Property and Equipment

 

The cost of furniture and fixtures and equipment is depreciated over the useful lives of the related assets. Leasehold improvements are amortized over the shorter of their estimated useful lives or the terms of the lease. Depreciation and amortization is recorded on the straight-line basis.

 

The range of estimated useful lives used for computing depreciation are as follows:

 

Furniture and fixtures	2 - 10 years
Office equipment	2 - 5 years
Leasehold improvements	3 - 15 years
Internally-developed software	3 - 5 years
Automobiles	3 - 5 years
Camera systems	3 years

 

The Company capitalizes eligible costs related to internally-developed software which were incurred during the application development stage, in accordance with ASC 985-20. In accordance with ASC 985-20, capitalized internally-developed software costs, net, not yet placed in service were $1,108,157 and $913,455 as of March 31, 2019 and December 31, 2018, respectively. The Company anticipates placing this internally-developed software into service in the second quarter of 2019.

 

Repairs and maintenance are expensed as incurred. Expenditures for additions, improvements and replacements are capitalized. Depreciation and amortization expense for the three months ended March 31, 2019 and 2018 was $71,148 and $82,039, respectively.

 

 

Business Combination

 

Management conducts a valuation analysis on the tangible and intangible assets acquired and liabilities assumed at the acquisition date thereof. During the measurement period, which may be up to one year from the   acquisition date, the Company may record adjustments to the fair value of these tangible and intangible assets   acquired and liabilities assumed, with the corresponding offset to goodwill. In addition, uncertain tax positions   and tax-related valuation allowances are initially established in connection with a business combination as of the   acquisition date. Upon the conclusion of the measurement period or final   determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent   adjustments are recorded to the Company’s consolidated statements of operations.

 

Amounts paid for acquisitions are allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The Company allocates a portion of the purchase price to the fair value of identifiable intangible assets. The fair value of identifiable intangible assets is based on detailed valuations that use information and assumptions provided by management. The Company allocates any excess purchase price over the fair value of the net tangible and intangible assets acquired to goodwill.

 

The Company recorded intangible assets for the acquisitions that occurred in 2018 and 2019. The Secure Education Consultants, Inc. (“Secure Education”) and OpenALPR Technology acquisitions were business combinations, which created both book and tax bases in non-goodwill intangible assets. Secure Education’s acquisition resulted in $0.4 million of non-goodwill intangible assets. The acquisition of OpenALPR Technology resulted in $11.8 million of technology-based intangibles.

 

Goodwill and Other Intangibles

 

In applying the acquisition method of accounting, amounts assigned to identifiable assets and liabilities acquired were based on estimated fair values as of the date of acquisition, with the remainder recorded as goodwill. Identifiable intangible assets are initially valued at fair value using generally accepted valuation methods appropriate for the type of intangible asset. Identifiable intangible assets with definite lives are amortized over their estimated useful lives and are reviewed for impairment, if indicators of impairment arise. Intangible assets with indefinite lives are tested for impairment within one year of acquisitions or annually as of October 1, and whenever indicators of impairment exist. The fair value of intangible assets is compared with their carrying values, and an impairment loss would be recognized for the amount by which a carrying amount exceeds its fair value. No impairments have been recorded through March 31, 2019.

 

Acquired identifiable intangible assets are amortized over the following periods:

 

 

Revenue Recognition

 

The Company recognizes revenues for the provision of services when persuasive evidence of an arrangement exists, services have been rendered or delivery has occurred, the fee is fixed or determinable and the collectability of the related revenue is reasonably assured. The Company principally derives revenues from fees for services generated on a project-by-project basis. Revenues for time-and-materials contracts are recognized based on the number of hours worked by the employees or consultants at an agreed-upon rate per hour set forth in the Company’s contracts or purchase orders. Revenues related to firm-fixed-price contracts are primarily recognized upon completion of the project as these projects are typically short-term in nature. Revenue from the sale of individual franchises is recognized when the contract is signed and collectability is assured, unless the franchisee is required to perform certain training before operations commence. The franchisor has no obligation to the franchisee relating to store development and the franchisee is considered operational at the time the franchise agreement is signed or when required training is completed, if applicable. Royalties from individual franchises are earned based upon the terms in the franchising agreement, which are generally the greater of $1,000 or 8% of the franchisee’s monthly gross sales.

 

 

For automated traffic safety enforcement revenue, the Company recognizes revenue when the required collection efforts, from citizens, are completed and posted to the municipality’s account. The respective municipality is then billed depending on the terms of the respective contract, typically 15 days after the preceding month while collections are reconciled. For contracts where the Company receives a percentage of collected fines, revenue is calculated based upon the posted payments from citizens multiplied by the Company’s contractual percentage. For contracts where the Company receives a specific, fixed monthly fee, regardless of citations issued or collected, revenue is recorded once the amount collected from citizens exceeds the monthly fee per camera. Rekor Recognition’s fixed-fee contracts typically have a revenue neutral provision whereby the municipality’s payment to Rekor Recognition cannot exceed amounts collected from citizens within a given month. OpenALPR generates revenue through a variety of services and products. Software license revenue is recognized at the time of delivery, while related maintenance service revenue is recognized over the period of performance. Cloud service software license revenue is offered as a fixed quantity over a specified term, for which revenue is recognized ratably.

 

Advertising

 

The Company expenses all non-direct-response advertising costs as incurred. Such costs were not material for the three months ended March 31, 2019 and 2018.

 

Use of Estimates

 

Management uses estimates and assumptions in preparing financial statements. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual amounts may differ from these estimates. On an on-going basis, the Company evaluates its estimates, including those related to collectability of accounts receivable, fair value of debt and equity instruments, and income taxes. 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.

 

Income Taxes

 

Income tax expense consists of U.S. federal and state income taxes. The Company is required to pay income taxes in certain state jurisdictions. Historically, AOC Key Solutions and GCP initially elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code. Under those provisions, neither AOC Key Solutions nor GCP paid federal corporate income tax, and in most instances state income tax, on its taxable income. AOC Key Solutions revoked its S Corporation election upon the March 15, 2016 merger with KeyStone and GCP revoked its S Corporation election upon the acquisition by the Company, and are therefore, subject to corporate income taxes. Firestorm is a single-member LLC with KeyStone as the sole member.

 

The Company uses 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, the Company fully reserved for its net deferred tax assets, except for the any deferred tax liability associated with indefinite-lived goodwill or non-goodwill intangibles, because management believes that it is more-likely-than-not that their benefits will not be realized in future periods. The Company will continue to evaluate its 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 Company’s 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 the Company’s accounting policy is to account for ASC 740-10-related penalties and interest as a component of the income tax provision in the consolidated statements of operations and comprehensive loss.

 

 

As of March 31, 2019 and December 31, 2018, the Company’s 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 March 31, 2019. 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.

 

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “2017 Act”) was enacted, which changes U.S. tax law and includes various provisions that impact the Company. The 2017 Act effects the Company by changing U.S. tax rates, increasing the Company’s ability to use accumulated net operating losses generated after December 31, 2017, and limiting the Company’s ability to deduct interest.

 

Equity-Based Compensation

 

The Company recognizes equity-based compensation based on the grant-date fair value of the award on a straight-line basis over the requisite service period, net of estimated forfeitures. Total equity-based compensation expense included in selling, general and administrative expenses in the accompanying consolidated statements of operations for the three months ended March 31, 2019 and 2018 was $62,852 and $112,455, respectively.

 

The Company estimates the fair value of stock options using the Black-Scholes option-pricing model. The use of the Black-Scholes option-pricing model requires the use of subjective assumptions, including the fair value and projected volatility of the underlying common stock and the expected term of the award.

