,175$1,147,219 during the year ended December 31, 2014, an increase2016, a decrease of $237,496 (39%$385,563 (34%). The increasedecrease is primarily attributable to the Company becomingnet promotional expenses associated with being the title sponsor of the Web.com Tour golf tournament held annually in the Kansas City Metropolitan area. Ourarea being less in 2017 compared to 2016. We incurred net promotional expense relatedexpenses of $266,280 in the twelve months ended December 310, 2017 relative to this sponsorship compared to $499,313 for twelve months ended December 31, 2016. The Company also decreased the number of trade shows it attended during 2017 as management questioned the efficiency and effectiveness of many of the 2015 tournament totaled $172,623. Additionally, we had increased participation inlesser attended trade shows and media advertising in trade publications and other marketing initiatives designed to help penetrate commercial markets for our DVM-250 Plus event recorders, and to increase awareness of our FirstVU HD, MicroVu HD, VuLink andeliminated them from the DVM-800 within our law enforcement channel during 2015.schedule.

Stock-based compensation expense.Stock based compensation expense totaled $1,623,033$1,752,579 and $834,593$1,592,365 for the years ended December 31, 20152017 and 2014,2016, respectively, an increase of $788,440 (94%$160,214 (10%). The increase is primarily dueIn 2017, we granted 100,000 stock options and 522,000 shares of restricted stock to the amortizationemployees, officers and directors compared to 40,000 stock options and 290,000 shares of the restricted stock granted during 2015 to our officers, directors, and other employees that had the effect of increasing the stock2016. We relied more on stock-based compensation expense for the year ended December 31, 2015during 2017 resulting in increased stock-based compensation compared to 2014. The total number of restricted shares granted and our market stock price was higher on the specific dates of the 2015 stock grants compared2016 as we attempted to previous years, which increased the grant date fair value attributable to the restricted stock grants.reduce cash expenses for liquidity reasons.

The total number of restricted shares granted to the Board of Directors, officers and employees increased to 326,500 shares during the year ended December 31, 2015 as compared to 192,500 shares during the year ended December 31, 2014. In addition, the weighted average grant date price of the shares increased to $8.42 per share compared to $5.33 per share during the year ended December 31, 2014.

Professional fees and expense. Professional fees and expenses totaled $1,368,758$1,526,448 and $1,153,985$1,930,625 for the years ended December 31, 20152017 and 2014,2016, respectively, an increasea decrease of $214,773 (19%$404,177 (21%). Professional fees during 2014 and 2015 were related primarily to normal public company matters, intellectual property matters and litigation matters. The increasedecrease in professional fees and expenses in 20152017 compared to 20142016 is primarily attributable to higher accounting fees andlower litigation expenses related to the conclusion of the Utility lawsuit and Taser matters. SeeLitigation for further discussion.the ongoing Axon and WatchGuard lawsuits. The Axon and WatchGuard matters continue and the reduced litigation charges in 2017 are principally due to both the Axon and WatchGuard lawsuits being under a stay order pending final USPTO rulings on the various IPR requests, which have largely now been ruled in our favor. The Axon case stay has been lifted and is now proceeding towards trial while the stay on the WatchGuard litigation is expected to be lifted in June or July 2018. The legal fees related to both the Axon and WatchGuard litigation are expected to ramp up during 2018 as we anticipate both cases will proceed to trial. We intend to pursue recovery from Axon, WatchGuard, their insurers and other responsible parties as appropriate.

Executive, sales and administrative staff payroll.Executive, sales and administrative staff payroll expenses totaled $2,941,151$2,698,702 and $2,012,552$4,115,816 for the years ended December 31, 20152017 and 2014,2016, respectively, an increasea decrease of $928,599 (46%$1,417,114 (34%). This increase is primarily attributable toThe primary reason for the hiringdecrease in executive, sales and administrative staff payroll was a reduction of additional$855,000 in executive bonuses and the redirection of certain technical support personnel to generate direct installation and other service revenues in the year ended December 31, 2017 compared to December 31, 2016. We had increased our technical support staff in 2017 to handle field inquiries and requests for product installation mattersservices because our installed customer base hashad expanded and the need for additional technical support staffand marketing was required for our newnewer products, such as the DVM-800 and FirstVU HD, VuVault.comHD. In 2017, we reassigned certain members of our technical support staff to direct services for product installation and FleetVU.other services for our customers and we are charging their respective payroll related expenses to service cost of sales in 2017 compared to 2016. The AMR contract includes installation services, which was one of several larger contracts that required technical support personnel to complete installation services in 2017. In addition, the Company establishedduring 2016 a special bonus plan during 2015,of $630,000 was awarded to our CEO, which resulteddid not occur in approximately $260,000 in compensation expense and the Company incurred an increase of approximately $250,000 in employee-based retention expenses.2017.

Other. Other selling, general and administrative expenses totaled $3,091,677$2,744,607 and $2,564,686$2,723,583 for the years ended December 31, 20152017 and 2014,2016, respectively, an increase of $526,991 (21%$21,024 (1%). The increase in other expenses in 20152017 compared to 20142016 is primarily attributable to increased consulting, contract labor andhealth insurance expenses. We are utilizing consultants to help develop engineering and manufacturing standard processes with a goal of achieving ISO 13485, ISO 9001, FDA cGMPs, and MD Directive 93/42/EEC certifications. We also utilized consultants to help design, develop and launch a new corporate website in 2015.premiums for our associates.

Operating Loss

For the reasons previously stated, our operating loss was $7,621,471$11,199,465 and $2,889,194$12,486,188 for the years ended December 31, 20152017 and 2014,2016, respectively, a deteriorationan improvement of $4,732,277 (164%$1,286,723 (10%). Operating loss as a percentage of revenues increased to 38%77% in 20152017 from 17%75% in 2014.2016.

Interest Income

Interest income increaseddecreased to $21,156$11,818 for the year ended December 31, 20152017 from $13,660$26,195 in 2014. The increase is attributable to an increase in average2016 which reflected our overall lower cash and cash equivalents balances relatedequivalent levels in 2017 compared to our $12.02016.

Interest Expense

We incurred interest expense of $733,736 and $3,102 during the years ended December 31, 2017 and 2016, respectively. We issued an aggregate of $4.0 million registered direct offeringprincipal amount of Debentures on December 30, 2016, which bore interest at the rate of 8% per annum on the unpaid balance outstanding at December 31, 2017. In addition, we issued two Notes with a principal balance of $700,000 in June 2017. One of these Notes and the Secured Note had an outstanding principal balance of $1,008,500 at December 31, 2017. No similar interest-bearing debt was outstanding during the year ended December 31, 2016.

We amortized to interest expense $405,895 and $-0-, representing the discount associated with the issuance of $1,358,500 of the Notes and the Secured Note during the years ended December 31, 2017 and December 31, 2016, respectively. The discount resulted from the issuance of detachable common stock purchase warrants together with the $1,358,500 principal amount of Notes and the Secured Note, which was completed in July 2015.recorded as a discount and amortized to interest expense over the term of the underlying Notes and Secured Note. The total remaining unamortized discount was $-0- at December 31, 2017, and 2016.

