Rekor Systems, Inc. 10-K

ITEM 5. MARKET FOR REGISTRANT ’ S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock is listed on the Nasdaq Capital Market under the symbol “REKR”. Holders As of March 25, 2024, there were 58 registered holders of record of our common stock, excluding stockholders for whom shares are held in “nominee” or “street name.” The actual number of common stockholders is greater than the number of record holders and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities . Dividend Policy We have never declared or paid any cash dividends on our common stock. We currently do not anticipate paying any cash dividends for the foreseeable future. Instead, we anticipate that all of our earnings will be used to provide working capital, to support our operations, and to finance the growth and development of our business, including potentially the acquisition of, or investment in, businesses, technologies or products that complement our existing business. Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including, but not limited to, our future earnings, capital requirements, financial condition, future prospects, applicable Delaware law, which provides that dividends are only payable out of surplus or current net profits and other factors our Board of Directors might deem relevant. 33 Table of Contents Recent Sales of Unregistered Securities STS Acquisition As previously disclosed under Item 3.02 in the Company’s Current Report on Form 8-K filed with the SEC on June 17, 2022, as part of the purchase price the Company issued to the sellers of STS 798,666 unregistered shares of the Company’s common stock, valued at $2,000,000. The stock consideration paid to the sellers was issued pursuant to an exemption under Section 4(a)(2) of the Securities Act of 1933, as amended, and/or Regulation D, as promulgated thereunder. Senior Notes with Warrants As previously disclosed under Item 3.02 in the Company’s Current Report on Form 8-K filed with the SEC on January 18, 2023, the Company entered into a securities purchase agreement with certain accredited investors, pursuant to which the Company agreed to issue and sell to the investors in a private placement transaction (i) up to $15,000,000 in aggregate principal amount of senior secured promissory notes, and (ii) warrants to purchase up to an aggregate of 7,500,000 shares of common stock of the Company. In connection with the initial closing on January 18, 2023, the Company issued $12,500,000 in aggregate principal amount of notes and warrants to purchase 6,250,000 shares of Common Stock, resulting in proceeds to the Company of $12,500,000 before reimbursement of expenses. ATD Acquisition As previously disclosed under Item 3.02 in the Company’s Current Report on Form 8-K filed with the SEC on January 3, 2024, as part of the purchase price the Company issued to the sellers of ATD 3,496,464 unregistered shares of the Company’s common stock, valued at $10,000,000. The stock consideration paid to the sellers was issued pursuant to an exemption under Section 4(a)(2) of the Securities Act of 1933, as amended, and/or Regulation D, as promulgated thereunder. On February 27, 2024, the Company filed a registration statement on Form S-3 to register these shares. 2023 Promissory Notes Redemption On March 4, 2024, the Company completed the redemption of all its outstanding senior secured notes (the “2023 Promissory Notes”). The 2023 Promissory Notes were redeemed at the redemption price of 115% of the $12,500,000 aggregate principal amount of the 2023 Promissory Notes, or approximately $14,375,000, plus accrued and unpaid interest to the redemption date of approximately $263,000 (the “Redemption Payment”). The noteholders elected to accept $1,875,000 of the Redemption Payment in the form of 750,000 unregistered shares of the Company’s common stock, par value $0.0001 per share, having a value of $2.50 per share, with the remainder of the Redemption Payment to be paid in cash. Use of Proceeds We have generated losses since our inception and have relied on cash on hand, external bank lines of credit, short-term borrowing arrangements, issuance of debt, the sale of a note, sale of our non-core subsidiaries, and the sale of common stock to provide cash for operations. We attribute losses to financing costs, public company corporate overhead, lower than expected revenue, and lower gross profit of some of our subsidiaries. Our cash proceeds have been primarily used for the acquisitions described above, research and development, legal, financing costs, acquisition costs and sales and marketing expenses related to new product development and our strategic shift to develop and promote the capabilities of our technology offerings. ITEM 6. [RESERVED] 34 Table of Contents ITEM 7. MANAGEMENT ’ S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following management’s discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included in this Annual Report and the historical financial statements of Rekor Systems, Inc., and the related notes thereto. Overview Rekor is working to revolutionize public safety, urban mobility, and transportation management using AI-powered solutions designed to meet the distinct demands of each market we serve. We work hand-in-hand with our customers to deliver mission-critical traffic and engineering services that assist them in achieving their goals. Our vision is to improve the lives of citizens and the world around them by enabling safer, smarter, and greener roadways and communities. We work towards this by collecting, connecting, and organizing the world’s mobility data, and making it accessible and useful to our customers for real-time insights and decisioning for situational awareness, rapid response, risk mitigation, and predictive analytics for resource and infrastructure planning and reporting. General The information provided in this discussion and analysis of Rekor’s financial condition, and results of operations covers the years ended December 31, 2023 and 2022. In 2022, we divested our Automated Traffic Safety Enforcement ("ATSE") business, a non-core business unit. As a result of the divestiture, we determined that ATSE met the criteria to be considered discontinued and it was no longer presented with continuing operations. Additionally, in 2022, we completed the acquisition of 100% of the issued and outstanding capital stock of Southern Traffic Services, Inc. ("STS"). This acquisition is included in the presentation of our continuing operations. 