Rekor Systems, Inc. - Annual Report: 2019 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

(Mark One)

 

☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2019

 

OR

 

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the transition period from          to      

 

Commission File Number: 001-38338

Rekor Systems, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware			81-5266334
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)
7172 Columbia Gateway Drive, Suite 400 Columbia, MD			21046
(Address of Principal Executive Offices)			(Zip Code)

 

(410) 762-0800

 (Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.0001 par value per share	REKR	The Nasdaq Stock Market

 

Securities Registered pursuant to Section 12(g) of the Act: None

  

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐		Accelerated filer ☐
Non-accelerated filer ☒		Smaller reporting company ☒ Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

 

The aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates of the registrant as of June 30, 2019 was approximately $18.5 million.

 

As of March 30, 2020, the Registrant had 22,768,757 shares of common stock, $0.0001 par value per share outstanding.

 

 

TABLE OF CONTENTS

 

 

 

		PAGE
PART I
Item 1.	Business	3
Item 1A.	Risk Factors	8
Item 1B.	Unresolved Staff Comments	15
Item 2.	Properties	15
Item 3.	Legal Proceedings	15
Item 4.	Mine Safety Disclosures	15
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	16
Item 6.	Selected Financial Data	16
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk.	25
Item 8.	Financial Statements and Supplementary Data.	26
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	51
Item 9A.	Controls and Procedures.	51
Item 9B.	Other Information.	51
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	52
Item 11.	Executive Compensation	56
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	59
Item 13.	Certain Relationships and Related Transactions, and Director Independence	60
Item 14.	Principal Accountant Fees and Services	61
Part IV
Item 15.	Exhibits, Financial Statements Schedules	62
Item 16.	Form 10-K Summary.	64

 

CERTAIN TERMS

Unless the context requires otherwise, all references in this Annual Report on Form 10-K (the “Annual Report”) to “Rekor Systems, Inc.,” “Rekor,” “Company,” “we,” “our” and “us” refer to Rekor Systems, Inc. and its consolidated subsidiaries.

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve substantial risks and uncertainties. All statements other than statements of historical facts contained in this Annual Report, including statements regarding our future results of operations and financial position, business strategy, prospective products and services, timing and likelihood of success, plans and objectives of management for future operations, and future results of current and anticipated products and services, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. These forward-looking statements speak only as of the date of this Annual Report and are subject to a number of risks, uncertainties and assumptions described under the sections in this Annual Report entitled “Risk Factors” and elsewhere in this Annual Report. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified and some of which are beyond our control, you should not rely on these forward-looking statements as predictions of future events. We undertake no obligation to update any forward-looking statement as a result of new information, future events or otherwise.

 

PART I

 

ITEM 1. BUSINESS

 

Overview

 

      We are a leader in the field of vehicle identification and management systems driven by leading edge advances in artificial intelligence ("AI"). In development for over five years using AI processes, including machine learning algorithms, our core software enables the creation of more powerful and capable vehicle recognition systems that can be deployed at a fraction of the cost of traditional vehicle recognition systems. The software enables a wider field of view, greater light sensitivity, recognitions at faster speeds and higher accuracy rates, in addition to the ability to identify the color, make and type of a vehicle and its direction of travel. These capabilities are particularly useful in solving a wide variety of real-world roadway and vehicle related challenges. In addition, the reductions in cost have opened up a number of new uses for vehicle recognition technology that were not previously cost effective. We currently provide products and services for governmental organizations, for large and small businesses and for individuals throughout the world. Customers are currently using our products or services in over 70 countries, with offerings for smart cities, public safety, security, transportation, parking and logistics.

 

Currently, our business activities also include providing professional services in the government contracting, aviation and aerospace industries. As part of the development of a new line of products for the public safety and security markets, we acquired industry leading vehicle recognition software in March 2019. In connection with this acquisition, we determined that our resources are best concentrated on vehicle recognition products and services and have reorganized and retooled our product development, business development and administrative resources, with increasing emphasis on the technology area. Our Board of Directors has also authorized management to explore opportunities for the sale of our professional services businesses. In keeping with the shift in resources and strategic direction that this represents, we have reorganized our financial reporting into two business segments: the Technology Segment and the Professional Services Segment. This report segmentation reflects our separate focus on and expectations for technology products and services versus professional services.

 

On March 29, 2019, we announced that our Board of Directors approved changing the Company’s name to Rekor Systems, Inc. This name change was a result of our increased focus on technology products and services, and aligns with the renaming of Brekford Traffic Safety, Inc. to Rekor Recognition Systems, Inc. In connection with this name change, we changed:

 

 

 

 

Technology Segment. The Technology Segment operations are conducted by our wholly owned subsidiary, Rekor Recognition Systems, Inc. (“Rekor Recognition”). Formerly named Brekford Traffic Safety, Inc., Rekor Recognition has been involved in the public safety business since 1996. In connection with the development of several new public safety products, we determined to acquire substantially all the assets of OpenALPR Technology, Inc. This acquisition (the “OpenALPR Technology Acquisition”), completed in March 2019, transferred vehicle recognition software and associated licenses and proprietary rights to OpenALPR Software Solutions, LLC (“OpenALPR”), a new wholly owned subsidiary of Rekor Recognition. OpenALPR’s vehicle recognition platform, already operating in more than 12,000 cameras in over 70 countries worldwide, has laid the groundwork for the expansion of our product line, enabling multiple deployment mechanisms.

 

Since the OpenALPR Technology Acquisition, we have expanded our vehicle recognition product and service lines into a much broader range of customer segments, starting with public safety. We shifted from a perpetual licensing model to a subscription-based model, rebranded the software suites as “Watchman” and “Car-Check” and released several packaged hardware/software solutions with preloaded versions of each of these vehicle recognition engines. By the end of 2019, we had a portfolio of more than 10 products, permitting us to offer full-scale vehicle recognition services for nearly any large or small public agency, commercial or residential setting.

 

Our software currently has the capability to analyze multi-spectral images and/or video streams produced by nearly any Internet Protocol security camera and concurrently extract license plate data by state from more than 70 countries, in addition to the vehicle’s make, color, type and direction of travel. When combined with speed optimized code, parallel processing capability and best-in-class accessories, such as cameras and communications modules, the software captures license plate data and vehicle characteristics at extremely high vehicle speeds with a high degree of accuracy, even in unusually difficult conditions, such as low lighting, poor weather, extreme camera viewing angles, and obstructions.

 

Prior to the development of our vehicle identification software, highly accurate results were not available using a typical Internet Protocol camera. We believe that the ability to use less expensive hardware will change the dynamics of the existing public safety market, enabling the creation of increasingly robust networks with cameras at more locations. In addition, we expect the cost advantages and high degree of accuracy to create competitive advantages in tolling systems and logistics operations that currently rely on complex radio frequency identification (RFID) systems. We also expect the lower costs, superior distance and field of view capabilities and the ability to capture additional vehicle information, such as direction, color, make and type of vehicle, to open opportunities in other market segments, such as parking operations, school safety and retail customer loyalty programs; and particularly smart cities and smart roadways. Smart roadway systems, sometimes referred to as smart transport or intelligent transport systems (“ITS”), inclusive of parking management and guidance, passenger information and traffic management systems, can optimize the movement of vehicles to make travel safer and more efficient. These technologies are expected to enable users to be more coordinated, better informed, and make safer and smarter use of transport networks.

 

Our vision is “AI with a Purpose.” We intend to evolve beyond vehicle recognition for public safety markets into the recognition and analysis of vehicle activities (inclusive of motion and behaviors), to develop systems to identify unsafe situations (e.g. wrong way driving, pedestrian on roadway, etc.) and optimize traffic flows, and to develop numerous other data driven applications centered around vehicle knowledge.

 

Professional Services Segment. We have provided professional services and staffing solutions to the government contracting and the aerospace and aviation industries. The Professional Services Segment includes AOC Key Solutions, Inc. (“AOC Key Solutions”); Global Technical Services, Inc. (“GTS”); Global Contract Professionals, Inc. (“GCP”, and together with GTS, “Global”); and Firestorm Solutions, LLC (Firestorm Solutions”) and Firestorm Franchising, LLC (“Firestorm Franchising” and together with Firestorm Solutions, “Firestorm”). Currently, as a leading provider of support services to the federal government contracting market, AOC Key Solutions’ primary clients are companies that serve the federal government. However, in support of our Technology Segment, we have recently been active in the state and local government contracting market. We provide professional services that offer scalable and compliant outsourced support for our government contractor clients. We help these clients to win government contracts and capture new businesses. Global provides specialized staffing services, primarily in the aerospace and aviation industries. In connection with our reorganization and focus on technology products and services, we are actively engaged in evaluating, reconfiguring, selling, and discontinuing various business assets or entities in the Professional Services Segment. As part of this process, we discontinued the operations of Firestorm Franchising and have determined to sell Global and AOC Key Solutions. In March 2020, we received a proposal from the current management of AOC Key Solutions to purchase that subsidiary.

 

 

Business Strategy

 

As part of our strategic shift in fiscal year 2019, we are focusing on the Technology Segment and further developing our footprint across different industries by distributing and licensing products and services with vehicle recognition features powered by our AI based technology. Current customers are using these products and services for: a) toll collection and traffic analysis in the transportation market, b) school and traffic safety and other law enforcement applications in the public safety market, c) parking management, d) perimeter management and surveillance in the private security market, e) operations and retail customer loyalty programs in the drive through retail market and f) vehicle tracking, perimeter security and warehouse operations in the logistics market.

 

As a result of our strategic shift, during the third quarter of 2019, we determined to sell Global, began to separately report the results of Global and considered substantially all of the assets and liabilities comprising Global as held for sale operations. Since we are reporting the operating results and cash flows of the Global as held for sale operations, they have been excluded from continuing operations and segment results for all periods presented. Prior to the third quarter of 2019, the operating results for Global were presented in the Professional Services segment. The assets and liabilities of Global are presented as current and long-term assets and liabilities of businesses held for sale in the consolidated balance sheets. Since we adopted a formal plan to sell Global in September 2019, we have received several non-bindings offers and indications of interest for the purchase of Global which we are in the process of evaluating. In March 2020, we received a proposal from current AOC Key Solutions management to purchase that subsidiary, which is being evaluated by our Board of Directors. No assurance can be given as to the certainty of the entry into, or the subsequent closing any of these proposed transactions regarding the purchase of Global and AOC Key Solutions.

 

Recent Developments

 

Our most significant developments since January 1, 2019, are described below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Description of Products and Services

 

Vehicle Recognition and Public Safety Products and Services

 

In March 2019, we acquired substantially all of the assets of a software development company, OpenALPR Technology, Inc., as indicated above and more fully described below. With this acquisition, we currently provide vehicle recognition and data management products and services with respect to over 12,000 cameras to customers in over 70 countries. The products and services, which operate in many installations with a high accuracy rate, include access to a web server with a self-managed database and a powerful, cross-platform application programming interface. The service provides seamless video analysis and data analytics and is continuously being developed using a “deep learning” convolutional neural network architecture to classify images. Current customers include law enforcement agencies, highway authorities, parking system operators, private security companies, and wholesale and retail operations supporting logistics and customer loyalty programs.

 

A key capability of our AI-based software is its ability to provide precision vehicle identification results with dramatically less expensive hardware, including use with existing cameras and computer equipment. It can support lighter and smaller, as well as less expensive equipment that is more adaptable for use in mobile applications. This can change the economics and dynamics of an existing market, eliminating the need for RFID technology on toll roads, for example, or allowing smart city programs to incorporate vehicle recognition capabilities into their operations without replacing existing camera infrastructure. In addition, our lower cost structure supports new applications of vehicle recognition capabilities, such as supporting retailers’ customer loyalty programs and facilitating user controlled parking management, in combination with ingress and egress control, for small homeowner’s associations.

 

We provide traffic safety systems for a number of municipalities in North America. These systems include hardware that identifies red light and school safety zone traffic violations and software that captures, provides forensic quality images and data, and supports citation management services. We also provide enterprise parking enforcement solutions that we license to parking management companies and municipalities. The further development of our products and services since the OpenALPR Technology acquisition has allowed us to begin expanding our product and service offerings throughout the world used by government agencies in other areas of the world. Since the second quarter of 2019, following the conversion of our sales methodology from permanent licenses to software-as-a-service, we have signed agreements with a number of municipalities and governmental agencies for the use of our products and services in North America and around the world and entered into licensing agreements with a number of multi-national parking, retailing and security systems providers.

 

Government Contracting Support

 

Our government contracting support services assist government contractors with critical aspects of their business. These services include market intelligence and opportunity identification; capture and strategic advisory; proposal strategy and development; teaming support; and managed human capital services. Our services also help commercially focused firms gain entry into the government contracting market.

 

Specialty Staffing Services

 

We also provide quality specialized contract personnel, temp-to-hire professionals, direct hires, and temporary or seasonal hires to the Department of Defense and a diverse group of companies in the aerospace and aviation industry nationally and have been instrumental in placing highly-skilled technical professionals in some of the world’s most prestigious engineering firms and government facilities for over 20 years. Some of the professionals that we place in the aerospace and aviation industry include: Federal Aviation Administration (“FAA”) certified airframe and power plant mechanics; avionics and embedded software engineers; Federal communications Commission (“FCC”) certified avionic technicians; licensed aircraft inspectors; flight test engineers; process/repair engineers; and simulation engineers. Specialty staffing is a service that most large aviation and aerospace companies need due to the time-sensitive aspects of their contracts, and our customers use specialty staffing to fulfill a variety of roles.

 

Our Markets

 

AI Products and Services Markets

 

The markets for our AI products and services are diverse: toll collection and traffic management; parking management and enforcement; safe and smart cities and roadways programs; government, military, corporate, community and personal security; wholesale and large retail logistics and customer loyalty programs, as well as public safety.

 

 

Clients

 

Our clients in these markets include federal, state and local government entities worldwide, major retailers, private security companies, parking management companies, fast food restaurant chains and logistics companies. We continue to explore new applications to further expand this growing client base.

 

Sales and Marketing

 

We offer our products and services in various markets through a combination of delivery mechanisms. For existing traffic safety clients, we provide full turnkey photo enforcement and citation management services, supported by the deployment of our hardware and software solutions. The programs are contracted directly with local government agencies, typically on a fixed monthly fee basis. For vehicle recognition services, we offer both direct contracting with customers as well as a reseller program through a growing network of reseller partners. Customer agreements are typically attained through specific proposals we submit in response to government requests for proposal (“RFP”), or through our standard Master Subscription Agreement available to agencies or commercial customers through direct purchase. Both software and hardware are sold on a full turnkey subscription basis to our direct customers. Our resellers purchase equipment or software subscriptions from Rekor and resell them to their end customers.

 

We maintain an in-house staff of sales and business development professionals who are responsible for identifying opportunities, finding and responding to RFPs, and growing and supporting our reseller network.

 

We launched the Rekor Partner Program (“Partner Program”) in January 2020 to establish a network of qualified and trusted business partners who will help to deliver our products and services worldwide. The Partner Program is open to technology solution providers, resellers, and integrators who want to deliver world class vehicle recognition solutions to customers in multiple business segments. These segments include public safety, security and surveillance, electronic toll collection, parking operations, banking and insurance, supply chain logistics, traffic management, and retail customer experience. Each partner is carefully vetted and selected by Rekor based on several qualifying factors including industry expertise, customer outreach, financial stability, past history, and geographic footprint.

 

We offer three levels of membership, with varying degrees of commitment and benefits. “Authorized Resellers” and “Premier Partners” are both resellers who receive a discount to our MSRP pricing for software and hardware solutions. They sign and manage their own customer agreements and are responsible for technology implementation and first level maintenance and support. Rekor provides an array of services to program partners including second level technical support, free training, not-for-resale demo systems at a discount to MSRP, and assistance with proposal development. The Rekor Ambassador membership level is for those companies and individuals who desire to promote and sell Rekor products and services, but do not have the capability to provide direct customer support. Once approved, Rekor Ambassadors receive the authorization and support mechanisms to sell Rekor products and solutions to customers, who sign agreements directly with Rekor. Customer agreements, technology implementation, and first and second level maintenance and support are Rekor’s responsibility.

 

Competition

 

Our current emphasis is on products and services that include vehicle recognition features. There are currently many competitors who provide products and services of this type. Typically, these competitors provide camera systems that employ optical character recognition (“OCR”) software to analyze electronically captured images and produce license plate information. These competitors include divisions or subsidiaries of large multi-national companies, such as Siemens, Motorola, Leonardo, Bosch and Genetec. Other competitors who rely primarily on OCR include Alert Systems, Arvoo, CA Traffic, Clearview, HTS, Kapsh, MAV, Nexcom, ParkingEye, Petards, PIPS Technology, TagMaster and Tattle. Except in a very limited environment, traditional OCR based software systems rely on specially designed cameras. 

 

A competitive advantage of our core software is that it can produce highly accurate data using most of the IP cameras on the market today. Since our core software can successfully analyze images produced by the typically lower-cost cameras used in existing security and surveillance systems, it can be used to add vehicle identification functionality to those systems without the need to use specialized equipment. As a result, we believe that we are well positioned to serve this market and can currently provide operators of existing security systems significant advantages in accuracy, usability and price that provide us with a competitive edge. In some cases, however, we have licensed our products and services to some of the vehicle recognition competitors listed above for use in camera systems specially designed for specific applications. We intend to continue to license on a non-exclusive basis to competitors in the vehicle recognition industry.

 

Although we believe there is no competitor that provides a similarly accurate and cost effective suite of products and services, we view our competition in the public safety and security areas two distinct categories – traditional OCR-based ALPR companies and newer software-only companies, some merely deploying OCR based technology on newer Internet Protocol cameras and others working to develop software using various AI processes. These software only companies include ARH, HIK Vision, Inex Tech, NDIRS, Neural Labs, Plate Smart and Sighthound. Our vehicle recognition software has been designed using an AI process commonly referred to as “machine learning” or more specifically “deep learning.” This process involves intensive analysis of large amounts of data using specialized neural network algorithms. For more than five years, our core software has been continuously updated through machine learning using millions of images from around the world. Direct comparisons or head-to-head competitive studies by several law enforcement customers and independent engineers have indicated that our software and systems have higher capture rates and a higher degree of accuracy for license plate identification than other competitors. Another unique advantage of our software is that, it in addition to country, state and license plate number, it can identify in real time the vehicle make, color, body type, and direction of travel.