 

The fair value of each option granted has been estimated as of the date of the grant using the Black-Scholes option pricing model with the following assumptions during the three months ended March 31, 2019:

 

 

Risk-Free Interest Rate – The yield on actively traded non-inflation indexed U.S. Treasury notes with the same maturity as the expected term of the underlying grants was used as the average risk-free interest rate.

 

Expected Term  – The expected term of options granted was determined based on management’s expectations of the options granted which are expected to remain outstanding.

 

Expected Volatility  – Because the Company’s common stock has only been publicly traded since late August 2017, there is not a substantive share price history to calculate volatility and, as such, the Company has elected to use the calculated value method.

 

Dividend Yield  – The Black-Scholes option pricing model requires an expected dividend yield as an input. The Company has not issued common stock dividends in the past nor does the Company expect to issue common stock dividends in the future.

 

Forfeiture Rate  – This is the estimated percentage of equity grants that are expected to be forfeited or cancelled on an annual basis before becoming fully vested. The Company estimates the forfeiture rate based on past turnover data, level of employee receiving the equity grant, and vesting terms, and revises the rate if subsequent information indicates that the actual number of instruments that will vest is likely to differ from the estimate. The cumulative effect on current and prior periods of a change in the estimated number of awards likely to vest is recognized in compensation cost in the period of the change.

 

Fair Value of Financial Instruments

 

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable and accounts payable approximate fair value as of March 31, 2019 and December 31, 2018 because of the relatively short-term maturity of these financial instruments. The carrying amount reported for long-term debt approximates fair value as of March 31, 2019 and December 31, 2018, 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 Accounting Standards Codification (“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.

 

The Company’s goodwill and other intangible assets are measured at fair value on a recurring and non-recurring basis, respectively, using Level 2 and Level 3 inputs.

 

The Company has concluded that its Series A Preferred Stock is a Level 3 financial instrument and that the fair value approximates the carrying value, which includes the accretion of the discounted interest component through March 31, 2019. There were no changes in levels during the three months ended March 31, 2019 and 2018.

 

Concentrations of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, and accounts receivable. Concentrations of credit risk with respect to accounts receivable are minimal due to the collection history and due to the nature of the Company’s client base. The Company limits its credit risk with respect to cash by maintaining cash balances with high-quality financial institutions. At times, the Company’s cash may exceed U.S. federally-insured limits, and as of March 31, 2019 and December 31, 2018, the Company had $4,500,382 and $2,176,907, respectively, of cash and cash equivalents on deposit that exceeded the federally-insured limit.

 

Earnings per Share

 

Basic earnings per share, or EPS, is computed using the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common and potentially dilutive securities outstanding during the period, except for periods of net loss for which no potentially dilutive securities are included because their effect would be anti-dilutive. Potentially dilutive securities consist of common stock issuable upon exercise of stock options or warrants using the treasury stock method. Potentially dilutive securities issuable upon conversion of the Series A and Series B Preferred Stock (see Note 10) are calculated using the if-converted method.

 

The Company calculates basic and diluted earnings per common share using the two-class method. Under the two-class method, net earnings are allocated to each class of common stock and participating security as if all of the net earnings for the period had been distributed. Participating securities consist of preferred stock that contain a nonforfeitable right to receive dividends and therefore are considered to participate in undistributed earnings with common stockholders.

 

 

Segment Reporting

 

The Financial Accounting Standards Board (“FASB”) ASC Topic 280, Segment Reporting , requires that an enterprise report selected information about reportable segments in its financial reports issued to its stockholders. Beginning with the first quarter of 2019, the Company changed its operating and reportable segments from one segment to two segments: the Technology Group and the Professional Services Group. The two segments reflect the Company’s separate focus on technology products and services verses professional services.

 

The Company’s Technology Group includes the wholly owned subsidiaries Rekor Recognition and OpenALPR. The Professional Services Group includes wholly owned subsidiaries AOC Key Solutions, Global and Firestorm. See Note 3 for further details on the Company’s reportable segments.

 

New Accounting Pronouncements

 

Recently Issued Accounting Pronouncements

 

Not Yet Adopted

 

In August 2018, the FASB issued Accounting Standards Update (“ASU”) No. 2018-13,  Fair Value Measurement (Topic 820), Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which modifies the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. ASU 2018-13 is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods, with early adoption permitted. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company is currently evaluating the effect that ASU 2018-13 will have on its consolidated financial statements and related disclosures.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). To simplify the subsequent measurement of goodwill, ASU 2017-04 requires only a single-step quantitative test to identify and measure impairment based on the excess of a reporting unit's carrying amount over its fair value. A qualitative assessment may still be completed first for an entity to determine if a quantitative impairment test is necessary. ASU 2017-04 is effective for fiscal year 2021 and is to be adopted on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company will test goodwill for impairment within one year of the acquisition or annually as of October 1, and whenever indicators of impairment exist. The Company is currently evaluating the effect that ASU 2017-04 will have on its financial statements and related disclosures.

 

In June 2016, the FASB issued ASU No. 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, 2019. The Company is currently in the process of evaluating the impact of adopting ASU 2016-13 on its consolidated financial statements.

 

There are currently no other accounting standards that have been issued, but not yet adopted, that will have a significant impact on the Company’s consolidated financial position, results of operations or cash flows upon adoption.

 

 

Recently Adopted

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”) . ASU 2016-02 requires lessees to recognize lease assets and lease liabilities on the balance sheet and requires expanded disclosures about leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 and interim periods in fiscal years beginning after December 15, 2018, with early adoption permitted. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”). ASU 2018-11 provides entities another option for transition, allowing entities to not apply the new standard in the comparative periods they present in their financial statements in the year of adoption. Effective January 1, 2019, the Company adopted ASU 2016-02, as amended, which requires lessees to recognize a right-of-use (“ROU”) lease assets and lease liability on the balance sheet for most lease arrangements and expands disclosures about leasing arrangements for both lessees and lessors, among other items. The Company adopted ASU 2016-02 using the optional transition method whereby the Company applied the new lease requirements under ASU 2016-02 through a cumulative-effect adjustment, which after completing our implementation analysis, resulted in no adjustment to its January 1, 2019 beginning retained earnings balance. On January 1, 2019, the Company recognized $920,950 of ROU operating lease assets and $950,927 of operating lease liabilities, including noncurrent operating lease liabilities of $727,513, as a result of adopting this standard. The difference between ROU operating lease assets and operating lease liabilities was primarily due to previously accrued rent expense relating to periods prior to January 1, 2019. As part of its adoption, the Company elected the following practical expedients: the Company has not reassessed whether any expired or existing contracts are or contain leases, the Company has not reassessed lease classification for any expired or existing leases; the Company has not reassessed initial direct costs for any existing leases; and the Company has not separated lease and non-lease components. The adoption of the standard did not have a material impact on the Company’s consolidated financial statements and related disclosures. The comparative periods have not been restated for the adoption of ASU 2016-02.