35 Table of Contents Acquisitions and Dispositions On June 17, 2022 , we completed the acquisition of STS by acquiring 100% of the issued and outstanding capital stock of STS. The acquisition included total consideration of $12,799,000 including: cash consideration of $6,500,000, $1,001,000 related to an earnout based on the achievement of certain performance metrics ("STS Earnout") and $1,298,000 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. On December 6, 2022, we divested our ATSE business, a non-core business unit, for approximate ly $3,390,000. On January 2, 2024, we completed the acquisition of All Traffic Data Services, LLC (“ATD”) for an aggregate purchase price of $19,795,000, consisting of $9,795,000 in cash which included closing adjustments and $10,000,000 of stock consideration. Opportunities, Trends and Uncertainties We look to identify the various trends, market cycles, uncertainties and other factors that may provide us with opportunities and present challenges that impact our operations and financial condition from time to time. Although there are many that we may not or cannot foresee, we believe that our results of operations and financial condition for the foreseeable future will be primarily affected by the following: ● Growing Smart City Market – According to a United Nations report, about two-thirds of the world population will live in urban areas by 2050. The world’s cities are getting larger, with longer commutes and the resulting impact on the environment and the quality of life. This trend requires forward-thinking officials to manage assets and resources more efficiently. We believe that advancements in “big data” connected devices and artificial intelligence can provide Intelligent Transportation System (“ITS”) solutions that can be used to reduce congestion, keep travelers safe, improve transportation, protect the environment, respond to climate change, and enhance the quality of life. We believe our data-driven, artificial intelligence-aided solutions provide useful tools that can effectively tackle the challenges cities and communities are facing today and will face over the coming decades. ● AI for Infrastructure – We believe that the application of AI to the analysis of conditions on roadways and other transportation infrastructure can significantly affect the safety and efficiency of travel in the future. As vehicles move towards full automation, there is a need for real-time data and actionable insights around traffic flow, identification of anomalous and unsafe movements – e.g. wrong way vehicles, stopped vehicles, or/and pedestrians on the roadway. Marketers and drive-thru retailers with loyalty programs can also benefit from rapid, lower cost identification of existing and potential customers in streamlining and accelerating local vehicular flow as well as data about the vehicles on the roadway. ● Connected Vehicle Data – Today’s new vehicles are equipped with dozens of sensors, collecting information about internal systems, external hazards, and driving behaviors. This data is a resource that transportation and other agencies are beginning to find valuable uses for. Notably, the data from these vehicles represent a virtual network that is independent of the infrastructure which is maintained and operated by the public agencies. Connected vehicle sensors can provide important information related to hazardous conditions, speed variations, intersection performance, and more. This data can help agencies and municipalities gain more visibility about conditions on their roads, supplementing data from existing infrastructure and allowing transportation information from rural areas that are not served by ITS infrastructure to be integrated into the overall analysis. ● New and Expanded Uses for Vehicle Recognition Systems – We believe that reductions in the cost of vehicle recognition products and services will significantly broaden the market for these systems. We currently serve many users who could not afford the cost, or adapt to the restrictions of, conventional vehicle recognition systems. These include smaller municipalities, homeowners’ associations, and organizations finding new applications such as innovative customer loyalty programs. We have seen and responded to an increase in the number of smaller jurisdictions that are testing vehicle recognition systems or that issued requests for proposals to install a network of vehicle recognition sensors. We also expect the availability of faster, higher-accuracy, lower-cost systems to dramatically increase the ability of crowded urban areas to manage traffic congestion and implement smart city programs. ● Adaptability of the Market – We have made a considerable investment in our advanced vehicle recognition systems because we believe their increased accuracy, affordability and ability to capture additional vehicle data will allow them to compete effectively with existing providers. Based on published benchmarks, our software currently outperforms competitors. However, large users of existing technology, such as toll road operators, have long-term contracts with service providers that have made considerable investments in their existing technologies and may not consider the improvements in accuracy or reductions in cost sufficient to justify abandoning their current systems in the near future. In addition, existing providers may be able to reduce the cost of their current offerings or elect to reduce prices and accept reduced profitability while working to develop their own systems or secure advanced systems from others who are also working to develop them. As a result, our success in establishing a major position in these markets will depend on being able to effectively communicate our presence, develop strong customer relationships, and maintain leadership in providing the capabilities that customers want. As with any large market, this will require considerable effort and resources. 