Rekor Systems, Inc. - Quarter Report: 2022 June (Form 10-Q)

SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (the “Quarterly Report”) contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve substantial risks and uncertainties, including particularly 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. These statements involve uncertainties, such as known and unknown risks, and are dependent on other important factors that may cause our actual results, performance, or achievements to be materially different from the future results, performance or achievements we express or imply. 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 Quarterly Report and are subject to a number of risks, uncertainties and assumptions described under the sections in our Annual Report on Form 10-K for the year ended December 31, 2021 entitled “Risk Factors” and elsewhere in this Quarterly Report. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made in this Form 10-Q and in other documents we file from time to time with the SEC that disclose risks and uncertainties that may affect our business. The forward-looking statements in this Form 10-Q do not reflect the potential impact of any divestiture, merger, acquisition, or other business combination that had not been completed as of the date of this filing. 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 FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

REKOR SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share amounts)

(Unaudited)

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

REKOR SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except share amounts)

(Unaudited)

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

REKOR SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY 

(Dollars in thousands, except share amounts)

(Unaudited)

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

REKOR SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

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

REKOR SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – GENERAL, BASIS OF PRESENTATION, AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

These unaudited condensed consolidated interim financial statements of Rekor Systems, Inc. and its subsidiaries (collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements. Accordingly, they do not contain all information and notes required by U.S. GAAP for annual financial statements. In the opinion of management, these unaudited condensed consolidated interim financial statements reflect all adjustments, which include normal recurring adjustments, necessary for a fair statement of the Company’s unaudited condensed consolidated financial position as of June 30, 2022, the unaudited condensed consolidated results of operations, unaudited condensed consolidated statements of shareholders’ equity and unaudited condensed consolidated statements of cash flows for the three and six month periods ended June 30, 2022 and 2021.

The financial data and other information disclosed in these notes are unaudited. The results for the three and six months ended June 30, 2022, are not necessarily indicative of the results to be expected for the year ending December 31, 2022.

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. The year-end condensed balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP.

Dollar amounts, except per share data, in the notes to these unaudited condensed consolidated financial statements are rounded to the closest $1,000.

Rekor is a global leader in intelligent infrastructure focused on addressing the world’s most critical challenges across transportation management, public safety, and key commercial markets. With a real-time intelligence platform driven by deep access to data, AI-powered software, and smart optical devices at-the-edge, the Company combines its industry expertise and advanced proprietary technologies to deliver insights that increase roadway safety, efficiency, and sustainability while enabling safer, smarter, and more connected cities and communities.

On June 17, 2022, the Company completed its acquisition of Southern Traffic Services ("STS") by acquiring 100% of the issued and outstanding capital stock of STS. Since the acquisition of STS occurred on June 17, 2022, the results of operations for STS from the date of acquisition have been included in the Company’s unaudited condensed consolidated statement of operations for the three and six months ended June 30, 2022.

On August 18, 2021, the Company completed its acquisition of Waycare Technologies Ltd. (“Waycare”) by acquiring 100% of the issued and outstanding capital stock of Waycare, which is now a wholly-owned subsidiary of the Company.

Use of Estimates

The preparation of the unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires the extensive use of management’s estimates. Management uses estimates and assumptions in preparing consolidated financial statements. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and reported revenues and expenses. On an ongoing basis, the Company evaluates its estimates, including those related to the collectability of accounts receivable, the fair value of intangible assets, the fair value of debt and equity instruments, income taxes and determination of standalone selling prices in contracts with customers that contain multiple performance obligations. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results  may differ from those estimates under different assumptions or conditions.

Reclassifications

Certain amounts in the prior year's financial statements have been reclassified to conform to the current year's presentation. Beginning in the third quarter of 2021, depreciation and amortization is presented separately from cost of revenue, general and administrative expenses, selling and marketing expenses and research and development expenses on the unaudited condensed consolidated statements of operations, whereas in prior periods these amounts were included together with the aforementioned financial statement captions. Additionally, as of September 30, 2021, the Company began to present other current liabilities separately from accounts payable and accrued expenses. Other current liabilities primarily consist of payroll and payroll related accounts. Amounts for the three and six month periods ending June 30, 2021 and the period ended December 31, 2021, have been reclassified to conform to the current year’s presentation.

Liquidity

For all annual and interim periods, management will assess going concern uncertainty in the Company’s unaudited condensed consolidated financial statements to determine whether there is sufficient cash on hand, capital raises and working capital, to operate for a period of at least one year from the date the unaudited condensed consolidated financial statements are issued, which is referred to as the “look-forward period”, as defined in U.S. GAAP. As part of this assessment, based on conditions that are known and reasonably knowable to management, management will consider various scenarios, forecasts, projections and estimates and will make certain key assumptions. These assumptions include, among other factors, its ability to raise additional capital, the expected timing and nature of the Company’s programs and projected cash expenditures and its ability to delay or curtail these programs or expenditures to the extent management has the proper authority to do so and considers it probable that those implementations can be achieved within the look-forward period.

The Company has generated losses since its inception and has relied on cash on hand, external bank lines of credit, the sale of a note, proceeds from the sale of common stock, proceeds from the private sale of the Company’s non-core subsidiaries, proceeds from note receivables, debt financings and a public offering of its common stock to support cash flow from operations. The Company attributes losses to non-capital expenditures related to the scaling of existing products, development of new products and service offerings and marketing efforts associated with these products and services. As of and for the six months ended June 30, 2022, the Company had working capital from continuing operations of $7,285,000 and a loss from continuing operations of $28,203,000.