Change in Fair value of Warrant Derivative Liabilities

Detachable warrants exercisable to purchase a total of 398,916 common shares, as adjusted, were issued in conjunction with the$2.0 million and $4.0 million Secured Convertible Notes (“Secured Convertible Notes”) during March and August 2014. The warrants were required to be treated as derivative liabilities because of their anti-dilution and down-round provisions. Accordingly, we estimated the fair value of such warrants as of their respective date of issuance and recordrecorded a corresponding derivative liability in the balance sheet. Upon exercise of the warrants we recognized a gain/loss based on the closing market price of the underlying common stock on the date of exercise. In addition, the warrant derivative liability is adjusted to the estimated fair value of any unexercised warrants as of December 31, 20152016 and 2014.

The holder2017. There remained warrants outstanding exercisable to purchase 12,200 shares of the Secured Convertible Notes exercised a portion of such warrants in August 2014 and in September 2014 with the change in value of the warrant derivative totaling $3,233,068 being recognized as a non-cash charge to operations during the year endedcommon stock at December 31, 2014 representing the increase in our stock price over the exercise price at the respective exercise dates. The changes in the fair value of the warrant derivatives related to unexercised warrants totaled $1,193,694 for the year ended December 31, 2014. The change in warrant derivative liabilities totaled $4,426,762 for the year ended December 31, 20142016 and 2017 and the warrant derivative liability balance was $2,186,214 as of$16,816 and $33,076 at December 31, 2014.2017 and 2016, respectively

The holder of the Secured Convertible Notes exercised a portion of its warrants in March 2015 and April 2015 with the change in value of the warrant derivative through the date of exercise resulting in a gain of $336,373 compared to the estimated warrant derivative liability balance. The resulting derivative balance of $1,748,155 was offset against the warrant derivative liability during the year ended December 31, 2015. The changes in the fair value of the warrant derivatives related to unexercised warrants resulted in a gain of $34,633$16,260 and $33,977 for the yearyears ended December 31, 2015. The change in warrant derivative liabilities resulted in a gain of $371,006 for the year ended December 31, 20152017 and the warrant derivative liability balance was $67,053 as of December 31, 2015.2016, respectively.

Change in Fair Value of Secured Convertible NotesDebentures Payable

We elected to account for the $4.0 million principal amount of Debentures outstanding at December 31, 2017 and record the Secured Convertible Notes2016 on their fair value basis. The holder ofTherefore, we determined the Secured Convertible Notes exercised its right to convert such notes to 316,716 common shares during July 2014 through September 2014. The change in fair market value of the Secured Convertible Notes associated withDebentures utilizing Monte Carlo simulation models which yielded an estimated fair value of $3,262,807 and $4,000,000 for the conversionDebentures including their embedded derivatives as of debt was $384,614 during the year ended December 31, 2014, representing2017 and 2016, respectively. No value was allocated to the increase in our stock price over the conversion pricedetachable Warrants as of the respective conversion dates. On December 4, 2014, the holderorigination date because of the Secured Convertible Note exercised its right to convert $36,600 principal amount into 6,000 shares of our common stock at the conversion price of $6.10 per share. The increase inrelative fair market value of these 6,000 shares over the $36,600 principal retired was $89,400, representing the increase in our stock price over the conversion price as of the conversion date. As of December 31, 2014 the fair market value of the remaining Secured Convertible NoteDebentures including its embedded derivative features approximated the gross proceeds of the financing transaction. We made principal payments totaling $750,000 reducing the outstanding amount of Debentures on August 24, 2017. The fair value of the Debentures was $3,273,431$3,262,807 at December 31, 2017 representing a change in fair market value for the year endedof $(12,807) from December 31, 2014 totaling $302,552. Accordingly, the total change in fair value of the two Secured Convertible Notes payable was $776,566 for the year ended December 31, 2014.

The holder of the Secured Convertible Notes exercised its right to convert the remaining principal balance of such Notes into 655,738 shares of common stock and 5,475 shares for accrued interest thereon at a conversion price of $7.32 per share in separate transactions between February 13 and 25, 2015. The increase in fair market value of the 655,213 shares over the $3,963,780 principal retired was $4,434,383, representing the increase in our stock price over the conversion price as of the conversion dates. Accordingly, the total change in fair value of the Secured Convertible Notes payable was a $4,434,383 loss for the year ended December 31, 2015,2016, which was recognized as a charge in the Consolidated Statement of Operations.

Secured Convertible Notes Issuance Expenses

We elected to account for and record our $4.0 million Secured Convertible NotesNote issued during December 2016 on a fair value basis. Accordingly, we were required to expense the related issuance costs to other expense whichin the consolidated statements of operations. Such costs totaled $93,845 and $579,066$281,570 for the yearsyear ended December 31, 2015 and 2014, respectively.2016. The 2015 expenses were attributable to the proxyissuance costs incurred for our Special Meeting of Shareholders held on February 13, 2015 to approve the issuance of shares above the Nasdaq Share Cap in connection with the issuance of the Secured Convertible Note in August 2014. The December 31, 2014 expenses included a $360,000$200,000 placement agent fee and the remainder was primarily legal fees. No similar debt issuances occurred in 2017.

Other Income (Expense)Loss on Extinguishment of Subordinated Notes Payable

Other income increased to $1,878 forOn June 30, 2017, the year ended December 31, 2015 from ($5,589)Company, in 2014.

Interest Expense

We incurred interest expense of $282,233 and $499,744 during the years ended December 31, 2015 and 2014, respectively, a decrease of $217,511 (44%). We issuedtwo separate transactions, borrowed an aggregate of $2.5 million principal amount of subordinated$700,000 under two unsecured notes during 2011, whichpayable to private, third-party lenders. The loans were funded on June 30, 2017 and both were represented by promissory notes (the “June Notes”) that bore interest at the rate of 8% per annum with principal and accrued interest payable on or before their maturity date of September 30, 2017. The June Notes were unsecured and subordinated to all existing and future senior indebtedness, as such term is defined in the June Notes. On September 30, 2017, the Company obtained an extension of the maturity date of one of the June Notes to December 31, 2017 and then a further extension to March 31, 2017. In connection with the first extension, the Company issued warrants to purchase 100,000 shares of common stock at $2.60 per share until November 15, 2022. The Company treated the extension of this debt as an extinguishment for financial accounting purposes. Accordingly, the estimated fair value of the warrants granted totaled $180,148, which was recorded as additional paid-in-capital and a loss on extinguishment of subordinated notes werepayable. The Company paid the second June Note in full in August 2017.

On September 29, 2017, the Company borrowed $300,000 under an unsecured note payable with a private, third party lender. The loan was represented by a promissory note that bore interest at 8% per annum and was due and payable in full on July 24, 2015.November 30, 2017 and could be prepaid without penalty. Such note was unsecured and subordinated to all existing and future senior indebtedness, as such term was defined in the note. On December 29, 2017 the Company borrowed an additional $350,000 from the same private, third party lender and combined the existing note issued in September 2017 into a Secured Note with a principal balance of $658,500 that is due and payable in full on March 24, 2014, we1, 2018 and may be prepaid without penalty. The Secured Note is secured by the Company’s intellectual property portfolio, as such term is defined in the related security agreement. In connection with issuance of the Secured Note the Company issued warrants to the $2.0 million Secured Convertible Note that remained outstandinglender exercisable to purchase 120,000 shares of common stock for $3.25 per share until its full conversion in three separate tranches between July 1, 2014December 28, 2022. The Company treated the issuance and September 19, 2014. On August 28, 2014, we issuedextension of this debt as an extinguishment for financial accounting purposes. Accordingly, the $4.0 million Secured Convertible Note bearing interest atestimated fair value of the ratewarrants granted totaled $244,379, which was recorded as additional paid-in-capital and a loss on extinguishment of 6% per annum that remained outstanding until its full conversion in eight separate tranches between February 13, 2015 and February 25, 2015.subordinated notes payable.