36 Table of Contents ● Expansion of Automated Enforcement of Motor Vehicle Laws – We expect contactless compliance programs to be expanded as the types of vehicle related violations authorized for automated enforcement increase and experience provides localities with a better understanding of the circumstances where it is and is not beneficial. We believe that future legislation will increasingly allow for automated enforcement of regulations such as motor vehicle insurance and registration requirements. Communities are currently searching for better means of achieving compliance with minor vehicle offenses, such as lapsed registrations, and safety issues such as motorists who fail to stop for school buses. For example, due to high rates of fatalities and injuries to law enforcement and other emergency response crews on roadsides, several states are considering authorizing automated enforcement of violations where motorists fail to slow down and/or move over for emergency responders and law enforcement vehicles at the side of the road. To the extent that legislative implementation is required, a deliberative and necessarily time-consuming process is involved. However, as states expand auto-enforcement, the market for these products and services should broaden in the public safety market. ● Graphic Processing Unit ( “ GPU ” ) Improvements – We expect our business to benefit from more powerful and affordable GPU hardware that has recently been developed. These GPUs are more efficient for image processing because their highly parallel structure makes them more efficient than general-purpose central processing units (“CPUs”) for algorithms that process large blocks of data, such as those produced by video streams. GPUs also provide superior memory bandwidth and efficiencies as compared to their CPU counterparts. The most recent versions of our software have been designed to use the increased GPU speeds to accelerate image recognition. The GPU market is predicted to grow as a result of a surge in the adoption of the Internet of Things (“IoT”) by the industrial and automotive sectors. As GPU manufacturers increase production volume, we hope to benefit from the reduced cost to manufacture the hardware included in our products or available to others using our services. ● Edge Processing – Demand for actionable roadway information continues to grow in parallel with sensor improvements, such as increasingly sophisticated internal software and optical and other hardware adapted to the use of this software. Over the last several decades, sensors have evolved and unlocked new capabilities with each advancement. Further, cellular networks have been optimized for downloading data rather than uploading data. As a result, while download speeds have improved significantly due to large investments in cellular infrastructure, this has resulted in relatively small improvements to cellular upload speeds. With roadside deployments experiencing explosive growth in count and density, scalability, latency and bandwidth have become aspects of competition in the market. Our systems have been designed to address these issues through the use of more effective edge processing, enabled both by incorporating the increasingly effective new GPUs into our systems and continual improvements in the efficiency of our AI algorithms. Our edge processing systems ingest local HD video streams at the source and convert the raw video data to text data, dramatically reducing the volume of data that needs to be transferred through the network. Edge processing allows us to scale a network dramatically without the bandwidth, cost, latency and dependability limitations that are experienced by other networks where raw video needs to be streamed to the cloud for processing. ● Accelerated Business Development and Marketing – Our ability to compete in a large, competitive and rapidly evolving industry will require us to achieve and maintain a visible leadership position. As a result, we have made significant investments in our business development, marketing and eCommerce activities to increase awareness and market adoption of our products and services within key markets. We anticipate that a sustained presence in the market, the continued development of strategic partnerships and other economies of scale will reduce the level of costs necessary to support sales of our products and services. However, the speed at which these markets grow to the degree to which our products and services are adopted is uncertain. 37 Table of Contents ● Infrastructure Investment and Jobs Act ( “ IIJA ” ) and the Bipartisan Infrastructure Law ( “ BIL ” ) - The IIJA, signed into law on November 15, 2021, provides for significant national investments in the transportation systems in the United States, including over $150 billion in new spending on roadway infrastructure, including intelligent transportation systems. We believe that our comprehensive offering of solutions positions the Company well to emerge as a technology leader in the expanded market for roadway intelligence that will benefit from this legislation. We have identified opportunities to access federal funding streams, and we are working to implement a program that capitalizes on this unprecedented U.S. federal investment in public safety, homeland security, and transportation infrastructure and ensures that our customers are positioned to capture as much of this extraordinary government spending as possible. Beyond the many recurring federal grant programs that could support customer purchases, and the $350 billion in American Rescue Plan Act allocations that public agencies are receiving now, we are particularly excited about the prospect of benefitting from the following new grant sources that are contained in the IIJA: $200 million annually for a “Safe Streets and Roads for All” program that would make competitive grants for state projects that significantly reduce or eliminate transportation-related fatalities. $150 million for the current administration to establish a grant program to modernize state data collection systems $500 million for the Strengthening Mobility and Revolutionizing Transportation (“SMART”) Grant Program that would support demonstration projects on smart technologies that improve transportation efficiency and safety. ● Recent Acquisitions - Over the past two years, Rekor has acquired two subsidiaries as part of its plans to advance its appeal to national and local transportation agencies. In the first of these acquisitions, we acquired a leader in the development of predictive analytics for traffic management using a combination of internally generated and third party data sources. This acquisition was designed to assure transportation agencies that we were developing the most advanced data analysis systems to support their missions in safety and efficiency. In the second acquisition, we acquired one of the leading existing providers of traffic data services in the United States. Uniquely, this Company had innovated a change in the service model from providing, servicing and maintaining