The Company’s cash decreased by $11,747,000 for the six months ended June 30, 2022 primarily due to the loss from continuing operations of $28,203,000. The decrease in cash was offset by the net proceeds of $20,408,000 from the 2022 Sales Agreement (see NOTE 10 - STOCKHOLDERS’ EQUITY for details on the 2022 Sales Agreement). As of June 30, 2022, the Company had $28,788,000 of gross funds available under the 2022 Sales Agreement. 

Management believes that based on relevant conditions and events that are known and reasonably knowable, its current forecasts and projections for one year from the date of the filing of the unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q, indicate the Company’s ability to continue operations as a going concern for at least that one-year period. The Company is actively monitoring its operations, the cash on hand and working capital. Should access to funds be unavailable, the Company will need to seek out additional sources of funding. If additional financing is not available, the Company also has contingency plans to reduce or defer expenses and cash outlays should operations weaken in the look-forward period.

Goodwill

The excess purchase consideration over the fair value of acquired assets and liabilities is recorded as goodwill. The Company will assess goodwill for impairment annually, or more often if events or changes in circumstances indicate that it might be impaired, by comparing its carrying value to the reporting unit’s fair value. The Company performs its annual impairment assessment on October 1, or more frequently, when events or circumstances indicate impairment may have occurred.

During the first half of 2022, the Company experienced a significant decline in its market capitalization, which management deemed a triggering event related to goodwill. As a result, the Company performed an interim impairment assessment as of June 30, 2022 and determined that as of the reporting date the Company did not have an impairment of goodwill. 

The Company utilized a weighted combination of the income-based approach and market-based approach to determine the fair value of the reporting unit. Key assumptions used in the income-based approach included forecasts of revenue, operating income, depreciation and amortization expense, capital expenditures and future working capital requirements, terminal growth rates, and discount rates based upon the reporting unit's weighted-average cost of capital adjusted for the risk associated with the operations at the time of the assessment. The income-based approach largely relied on inputs that were not observable to active markets, which would be deemed “Level 3” fair value measurements, as defined in the Fair Value Measurements section above. Key assumptions used in the market-based approach included the selection of appropriate peer group companies. Changes in the estimates and assumptions used to estimate fair value could materially affect the determination of fair value and the impairment test result.

Fair Value of Financial Instruments

The carrying amounts reported in the unaudited condensed consolidated balance sheets for cash and cash equivalents, restricted cash and cash equivalents, short-term investments, accounts receivable and accounts payable approximate fair value as of June 30, 2022 and December 31, 2021, because of the relatively short-term maturity of these financial instruments. The carrying amount reported for long-term debt and long-term receivables approximates fair value as of June 30, 2022 and December 31, 2021, given management’s evaluation of the instrument’s current rate compared to market rates of interest and other factors.

The determination of fair value is based upon the fair value framework established by ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”). Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. ASC 820 also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.

There were no changes in levels during the six months ended June 30, 2022.

Revenue Recognition

The Company derives its revenues primarily from the sale of software, hardware and related services, including customer support and implementation services and management services in connection with our traffic safety solutions. Revenue is recognized upon transfer of control of promised products and services to the Company’s customers, in an amount that reflects the consideration the Company expects to receive in exchange for those products and services.

To determine revenue recognition for arrangements that the Company determines are within the scope of ASC 606, the Company performs the following five steps:

The following table presents a summary of revenue (dollars in thousands):

Revenues

Recurring revenue

Recurring revenue includes the Company’s SaaS revenue, subscription revenue, eCommerce revenue and customer support revenue. The Company generates recurring revenue from long-term contracts with customers that provide periodic payments and short-term contracts that are automatically invoiced on a monthly basis. The Company’s recurring revenue is generated by a combination of direct sales, partner-assisted sales, and eCommerce sales.

Recurring revenues are generated through the Company’s SaaS model, where the Company provides customers with the right to access the Company’s software solutions for a fee. These services are made available to the customer continuously throughout the contractual period. However, the extent to which the customer uses the services may vary at the customer’s discretion. The Company's contracts with customers are generally for a term of one to five years. The payment for SaaS solutions may be received either at the inception of the arrangement or over the term of the arrangement. These SaaS solutions are considered to have a single performance obligation where the customer simultaneously receives and consumes the benefit, and as such, we recognize revenue for these arrangements ratably over the term of the contractual agreement.

The Company also currently receives recurring revenues under contracts entered into using a subscription model for bundled hardware and software over a period. Payments for these subscriptions are received periodically over the term of the agreement and revenue is recognized ratably over the term of the agreement. In addition, some of our subscription revenue includes providing access through a web server to the Company’s software solutions, a self-managed database, and a cross-platform application programming interface. The subscription arrangements with these customers typically do not provide the customer with the right to take possession of the Company’s software at any time. Instead, customers are granted access to the Company’s solutions over the contractual period. The Company’s subscription services arrangements are non-cancelable and do not contain refund-type provisions. Accordingly, any fixed consideration related to the arrangement is generally recognized as recurring revenue on a straight-line basis over the contract term beginning on the date access to the Company’s software is provided.

eCommerce revenue is defined by the Company as revenue obtained through direct sales on the Company’s eCommerce platform. The Company’s eCommerce revenue generally includes subscriptions to the Company’s vehicle recognition software which can be purchased online and activated through a digital key. The Company's contracts with customers are generally for a term of one month with automatic renewal each month. The Company invoices and receives fees from its customers monthly.