We amortized to interest expense $55,187 and $132,447, representingThe loss on extinguishment of subordinated notes payable aggregated $424,527 for the discount associated with the $2.5 million subordinated note during yearsyear ended December 31, 2015 and 2014, respectively. The total remaining unamortized discount was $0 and $55,187 at December 31, 2015 and 2014, respectively.2017. There were no similar extinguishment of subordinated notes payable in 2016.

Loss before Income Tax Benefit

As a result of the above, we reported a loss before income tax benefit of $12,037,892$12,342,457 and $9,163,261$12,710,688 for the years ended December 31, 20152017 and 2014,2016, respectively, a deteriorationan improvement of $2,874,631 (31%$368,231 (3%).

Income Tax Benefit

The new tax act eliminates the alternative minimum tax (AMT) for corporations and allows any remaining AMT carryforward to become refundable in 2018 and beyond tax returns. As a result, we did not provide a valuation reserve on the deferred tax asset represented by the AMT tax credit carryforward as of December 31, 2017. Accordingly, we recorded an income tax benefit of $90,000 at December 31, 2017 representing the AMT credit carryforwards that are now refundable under the new tax act.

We did not record an income tax benefit related to our losses for the years ended December 31, 2015 and 2014, respectively,2016, due to our overall net operating loss carryforwardscarryforward available. We have further determined to continue providing a full valuation reserve on our net deferred tax assets as of December 31, 2015.2017 exclusive of AMT tax credit carryforward. During 2015,2017, we increasedreduced our valuation reserve on deferred tax assets by $5,413,000$4,385,000 whereby our deferred tax assets continue to be fully reserved due to our recent operating losses.

We had approximately $30,700,000$49,305,000 of net operating loss carryforwards and $1,747,000$1,795,000 of research and development tax credit carryforwards as of December 31, 20152017 available to offset future net taxable income.

Net Loss

As a result of the above, we reported net losses of $12,037,892$12,252,457 and $9,163,261$12,710,688 for the years ended December 31, 20152017 and 2014,2016, respectively, a deteriorationan improvement of $2,874,631 (31%$458,231 (4%).

Basic and Diluted Loss per Share

The basic and diluted loss per share was $2.77$1.76 and $3.54$2.38 for the years ended December 31, 20152017 and 2014,2016, respectively, for the reasons previously noted. All outstanding stock options and common stock purchase warrants were considered antidilutive and therefore excluded from the calculation of diluted loss per share for the years ended December 31, 20152017 and 20142016 because of the net loss reported for each period.

Liquidity and Capital Resources

Overall:

During 2011,The Company’s Board of Directors has initiated a review of strategic alternatives to best position the Company for the future, including, but not limited to, monetizing its patent portfolio and related patent infringement litigation against Axon and WatchGuard, the sale of all or certain assets, properties or groups of properties or individual businesses or merger or combination with another company. The result of the strategic review may also include the continued implementation of the Company’s business plan with additional debt or equity financing. The Company retained Roth Capital Partners (“Roth”) to assist in this review and process. Thus, the Company is considering alternatives to address its near-term and long-term liquidity and operational issues. There can be no assurance that a transaction or financing will result from this process. As part of this overall strategic alternatives process, the Board of Directors approved a private placement that closed on April 3, 2018 and is described below in “Subsequent Developments.” Management believes this financing has addressed the Company’s near-term liquidity needs which primarily included the repayment of principal and interest on the Debentures, June Note and Secured Note.

Subsequent Developments:

On April 3, 2018, the Company completed a private placement (the “Private Placement”) to institutional investors of $6.05 million in principal amount of Senior Secured Convertible Promissory Notes (the “Notes”) and warrants exercisable to purchase 806,667 shares of common stock (the “Warrants). The Notes and Warrants were issued pursuant to a Securities Purchase Agreement (the “SPA”) between the Company and the investors (the “Holders”). The Private Placement resulted in gross proceeds of $5.5 million before placement agent fees and other expenses associated with the transaction. A portion of the proceeds were used to repay in full the Debentures issued in December 2016 and the approximately $1,008,500 principal amount and accrued interest on the June Note and Secured Note. The balance of the net proceeds will be used for working capital and general corporate purposes. Roth Capital Partners acted as placement agent for the Company and received a placement fee of approximately $250,000.

Prior to the maturity date, the Notes bear interest at 8% per annum, which twelve (12) months’ interest amount shall be guaranteed; provided, however, that in the event that a cash prepayment or amortization is made pursuant to the Notes, the Company shall only be required to pay an amount equal to the annualized additional interest due on the then outstanding principal balance of the Notes. Interest shall be paid at the Company’s discretion in cash, or subject to the equity conditions contained in the Notes, in shares of the Company’s common stock. The Notes rank senior to the Company’s existing and future indebtedness of the Company and are secured by all assets and intellectual property to the extent and as provided in the underlying security and related documents.

The Notes are convertible at any time after their date of issue at the option of the Holders into shares of common stock at $2.50 per share (the “Conversion Price”). The Notes mature on May 3, 2019 (the “Maturity Date”). Commencing on July 1, 2018, and continuing for each fiscal month thereafter through the Maturity Date, the Company will make payments of principal and interest to the Holders to fully amortize the Notes. The Conversion Price is subject to adjustment upon stock splits, reverse stock splits, and similar capital changes.

At any time after issuance of the Notes, so long as there is no event of default under the Notes, the Company may deliver to the Holders a notice of prepayment with respect to any portion of the principal amount of the Notes, any accrued and unpaid interest (including, without limitation, guaranteed interest on any outstanding principal) and any other amounts due under the Notes. If the Company exercises its right to prepay the Notes, the Company will pay to the Holders an amount in cash equal to the sum of the then outstanding principal amount of the Notes and guaranteed interest as follows: (i) from the initial issuance date of the Notes to August 1, 2018, a 0% premium; (ii) from August 2, 2018 to December 1, 2018, a 110% premium; and (iii) from December 2, 2018 to the Maturity Date, a 115% premium.

At any time after issuance of the Notes, in the event that the Company (i) consummates any public or private offering or other financing or capital-raising transaction of any kind (each a “Subsequent Offering”), in which the Company receives, in one or more contemporaneous transactions, gross proceeds of $10,000,000, (ii) receives cash, in the aggregate, of at least $10,000,000 from any Action (as defined in the SPA), at any time upon ten (10) days written notice to the Holders, but subject to the Holders’ conversion rights set forth herein, the Company must make a mandatory redemption in full of the Notes to the Holders. The required redemption of the Notes would be at an amount equal to the outstanding principal amount of the Notes, any accrued and unpaid interest (including, without limitation, guaranteed interest), and any other amounts due under the Notes at the same premium described above with respect to prepayments.