 

We are in the early stages of our business development efforts and have concentrated primarily on the public safety, security and surveillance and parking management areas. Our products and services are also being used in the logistics, banking and insurance and customer experience areas industries. However, in most cases we serve primarily as a service provider to other companies active in these areas. Therefore, our competitors in these areas are expected to be the other vehicle recognition software providers listed above.

 

To a very limited extent, our services are also currently being used in the electronic tolling industry. There are a number of large, well established multi-national electronic tolling services companies, including Vera Mobility and Conduent. These competitors rely primarily on RFID technology and have large, long term contracts that involve extensive infrastructure installations. In recent years, automated license plate reading systems have increasingly replaced manual toll taking for vehicles that are not equipped with RFID technologies compatible with the toll operator’s system. We believe that the level of accuracy that can be achieved with our core software provides us with a competitive edge in connection with this movement to replace manual systems. We also believe that direct vehicle recognition should ultimately be recognized as a more efficient and cost effective means of toll collection than the use of RFID systems. We are not yet in a position to undertake a full-scale entry into this market, however, and are evaluating our options as to how best to proceed.

 

Another rapidly developing area that we expect to participate in is the implementation of “smart city” transportation management systems. In May of 2019, Rekor was selected by Nokia to provide vehicle recognition solutions for deployment within its Scene IoT analytics platform. This platform has been designed to analyze video from interconnected camera networks and detect anomalies that can be used by public agencies. We will be looking for opportunities to participate in the development of smart city systems in association with Nokia in other key participants in this burgeoning area.

 

Competitive Strengths

 

In the public safety and vehicle recognition market, we believe we have, and can further develop, the following competitive strengths:

 

 

Growth Strategies

 

Our vehicle recognition product portfolio sits at the intersection of the video surveillance, video management software and ALPR markets. We believe there are significant opportunities within these markets which could lead to the expansion our business. Growth in vehicle recognition is being driven by multiple government and law enforcement applications as well as a broad range of new applications such as customer service, tolling and school security.

 

In addition, we believe that growth will be impacted by an increased demand for improvements in security, public safety and business intelligence that will in turn lead to increased spending in infrastructure, government spending on intelligent transportation systems, deployment of security and surveillance and traffic enforcement applications.

Rapid urbanization, increased globalization, the increased awareness about the human impact on the planet are all driving factors for intelligent transportation and the smart highway market. Additionally, the growing trend toward the adoption of smart cities is also expected to expand the prospects for the smart highway market.

We use AI to extract the identity, characteristics and movements of vehicles and other objects on the roadway for the purpose of enhancing safety, increasing operational efficiencies and improving the experience of people - this is “AI with a purpose”. We believe we can play an important role in enabling Smart Roadways/Highways and Cities.

These market trends create significant opportunities for us to expand our market presence while developing relationships with both new customers and expending relationship with existing customers.

 

Our current emphasis on growth is to concentrate available resources on expanding sales of products and services that exploit the competitive advantages of our technology. In particular, we are working to further develop our existing cloud-based subscription services for smaller clients and to license our technology to original equipment manufacturers and large government and commercial customers for use with new and existing security, logistics, traffic management, vehicle location and customer loyalty systems.

 

As we work to develop our sales and marketing capabilities, we expect our efforts with respect to products and services in our Technology Segment to be concentrated principally on subscription-based solutions.

 

Government Contracting Support Market

 

According to the U.S. Treasury, the total dollar value of federal government contracts awarded over the last decade has ranged from a high of approximately $575 billion in fiscal year 2019 to a low of approximately $440 billion in fiscal year 2015. It is estimated that the federal government signs over 11 million contracts per year. This magnitude of spending creates a stable market for government contracting support services.

 

According to the U.S. federal government’s System for Award Management (“SAM”) database, as of February 2020, there were over 483,000 registered and active government contractors, of which slightly over 50,000 are in Washington, DC, Maryland and Virginia. Many of these contractors are in an area commonly known as the “Beltway” and are in close proximity to the headquarters of our wholly owned subsidiary, AOC Key Solutions. The U.S. federal government’s contract spending in Washington, DC, Maryland and Virginia was more than $119 billion in fiscal year 2019, according to USASpending.gov. This represents over 20% of the $575 billion of total contract spending in fiscal year 2019. In addition, the vast majority of out of state contractors maintain some type of office (headquarters, government relations staff, marketing personnel, communications experts, and satellite offices) in the Washington, DC metropolitan area. The sheer size of the government contracting, locally and nationally, presents growth opportunities for us.

 

Because of the geographic footprint of these clients, there is also a large, but fragmented, family of service providers for these government contractors. Although the businesses that provide resources to the government contracting sector are diverse and highly fragmented, their clients have many common needs resulting from the basic qualifications and standard requirements inherent in the government procurement process.

 

The Government Contracting Support industry provides a smorgasbord of services to companies large, medium, and small. Typically, these services include contract opportunity identification and tracking, marketing and business development support, contract capture support, contract win strategy formulation, contract capture support, multi-company team creation, technical solution architecture, provision of staffing, bid and proposal support, and oral proposal development. 

 

Clients

 

To be a government contractor, a company must be able to meet rigid standards. As a result, our clients are typically well-established, financially stable businesses with both a reputation for excellence and high standards and a demonstrated ability to survive and prosper through innovation and adaptation. Government contractors range from small privately-owned lifestyle companies to members of the Fortune 100. Since 1983, we have served thousands of these entities.

 

Overall, our government contracting clients provide government agencies with the following types of services (list is presented alphabetically and is only a sampling of the full range of products and services provided by the private sector): aerospace operations; architect, engineering, and construction; emergency response; environmental management; facilities management; human capital support; independent verification and validation; industrial products and services; information technology; logistics; military construction; program management; quality assurance; research and development; security services; staff augmentation; telecommunications; training; transportation services; warfighter support; and weapons program development and support. In turn, we support our clients providing or seeking to provide these services to the government.

 

Marketing and Sales

 

We obtain client engagements using a variety of tools, techniques, and processes. Engagements are obtained primarily through business development efforts, cross-selling of our services to existing clients, and maintaining client relationships. We also benefit from referrals from existing and former clients. Our business development efforts emphasize lead generation, industry group networking and corporate visibility via a robust web site and social media presence. Most of our business development efforts are led by members of our professional teams, who in most cases are also responsible for managing projects.

 

Competition

 

In the government contracting industry, the sectors in which we operate are highly fragmented and characterized by many smaller companies generally having fewer than ten employees. These companies tend to focus their operations on local customers or specialized niche activities. As a result, we compete with many smaller, more specialized companies that concentrate their resources in particular areas of expertise.

 

The extent of our competition also varies according to sectors and geographic areas. We compete on quality of service, relevant experience, staffing capabilities, reputation, geographic presence, stability, and price. Price differentiation remains an important element in competitive tendering and is a significant factor in bidding for contracts.

 

The importance of the foregoing factors varies widely based upon the nature, location, and scale of our clients’ needs. We believe that certain economies of scale can be realized by service providers that establish a national presence and reputation for providing high-quality and cost-effective services. Our ability to compete successfully depends upon the effectiveness of our marketing efforts, the strength of our client relationships, our ability to accurately estimate costs and bid for work, the quality of the work we perform, and our ability to hire and train qualified personnel.

 

Competitive Strengths

 

We have a solid reputation for quality service in the government contracting market. In part, this reputation is based upon our industry-recognized depth of experience, ability to attract and retain quality professionals, and expertise across multiple service sectors. We employ seasoned professionals with a broad array of specialties, a strong customer service orientation and in many cases, the required professional certifications and advanced degrees. As of March 30, 2020, 100% of our management and staff involved with proposal services were certified by the Association of Proposal Management Professionals (“APMP”) the leading industry group in our areas of expertise. The services that we provide are highly specialized professional services that have high barriers to entry.

 

We also maintain state of the art proposal infrastructure. This infrastructure includes specially equipped proposal war rooms for use by our clients when desired. We maintain an in-house production and graphics development capability. Our competitive strengths are also bolstered by a secure IT network containing a data base that, in many cases, dates back to the early 1980s.

 

In addition to a robust foundation of in-house professionals, we also have access to approximately 350 technical and management consultants who can provide subject matter expertise for unique projects and who can supplement our workforce based on client demand. Our combination of niche market experience and professionals with requisite expertise has enabled us to develop strong relationships with our core clients. By serving clients on a long-term basis, we can gain a deep understanding of their overall business needs as well as the unique technical requirements of their projects. This increased understanding gives us the opportunity to provide superior value to our clients by allowing us to more fully assess and better manage the risks inherent in their projects.

 

Growth Strategies

 

The universe of providers that service our clients is fragmented and diverse. Drawing on the insights and experience of our leadership team, we expect to both increase our contact with, and improve our understanding of, the needs of the enterprises we serve. We will then work to further enhance our ability to perform in these areas by providing material support as well as exchanges of talent and ideas. By increasing contact with our clients, we will also be working to enhance our clients’ awareness of these capabilities across our subsidiaries.

 

 

Our History

 

We are a Delaware corporation that was formed in February 2017 to effectuate the mergers of, and become a holding company for KeyStone Solutions, Inc. (“KeyStone”). Our services are currently provided through seven wholly owned subsidiaries: AOC Key Solutions; Rekor Recognition; Firestorm; GTS and GCP (collectively referred to as “Global”); and as of March 12, 2019, OpenALPR. In 2018, the operations of Novume Media, Inc. (“Novume Media”) were discontinued. On February 28, 2019, we changed the name of Brekford Traffic Safety, Inc. to Rekor Recognition Systems, Inc. For narrative purposes, all references to Brekford are to Brekford Traffic Safety, Inc. before February 28, 2019 and under the name Rekor Recognition Systems, Inc. on and after February 28, 2019. On August 20, 2019, we founded Rekor Public Safety Network, LLC. On January 6, 2020, GCP was merged into GTS with GTS being the surviving entity.

 

AOC Key Solutions was originally organized in 1983. Rekor Recognition was organized in 1996. The Firestorm Entities were organized in 2005. The Global Entities were formed in 1989. OpenALPR was organized in 2019.

 

Acquisitions

 

On March 12, 2019, we completed the OpenALPR Technology Acquisition.

 

On June 1, 2019, we sold all the interest we had acquired in Secured Education, LLC, which we acquired on January 1, 2018, and discontinued operations of BC Management. In connection with these actions we recognized a write-off of intangible assets of $242,000. In addition, in June 2019, we discontinued the operations of Firestorm Franchising, resulting in a write-off of an additional $1,310,000 in intangible assets related to Firestorm in the second quarter of 2019.

 

Additional information concerning the OpenALPR Technology Acquisition and the restructuring of Firestorm is provided in this Annual Report on Form 10-K under “Management’s Discussion and Analysis of Financial Conditions and Results of Operations.”

 Reportable Segments

 

In 2019, we conducted core operations through our primary operating subsidiaries: OpenALPR, Rekor Recognition, AOC Key Solutions, Global and Firestorm.

 

With the OpenALPR Technology Acquisition in 2019, we changed our operating and reportable segments from one segment to two segments. The two segments reflect our separate management focus both on technology products and services and on professional services. For comparative purposes we have presented the Technology Segment and the Professional Services Segment for the year ended December 31, 2019 and 2018.

  

Employees

 

As of March 30, 2020, Rekor had 472 employees, of which 117 were full time and 355 were project-based staff provided to our clients. We consider our employee relations to be good. To date, we have been able to locate and engage highly qualified employees as needed and do not expect our growth efforts to be constrained by a lack of qualified personnel. We will continue to engage additional highly qualified personnel for our public safety and vehicle recognition markets.

 

Seasonality

 

Our Technology Segment generates revenues from long-term licensing and subscriptions to our and products and services. Therefore, we do not presently anticipate significant seasonality impact on our Technology Segment revenues. Should our penetration of tolling and other markets involving per recognition fees expand, we would expect to become more subject to seasonal traffic patterns.

 

In our Professional Services Segment, we generate revenues from fees and reimbursable expenses for professional services primarily billed on an hourly rate, time-and-materials (“T&M”) basis. In the professional services and specialty staffing areas, our clients are typically invoiced monthly, with revenue recognized as the services are provided. Currently, T&M contracts represent substantially all of our client engagements in these areas and do not provide us with a high degree of predictability of future period performance. A small portion of our professional services contracts are fixed-fee engagements which can be invoiced once for the entire job, or there could be several “progress” invoices for accomplishing various phases, reaching contractual milestones or on a periodic basis.

 

Previously, Rekor’s financial results have been impacted principally by the demand by clients for support in the professional services and specialty staffing areas, the degree to which full-time staff can be kept occupied in revenue-generating activities, success of the sales team in generating client engagements, and number of business days in each quarter. The number of business days on which revenue is generated by our staff and consultants is affected by the number of vacation days taken, as well as the number of holidays in each quarter. There are typically fewer business work days available in the fourth quarter of the year, which can impact revenues during that period. The staff utilization rate can also be affected by seasonal variations in the demand for services from clients. Since earnings may be affected by these seasonal variations, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year. The sale of the subsidiaries in the Professional Services Segment will result in the Technology Segment having a greater impact on our results of operations. In the near term, this is expected to make our results heavily dependent on opportunities for growth in technology sales. However, due to the long term nature of our subscription sales model, we expect the long term effect of these sales to be stabilizing on our revenue stream.

 

Unexpected changes in the demand for our services can result in significant variations in revenues, and present a challenge to optimal hiring, staffing and use of consultants. The volume of work performed can vary from period to period.

 

Insurance and Risk Management

 

We maintain insurance covering professional liability and claims involving bodily injury, property and economic loss. We consider our present limits of coverage, deductibles, and reserves to be adequate. Whenever possible, we endeavor to eliminate or reduce the risk of loss on a project through the use of quality assurance and control, risk management, workplace safety, and other similar methods.

 

Risk management is an integral part of our project management approach for fixed-price contracts and our project execution process. We also evaluate risk through internal risk analyses in which our management reviews higher-risk projects, contracts, or other business decisions that require corporate legal and risk management approval.

 

Regulation

 

We are regulated in some of the fields in which we operate. When working with governmental agencies and entities, we must comply with laws and regulations relating to the formation, administration, and performance of contracts. These laws and regulations contain terms that, among other things may require certification and disclosure of all costs or pricing data in connection with various contract negotiations. We also work with U.S. federal government contractors and have staff cleared to work on classified materials. Two of our leased facilities are cleared for classified material. We are subject to the laws and regulations that restrict the use and dissemination of information classified for national security purposes.

 

To help ensure compliance with these laws and regulations, our employees are sometimes required to complete tailored ethics and other compliance training relevant to their position and our operations.

 

ITEM 1A. RISK FACTORS

 

Risks Relating to Our Corporate Structure and Business

 

We are currently not profitable, and we may be unable to become profitable on a quarterly or annual basis.

 

For the year ended December 31, 2019, we had a loss from continuing operations before taxes of $14,365,000. We cannot assure that we will be profitable in the future. Our ability to become profitable in future periods could be impacted by government activity and regulation, economic instability and other items that are not in our control. We cannot assure that our financial performance will sustain a sufficient level to completely support operations. A significant portion of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues or increases in planned investments. In addition, we have experienced and expect to continue to experience significant expenses related to acquisitions and the development of new products and services. Our strategic transition to a technology based company focused on vehicle recognition systems will require us to generate sufficient revenues from the vehicle recognition market to support our business plan while continuing to operate as a public company. As a result, we may continue to experience operating losses and net losses in the future, which would make it difficult to fund operations and achieve our business plan and could cause the market price of our common stock to decline.

 

We have not been a leading provider of vehicle recognition devices in the past and do not have the level of established contacts and existing business relationships that some of our competitors have.

 

Although it is growing, our presence in the public safety and vehicle recognition market has been limited and with the acquisition of assets from OpenALPR has only recently extended beyond the United States and Canada. As a result of this, although we believe our products and services have significant competitive advantages, we may encounter difficulties in establishing widespread market acceptance of our products in various markets and regions. Early successes in penetrating these markets and regions may not be able to be sustained once our ability to compete with our more established competitors comes to their attention. They may seek to develop more competitive products before their existing contracts expire, reduce prices, use to advantage their past association as a trusted provider and their superior financial and marketing resources and use other stratagems to this competitive advantage, which could significantly impact our ability to grow as rapidly as we expect.

 

 

 

If we experience declining or flat revenues and fail to manage such declines effectively, we may be unable to execute our business plans and may experience future weaknesses in operating results.

 

To achieve future growth, we will need to continue to add additional qualified personnel and invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in operating results. In addition, our future expansion is expected to place a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these activities or any revenue declines successfully, our business, financial condition and results of operations could be adversely affected.

 

 

If we are unable to attract new customers to our services on a cost-effective basis, our revenue and results of operations will be adversely affected.

 

We must continue to attract a large number of customers on a cost-effective basis. We rely on a variety of marketing methods to attract new customers to our services. Our ability to attract new customers also depends on the competitiveness of the pricing of our products and services. If our current marketing initiatives are not successful or become unavailable, if the cost of such initiatives were to significantly increase, or if our competitors offer similar services at lower prices, we may not be able to attract new customers on a cost-effective basis and, as a result, our revenue and results of operations would be adversely affected.

 

If we are unable to retain our existing customers, our revenue and results of operations would be adversely affected.

 

With the addition of OpenALPR, some of the products and services offered by us are sold pursuant to agreements that are on a short-term subscription basis. Customers have no obligation to renew their subscriptions after their subscription period expires, and these subscriptions may not be renewed on the same or more profitable terms. As a result, our ability to sustain our revenue base depends in part on subscription renewals. We may not be able to accurately predict future trends in customer renewals, and our customers’ renewal rates may decline or fluctuate because of several factors, including their satisfaction or dissatisfaction with our products and services, the prices of our services, the prices of the products and services offered by our competitors or reductions in our customers’ spending levels. If our customers do not renew their subscriptions for our products and services, renew on less favorable terms, or do not purchase additional functionality or subscriptions, our revenue may grow more slowly than expected or decline, and our profitability and gross margins may be harmed.

 

Our sales cycles for enterprise and government clients can be long, unpredictable and require considerable time and expense, which may cause our operating results to fluctuate.