Customer support revenue is associated with perpetual licenses and long-term subscription arrangements and consists primarily of technical support and product updates. The Company’s customer support team is ready to provide these maintenance services, as needed, to the customer during the contract term. The customer benefits evenly throughout the contract period from the guarantee that the customer support resources and personnel will be available to them. As customer support is not critical to the customers' ability to derive benefit from their right to use the Company’s software, customer support is considered a distinct performance obligation when sold together with a long-term license for the software. Customer support for perpetual and term licenses is renewable, generally on an annual basis, at the option of the customer. Customer support for subscription licenses is renewable concurrently with such licenses for the same duration of time. Revenue for customer support is recognized ratably over the contract period based on the start and end dates of the customer support obligation, in line with how the Company believes services are provided.

Product and service revenue

Product and service revenue is defined as the Company’s contactless compliance revenue, implementation revenue, perpetual license sales and hardware sales.

Contactless compliance revenues reflect arrangements to provide traffic safety systems to several jurisdictions in North America. These systems include hardware that identifies red light and school safety zone traffic violations and software that captures and records forensic images and analyzes the images to provide data and support citation management services. In the first quarter of 2021, the Company launched a new service offering for the State of Oklahoma to support its Uninsured Vehicle Enforcement Diversion (“UVED”) Program. Rekor provides hardware, software and services to identify uninsured motor vehicles, notify owners of non-compliance and assist them in obtaining the required insurance as an alternative to traditional enforcement methods. Revenue is recognized monthly based on the number of citations collected by the relevant jurisdiction.

Implementation revenue is recognized when the Company provides pilot programs to customers. Pilot programs may involve a one-time fee for a defined period in which the customer can use the Company’s software in connection with a previously installed camera network or connected vehicle data. At the end of the pilot program, the customer can convert from a pilot program to a subscription model which has a typical term between one and five years. The Company’s pilot program revenue is recognized at various stages of completion.

In addition to the recurring software sales, the Company recognizes revenue related to the sale of perpetual software licenses. The Company sells perpetual licenses that provide customers the right to use software for an indefinite period in exchange for a one-time license fee, which is generally paid at contract inception. The Company’s perpetual licenses provide a right to use intellectual property (“IP”) that is functional in nature and have significant stand-alone functionality. Accordingly, for perpetual licenses of functional IP, revenue is recognized at the point-in-time when the customer has access to the software, which normally occurs once software activation keys have been made available to the customer.

The Company generates revenue through the sale of hardware through its partner program distribution channels and direct sales. The Company satisfies its performance obligation and invoices end-user customers upon transfer of control of the hardware to the customers. The Company offers hardware installment to customers which ranges from one to six months. The revenue related to the installation component is recognized at various stages of completion

Revenue by Customer Type

The following table presents a summary of revenue by customer type (dollars in thousands):

Performance obligations

The Company contracts with customers in a variety of ways, including contracts that obligate the Company to provide services over time. Some contracts include performance obligations for several distinct services. For those contracts that have multiple distinct performance obligations, the Company allocates the total transaction price to each performance obligation based on its relative standalone selling price, which is determined based on the Company’s overall pricing objectives, taking into consideration market conditions and other factors. This may result in a deferral or acceleration of revenue recognized relative to cash received for each distinct performance obligation. When the Company recognizes revenue due to the sale of hardware or perpetual software licenses, the impact on the overall unsatisfied performance obligations is relatively small as the Company satisfies most of its performance obligations at the point in time that the control of the hardware or software has transferred to the customer.

Where performance obligations for a contract with a customer are not yet satisfied or have only been partially satisfied as of a particular date, the unsatisfied portion is to be recognized as revenue in the future. As of June 30, 2022, the Company had approximately $31,940,000 of remaining performance obligations not yet satisfied or partially satisfied. The Company expects to recognize approximately 57% of this amount as revenue over the succeeding twelve months, and the remainder is expected to be recognized over the next two to four years thereafter.

Unbilled accounts receivable

The timing of revenue recognition, billings and cash collections result in billed accounts receivable, unbilled accounts receivables, and contract liabilities on the unaudited condensed consolidated balance sheets. Billed and unbilled accounts receivable are presented as part of accounts receivable, net, on the unaudited condensed consolidated balance sheets. When billing occurs after services have been provided, such unbilled amounts will generally be billed and collected within 60 to 120 days, but typically no longer than over the next twelve months. Unbilled accounts receivables of $551,000 and $415,000 were included in accounts receivable, net, in the unaudited condensed consolidated balance sheets as of June 30, 2022 and December 31, 2021, respectively.

Contract liabilities

When the Company advance bills clients prior to providing services, generally such amounts will be earned and recognized in revenue within the next six months to five years, depending on the subscription or licensing period. These assets and liabilities are reported on the unaudited condensed consolidated balance sheets on a contract-by-contract basis at the end of each reporting period. Changes in the contract asset and liability balances during the six months ended June 30, 2022 were not materially impacted by any other factors. Contract liabilities as of June 30, 2022 and December 31, 2021 were $2,887,000 and $3,272,000, respectively. During the six months ended June 30, 2022, $1,538,000 of the contract liabilities balance as of December 31, 2021 was recognized as revenue.