agency resources to a data services model where overlapping entities could benefit from our modular approach to data collection and dissemination. Each of these acquisitions has led to increased visibility for the Company among national and state level DOTs in the United States and Israel. ● Challenges to Executing on the Corporate Strategy – As an acquirer and integrator of established technology companies in the ITS industry, there is an inherent risk associated with the successful implementation and execution of the strategy. If Rekor is unable to successfully implement and execute its plans, there could be a material and adverse effect on the Company’s business, results of operations, and financial condition. ● Inability to Achieve Profitability - Rekor continues to grow its business, its operating expenses and capital expenditures have increased, and it has not yet achieved the level of sustaining profitability. As a result, if the Company is unable to generate additional revenue or achieve planned efficiencies in operations, or if its revenue declines significantly, Rekor may not be able to achieve profitability in the future, which would materially and adversely affect the Company’s business. ● Inability to Retain Qualified Personnel – Rekor’s success depends on the continued efforts and abilities of the senior management team and key engineering and marketing specialists. Although Rekor has employment agreements with these employees, they may not choose to remain employed by Rekor. Should one or more key personnel leave the Company or join a competitor, the Company’s business, operating results, and financial condition can be adversely affected. ● Inability to Compete Effectively - Competition and technological advancements by others may erode the Company’s business and result in inability to capture new business and revenue. Each business line faces significant competitive pressures within the markets in which they operate. While Rekor continues to work to develop and strengthen its competitive advantages, many factors such as market and technology changes may erode or prevent this. If the Company is unable to successfully maintain its competitive advantage, the Company’s business, operating results, and financial condition can be adversely affected. ● Cyber Security Risks - Rekor relies on information technology in all aspects of its business. A significant disruption or failure in the information technology systems could result in services interruptions, safety failures, security violations, regulatory compliance failures, an inability to protect information and assets against intruders, and other operational difficulties. This could result in the loss of assets and critical information and expose the Company to remediation costs and reputational damage. Although Rekor takes reasonable steps intended to mitigate these risks, a significant disruption or cyber intrusion could lead to misappropriation of assets or data corruption and could adversely affect the Company’s results of operations, financial condition, and liquidity. ● Intellectual Property Claims - Third parties that have been issued patents or have filed for patent applications similar to those used by the Company’s operating subsidiaries may result in intellectual property claims against the Company. Rekor cannot determine with certainty whether existing third-party patents or the issuance of any future third party patents would require any of its operating subsidiaries to alter their respective technologies, obtain licenses or cease certain activities. Should the Company be unable to defend against such claims, the Company’s business, operating results, and financial condition can be adversely affected. Other than as discussed above and elsewhere in this Annual Report on Form 10-K, we are not aware of any trends, events or uncertainties that are likely to have a material effect on our financial condition. 38 Table of Contents Components of Operating Results Revenues The Company derives its revenues primarily from the sale of its roadway data aggregation, traffic management and licensing offerings. These offerings include a mixture of data collection, implementation, engineering, customer support and maintenance services as well as software and hardware. 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. Costs of revenues, excluding depreciation and amortization Direct costs of revenues consist primarily of the portion of technical and non-technical salaries and wages and payroll-related costs incurred in connection with revenue-generating activities. Direct costs of revenues also include production expenses, data subscriptions, sub-consultant services and other expenses that are incurred in connection with our revenue-generating activities. Direct costs of revenues exclude the portion of technical and non-technical salaries and wages related to marketing efforts, vacations, holidays, and other time not spent directly generating fees under existing contracts. Such costs are included in operating expenses. We expense direct costs of revenues when they incur. 39 Table of Contents Operating Expenses Our operating expenses consist of general and administrative expenses, sales and marketing, research and development and depreciation and amortization. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, payroll taxes and stock-based compensation expenses. Operating expenses also include impairment of assets. General and Administrative General and administrative expenses consist of personnel costs for our executive, finance, legal, human resources, and administrative departments. Additional expenses include office leases, professional fees, and insurance. We expect our general and administrative expenses to continue to remain high for the foreseeable future due to the costs associated with our growth and the costs of accounting, compliance, legal, insurance, and investor relations as a public company. Our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. However, our general and administrative expenses have decreased as a percentage of our revenue and, to the extent we continue to be successful in generating increased revenue, we expect our general and administrative expenses to decrease as a percentage of our revenue over the long term. Sales and Marketing Sales and marketing expenses consist of personnel costs, marketing programs, travel and entertainment associated with sales and marketing personnel, expenses for conferences and trade shows. We will require