 

The timing of our revenue from sales to enterprise and government clients is difficult to predict. These efforts require us to educate our clients about the use and benefit of our services, including the technical capabilities and potential cost savings to an organization. Enterprise clients typically undertake a significant evaluation process that has in the past, resulted in lengthy sales cycles, typically several months. We spend substantial time, effort and money on our enterprise sales efforts without any assurance that these efforts will produce any sales. In addition, subscriptions are frequently subject to budget constraints and unplanned administrative, processing and other delays. If sales expected from a specific client for a particular reporting period are not realized in that period or at all, our results could fall short of expectations and our business, operating results and financial condition could be adversely affected.

 

If our efforts to build a strong brand identity are not successful, we may not be able to attract or retain subscribers and our operating results may be adversely affected.

 

We believe that building and maintaining a strong brand identity plays an important role in attracting and retaining customers for our products and users for our services, who may have other options from which to obtain services. We are currently involved in a major initiative to establish a new brand for our technology products and services in the public safety and vehicle recognition markets, which will require time and expense. In order to build a strong brand, we believe that we must offer innovative service offerings that our customers and subscribers’ value, and also market and promote those service offerings through effective marketing campaigns, promotions and communications with our customer base. From time to time, clients and subscribers may express dissatisfaction with our products and services or react negatively to our strategic business decisions, such as changes that we make in pricing, features or service offerings, including the discontinuance of a free service. To the extent that client dissatisfaction with our services or strategic business decisions is widespread or not adequately addressed, our brand identity may suffer and, as a result, our ability to attract and retain clients and subscribers may be adversely affected, which could adversely affect our operating results.

 

We may not be able to capitalize on potential emerging market opportunities and new services that we introduce may not generate the revenue and earnings we anticipated, which may adversely affect our business.

 

Our business strategy involves identifying emerging market opportunities which we can capitalize on by successfully developing and introducing new products and services or enhancing existing products and services designed to address those market opportunities. We have made, and expect to continue to make, investments in research and development in an effort to capitalize on potential emerging market opportunities that we have identified in the public safety and vehicle recognition markets. Emerging markets and opportunities often take time to fully develop, and they attract a significant number of competitors. If the emerging markets we have targeted ultimately fail to materialize as we or others have anticipated or if potential clients choose to adopt solutions offered by our competitors rather than our own solutions, we may not be able to generate the revenue and earnings we anticipated, and our business and results of operations would be adversely affected.

 

Industry consolidation may result in increased competition.

 

Some of our competitors have made or may make acquisitions or may enter into partnerships or other strategic relationships to offer a more comprehensive service than they individually had offered. In addition, new entrants not currently considered to be competitors may enter the market through acquisitions, partnerships or strategic relationships. We expect these trends to continue as companies attempt to strengthen or maintain their market positions. Many of the companies driving this trend have significantly greater financial, technical and other resources than we do and may be better positioned to acquire and offer complementary services and technologies. The companies resulting from such combinations may create more compelling service offerings and may offer greater pricing flexibility than we can or may engage in business practices that make it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs, technology or service functionality. These pressures could result in a substantial loss of customers or a reduction in our revenues.

 

We may not be able to respond to rapid technological changes in time to address the needs of our customers, which could have a material adverse effect on our sales and profitability.

 

The cloud-based services markets in which some of our products and services compete are characterized by rapid technological change, the frequent introduction of new products and services and evolving industry standards. Our ability to remain competitive will depend in large part on our ability to continue to enhance our existing products and services and develop new service offerings that keep pace with these markets’ rapid technological developments. Additionally, to achieve market acceptance, we must effectively anticipate and offer products and services that meet changing client demands in a timely manner. Clients may require features and capabilities that our current products and services do not have. If we fail to develop products and services that satisfy customer requirements in a timely and cost-effective manner, our ability to renew subscriptions with existing clients and our ability to create or increase demand for our products and services will be harmed, and our revenue and results of operations would be adversely affected.

 

The success of our business will depend, in part, on the continued services of certain key personnel and our ability to attract and retain qualified personnel.

 

The success of our business will depend, in part, on the continued services of certain members of our management. In particular, the loss of the services of Robert A. Berman, as President and Chief Executive Officer and a director, Matthew Hill, our Chief Science Officer and Chris Kadoch, our Chief Technology Officer, could have a material adverse effect on our business, results of operations, and financial condition. Our inability to attract and retain qualified personnel could significantly disrupt our business.

 

Although we take prudent steps to retain key personnel, we face competition for qualified individuals from numerous professional services and technology companies. For example, our competitors may be able to attract and retain more qualified professional and technical personnel by offering more competitive compensation packages. If we are unable to attract new personnel and retain our current personnel, we may not be able to develop and maintain our services at the same levels as our competitors and we may, therefore, lose potential customers and sales penetration in certain markets. It may also be difficult to attract and retain qualified individuals in the timeframe demanded by our clients. Furthermore, some of our contracts may require us to employ only individuals who have particular government security clearance levels. Our failure to attract and retain key individuals could impair our ability to provide services to our clients and conduct our business effectively. Our failure to attract and retain suitably qualified individuals could have an adverse effect on our ability to implement our business plan and, as a result, our ability to compete would decrease, our operating results would suffer and our revenues would decrease.

  

We may fail to realize the anticipated benefits of acquisitions which we consummate, and we may be subject to business uncertainties.

 

We acquired substantially all of the assets of OpenALPR in March 2019. We are continuing to integrate the operations of OpenALPR that previously operated independently. There can be no assurance that we will not encounter significant difficulties in further integrating operations of OpenALPR or that it will achieve the results of operations that we expected.

 

Uncertainties about the effect of our acquisition on employees and customers may have an adverse effect on our Company. These uncertainties may impair our ability to attract, retain and motivate key personnel for a period of time after the acquisitions, and could cause customers, suppliers and others that deal with us to seek to change existing business relationships with us, which may have an adverse effect on our Company. Employee retention may be particularly challenging, as employees may experience uncertainty about their future roles with the Company.

 

The achievement of the benefits expected from integration of acquired companies may require us to incur significant costs. The incurrence of any such costs, as well as any unexpected costs or delays, in connection with such integration, could have a material adverse effect on our business, operating results or financial condition.

 

Our strategic transition to primarily a technology based business focused on vehicle recognition systems entails a number of risks, including but not limited to our ability to generate sufficient revenue and cash flow to successfully execute our business plan.

 

 

We may be required to write-down certain assets after completing our required annual evaluations, which may affect our reported financial results.

 

The initial determination of the fair value of assets we acquire upon consummation of an acquisition is based upon an internal valuation. We are required to analyze the carrying value of our acquired intangibles and goodwill on an annual basis going forward. After the detailed annual evaluation of the carrying value of the intangible assets, as supported by external analysis, we may be required to make adjustments to our consolidated balance sheet and/or statement of operations. Any adjustments will affect our reported financial results.

 

We may be required to redeem our outstanding shares of Series A Preferred Stock.

 

The holders of our outstanding shares of Series A Preferred Stock (consisting of 502,327 shares as of December 31, 2019), will have the right to require the Company to redeem their shares, at any time from and after November 8, 2021, at a price of $15.00 per share plus any accrued but unpaid dividends (such accrued but unpaid Series A Preferred Stock dividends are equal to an aggregate of $551,000 as of December 31, 2019). In the event that the market price of our common stock does not exceed the conversion price of the Series A Preferred Stock at the time of redemption, the holder of outstanding shares of Series A Preferred Stock are likely to require us to redeem the shares, which would likely have a material adverse effect on our liquidity, capital resources and business prospects.

 

Our significant debt obligations could impair our liquidity and financial condition. If we default on our secured debt, the lender may foreclose on our assets.

  

As of December 31, 2019, we (through our wholly owned subsidiary, Global) had $1,842,000 outstanding under our secured borrowing agreement with LSQ Funding Group, L.C. (“LSQ”), secured by our subsidiaries accounts receivables. LSQ agreed to advance Global, 90% of all eligible account receivables with a maximum facility amount of $10,000,000. If we default on this debt, the lender may foreclose on its collateral, which would have a material adverse effect on our business and operations.

 

As of December 31, 2019, we (through our wholly owned subsidiary, AOC Key Solutions) had $1,894,000 outstanding under secured borrowing agreement with LSQ, secured by our subsidiary’s accounts receivable. LSQ agreed to advance to our subsidiary, 90% of all eligible account receivables with a maximum facility amount of $5,000,000. If we default on this debt, the lender may foreclose on its collateral, which would have a material adverse effect on our business and operations.

 

We also have $1,000,000 of additional subordinated notes outstanding in connection with our acquisition of Firestorm.

  

On March 12, 2019, Rekor entered into a note purchase agreement (the “Note Purchase Agreement”) pursuant to which investors purchased $20,000,000 principal amount of Rekor promissory notes (the “2019 Promissory Notes”). $2,000,000 of the proceeds of sale of these Promissory Notes was used to retire in its entirety the 2018 Promissory Note and $500,000 was used to retire in its entirety the subordinated note with Avon Road Partners, L.P. The balance of the proceeds from the sale of the 2019 Promissory Notes were used to finance the OpenALPR Technology Acquisition and to provide working capital. The Promissory Notes bear interest at 16% per annum, of which at least 10% per annum is required to be paid in cash. The full remaining portion of all interest, if any, accrues and is to be paid at maturity or earlier redemption. The notes are secured by a security interest in substantially all of the assets of Rekor. The Note Purchase Agreement has an effective interest rate of 24.87%. The Promissory Notes were originally due and payable on March 11, 2021. In March 2020, the maturity date of the Promissory Note was extended to June 12, 2021. If, on maturity of the 2019 Promissory Notes, we are unable to refinance or otherwise pay the principal and redemption fee, together with the balance of the accumulated interest on the 2019 Promissory Notes, the holders of the 2019 Promissory Notes may foreclose on their collateral, which would have a material adverse effect on our business and operations. 

 

Our current debt obligations could require us to dedicate a substantial portion of our cash flow and raise additional capital through equity sales to fund payments of interest, which reduces the availability of our cash flow to fund working capital, capital expenditures and meet other corporate requirements; make it more difficult for us to satisfy our other obligations; impede us from obtaining additional financing in the future; impose restrictions on us with respect to the use of our available cash; place us at a competitive disadvantage when compared to our competitors who have less debt; and make us more vulnerable in the event of a downturn in our business prospects. In addition, unless we are able to retire or refinance the debt issued pursuant to the Note Purchase Agreement on or prior to June 12, 2021, we could be held in default, which would substantially impair the value of our assets and our common stock.

 

We have depended on waivers from our 2019 Promissory Note holders to avoid a default under the Note Purchase Agreement.

 

The Note Purchase Agreement under which the 2019 Promissory Note was issued contains numerous covenants, some of which we have been unable to comply with. Our ability to avoid default under the Note Purchase Agreement may depend on our continued ability to obtain deferrals or waivers of the requirements of these covenants. The holders of the 2019 Promissory Notes are under no obligation to grant such waivers and may be entitled to foreclose on their collateral in the event we fail to cure breaches of our covenants, which would have a material adverse effect on our business and operations.

 

 

We may issue additional notes or other debt securities, or otherwise incur substantial additional debt which may adversely affect our leverage and financial condition and thus negatively impact the value of our stockholders’ investment in the Company.

 

The anticipated cash needs of our business could change significantly as we pursue business opportunities, if our business plans change, if economic conditions change from those currently prevailing or from those now anticipated, or if other unexpected circumstances arise that may have a material effect on the cash flow or profitability of our business. If we require additional capital resources to grow our business, either internally or through acquisition, we may need to seek to secure additional debt financing. We may not be able to obtain financing arrangements on acceptable terms or in amounts sufficient to meet our needs in the future.

 

The incurrence of debt could have a variety of negative effects, including: default and foreclosure on our assets if our operating revenues are insufficient to repay our debt obligations; acceleration of our obligations to repay the indebtedness and increased interest payments if we breach covenants that include the maintenance of certain financial ratios or reserves without a waiver or renegotiation of that covenant; and limitations on our ability to borrow additional amounts for expenses, capital expenditures, acquisitions, debt service requirements, execution of our strategy and other purposes and other disadvantages compared to our competitors who have less debt.

 

Our business has significant working capital needs and if we are unable to satisfy those needs from cash generated from our operations, borrowing or sales of equity, our financial condition will be adversely affected.

 

We will require significant amounts of working capital to operate our business, implement our plans for growth and maintain our competitive advantages. If we experience a significant and sustained drop in operating profits, or if there are unanticipated reductions in cash inflows or increases in cash outlays, we may be subject to cash shortfalls. If such a shortfall were to occur for even a brief period, it could have a significant adverse effect on our business. In particular, we use working capital to pay interest expenses and expenses relating to our employees and temporary workers and to satisfy our workers’ compensation liabilities. Generally, we pay our workers on a biweekly basis while we generally receive payments from our customers 30 to 60 days after billing. As a result, we must maintain sufficient cash availability to pay employees and independent contractors and fund related payroll liabilities prior to receiving payment from customers.

 

We have derived working capital for our operations primarily through cash from operating activities from our subsidiaries, secured borrowing arrangements, issuance of debt, the sale of assets and the sale of our equity. We believe that our current sources of capital are adequate to meet our working capital needs. However, our available sources of capital are limited. If our working capital needs increase in the future, we may be forced to seek additional sources of capital, which may not be available on commercially reasonable terms.

 

Any future failure to comply with the covenants which may occur under our promissory notes could result in an event of default which, if not cured or waived, could trigger increased interest payments or prepayment obligations which could adversely affect our business, financial condition and results of operations.

  

Our operating results may be harmed if we are required to collect sales or other related taxes for our licensing and subscription products and services or pay regulatory fees in jurisdictions where we have not historically done so.

 

Primarily due to the nature of our cloud-based services in certain states and countries, we do not believe we are required to collect sales or other related taxes from our customers in certain states or countries. However, one or more other states or countries may seek to impose sales, regulatory fees or other tax collection obligations on us, including for past sales by us or our resellers and other partners. A successful assertion that we should be collecting sales or other related taxes on our services or paying regulatory fees could result in substantial tax liabilities for past sales, discourage customers from purchasing our services or otherwise harm our business and operating results.

 

Improper disclosure of confidential and personal data could result in liability and harm to our reputation.

 

Our handling and storage of the data we collect from some of our employees, customers and vendors, and our processing of data, which may include confidential or personally identifiable information, through the services we provide, may be subject to a variety of laws and regulations, which have been adopted by various federal, state and foreign governments to regulate the collection, distribution, use and storage of personal information of individuals. Several foreign countries in which we conduct business, including the European Economic Area (“EEA”) and Canada, currently have in place, or have recently proposed, laws or regulations concerning privacy, data protection and information security, which are more restrictive than those imposed in the United States. Some of these laws are in their early stages and we cannot yet determine the impact these revised laws and regulations, if implemented, may have on our business. However, any failure or perceived failure by us to comply with these privacy laws, regulations, policies or obligations or any security incident that results in the unauthorized release or transfer of personally identifiable information or other customer data in our possession, could result in government enforcement actions, litigation, fines and penalties and/or adverse publicity, all of which could have an adverse effect on our reputation and business.

 

For example, the European Economic Area (“EEA”) wide General Data Protection Regulation (“GDPR”) became applicable on May 25, 2018, replacing the data protection laws of each EEA member state. The GDPR implemented more stringent operational requirements for processors and controllers of personal data, including, for example, expanded disclosures about how personal information is to be used, limitations on retention of information, increased requirements to erase an individual’s information upon request, mandatory data breach notification requirements and higher standards for data controllers to demonstrate that they have obtained valid consent for certain data processing activities. It also significantly increases penalties for non-compliance, including where we act as a service provider (e.g. data processor). If our privacy or data security measures fail to comply with applicable current or future laws and regulations, we may be subject to litigation, regulatory investigations, enforcement notices requiring us to change the way we use personal data or our marketing practices, fines, for example, of up to 20 million Euros or up to 4% of the total worldwide annual turnover of the preceding financial year (whichever is higher) under the GDPR, or other liabilities, as well as negative publicity and a potential loss of business.

 

Data protection regulation remains an area of increased focus in all jurisdictions and data protection regulations continue to evolve. There is no assurance that we will be able to meet new requirements that may be imposed on the transfer of personally identifiable information from the EU to the United States without incurring substantial expense or at all. European and/or multi-national customers may be reluctant to purchase or continue to use our services due to concerns regarding their data protection obligations. In addition, we may be subject to claims, legal proceedings or other actions by individuals or governmental authorities if they have reason to believe that our data privacy or security measures fail to comply with current or future laws and regulations.

 

Moreover, we must ensure that certain vendors and customers who have access to such information also have the appropriate privacy policies, procedures and protections in place. Although we take customary measures to protect such information, the continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. If our security measures are breached as a result of third-party action, employee or subcontractor error, malfeasance or otherwise, and, as a result, someone obtains unauthorized access to customer data, our reputation may be damaged, our business may suffer and we could incur significant liability. Techniques used to obtain unauthorized access or to sabotage systems change frequently and are growing increasingly sophisticated. As a result, we may be unable to anticipate these techniques or to implement adequate preventative measures.

  

This environment demands that we continuously improve our design and coordination of security controls throughout the Company. Despite these efforts, it is possible that our security controls over data, training, and other practices we follow may not prevent the improper disclosure of personally identifiable or other confidential information.

 

If an actual or perceived breach of our security occurs, we could be liable under laws and regulations that protect personal or other confidential data resulting in increases costs or loss of revenues and the market perception of our services could be harmed.

 

Our business could be negatively impacted by cyber and other security threats or disruptions.

 

We face various cyber and other security threats, including attempts to gain unauthorized access to sensitive information and networks; insider threats; threats to the security of our facilities and infrastructure; and threats from terrorist acts or other acts of aggression. Cyber threats are constant and evolving and include, but are not limited to, computer viruses, malicious software, destructive malware, attacks by computer hackers attempts to gain unauthorized access to data, disruption or denial of service attacks, and other electronic security breaches that could lead to disruptions in mission critical systems, unauthorized release or loss of confidential, personal or otherwise protected information (ours or that of our employees, customers or subcontractors), and corruption of data, networks or systems. In addition, we could be impacted by cyber threats or other disruptions or vulnerabilities found in products we use or in our partners’ or customers’ systems that are used in connection with our business. Our clients and subcontractors face similar threats and/or they may not be able to detect or deter them, or effectively to mitigate resulting losses. These threats could damage our reputation as well as our subcontractor’s ability to perform and could affect our client’s ability to pay.