The services due for contract liabilities described above are shown below as of June 30, 2022 (dollars in thousands):

Costs to Obtain and Fulfill a Contract

Practical Expedients Election ‒ Costs to Obtain and Fulfill a Contract ‒ The Company’s incremental costs to obtain a contract consist of sales commissions. When the amortization period would be one year or less, the Company elects to use the practical expedient election to expense the costs to obtain a contract as they are incurred.

Cash and Cash Equivalents, and Restricted Cash and Cash Equivalents

The Company considers all highly liquid debt instruments, including U.S. Treasury Bills purchased with a maturity of three months or less, to be cash equivalents.

Cash subject to contractual restrictions and not readily available for use is classified as restricted cash and cash equivalents. The Company’s restricted cash balances are primarily made up of cash collected on behalf of certain client jurisdictions. Restricted cash and cash equivalents for these client jurisdictions as of June 30, 2022 and December 31, 2021 were $865,000 and $804,000, respectively, and correspond to equal amounts of related accounts payable and are presented as part of accounts payable and accrued expenses in the accompanying unaudited condensed consolidated balance sheets.

Concentrations of Credit Risk

The Company deposits its temporary cash investments with highly rated financial institutions that are located in the United States and Israel. The United States deposits are federally insured up to $250,000 per account. As of June 30, 2022 and December 31, 2021, the Company had deposits from continuing operations totaling $14,853,000 and $26,600,000, respectively, in five U.S. financial institutions and one Israeli financial institution.

The Company has a market concentration of revenue and accounts receivable from continuing operations related to its customer base.

Customer A accounted for less than 10% and 28% of the Company’s unaudited condensed consolidated revenues for the three months ended June 30, 2022 and 2021, respectively. Customer A accounted for less than 10% and 16% of the Company’s unaudited condensed consolidated revenues for the six months ended June 30, 2022 and 2021, respectively.

No other single customer accounted for more than 10% of the Company’s unaudited condensed consolidated revenues for the three and six months ended June 30, 2022 and 2021.

As of June 30, 2022, no single customer accounted for more than 10% of the unaudited condensed consolidated accounts receivable balance. As of December 31, 2021, Company B accounted for 13% of the unaudited condensed consolidated accounts receivable balance.

No other single customer accounted for more than 10% of the Company’s unaudited condensed consolidated accounts receivable balance as of  December 31, 2021.

Other Current Liabilities

A summary of other current liabilities is as follows (in thousands):

Significant Accounting Policies

Additional significant accounting policies of the Company are also described in Note 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

New Accounting Pronouncements Effective in Future Periods

In June 2016, the FASB issued Accounting Standards Update ("ASU") 2016-13 Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss methodology, which will result in more timely recognition of credit losses. ASU 2016-13 is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2022. Upon adoption of the new standard, the Company will begin recognizing an allowance for credit losses based on the estimated lifetime expected credit loss related to the Company’s financial assets. Due to the nature and extent of the Company’s financial instruments (primarily accounts receivable and a note receivable) currently within the scope of ASU 2016-13 and based on the Company’s analysis of ASU 2016-13 and the historical, current and expected credit quality of the Company’s customers, the Company does not expect ASU 2016-13 to have a material impact on its unaudited condensed consolidated statements of operations and balance sheets.

The Company does not believe that any recently issued, but not yet effective, accounting standards, other than the standards discussed above, could have a material effect on the accompanying unaudited condensed consolidated financial statements. As new accounting pronouncements are issued, the Company will adopt those that are applicable under the circumstances.

NOTE 2 – ACQUISITIONS

STS Acquisition

On June 17, 2022, the Company completed its acquisition of Southern Traffic Services ("STS") by acquiring 100% of the issued and outstanding capital stock of STS. The acquisition included total consideration of $14,500,000 including; cash consideration of $6,500,000, $2,000,000 related to an earnout based on the achievement of certain performance metrics ("STS Earnout") and $2,000,000 contingent on the closing of a future contract ("STS Contingent Consideration"),798,666 shares of the Company’s common stock, valued at $2,000,000, and a $2,000,000 note. As a result of the transaction, STS has become a wholly-owned subsidiary of the Company. 

The STS Contingent Consideration will be paid in cash if on or prior to October 30, 2024, the Company enters into a multi-year extension of the Georgia Department of Transportation Contract on substantially similar terms and conditions. The STS Contingent Consideration shall be payable within 30 days of the effectiveness of the extension of the Georgia Department of Transportation Contract. STS Contingent Consideration is presented as part of other non-current liabilities on the unaudited condensed consolidated balance sheets.

The Company shall pay the STS Earnout payment based on the STS EBITDA for the twelve month period ended December 31, 2022. The STS Earnout payment shall in no event exceed $2,000,000. Any payment related to the STS Earnout will be paid within 60 days of December, 31, 2022. The STS Earnout is presented as part of other current liabilities on the unaudited condensed consolidated balance sheets. 

The purchase price for the acquisition of  STS has been preliminarily allocated to the assets acquired and liabilities assumed based on fair values as of the acquisition date. The table below shows the breakdown related to the preliminary purchase price allocation for the acquisition (dollars in thousands):

Waycare Acquisition

On August 18, 2021, the Company completed its acquisition of Waycare by acquiring 100% of the issued and outstanding capital stock of Waycare. The aggregate purchase price for the shares of Waycare was $60,171,000. The purchase price was comprised of $39,884,000 of cash and 2,784,474 shares of the Company’s common stock, valued at $20,287,000. As a result of the transaction, Waycare has become a wholly-owned subsidiary of the Company.