significant investments in our sales and marketing expenses to continue the rate of growth in our revenues, further penetrate existing markets and expand our customer base into new markets. Research and Development Research and development expenses consist of personnel costs, software used to develop our products and consulting and professional fees for third-party development resources. Our research and development expenses support our efforts to continue to add capabilities to and improve the value of our existing products and services, as well as develop new products and services. Depreciation and Amortization Depreciation and amortization expenses are primarily attributable to our capital investments and consist of fixed asset depreciation, amortization of intangibles considered to have definite lives, and amortization of capitalized internal-use software costs. Other Income (Expense) Other income (expense) consists primarily of legal settlements, legal judgements, interest income and expense in connection with our debt arrangements, costs associated with the extinguishment of our debt arrangements, gains on the sale of subsidiaries, gains or losses on the sale of fixed assets, interest income earned on cash and cash equivalents, short-term investments and note receivables. Income Tax Provision Income tax provision consists primarily of income taxes in certain domestic jurisdictions in which we conduct business. We have recorded deferred tax assets for which a full valuation allowance has been provided, including net operating loss carryforwards and tax credits. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses. 40 Table of Contents Results of Operations Our historical operating results in dollars are presented below. The analysis of operations is solely related to continuing operations and does not consider the results of discontinued operations. The following selected consolidated financial data should be read in conjunction with the foregoing information contained in this Item 7 and with the consolidated financial statements and the notes thereto in Item 8 of Part II, “Financial Statements and Supplementary Data.” Only historical operating results are presented below. Historical results are not necessarily indicative of future results. Year ended December 31, (Dollars in thousands) 2023 2022 Revenue $ 34,933 $ 19,920 Cost of revenue, excluding depreciation and amortization 16,499 10,890 Operating expenses: General and administrative expenses 27,038 26,612 Selling and marketing expenses 7,347 8,329 Research and development expenses 18,271 18,616 Depreciation and amortization 7,894 6,422 Goodwill impairment - 34,835 Total operating expenses 60,550 94,814 Loss from continuing operations (42,116 ) (85,784 ) Other income (expense): Gain on extinguishment of debt 527 - Gain on the sale of business - 2,643 Interest expense, net (3,596 ) (21 ) Other expense, net (468 ) (1,279 ) Total other income (expense) (3,537 ) 1,343 Loss before income taxes (45,653 ) (84,441 ) (Provision) benefit for income taxes (32 ) 987 Net loss from continuing operations $ (45,685 ) $ (83,454 ) 41 Table of Contents Comparison of the Years Ended December 31, 2023 and 2022 Revenue Year ended December 31, Change (Dollars in thousands) 2023 2022 $ % Revenue $ 34,933 $ 19,920 $ 15,013 75 % The increase in revenue for the year ended December 31, 2023, compared to the year ended December 31, 2022, was primarily attributable to our Urban Mobility product line. During the year ended December 31, 2023, revenue attributable to our Urban Mobility product line was $16,773,000, compared to $7,692,000 compared for the year ended December 31, 2022. Additionally, our contactless compliance revenue increased $1,110,000 for the year ended December 31, 2023 compared to the year ended December 31, 2022. The remaining increase in revenue growth during the year ended December 31, 2023, compared to the year ended December 31, 2022 was primarily attributable to increased sales in sales of the Company's software and hardware products. Cost of Revenue, Excluding Depreciation and Amortization Year ended December 31, Change (Dollars in thousands) 2023 2022 $ % Cost of revenue, excluding depreciation and amortization $ 16,499 $ 10,890 $ 5,609 52 % For the year ended December 31, 2023, cost of revenue, excluding depreciation and amortization increased compared to the corresponding prior periods primarily due to an increase in personnel and other direct costs such as hardware that were incurred to support our increase in revenue. The costs of revenue increased at a lower rate than our revenue increased as the Company was able to realize efficiencies in its operations and better manage its software costs. 42 Table of Contents Operating Expenses Year ended December 31, Change (Dollars in thousands) 2023 2022 $ % Operating expenses: General and administrative expenses $ 27,038 $ 26,612 $ 426 2 % Selling and marketing expenses 7,347 8,329 (982 ) -12 % Research and development expenses 18,271 18,616 (345 ) -2 % Depreciation and amortization 7,894 6,422 1,472 23 % Goodwill impairment - 34,835 (34,835 ) -100 % Total operating expenses $ 60,550 $ 94,814 $ (34,264 ) -36 % General and Administrative Expenses The increase in general and administrative expenses during the year ended December 31, 2023, compared to the year ended December 31, 2022, were primarily due to increases related to our automobile fleet and insurance. These costs were partially offset due to a decrease in our personnel costs related to a reduction of salaries and overall payroll during the year. Additionally, for the year ended December 31, 2022, the Company recognized a $1,001,000 gain related to the remeasurement of the STS Earnout which decreased the Company's general and administrative expenses during the period. Selling and Marketing Expenses The decrease in selling and marketing expenses during the year ended December 31, 2023, compared to the year ended December 31, 2022, was primarily due to a $965,000 decrease in stock-based compensation expenses. Research and Development Expense The decrease in research and development expenses during the year ended December 31, 2023, compared to the year ended December 31, 2022, was primarily attributable to a decrease in subcontractor labor expenses as the Company utilized its current workforce to focus on the development of new products and software. 