 

Although we use various procedures and controls to monitor and mitigate the risk of these threats to us, our clients and our partners, there can be no assurance that these procedures and controls will be sufficient. The impact of these factors is difficult to predict, but one or more of them could result in the loss of information or capabilities, harm to individuals or property, damage to our reputation and/or require remedial actions or lead to loss of business, regulatory actions potential liability and financial loss, any one of which could have a material adverse effect on our financial position, results of operations and/or cash flows.

 

 

We are dependent upon technology services, and if we experience damage, service interruptions or failures in our computer and telecommunications systems, our customer and worker relationships and our ability to attract new customers may be adversely affected.

 

Our business could be interrupted by damage to or disruption of our computer, telecommunications equipment, software systems, or software applications. Our customers’ businesses may be adversely affected by any system, application or equipment failure we experience. As a result of any of the foregoing, our relationships with our customers may be impaired, we may lose customers, our ability to attract new customers may be adversely affected and we could be exposed to contractual liability. Precautions in place to protect us from, or minimize the effect of, such events may not be adequate.

 

In addition, the failure or disruption of mail, communications and/or utilities could cause an interruption or suspension of our operations or otherwise harm our business. Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of any system or operational failure or disruption and, as a result, revenue, profits and operating results could be adversely affected.

 

If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our services will likely decline.

 

The markets in which we operate are in general characterized by the following factors: changes due to rapid technological advances; additional qualification requirements related to technological challenges; and evolving industry standards and changes in the regulatory and legislative environment. Our future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad acceptance of new product and service enhancements incorporating the latest technological advancements.

 

We operate in highly competitive industries, some with low barriers to entry, and may be unable to compete successfully against existing or new competitors.

 

Our business is competitive, and we compete with companies in highly competitive industries that may have greater name recognition and financial resources, as well as many independent sole-proprietors who sell themselves as outsourced resources. We also compete with providers of outsourcing services, systems integrators, computer systems consultants and other providers of services. We expect that the level of competition will remain high, which could limit our ability to maintain or increase our market share or profitability.

  

The needs of our clients change and evolve regularly. Accordingly, our success depends on our ability to develop services and solutions that address these changing needs of our clients, and to provide people and technology needed to deliver these services and solutions. In order to compete effectively in our markets, we must target our potential customers carefully, continue to improve our efficiencies and the scope and quality of our services, and rely on our service quality, innovation, and client relations to provide services on a cost-effective basis to our clients. Our competitors may be able to provide clients with different or greater capabilities or technologies or better contract terms than we can provide, including technical qualifications, past contract experience, geographic presence, price and the availability of qualified professional personnel.

 

In addition, heightened competition among our existing competitors, especially on a price basis, or by new entrants into the market, could create additional competitive pressures that may reduce our margins and adversely affect our business. If our competitive advantages are not compelling or sustainable, then we are unlikely to increase or sustain profits and our stock price could decline.

 

A downturn of the U.S. or global economy could result in our customers using fewer products and services or becoming unable to pay us for our services on a timely basis or at all, which would materially adversely affect our business.

 

Because demand for our solutions and services are sensitive to changes in the level of economic activity, our business may suffer during economic downturns. During periods of weak economic growth or economic contraction, the demand for outsourced services could decline. When demand drops, our operating profit could be impacted unfavorably as we experience a deleveraging of our selling and administrative expense base because expenses may not decline as quickly as revenues. In periods of decline, we can only reduce selling and administrative expenses to a certain level without negatively impacting the long-term potential of our business.

 

Additionally, during economic downturns companies may slow the rate at which they pay their vendors, or they may become unable to pay their obligations. If our customers become unable to pay amounts owed to us, or pay us more slowly, then our cash flow and profitability may suffer significantly.

 

We may be exposed to employment-related claims and losses, including class action lawsuits, which could have a material adverse effect on our business.

 

We typically place or assign personnel in the workplaces of other businesses. The risks of these activities include possible claims relating to: wrongful termination or denial of employment; damage to customer facilities due to negligence; violations of employment rights related to employment screening or privacy issues; fraudulent or criminal activity; misappropriation of funds; misuse of customer proprietary information; inadvertent assignment of illegal aliens; and discrimination and harassment.

 

We may incur fines and other losses or negative publicity with respect to these claims. In addition, these claims may give rise to litigation, which could be time-consuming and expensive. New employment and labor laws and regulations may be proposed or adopted that may increase the potential exposure of employers to employment-related claims and litigation. There can be no assurance that the corporate policies we have in place to help reduce our exposure to these risks will be effective or that we will not experience losses as a result of these risks. There can also be no assurance that the insurance policies we have purchased to insure against certain risks will be adequate or that insurance coverage will remain available on commercially reasonable terms or be sufficient in amount or scope of coverage.

 

We are dependent on workers’ compensation insurance coverage at commercially reasonable terms.

 

We provide workers’ compensation insurance for our employees and temporary workers and are contractually obligated to collateralize our workers’ compensation obligations under our workers’ compensation program through irrevocable letters of credit, surety bonds or cash. A significant portion of our workers’ compensation program renews annually on January 1 of each year, and as part of the renewal, could be subject to an increase in collateral. In addition, collateral requirements can be significant and place pressure on our liquidity and working capital capacity. Further, we cannot be certain we will be able to obtain appropriate types or levels of insurance in the future or that adequate replacement policies will be available on commercially reasonable terms. Depending on future changes in collateral requirements, we could be required to seek additional sources of capital in the future, which may not be available on commercially reasonable terms, or at all. The loss of our workers’ compensation insurance coverage would prevent us from doing business in the majority of our markets

 

Any future Congressional spending cuts, delays in the completion of the appropriation process or condition that affects the U.S. Government could adversely impact our operating results.

 

If annual appropriations bills are not enacted on a timely basis for future fiscal years, the U.S. government may once again operate under continuing resolution(s), thus abating request for proposal (“RFP”) processes and restricting new contracts or program starts and resulting in government slowdowns, or even shutdowns. The uncertainty regarding the volume of RFPs issued by the U.S. government could have long-term impacts for our industry and our Company. Because we generate significant revenues from clients that bid on contracts with U.S. government agencies, our operating results could be adversely affected by government slowdowns or shutdowns, spending caps or changes in national budgetary priorities. In addition, delays in RFP releases, slow program starts or uncertainty in the award of contracts or task orders could adversely impact our operating results.

 

Any condition or occurrence that affects society or the U.S. government can also impact government contractors. Because our Company maintains a significant presence among government contractors, we could be adversely affected by a national or international event that undermines confidence in the government or financial markets. Any impact on federal spending could have a negative effect on our revenue and adversely affect our future results.

 

If our contractors and subcontractors fail to satisfy their obligations to us or other parties, or if we are unable to maintain these relationships, our revenue, profitability, and growth prospects could be adversely affected.

 

We depend on contractors and subcontractors in conducting our business. There is a risk that we may have disputes with our contractors or subcontractors arising from, among other things, the quality and timeliness of work performed by the contractor or subcontractor, client concerns about the contractor or subcontractor, or our failure to extend existing task orders or issue new task orders under a contract or subcontract. In addition, if any of our subcontractors fail to perform the agreed-upon services, go out of business, or fail to perform on a project, then our ability to fulfill our obligations as a prime contractor may be jeopardized and we may be contractually responsible for the work performed by those contractors or subcontractors. Historically, our relationship with our contractors and subcontractors have been good, and we have not experienced any material failure of performance by our contractors and subcontractors. However, there can be no assurance that such experience will continue and the absence of qualified subcontractors with which we have a satisfactory relationship could adversely affect the quality of our service and our ability to perform under some of our contracts.

 

We also rely on relationships with other contractors when we act as their subcontractor or joint venture partner. Our future revenue and growth prospects could be adversely affected if other contractors eliminate or reduce their subcontracts or teaming arrangement relationships with us or if a government agency terminates or reduces these other contractors’ programs, does not award them new contracts, or refuses to pay under a contract.

  

 

Our Professional Services Segment is directly tied to the success of our government contracting clients, which are increasingly reliant on Indefinite Delivery/Indefinite Quantity (“ID/IQ”) contracts. ID/IQ contracts are not firm orders for services, and we may generate limited or no revenue from these contracts which could adversely affect our operating performance.

 

ID/IQ contracts are typically awarded to multiple contractors, and the award of an ID/IQ contract does not represent a firm order for services. Generally, under an ID/IQ contract, the government is not obligated to order a minimum of services or supplies from its contractor, irrespective of the total estimated contract value. In effect, an ID/IQ award acts as a “license,” permitting a government contractor to bid on task orders issued under the ID/IQ contract, but not guaranteeing the award of individual task orders. Following an award under a multi-award ID/IQ program, the customer develops requirements for task orders that are competitively bid against all of the contract awardees. However, many contracts also permit the U.S. government to direct work to a specific contractor. Our clients may not win new task orders under these contracts for various reasons, including price, past performance and responsiveness, among others. We support our government contractor clients both when they compete to get the umbrella ID/IQ contract and subsequently when we help the winners of those contracts compete for individual tasks. The proposals for both stages can be relatively brief and require quick turn-arounds, thus potentially reducing some opportunities to be awarded significant turn-key engagements. While it is possible that the increased importance of winning the umbrella ID/IQ contract will prompt clients to hire outside firms to prepare their proposals, it is also likely that government contractors will decide to prepare ID/IQ proposals without the assistance from outside experts.

 

We incur substantial costs as a result of operating as a public company and our management is required to devote substantial time to related compliance matters.

 

As a public company, we incur significant legal, accounting, and other expenses. under rules implemented by the United States Securities and Exchange Commission (“SEC”), and The Nasdaq Stock Market (“Nasdaq”). These impose various requirements on public companies, including establishing and maintaining effective disclosure and financial controls and corporate governance practices. Our management team will need to devote a substantial amount of time to these compliance requirements and we may need to hire additional personnel. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.

 

Pursuant to Section 404 of the Sarbanes-Oxley Act, we are required to furnish a report by our management on our internal control over financial reporting. To achieve compliance with Section 404, we engage in a process to document and evaluate our internal control over financial reporting, which is both costly and challenging. In this regard, we will need to continue to dedicate internal resources, potentially engage outside consultants, and adopt a detailed work plan to assess and document the adequacy of internal control over financial reporting, continue steps to improve control processes as appropriate, validate through testing that controls are functioning as documented, and implement a continuous reporting and improvement process for internal control over financial reporting.

 

In addition, changing laws, regulations, and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs, and making some activities more time consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations, and standards, and this investment may result in increased general and administrative expenses and divert management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us and our business may be harmed.

 

As a public company, complying with applicable rules and regulations will make it more expensive for us to obtain director and officer liability insurance, and we may be required to incur substantially higher costs to obtain and maintain the same or similar coverage.

 

Our ability to use our net operating losses to offset future taxable income may be subject to certain limitations, which could subject our business to higher tax liability.

 

We may be limited in the portion of net operating loss carry forwards that we can offset future taxable income for U.S. federal and state income tax purposes. As of December 31, 2019, we had gross federal and state net operating loss carryforwards, or NOLs, of approximately $19.2 million and $12.0 million, net of federal tax effect, respectively. A lack of future taxable income could adversely affect our ability to use these NOLs. In addition, future changes in our stock ownership, including through acquisitions, could result in ownership changes under Section 382 of the Internal Revenue Code and may result in a limitation on the amount of NOL carry forwards that could be used annually to offset future taxable income and taxes payable. Our NOLs at December 31, 2019 may also be impaired under similar provisions of state law, and may expire unused or underused, which would prevent us from using our NOL carry forwards to offset future taxable income.

 

Assertions by a third party that our services and solutions infringe its intellectual property, whether or not correct, could subject us to costly and time-consuming litigation or result in settlements or licensing arrangements that could affect our short-term or long-term profitability.

 

There is frequent litigation in the software and technology industries based on allegations of infringement or other violations of intellectual property rights. We are currently involved in a patent infringement lawsuit brought by a third party (Vigilant Solutions, LLC) as disclosed in more detail below under “Item 3 – Legal Proceedings”, and may in the future be subject to other third-party patent infringement or other intellectual property-related lawsuits as we become increasingly visible and face more intense competition. Regardless of the merit of these claims, they can be time-consuming, result in costly litigation and diversion of technical and management personnel or require us to develop a non-infringing technology or enter into license agreements. Because of the potential for court awards that are difficult to predict, it is not unusual to find even arguably unmeritorious claims settled for significant amounts. In addition, our service agreements may require us to indemnify our customers from certain third-party intellectual property infringement claims, which could increase our costs as a result of defending such claims and may require that we pay damages if there were an adverse ruling related to any such claims. Competitors may also seek to use these claims and the pendency of associated litigation as a means of attempting to discredit us or make potential customers fearful of using us, which could harm our relationships with our customers, deter future customers from subscribing to our services or expose us to further litigation. These costs, monetary or otherwise, associated with defending against third party allegations of infringement could have negative effects on our business, financial condition and operating results. 

If our services are used to commit intentional or illegal acts, we may incur significant liabilities, our services may be perceived as not secure, and customers may curtail or stop using our services.

 

Certain services offered by us enable customers to capture data from video images. Although our service agreements require our customers to comply with all applicable laws, we do not exercise direct control over use or content of information obtained by our customers through the use of our services. If our services are used by others to commit bad or illegal acts, we may become subject to claims and subject to other potential liabilities. Defending against such claims could be expensive and time-consuming, and there is a possibility that we could incur significant liability to entities who were the harmed of such acts. As a result, our business may suffer, and our reputation may be damaged.

 

 We use a limited number of data centers to deliver our services. Any disruption of service at these facilities could harm our business.

 

Our cloud-based services are hosted from third-party data center facilities located in various parts of the United States. We also use these facilities for some of our development efforts. We do not control the operation of these facilities. The owners of these data center facilities have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, we may be required to transfer to new data center facilities, and we may incur significant costs and possible service interruption in connection with doing so. In addition, our operations and development efforts could be seriously affected by failures or interruptions in service at these facilities. Any changes in third-party service levels at these third-party data centers or any errors, defects, disruptions or other performance problems with our services related to the non-performance of these facilities could harm our reputation and may damage our clients’ businesses. Interruptions in our services might reduce our revenue, cause us to issue credits to clients, subject us to potential liability, cause clients to terminate their subscriptions or harm our renewal rates.

 

 

Our long-term success depends, in part, on our ability to expand the sales of our services to customers located outside of the United States, and thus our business is susceptible to risks associated with international sales and operations.

 

We currently maintain offices and have sales personnel inside of the United States. However, we plan on expanding our international operations. Our international expansion efforts may not be successful. In addition, conducting international operations subjects us to other risks than those we have generally faced in the United States. These risks include: localization of our services and adaptation for local practices, differences in local, legal standards and regulatory requirements; difficulties in managing and staffing international operations; fluctuations in currency exchange rates; dependence on customers, third parties, and channel partners with whom we do not have extensive experience; potentially adverse tax consequences, including the complexities of foreign value-added or other tax systems; reduced or varied protection for intellectual property rights in some countries; and increased financial accounting and reporting burdens and complexities. Operating in international markets also requires significant management attention and financial resources. The investment and additional resources required to establish operations and manage growth in other countries may not produce desired levels of revenue or profitability.

 

Our success depends in large part on our ability to protect and enforce our intellectual property rights.

 

We rely on a combination of trade secret, patent, copyright, service mark and trademark laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our intellectual property rights, all of which can provide only limited protection. In addition, we have not patented significant technologies used to provide our services. We cannot assure you any future patents that may be applied for and issued will not be challenged, invalidated or circumvented. Any patents that may issue in the future from future patent applications may not provide sufficiently broad protection or they may not prove to be enforceable in actions against alleged infringers. Also, we cannot assure you that any future service mark or trademark registrations will be issued for pending or future applications or that any registered service marks or trademarks will be enforceable or provide adequate protection of our proprietary rights.

 

We endeavor to enter into agreements with our employees and contractors and agreements with parties with whom we do business to limit access to and disclosure of our proprietary information. The steps we have taken, however, may not prevent unauthorized use or the reverse engineering of our technology. Moreover, others may independently develop technologies that are competitive to ours or infringe our intellectual property. Enforcement of our intellectual property rights also depends on our successful legal actions against these infringers, but these actions may not be successful, even when our rights have been infringed.

 

Furthermore, effective patent, trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are available. In addition, the legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related industries are uncertain and still evolving.

 

Material defects or errors in the software that we use to deliver our services could harm our reputation, result in significant costs to us and impair our ability to sell our solutions.

 

The software applications underlying our products and services are inherently complex and may contain material defects or errors, particularly when first introduced or when new versions or enhancements are released. Any defects that cause interruptions to the availability of our products and services could result in: a reduction in sales or delay in market acceptance of our services; sales credits or refunds to customers; loss of existing customers and difficulty in attracting new customers; reputational harm; and diversion of internal resources. The costs incurred in correcting any material defects or errors in our products and services may be substantial and could harm our operating results.

 

Government regulation of the Internet, telecommunications and other communications technologies could harm our business and operating results.

 

As Internet commerce and telecommunications continue to evolve, increasing regulation by federal, state or foreign governments and agencies becomes more likely. Any increase in regulation could affect our clients’ ability to collect and share data, potentially reducing demand for our products and services. In addition, taxation of products and services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet or utilizing telecommunications services may also be imposed. Any regulation imposing greater fees for Internet use or restricting the exchange of information over the Internet could diminish the viability of our services, which could harm our business and operating results.

 

Natural disasters, public health crises, political crises, and other catastrophic events or other events outside of our control may damage our business and operating results.

 

In the event of natural disasters, public health crises, such as pandemics and epidemics, political crises, such as terrorism, war, political instability or other conflict, or other events outside of our control, our business and operating results could suffer. Moreover, these types of events could negatively impact consumer spending in the impacted regions or depending upon the severity, globally, which could adversely impact our operating results. For example, a widespread health epidemic, such as the outbreak of a respiratory illness caused by a novel coronavirus first identified in Wuhan, China caused the World Health Organization declaring a global emergency on January 30, 2020. At this point, the extent to which the coronavirus may impact our results is uncertain.