The purchase price for the acquisition of Waycare has been allocated to the assets acquired and liabilities assumed based on fair values as of the acquisition date. The table below shows the breakdown related to the purchase price allocation for the acquisition (dollars in thousands):

The technology acquired by the Company as part of the acquisition of Waycare has an estimated useful life of seven years and is presented as part of intangible assets, net on the unaudited condensed consolidated balance sheets.

Operations of Combined Entities

The following unaudited pro forma combined financial information gives effect to the acquisition of Waycare and STS as if it was consummated as of January 1, 2021. This unaudited pro forma financial information is presented for information purposes only and is not intended to present actual results that would have been attained had the acquisition been completed as of January 1, 2021 (the beginning of the earliest period presented) or to project potential operating results as of any future date or for any future periods.

NOTE 3 – INVESTMENTS

Investments in Unconsolidated Companies

In February 2017, the Company contributed substantially all of the assets and certain liabilities related to its vehicle services business to Global Public Safety (the “GPS Closing”). After the GPS Closing, the Company continues to own 19.9% of the units of Global Public Safety. This equity investment does not have a readily determinable fair value and the Company reports this investment at cost, less impairment. As of June 30, 2022 and December 31, 2021 the investment in Global Public Safety had a value of $0.

In June 2020, the Company announced a joint venture in which the Company would have a 50 percent equity interest in Roker Inc. (“Roker”). In the third quarter of 2020 and the first quarter of 2021, the Company contributed $75,000 for its 50% equity interest for a total investment of $150,000. This investment is accounted for under the equity method. During the three and six months ended June 30, 2021, the Company recognized a loss in its unconsolidated investments of $74,000 and $150,000, respectively. As of June 30, 2022 and December 31, 2021 the investment in Roker had a value of $0.

There have been no distributions or earnings received from either investment. 

Roker SAFE

In April 2021, in exchange for $1,000,000 the Company entered into a SAFE with Roker (the “Roker SAFE”). In  October 2021 and during the 2022 fiscal year, the Company invested an additional $250,000 and $450,000, respectively, in the Roker SAFE. The Roker SAFE allows the Company to participate in future equity financings of Roker, through a share-settled redemption of the amount invested (such notional being the “invested amount”). Alternatively, upon the occurrence of a change of control or an initial public offering (other than a qualified financing), the Company has the option to receive either (i) cash payment equal to the invested amount under the SAFE, or (ii) a number of shares of common stock equal to the invested amount divided by the liquidity price set forth in the Roker SAFE. The Company’s investment in the Roker SAFE is recorded on the cost method of accounting and included under SAFE investment on the unaudited condensed consolidated balance sheets and is shown as long-term, as it is not readily convertible into cash. If the Company identifies factors that may be indicative of impairment, the Company will review the investment for impairment. No factors indicative of impairment were identified during the three months ended June 30, 2022. 

NOTE 4 – SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Supplemental disclosures of cash flow information for the six months ended June 30, 2022 and 2021 were as follows (dollars in thousands):

NOTE 5 – OPERATING LEASES

The Company has operating leases for office facilities in various locations throughout the United States and Israel. The Company’s leases have remaining terms of one to ten years. Certain of the Company’s leases include options to extend the term of the lease or to terminate the lease prior to the end of the initial term. When it is reasonably certain that the Company will exercise the option, the Company will include the impact of the option in the lease term for purposes of determining total future lease payments.

Operating lease expense from continuing operations for the three months ended June 30, 2022 and 2021 was $504,000 and $84,000, and for the six months ended June 30, 2022 and 2021 was $915,000 and $173,000, respectively, and is presented as part of general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations.

Cash paid for amounts included in the measurement of operating lease liabilities from continuing operations was $52,000 and $171,000 for the six months ended June 30, 2022 and 2021, respectively.

In the first quarter of 2022, the Company entered into a lease agreement for its Israeli operations. As part of the lease agreement, there were $919,000 in lease incentives provided to the Company which will be used to update the structure of the leased space and furnish the leased space.

Supplemental balance sheet information related to leases as of  June 30, 2022 was as follows (dollars in thousands):

NOTE 6 – INTANGIBLE ASSETS AND GOODWILL

STS Acquisition

The purchase price has been preliminarily allocated to the assets acquired and liabilities assumed based on fair values as of the acquisition date. Since the acquisition of STS occurred on June 17, 2022, the results of operations for STS from the date of acquisition have been included in the Company’s consolidated statement of operations for the three and six months ended June 30, 2022. As part of the Company's preliminary purchase price allocation for the acquisition, the Company recognized $4,999,000 in goodwill and $1,793,000 in customer relationships. 

Intangible Assets Subject to Amortization

The following summarizes the change in intangible assets from December 31, 2021 to June 30, 2022 (dollars in thousands):

The following provides a breakdown of identifiable intangible assets as of June 30, 2022 (dollars in thousands):

These intangible assets are amortized on a straight-line basis over their estimated useful life. Amortization expense attributable to continuing operations for the three months ended  June 30, 2022 and 2021 was $991,000 and $409,000, respectively, and for the six months ended June 30, 2022 and 2021 was $1,992,000 and $818,000, respectively and is presented as part of depreciation and amortization in the accompanying unaudited condensed consolidated statements of operations.

