Digital Ally (
) is a company that used to be loved by Wall Street. On June 12,
2008, when the stock closed at $8.97 per share, Dawson James
Securities was recommending it as a strong buy with a target of
$17.50 per share. You can access their report
Fast forward to the fourth quarter of 2010 - the stock is
despised by the investment community, and investors can pick up
shares for as little as $1.60 per share. While the target price of
$17.50 might be unrealistic, I believe that the price of $8 to $10
per share within the next few years is not outrageous. Based on my
tour of the company and conversations with several members of the
management team, it is obvious that the reason they are
accumulating stock is because they believe it is headed much
Digital Ally produces digital video imaging and storage products
for use in law enforcement and security applications. The company's
products are an in-car digital video/audio recorder built into a
rearview mirror; a weather-resistant mobile digital video recording
system for use on motorcycles, ATVs and boats; a miniature digital
video system designed to be worn on an individual's body; and a
digital video/audio recorder built into a flashlight for use by law
enforcement agencies and other security organizations.
The following is a YouTube video describing the company's
products and how they benefit customers:
Digital Ally was formerly known as Trophy Tech Corporation,
which was founded by the younger brother of Stan Ross, the current
CEO of Digital Ally. At that point, Ross was only an investor in
the company. The company's principal product, a digital video
recording system, was originally created for use in the bow hunting
industry. The business model that was in place was ineffective, and
Ross's brother was more interested in hunting than in running a
business, so he eventually asked him to take over the leadership
In 2004, the company changed its business plan to adapt its
digital video recording system for use in the law enforcement and
security markets. During the transition process, Ross consulted his
friend Kenneth L. McCoy, current vice president of sales and
marketing, on whether the newly designed in-car video cameras would
be of any interest to the law enforcement industry. Because McCoy
had been selling various products to the law enforcement industry,
he believed that because Digital Ally's in-car video cameras were
superior, less expensive, and more compact than the competing
products, they were going to be a huge success. Soon after, McCoy
decided to join Digital Ally full time. Because of his extensive
contacts in the industry, he hired experienced sales professionals
who either had worked for him or who he knew were some of the best.
Because these sales professionals already had established
relationships with contacts in the law enforcement industry,
Digital Ally was able to penetrate the market and grow sales
click to enlarge
Digital Ally Advantage
Digital Ally's biggest advantage is that it can manufacture and
sell its products more cheaply than most of its competitors and at
the same time deliver superior quality. The reason why the company
can do that is because of its internal sales force. The majority of
its competitors use third party distributors to sell their products
to the end user, where Digital Ally, through its well-connected
sales force, goes directly to the customer. This advantage allows
the company to be competitive on price and, at the same time, enjoy
Why is Digital Ally's stock so cheap?
Ever since the company changed its business plan in 2004 and
started shipping products in 2006, it grew revenues every single
quarter from the first quarter of 2006 to the second quarter of
2008. During this time, Wall Street cheered the company, and NASDAQ
even gave Digital Ally an award for its fabulous stock market
performance. Analysts were predicting record sales, assigning the
stock a target price as high as $17.50 per share. In June 2008, the
total number of analysts following the company was 24. Two of them
had a neutral rating and 22 had a buy rating on Digital Ally
Then, when the company reported performance for the third
quarter of 2008, revenues were down for the first time. From that
point, investors experienced mostly frustration and pain. On May
16, 2008, the stock closed at $10.64 per share, and on March 27,
2009, it closed at $1.62 per share. Today, it is still trading
around this price, and only one analyst continues to follow the
What happened? During the third quarter 2008 conference call,
the management explained that the U.S. economic recession forced
many law enforcement agencies to delay near-term purchases of
equipment. When fourth quarter 2008 results were reported,
investors got hit with more bad news. Revenues went down so much
that the company even reported an operating loss. During the
conference call, the management explained that the bad quarter's
results were caused partly by the economy and partly by problems
associated with delivering a new product to market.
Up to this point, the company predominantly relied on sales from
the DVM-500, and in 2008, it prepared to introduce its new product,
the DVM-750, which included more features than the DVM-500. The
head of the R&D department gave the management a time frame of
when the DVM-750 was going to be ready for shipment and the
management marketed the new product accordingly. Unfortunately, the
DVM-750 was not developed on time. Many customers, instead of
purchasing the DVM-500, chose to wait for the DVM-750, causing
sales to drop significantly. When I spoke with the CEO, he said
they did it to themselves and they should have never marketed a new
product until it was ready. The head of the R&D department was
fired for misleading the management and causing investors to lose a
significant amount of money.
During the first half of 2009, the company worked on recovering
from the punch it received in the second half of 2008. This
included hiring Steven Phillips as the vice president of
engineering. For the previous 11 years, Phillips held a variety of
engineering and management positions with Garmin International (
By the third quarter of 2009, the company regained its
profitability and things continued to improve in the fourth quarter
of 2009. The stock price rose as high as $3 per share to reflect
these improvements. During the fourth quarter of 2009, the
management was happy to put 2009 behind them and was excited about
the outlook for 2010.
During the first quarter of 2010, the management told investors
that 2010 was going to be a record year for Digital Ally because
the company experienced an increase in inquiries and bid activity
from international customers in the fourth quarter of 2009. Even
though the international orders had not come through by the second
quarter of 2010, the management reiterated that the company was
still going to have a record year.
During the third quarter of 2010, the management disappointed
investors again. International orders still hadn't come through.
Instead of continuing to paint 2010 as a record year, the
management did a 180-degree turn and announced that the company was
going to institute a vigorous cost-cutting program with the goal of
achieving positive cash flow based solely on its domestic business.