 

Risks relating to our common stock

 

There has been a limited public market for our common stock, the stock price of our common stock may be volatile or may decline regardless of our performance, and you may not be able to resell your shares at or above the public offering price.

 

Our common stock was previously quoted on the OTCQX and has been trading on the Nasdaq since January 10, 2018. There is no established trading market for some of our securities and there has been a limited public market for our common stock. The market prices of the securities of newly listed companies can be highly volatile. The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: variations in our results of operations, cash flows, and other financial metrics and non-financial metrics, and how those results compare to analyst expectations; variations in general market, financial markets, economic, and political conditions in the United States; failure of securities analysts to initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; sales of shares of our common stock by us or our stockholders; rumors and market speculation involving us or other companies in our industry; new laws, regulations, or executive orders, or new interpretations of existing laws or regulations applicable to our business; lawsuits threatened or filed against us, or unfavorable determinations or settlements in any such suits; and developments or disputes concerning our intellectual property or our technology, or third-party proprietary rights.

 

In addition, the stock markets have shown the capacity to experience extreme price and volume fluctuations that can have short- and long-term effects on the market prices of equity securities of many companies. Stock prices of many companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business, and harm our business.

 

Our common stock may be delisted from the Nasdaq Capital Market.

 

We may be unable to maintain the listing of our common stock on the Nasdaq. If, for any reason, Nasdaq should delist our common stock from trading on its exchange and we are unable to obtain listing on another national securities exchange or take action to restore our compliance with the Nasdaq continued listing requirements, a material adverse effect on our shareholders may occur due to a reduction in some or all of the following: the market price of our common shares; the liquidity of our common shares; our ability to obtain financing for the continuation of our operations; the number of market makers in our common shares; and the number of institutional and general investors that will consider investing in our common shares.

 

In the event that our common stock were to be delisted from the Nasdaq, it may be considered a “penny stock.” Securities broker-dealers participating in sales of our common stock would then be subject to the “penny stock” regulations set forth in Rules 15g-2 through 15g-9 promulgated under the Exchange Act. Generally, brokers may be less willing to execute transactions in securities subject to the “penny stock” rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.

 

If securities or industry analysts do not publish research or publishes inaccurate or unfavorable reports about our business, our stock price and trading volume could decline.

 

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business, our market and our competitors. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our shares or change their opinion of our shares, our share price would likely decline. If one or more of these analysts cease covering us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our share price or trading volume to decline.

 

Sales of a substantial number of shares of our common stock may cause the price of our common stock to decline.

 

As of March 30, 2020, we have a total of 22,768,757 shares of common stock outstanding and 1,846,767 warrants. Based on shares outstanding as of March 30, 2020, 9,400,959 shares of common stock, or 41.3%, are held by our officers, directors and their affiliated entities, and will be subject to volume limitations under Rule 144 under the Securities Act and various vesting agreements. In addition, 3,583,355 shares of our common stock that are subject to outstanding options, restricted stock units and warrants as of March 30, 2020, as well as 843,807 shares issuable upon the conversion of our Series A Preferred Stock, and 492,561 shares issuable upon the conversion of our Series B Preferred Stock, will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, and Rules 144 and 701 under the Securities Act.

 

We cannot predict what effect, if any, sales of our shares in the public market or the availability of shares for sale will have on the market price of our common stock. However, future sales of substantial amounts of our common stock in the public market, including shares issued on exercise of outstanding options, or the perception that such sales may occur, could adversely affect the market price of our common stock.

 

We also expect that significant additional capital may be needed in the future to continue our planned operations. To raise capital, we may sell common stock, convertible securities or other equity securities in one or more transactions at prices and in a manner we determine from time to time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock.

 

Investors may experience future dilution as a result of future equity offerings.

 

In order to raise additional capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable for our common stock. We cannot assure investors that we will be able to sell shares or other securities in any other offering at a price per share that is equal to or greater than the price per share paid by investors, and investors purchasing our shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional shares of our common stock or other securities convertible into or exchangeable for our common stock in future transactions may be higher or lower than the price per share paid by investors.

 

 

We do not intend to pay dividends on our common stock for the foreseeable future.

 

We have never declared or paid any cash dividends on our common stock and do not intend to pay any cash dividends on our common stock in the foreseeable future. Our Series A Preferred Stock and our Series B Preferred Stock are entitled to quarterly dividends as set forth in more detail in the section entitled “Description of Capital Stock.” We currently anticipate that for the foreseeable future we will retain all of our future earnings for the development, operation and growth of our business and for general corporate purposes. Any future determination to pay dividends on our common stock in will be at the discretion of our Board of Directors. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments.

 

Our executive officers, directors, principal stockholders and their affiliates will continue to exercise significant influence over our company, which will limit your ability to influence corporate matters and could delay or prevent a change in corporate control.

 

As of March 30, 2020, our executive officers, directors, five percent or greater stockholders and their respective affiliates owned in the aggregate approximately 46.1% of our common stock.

 

These stockholders have the ability to influence us through this ownership position and may be able to determine all matters requiring stockholder approval. For example, these stockholders may be able to control elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets, or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our stockholders. The interests of this group of stockholders may not always coincide with your interests or the interests of other stockholders and they may act in a manner that advances their best interests and not necessarily those of other stockholders, including seeking a premium value for their common stock, and might affect the prevailing market price for our common stock.

 

We are a “smaller reporting company” and, as a result of the reduced disclosure and governance requirements applicable to smaller reporting companies, our common stock may be less attractive to investors.

 

We are a “smaller reporting company,” meaning that we are not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent company that is not a “smaller reporting company,” have a public float of less than $250 million or have annual revenues of less than $100 million and public float of less than $700 million during the most recently completed fiscal year. As a “smaller reporting company,” we are subject to lesser disclosure obligations in our SEC filings compared to other issuers. Specifically, "smaller reporting companies" are able to provide simplified executive compensation disclosures in their filings, are exempt from the provisions of Section 404(b) of the Sarbanes-Oxley Act requiring that independent registered public accounting firms provide an attestation report on the effectiveness of internal control over financial reporting and have certain other decreased disclosure obligations in their SEC filings, including, among other things, only being required to provide two years of audited consolidated financial statements in annual reports. Decreased disclosures in our SEC filings due to our status a “smaller reporting company” may make it harder for investors to analyze our operating results and financial prospects.

 

Delaware law and provisions in our certificate of incorporation and bylaws could make a merger, tender offer or proxy contest difficult, thereby depressing the trading price of our common stock.

 

The anti-takeover provisions of the Delaware General Corporation Law, or the DGCL, may discourage, delay or prevent a change of control by prohibiting us from engaging in a business combination with stockholders owning in excess of 15% of our outstanding voting stock for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including that: the request of one or more stockholders holding shares in the aggregate entitled to cast not less than 35% of the vote at a meeting is required to call a stockholder meeting. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and cause us to take certain actions you desire.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

Not applicable.

ITEM 2.    PROPERTIES

Our principal executive offices are located at 7172 Columbia Gateway Drive, Suite 400, Columbia, Maryland 21046. We do not own any real property. We currently operate out of five leased locations and our lease terms range from month-to-month to multiyear commitments. We do not consider any of our leased properties to be materially important to us. While we believe it is necessary to maintain offices through which our services are coordinated, we feel there are sufficient available office rental properties to adequately serve our needs should we need to relocate or expand our operations.

 

ITEM 3. LEGAL PROCEEDINGS

Vigilant Solutions, LLC, a subsidiary of Motorola Solutions, Inc., filed a complaint on February 21, 2020 against us and certain of our subsidiaries in the US District Court for the District of Maryland. The complaint alleges that certain of our products violate a patent held by Vigilant. We have retained counsel to investigate the claims made in the complaint and our investigation into these matters is ongoing. Nevertheless, based on a review of the complaint, we believe that we have substantial defenses to the allegations contained in the complaint and that the validity of the patent underlying the complaint is subject to challenge. We intend to vigorously defend the allegations of the Vigilant complaint.

On January 31, 2020, our wholly owned subsidiary, OpenALPR filed a complaint in the US District Court for the Western District of Pennsylvania against a former customer, Plate Capture Solutions, Inc. (“PCS”) for breach of software license agreements pursuant to which software to was licensed to PCS. On February 19, 2020 PCS filed an answer, counterclaim and joinder in the case, among other things, seeking to join us as a party to the litigation and making counterclaims for defamation, fraud and intentional interference with existing and future business relationships. We believe that we have substantial defenses to the counterclaims and intend to vigorously defend the allegations of the counterclaims.

On August 19, 2019, we filed suit in the United States District Court for the Southern District of New York against three former executives of Rekor and Firestorm (the Firestorm Principals). The Complaint alleges that the Firestorm Principals fraudulently induced the execution of the Membership Interest Purchase Agreement pursuant to which Firestorm was acquired by us, and seeks rescission of the Membership Interest Purchase Agreement and certain transactions contemplated thereby, including the issuance of notes and warrants to the Firestorm Principals. On October 9, 2019, we filed an Amended Complaint. On November 4, 2019, the Firestorm Principals filed an answer to the Amended Complaint and asserted counterclaims against Rekor, Firestorm, and certain of our executives. On December 16, the Firestorm Principals filed a Motion for Judgment on the Pleadings. On January 30, 2020, we filed a Second Amended Complaint. The Firestorm Principals responded to the Second Amended Complaint on February 28, 2020. Our deadline for responding to the Firestorm Principals’ counterclaims is April 2020. We intend to vigorously litigate this action and believe that the Firestorm Principals’ counterclaims are without merit.

In addition, from time to time, we are named as a party to various other lawsuits, claims and other legal and regulatory proceedings that arise in the ordinary course of business. These actions typically seek, among other things, compensation for alleged personal injury, breach of contract, property damage, infringement of proprietary rights, punitive damages, civil penalties or other losses, or injunctive or declaratory relief. With respect to such lawsuits, claims and proceedings we accrue reserves when a loss is probable, and the amount of such loss can be reasonably estimated. It is our management’s opinion that the outcome of these proceedings, individually and collectively, will not be material to our consolidated financial statements as a whole.

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Our common stock is listed on the Nasdaq Capital Market under the symbol “REKR”.

 

Holders

 

As of February 18, 2020, there were 80 registered holders of record of our common stock, excluding stockholders for whom shares are held in “nominee” or “street name.” The actual number of common stockholders is greater than the number of record holders, and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities.

 

Dividend Policy

 

We have never declared or paid any cash dividends on our common stock and we have declared and paid cash dividends for our preferred stock. We currently do not anticipate paying any cash dividends for the foreseeable future. Instead, we anticipate that all of our earnings will be used to provide working capital, to support our operations, and to finance the growth and development of our business, including potentially the acquisition of, or investment in, businesses, technologies or products that complement our existing business. Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including, but not limited to, our future earnings, capital requirements, financial condition, future prospects, applicable Delaware law, which provides that dividends are only payable out of surplus or current net profits and other factors our Board of Directors might deem relevant.

 

Sales of Unregistered Securities

 

On March 12, 2019, as partial consideration for its acquisition of certain assets of OpenALPR, Rekor issued 600,000 shares of its common stock to the seller, valued at $397,000. On the same date, Rekor issued senior secured promissory notes in an aggregate principal amount of $20,000,000 and warrants to purchase 2,500,000 shares of its common stock, which are immediately exercisable at an exercise price of $0.74 per share, to certain individuals and entities.

The foregoing issuances were issued in reliance upon the exemptions from registration under the Securities Act of 1933, as amended, provided by Section 4(a)(2) and Rule 506 of Regulation D promulgated thereunder. 

Public Offering and Shelf Registration

In November 2018, Rekor completed a public offering of its common stock (the “Offering”) and issued and sold 4,125,000 shares of its common stock at a public offering price of $0.80 per share.

The offer and sale of all of the shares in the Offering was registered under the Securities Act pursuant to a registration statement on Form S-3 (File No. 333- 224423) (the “S-3 Registration Statement”), which was declared effective by the SEC on April 30, 2018, a preliminary prospectus supplement to the S-3 Registration Statement filed with the SEC on October 25, 2018 (the “Preliminary Prospectus Supplement”), a free writing prospectus filed with the SEC on October 24, 2018 (the “Free Writing Prospectus”), and a final prospectus supplement to the S-3 Registration Statement filed with the SEC on October 31, 2018 (the “Final Prospectus Supplement” and the S-3 Registration Statement as supplemented by the Preliminary Prospectus Supplement and the Final Prospectus Supplement, together with the Free Writing Prospectus, the “Registration Statement”). Under the Registration Statement, Rekor registered 4,125,000 shares of common stock and 618,750 shares of common stock issuable upon exercise of the underwriters’ option to purchase additional shares of common stock at a public offering price of $0.80 per share for a registered aggregate offering price of approximately $3,800,000. Following the sale of the shares in connection with the closing of the Offering on November 1, 2018, the Offering terminated. The Offering commenced on October 24, 2018 and did not terminate until the sale of all of the shares offered.

Rekor received aggregate gross proceeds from the Offering of approximately $3,300,000, and aggregate net proceeds of approximately $2,800,000 after deducting underwriting discounts and commissions of $200,000 and offering expenses of $300,000, for total expenses, including underwriting discounts and commissions of $500,000. No payments for such expenses were made directly or indirectly to any of Rekor’s officers, directors, or their associates, any persons owning 10% or more of any class of Rekor’s equity securities or any of Rekor’s affiliates.

There has been no material change in Rekor’s planned use of the net proceeds from the Offering as described in the Final Prospectus Supplement.

At-the-Market Agreement

On August 14, 2019, we entered into the Sales Agreement with B. Riley FBR to create an at the market equity program under which we from time to time may offer and sell shares of our common stock, having an aggregate offering price of up to $15,000,000, through or to B. Riley FBR. Subject to the terms and conditions of the Sales Agreement, B. Riley FBR will use its commercially reasonable efforts to sell the shares of our common stock from time to time, based upon our instructions. B. Riley FBR will be entitled to a commission equal to 3.0% of the gross proceeds from each sale. We incurred issuance costs of approximately $226,000 related to legal, accounting, and other fees in connection with the Sales Agreement. These costs were charged against the gross proceeds of the Sales Agreement and presented as a reduction to additional paid-in capital on the consolidated balance sheets.

Sales of our common stock under the Sales Agreement are to be issued and sold pursuant to our shelf registration statement on Form S-3 (File No 333- 224423), previously filed with the Securities and Exchange Commission (“SEC”) on April 24, 2018 and declared effective by the SEC on April 30, 2018. As of December 31, 2019, based on settlement date, we sold 1,292,730 shares of common stock at a weighted-average selling price of $2.53 per share in accordance with the Sales Agreement. Net cash provided from the Sales Agreement was $2,949,000 after paying $226,000 related to the issuance costs stated above, as well as, 3.0% or $98,000 related to cash commissions provided to B. Riley FBR. As of December 31, 2019, $11,727,000 remained available for sale under the Sales Agreement.

Use of Proceeds

 

We have generated losses since our inception in February 2017 and have relied on cash on hand, external bank lines of credit, short-term borrowing arrangements, issuance of debt, the sale of a note, and the sale of common stock to provide cash for operations. We attribute losses to merger costs, financing costs, public company corporate overhead, lower than expected revenue, and lower gross profit of some of our subsidiaries. Our proceeds have been primarily used for research and development and sales and marketing expenses related to new product development and our strategic shift to develop and promote capabilities to the OpenALPR software in 2019. 

 

ITEM 6. SELECTED FINANCIAL DATA

 

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this Item.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following management’s discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included in this Annual Report and the historical financial statements of Rekor Systems, Inc., and the related notes thereto.

 

Overview

 

 

 

Currently, our business activities include providing professional services in the government contracting, aerospace and aviation industries. As part of the development of a new line of products for the public safety and security markets, we acquired industry leading vehicle recognition software in March 2019. In connection with this acquisition, we determined that our resources are best concentrated on vehicle recognition products and services and have reorganized and retooled our product development, business development and administrative resources, with increasing emphasis on the technology area. Our Board of Directors has also authorized management to explore opportunities for the sale of our professional services businesses. In keeping with the shift in resources and strategic direction that this represents, we have reorganized our financial reporting into two business segments: the Technology Segment and the Professional Services Segment. These two segments reflect our separate focus on and expectations for technology products and services versus professional services.

 

On March 29, 2019, we announced that our Board of Directors approved changing the Company’s name to Rekor Systems, Inc. This name change was a result of our increased focus on technology products and services, and aligns with the renaming of Brekford Traffic Safety, Inc. to Rekor Recognition Systems, Inc. In connection with this name change, we changed:

 

 

 

 

Technology Segment. The Technology Segment operations are conducted by our wholly owned subsidiary, Rekor Recognition Systems, Inc. (“Rekor Recognition”). Formerly Brekford Traffic Safety, Inc., Rekor Recognition has been active in the public safety industry since 1996. In connection with the development of several new public safety products, we determined to acquire substantially all the assets of OpenALPR Technology, Inc. The OpenALPR Technology Acquisition, completed in March 2019, transferred vehicle recognition software and associated licenses and proprietary rights to OpenALPR Software Solutions, LLC (“OpenALPR”), a new wholly owned subsidiary of Rekor Recognition, as we have been focused on developing a line of products to transform the fundamental concepts of vehicle recognition. OpenALPR’s vehicle recognition platform, already operating in more than 12,000 cameras in 70 countries worldwide, has laid the groundwork for the expansion of our product line, enabling multiple deployment mechanisms.

 

Since the OpenALPR Technology Acquisition, we have expanded our vehicle recognition product and service lines into a much broader range of customer segments, starting with public safety. We shifted from a perpetual licensing model to a subscription-based model, rebranded the software suites as “Watchman” and “Car-Check” and released several packaged hardware solutions with each of these vehicle recognition engines. By the end of 2019, we had a portfolio of more than 10 products, permitting us to offer full-scale vehicle recognition services for nearly any large or small public agency, commercial or residential setting.