As of June 30, 2022, the estimated impact on continuing operations from annual amortization from intangible assets for each of the next five fiscal years and thereafter is as follows (dollars in thousands):

NOTE 7 – DEBT

STS Notes

Firestorm Notes

On January 25, 2017, pursuant to the terms of the Company’s acquisition of certain now discontinued subsidiaries (collectively referred to herein as “Firestorm”), the Company issued $1,000,000 in the aggregate form of four unsecured, subordinated promissory notes with interest payable over five years. The principal amount of one of the notes payable is $500,000 payable at an interest rate of 2.0% and the remaining three notes are evenly divided over the remaining $500,000 and payable at an interest rate of 7.0%. The notes mature on January 25, 2022. The aggregate balance of these notes payable was $1,000,000 and $998,000, net of unamortized interest, as of June 30, 2022 and December 31, 2021, respectively, to reflect the amortized fair value of the notes issued due to the difference in interest rates of $0 and $2,000, respectively. The Company is not paying current interest on these notes and did not pay the principal due in January 2022 as the Company has requested rescission in connection with the Firestorm acquisition and is currently in litigation with the sellers (see NOTE 9- COMMITMENTS AND CONTINGENCIES).

Interest Expense

The following table presents the interest expense related to the contractual interest and the amortization of debt issuance costs for the Company’s debt arrangements (dollars in thousands):

Schedule of Principal Amounts Due of Debt

The principal amounts due for long-term notes payable are shown below as of June 30, 2022 (dollars in thousands):

NOTE 8 – INCOME TAXES

The Company established a valuation allowance against deferred tax assets during 2017 and has continued to maintain a full valuation allowance, outside of the deferred tax liability related to the indefinite lived intangible, through  June 30, 2022.

The Company files income tax returns in the United States and in various states. No U.S. Federal, state or foreign income tax audits were in process as of June 30, 2022.

The Company 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, the Company fully reserved for its net deferred tax assets, outside of the deferred tax liability related to the indefinite lived intangible, because the Company believes that it is not more likely than not that their benefits will be realized in future periods. The Company will continue to evaluate its 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 Company’s net deferred income tax assets satisfy the realization standard, the valuation allowance will be reduced accordingly.

For the three and six months ended June 30, 2022 and 2021, the Company did not record any interest or penalties related to unrecognized tax benefits. It is the Company’s policy to record interest and penalties related to unrecognized tax benefits as part of income tax expense. The 2018 through 2020 tax years remain subject to examination by the Internal Revenue Service.

NOTE 9 – COMMITMENTS AND CONTINGENCIES

On  August 19, 2019, the Company filed suit in the United States District Court for the Southern District of New York against three former executives of the Company who were founders of Firestorm (the “Firestorm Principals”)—Rekor Systems, Inc. v. Suzanne Loughlin, et al., Case no. 1:19-cv-07767-VEC. On  January 30, 2020, the Company filed a Second Amended Complaint (the “Complaint’) alleging that the Firestorm Principals fraudulently induced the execution of the Membership Interest Purchase Agreement wherein Firestorm was acquired by the Company. The Complaint also alleged claims for breach of fiduciary duty, violations of the Computer Fraud and Abuse Act (“CFAA”), conversion, and trespass to chattels arising from the Firestorm Principals’ alleged deletion of company email records. The Complaint requests equitable rescission of the acquisition transaction and monetary damages.

The Firestorm Principals answered together with counterclaims on  February 28, 2020. Thereafter, on  March 30, the Company moved to dismiss the counterclaims against certain directors and officers named as counterclaim-defendants, resulting in the Firestorm Principals voluntarily dismissing the counterclaims against those parties. Thereafter the Company filed its response and affirmative defenses to the Counterclaims on  April 22, 2020. On  April 27, 2020, the Firestorm Principals filed a Motion for Partial Judgment on the Pleadings, which the Company opposed. In addition, on  December 9, 2019, the Firestorm Principals filed a motion for an interim award of expenses and attorney’s fees. With respect to the Firestorm Principals’ motion for judgment on the pleadings, the Court’s  November 23, 2020 order denied that motion in its entirety. In that same order, the Court granted in part and denied in part the Firestorm Principals’ fee advance motion.

In  April 2021, the Firestorm Principals filed a notice of motion for partial summary judgment, seeking summary judgment on several of the Company’s claims and the Firestorm Principals’ counterclaims, which the Company, along with counterclaim-defendants Firestorm Franchising, LLC and Firestorm Solutions, LLC, filed its opposition to the partial summary judgment motion on  June 21, 2021. The Firestorm Principals filed their reply in support of their partial summary judgment motion on  July 9, 2021. On  March 14, 2022, the Court issued an opinion and order which denied summary judgment to the Firestorm Principals on the Company's main fraudulent omission claim, the conversion and trespass to chattels claims as to Defendants Loughlin and Rhulen and the breach of fiduciary duty claim as to Defendant Loughlin. The Court also denied summary judgment to the Firestorm Principals on their breach of warrants, anticipatory breach of warrants, and anticipatory breach of promissory notes counterclaims and the breach of contract counterclaim asserted by Defendant Satterfield. The Court granted summary judgment to the Firestorm Principals on our CFAA claims, based on recent case law clarifying that such claims do not apply to employees who have authorized access to an employer’s computer and misuse that access, and granted summary judgment to one defendant on our conversion, and trespass to chattels claims because Rekor represented it was prepared to dismiss those claims. The Court also granted summary judgment on one breach of contract counterclaim asserted by a company related to the Firestorm Principals, holding that the $25,500 amount at issue could not be set off by or recouped from our damages in this case.