 

In June 2018, the FASB issued ASU No. 2018-07,  Compensation – Stock Compensation (Topic 718) , Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”), which is intended to simplify aspects of share-based compensation issued to non-employees by making the guidance consistent with the accounting for employee share-based compensation. ASU 2018-07 is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods, with early adoption permitted but no earlier than an entity’s adoption date of Topic 606. The Company adopted the provisions of ASU 2018-07 effective January 1, 2019. Adopting ASU 2018-07 had no impact on the Company’s consolidated financial statements and related disclosures.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which was further amended in 2015 and 2016 (Topic 606). ASU 2014-09 provides companies with a single model for use in accounting for revenue arising from contracts with customers and supersedes previous revenue recognition guidance, including industry-specific revenue guidance. The core principle of the model is to recognize revenue when control of the goods or services transfers to the customer, as opposed to recognizing revenue when the risks and rewards transfer to the customer under the previous revenue guidance. The guidance permits companies to either apply the requirements retrospectively to all prior periods presented (full retrospective method), or apply the requirements in the year of adoption, through a cumulative adjustment (modified retrospective method). The Company adopted Topic 606 effective January 1, 2018 using the modified retrospective method. The adoption of Topic 606 resulted in the following changes: 1) a change to franchisee agreements recorded prior to 2017; and 2) the timing of certain contractual agreements which the Company deemed as immaterial. Revenue recognition related to the Company’s other revenue streams remained substantially unchanged following the adoption of Topic 606 and therefore did not have a material impact on its revenues. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.

 

Practical Expedients Election ‒ Costs to Obtain and Fulfill a Contract ‒ The Company’s incremental costs of obtaining a contract consist of sales commissions. As part of adopting Topic 606, the Company elected to use the practical expedient to expense costs to obtain a contract as incurred when the amortization period would have been one year or less. As of March 31, 2019, costs incurred to fulfill contracts in excess of one year have been immaterial to date.

 

Revenue Recognition ‒ The Company generates substantially all revenues from providing technology products and services and professional services to clients. A single contract could include one or multiple performance obligations. For those contracts that have multiple 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 our overall pricing objectives, taking into consideration market conditions and other factors.

 

 

 

Revenue is recognized when control of the goods and services provided are transferred to our customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods and services using the following steps:

 

 

The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

 

Disaggregated Revenue ‒ The Company disaggregates revenue from contracts with customers by contract type, as it believes it best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.

The Company’s revenue by contract type is as follows:

 

	For the Three Months Ended March 31,
	2019	2018
Revenues
Time and materials	$ 10,799,306	$ 10,321,152
Fixed price	817,265	874,202
Franchising	9,650	23,415
Total revenue	$ 11,626,221	$ 11,218,769

 

Performance Obligations ‒ Performance obligations for three different types of services are discussed below:

 

Accounts Receivable, Net ‒ Accounts receivable, net, are amounts due from customers where there is an unconditional right to consideration. Unbilled receivables of $1,672,178 and $1,124,705 are included in this balance as of March 31, 2019 and December 31, 2018, respectively. The payment of consideration related to these unbilled receivables is subject only to the passage of time.

 

The Company reviews accounts receivable on a periodic basis to determine if any receivables will potentially be uncollectible. Estimates are used to determine the amount of the allowance for doubtful accounts necessary to reduce accounts receivable to its estimated net realizable value. The estimates are based on an analysis of past due receivables, historical bad debt trends, current economic conditions, and customer specific information. After the Company has exhausted all collection efforts, the outstanding receivable balance relating to services provided is written off against the allowance. Additions to the provision for bad debt are charged to expense.

 

The Company determined that an allowance for loss of $45,560 and $24,405 was required as of March 31, 2019 and December 31, 2018, respectively.

 

 

In May 2017, the FASB issued ASU No. 2017-09, Compensation - Stock Compensation: Scope of Modification Accounting (“ASU 2017-09”), which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. An entity will account for the effects of a modification unless the fair value of the modified award is the same as the original award, the vesting conditions of the modified award are the same as the original award and the classification of the modified award as an equity instrument or liability instrument is the same as the original award. ASU 2017-09 is effective for fiscal year 2019. The update is to be adopted prospectively to an award modified on or after the adoption date. Early adoption is permitted. The Company adopted ASU 2017-09 in 2018 and the impact of the adoption was not material to its consolidated financial statements and related disclosures.

 

NOTE 3 – INFORMATION ON BUSINESS SEGMENTS

 

FASB ASC Topic 280, Segment Reporting , requires that an enterprise report selected information about reportable segments in its financial reports issued to its stockholders. Beginning with the first quarter of 2019, the Company changed its operating and reportable segments from one segment to two segments: the Technology Group and the Professional Services Group. The two segments reflect the Company’s separate focus on technology products and services versus professional services.

 

The Company’s Technology Group includes wholly owned subsidiaries Rekor Recognition and OpenALPR. The financial results of OpenALPR are included beginning as of March 12, 2019 (see Note 4). The Professional Services Group includes wholly owned subsidiaries AOC Key Solutions, Global, and Firestorm. The Company provides general corporate services to its segments, however, these services are not considered when making operating decisions and assessing segment performance. These services are reported as “Corporate Services” below and these include costs associated with executive management, financing activities and public company compliance.

 

Summarized financial information concerning the Company’s reportable segments is presented below:

 

	For the Three Months Ended March 31,
	2019	2018
Revenue:
Technology group	$ 1,009,843	$ 874,202
Professional services group	10,616,378	10,344,567
Total revenue	$ 11,626,221	$ 11,218,769
Cost of revenue:
Technology group	$ 490,110	$ 327,796
Professional services group	8,032,445	7,806,240
Total cost of revenue	$ 8,522,555	$ 8,134,036
Gross profit:
Technology group	$ 519,734	$ 546,406
Professional services group	2,583,933	2,538,327
Total gross profit	$ 3,103,666	$ 3,084,733
Selling, general and administrative expenses:
Technology group	$ 718,473	$ 804,421
Professional services group	2,863,950	2,913,655
Corporate expenses	987,341	1,562,874
Total operating expenses	$ 4,569,764	$ 5,280,950
Loss from operations:
Technology group	$ (198,739 )	$ (258,015 )
Professional services group	(280,018 )	(375,327 )
Corporate expenses	(987,341 )	(1,562,874 )
Total loss from operations	$ (1,466,098 )	$ (2,196,216 )

 

 

 

NOTE 4 – ACQUISITIONS

 

Secure Education Consultants Acquisition

 

On January 1, 2018, the Company completed its acquisition of certain assets of Secure Education through Firestorm. Consideration paid as part of this acquisition included: $99,197 in cash; 33,333 shares of Rekor common stock valued at $163,332; warrants to purchase 33,333 shares of Rekor common stock, exercisable over a period of five years, at an exercise price of $5.44 per share, valued at $65,988; and warrants to purchase 33,333 of Rekor common stock, exercisable over a period of five years, at an exercise price of $6.53 per share, valued at $57,484.

 

The Company has completed its analysis of the purchase price allocation. The Company recorded $386,001 of customer relationships as intangibles. The table below shows the final breakdown related to the Secure Education acquisition:

 

 

OpenALPR Acquisition

 

On November 14, 2018, the Company entered into an Asset Purchase Agreement (the “OpenALPR Purchase Agreement”) by and among the Company, OpenALPR Technology and Matthew Hill pursuant to which the Company agreed to purchase all of the assets of OpenALPR Technology and its subsidiaries, except for certain excluded assets, and assumed certain liabilities as provided for in the OpenALPR Purchase Agreement. The Company agreed to pay $15,000,000, subject to certain adjustments, provided that OpenALPR Technology could elect to receive up to 1,000,000 shares of the Company’s common stock, par value, $0.0001 per share, in lieu of up to $5,000,000 in cash valued at a price per share of $5.

 

On February 15, 2019, the Company entered into Amendment No. 1 to the OpenALPR Purchase Agreement, pursuant to which the parties agreed to amend the Base Purchase Price to $7,000,000, subject to adjustment after closing, issue a promissory note in the amount of $5,000,000, and issue 600,000 shares of Rekor common stock as consideration for the acquisition of OpenALPR Technology’s assets.