For now, expectations about new international business were put on
the back burner.
By now, the majority investors were out of patience. Here are
some comments from investors on the Yahoo message board:
"How anyone can remain long this stock is beyond me.
Management is not getting it done here."
"I gave up on this company months ago. First, they weren't
going to make projections because of what happened the previous
year. Then they come out and say this is going to be their best
year ever. And now it's crap. It's all a joke."
"The BOD is out of control…no accountability."
"The reason DGLY is trading at these levels is because
management has not executed. Until this management team delivers
on its forward projections, investors will continue to take a
'wait and see' approach. Lack of investor interest has driven the
stock price lower."
"I don't believe anything coming from this management team any
longer. Serial failures."
"Not sure I'd believe this management team if they told me the
sky was blue!"
Why Do I Think Investing in Digital Ally Is Going to Be
There is so much negativity priced into this stock that any
positive event is likely to propel this stock much higher.
The company's products are better and cheaper than its
competitors. I personally spoke with several customers who
confirmed this. The domestic market for in-car video systems is
still growing. At the beginning of 2008, the company had 1,700 law
enforcement agencies as customers. Today, it is around 4,000. In
2005, the company had no presence in the market, and today it has
15 percent market share (per the CEO). It is not easy to break into
the law enforcement market, and Digital Ally was able to because of
its superior product and well-connected sales force.
In the early days, because the company was not well known, it
was only able to sell to small law enforcement agencies, but now
that its brand has been established, it is able to sell to larger
agencies. Additionally, the company does not yet have a large
presence in California and in the East Coast states.
Because of its successful products, international customers
started to notice Digital Ally. The company has already shipped
products to other countries such as Turkey. Since the beginning of
2009, it hired an international sales manager and a salesperson to
cover Europe and the Middle East and appointed international
distribution agents. In the fourth quarter of 2009, 36 agents
represented Digital Ally in various countries outside the United
Once the promised international sales start being shipped, the
contribution to revenues will be significant. I do not believe that
the management intentionally wanted to mislead investors about 2010
being a record year. Based on my personal visit to the company, I
believe that they truly thought that these orders were going to be
shipped. Although some orders were placed, the company has a policy
of not shipping international orders until payment is received,
because once, it had to wait 12 months to collect on an
The nature of international orders is that they are not as
predictable as domestic orders, but, when they come, they tend to
be large. For example, one order from Turkey was over $3 million,
which is half of the company's domestic business in one quarter.
Another order from South America that hasn't shipped yet is around
the same amount. Based on my conversation with Ken McCoy, vice
president of sales and marketing, the international orders that
were supposed to ship in 2010 were not canceled - they were delayed
due to funding issues caused by political and social unrest in
certain parts of the countries involved.
The company has also other promising products that can impact
future revenues tremendously. For example, the Laser Ally Speed
Gun, a hand-held speed detector, is a new product that the company
started shipping recently. It is the only product on the market
that cannot be jammed. It is being sold to the same customers as
the in-car video systems.
Another product, the DVM-250, is a rearview mirror based digital
audio and video recording system with many but not all of the
features of the DVM-500 and the DVM-750. The first shipment is
expected to occur in January 2011. This product will be sold for
use in school buses, taxis, and mass transit vehicles. The market
potential for the DVM-250 is promising.
The difficulty in predicting Digital Ally's future revenues
creates a challenge when it comes to valuing the company. With that
being said, you do not need to know exactly what something is worth
as long as you know you are buying it for less than what it is
worth. In other words, Digital Ally is very cheap at the current
price because the market does not believe that it will ever grow
revenues from international sales or from the sales of other
products. When Digital Ally proves the market wrong, the stock is
likely to move much higher than the current price.
While future sales are difficult to forecast, the domestic
business is stable. Based on the management's comments, the
domestic business for in-car video systems is a $2 million per
month or $24 million per year business. Knowing this, we can
estimate what the domestic business is worth. In 2009, the
company's revenues were $26 million, but the bottom line was
negative because of heavy investments in international business
that did not bring meaningful increases in revenues. In 2007 and
2008, the company was profitable on $19 and $33 million in
revenues, respectively. Currently, the management's goal is to
bring the company back to profitability without relying on
international business. Based on my recent phone conversation with
the CEO, he is very happy with the current progress towards
profitability just on the domestic business.
Assuming that the company can operate with a cost structure
similar to what was in place in 2007 and 2008, it is not
unreasonable to assume that it can achieve a 9 percent net profit
margin. With $24 million in revenues, this translates into $2.2
million of net income. Applying a conservative multiple of 12 would
mean that Digital Ally's domestic business is worth $26 million.
This value, of course, ignores any revenue potential from
additional products such as the DVM-250, the Laser Ally Speed Gun,
and any international orders that could be just around the corner.
Because the current market capitalization of Digital Ally is around
$26 million, none of the upside is priced into the stock price.
When Digital Ally finally gets back on track and starts showing
a positive trend in revenues and operating profits, investors will
quickly forget why they hated the company, and the stock price will
follow. It might take several good quarters to see any meaningful
stock price recovery as investors are skeptical, but after studying
and visiting the company, I believe that Digital Ally will be able
to achieve this. Also, seeing several insiders accumulating stock
confirms my belief.
I, or persons whose accounts I manage, own shares of Digital Ally (
). This report is not a solicitation to buy or sell securities.
Neither Mariusz Skonieczny nor Classic Value Investors, LLC, is
responsible for any losses resulting from purchasing or disposing
shares of Digital Ally (
). You are advised to consult your financial advisor or conduct the
due diligence yourself.
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