 

Our vehicle recognition software currently has the capability to analyze multi-spectral images and/or video streams produced by nearly any Internet Protocol security camera and concurrently extract license plate data by state from more than 70 countries, as well as provide the vehicle’s make, color, type, and direction of travel. When combined with speed optimized code, parallel processing capability and best-in-class accessories, such as cameras and communications modules, Watchman software delivers vehicle recognition solutions at extremely high-capture rates and with a high degree of accuracy. Additionally, our multi-spectral capabilities enable reading of license plates and vehicle characteristics in unusually difficult conditions (e.g. low lighting, poor weather, extreme camera viewing angles, and obstructions).

 

Prior to the development of our vehicle identification software, highly accurate results were not available using a typical Internet Protocol camera. We believe that the ability to use less expensive hardware will change the dynamics of the existing public safety market, enabling the creation of increasingly robust networks with cameras at more locations. In addition, we expect the cost advantages and high degree of accuracy to create competitive advantages compared to electronic tolling systems and logistics operations that currently rely on RFID systems. We also believe our lower costs, our distance and field of view capabilities and the ability to capture additional vehicle information, such as vehicle direction and color, make and type of vehicle, have opened opportunities in other market segments such as parking operations, school safety, retail customer loyalty programs and particularly smart cities and smart roadways. Smart roadway systems, sometimes referred to as “smart transport” or “intelligent transport systems” (“ITS”), inclusive of parking management and guidance, passenger information, and traffic management systems, can optimize the movement of vehicles to make travel safer and more efficient. These technologies are expected to enable users to be more coordinated, better informed, and make safer and smarter use of transport networks.

 

Our vision is “AI with a Purpose.” We intend to evolve beyond vehicle recognition for public safety markets into the recognition and analysis of vehicles activities (inclusive of motion and behaviors) to identify unsafe situations (e.g. wrong way driving, pedestrian on roadway, etc.), optimize traffic flows, and develop numerous other data driven applications centered around vehicle knowledge.

 

Professional Services Segment. We provide professional services and staffing solutions to the government contracting and the aerospace and aviation industries. The Professional Services Segment includes AOC Key Solutions, Inc. (“AOC Key Solutions”); Global Technical Services, Inc. (“GTS”); Global Contract Professionals, Inc. (“GCP”, and together with GTS, “Global”); and Firestorm Solutions, LLC (Firestorm Solutions”) and Firestorm Franchising, LLC (“Firestorm Franchising” and together with Firestorm Solutions, “Firestorm”). Currently, as a leading provider of support services to the federal government contracting market, AOC Key Solutions’ primary clients are companies that serve the federal government. However, in support of our Technology Segment, we have recently been active in the state and local government contracting market. We provide professional services that offer scalable and compliant outsourced support for our government contractor clients. We help these clients to win government contracts so that they capture new businesses. Global provides specialized staffing services, primarily in the aerospace and aviation industries. In connection with our internal reorganization, we are actively engaged in evaluating, reconfiguring, selling, and discontinuing various business assets or entities in the Professional Services Segment. As part of this process, we have discontinued the operations of Firestorm Franchising and have determined to sell Global and AOC Key Solutions.

 

As part of our strategic shift in fiscal year 2019, we are focusing on the Technology Segment and further developing our footprint across different industries by further developing our AI based technologies and distributing and licensing products and services with advanced vehicle recognition features. Current customers are using these products and services for: a) toll collection and traffic analysis in the transportation market, b) school and traffic safety, parking and other law enforcement applications in the public safety market, c) perimeter management and surveillance in the private security market, d) operations and retail customer loyalty programs and e) vehicle tracking, perimeter security and warehouse operations in the logistics market.

 

As a result of our strategic shift, during the third quarter of 2019, we began to separately report the results of Global and considered including substantially all of the assets and liabilities comprising Global as held for sale operations. We are also reporting the operating results and cash flows of Global as held for sale operations, and thus they have been excluded from continuing operations and segment results for all periods presented. Prior to the third quarter of 2019, the operating results for Global were presented in the Professional Services segment. The assets and liabilities of Global are presented as current and long-term assets and liabilities of businesses held for sale in the condensed consolidated balance sheets. Since we adopted a formal plan to sell Global in September 2019, we have received several non-binding offers and indications of interest for the purchase of Global which we are in the process of evaluating. In March of 2020, we also received a proposal from the current management of AOC Key Solutions to purchase that subsidiary, which we are also currently evaluating. No assurance can be given as to the certainty of the entry into, or the subsequent closing any of these, proposed transactions.

 

General

 

The information provided in this discussion and analysis of Rekor’s financial condition and results of operations covers the years ended December 31, 2019 and 2018. During 2019 the Company completed the OpenALPR Technology Acquisition as more fully described below.

 

Our financial results are impacted principally by the demand by clients for our products and services, the degree to which full-time staff can be kept occupied in revenue-generating activities and the success of our sales team in generating client engagements.

 Unexpected changes in the demand for our products and services can result in significant variations in revenues, and present a challenge to optimal hiring, staffing and use of consultants. The volume of work performed can vary from period to period.

 

The statements of operations and other information provided in this discussion and analysis of the financial condition and results of operations of Rekor should be read in conjunction with the Rekor audited consolidated financial statements and the historical financial statements of Rekor Recognition, KeyStone, Firestorm and Global, and the related notes thereto which were filed with the SEC by either KeyStone or Rekor.

 

Acquisitions

 

On March 12, 2019, we completed the OpenALPR Technology Acquisition.

 

On June 1, 2019, we sold all the interest we had acquired in Secure Education Consultants, LLC, which we acquired on January 1, 2018. At that time, we also discontinued operations of BC Management. In connection with these actions we recognized a write-off of intangible assets of $242,000. In addition, in June 2019, we discontinued the operations of Firestorm Franchising, resulting in a write-off of an additional $1,310,000 in intangible assets related to Firestorm.

 

 

Opportunities, Trends and Uncertainties

 

We look to identify the various trends, market cycles, uncertainties and other factors that may provide us with opportunities and present challenges that impact our operations and financial condition from time to time. Although there are many that we may not or cannot foresee, we believe that our results of operations and financial condition for the foreseeable future will be primarily affected by the following:

 

 

 

 

 

 

 

 

 

 

 

We believe that recent developments in computing capabilities, such as GPU advances, and new techniques of analysis, sometimes referred to broadly as AI, have broadened the market for vehicle recognition technology and created new opportunities in existing markets. With our new line of products and services, our Technology Segment is working to actively exploit these opportunities. With the anticipated continuation of a stable economic outlook for the government contracting, we believe that the outlook for the operations of our subsidiaries in the Professional Services Segment remains positive.

 

Considerable uncertainty currently exists concerning the extent of spread, efficaciousness of countermeasures and severity of the economic impact of the Covid19 corona virus. This has had, and may continue to have, a severe impact on the financial markets that we depend on to fund our operations. If these economic and market conditions continue for an extended period of time, it could have a significant impact on our financial performance and ability to execute our business strategy. Other than as described above and elsewhere in this Annual Report on Form 10-K, we are not aware of any trends, events or uncertainties that are likely to have a material effect on our financial condition.

 

NeoSystems Merger

 

We filed a Registration Statement on Form S-1 with the SEC on January 25, 2018. A significant portion of the proceeds from the proposed offering were to be used for the planned acquisition of NeoSystems LLC (“NeoSystems”) under a merger agreement. On March 7, 2018, we received notice of termination of the merger agreement and subsequently paid NeoSystems $225,000 in required payments, which was recorded as a selling, general and administrative expense in the year ended December 31, 2018. No securities were sold in connection with the offering contemplated by the Registration Statement on Form S-1 and it was withdrawn on November 26, 2018.

 

Sale of Note

 

On February 13, 2018, Rekor Recognition sold a note receivable from Global Public Safety, LLC (“Global Public Safety”), which it had received as part of the purchase price consideration in connection with the sale of its legacy upfitting business prior to its acquisition by Rekor as a result of the merger with KeyStone in 2017. As of December 31, 2017, based on the decision to sell the note receivable to an unrelated third party, we reclassified the note receivable balance to a current asset and wrote down $450,000 as other expense, thus reducing the balance to $1,475,000. Rekor Recognition continues to retain a 19.9% interest in Global Public Safety.

 

Promissory Notes

 

2018 Promissory Note

 

On April 3, 2018, we entered into a transaction pursuant to which an institutional investor (the “Lender”) loaned $2,000,000 to us (the “2018 Promissory Note”). The 2018 Promissory Note is discussed in further detail in this Management’s Discussion and Analysis of Financial Conditions and Results of Operations under the heading “Liquidity and Capital Resources.”

 

 

2019 Promissory Note

 

On March 12, 2019, we entered into a note purchase agreement pursuant to which investors (the “2019 Lenders”) loaned us $20,000,000 in exchange for promissory notes (the “2019 Promissory Notes”) and we issued to the 2019 Lenders warrants to purchase 2,500,000 shares of our common stock (the “March 2019 Warrants”). The 2019 Lenders included the lender for the 2018 Note, a senior company executive and another entity exchanging 2019 Promissory Notes for related party company indebtedness. The 2019 Promissory Note and March 2019 Warrants are discussed in further detail this in Management’s Discussion and Analysis of Financial Conditions and Results of Operations under “Liquidity and Capital Resources.”

 

Other than as discussed above and elsewhere in this Annual Report on Form 10-K, we are not aware of any trends, events or uncertainties that are likely to have a material effect on our financial condition.

 

Public Offering of Common Stock

 

On November 1, 2018, we issued 4,125,000 shares of common stock through an underwritten public offering at a public offering price of $0.80 per share. Net proceeds were approximately $2.8 million. In addition, we granted underwriters a 45-day option to purchase up to 618,750 additional shares of common stock to cover over-allotment, if any. The underwriters did not exercise this option and the options were cancelled. As part of this transaction, we also issued to the underwriter warrants to purchase an aggregate of 206,250 shares of common stock, exercisable over a period of five years, at an exercise price of $1.00 per share. The underwriter warrants had a value of approximately $0.2 million at issuance and are exercisable commencing April 27, 2019 and expire on October 29, 2023. As of December 31, 2019, the underwriter’s had 7,567 unexercised warrants which have an immaterial value.  

 

At-the-Market Agreement

 

On August 14, 2019, we entered into the Sales Agreement with B. Riley FBR to create an at the market equity program under which we from time to time may offer and sell shares of our common stock, having an aggregate offering price of up to $15,000,000, through or to B. Riley FBR. Subject to the terms and conditions of the Sales Agreement, B. Riley FBR will use its commercially reasonable efforts to sell the shares of our common stock from time to time, based upon our instructions. B. Riley FBR is entitled to a commission equal to 3.0% of the gross proceeds from each sale. We incurred issuance costs of approximately $226,000 related to legal, accounting, and other fees in connection with the Sales Agreement. These costs were charged against the gross proceeds of the Sales Agreement and presented as a reduction to additional paid-in capital on the consolidated balance sheets.

 

Sales of our common stock under the Sales Agreement are to be issued and sold pursuant to our shelf registration statement on Form S-3 (File No 333-224423), previously filed with the Securities and Exchange Commission (“SEC”) on April 24, 2018 and declared effective by the SEC on April 30, 2018. As of December 31, 2019, based on settlement date, we sold 1,292,730 shares of common stock at a weighted-average selling price of $2.53 per share in accordance with the Sales Agreement. Net cash provided from the Sales Agreement was $2,949,000 after paying $226,000 related to the issuance costs stated above, as well as 3.0% or $98,000 related to cash commissions provided to B. Riley FBR. As of December 31, 2019, $11,727,000 remained available for sale under the Sales Agreement.

 

Components of Revenues and Expenses

 

Revenues

 

We generate our revenues substantially from two sources: (1) licensing and subscription revenues for software and related products and services and (2) professional services to clients.

 

Revenue is recognized upon transfer of control of promised products and services to our customers, in an amount that reflects the consideration we expect to receive in exchange for those products and services. If the consideration promised in the contract includes a variable amount, for example maintenance fees, we include an estimate of the amount we expect to receive in the total transaction price, if it is probable that a significant reversal of cumulative revenue recognized will not occur.

 

We determine the amount of revenue to be recognized through application of the following steps:

 

The subscription revenues from software licenses, technology products and services are comprised of fees that provide customers with access to the software licenses and related support and updates during the term of the arrangement. Revenue is generally recognized ratably over the contract term. During the second quarter of 2019, we changed our method of selling in the Technology Segment from perpetual software licenses to monthly service subscriptions. This change is expected to impact our revenue in the short term as we will now recognize revenue ratably over the contract period rather than at a point in time when the customer takes possession of the license. The amount of contract revenue received over the long term is not expected to decline. Our subscription services arrangements are non-cancelable and do not contain refund-type provisions.

 

The professional services contracts recognize revenue based on a time and materials or fixed fees basis. These revenues are recognized as the services are rendered for time and materials contracts, on a proportional performance basis for fixed price contracts, or ratably over the contact term for fixed price contracts with subscription services.

 

Costs of Revenues

 

Direct costs of revenues consist primarily of that portion of technical and non-technical salaries and wages and payroll-related costs incurred in connection with revenue generating activities. Direct costs of revenues also include production expenses, sub-consultant services, and other expenses that are incurred in connection with our revenue generating activities. Direct costs of revenues exclude that portion of technical and non-technical salaries and wages related to marketing efforts, vacations, holidays, and other time not spent directly generating fees under existing contracts. Such costs are included in operating expenses. We expense direct costs of revenues when incurred.

 

Operating Expenses

 

Our operating expenses consist of general and administrative expenses, sales and marketing and research and development. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, payroll taxes and stock-based compensation expense. Operating expenses also include depreciation, amortization and impairment of assets.

 

General and Administrative

 

General and administrative expense consists of personnel costs for our executive, finance, legal, human resources and administrative departments. Additional expenses include travel and entertainment, professional fees and insurance.

 

We expect our general and administrative expense to continue to increase in absolute dollars for the foreseeable future due to additional costs associated with accounting, compliance, insurance and investor relations as a public company. However, we expect our general and administrative expense to decrease as a percentage of our revenue over the long term, although our general and administrative expense may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

 

Sales and Marketing

 

Sales and marketing expenses consist of personnel costs, marketing programs, travel and entertainment associated with sales and marketing personnel, expenses for conferences and trade shows. We intend to make significant investments in our sales and marketing expenses to grow revenue, further penetrate the market and expand our customer base. With the release of our Partners Program we expect our sales and marketing expense to increase in the future.

 

 

Research and Development

 

Research and development expenses consists of personnel costs, software used to develop our products and consulting and professional fees for third-party development resources. Our research and development expenses support our efforts to continue to add capabilities to our existing products and the strategic shift to develop additional capabilities and improve our AI software.

 

We expect our research and development expense to continue to increase in absolute dollars for the foreseeable future as we continue to invest in research and development efforts to enhance the functionality of our AI software. However, we expect our research and development expense to decrease as a percentage of our revenue over the long term, although our research and development expense may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

 

Other Income (Expense)

 

Other income (expense) net consists primarily of interest expense in connection with our debt arrangements, costs associated with the extinguishment of our debt arrangements, gains and losses on the sale of fixed assets and interest income earned on cash and cash equivalents and short-term investments.

 

Income Tax Provision

 

Income tax provision consists primarily of income taxes in certain domestic jurisdictions in which we conduct business. We have recorded deferred tax assets for which a full valuation allowance has been provided, including net operating loss carryforwards and tax credits. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses.

 

Results of Operations

  

The results and the analysis of operations below is solely related to continuing operations and do not include results of operations of our subsidiary, Global, which is being held for sale. The following selected consolidated financial data should be read in conjunction with the foregoing information contained in this Item 7 and with the consolidated financial statements and the notes thereto in Item 8 of Part II, “Financial Statements and Supplementary Data.” Only historical operating results are presented below. Historical results are not necessarily indicative of future results.

 

	Year ended December 31,
	2019	2018
Revenue:	(Dollars in thousands)
Technology	$5,469	$3,522
Professional Services	13,851	16,532
Total revenue	19,320	20,054
Cost of revenue:
Technology	1,652	1,642
Professional Services	7,406	8,336
Total cost of revenue	9,058	9,978
Gross profit:
Technology	3,817	1,880
Professional Services	6,445	8,196
Gross profit	10,262	10,076
Operating expenses:
General and administrative expenses	14,151	13,310
Selling and marketing expenses	2,222	1,758
Research and development expenses	1,429	131
Impairment of intangibles	1,549	-
Operating expenses	19,351	15,199
Loss from operations	(9,089)	(5,123)
Other expense:
Loss on extinguishment of debt	(1,158)	-
Interest expense	(4,098)	(492)
Other expense	(20)	(65)
Total other expense	(5,276)	(557)
Loss before income taxes	(14,365)	(5,680)
Income tax provision	(47)	(29)
Net loss from continuing operations	$(14,412)	$(5,709)

 

Comparison of the Years Ended December 31, 2019 and 2018

 

Restructuring

 

As part of our shift in strategic direction in 2019, we are focusing on our Technology Segment and management has been evaluating the disposition of the subsidiaries in our Professional Services Segment: AOC Key Solutions, Global and Firestorm. As part of evaluating the future of Firestorm, management decided to sell Secure Education and transfer the BC Management line of business to its founder in the second quarter of 2019. In addition, management determined to discontinue the operation of Firestorm Franchising, LLC, a division of Firestorm, due to non-performance by franchisees. As further discussed under Item 3, “Legal Proceedings”, above, we have commenced an action to rescind the original purchase of Firestorm. As a result of these changes, the Professional Services Segment revenue was expected to decrease compared to the corresponding periods in 2018.

 

Also, in June 2019, our Board of Directors authorized the sale of Global. As a result, management has been negotiating with potential buyers and has determined that Global should be classified as held for sale. Accordingly, results of operations for Global have not been included in the comparisons shown below for either 2018 or 2019. The results for our Professional Services Segment are for AOC Key Solutions and Firestorm. In January 2020, the Board of Directors authorized the sale of AOC Key Solutions. Therefore, beginning in 2020, it is expected that all Professional Services operations will be classified as held for sale.