43 Table of Contents Depreciation and Amortization The increase in depreciation and amortization during the period is attributable primarily to the increased technology-based intangible assets that were acquired as part of our acquisition of STS. Goodwill Impairment During the third quarter of 2022, we experienced a significant decline in our market capitalization, which management deemed a triggering event related to goodwill. As a result, we performed an interim impairment assessment as of September 30, 2022 and determined that as of the reporting date we had an impairment related to goodwill in the amount of $34,835,000. Other Income (Expense) Year ended December 31, Change (Dollars in thousands) 2023 2022 $ % Other income (expense): Gain on extinguishment of debt $ 527 $ - $ 527 - Gain on the sale of business - 2,643 (2,643 ) -100 % Interest expense, net (3,596 ) (21 ) (3,575 ) -17024 % Other expense, net (468 ) (1,279 ) 811 63 % Total other income (expense) $ (3,537 ) $ 1,343 $ (4,880 ) 363 % Interest expense increased period over period due to the issuance of the 2023 Promissory Notes. Other expense, net increased in the current period compared to the prior period as a result of legal judgements and settlements that happened during the year ended December 31, 2022. For additional details regarding our legal settlements please s ee Item 3 of Part I, “Legal Proceedings”. In connection with the sale of ATSE, we recognized a gain on the sale of the business of $2,643,000 during the year ended December 31, 2022. Gain on extinguishment of debt is a result of the settlement agreement in the Firestorm litigation. As part of the settlement, we recorded a reduction to notes payable, the related accrued interest and other assets and liabilities which were part of the Firestorm entities. Income Tax Provision (Benefit) The provision for income taxes for the year ended December 31, 2023 , was $32,000 , a s compared to tax benefit of $987,000 for the year ended December 31, 2022 , which is due primarily to the step-up in the basis of intangible assets related to the STS acquisition. We established a valuation allowance against deferred tax assets in the fourth quarter of 2017 and have continued to maintain a full valuation allowance through the year ended December 31, 2023 . 44 Table of Contents Non-GAAP Measures EBITDA and Adjusted EBITDA We calculate EBITDA as net loss before interest, taxes, depreciation and amortization. We calculate Adjusted EBITDA as net loss before interest, taxes, depreciation and amortization, adjusted for (i) impairment of intangible assets, (ii) loss on extinguishment of debt, (iii) stock-based compensation, (iv) losses or gains on sales of subsidiaries, (v) losses associated with equity method investments, (vi) merger and acquisition transaction costs and (vii) other unusual or non-recurring items. EBITDA and Adjusted EBITDA are not measurements of financial performance or liquidity under accounting principles generally accepted in the U.S. (“U.S. GAAP”) and should not be considered as an alternative to net earnings or cash flow from operating activities as indicators of our operating performance or as a measure of liquidity or any other measures of performance derived in accordance with U.S. GAAP. EBITDA and Adjusted EBITDA are presented because we believe they are frequently used by securities analysts, investors and other interested parties in the evaluation of a company’s ability to service and/or incur debt. However, other companies in our industry may calculate EBITDA and Adjusted EBITDA differently than we do. The following table sets forth the components of the EBITDA and Adjusted EBITDA for the periods included (dollars in thousands): Year ended December 31, 2023 2022 Net loss from continuing operations $ (45,685 ) $ (83,454 ) Provision (benefit) for income taxes 32 (987 ) Interest expense, net 3,596 21 Depreciation and amortization 7,894 6,422 EBITDA $ (34,163 ) $ (77,998 ) Gain on extinguishment of debt $ (527 ) $ - Share-based compensation 4,352 6,616 Gain on the sale of ATSE - (2,643 ) Loss (gain) due to the remeasurement of the STS Earnout and Contingent Consideration, net 384 (883 ) Impairment of SAFE agreement 101 - Goodwill impairment - 34,835 Legal judgements and settlements 801 1,608 One-time consulting fees 365 1,024 Adjusted EBITDA $ (28,687 ) $ (37,441 ) 45 Table of Contents Adjusted Gross Profit and Adjusted Gross Margin Adjusted Gross Profit is a non-GAAP financial measure that we define as revenue less cost of revenue, excluding depreciation and amortization. We define Adjusted Gross Margin as our Adjusted Gross Profit divided by our revenue. We expect Adjusted Gross Margin to continue to improve over time to the extent that we can gain efficiencies through the adoption of our technology and successfully cross-sell and upsell our current and future offerings. However, our ability to improve Adjusted Gross Margin over time is not guaranteed and could be impacted by the factors affecting our performance. We believe Adjusted Gross Profit and Adjusted Gross Margin are useful to investors, as they eliminate the impact of certain non-cash expenses and allow a direct comparison of these measures between periods without the impact of non-cash expenses and certain other nonrecurring operating expenses. The following table sets forth the components of the Adjusted Gross Profit and Adjusted Gross Margin for the periods included (dollars in thousands) : Year ended December 31, 2023 2022 (Dollars in thousands, except percentages) Revenue $ 34,933 $ 19,920 Cost of revenue, excluding depreciation and amortization 16,499 10,890 Adjusted Gross Profit $ 18,434 $ 9,030 Adjusted Gross Margin 52.8 % 45.3 % Adjusted Gross Margin, for the year ended December 31, 2023 increased to 52.8% from 45.3% for the year ended December 31, 2022 . As the Company continues to scale and standardize its product offerings it has begun to realize operational efficiencies that have resulted in an improved Adjusted Gross Margin. Additionally, the Company has worked diligently to reduce its software and data costs. 