 

On March 8, 2019, the Company entered into Amendment No. 2 to the OpenALPR Asset Purchase Agreement which eliminated the working capital adjustment set forth in the OpenALPR Asset Purchase Agreement, as amended, and replaced it with an adjustment for prepaid maintenance contracts.

 

On March 12, 2019, the Company completed the acquisition of certain assets of OpenALPR Technology and assumed certain liabilities. (the “OpenALPR Acquisition”). Consideration paid as part of the OpenALPR Acquisition was: $7,000,000 in cash, subject to adjustment after closing; 600,000 shares of Rekor common stock, valued at $396,600; and $5,000,000 of the 2019 Promissory Notes (see Note 8) principal amount, together with an accompanying warrant to purchase 625,000 shares of Rekor common stock, exercisable over a period of five years, at an exercise price of $0.74 per share, valued at $208,125 (“March 2019 Warrants” see Note 8). As the OpenALPR Technology acquisition has recently been completed, the Company is currently in the process of completing the purchase price allocation treating the OpenALPR Technology acquisition as a business combination.

 

 

 

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 OpenALPR Technology occurred on March 12, 2019, the results of operations for OpenALPR Technology from the date of acquisition have been included in the Company’s consolidated statement of operations for the three months ended March 31, 2019. The table below shows the breakdown related to the preliminary purchase price allocation for the OpenALPR Technology acquisition:

 

 

Hill Employment Agreement

 

On November 14, 2018, concurrent with the execution of the OpenALPR Purchase Agreement, the Company entered into an employment agreement with Matthew Hill (the “Hill Employment Agreement”) which became effective as of March 12, 2019, the closing date of the OpenALPR Purchase Agreement. Pursuant to the Hill Employment Agreement, Mr. Hill began serving as the Company’s Chief Science Officer. The Hill Employment Agreement provides for a term of three years, unless earlier terminated pursuant to the terms thereof, which term renews for additional one-year terms until terminated upon 90-days advance notice. Mr. Hill will earn an annual base salary of $165,000.

 

Either party may terminate the Hill Employment Agreement with or without cause with notice as contemplated by the Hill Employment Agreement, provided however, if Mr. Hill resigns, he shall provide the Company with at least six months prior written notice. The Hill Employment Agreement provides for the payment of severance under certain circumstances as outlined therein.

 

Operations of Combined Entities

 

The following unaudited pro forma combined financial information gives effect to the acquisition of Secure Education and OpenALPR Technology as if they were consummated as of January 1, 2018. 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, 2018 (the beginning of the earliest period presented) or to project potential operating results as of any future date or for any future periods.

 

	Three Months Ended March 31,
	2019	2018
Revenues	$ 12,595,218	$ 11,421,765
Net income (loss)	$ (2,067,077 )	$ (2,104,936 )
Basic earnings (loss) per share	$ (0.12 )	$ (0.16 )
Diluted earnings (loss) per share	$ (0.12 )	$ (0.16 )
Basic Number of Shares	19,367,619	15,130,030
Diluted Number of Shares	19,367,619	15,130,030

 

NOTE 5 – INVESTMENT AT COST AND NOTES RECEIVABLE

 

The Company owns a minority interest of 19.1% of Global Public Safety, LLC (“Global Public Safety”). The Company is accounting for this as an investment at cost. The Company recorded an impairment of $262,140 related to the investment in Global Public Safety for the year end December 31, 2018.

 

 

In February 2018, the Company sold a $2,000,000 promissory note that it had acquired in connection with the acquisition of Rekor Recognition. The current portion of notes receivable was $0 as of March 31, 2019 and December 31, 2018. In connection with the sale, the Company indemnified the unrelated third-party buye r for any amount of principal and interest not paid by LB&B Associates, Inc.

 

 

With the acquisition of Secure Education, the Company identified customer relationships and marketing-related intangibles of $386,801. With the acquisition of OpenALPR Technology, the Company identified technology-based intangibles of $11,845,073 in its preliminary purchase price allocation. These assets are being amortized on a straight-line basis over their weighted average estimated useful life of 5.7 years and amortization expense amounted to $369,924 and $255,294 for the three months ended March 31, 2019 and 2018, respectively.

 

As of March 31, 2019, the estimated annual amortization expense for each of the next five fiscal years and thereafter is as follows:

 

 

 

 

 

 

On January 5, 2018, April 6, 2018 and July 9, 2018, the Company paid cash dividends of $87,907 to shareholders of record of Series A Preferred Stock as of the end of the previous month. On September 30, 2018, December 31, 2018 and March 31, 2019, the Company accrued dividends of $87,907 to these Preferred Stock shareholders and did not pay dividends in cash. Accrued dividends payable to Series A Preferred Stock shareholders were $263,722 and $175,814 as of March 31, 2019 and December 31, 2018, respectively.

 

On January 5, 2018, April 6, 2018 and July 9, 2018, the Company paid cash dividends of $27,001 to shareholders of record of Series B Preferred Stock as of the end of the previous month. On September 30, 2018, December 31, 2018 and March 31, 2019, the Company accrued dividends of $27,001 to these Preferred Stock shareholders and did not pay dividends in cash. Accrued dividends payable to Series B Preferred Stock shareholders were $81,003 and $54,002 as of March 31, 2019 and December 31, 2018, respectively.

 

NOTE 8 – DEBT

 

Line of Credit

 

Global has revolving lines of credit with Wells Fargo Bank National Association (“WFB”) (“Wells Fargo Credit Facilities”). WFB agreed to advance to Global, 90% of all eligible accounts with a maximum facility amount of $5,000,000. Interest is payable under the Wells Fargo Credit Facilities at a monthly rate equal to the Three-Month LIBOR, (as such term is defined under the Wells Fargo Credit Facilities), in effect from time to time plus 3%, plus an additional margin of 3%. Payment of the revolving lines of credit is secured by the accounts receivable of Global. The current term of the Wells Fargo Credit Facilities run through December 31, 2019, with automatic renewal terms of 12 months. WFB or Global may terminate the Wells Fargo Credit Facilities upon at least 60 days’ written notice prior to the last day of the current term. The principal balance as of March 31, 2019 and December 31, 2018 was $2,046,043 and $1,094,766, respectively. As part of the agreements for the Wells Fargo Credit Facilities, Global must maintain certain financial covenants. Global met all such financial covenant requirements for the three months ended March 31, 2019.

 

 

 

On November 12, 2017, AOC Key Solutions entered into an Account Purchase Agreement and related agreements (the “AOC Wells Agreement”) with WFB. Pursuant to the AOC Wells Agreement, AOC Key Solutions agreed to sell and assign to WFB all of its Accounts (as such term is defined in Article 9 of the Uniform Commercial Code), constituting accounts arising out of sales of Goods (as such term is defined in Article 9 of the Uniform Commercial Code) or rendition of services that WFB deems to be eligible for borrowing under the AOC Wells Agreement. WFB agreed to advance to AOC Key Solutions, 90% of all eligible accounts with a maximum facility amount of $3,000,000. Interest is payable under the AOC Wells Agreement at a monthly rate equal to the Daily One Month LIBOR, (as such term is defined under the AOC Wells Agreement), in effect from time to time plus 5%. The AOC Wells Agreement also provides for a deficit interest rate equal to the then applicable interest rate plus 50% and a default interest rate equal to the then applicable interest rate or deficit interest rate, plus 50%. The initial term of the AOC Wells Agreement runs through December 31, 2018 (the “Initial Term”), with automatic renewal terms of 12 months (the “Renewal Term”), commencing on the first day after the last day of the Initial Term. The current term of the AOC Wells Agreement runs through December 31, 2019. AOC Key Solutions may terminate the AOC Wells Agreement upon at least 60 days’ prior written notice, but no more than 120 days’ written notice, prior to and effective as of the last day of the Initial Term or the Renewal Term, as the case may be. WFB may terminate the AOC Wells Agreement at any time and for any reason upon 30 days’ written notice or without notice upon the occurrence of an Event of Default (as such term is defined in the AOC Wells Agreement) after the expiration of any grace or cure period. The principal balance as of March 31, 2019 and December 31, 2018 was $368,606 and $566,447, respectively. As part of the AOC Wells Agreement, AOC Key Solutions must maintain certain financial covenants. AOC Key Solutions met all such financial covenant requirements for the three months ended March 31, 2019.