In April 2022, The Company filed a notice of motion seeking partial summary judgement on several of the of the Company’s claims and the Firestorm Principals’ counterclaims, which the Firestorm Principals opposed. On July 29^th, 2022, the Court issued an opinion and order, which granted the motion in part and denied it in part. The order dismissed the Firestorm Principal’s counterclaim against the Company for libel. The order also dismissed the Company’s claim for breach of fiduciary duty against one  defendant on the ground that he was not employed by the Company, but by a subsidiary of the Company that is not a party to the case. The court also denied summary judgement to the Company as to the breach of fiduciary duty claim against the other defendants and as to the trespass to chattels and conversion claims as to all defendants, on the ground that issues of fact remain contested. On the same ground, the court also denied summary judgement to the Company as to a breach of contract claim  by one defendant relating to an alleged change in employment status.

In 2020, the Firestorm Principals filed various suits in New York, Delaware and Virginia against directors and officers of the Company, alleging breach of fiduciary duty and libel. The defendants in the suits moved to dismiss the amended complaint. At this stage of these litigations, the suits against two of the directors have been dismissed and one has been permitted to proceed. On  September 28, 2021, the Delaware court issued an order denying the defendant’s motion to dismiss. On  October 21, 2021, the defendants filed a motion for reconsideration of the Delaware court’s dismissal order; which was denied on  February 28, 2022. On  March 16, 2022, the court in the Virginia action dismissed the breach of fiduciary duty claim without prejudice (so it can be refiled in Delaware Chancery Court) and denied the motion with respect to the defamation claim on jurisdictional grounds. The defamation claim in Virginia will now be challenged on substantive grounds.

In July 2022, the Firestorm Principals obtained new counsel.  On July 21, 2022, the Firestorm Principals’ new counsel requested an adjournment of the October 17, 2022 trial date and related pre-trial deadlines, which the Company did not oppose.  On July 22, 2022, the Court granted the request and rescheduled trial to begin on February 13, 2023.

At this stage of these litigations, the Company is unable to render an opinion regarding the likelihood of a favorable outcome. The Company intends to continue vigorously litigating its claims against the Firestorm Principals and believes that the Firestorm Principals’ remaining counterclaims and suits against Rekor directors and officers are without merit.

On  September 18, 2020, Fordham Financial Management, Inc. (“Fordham”) commenced a lawsuit against the Company in the Supreme Court for the State of New York, New York County. Fordham alleges that the Company breached an underwriting agreement with Fordham. Fordham has brought claims for breach of contract, a declaratory judgment, and attorneys’ fees and expenses, and seeks damages. The Complaint was served on the Company on  September 25, 2020. The Company issued a motion to dismiss counterclaims on  June 23, 2021. The Court granted Fordham’s motion to dismiss Rekor’s counterclaims on  October 23, 2021. On  November 29, 2021, the Company filed a notice of appeal with the Appellate Division and a motion to reargue that decision and order, arguing that the court misunderstood the nature and purpose of the prospectus supplement, which was actually prepared by the plaintiff after it set the prices for the 2018 offering. On  March 3, 2022, the court denied the motion to reargue. In doing so, however, the court clarified that the dismissal was without prejudice, which would permit the Company to refashion the counterclaims in the future, although the Company’s has filed an appeal in the appellate division. The Company has cross-moved for summary judgment seeking the dismissal of plaintiff’s complaint on the basis that plaintiff opted against exercising its right of first refusal when it declined the opportunity to manage the 2019 ATM Program.  Both plaintiff’s motion and Rekor’s cross-motion are now returnable on August 18, 2022.

At this stage of the Fordham litigation, the Company is unable to render an opinion regarding the likelihood of a favorable outcome. However, the Company maintains that Fordham’s claims have no merit. To that end it intends to vigorously litigate this action.

In addition, from time to time, the Company  may be 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 the Company accrues reserves when a loss is probable, and the amount of such loss can be reasonably estimated. It is the Company’s opinion that the outcome of these proceedings, individually and collectively, will not be material to the Company’s consolidated financial statements as a whole.

NOTE 10 – STOCKHOLDERS’ EQUITY

At-the-Market Offering

On  February 24, 2022, the Company entered into an At-the-Market Issuance Sales Agreement (the “2022 Sales Agreement”) with B. Riley Securities, Inc. (the “Agent”) to create an at the market equity program under which the Company from time to time  may offer and sell shares of its common stock, par value $0.0001 per share, having an aggregate offering price of up to $50,000,000 (the “Shares”) through or to the Agent. The Agent is entitled to a commission equal to 3.0% of the gross proceeds from each sale. The Company incurred issuance costs of approximately $169,000 related to legal, accounting, and other fees in connection with the 2022 Sales Agreement. These costs were charged against the gross proceeds of the 2022 Sales Agreement and presented as a reduction to additional paid-in capital on the accompanying unaudited condensed consolidated balance sheets.

For the six months ended June 30, 2022, the Company sold 7,598,801 shares of common stock at a weighted-average selling price of $2.79 per share in accordance with the 2022 Sales Agreement. Net cash provided from the 2022 Sales Agreement was $20,408,000 after paying $169,000 related to the issuance cost, as well as 3.0% or $635,000 related to cash commissions provided to the Agent.

STS Acquisition

In connection with the acquisition as described in NOTE 2 – ACQUISITIONS, the Company issued 798,666 shares of the Company’s common stock as part of the consideration.