46 Table of Contents Key Performance Indicators We regularly review several indicators, including the following key indicators, to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions. Recurring Revenue As part of the ongoing development of our selling strategy, we have been focusing on sales that employ contracts with recurring revenue. We expect these contracts to provide a more predictable stream of revenues, compared to one-time sales of hardware and software licenses which are generally more difficult to predict. Our recurring revenue model and revenue retention rates provide significant visibility into our future operating results and cash flow from operations. This visibility enables us to better manage and invest in our business. The following table sets forth our recurring revenue for the periods included (dollars in thousands) : Year ended December 31, 2023 2022 Change $ % Recurring revenue $ 20,755 $ 13,091 $ 7,664 59 % As we continue to focus on long-term contracts with recurring revenue as part of our business model, we expect recurring revenue growth in future periods to continue to increase as we move to market our suite of products through our Rekor One™ platform. However, procurement requirements for some of our largest customers may result in periods when there is an increase one-time sales as compared to recurring revenues, which may cause the proportion of recurring revenues generated in those periods to fluctuate. Total Contract Value The total contract value of contracts won in the current period also provides us with visibility into our future operating results and cash flows from operations. Total contract value is a non-GAAP measure in which there are certain assumptions that we make when determining the total contract value of an agreement, such as the success rate of renewal periods, cancellations and usage estimates. For the year ended December 31, 2023, we won contracts valued at $49,087,000 , compared to $21,962,000 of contracts won for the year ended December 31, 2022. This represents growth of $27,125,000 or 124% , period over period. Performance Obligations While a portion of the total contract value won in a particular period represents revenue earned during the period, the remainder represents future performance obligations that can provide an indication of our future revenues. As of December 31, 2023, we had appro ximately $26,390,000 of performance obligations with respect to contracts that were closed prior to December 31, 2023 but have a contractual period beyond December 31, 2023 . This represents growth of $4,978,000 or 23% compared to $21,412,000 of performance obligations as of December 31, 2022. These contracts generally cover a term of one to five years, during which the Company will recognize revenue ratably over the contract term. We currently expect to recognize approximately $18,624,000 of this amount over the succeeding twelve months, and the remainder is expected to be recognized over the following four years. On occasion, our customers will prepay the full contract or a substantial portion of the contract. Amounts related to the prepayment of the contract related to the performance obligation for a service period that is not yet met are recorded as part of our contract liabilities balance. 47 Table of Contents Lease Obligations As of December 31, 2023 , we had significant leased building space at the following locations: ● Columbia, Maryland – The corporate headquarters ● Tel Aviv, Israel We believe our facilities are in good condition and adequate for their current use. We expect to improve, replace and increase facilities as considered appropriate to meet the needs of our planned operations. 48 Table of Contents Liquidity and Capital Resources The net cash flows from operating, investing and financing activities for the periods below were as follows (dollars in thousands): Year ended December 31, 2023 2022 Change $ % Net cash used in operating activities - continuing operations $ (32,178 ) $ (40,070 ) $ 7,892 20 % Net cash provided by (used in) investing activities - continuing operations 270 (8,264 ) 8,534 -103 % Net cash provided by financing activities - continuing operations 45,602 23,868 21,734 91 % Net increase (decrease) in cash, cash equivalents and restricted cash and cash equivalents - continuing operations $ 13,694 $ (24,466 ) $ 38,160 -156 % Net cash used in operating activities for the year ended December 31, 2023, had a net decrease of $7,892,000, which was attributable to the improvement of our Adjusted EBITDA of $8,754,000 which saw a 23% improvement period over period. The net increase in net cash used in investing activities of $8,534,000 was primarily due to a decrease in the outflow of funds related to merger and acquisition activities and capital expenditures. During the year ended December 31, 2023, the Company had net cash outflows of $1,388,000 related to capital expenditures compared to $4,171,000 for the year ended December 31, 2022. Additionally, during the year ended December 31, 2022, the Company had net cash outflows of $6,389,000 related to the acquisition of STS. This outflow was partially offset by $3,051,000 in cash proceeds from the sale of the Company's ATSE business unit. Net cash provided by financing activities for the year ended December 31, 2023 increased by $21,734,000 from the prior year ended December 31, 2022. During the year ended December 31, 2023, as part of our 2023 Promissory Notes and the 2023 Registered Direct Offering, we received net proceeds of $11,100,000 and $9,159,000, respectively. Additionally, in the third quarter of 2023, we received gross proceeds of $10,996,000 related to the exercise of warrants associated to the 2023 Registered Direct Offering. Lastly, in the fourth quarter of 2023, we raised $14,330,000 related to our Series A Prime Revenue Sharing Notes. In the prior comparable period, through our 2022 Sales Agreement, we received net proceeds, after deducting the underwriting discounts and commissions and offering expenses payable by us, of $22,754,000. For the years ended December 31, 2023 and 2022 , we funded our operations primarily through cash from the sale of equity, operating activities from our subsidiaries and the issuance of debt. As of December 31, 2023 , we had unrestricted cash and cash equivalents from continuing operations of $15,385,000 and working capital of $8,100,000, as compared to unrestricted cash and cash equivalents of $1,924,000 and a working capital deficit of $6,010,000 as of December 31, 2022 . Liquidity and Going Concern Management has assessed going concern uncertainty to determine whether there is sufficient cash on hand, together with expected capital raises and working capital, to assure operations for a period of at least one year from the date these 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 has considered 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 and negative operating cashflows since its inception and has relied on external sources of financing to support the cash flow from operations. The