 

Long-Term Debt

 

On March 16, 2016, the Company entered into a Subordinated Note and Warrant Purchase Agreement (the “Avon Road Note Purchase Agreement”) pursuant to which $500,000 in subordinated debt (the "Avon Road Note") was issued by the Company to Avon Road Partners, L.P. (“Avon Road”), an affiliate of Robert Berman, the Company’s President and CEO and a member of the Company’s Board of Directors. The Avon Road Subordinated Note Warrants had an expiration date of March 16, 2019.

 

On March 12, 2019, the $500,000 balance due on the Avon Road Note was retired in its entirety from the proceeds of the 2019 Promissory Notes (see below).

 

On January 25, 2017, pursuant to the terms of its acquisition of Firestorm, the Company issued $1,000,000 in the aggregate of unsecured, subordinated promissory notes with interest payable over five years $500,000 of the notes are payable at an interest rate of 2% and the remaining note is payable at an interest rate of 7%. The notes mature on January 25, 2022. The balance of these notes payable was $947,531 and $938,272, net of unamortized interest, as of March 31, 2019 and December 31 2018, respectively, to reflect the amortized fair value of the notes issued due to the difference in interest rates of $52,469 and $61,728, respectively.

 

On April 3, 2018, the Company and Rekor Recognition entered into a transaction pursuant to which an institutional investor (the “2018 Lender”) loaned $2,000,000 to the Company and Rekor Recognition (the “2018 Promissory Note”). The loan was originally due and payable on May 1, 2019 and bears interest at 15% per annum, with a minimum of 15% interest payable if the loan is repaid prior to May 1, 2019. In addition, the Company issued 35,000 shares of common stock to the 2018 Lender, which shares contain piggy-back registration rights. If the shares are not registered on the next selling shareholder registration statement, the Company will be obligated to issue an additional 15,000 shares to the 2018 Lender. Upon the sale of Rekor Recognition or its assets, the 2018 Lender was entitled to receive 7% of any proceeds received by the Company or Rekor Recognition in excess of $5 million (the “Lender’s Participation”). In addition, commencing January 1, 2020, the 2018 Lender shall be paid 7% of Rekor Recognition’s earnings before interest, taxes, depreciation and amortization, less any capital expenditures, which amount would be credited for any payments that might ultimately be paid to the 2018 Lender as its Lender’s Participation, if any. At April 3, 2018, the fair value of shares issued was $126,000. On October 24, 2018, the Company and Rekor Recognition entered into a note amendment with the 2018 Lender by which the maturity date of the note was extended to May 1, 2020 (the “2018 Promissory Note Amendment”). The 2018 Promissory Note Amendment further provided for payment of interest through May 1, 2019, if the principal was repaid before May 1, 2019. At October 24, 2018, an additional $62,500 fee was paid as consideration for extending the maturity date to May 1, 2020 and designated as financing costs related to the 2018 Promissory Note Amendment. Amortized financing cost for the three months ended March 31, 2019 and 2018 was determined to be $31,425 and $96,378, respectively, is included in interest expense. The 2018 Promissory Note has an effective interest rate of 19.5%. On March 12, 2019, the $2,000,000 balance due on the 2018 Promissory Note was retired in its entirety and Rekor paid to the 2018 Lender $1,050,000 of consideration for the Lender’s Participation and $75,000 of interest due through May 1, 2019. All amounts paid were obtained from the proceeds of the 2019 Promissory Notes (see below). The 2018 Lender consideration of $1,050,000 for the Lender’s Participation and unamortized financing costs of $62,609 are recorded as extinguishment of debt of $1,112,609 for the three months ended March 31, 2019.

 

 

2019 Promissory Notes

 

On March 12, 2019, Rekor entered into a note purchase agreement pursuant to which investors, including OpenALPR Technology (see Note 4), (the “2019 Lenders”) loaned $20,000,000 to Rekor (the “2019 Promissory Notes”) and the Company issued to the 2019 Lenders warrants to purchase 2,500,000 shares of Rekor common stock (the “March 2019 Warrants”). The loan is due and payable on March 11, 2021 and bears interest at 16% per annum, of which at least 10% per annum shall be paid in cash. The full remaining portion of all interest, if any, shall accrue and 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, including a fixed charge ratio, minimum liquidity and maximum capital expenditures, as defined. Transaction costs were approximately $403,250 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 $705,943. The warrants are exercisable commencing March 12, 2019 and expire on March 12, 2024. The 2019 Promissory Notes has an effective interest rate of 24.87%.

 

The principal amounts due for long-term notes payable described above and a minor equipment note payable are shown below as of March 31, 2019:

 

 

NOTE 9 – INCOME TAXES

 

The Company accounts for income taxes in accordance with ASC Topic 740. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. In determining the need for a valuation allowance, management reviews both positive and negative evidence pursuant to the requirements of ASC Topic 740, including current and historical results of operations, future income projections and the overall prospects of the Company’s business.

 

The 2017 Act changes U.S. tax law and includes various provisions that impact our company. The 2017 Act effects our company by changing U.S. tax rates, increasing the Company’s ability to utilize accumulated net operating losses generated after December 31, 2017, and impacts the estimates of our deferred tax assets and liabilities.

 

The Company’s income tax provision for the three months ended March 31, 2019 and 2018 was $11,761 and $0, respectively. The increase in the tax expense is primarily related to state minimum taxes and the state of Texas gross receipts tax. The Company established a valuation allowance against deferred tax assets during 2017 and has continued to maintain a full valuation allowance through the three months ended March 31, 2019.

 

The Company files income tax returns in the United States and in various state and foreign jurisdictions. No U.S. Federal, state or foreign income tax audits were in process as of March 31, 2019.

 

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, the Company fully reserved for its net deferred tax assets because management believes that it is more-likely-than-not that their benefits will not 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 months ended March 31, 2019 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 2015 through 2018 tax years remain subject to examination by the IRS.

 

NOTE 10 – STOCKHOLDERS’ EQUITY

 

Common Stock

 

The Company is authorized to issue 30,000,000 shares of common stock, $0.0001 par value. As of March 31, 2019 and December 31, 2018, the issued and outstanding common shares of Rekor were 19,367,619 and 18,767,619, respectively.

 

In January 2018, the Company issued 33,333 shares of Rekor common stock as consideration as part of its acquisition of Secure Education.

 

In April 2018, the Company issued 35,000 shares of Rekor common stock as additional consideration to the 2018 Lender in connection with the 2018 Promissory Note.

 

As part of its acquisition of Brekford on August 29, 2017, the Company assumed warrants to purchase 56,000 shares of Rekor common stock (the “Brekford Warrants”) (see Note 11). Effective October 16, 2018, the Company entered into exchange agreements with holders of the Brekford Warrants pursuant to which the Company issued to the holders an aggregate of 96,924 shares of common stock in exchange for the return of the warrants to the Company for cancellation.

 

On November 1, 2018, the Company 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 to the Company was approximately $2.8 million. In addition, the Company 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 the consideration to the underwriters, the Company issued to the underwriters 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 have a value of approximately $0.2 million and are exercisable commencing April 27, 2019 and expire on October 29, 2023.