 

Revenue

 

	Year ended December 31,		Change
(dollars in thousands)	2019	2018	$	%
Revenue:
Technology	$5,469	$3,522	$1,947	55%
Professional Services	13,851	16,532	(2,681)	-16%
Total revenue from continuing operations	$19,320	$20,054	$(734)	-4%

 

The increase in revenue in the Technology Segment was primarily attributable to the acquisition of OpenALPR in March 2019. During the year ended December 31, 2019, total revenue attributable to software and licensing was approximately $2,055,000 compared to no revenue recognized in the corresponding period in 2018. For additional information concerning pro-forma revenues attributable to software and licensing see “Technology Revenues” below in this section and for information concerning pro-forma revenues attributable to software and licensing during 2018, see Note 2 to the financial statements included in this report. Revenue related to our automated traffic safety enforcement remained fairly consistent year over year.

 

The decrease in revenues in the Professional Services Segment was primarily attributable to the winding down of Firestorm operations. During the year ended December 31, 2019, revenue related to Firestorm decreased by $2,324,000 from $3,330,000 for the year ended December 31, 2018 to $1,006,000 for the year ended December 31, 2019. The additional decrease in revenue is attributable to a decrease in revenue at AOC Key Solutions related mainly to the federal government furlough during the first quarter of 2019.

 

 

Cost of Revenue, Gross Profit and Gross Margin

 

	Year ended December 31,		Change
(dollars in thousands)	2019	2018	$ or % Points	%
Cost of revenue:
Technology	$1,652	$1,642	$10	1%
Professional Services	7,406	8,336	(930)	-11%
Total cost of revenue	9,058	9,978	(920)	-9%
Gross profit:
Technology	3,817	1,880	1,937	103%
Professional Services	6,445	8,196	(1,751)	-21%
Gross profit	$10,262	$10,076	$186	2%
Gross margin:
Technology	70%	53%	17%	32%
Professional Services	47%	50%	-3%	-6%
Gross margin	53%	50%	3%	6%

 

The increase in gross profit in the Technology Segment was primarily attributable to the inclusion of OpenALPR since its acquisition in March 2019. We realize higher margins from the revenues associated with software and licensing since there are less labor costs incurred.

 

The decrease in the cost of revenues and gross profit in the Professional Services Segment was primarily related to the winding down of Firestorm lines of business and also reflected a decrease in direct billable labor as a result of the federal government furlough. During the year ended December 31, 2019, the cost of revenue and gross profit associated with Firestorm decreased $758,000 and $1,567,000, respectively.

 

Operating Expenses 

 

	Year ended December 31,		Change
(dollars in thousands)	2019	2018	$	%
Operating expenses:
General and administrative expenses	$14,151	$13,310	$841	6%
Selling and marketing expenses	2,222	1,758	464	26%
Research and development expenses	1,429	131	1,298	991%
Impairment of intangibles	1,549	-	1,549	-
Operating expenses	$19,351	$15,199	$4,152	27%

 

General and Administrative Expenses

 

During the year ended December 31, 2019, amortization expenses related to intangible assets increased by $570,000 compared to the year ended December 31, 2018 due to the OpenALPR Technology Acquisition. The majority of the remaining increase to general and administrative expenses is attributable mainly to the increased staffing to support the Company’s growth plan in the Technology Segment.

 

Selling and Marketing Expenses

 

The increase in the selling and marketing expenses during the year is attributable mainly to the increased marketing efforts to promote our products and services including trade shows, digital marketing, and other sales and marketing activities for developing our Technology Segment and increase staffing to support the Company’s growth plan. The overall increase in selling and marketing expenses was partially offset by a decrease in selling and marketing expenses related to the Professional Services Segment due to the realignment of Firestorm in the current year.

 

Research and Development Expense

 

The overall increase in research and development expenses is primarily attributable to the strategic shift to develop new products and additional software capabilities in 2019, as a result of our increased focus on the Technology Segment. The increase in our research and development expenses is mainly attributable to an increase in headcount and hours associated with the research and development activities.

 

Impairment of Intangibles

 

In June 2019, we discontinued the operations of BC Management and terminated agreements of all franchisees of Firestorm Franchising, LLC. As a result, we reevaluated the intangible assets related to these subsidiaries and recognized $1,549,000 in impairment charges related to intangible assets. The loss is presented as impairment of intangibles on the consolidated statement of operations.

 

Other Expense

 

	Year ended December 31,		Change
(dollars in thousands)	2019	2018	$	%
Other expense:
Loss on extinguishment of debt	$(1,158)	$-	$(1,158)	-
Interest expense	(4,098)	(492)	(3,606)	-733%
Other expense	(20)	(65)	45	69%
Total other expense	$(5,276)	$(557)	$(4,719)	847%

 

The increase in other expenses is primarily attributable to an increase in interest expense related to the 2019 Promissory Note. Additionally, the increase in other expenses was attributable to costs associated with the extinguishment of debt of $1,158,000 during the year ended December 31, 2019. 

 

Income Tax Expense

 

The income tax provision for the year ended December 31, 2019, was $47,000, is due primarily to the state taxes, as compared to tax expense of $29,000 for the year ended December 31, 2018. There is also approximately $10,000 of deferred taxes related to the goodwill recognized related to the OpenALPR acquisition. We established a valuation allowance against deferred tax assets in the fourth quarter of 2017 and have continued to maintain a full valuation allowance through the year ended December 31, 2019.

 

 

Non-GAAP Measures

 

EBITDA and Adjusted EBITDA

 

We calculate EBITDA as net loss before interest, taxes, depreciation and amortization. We calculate Adjusted EBITDA as net loss before interest, taxes, depreciation and amortization, adjusted for (i) impairment of intangible assets, (ii) loss on extinguishment of debt, (iii) stock-based compensation, (iv) losses on sales of subsidiaries, and (v) other unusual or non-recurring items. EBITDA and Adjusted EBITDA are not measurements of financial performance or liquidity under accounting principles generally accepted in the U.S. (U.S. GAAP) and should not be considered as an alternative to net earnings or cash flow from operating activities as indicators of our operating performance or as a measure of liquidity or any other measures of performance derived in accordance with U.S. GAAP. EBITDA and Adjusted EBITDA are presented because we believe they are frequently used by securities analysts, investors and other interested parties in the evaluation of a company’s ability to service and/or incur debt. However, other companies in our industry may calculate EBITDA and Adjusted EBITDA differently than we do.

 

The following table sets forth the components of the EBITDA and Adjusted EBITDA for the periods included (dollars in thousands):

 

	Year ended December 31,
	2019	2018
Net loss	$(14,412)	$(5,709)
Income taxes	47	29
Interest	4,098	495
Depreciation and amortization	1,867	1,047
EBITDA	$(8,400)	$(4,138)
Impairment of intangible assets	$1,549	$-
Loss on extinguishment of debt	1,158	-
Share-based compensation	446	465
Restructuring charges	333	-
Loss on sale of Secure Education	3	-
Adjusted EBITDA	$(4,911)	$(3,673)

 

The following activities have impacted our Adjusted EBITDA from continuing operations as of December 31, 2019. In March 2019, we recorded costs in connection with the extinguishment of the $2,000,000 2018 Promissory Note of $1,113,000. In July 2019, we recorded costs in connection with the extinguishment of our line of credit with Wells Fargo of $45,000. In June we initiated restructuring and transition activities to improve operational efficiency, reduce costs and better position us to drive future revenue growth. In connection with these activities, we recorded $333,000 of charges related to these restructuring activities. Additionally, in June 2019, we discontinued the operations of BC Management and terminated agreements of all franchisees of Firestorm Franchising, LLC. As a result, we re-evaluated the intangible assets related to these subsidiaries and recognized $1,549,000 in impairment charges related to intangible assets.

 

Technology Revenues

 

Due to the strategic shift to focus more on our Technology Segment, we have used additional metrics to measure the revenue growth associated with our Technology Segment. We calculated our Pro-forma Technology Segment revenue to include the net sales of OpenALPR Technology, Inc., as if the OpenALPR Technology Acquisition occurred as of December 31, 2017. This amount is presented as we believe comparative segment revenue growth is used by securities analysts, investors and other interested parties in the evaluation of a company’s ability to grow.

 

The following table sets forth the components of the per-forma Technology Segment revenue (without the inclusion of OpenALPR revenue prior to the OpenALPR Technology Acquisition) and pro-forma Technology Segment revenue (with the inclusion of OpenALPR revenue prior to the OpenALPR Technology Acquisition) for the periods indicated (dollars in thousands):

 

	Year ended December 31,		Change
	2019	2018	$	%
Per-forma Technology Segment Revenue
Automated traffic safety enforcement	$3,403	$3,413	$(10)	0%
Licensing and subscription revenue	2,066	-	2,066	100%
Other	-	109	(109)	-100%
Per-forma Technology Segment Revenue	$5,469	$3,522	$1,947	55%
Pro-forma Technology Segment Revenue
Automated traffic safety enforcement	$3,403	$3,413	$(10)	0%
Licensing and subscription revenue	3,035	1,713	1,322	78%
Other	-	109	(109)	-100%
Pro-forma Technology Segment Revenue	$6,438	$5,235	$1,203	23.0%

 

The following activities have impacted our Technology Segment revenues as of December 31, 2019. During the second quarter of 2019, we began to implement a change in our sales model from perpetual software licenses to periodic service subscriptions. Under the perpetual license model, we generally received full payment for a license when the license was issued and we would receive significantly lower periodic payments subsequently for maintenance of the license. Under the perpetual license model, all the revenue associated with a software license was recognized upon the issuance of the license, which was typically contemporaneous with cash payment. Under our new subscription model, the revenue is now recognized ratably against a contract liability for the paid-for period of the software subscription. Subscriptions are typically for 36 or 60 months, while payments may be made monthly, yearly or entirely in advance. This change to the model has resulted in a $1,317,000 increase in our contract liabilities balance from $207,000 as of December 31, 2018 to $1,524,000 as of December 31, 2019.

 

Lease Obligations

 

At December 31, 2019, we leased building space at the following locations in the U.S.:

 

 

We believe our facilities are in good condition and adequate for their current use. We may improve, replace or reduce facilities as considered appropriate to meet the needs of our operations.

 

 

Liquidity and Capital Resources

 

The net cash flows from operating, investing and financing activities for the periods below were as follows (dollars in thousands):

 

	For the Year Ended December 31,
	2019	2018	Change
(dollars in thousands)			$	%
Net cash used in operating activities-continuing operations	$(11,767)	$(3,076)	$(8,691)	283%
Net cash (used in) provided by investing activities - continuing operations	(556)	472	(1,028)	-218%
Net cash provided by financing activities-continuing operations	11,639	2,409	9,230	383%
Net decrease in cash, cash equivalents and restricted cash and cash equivalents- continuing operations	$(684)	(195)	$(489)	251%

 

Net cash used in operating activities – continuing operations for the year ended December 31, 2019 increased by $8,691,000 which was primarily due to an increase in net loss from continuing operations to $14,412,000 for the year ended December 31, 2019, compared to $5,709,000 for the year ended December 31, 2018. Additionally, as of December 31, 2019 there was $5,101,000 of cash outflows related to the change in accounts receivable compared to a $733,000 cash inflow as of December 31, 2018. This change is related to the timing of our collections. These cash outflows were partially offset by (i) an impairment of intangible assets in the amount of $1,549,000 from Firestorm, (ii) $1,158,000 loss on extinguishment of debt we incurred in the first and third quarter of 2019, (iii) an increase in amortization of intangible assets of $1,308,000 in the year ended December 31, 2019, compared to $738,000 in the year ended December 31, 2018, (iv) an increase in amortization of deferred financing costs of $1,101,000 in the year ended December 31, 2019, compared to $94,000 in the year ended December 31, 2018, and (v) an increase in contract liabilities of $929,000 in the year ended December 31, 2019, compared to a $22,000 increase in the year ended December 31, 2018, mainly a result of $800,000 we received from a customer for a five-year software license.

 

The net decrease of net cash (used in) provided by investment activities – continuing operations of $1,028,000 was primarily due to proceeds from sale of note receivable in the amount of $1,475,000 received during the year ended December 31, 2018. This was partially offset by proceeds of $250,000 from the sale of Secure Education to a third party and a reduction in capital expenditures during the year ended December 31, 2019.

 

Net cash provided by financing activities – continuing operations for the year ended December 31, 2019 increased $9,230,000 from the prior year ended December 31, 2018. The increase was primarily due to (i) proceeds of $3,839,000 from the 2019 Promissory Notes, (ii) proceeds of $2,949,000 from sale of the Company common stock through the at-the-market agreement, and (iii) proceeds of $5,463,000 from the secured borrowing arrangement with LSQ Funding Group, L.C. (“LSQ”). This was partially offset by the repayment of the Wells Fargo line of credit.

 

During 2019 and 2018, we funded our operations primarily through cash from operating activities from our subsidiaries, secured borrowing arrangements, issuance of debt, and the sale of equity. As of December 31, 2019, we had unrestricted cash and cash equivalents from continuing operations of $1,180,000 and working capital deficit of $912,000, as compared to unrestricted cash and cash equivalents of $2,069,000 and working capital deficit of $44,000 as of December 31, 2018.

 

We believe our existing cash and net cash flow will fund our operations over the next twelve months.

 

Operating assets and liabilities consist primarily of receivables from billed and unbilled services, accounts payable, accrued expenses, current portion of long-term debt and secured borrowing arrangements, and accrued payroll and related benefits. The volume of billings and timing of collections and payments affect these account balances.

 

At December 31, 2019, within the Technology Segment, we had approximately $10,102,000 of licensing and subscription contracts that were closed prior to December 31, 2019, but, have a contractual subscription period beyond December 31, 2019. These subscription contracts generally cover a term of one to five years, in which the Company will recognize revenue ratably over the contract term. On occasion our customers will prepay the full contract or a substantial portion of the contract. Amounts related to the prepayment of the subscription contract for a service period that is not yet met are recorded as part of our contract liabilities balance. We currently expect to recognize approximately 46% of this amount over the succeeding twelve months, and the remainder is expected to be recognized over the following four years.

 

At March 20, 2020, within the Technology Segment, we had approximately $13,833,000 of licensing and subscription contracts that were closed prior to March 20, 2020, but, have a contractual subscription period beyond March 20, 2020. The table below represents growth from December 31, 2018, or 105% and 181% through December 31, 2019 and March 20, 2020, respectively.

 

The table below shows the quarter by quarter growth in the unaudited remaining contract value of licensing and subscription contracts in the Technology Segment (dollars in thousands):

 

 

Series A Preferred Stock

 

The holders of Rekor Series A Preferred Stock are entitled to quarterly dividends in the amount of $0.175 (7% per annum) per share. Dividends accrue quarterly and dividend payments for declared dividends are due within five business days following the end of a quarter.

 

For the year ended December 31, 2019 and 2018, we paid cash dividends of $0 and $264,000, respectively, to shareholders of record of Series A Preferred Stock. Accrued dividends payable to Series A Preferred Stock shareholders were $551,000 and $176,000 as of December 31, 2019 and December 31, 2018, respectively, and are presented as part of the accounts payables and accrued expenses on the consolidated balance sheets.

 

Series B Preferred Stock

 

As part of the acquisition of Global, we issued 240,861 shares of $0.0001 par value Series B Preferred Stock. All Series B Preferred Stock was issued at a price of $10.00 per share with a conversion price of $5.00 per share. Each Series B Preferred Stock has an automatic conversion feature based on our common stock share price. The Series B Preferred Stock is entitled to quarterly cash dividends of 1.121% (4.484% per annum) per share. Dividends accrue quarterly and dividend payments for declared dividends are due within five business days following the end of a quarter. For the years ended December 31, 2019 and 2018, we paid cash dividends of $108,000 and $81,000, respectively, related to accrued dividends for Series B Preferred Stock shareholders. Accrued dividends payable to Series B Preferred Stock shareholders were $54,000 as of December 31, 2019 and December 31, 2018.

 

Short-Term Borrowing

 

On August 9, 2019, our wholly owned subsidiaries, Global Technical Services, Inc. and Global Contract Professionals, Inc, (together "Global"), entered an agreement with an unrelated third party, LSQ, pursuant to which Global sells its accounts receivable to LSQ and LSQ advances Global 90% of the value of the receivable. Global can advance up to $10,000,000 at one time. The term of the agreement is for 12 months and automatically renews for additional 12-month periods. The agreement is presented as secured borrowings, as the accounts receivable are sold with recourse back to Global, meaning that Global bears the risk of non-payment by the account debtor. The funded amount of accounts receivables that LSQ has provided to Global was $1,842,000 as of December 31, 2019 and is presented as part of current liabilities held for sale on the consolidated balance sheets. To secure its obligations to LSQ, Global has granted a first priority security interest in Global's accounts receivable and proceeds thereof. As of December 31, 2019, there were approximately $2,455,000 of receivables that are subject to collateral as part of this agreement. The receivables held as collateral are presented in assets held for sale on the consolidated balance sheets.

 

On August 9, 2019, AOC Key Solutions, also entered into an agreement with LSQ, as an unrelated third party, pursuant to which AOC Key Solutions sells its accounts receivable to LSQ and LSQ advances 90% of the value of the receivable to AOC Key Solutions. AOC Key Solutions can advance up to $5,000,000 at one time. The term of the agreement is for 12 months and automatically renews for additional 12-month periods. The agreement is presented as secured borrowings, as the accounts receivable are sold with recourse back to AOC Key Solutions, meaning that AOC Key Solutions bears the risk of non-payment by the account debtor. The funded amount of accounts receivables that LSQ has provided fund to AOC Key Solutions was $1,894,000 as of December 31, 2019 and is presented as part of the short-term borrowings on the consolidated balance sheets. To secure its obligations to LSQ, AOC Key Solutions has granted a first priority security interest in the AOC Key Solution’s accounts receivable and proceeds thereof. As of December 31, 2019, there were approximately $2,714,000 of receivables that are subject to collateral as part of this agreement. The receivables held as collateral are presented in the accounts receivable, net on the consolidated balance sheets.

 

During the year ended December 31, 2019, we recorded $112,000, in interest expense from continuing operations, related to the agreement with LSQ. Additionally, during the year ended December 31, 2019, we recorded $169,000 in interest expense from operations held for sale, related to the agreement with LSQ.

 

 

Promissory Notes 

 

On March 12, 2019, we issued the 2019 Promissory Notes and the March 2019 Warrants. The loan was due and payable on March 11, 2021. In March 2020, we received an extension of the maturity date of the loan until June 12, 2021. The loan bears interest at 16% per annum, of which at least 10% per annum is required to be paid in cash. The full remaining portion of all interest, if any, accrues and is to be paid-in-kind. The notes also require a premium, if paid before the maturity date, a $1,000,000 exit fee due at maturity, and compliance with affirmative, negative and financial covenants. The covenants related to this note were deferred until June 2020. Transaction costs were approximately $403,000 for a work fee payable over 10 months, $290,000 in legal fees and a $200,000 closing fee. The loan is secured by a security interest in substantially all of the assets of Rekor. The March 2019 Warrants are exercisable over a period of five years, at an exercise price of $0.74 per share, and are valued at $706,000. The warrants were exercisable commencing March 12, 2019 and expire on March 12, 2024. The 2019 Promissory Notes have an effective interest rate of 24.87%. On March 12, 2019, we retired the entire $500,000 balance due on a promissory note issued under a March 16, 2016 Subordinated Note and Warrant Purchase Agreement with Avon Road Partners, L.P. (“Avon Road”), an affiliate of Robert Berman, Rekor’s President and CEO and a member of our Board of Directors. Under this agreement, we also issued to Avon Road, warrants to purchase 121,247 shares of our common stock. These warrants were exercised on December 11, 2017 for proceeds of $125,000 and none of these warrants were outstanding as of December 31, 2019 and December 31, 2018. The promissory note to Avon Road was extinguished on March 12, 2019 from proceeds of the 2019 Promissory Notes. Amortized financing cost for the year ended December 31, 2019 was $1,101,000 and is included in interest expense on the consolidated statement of operations.

 

The 2019 Promissory Notes resulting in the following detailed transaction (dollars in thousands):

 

Financing:
Notes payable, includes exit fee	$21,000
Debt discount financing costs	(2,599)
Extinguishment of debt	(1,113)
Repayment of notes payable and interest expense, net of debt discount	(2,515)
Investment in OpenALPR Technology, includes $7,000,000 cash paid and $5,000,000 note assumed by seller	(12,000)
Issuance of warrants in conjunction with notes payable	706
Accounts Payable	360
Net cash proceeds from notes payable	$3,839

 

As of December 31, 2019, Rekor did not have any material commitments for capital expenditures.

 

Balance Sheet Arrangements, Contractual Obligations and Commitments

 

As of the date of this Annual Report on Form 10-K, we did not have any off-balance sheet arrangements that have had or are reasonably likely to have a material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital resources or capital expenditures.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations is based upon Rekor’s consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements requires the management of Rekor to make estimates and judgments that affect the reported amounts in our consolidated financial statements.

 

We believe the application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Rekor bases its estimates on historical experience and on various other assumptions that management of Rekor believes to be reasonable under the circumstances, the results of which form management’s basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, or if management made different judgments or utilized different estimates.

 

Rekor’s accounting policies are further described in its historical audited consolidated financial statements and the accompanying notes included elsewhere in this Form 10-K. Rekor has identified the following critical accounting policies:

 

Revenue Recognition

 

We generate our revenues substantially from two sources: (1) licensing and subscription revenues for software and related technology products and services and (2) professional services to clients. Some of our revenues are subject to seasonal variation, as more fully described in “Seasonality” below. In some cases, we have sold software on a long term license basis, that includes continuing opportunities to contract for maintenance and support at a relatively low periodic cost. In connection with such sales, we have deferred revenue recognition to spread it over the expected life of the contract and have established a contract liability associated with the contract. Our current sales model is oriented toward subscription sales.

 

Revenue is recognized upon transfer of control of promised products and services to our customers, in an amount that reflects the consideration we expect to receive in exchange for those products and services. If the consideration promised in the contract includes a variable amount, for example maintenance fees, we include an estimate of the amount we expect to receive in the total transaction price, if it is probable that a significant reversal of cumulative revenue recognized will not occur.

 

The revenues for technology products and services are from fees that provide customers with software licenses and related support. During the second quarter of 2019, we changed our method of selling in the Technology Segment from perpetual software licenses, with associated maintenance services, to service subscriptions of limited duration. These subscriptions give the customer a license to use the latest version of the software only during the term of the subscription. Revenue is generally recognized ratably over the contract term. This change has impacted our revenue in the short term. However, the amount of contract revenue received over the long term is not expected to be reduced. Our subscription services arrangements are non-cancelable and do not contain refund-type provisions.

 

The professional services contracts recognize revenue based on a time and materials or fixed fees basis. These revenues are recognized as the services are rendered for time and materials contracts, on a proportional performance basis for fixed price contracts, or ratably over the contact term for fixed price contracts with subscription services.

 

Accounts Receivable

 

Accounts receivable are customer obligations due under normal trade terms. We perform continuing credit evaluations of its clients’ financial condition, and we generally do not require collateral.

 

Management reviews accounts receivable to determine if any receivables will potentially be uncollectible. Factors considered in the determination include, among other factors, number of days an invoice is past due, client historical trends, available credit rating information, other financial data and the overall economic environment. Collection agencies may also be used if management so determines.

 

We record an allowance for doubtful accounts based on specifically identified amounts that are believed to be uncollectible. We also record as an additional allowance a certain percentage of aged accounts receivable, based on historical experience and our assessment of the general financial conditions affecting its customer base. If actual collection experience changes, revisions to the allowance may be required. After all reasonable attempts to collect an account receivable have failed, the amount of the receivable is written off against the allowance. The balance in the allowance for doubtful accounts was $48,000 and $24,000 as of December 31, 2019 and 2018, respectively and related to the Professional Services Segment.

 

 

Income Taxes

 

We use the liability method of accounting for income taxes as set forth in the authoritative guidance for accounting for income taxes. This method requires an asset and liability approach for the recognition of deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Management has evaluated the recoverability of the net deferred income tax assets and the level of the valuation allowance required with respect to such net deferred income tax assets. After considering all available facts, we fully reserved for our net deferred tax assets because management believes that it is more likely than not that their benefits will not be realized in future periods. We will continue to evaluate net deferred tax assets to determine whether any changes in circumstances could affect the realization of their future benefit. If it is determined in future periods that portions of the net deferred income tax assets satisfy the realization standard, the valuation allowance will be reduced accordingly.

 

The tax effects of uncertain tax positions are recognized in the consolidated financial statements only if the position is more likely than not to be sustained on audit, based on the technical merits of the position. For tax positions meeting the more likely than not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50% likelihood of being realized. It is our accounting policy to account for Accounting Standards Codification (“ASC”) 740-10-25-related penalties and interest as a component of the income tax provision in the consolidated statements of operations.

 

As of December 31, 2019, and 2018, our evaluation revealed no uncertain tax positions that would have a material impact on the financial statements. The 2016 through 2018 tax years remain subject to examination by the IRS, as of December 31, 2019. Our management does not believe that any reasonably possible changes will occur within the next twelve months that will have a material impact on the financial statements.

 

Going Concern and Management’s Plan

 

Beginning with the year ended December 31, 2018 and all annual and interim periods thereafter, we will assess going concern uncertainty in our consolidated financial statements to determine whether there is sufficient cash on hand and working capital, including available borrowings on loans and external bank lines of credit, to operate for a period of at least one year from the date the consolidated financial statements are issued or available to be issued, which is referred to as the “look-forward period”, as defined in GAAP. As part of this assessment, based on conditions that are known and reasonably knowable to us, we will consider various scenarios, forecasts, projections, estimates and will make certain key assumptions, including the timing and nature of projected cash expenditures or programs, our ability to delay or curtail expenditures or programs and our ability to raise additional capital, if necessary, among other factors. Based on this assessment, as necessary or applicable, we make certain assumptions around implementing curtailments or delays in the nature and timing of programs and expenditures to the extent we deem probable that those implementations can be achieved and that we have the proper authority to execute them within the look-forward period.

 

We have generated losses since inception in February 2017 and have relied on cash on hand, external bank lines of credit, the sale of notes, debt financing and sales of common stock to support cashflow from operations. We attribute losses to restructuring and merger costs, public company corporate overhead and non-capital expenditures consequent to our change in strategic direction. As of and for the year ended December 31, 2019, we had a net loss from continuing operations of $14,412,000 and a working capital deficit of $912,000. The cash, cash equivalents and restricted cash and cash equivalents position was decreased by $684,000 for the year ended December 31, 2019 due to the net loss from operations, offset by the net proceeds of $3,839,000 from senior secured notes, the net proceeds of $2,949,000 from the At-the-Market Agreement and the net proceeds from the secured borrowing arrangement of $5,463,000.

 

We believe that based on relevant conditions and events that are known and reasonably knowable, our current forecasts and projections, for one year from the date of the filing of the consolidated financial statements in this Annual Report on Form 10-K, indicate our ability to continue operations as a going concern for that one-year period. We are actively monitoring our operations, the cash on hand and working capital. Additionally, as of December 31, 2019, we believe we have access to raise up to $11,727,000 through the At Market Issuance Sales Agreement (the “Sales Agreement”). As of March 30, 2020, we have $9,655,000 available for sale under the Sales Agreement. We will continue to raise capital through the Sales Agreement to help fund operations. Should access to those funds be unavailable, we will need to seek out additional sources of funding. Furthermore, we have contingency plans to reduce or defer expenses and cash outlays should operations weaken in the look-forward period or additional financing, if needed, is not available.

Our ability to generate positive operating results and complete the execution of our business strategy will depend on (i) our ability to maintain timely collections from existing customers in, as well as continue the growth of, our Technology Segment, (ii) timely completion of the disposition of the businesses in our Professional Services Segment, (iii) the continued performance of our contractors, subcontractors and vendors, (iv) our ability to maintain and build good relationships with our lenders and financial intermediaries, (v) our ability to meet debt covenants or obtain waivers in case of noncompliance and (vi) the stability of the world economy and global financial markets. To the extent that events outside of our control have a significant negative impact on economic and/or market conditions, they could affect payments from customers, services and supplies from vendors, our ability to continue to secure new business, raise capital, complete the sale of our assets held for sale in a timely fashion and otherwise, depending on the severity of such impact, materially adversely affect our operating results.

 

New Accounting Pronouncements

 

See Item 8 of Part II, “Financial Statements and Supplementary Data — Note 1 — Business and Significant Accounting Policies” 

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this Item.

 

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTRY DATA

 

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Reports of Independent Registered Public Accounting Firms											27
Consolidated Balance Sheets as of December 31, 2019 and 2018											29
Consolidated Statements of Operations for the Years Ended December 31, 2019 and 2018											30
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2019 and 2018											31
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019 and 2018											32
Notes to Consolidated Financial Statements											33

 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Rekor Systems, Inc.

Opinion on the Financial Statements

We have audited, before the effects of the adjustments to classify certain amounts due to the held for sale classification of Global Technical Services, Inc. and Global Contract Professionals, Inc. (together “Global”), as described in Notes 1 and 3, the accompanying consolidated balance sheet of Rekor Systems, Inc. and its subsidiaries (previously known as Novume Solutions, Inc.) (the “Company”) as of December 31, 2018, and the related consolidated statements of operations, stockholders’ (deficit) equity, and cash flows for the year then ended (the 2018 consolidated financial statements before the effects of the adjustments to classify certain amounts due to the held for sale classification of Global as described in Notes 1 and 3 are not presented herein) (collectively referred to as the 2018 consolidated financial statements). In our opinion, the 2018 consolidated financial statements, before the effects of the adjustments to classify certain amounts due to the held for sale classification of Global, as described in Notes 1 and 3, present fairly, in all material respects, the financial position of Rekor Systems, Inc, as of December 31, 2018, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

We were not engaged to audit, review, or apply any procedures to the adjustments to classify certain amounts due to the held for sale classification of Global, as described in Notes 1 and 3 and, accordingly, we do not express an opinion or any other form of assurance about whether such adjustments are appropriate and have been properly applied. Those adjustments were audited by Friedman LLP. 

Basis for Opinion

These 2018 consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's 2018 consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 2018 consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the 2018 consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the 2018 consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion. 

/s/ BD & Company, Inc.

BD & Company, Inc.

 

We served as the Company’s auditor from 2017 through 2018.

Owings Mills, Maryland

April 11, 2019

 

REKOR SYSTEMS, INC. AND SUBSIDERIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

	December 31, 2019	December 31, 2018
ASSETS
Current Assets
Cash and cash equivalents	$1,180	$2,069
Restricted cash and cash equivalents	461	609
Accounts receivable, net	4,831	2,976
Inventory	302	73
Other current assets, net	230	167
Current assets held for sale	3,226	2,636
Total current assets	10,230	8,530
Property and equipment, net	483	462
Right-of-use lease assets, net	782	-
Goodwill	6,336	1,402
Intangible assets, net	8,244	3,456
Deposits and other long-term assets	11	51
Long-term assets held for sale	2,906	4,154
Total assets	$28,992	$18,055
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current Liabilities
Accounts payable and accrued expenses	$4,971	$3,437
Short-term borrowings	1,894	566
Notes payable, current portion	-	2,469
Lease liability, short-term	302	-
Contract liabilities	749	207
Current liabilities held for sale	2,416	1,895
Total current liabilities	10,332	8,574
Notes payable	20,409	875
Lease liability, long-term	667	-
Deferred rent	-	8
Contract liabilities, long-term	775	-
Deferred tax liability	10	-
Long term liabilities held for sale	30	90
Total liabilities	32,223	9,547
Series A Cumulative Convertible Redeemable Preferred stock, $0.0001 par value, 505,000 shares authorized and 502,327 shares issued and outstanding as of December 31, 2019 and December 31, 2018, respectively	5,804	5,052
Commitments and Contingencies
Stockholders' (Deficit) Equity
Common stock, $0.0001 par value, 30,000,000 shares authorized, 21,595,653 and 18,767,619 shares issued and outstanding as of December 31, 2019 and December 31, 2018, respectively	2	2
Preferred stock, $0.0001 par value, 2,000,000 authorized, 505,000 shares designated as Series A and 240,861 shares designated as Series B as of December 31, 2019 and December 31, 2018, respectively	-	-
Series B Cumulative Convertible Preferred stock, $0.0001 par value, 240,861 shares authorized, issued and outstanding as of December 31, 2019 and December 31, 2018, respectively	-	-
Additional paid-in capital	19,371	15,518
Accumulated deficit	(28,408)	(12,064)
Total stockholders’ (deficit) equity	(9,035)	3,456
Total liabilities and stockholders’ (deficit) equity	$28,992	$18,055

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

REKOR SYSTEMS, INC. AND SUBSIDERIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except share data)

 

	Year ended December 31,
	2019	2018
Revenue:
Technology	$5,469	$3,522
Professional Services	13,851	16,532
Total revenue	19,320	20,054
Cost of revenue:
Technology	1,652	1,642
Professional Services	7,406	8,336
Total cost of revenue	9,058	9,978
Gross profit:
Technology	3,817	1,880
Professional Services	6,445	8,196
Gross profit	10,262	10,076
Operating expenses:
General and administrative expenses	14,151	13,310
Selling and marketing expenses	2,222	1,758
Research and development expenses	1,429	131
Impairment of intangibles	1,549	-
Operating expenses	19,351	15,199
Loss from operations	(9,089)	(5,123)
Other income (expense):
Loss on extinguishment of debt	(1,158)	-
Interest expense	(4,098)	(492)
Other expense	(20)	(65)
Total other expense	(5,276)	(557)
Loss before income taxes	(14,365)	(5,680)
Income tax provision	(47)	(29)
Net loss from continuing operations	$(14,412)	$(5,709)
Income (loss) from operations held for sale (including goodwill impairment of $1,022,000 in 2019)	(1,472)	6
Income tax provision from operations held for sale	-	-
Net income (loss) from operations held for sale	(1,472)	6
Net loss	$(15,884)	$(5,703)
Loss per common share from continuing operations - basic and diluted	(0.78)	(0.44)
Income (loss) per common share from operations held for sale - basic and diluted	(0.07)	-
Loss per common share - basic and diluted	$(0.85)	$(0.44)
Weighted average shares outstanding
Basic and diluted	20,033,023	15,409,014

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

REKOR SYSTEMS, INC. AND SUBSIDERIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 (Dollars in thousands, except share data)

 

 

	Shares of Common Stock	Common Stock	Shares of Series B Preferred Stock	Series B Preferred Stock	Additional Paid-In Capital	Accumulated Deficit	Total Stockholders’ Equity (Deficit)
Balance as of December 31, 2017	14,463,364	$1	240,861	$-	$12,343	$(5,834)	$6,510
Cumulative effect adjustment of adopting ASU 2014-09	-	-	-	-	-	(67)	(67)
Balance as of January 1, 2018	14,463,364	1	240,861	-	12,343	(5,901)	6,443
Stock-based compensation	-	-	-	-	465	-	465
Issuance of warrants	-	-	-	-	123	-	123
Issues of common stock, net of costs	4,125,000	1	-	-	2,796	-	2,797
Issuance of common stock for the extinguishment of warrants	96,924	-	-	-	134	-	134
Net common stock issued in Secure Education Consultants acquisition	33,333	-	-	-	163	-	163
Issuance related to note payable	35,000	-	-	-	126	-	126
Issuance upon exercise of stock options	13,998	-	-	-	23	-	23
Preferred stock dividends	-	-	-	-	-	(460)	(460)
Accretion of Series A preferred stock	-	-	-	-	(655)	-	(655)
Net loss	-	-	-	-	-	(5,703)	(5,703)
Balance as of December 31, 2018	18,767,619	2	240,861	-	15,518	(12,064)	3,456
Stock-based compensation	-	-	-	-	446	-	446
Issuance of warrants in conjunction with notes payable	-	-	-	-	706	-	706
Exercise of cashless warrants in exchange for common stock	815,290	-	-	-	-	-	-
Exercise of warrants in exchange for common stock	116,376	-	-	-	103	-	103
Common stock issued in OpenALPR acquisition	600,000	-	-	-	397	-	397
Issuance of common stock pursuant to at the market offering, net	1,292,730	-	-	-	2,949	-	2,949
Exercise of warrants related to series A preferred stock	3,638	-	-	-	4	-	4
Preferred stock dividends	-	-	-	-	-	(460)	(460)
Accretion of Series A preferred stock	-	-	-	-	(752)	-	(752)
Net loss	-	-	-	-	-	(15,884)	(15,884)
Balance as of December 31, 2019	21,595,653	$2	240,861	$-	$19,371	$(28,408)	$(9,035)