Company attributes losses to non-capital expenditures related to the scaling of existing products and services, development of new products and services and marketing efforts associated with these existing and new products and services. As of and for the year ended December 31, 2023, the Company had working capital from continuing operations of $8,100,000 and a loss from continuing operations of $45,685,000. Our cash increased by $13,245,000 for the year ended December 31, 2023 primarily due to net cash provided by financing activities of $45,602,000 which was offset by the net cash used in operating activities of $32,627,000. Based on the Company's current business plan assumptions and the expected cash burn rate, the Company believes that the existing cash is insufficient to fund its current level of operations for the next twelve months following the issuance of these consolidated financial statements. These factors raise substantial doubt regarding the Company’s ability to continue as a going concern. The Company's ability to generate positive operating results and execute its business strategy will depend on (i) its ability to continue the growth of its customer base, (ii) its ability to continue to improve its quarterly financial metrics such as net loss and cash used from operating activities (iii) the continued performance of its contractors, subcontractors and vendors, (iv) its ability to maintain and build good relationships with investors, lenders and other financial intermediaries, (v) its ability to maintain timely collections from existing customers, and (vi) the ability to scale its business processes. To the extent that events outside of the Company's control have a significant negative impact on economic and/or market conditions, they could affect payments from customers, services and supplies from vendors, its ability to continue to secure and implement new business, raise capital, and otherwise, depending on the severity of such impact, materially adversely affect its operating results. 49 Table of Contents Balance Sheet Arrangements, Contractual Obligations and Commitments As of the date of this Annual Report on Form 10-K, we did not have any off-balance sheet arrangements that have had or are reasonably likely to have a material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital resources or capital expenditures. Critical Accounting Estimates Our discussion and analysis of our financial condition and results of our operations is based upon our audited consolidated financial statements as of and for the years ended December 31, 2023 and 2022, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. We believe the application of the estimates inherently required therein, are reasonable. These estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Rekor bases its estimates on historical experience and on various other assumptions that the management of Rekor believes to be reasonable under the circumstances, the results of which form management’s basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, or if management made different judgments or utilized different estimates. 50 Table of Contents Revenue Recognition Judgment is required for the estimation of the standalone selling price (“SSP”) and the allocation of the transaction price by relative SSPs. We have arrangements that include multiple performance obligations in which we need to allocate the transaction price using the SSP. Our customer arrangements containing multiple performance obligations typically include the sale and installation of cameras systems, licensing of our software and the performance of maintenance services over a contractual term. In most instances, we have determined these performance obligations qualify as distinct performance obligations, as the customer can benefit from the service on its own or together with other resources that are readily available to the customer, and our promise to transfer the service is separately identifiable from other promises in the contract. For arrangements that contain multiple performance obligations, we exercise judgment in allocating the transaction price based on the relative SSP method by comparing the SSP of each distinct performance obligation to the total value of the contract. We apply judgment in determining the SSP for each distinct performance obligation. Liquidity Analysis Our liquidity analysis requires a blend of judgment and estimation, relying on both quantitative data and qualitative insights to assess our ability to sustain our operations over the forward-looking period. Management’s analysis involves a comprehensive evaluation of numerous factors to determine whether we can continue our operations during the look-forward period. We evaluate our recent financial performance, liquidity position, and our ability to meet our financial obligations as they become due. Factors such as financial projections, profitability, cash flow, and debt commitments require estimation and are examined to gauge our financial health. Our ability to manage our cash flow is another critical aspect of the analysis. Effective cash flow management ensures that we have sufficient liquidity to cover our operating expenses, debt repayments, and other financial obligations. Our cash flow projections are reviewed to determine whether we can generate enough cash to sustain our operations during the look-forward period. Our estimates over our financial projections play a vital role in our analysis. We utilize various assumptions and factors such as market conditions, customer relationships, our sales pipeline, industry trends, and our strategic initiatives to develop and validate our financial projections. Conducting a liquidity analysis is an exercise in judgment, requiring us to evaluate data points, forecasts, and qualitative insights to arrive at a comprehensive assessment of our ability to remain cash flow positive during the look-forward period. In this process, we must exercise caution, recognizing the inherent uncertainties and limitations of our estimations and financial analysis while striving to provide feasible plan that can successfully mitigate conditions and events that may raise doubt of our ability to continue as a going concern. New Accounting Pronouncements See Item 8 of Part II, “Financial Statements and Supplementary Data — Note 1 — Business and Significant Accounting Policies” 51 Table of Contents ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide the information required by this Item.