 

On December 13, 2018, the Company received a letter from the Nasdaq indicating that the Company is required to maintain a minimum bid price of $1 per share of its common stock. The Company's closing bid price of its common stock had been less than $1 for the previous 30 consecutive business days. As such, the Company was not compliant with the minimum bid price requirements under Nasdaq Listing Rule 5550(a)(2). The letter from Nasdaq provided the Company with a compliance period of 180 calendar days, or until June 11, 2019, to regain compliance with the minimum bid price requirement. If at any time during this 180-day compliance period the closing bid price of the Company’s common stock is at least $1 for a minimum of 10 consecutive business days, then Nasdaq will provide the Company with written confirmation of compliance and the matter will be closed.

 

In the event the Company’s common stock were to be delisted from the Nasdaq, management expects that it would be traded on the OTCQB or OTCQX, which are unorganized, inter-dealer, over-the-counter markets which provides significantly less liquidity than the Nasdaq or other national securities exchanges.

 

For the year ended December 31, 2018, the Company issued 13,998 shares of Rekor common stock related to the exercise of common stock options.

 

On February 15, 2019, the Company entered into Amendment No. 1 to the OpenALPR Purchase Agreement, pursuant to which the Company agreed to issue 600,000 shares of Rekor common stock as partial consideration for the acquisition of the assets of OpenALPR Technology. On March 12, 2019, the Company issued 600,000 shares of Rekor common stock pursuant to the acquisition of OpenALPR Technology.

 

For the three months ended March 31, 2019 and 2018, the Company issued 600,000 and 33,333 shares of Rekor common stock, respectively. For the three months ended March 31, 2019 and 2018, no options were exercised related to common stock.

 

 

 

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 are 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 are entitled to quarterly dividends of 7.0% per annum per share. The holders of Series A Preferred Stock have a put right to convert each share into common stock at an initial conversion price and a specified price which increases annually based on the passage of time beginning in November 2019. The holders of Series A Preferred Stock also have a put right after 60 months from the issuance date to redeem any or all of the Series A Preferred Stock at a redemption price of $15.00 per share plus any accrued but unpaid dividends. The Company has a call right after 36 months from the issuance date to redeem all of the Series A Preferred Stock at a redemption price which increases annually based on the passage of time beginning in November 2019. The Series A Preferred Stock contains an automatic conversion feature based on a qualified initial public offering in excess of $30,000,000 or a written agreement by at least two-thirds of the holders of Series A Preferred Stock at an initial conversion price and a specified price which increases annually based on the passage of time beginning in November 2016. 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 consolidated balance sheets as of March 31, 2019 and December 31, 2018.

 

The Company adjusts the value of the Series A Preferred Stock to redemption value at the end of each reporting period. The adjustment to the redemption value is recorded through additional-paid-in-capital of $178,501 and $155,343 for the three months ended March 31, 2019 and March 31, 2018, respectively.

 

As of March 31, 2019 and December 31, 2018, 502,327 shares of Series A Preferred Stock were issued and outstanding.

 

The holders of Series A Preferred Stock are entitled to quarterly cash dividends 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. On January 5, 2018, April 6, 2018 and July 9, 2018, the Company paid cash dividends of $87,907 to shareholders of record of Series A Preferred Stock as of the end of the previous month. On September 30, 2018, December 31, 2018 and March 31, 2019, the Company accrued dividends of $87,907 to Series A Preferred Stock shareholders of record. Accrued dividends payable to Series A Preferred Stock shareholders were $263,722 and $175,814 as of March 31, 2019 and December 31, 2018, respectively, and are included in accrued expenses on the accompanying condensed consolidated balance sheets.

 

On February 15, 2019, the Company’s Series A Preferred Stock, which had been designated as securities trading on the OTC Markets OTCQX exchange, was transferred to being designated as trading on the OTC Markets OTCQB exchange.

 

Series B Cumulative Convertible Preferred Stock

 

Of the 2,000,000 authorized shares of preferred stock, 240,861 shares are designated as $0.0001 par value Rekor Series B Cumulative Convertible Preferred Stock (the "Series B Preferred Stock"). The Series B Preferred Stock has a conversion price of $5.00 per share. Each Series B Preferred Stock has an automatic conversion feature based on the share price of the Company. The holders of Series B Preferred Stock are 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. On January 5, 2018, April 6, 2018 and July 9, 2018, the Company paid cash dividends of $27,001 to shareholders of record of Series B Preferred Stock as of the end of the previous month. On September 30, 2018, December 31, 2018 and March 31, 2019, the Company accrued dividends of $27,001 to Series B Preferred Stock shareholders of record. Accrued dividends payable to Series B Preferred Stock shareholders were $81,003 and $54,002 as of March 31, 2019 and December 31, 2018, respectively, and are included in accrued expenses on the accompanying condensed consolidated balance sheets.

 

 

 

Warrants

 

The Company has a total of 3,973,163 and 1,473,163 warrants issued and outstanding as of March 31, 2019 and December 31, 2018, respectively. These warrants are exercisable and convertible for a total of 3,714,491 and 1,214,491 shares of Rekor common stock as of March 31, 2019 and December 31, 2018, respectively. On February 15, 2019, the Company’s Unit Warrants (see Note 10) which had been designated as securities trading on the OTC Markets OTCQX exchange were transferred to the OTC Markets OTCQB exchange.

 

As part of its acquisition of Brekford on August 29, 2017, the Company assumed Brekford’s obligations with respect to the Brekford Warrants. The exercise price for the Brekford Warrants was $7.50 and they expired on March 31, 2020. Effective October 16, 2018, the Company entered into exchange agreements with holders of the Brekford Warrants pursuant to which the Company issued to the holders an aggregate of 96,924 shares of common stock in exchange for the return of the warrants to the Company for cancellation. As of March 31, 2019 and December 31, 2018, no Brekford Warrants were outstanding. (See Note 11).

 

As part of a Regulation A Offering in fiscal year 2016 and 2017, the Company issued 502,327 Unit Warrants to the holders of Series A Preferred Stock. The exercise price for these Unit Warrants is $1.03 and they are convertible into a total of 243,655 shares of Rekor common stock. The Unit Warrants expire on November 23, 2023. As of March 31, 2019, and December 31, 2018, there are 502,327 Unit Warrants outstanding.

 

On March 16, 2016, the Company entered into the Avon Road Note Purchase Agreement, as more fully described in Note 8 above, pursuant to which the Company issued warrants to purchase 121,247 shares of its common stock to Avon Road, an affiliate of Robert Berman, Rekor’s President and CEO and a member of the Company’s Board of Directors. These warrants were exercised on December 11, 2017 for proceeds of $125,006 and there were no Avon Road Subordinated Note Warrants outstanding as of March 31, 2019 and December 31, 2018.

 

As part of the acquisition of Firestorm on January 24, 2017, the Company issued: warrants to purchase 315,627 shares of its common stock, exercisable over a period of five years, at an exercise price of $2.5744 per share; and warrants to purchase 315,627 shares of its common stock, exercisable over a period of five years, at an exercise price of $3.6083 per share (the “Firestorm Warrants”). The expiration date of the Firestorm Warrants is January 24, 2022. As of March 31, 2019 and December 31, 2018, there were 631,254 Firestorm Warrants outstanding.

 

Pursuant to its acquisition of BC Management on December 31, 2017, the Company issued: warrants to purchase 33,333 shares of its common stock, exercisable over a period of five years, at an exercise price of $5.44 per share; and warrants to purchase 33,333 shares of its common stock, exercisable over a period of five years, at an exercise price of $6.53 per share (the “BC Management Warrants”). The expiration date of the BC Management Warrants is December 31, 2022. As of March 31, 2019 and December 31, 2018, there were 66,666 BC Management Warrants outstanding.