Waycare Acquisition

In connection with the acquisition as described in NOTE 2 – ACQUISITIONS, the Company issued 2,784,474 shares of the Company’s common stock as part of the consideration.

2021 Public Offering

On February 9, 2021, the Company issued and sold 6,126,939 shares of its common stock (which includes 799,166 shares of common stock sold pursuant to the exercise of an overallotment option) (the “2021 Public Offering”). The net proceeds to the Company, after deducting the underwriting discounts and commissions and estimated offering expenses payable by the Company, were approximately $70,125,000. 

Preferred Stock

The Company is authorized to issue up to 2,000,000 shares of preferred stock, $0.0001 par value. The Company’s preferred stock may be entitled to preference over the common stock with respect to the distribution of assets of the Company in the event of liquidation, dissolution or winding-up of the Company, whether voluntarily or involuntarily, or in the event of any other distribution of assets of the Company among its shareholders for the purpose of the winding-up of its affairs. The authorized but unissued shares of the preferred stock may be divided into and issued in, designated series from time to time by one or more resolutions adopted by the Board of Directors of the Company. The Board of Directors of the Company, in its sole discretion, has the power to determine the relative powers, preferences and rights of each series of preferred stock.

Series A Cumulative Convertible Redeemable Preferred Stock

Of the 2,000,000 authorized shares of preferred stock, 505,000 shares were designated as $0.0001 par value Series A Cumulative Convertible Redeemable Preferred Stock (the “Series A Preferred Stock”). The holders of Series A Preferred Stock were entitled to quarterly dividends of 7.0% per annum per share.

Based on the terms of the Series A Preferred Stock, the Company concluded that the Series A Preferred Stock should be classified as temporary equity in the accompanying unaudited condensed consolidated balance sheets.

Rekor adjusted the value of the Series A Preferred Stock to redemption value at the end of each reporting period. The adjustment to the redemption value was recorded through additional paid-in capital of $0 and $101,000 for the three months ended June 30, 2022 and 2021, respectively.

As a result of the closing of the 2021 Public Offering in the first quarter of 2021, all of the issued and outstanding Series A Preferred Stock was converted pursuant to the original terms of the agreement into 899,174 shares of the Company’s common stock.

Series B Cumulative Convertible Preferred Stock

Of the 2,000,000 authorized shares of preferred stock, 240,861 shares were designated as $0.0001 par value Rekor Series B Cumulative Convertible Preferred Stock (the “Series B Preferred Stock”). As part of the TeamGlobal Merger, the Company 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 as part of the acquisition of TeamGlobal. The Series B Preferred Stock had a conversion price of $5.00 per share. Each Series B Preferred Stock had an automatic conversion feature based on the share price of Rekor.

As a result of the volume weighted average share price of the Company’s common stock being over $7.50 for thirty consecutive days, in the first quarter of 2021, all of the Company’s issued and outstanding Series B Preferred Stock was converted pursuant to the original terms of the agreement into 517,611 shares of the Company’s common stock.

Warrants

A summary of the warrant activity for the Company for the period ended June 30, 2022 is as follows:

NOTE 11 – EQUITY INCENTIVE PLAN

Stock Options

Stock options granted under the 2017 Plan may be either incentive stock options (“ISOs”) or non-qualified stock options (“NSOs”). ISOs may be granted to employees and NSOs may be granted to employees, directors, or consultants. Stock options are granted at exercise prices as determined by the Board of Directors. The vesting period is generally three years with a contractual term of ten years.

Stock compensation expense related to stock options for the three months ended  June 30, 2022 and 2021 was $14,000 and $31,000, respectively, and for the six months ended June 30, 2022 and 2021 was $42,000 and $60,000, respectively, and is presented, based on the awardees operating department, as general administrative, selling and marketing and research and development expenses in the accompanying unaudited condensed consolidated statements of operations. 

A summary of stock option activity under the Company’s 2017 Plan for the period ended June 30, 2022 is as follows:

As of June 30, 2022, there was $3,000 of unrecognized stock compensation expense related to unvested stock options granted under the 2017 Plan that will be recognized over a weighted average period of 0.18 years.

Restricted Stock Units

Stock compensation expense related to RSU’s for the three months ended  June 30, 2022 and 2021 was $1,871,000 and $1,094,000, respectively, and for the six months ended June 30, 2022 and 2021 was $3,743,000 and $1,846,000, respectively, and is presented, based on the awardees operating department, as general administrative, selling and marketing and research and development expenses in the accompanying unaudited condensed consolidated statements of operations.

Pursuant to the terms of the Waycare purchase agreement, the Company reserved for issuance to Waycare’s continuing employees an aggregate of 686,248 restricted stock units, which were issued on October 28, 2021, pursuant to the terms of the Company’s 2017 Equity Award Plan, as amended. The restricted stock units are subject to customary vesting schedules and are intended to incentivize the continued performance of Waycare’s employees.

A summary of RSU activity under the Company’s 2017 Plan for the six months ended June 30, 2022 is as follows:

The grant date fair value is based on the estimated fair value of the Company’s common stock on the date of grant. All RSUs granted vest upon the satisfaction of a service-based vesting condition.

As of June 30, 2022, there was $13,838,000 of unrecognized stock compensation expense related to unvested RSUs granted under the 2017 Plan that will be recognized over an average remaining period of 2.00 years.

NOTE 12 – LOSS PER SHARE

The following table provides information relating to the calculation of loss per common share: