Rekor Systems, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cautionary Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q (the “Quarterly Report”) contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve substantial risks and uncertainties including particularly statements regarding our future results of operations and financial position, business strategy, prospective products and services, timing and likelihood of success, plans and objectives of management for future operations, and future results of current and anticipated products and services. These statements involve uncertainties, such as known and unknown risks, and are dependent on other important factors that may cause our actual results, performance or achievements to be materially different from the future results, performance or achievements we express or imply. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. These forward-looking statements speak only as of the date of this Quarterly Report and are subject to a number of risks, uncertainties, and assumptions described under the sections in our Annual Report on Form 10-K for the year ended December 31, 2020 and our Quarterly Reports for the quarter’s ended March 31, 2021 and June 30, 2021, entitled “Risk Factors” and elsewhere in this Quarterly Report. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made in this Form 10-Q and in other documents we file from time to time with the Securities and Exchange Commission (the “SEC”) that disclose risks and uncertainties that may affect our business. The forward-looking statements in this Form 10-Q do not reflect the potential impact of any divestitures, mergers, acquisitions, or other business combinations that had not been completed as of the date of this filing. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified and some of which are beyond our control, you should not rely on these forward-looking statements as predictions of future events. We undertake no obligation to update any forward-looking statement as a result of new information, future events or otherwise. Specific factors that might cause actual results to differ from our expectations include, but are not limited to: ● significant risks, uncertainties and other considerations discussed in this report; ● operating risks, including supply chain, equipment or system failures, cyber and other malicious attacks and other events that could affect the amounts and timing of revenues and expenses; ● reputational risks affecting customer confidence or willingness to do business with us; ● financial market conditions and the results of financing efforts; ● our ability to successfully identify, integrate and complete acquisitions and dispositions, including the integration of the Waycare Acquisition; ● our ability to access the public markets for debt or equity capital; ● political, legal, regulatory, governmental, administrative and economic conditions and developments in the United States (“U.S.”) and other countries in which we operate and, in particular, the impact of recent and future federal, state and local regulatory proceedings and changes, including legislative and regulatory initiatives associated with our products; ● current and future litigation; ● competition from other companies with an established position in the markets we have recently entered or are seeking to enter or from other companies who are seeking to enter markets we already serve; ● our failure to successfully develop products using our technology that are accepted by the markets we serve or intend to serve or the development of new technologies that change the nature of our business or provide our customers with products or services superior to or less expensive than ours; ● the inability of our strategic plans and goals to expand our geographic markets, customer base and product and service offerings; 31 Table of Contents ● risks associated with pandemics and other global health emergencies, such as the spread of a novel strain of coronavirus (“COVID-19”) around the world since the first quarter of 2020 which has caused significant volatility in U.S. and international markets and has created significant uncertainty around the breadth and duration of business disruptions related to COVID-19, as well as its impact on the U.S. and international economies; and ● risks associated with cyberattacks on international, national, local and Company information infrastructure by rogue businesses or criminal elements or by agents of governments engaged in asymmetric disruptions for competitive, economic, or military reasons. Investors are cautioned that these forward-looking statements are inherently uncertain. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein. Other than as required by law, we undertake no obligation to update forward-looking statements even though our situation may change in the future. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report and the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 Annual Report”), our Quarterly Reports for the quarters ended March 31, 2021 and June 30, 2021 and any updates contained herein as well as those set forth in our reports and other filings made with the SEC. General Overview Rekor Systems, Inc. develops innovative products and services for the intelligent infrastructure market and is working to drive the world to be safer, smarter, and more efficient. As a provider of comprehensive, continuous and real-time roadway intelligence, Rekor delivers integrated solutions, actionable insights and predictions that increase roadway safety, increase efficiency and better protect the environment. With a global footprint across 65 countries, we provide actionable and real-time insights to commercial clients, as well as government entities. Our vision is to provide innovations that improve the lives, safety and well-being of people using AI and other advanced technologies. Our capabilities appeal to businesses and governmental entities in solving a wide variety of real-world mobility and infrastructure-related operational challenges. Using the latest technology that gathers and collates comprehensive data and transforms this data into actionable insights, the Company delivers useable solutions that empower smart cities and intelligent roadways. Our suite of solutions is seamless, easy to use, and can tie directly into customer workflows, providing value directly to users in their daily operations. Our products and services contribute to building environmentally friendly cities and roadways that leverage our insights to operate more efficiently and sustainably. Customers can operate our technology on existing systems or use our advanced sensors and third-party data to create a holistic view of the roadway and infrastructure. Currently, customers use our solutions for a variety of applications, including roadway safety and incident management, traffic and infrastructure analytics, sustainability and green initiatives, public safety and contactless compliance. We create safer communities by providing government agencies with the technology they need to effectively protect and serve their citizens and provide businesses with solutions to improve customer experience, enhance revenue, reduce operating costs and drive operational efficiency. Rekor aggregates data using mobile and mounted optical sensors with on-device (“edge”) processing, as well as through the acquisition of data feeds from third party vendors such as connected vehicles, weather, construction, and traffic data. Our tech stack, with its open architecture, allows seamless integration with any Internet Protocol (“IP”) optical device, reducing our clients’ need to invest in legacy system upgrades and affording them the ability to gain additional value from existing infrastructure. Our advanced sensors use edge processing to capture, store, and process real-time data close to the source, allowing them to provide almost instant actionable insights from the roadway. We use artificial intelligence and machine learning to process the large amounts of information we capture and integrate and use it to provide tailored solutions to our clients. Our sophisticated and proprietary personally identifiable information (“PII”) filter de-identifies relevant data in an irreversible way so that it is incorporated into our intelligent infrastructure platform in full compliance with the security and privacy requirements of each end user. Authorized entities can also leverage our operational data to improve public safety and institute contactless compliance programs. 32 Table of Contents Rekor One™ is our single source platform for intelligent infrastructure. Rekor One provides government agencies with real-time roadway intelligence using cutting edge artificial intelligence and machine learning technology that can be significantly enhanced using our proprietary advanced sensors. The result is a powerful analytics platform that delivers a comprehensive picture of vehicles, traffic, incidents and more within a particular jurisdiction. Rekor One’s actionable insights improve operations, enable better informed decision making, and allow for more strategic allocation of resources. The solution is hardware and software agnostic, allowing for seamless integration without interrupting existing systems in place. Our platform was built to allow us to create custom applications for an array of use cases. Some use cases used today include: · Traffic and Congestion Forecasting · Cross-Agency Incident Management · Electric Vehicle Monitoring · Commercial Vehicle and Tonnage Monitoring · Environmental Impact · On-Demand Traffic View · Contactless Compliance · License Plate Recognition & Vehicle Recognition for Public Safety Ultimately, we seek to deliver insights through an expanding software portfolio that not only addresses the challenges our customers are currently facing but also empowers them to effectively deal with their evolving challenges in the future. Our vehicle recognition solution has the capability to analyze multi-spectral images and video streams using AI trained algorithms and concurrently extract license plate data by state or province from approximately 80 countries, together with the vehicle’s make, model, color, body type, and direction of travel. When combined with speed-optimized code, parallel processing capability and best-in-class hardware accessories, such as optical sensors and communications modules, the solution captures license plate data and vehicle characteristics at extremely high vehicle speeds with a high degree of accuracy. It is also able to effectively operate in unusually difficult conditions, such as low lighting, poor weather, extreme camera viewing angles, and obstructions. Our incident management solution also uses artificial intelligence and machine learning to detect anomalies in regular traffic patterns. A jurisdiction will be broken down into sections of roadway that are then analyzed methodically by our platform. Historical incident information will be fed into the system from multiple sources. This data contains clues that the algorithm can use to identify when a roadway is most likely to exhibit high crash risk, is displaying irregular patterns of traffic, or there might be an incident on the road. Based on current variables at play and the knowledge the system has gained, our platform displays these insights on the live map for agencies to assess and respond to proactively. Each insight and its outcomes are used in the machine learning algorithms to improve the accuracy of our modeling. It is with this advanced technology and breadth of use-cases across multiple industries that we seek to address issues of aging infrastructure, increasing traffic congestion, and depletion of natural resources, by providing customers with the ability to collect, analyze and communicate actionable roadway and community intelligence in an accurate, real-time, and cost-effective manner. We provide actionable and differentiated answers on a single platform that is built to serve multiple missions. Our operations are conducted by our wholly owned subsidiary, Rekor Recognition Systems, Inc. (“Rekor Recognition”) and Waycare. In October 2020, we announced the launch of Rekor One™, an advanced platform that serves as a unifying source of roadway intelligence for multiple government agencies across cities, counties, and states. Rekor One™ next generation operating system purpose built for the intelligent infrastructure industry. Using patented AI and Machine learning, our operating system joins many disparate data points and transforms them into purpose-built solutions that provide a more complete picture of the roadway. This technology disrupts the 100-year-old intelligent transportation systems (“ITS”) legacy systems that exist today and brings real-time solutions to customers, all unified under a single platform that helps municipalities and businesses make the world safer, smarter, and more efficient. 33 Table of Contents Recent Developments The most significant developments in our company and business since January 1, 2021 are described below: · On October 22, 2021, we announced that our Waycare subsidiary was honored with a Nevada Traffic Safety Project of the Year Award for its part in Nevada’s “Road to Zero” program. The Nevada Highway Patrol (NHP) and the Regional Transportation Commission of Southern Nevada (RTC) were joint recipients of the award. The accolade, which was announced October 18 at the 2021 Nevada Traffic Safety Summit in Las Vegas, recognizes individuals and organizations that have made an outstanding effort to eliminate serious injury and fatal crashes on Nevada roadways. · On October 19, 2021, we announced that the City of Chattanooga, Tennessee (or the “City”) has selected our Rekor One™ platform to provide traffic analytics in support of its Smart Corridor+ infrastructure initiative. With a total area of 144.6 square miles and a population of 181,099, the City will be using Rekor One as part of a pilot program to capture and analyze traffic data to help the City discover new approaches for battling traffic congestion, improve forecasting, estimate emissions from real-time data, and increase public safety. · On October 11, 2021, we announced that our wholly owned subsidiary, Waycare Technologies (“Waycare”) was selected for a strategic research initiative by Volvo Cars to ascertain how artificial intelligence can be used to enable predictive awareness in a smart city context. This marks the first deployment in Europe for the company’s crash prediction technology. The six-month pilot test, beginning in October 2021, involves the Waycare technology being used for AI-based crash prediction in Volvo Cars’ hometown of Gothenburg, Sweden. Volvo Cars is leading the research project for Drive Sweden’s AI Aware program, which investigates and tests central traffic control that supports connected and automated vehicles. The test will be performed in conjunction with the Swedish Transport Administration (“STA”) and the Gothenburg Traffic Management Center (“TMC”). · On October 5, 2021, we announced that we have partnered with the world’s leading Weather Intelligence Platform, Tomorrow.io. The partnership will enable data integration to provide transportation agencies increased visibility into weather-related challenges impacting traffic conditions. Government agencies and other field users will benefit from predictive insights to identify high risk zones and routes and enable proactive operational decisions to increase road safety prior to weather impact. · On October 4, 2021, we announced that three Mid-Atlantic customers will deploy Rekor solutions to improve public safety in their respective municipalities. With each of these customers, Rekor’s technology met or exceeded rigorous performance requirements necessary to support public safety missions including being a turnkey, cloud-based solution that is not dependent on proprietary infrastructure. · On September 30, 2021, we announced that our wholly owned subsidiary Waycare has collaborated with the Toyota Mobility Foundation (“TMF”) to reduce traffic congestion and incidents in Bangkok, Thailand. The deployment, which is expected to run for a year, targets Thailand’s oldest and busiest road—Rama IV Road in Bangkok. · On September 21, 2021, we announced that our wholly owned subsidiary Waycare launched a Road Safety Pilot with the Utah Department of Transportation (“UDOT”) and Utah Department of Public Safety (“DPS”). The pilot, which launched in July 2021, will focus on major corridors in the Salt Lake City region along Interstates 15, 215, and 80, as well as Utah State Route 201. The agencies will leverage the Company's solutions to enable quicker, more efficient incident management and mitigation strategies, in addition to improving its collaboration and reporting capabilities. · On September 9, 2021, we announced that our wholly owned subsidiary Waycare has been selected by the Louisiana Department of Transportation and Development (“LaDOTD”) for a pilot program to help reduce congestion and collisions in the Baton Rouge area and promote speed harmonization for a safer driving experience. The initial deployment, which kicked off July 15, 2021, focuses on some of the region’s most dangerous sections of highway: Interstate 10 (“I-10”) and Interstate 12 (“I-12”). 