 

Pursuant to its acquisition of Secure Education on January 1, 2018, the Company issued: warrants to purchase 33,333 shares of its common stock, exercisable over a period of five years, at an exercise price of $5.44 per share; and warrants to purchase 33,333 shares of its common stock, exercisable over a period of five years, at an exercise price of $6.53 per share (the “Secure Education Warrants”). The expiration date of the Secure Education Warrants is January 1, 2023. As of March 31, 2019 and December 31, 2018, there were 66,666 Secure Education Warrants outstanding.

 

On November 1, 2018, in connection with an underwritten public offering of its common stock, the Company issued to the underwriters warrants to purchase 206,250 shares of its common stock, exercisable over a period of five years, at an exercise price of $1.00 per share. These warrants have a value of approximately $0.2 million and are exercisable commencing April 27, 2019 and expire on October 29, 2023. As of March 31, 2019 and December 31, 2018, all 206,250 warrants related to the 2018 underwritten public offering remain outstanding.

 

On March 12, 2019, in connection with the 2019 Promissory Notes, the Company issued 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 (see Note 8). Of the 2,500,000 warrants, 625,000 were issued as partial consideration for its acquisition of certain assets of OpenALPR Technology (see Note 4).

 

NOTE 11 – WARRANT DERIVATIVE LIABILITY

 

As part of its acquisition of Rekor Recognition on August 29, 2017, the Company assumed the Brekford Warrants to purchase 56,000 shares of its common stock (see Note 10). The Brekford Warrants permit the holder to purchase 56,000 shares of the Company’s common stock with an exercise price of $7.50 per share.

 

 

 

The Brekford Warrants exercise price is subject to anti-dilution adjustments that allow for its reduction in the event the Company subsequently issues equity securities, including shares of common stock or any security convertible or exchangeable for shares of common stock, for no consideration or for consideration less than $7.50 a share. The Company accounted for the conversion option of the Brekford Warrants in accordance with ASC Topic 815. Accordingly, the conversion option is not considered to be solely indexed to the Company’s own stock and, as such, was recorded as a liability.

 

Effective October 16, 2018, the Company entered into exchange agreements with holders of the Brekford Warrants pursuant to which the Company issued to the holders an aggregate of 96,924 shares of common stock in exchange for the return of the warrants to the Company for cancellation and extinguishment of the warrant liability.

 

NOTE 12 – COMMON STOCK OPTION AGREEMENT

 

On March 16, 2016, two stockholders of the Company entered into an option agreement with Avon Road (collectively, the “Avon Road Parties”). Under the terms of this agreement Avon Road paid the stockholders $10,000 each (a total of $20,000) for the right to purchase, on a simultaneous and pro-rata basis, up to 4,318,856 shares of Rekor’s common stock owned by those two shareholders at $0.52 per share, which was determined to be the fair value. The option agreement had a two-year term which would have expired on March 16, 2018. On September 7, 2017, the Avon Road Parties entered into an amended and restated option agreement which extended the right to exercise the option up to and including March 21, 2019 (the “Amended and Restated Option Agreement”). Pursuant to the Amended and Restated Option Agreement, Avon Road exercised the option to purchase 4,318,856 shares of Rekor’s common stock.

 

NOTE 13 – OPERATING LEASES

 

The Company leases facilities for office space in various locations throughout the United States. The office leases have remaining lease terms of one to five years, some of which include options to terminate within one year.

 

Operating lease expense   for the three months ended March 31, 2019 and 2018 was $139,721 and $192,964, respectively, and is included in selling, general and administrative expenses.

 

Cash paid for amounts included in the measurement of operating lease liabilities was $$38,735 for the three months ended March 31, 2019.

 

There were no right-of-use lease assets obtained in exchange for lease obligations for the three months ended March 31, 2019.

 

Supplemental balance sheet information related to leases was as follows:

 

 

 

 

Maturities of lease liabilities were as follows:

 

 

NOTE 14 – COMMITMENTS AND CONTINGENCIES

 

NeoSystems

 

The Company planned to acquire NeoSystems LLC (“NeoSystems”) under an agreement entered into on November 16, 2017. The consummation of the merger was subject to, among other things, the completion of the Qualifying Offering by February 28, 2018. On March 7, 2018, the Company received notice of termination of the Agreement and Plan of Merger (the “NeoSystems Merger Agreement”). The stated basis of termination by NeoSystems was due to the Company’s failure to complete a Qualifying Offering, as defined in the NeoSystems Merger Agreement, by February 28, 2018. The terms of the NeoSystems Merger Agreement provided that upon termination, the Company was required to pay certain fees and expenses of legal counsel, financial advisors, investment bankers and accountants. On November 29, 2018, the Company paid NeoSystems $225,000 to cover such fees and expenses, which were recorded as a selling, general and administrative expense.

 

OpenALPR Asset Purchase Agreement

 

On November 14, 2018, the Company entered into the OpenALPR Purchase Agreement. As consideration for the OpenALPR Acquisition, the Company agreed to pay $15,000,000, subject to certain adjustments, provided that OpenALPR Technology could elect to receive up to 1,000,000 shares of the Company’s common stock, par value, $0.0001 per share, in lieu of up to $5,000,000 in cash valued at a price per share of $5. The OpenALPR Purchase Agreement was subsequently amended and on March 12, 2019, the Company completed the acquisition of certain assets of OpenALPR Technology and assumed certain liabilities as described in Note 4.

 

NOTE 15 – EQUITY INCENTIVE PLAN

 

In August 2017, the Company approved and adopted the 2017 Equity Award Plan (the “2017 Plan”) which replaced the 2016 Equity Award Plan (the “2016 Plan”). The 2017 Plan permits the granting of stock options, stock appreciation rights, restricted and unrestricted stock awards, phantom stock, performance awards and other stock-based awards for the purpose of attracting and retaining quality employees, directors and consultants. Maximum awards available under the 2017 Plan were initially set at 3,000,000 shares.

 

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 to four years with a contractual term of 10 years.

 

The 2017 Plan is administered by the Administrator, which is currently the Board of Directors of the Company. The Administrator has the exclusive authority, subject to the terms and conditions set forth in the 2017 Plan, to determine all matters relating to awards under the 2017 Plan, including the selection of individuals to be granted an award, the type of award, the number of shares of Rekor common stock subject to an award, and all terms, conditions, restrictions and limitations, if any, including, without limitation, vesting, acceleration of vesting, exercisability, termination, substitution, cancellation, forfeiture, or repurchase of an award and the terms of any instrument that evidences the award.

 

 

The Company has also designed the 2017 Plan to include a number of provisions that Rekor’s management believes promote best practices by reinforcing the alignment of equity compensation arrangements for nonemployee directors, officers, employees, consultants and stockholders’ interests. These provisions include, but are not limited to, the following:

 

No Discounted Awards . Awards that have an exercise price cannot be granted with an exercise price less than the fair market value on the grant date.

 

No Repricing Without Stockholder Approval . The Company cannot, without stockholder approval, reduce the exercise price of an award (except for adjustments in connection with a Rekor recapitalization), and at any time when the exercise price of an award is above the market value of Rekor common stock, the Company cannot, without stockholder approval, cancel and re-grant or exchange such award for cash, other awards or a new award at a lower (or no) exercise price.

 

No Evergreen Provision . There is no evergreen feature under which the shares of common stock authorized for issuance under the 2017 Plan can be automatically replenished.

 

No Automatic Grants . The 2017 Plan does not provide for “reload” or other automatic grants to recipients.

 

No Transferability. Awards generally may not be transferred, except by will or the laws of descent and distribution or pursuant to a qualified domestic relations order, unless approved by the Administrator.

 

No Tax Gross-Ups. The 2017 Plan does not provide for any tax gross-ups.

 

No Liberal Change-in-Control Definition. The change-in-control definition contained in the 2017 Plan is not a “liberal” definition that would be activated on mere stockholder approval of a transaction.

 

“Double-trigger” Change in Control Vesting. If awards granted under the 2017 Plan are assumed by a successor in connection with a change in control of the Company, such awards will not automatically vest and pay out solely as a result of the change in control, unless otherwise expressly set forth in an award agreement.

 

No Dividends on Unearned Performance Awards . The 2017 Plan prohibits the current payment of dividends or dividend equivalent rights on unearned performance-based awards.

 

Limitation on Amendments.  No amendments to the 2017 Plan may be made without stockholder approval if any such amendment would materially increase the number of shares reserved or the per-participant award limitations under the 2017 Plan, diminish the prohibitions on repricing stock options or stock appreciation rights, or otherwise constitute a material change requiring stockholder approval under applicable laws, policies or regulations or the applicable listing or other requirements of the principal exchange on which Rekor’s shares are traded.

 

Clawbacks. Awards based on the satisfaction of financial metrics that are subsequently reversed, due to a financial statement restatement or reclassification, are subject to forfeiture.

 

When making an award under the 2017 Plan, the Administrator may designate the award as “qualified performance-based compensation,” which means that performance criteria must be satisfied in order for an employee to be paid the award. Qualified performance-based compensation may be made in the form of restricted common stock, restricted stock units, common stock options, performance shares, performance units or other stock equivalents. The 2017 Plan includes the performance criteria the Administrator has adopted, subject to stockholder approval, for a “qualified performance-based compensation” award.

 

 

A summary of stock option activity under the Company’s 2017 Plan for the three months ended March 31, 2019 is as follows:

 

 

Stock compensation expense for the three months ended March 2019 and 2018 was $62,852 and $112,455, respectively, and is included in selling, general and administrative expenses in the accompanying consolidated statements of operations. The weighted average grant date fair value of options granted for the three months ended March 31, 2019 and 2018 was $0.68 and $2.21, respectively. The intrinsic value of the stock options granted during the three months ended March 31, 2019 was $2,600. The total fair value of shares that became vested after grant during the three months ended March 31, 2019 and 2018 was $512,657   and $1,325,929, respectively.

 

As of March 31, 2019, there was $422,097 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 1.56 years.

 

NOTE 16 – EMPLOYEE BENEFIT PLAN

 

AOC Key Solutions has a defined contribution savings plan under Section 401(k) of the Internal Revenue Code (the “Code”) (the “AOC 401(k) Plan”) which was amended on January 1, 2013, as required by the Code. Pursuant to the amended AOC 401(k) Plan, AOC Key Solutions will make nondiscretionary “safe harbor” matching contributions for all participants of 100% of the participant’s salary deferrals up to 3%, and 50% of deferrals up to the next 2%, of the participant’s compensation.

 

Rekor Recognition has a defined contribution savings plan under Section 401(k) of the Code (the “Rekor Recognition 401(k) Plan”). The Rekor Recognition 401(k) Plan is a defined contribution plan, which covers substantially all U.S.-based employees who have completed three months of service. The Rekor Recognition 401(k) Plan provides that Rekor Recognition will match 50% of the participant salary deferrals up to 3% of a participant’s compensation for all participants.

 

GCP also maintains a 401(k) plan (the “GCP 401(k) Plan”), which was amended September 15, 2014. However, GCP has not historically made matching contributions to the GCP 401(k) Plan.

 

On January 1, 2019, the Company established the Novume Solutions, Inc. 401(k) Plan (the “Novume 401(k) Plan”), a Qualified Automatic Contribution Arrangement (QACA) safe harbor plan, and the AOC 401(k) Plan, the Rekor Recognition 401(k) Plan, and the GCP 401(k) Plan were amended and merged into the Novume 401(k) Plan. Employees that satisfied the eligibility requirements became participants in the Novume 401(k) Plan. The Company contributes an amount equal to the sum of 100% of a participant’s elective deferrals that do not exceed 1% of participant’s compensation, plus 50% of the participant’s elective deferrals that exceed 1% of the participants compensation, but do not exceed 6% of the participant’s compensation. Employee contributions are fully vested and matching contributions are subject to a two-year service vesting schedule.

 

The amount of contributions recorded by the Company under these plans during the three months ended March 31, 2019 and 2018 was $88,571and $45,531, respectively.

 

 

NOTE 17 – INVENTORY

 

As of March 31, 2019 and December 31, 2018, inventory consisted entirely of parts of $120,191 and $72,702, respectively.

 

As the Company had a net loss for the three months ended March 31, 2019, the following 6,316,157 potentially dilutive securities were excluded from diluted loss per share: 3,714,491 for outstanding warrants, 974,487 related to the Series A Preferred Stock, 481,722 related to the Series B Preferred Stock and 1,145,457 related to outstanding options.

 

As the Company had a net loss for the three months ended March 31, 2018, the following potentially 3,913,995 dilutive securities were excluded from diluted loss per share: 917,950 for outstanding warrants, 974,487 related to the Series A Preferred Stock, 481,722 related to the Series B Preferred Stock and 1,539,836 related to outstanding options.

 

(Loss) Earnings Per Share under Two – Class Method

 

The Series A Preferred Stock and Series B Preferred Stock have the non-forfeitable right to participate on an as converted basis at the conversion rate then in effect in any common stock dividends declared and, as such, is considered a participating security. The Series A Preferred Stock and Series B Preferred Stock are included in the computation of basic and diluted loss per share pursuant to the two-class method. Holders of the Series A Preferred Stock and Series B Preferred Stock do not participate in undistributed net losses because they are not contractually obligated to do so.

 

The computation of diluted (loss) earnings per share attributable to common stockholders reflects the potential dilution that could occur if securities or other contracts to issue shares of common stock that are dilutive were exercised or converted into shares of common stock (or resulted in the issuance of shares of common stock) and would then share in our earnings. During the periods in which the Company records a loss attributable to common stockholders, securities would not be dilutive to net loss per share and conversion into shares of common stock is assumed not to occur.

 

 

 

The following table provides a reconciliation of net (loss) to preferred shareholders and common stockholders for purposes of computing net (loss) per share for the three months ended March 31, 2019 and 2018:

 

	Three Months Ended March 31,
	2019	2018
Numerator:
Net (loss) earnings from continuing operations	$ (2,875,199 )	$ (2,193,844 )
Less: preferred stock accretion	(178,501 )	(155,343 )
Less: preferred stock dividends	(114,908 )	(114,908 )
Net (loss) attributable to shareholders	$ (3,168,608 )	$ (2,464,095 )
Denominator (basic):
Weighted average common shares outstanding	18,800,496	14,496,697
Participating securities - Series A preferred stock	974,487	974,487
Participating securities - Series B preferred stock	481,722	481,722
Weighted average shares outstanding	20,256,705	15,952,906
Loss per common share - basic under two-class method	$ (0.16 )	$ (0.15 )
Denominator (diluted):
Weighted average common shares outstanding	18,800,496	14,496,697
Participating securities - Series A preferred stock	974,487	974,487
Participating securities - Series B preferred stock	481,722	481,722
Weighted average shares outstanding	20,256,705	15,952,906
Loss per common share - basic under two-class method	$ (0.16 )	$ (0.15 )