The Notes also provide for mandatory conversion by the Holders in the event thatat any time (x) the VWAP (volume weighted average price as defined in the Notes) of the common stock listed on the trading market (as defined in the SPA) exceeds $4.50 (as adjusted for stock splits, stock dividends, stock combinations, recapitalizations and similar events) for twenty (20) consecutive trading days, and (y) no failure of the equity conditions (as defined in the Notes) then exists, the Company shall have the right to require the Holders to convert all, or any part, of the conversion amount (as defined in the Notes) of the Notes (but in no event less than the lesser of (I) two (2) times the daily average trading volume for the prior (20) consecutive trading date (as defined in the notes), and (II) all of the conversion amount then remaining under the Notes), as designated in the mandatory conversion notice (as defined in the Notes) into fully paid, validly issued and nonassessable shares of common stock in accordance with Notes at the conversion price as of the mandatory conversion date (as defined in the Notes).

So long as the Notes are outstanding, the Company is prohibited from entering into any variable rate transactions (as defined in the Notes).

Upon the occurrence of an event of default under the Notes, the Company must repay to the Holders, in cash or in shares of common stock at the greater of (i) a 135% premium of the outstanding principal amount of the Notes and accrued and unpaid interest hereon, in addition to the payment of all other amounts, costs, expenses and liquidated damages due in respect of the Notes; and (ii) the outstanding principal amount of the Notes and accrued and unpaid interest hereon, in addition to the payment of all other amounts, costs, expenses and liquidated damages due in respect of the Notes, divided by the conversion price, multiplied by (b) the highest closing price for the common stock on the trading Market (as defined in the SPA) during the period beginning on the date of first occurrence of the event of fault and ending one (1) day prior to the mandatory prepayment date in the prepayment section of the Notes.

The Warrants issued in conjunction with the Notes are exercisable to purchase up to 806,667 shares of common stock commencing on the date of issuance at an exercise price of $3.00 per share (the “Exercise Price”). The Warrants will expire on the fifth (5^th) anniversary of their date of issuance. The exercise price is subject to adjustment upon stock splits, reverse stock splits, and similar capital changes. The Warrants provide for cashless exercise in the event that after 180-days after their issuance a registration statement on Form S-1 (or other applicable registration statement under the Securities Act of 1933, as amended (the “Securities Act”)) covering the resale of all shares of common stock underlying the Warrants is not available for the issuance of such shares of common stock. A Holder has no right to convert the Note or exercise the Warrant to the extent that such conversion or exercise would result in the Holder being the beneficial owner in excess of 4.99% (or, upon election of purchaser, 9.99%), which beneficial ownership limitation may be increased or decreased up to 9.99% upon notice to the Company, provided that any increase in such limitation will not be effective until 61 days following notice to the Company.

Pursuant to the SPA, the Company must within forty-five (45) days of the closing date file with the U.S. Securities and Exchange Commission a registration statement on Form S-1 (or other applicable registration statement under the Securities Act) covering the resale of all shares of common stock issuable upon conversion or exercise of the Notes and Warrants, respectively.

Discussion of Liquidity and Capital Resources:

On June 30, 2017, we borrowed an aggregate of $700,000 under notes (the “June Notes”) with two private, third-party lenders. The unsecured Notes bore interest of 8% per annum with all principal and accrued interest due on or before their September 30, 2017 maturity date. In connection with the issuance of the June Notes we issued the lenders warrants exercisable to purchase a total of $2.5 million200,000 shares of common stock at an exercise of $3.65 per share and an expiration date of June 29, 2022. On September 30, 2017 we negotiated an extension of the maturity date of one of the June Notes to December 31, 2017 and then an extension to March 31, 2018. In connection with the first extension, we issued warrants exercisable to purchase 100,000 shares of common stock at $2.60 per share until November 15, 2022. We retired the second June Note that had a principal balance of $350,000 in August 2017.

On September 29, 2017, we borrowed $300,000 under an unsecured credit facilitypromissory note with a private, third-party lender. The $2.5 million of subordinated notesSuch note bore interest at the rate of 8% per annum with all principal and areaccrued interest due on or before its November 30, 2017 maturity date. In connection with the note we issued the lender warrants exercisable to purchase a total of 100,000 shares common stock at an exercise of $2.75 per share and an expiration date of September 30, 2022.

On December 29, 2017, we borrowed an additional $350,000 with the same private, third party lender and combined the existing note issued in September 2017 into a new note (the “Secured Note”) with a principal balance of $658,500 that is due and payable interest onlyin full on a monthly basis.March 1, 2018 and may be prepaid without penalty. The subordinated notes were subordinated to all existing and future senior indebtedness;Secured Note is secured by our intellectual property portfolio, as such term is defined in the Notes. On December 4, 2013,Secured Note. In connection with issuance of the Secured Note we entered into an agreement withissued warrants to the lender that extended the maturity dates of the subordinated notes from May 30, 2014exercisable to May 30, 2015, which was later extended to August 15, 2015. The subordinated notes were unsecured and did not prevent us from obtaining new senior secured financings. On July 24, 2015, we paid the entire $2.5 million of outstanding principal together with all accrued interest in full.

On March 24, 2014, we completed a private placement of the $2.0 million Secured Convertible Note, which bore interest at 6% per annum, payable quarterly, and was secured by all of our assets. In addition, we issued the holder detachable warrants to acquire 130,000purchase 120,000 shares of common stock at $10.00for $3.25 per share (the “March 2014 Warrant”). On July 10, 2014 we anduntil December 28, 2022. We used the holderproceeds of the $2.0 million Secured Convertible Note entered into an agreement under which we reduced the conversion price of the Senior Secured Note to $6.25 per share during the period from July 11 to July 14, 2014. During the foregoing period the holder converted $1,777,778 principal amount and $2,963 accrued interest on the Secured Convertible Note into 284,928 shares of our common stock. On July 15, 2014 the conversion price returned to $8.55 per share. The holder of the $2.0 million Secured Convertible Note exercised its right to convert the remaining outstanding principal into 26,263 shares of common stock in two separate tranches on August 28, 2014 and September 19, 2014. In addition, the holder exercised its warrant to purchase 130,000 shares of common stock resulting in cash proceeds of $951,600 during 2014 and utilized the cashless exercise featurenote transactions for the remaining 6,621 shares.general working capital purposes.

On August 28, 2014, we completed a second private placement to the holder of the $2.0 million Secured Convertible Note and issued the $4.0 million Secured Convertible Note, which bore interest at 6% per annum, payable quarterly, and was secured by all assets of the Company. Principal payments were not required until the sixth month after origination and continued ratably for the remaining 18-month term. The principal and interest payments could be made through the payment of cash or in-kind by transferring unrestricted and fully registered shares in an amount equivalent to 80% of the volume weighted average trading price for the 20 consecutive trading days preceding the payment date. The $4.0 million Secured Convertible Note was convertible into shares of common stock at the holder’s option at a conversion price of $6.10 per share at any time it was outstanding. In addition, we could force conversion if the market price exceeded $12.20 per share for 20 consecutive trading days. In connection with the second private placement we issued a warrant exercisable to purchase 262,295 shares of common stock at $7.32 per share (the “August Warrant”), which was exercisable immediately and expires August 28, 2019.

On December 4, 2014, the holder of the $4.0 million Secured Convertible Note converted $36,600 of principal into 6,000 shares of common stock and in February 2015 the holder exercised its conversion rights on the remaining principal and accrued interest balances in exchange for an additional 655,213 shares of common stock. The $4.0 million Secured Convertible Note and August Warrant contained anti-dilution provisions and restricted the incurrence of additional secured indebtedness. We paid a placement agent fee of $240,000 and approximately $101,500 of other third party costs in connection with the transaction, which included legal fees. We used the funds generated by this credit facility to provide the working capital for our operations in 2015.

In connection with the anti-dilution provisions of the March 2014 Warrant, the Company was required to increase the number of shares to be issued upon the exercise of the March 2014 Warrant to 136,621 from 100,000 and to reduce the exercise price to $7.32 from $10.00 per share in connection with the August 2014 private placement.

In accordance with the terms of the $4.0 million Secured Convertible Note we were required to maintain minimum cash balance of not less than $1.5 million until such time as we satisfied all of the “Equity Conditions,” as defined in the $4.0 million Secured Convertible Note. Such Equity Conditions included our shareholders approving the issuance of shares above the Nasdaq Share Cap. The $1.5 million minimum cash balance was reported as restricted cash separate from cash and cash equivalents in the consolidated balance sheet as of December 31, 2014. On February 13, 2015, the shareholders approved the issuance of shares above the Nasdaq Share Cap, thereby releasing the restriction on the cash balances.

Between February 13 and 25, 2015 the holder of the $4.0 million Secured Convertible Note exercised its right to convert the remaining principal on the $4.0 million Secured Convertible Note into 655,738 shares of common stock and 5,475 shares for accrued interest at the conversion price of $7.32 per share. In addition, the holder also exercised part of its August Warrant to purchase 212,295 shares of common stock resulting in cash proceeds of $1,553,999 during first quarter 2015. The holder exercised part of its August Warrant to purchase 37,800 shares resulting in cash proceeds of $276,690 during second quarter 2015. Warrants to purchase a total of 12,200 common shares for $7.32 remain outstanding as of December 31, 2015.

On July 22, 2015,23, 2017, we closed a $12.0$3.0 million offering of our common stock and common stock purchase warrants in an at-the-marketa registered direct offering and a concurrent private placement of two series of common stock purchase warrants with two investors.offering. At the closing, we sold to institutional investors in a registered direct offering an aggregate of 879,766940,000 shares of our common stock at a price of $3.00 per share and Series B Warrants, for gross offering proceeds of $3.0 million. For each share of common stock purchased, investors received two registered warrants, each with an exercise price of $13.64 in a registered direct offering to$3.36 per share (the “Series A-1 Warrant” and the investors. We also issued a registered short-term warrant to the investors“Series A-2 Warrant”). The Series A-1 Warrants are exercisable to purchase a total of 437,086 shares of common stock in such offering. Additionally, in a concurrent private placement, we issuedup to the investors short-term warrants exercisable to purchase a total of 222,738680,000 shares of common stock and long-termhave a term of five years commencing six months following the closing date. The Series A-2 warrants are immediately exercisable to purchase a total200,000 shares of 879,766common stock and have a term of five years commencing on the closing date. Additionally, the Company issued to certain of the investors, in lieu of shares of common stock at closing, Series B Warrants that are immediately exercisable (the “Series B Warrant”) to purchase 60,000 shares of common stock for which the investors paid $2.99 per share at the closing and will pay $0.01 per share upon exercise of the Series B Warrant so that such investors’ beneficial ownership interest would not exceed 9.9% of the issued and outstanding shares of common stock. Both the short-term registered and private placement warrants are immediately exercisable, have anThe Series B Warrants terminate upon exercise price of $13.43 per share and expire 24 months from the date of issuance. The long-term warrants are immediately exercisable, have an exercise price of $13.43 per share and expire five and one-half years from the date of issuance.in full. After placement agent fees and other estimated offering expenses, the net offering proceeds to us totaled approximately $11.2 million prior to any exercise of the warrants.$2.8 million. The foregoing warrants issued in this transaction did not contain terms that would require us to record derivative warrant liabilities that could affect our financial statements. Proceeds of the offering were used to repaypay a portion of the $2.5 millionoutstanding principal amountbalance of subordinated notes plus accrued interest in fullthe Debentures, retire one of the June Notes and for other working capital purposes.

After completionOn December 30, 2016, we completed a private placement of the $12.0 million offering on July 22, 2015 and the payment of the $2.5$4.0 million principal amount of subordinated notes,Debentures with two institutional investors. Such Debentures bear interest at 8% per annum payable in cash on a quarterly basis and are secured by substantially all of our tangible and certain intangible assets. In addition, we believeissued the investors warrants to acquire 800,000 shares of common stock at $5.00 per share. We made payments of $750,000 against the Debentures on August 24, 2017. The Debentures mature on March 30, 2018 and are convertible at any time six months after their date of issue at the option of the holders into shares of common stock at $5.00 per share. In addition, we have sufficientcan elect to redeem the Debentures at 112% of their outstanding principal balance and could force conversion by the holders if the market price exceeds $7.50 per share for ten consecutive trading days. We used the proceeds of this private placement for general working capital purposes.

As discussed in “Subsequent Developments” above, we retired the maturing Debentures, June Note and Secured Note with part of the cash proceeds of the Private Placement of Notes that closed on April 3, 2018. This recent development is a part of the strategic alternatives initiative discussed above and addressed our near-term liquidity needs.

If we must further supplement our liquidity to support our operations for 2016.in 2018, given our recent history of net operating losses and negative cash flows, we do not believe that traditional banking indebtedness would be available to us given our recent operating history. Our 2018 operating plan could include raising additional capital through an asset sale, a public offering or a private placement of debt or equity, all of which are under consideration as part of our strategic alternatives. We have demonstrated our ability to raise new debt or equity capital in recent years and specifically the recent Private Placement, and if necessary, we believe that we could raise additional capital during the next 12 months if required, but can offer no assurances in this regard. In addition, if the need arises,in early 2018 we may seek commercial credit facilities including traditional bank borrowings to improvecut our liquidity positionoperating overhead significantly by a reduction in work force and to finance growth opportunities or future capital needs that may arise.other cost saving measures.

We haveFurther, we had warrants outstanding exercisable to purchase 1,599,2903,233,466 shares of common stock at a weighted average exercise price $13.25$6.57 per share outstanding as of December 31, 2015.2017. In addition, there are common stock purchase options outstanding covering 328,690exercisable to purchase 250,269 shares at an average price of $20.43$18.80 per share. TheWe could potentially use such outstanding warrants to provide near-term liquidity if we could induce their holders to exercise their warrants by adjusting/lowering the exercise price on a temporary or permanent basis if the exercise price was below the then market price of theseour common stock, equivalents wouldalthough we can offer no assurances in this regard. Ultimately, we must restore profitable operations and positive cash flows to provide us with an additional potential sourceliquidity to support our operations and, if necessary, to raise capital on commercially reasonable terms in 2018, although we can offer no assurances in this regard.

Based on the uncertainties described above, we believe our business plan does not alleviate the existence of liquidity.substantial doubt about our ability to continue as a going concern within one year after the date of the financial statements in this Report.

We had $6,924,079$554,712 of available cash and equivalents (including $500,000 of restricted cash) and net working capital of approximately $18.7$1.7 million as of December 31, 2015.2017. Net working capital as of December 31, 2015 includes2017 included approximately $3.4$2.0 million of accounts receivable and $10.7$8.8 million of inventory.

Cash and cash equivalents balances: As of December 31, 2015,2017, we had cash and cash equivalents with an aggregate unrestricted balance of $6,924,079, an increase$54,712, a decrease from a balance of $3,049,716$3,883,124 at December 31, 2014.2016. Summarized immediately below and discussed in more detail in the subsequent subsections are the main elements of the $3,874,363$3,828,412 net increasedecrease in cash during the year ended December 31, 2015:2017:

The net result of these activities was an increasea decrease in unrestricted cash of $3,874,363$3,828,412 to $6,924,079$54,712 for the year ended December 31, 2015.2017.

Commitments:

We had $6,924,079$54,712 of cash and cash equivalent balances and net positive working capital approximating $18.7$1.7 million as of December 31, 2015.2017. Accounts receivable balances represented $3,368,909$1,978,836 of our net working capital at December 31, 2015.2017. We intend to collect our outstanding receivables on a timely basis and reduce the overall level during 2016,2018, which would help to provide positive cash flow to support our operations during 2016.2018. Inventory represented $10,661,766$8,750,713 of our net working capital at December 31, 20152017 and finished goods represented $7,895,663$6,964,624 of total inventory. We are actively managing the level of inventory and our goal is to reduce such levelslevel during 20162018 by our sales activities, which should provide additional cash flow to help support our operations during 2016.2018.

Capital Expenditures. We had no material commitments for capital expenditures at December 31, 2015.2017.

Lease commitments-Operating Leases. We have a long-term operating lease agreement for office and warehouse space that expires in April 2020. We have also entered into month-to-month leases for equipment and facilities. Rent expense for the years ended December 31, 20152017 and 20142016 was $401,845$397,924 and $398,624,$397,924, respectively, related to these leases. Following are our minimum lease payments for each year and in total.

License agreements.We have several license agreements under which we have been assigned the rights to certain licensed materials used in our products. Certain of these agreements require us to pay ongoing royalties based on the number of products shipped containing the licensed material on a quarterly basis. Royalty expense related to these agreements aggregated $26,454$21,188 and $27,053$25,161 for the years ended December 31, 20152017 and 2014,2016, respectively.

Following is a summary of our licenses as of December 31, 2015:

Supply and distribution agreement.

We entered into a supply and distribution agreement with Dragoneye on May 1, 2010 under which it was granted the exclusive world-wide right to sell and distribute a proprietary law enforcement speed measurement device and derivatives to its customers. The term of the agreement was 42 months after the date Dragoneye began full scale production of the product, which commenced in August 2010 and final certification of the product was obtained. The agreement had minimum purchase requirements of 1,000 units per period over three commitment periods. On January 31, 2012, the agreement was amended to reduce the minimum purchase commitment over the second and third years by 52% of the original commitment. We agreed to release our world-wide right to exclusively market the product to the law enforcement community in exchange for the reduction in the purchase commitment.

The agreement originally required minimum order quantities that represent a remaining unfulfilled commitment to acquire $634,680 of product as of December 31, 2014. Dragoneye is responsible for all warranty, damage or other claims, losses or liabilities related to the product and is obligated to defend and indemnify us against such risks. We held approximately $1,318,000 of such products in finished goods inventory as of December 31, 2015 and had sold approximately 1,010 units since the beginning of the agreement through December 31, 2015.

We filed a lawsuit on June 15, 2013 against Dragoneye for breaching the contract and participated in a mediation of the lawsuit on August 12, 2015 that resulted in a settlement on August 25, 2015. The settlement includes the repair of all LaserAlly units we currently hold and future customer returned units exhibiting the same failure. See “Litigation” below for further details.

Litigation.

We areThe Company is subject to various legal proceedings arising from normal business operations. Although there can be no assurances, based on the information currently available, we believemanagement believes that it is probable that the ultimate outcome of each of the actions will not have a material adverse effect on ourthe consolidated financial statements.statement of the Company. However, an adverse outcome in certain of the actions could have a material adverse effect on ourthe financial results of the Company in the period in which it is recorded.

On June 5, 2013, weAxon

The Company owns the “‘452 Patent”, which generally covers the automatic activation and coordination of multiple recording devices in response to a triggering event, such as a law enforcement officer activating the light bar on the vehicle.

The Company filed suit on January 15, 2016 in the U.S. District Court for the District of Kansas (Case No: 2:16-cv-02032) against Axon, alleging willful patent infringement against Axon’s body camera product line and Signal auto-activation product. The Company is seeking both monetary damages and a permanent injunction against Axon for infringement of the ‘452 Patent.

In addition to the infringement claims, the Company brought claims alleging that Axon conspired to keep the Company out of the marketplace by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Axon bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state law and federal antitrust law. The Company’s lawsuit also seeks monetary and injunctive relief, including treble damages, for these alleged violations.

Axon filed an answer, which denied the patent infringement allegations on April 1, 2016. In addition, Axon filed a lawsuitmotion to dismiss all allegations in the complaint on March 4, 2016 for which the Company filed an amended complaint on March 18, 2016 to address certain technical deficiencies in the pleadings. Axon amended and renewed its motion to seek dismissal of the allegations that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state law and federal antitrust law on April 1, 2016. Formal discovery commenced on April 12, 2016 with respect to the patent related claims. In January 2017, the Court granted Axon’s motion to dismiss the portion of the lawsuit regarding claims that it had bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state law and federal antitrust law. The Company has appealed this decision to the United States Court of Appeals for the Federal Circuit and is awaiting its decision.

In December 2016 and January 2017, Axon filed two petitions forInter Parts Review (“IPR”) against the ‘452 Patent. The USPTO rejected both of Axon’s petitions. Axon is now statutorily precluded from filing any more IPR petitions against the ‘452 Patent.

The District Court litigation in Kansas was temporarily stayed following the filing of the petitions for IPR. However, on November 17, 2017, the Federal District Court of Johnson County, Kansas rejected Axon’s request to maintain the stay. With this significant ruling, the parties will now proceed towards trial. Since litigation has resumed, aMarkman hearing was held on March 7, 2018 and the parties have continued to engage in discovery. All remaining significant deadlines will be set when the Court issues itsMarkmanorder. See earlier explanation of aMarkman hearing.

WatchGuard

On May 27, 2016 the Company filed suit against Dragoneye. We had enteredWatchGuard, (Case No. 2:16-cv-02349-JTM-JPO) alleging patent infringement based on WatchGuard’s VISTA Wifi and 4RE In-Car product lines.

The USPTO has granted multiple patents to the Company with claims covering numerous features, such as automatically activating all deployed cameras in response to the activation of just one camera. Additionally, Digital Ally’s patent claims cover automatic coordination as well as digital synchronization between multiple recording devices. The Company also has patent coverage directed to the coordination between a multi-camera system and an officer’s smartphone, which allows an officer to more readily assess an event on the scene while an event is taking place or immediately after it has occurred.

The Company’s lawsuit alleges that WatchGuard incorporated this patented technology into its VISTA Wifi and 4RE In-Car product lines without its permission. Specifically, Digital Ally is accusing WatchGuard of infringing three patents: the ‘292 and ‘452 Patents and U.S. Patent No. 9,325,950 the (“ ‘950 Patent”). The Company is aggressively challenging WatchGuard’s infringing conduct, seeking both monetary damages, as well as seeking a supply and distribution agreement with Dragoneye on May 1, 2010 under which we were granted the rightpermanent injunction preventing WatchGuard from continuing to sell its VISTA Wifi and distribute4RE In-Car product lines using Digital Ally’s technology to compete against it. On May 8, 2017, WatchGuard filed a proprietary law enforcement speed measurement devicepetition seeking IPR of the ‘950 Patent. The Company will vigorously oppose that petition. On December 4, 2017 The Patent Trial and derivativesAppeal Board (“PTAB”) rejected the request of WatchGuard Video to our customers underinstitute aninter partesreview (“IPR”) on the trade name LaserAlly.‘950 Patent. The parties amendedlawsuit also involves the agreement on January 31, 2012. In our complaint we alleged that Dragoneye breached‘292 Patent and the contract because it failed to maintain as confidential information our customer list; it infringed on our trademarks, including LaserAlly and Digital Ally; it tortiously interfered with our existing contracts and business relationships with our dealers, distributors, customers and trading partners; and it engaged in unfair competition and violated‘452 Patent, the Kansas Uniform Trade Secrets Statutes. We amended the complaint to include claims regarding alleged material defectssame two patents asserted against Axon. The ‘292 Patent is in the products supplied under the agreement. We participated in a mediation of the lawsuit on August 12, 2015 and agreed to an omnibus resolution of the matter. The settlement included the return of and repair free of charge of all LaserAlly units we held and future customer returned units exhibiting the same or similar failure. Dragoneye was allowed no more than 120 days from October 1, 2015 to repair all units, upgrade all units to current firmware release and to re-certify the units. We will remit the unpaid balance of approximately $191,000 ($91,684.47 remaining at December 31, 2015) currently recorded in accounts payable to Dragoneye in five payments concurrentIPR process with the repair and return of units by Dragoneye. Furthermore, all ofUSPTO, while WatchGuard is now statutorily barred from any further IPR’s challenges with respect to the remaining minimum contractual purchase requirements were voided. On August 25, 2015,‘950 Patent. The lawsuit has been stayed pending a decision from the judge approvedUSPTO on the parties’ joint stipulation of dismissal with prejudice,‘292 Patent IPR petition which finalized the settlement.is expected in June 2018.

Utility Associates, Inc.

On October 25, 2013, wethe Company filed a complaint in the United States District Court for the District of Kansas (2:13-cv-02550-SAC)to eliminate threats by a competitor, Utility Associates, Inc. (“Utility”), of alleged patent infringement regarding U.S. Patent No. 6,831,556 (the “ ’556 patent”‘556 Patent”). Specifically, the lawsuit seeks a declaration that ourthe Company’s mobile video surveillance systems do not infringe any claim of the ’556 patent. We‘556 Patent. The Company became aware that Utility had mailed letters to current and prospective purchasers of ourits mobile video surveillance systems threatening that the use of such systems purchased from third parties not licensed to the ’556 patent‘556 Patent would create liability for them for patent infringement. We reject Utility’s assertion and will vigorously defend the right of end-users to purchase such systems from providers other than Utility. The United States District Court for the District of Kansas dismissed the lawsuit because it decided that Kansas was not the proper jurisdictional forum for the dispute. The District Court’s decision was not a ruling on the merits of the case. We appealed the decision and the Federal Circuit affirmed the District Court’s previous decision.

In addition, wethe Company began proceedings to invalidate the ’556 patent‘556 Patent through a request forinter partes review IPR of the ’556‘556 patent at the United States Patent and Trademark Office (“USPTO”).USPTO. On July 27, 2015, the USPTO invalidated key claims in Utility’s ’556‘556 Patent. The Final Decision from the USPTO significantly curtailscurtailed Utility’s ability to threaten law enforcement agencies, municipalities, and others with infringement of the ’556‘556 Patent. Utility has appealed this decision to the United States Court of Appeals for the Federal Circuit. Briefs have not yet been filed and no scheduleThe United States Court of Appeals for oral argument has been issued. We believe Utility will have a difficult time convincing the appellate court to overturnFederal affirmed the decisionruling of the USPTO.USPTO summarily thus concluding the matter.

On June 4,6, 2014 wethe Company filed ana separate Unfair Competition lawsuit against Utility Associates, Inc. (“Utility”) in the United States District Court for the District of Kansas. In thethat lawsuit we contendit contended that Utility has defamed usdisparaged the Company and illegally interfered with ourits contracts, customer relationships and business expectancies by falsely asserting to ourits customers and others that ourits products violate the ’556‘556 Patent, of which Utility claims to be the holder.

Our suit also includes claims against Utility for tortious interference with contract and violation of the Kansas Uniform Trade Secrets Act, arising out of Utility’s employment of one of our employees, in violation of that employee’s Non-Competition and Confidentiality agreements with us. In addition to damages, we are seeking temporary, preliminary, andthe Company sought permanent injunctive relief, prohibiting Utility from among other things, continuing to threatenthreated or otherwise interfere with ourthe Company’s customers. On March 4, 2015, an initial hearing was held upon ourthe Company’s request for injunctive relief.

Based upon facts revealed at thea March 4, 2015 injunction hearing, on March 16, 2015, wethe Company sought leave to amend ourits Complaint in the Kansasunfair competition suit to assert additional claims against Utility. Those new claims includeincluded claims of actual or attempted monopolization, in violation of § 2 of the Sherman Act, claims arising under a new Georgia statute that prohibits threats of patent infringement in “bad faith,” and additional claims of unfair competition/false advertising in violation of § 63(a) of the Lanham Act. As these statutes expressly provide, we are seeking treble damages, punitive damages and attorneys’ fees, as well as injunctive relief. The Court concluded its injunction hearing on April 22, 2015, and allowed usthe Company leave to amend our complaint,add these claims, but denied ourits preliminary injunction. Subsequent to the injunction hearing, Utility withdrew from the market the in-car video recording device that it had sold in competition with the Company’s own products of similar function and which Utility had attempted to market using threats of patent infringement. After discovery closed, Utility filed a Motion for Summary Judgment and the Company filed a Motion for Partial Summary Judgment. On March 30, 2017, the Court entered its order granting Utility’s motion and denying the Company’s motion for summary judgment. The case is now inCompany believed the discovery stage. However, we believe thatDistrict Court had made several errors when ruling on the USPTO’s final decision issued on July 27, 2015 will provide us with substantial basis to pursue our claims either through court trial or bymotions for summary judgment, motions. We intendand filed an appeal to pursue recovery from Utility, its insurers and other parties, as appropriate.

On June 13, 2014, Utility filed suit in the United States District Court of Appeals for the Northern DistrictTenth Circuit (10^th Circuit”). While the appeal was pending, Utility filed a motion for the recovery from the Company of Georgia against us alleging infringementsome $800,000 in alleged attorney’s fees as provided, purportedly, under the Lanham Patent and Uniform Trade Secrets Act. That motion was denied in its entirety by final judgement entered February 14, 2018. On February 16, 2018, the 10^th Circuit issued its decision affirming the decision of the ’556 patent.District Court. The suitCompany filed a petition for rehearing by the panel anden banc which was servedalso denied. Utility has filed its own motion for the recovery of attorney fees, on us on June 20, 2014. As alleged in our first filed lawsuit described above, we believe the ’556 patent is both invalid and not infringed. Further, the USPTO issued its final decision invalidating 23 of the 25 claims assertedappeal in the ’556 Patent, as noted above. We believe thatalleged amount of $125,000. That motion has not yet been fully briefed but the suit filed by Utility is without merit and weCompany will vigorously defendit on substantially the claims asserted against us. An adverse resolution of the foregoing litigation or patent proceedings could have a material adverse effect on our business, prospects, results of operations, financial condition, and liquidity. The Court stayed all proceedings with respect to this lawsuit pending the outcome of the patent review performedsame grounds upon which Utility’s prior motion for attorney’s fees was denied by the USPTO and the appellate court. Based on the USPTO’s final decision to invalidate substantially all claims contained in the ’556 patent, we intend to file for summary judgment in our favor if Utility does not request outright dismissal.

The Company received notice in April 2015 that TASER International, Inc. (“Taser”), one of our competitors, had commenced an action in the USPTO for a re-examination of our U.S. Patent No. 8,781,292 (“the ’292 Patent). A re-examination is essentially a request that the USPTO review whether the patent should have issued in its present form in view of the “prior art,” e.g., other patents in the same technology field. The prior art used by Taser to request the re-examination is a patent application (which never issued into a patent) assigned to an unrelated third party and was not the result of any of Taser’s own research and development efforts.

Our ’292 Patent is directed to a system that determines when a recording device, such as a law enforcement officer’s body camera or in-car video recorder, begins recording and automatically instructs other recording devices to begin recording. The technology described in the ’292 Patent is incorporated in our VuLink product.

On August 17, 2015 the USPTO issued a first, non-final action rejecting all 20 claims of the ’292 Patent respecting our’292 Patent, which was undergoing anex parte re-examination. We were provided the opportunity to discuss the merits of the prior art and the scope of the patent claims with the patent Examiner handling the reexamination and to amend the patent claims. On January 14, 2016 the USPTO ultimately rejected Taser’s efforts and confirmed the validity of the ’292 patent with 59 claims covering various aspects of our auto-activation technology. On February 2, 2016 the USPTO issued another patent relating our auto-activation technology for law enforcement cameras. U.S. Patent No. 9,253,452 (“the ’452 patent”) generally covers the automatic activation and coordination of multiple recording devices in response to a triggering event such as a law enforcement officer activating the light bar on the vehicle.District Court.

The Company filed suit on January 15, 2016 in the U.S. District Court for the District of Kansas (Case No: 2:16-cv-02032) against Taser, alleging that Taser willfully infringed the ’292 Patent by selling and offering to sell its Axon camera product line and Signal Performance Power Magazine. The lawsuit was initiated after the USPTO reconfirmed the validity of the ’292 patent. On February 2, 2016, we amended our complaint against Taser, further alleging that Taser is directly and indirectly liable for infringing the ’452 Patent. Our amended complaint seeks both monetary damages and a permanent injunction against Taser for infringing both the ’452 and ’292 Patents.

In addition to the ’452 Patent infringement claims, the February 2, 2016 amended complaint added a new set of claims to the lawsuit alleging that Taser conspired to keep us out of the marketplace by engaging in improper, unethical, and unfair competition. The amended lawsuit alleges Taser bribed officials and otherwise conspired to secure no-bid contracts for its products in violation of both state law and federal antitrust law. Our lawsuit also seeks monetary and injunctive relief, including treble damages, for these alleged violations.

On February 19, 2016 TASER asked for and was granted an extension of time to answer or otherwise plead to the complaint alleging willful patent infringement, the bribery of officials and otherwise conspired to secure no-bid contracts for its products in violation of both state law and federal antitrust law. On March 4, 2016, TASER filed a motion to dismiss our complaint which is now pending before the court.

On or about May 22, 2014, Stephen Gans, a former director and former principal shareholder of us, filed a complaint in the Eighth Judicial District Court, Clark County, Nevada that asserts claims against us and Stanton E. Ross, Leroy C. Richie, Daniel F. Hutchins and Elliot M. Kaplan (the “Defendant Directors”), who are members of its Board of Directors. We were served with the complaint on May 28, 2014. Among other things, the complaint alleged (i) that the Defendant Directors breached their fiduciary duties by failing to consider a financing proposal offered by Mr. Gans and his affiliates; and (ii) that the Defendant Directors, acting at the direction of Stanton E. Ross, did not independently and objectively evaluate Mr. Gans’ protestations about certain alleged transactions between us and Infinity Energy Resources, Inc., and by so doing, breached their fiduciary duties. We and the Defendant Directors vigorously defended the claims asserted against us and them. We and the Defendant Directors filed a response denying all of the plaintiff’s allegations and have asserted counter-claims that allege that Gans committed improper acts that included: (a) failing to disclose the nature and substance of an SEC investigation of Gans; (b) engaging in potential insider trading; (c) misappropriating our confidential information; (d) attempting to use his position as a director to personally enrich himself; and (e) making unauthorized, misleading, and factually inaccurate filings to the SEC about us.

On December 11, 2014, the parties agreed in principle to compromise and dismiss with prejudice substantially all of their claims. Within the scope of that settlement are each of the “shareholder derivative claims” that Gans had asserted against us and the Defendant Directors. The settlement to which the parties agreed resulted in no monetary recovery by any party. On April 7, 2015 the Court approved the settlement of all shareholder derivative claims.

We are also involved as a plaintiff and defendant in ordinary, routine litigation and administrative proceedings incidental to its business from time to time, including customer collections, vendor and employment-related matters. We believe thatThe Company believes the likely outcome of any other pending cases and proceedings will not be material to ourits business or its financial condition.

Sponsorship.On April 16, 2015 we entered into a Title Sponsorship Agreement under which we became the title sponsor for a Web.com Tour golf tournament (the “Tournament”) held annually in the Kansas City Metropolitan area. Such Agreement provides us with naming rights and other benefits for the annual Tournament for the years 2015 through 2019 annual Tournament in exchange for the following sponsorship fee:

We have the right to sell and retain the proceeds from the sale of additional sponsorships, including but not limited to a presenting sponsorship, a concert sponsorship and founding partnerships for the Tournament. We recorded a net sponsorship expense of $173,335 relating to$266,280 and $499,313 for the 2015 Tournament during the yearyears ended December 31, 2015. Such expense was included in sales2017 and promotional expense in2016, respectively. We are negotiating with the accompanying statement of operations.

Stock Repurchase Program. On August 25, 2015,Web.com Tour golf tournament officials to terminate our sponsorship fee commitments for the Board of Directors approved a program2018 and 2019 Tournaments. There can be no assurance that authorizes the repurchase of up to $2.5 million of the Company’s common stock in the open market, or in privately negotiated transactions. The repurchases, if and when made,it will be subjectsuccessful in negotiating the termination of this sponsorship agreement or that if successful in such negotiations, on terms acceptable or favorable to market conditions, applicable rules of the Securities and Exchange Commission and other factors. The repurchase program will be funded using a portion of cash and cash equivalents, along with cash flow from operations. Purchases may be commenced, suspended or discontinued at any time. We have not repurchased any shares under this program as of December 31, 2015.us.