34 Table of Contents ● On August 19, 2021, we announced the successful closing of the acquisition of Waycare Technologies Ltd. a privately held company focused on optimizing traffic management systems using predictive analytics. Pursuant to the purchase agreement the Company provided $61,000,000 in total consideration consisting of a combination of cash and common stock and acquired 100% of the issued and outstanding capital stock of Waycare from its stockholders. ● In July 2021, we announced the selection of or Rekor One™ vehicle recognition system by the City of Albany, New York, in partnership with the Albany Police Department. Rekor was selected after a competitive bid process in June 2021 to help maintain the safety and security of the community and its citizens. ● In July 2021, we announced that Wisconsin’s Waukesha County has selected the Rekor One™ vehicle recognition system for implementation at eight of its public park entrances. The solution was selected after a competitive bid process in early 2021, to help maintain the security of each location and to ensure entrance fee compliance. ● On February 26, 2021, we announced that the State of North Dakota Parks and Recreation Department selected our Rekor One™ solution to help state park leadership understand use patterns and plan for future needs. ● In February 2021, we completed an underwritten public offering of 6,126,939 shares of common stock of the Company at a price to the public of $12.25 per share. We received aggregate gross proceeds of approximately $75.1 million from the offering, prior to deducting underwriting discounts and commissions and offering expenses payable by us. We intend to use these proceeds to increase our product development, sales and marketing efforts and to consider strategic partnerships and acquisitions in our target markets. As a result of the offering, all of our Series A Cumulative Convertible Redeemable Preferred Stock automatically converted into 899,174 shares of our common stock. In addition, on February 9, 2021, we issued 517,611 shares of our common stock, due to the automatic conversion of 240,861 shares of Series B Preferred Stock, as a result of the volume weighted share price of our common stock exceeding certain thresholds. These automatic conversions resulted in the retirement of all of our outstanding preferred shares. ● On January 7, 2021, we announced that the State of Oklahoma had integrated our Rekor One™ platform across relevant state systems to provide vehicle information associated with uninsured motorists as part of the state’s Uninsured Vehicle Enforcement Diversion (“UVED”) Program, which is operated by the Oklahoma District Attorneys Council. Oklahoma’s UVED Program uses our vehicle recognition technology to leverage existing state resources to ensure that all drivers have at least the minimum required amount of liability insurance, ultimately leading to safer roadways. The platform allows for real-time detection of non-compliant vehicles and instant data consolidation into a regularly updating insurance system connected to the state’s enforcement and intervention programs. We assist Oklahoma drivers by providing a one-stop web portal for uninsured motorists to easily find non-standard and standard insurance for their vehicles. With the successful implementation of Oklahoma’s UVED Program, we have now established a leading position in the implementation of an innovative program under active consideration by a number of other states. 35 Table of Contents 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 Nation’s report, about two-thirds of the world population will live in urban areas by 2050. Our cities are getting larger, our commute longer, roads bigger and the impact on the environment and the quality of life is worse than ever been. This trend requires forward-thinking officials to manage assets and resources more efficiently than they have in the past. We believe that advancements in “big data”, connected devices and artificial intelligence will allow for ITS solutions and applications 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 the necessary tools to more effectively tackle the challenges cities and communities are facing today and over the coming decades. ● AI for Infrastructure – We believe that the application of AI to the analysis of infrastructure, including roadways and roadway conditions will significantly affect vehicular 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 vehicular flow as well as data around the vehicles on the roadway. ● Connected Vehicle Data – Today’s vehicles are equipped with dozens of sensors, collecting information about internal systems, external hazards, and driving behaviors. This data is an untapped resource for cities and transportation agencies alike. 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 provide important information related to hazardous conditions, speed variations, intersection performance, and more. This data can help agencies and cities gain more visibility on their roads, supplementing the existing city infrastructure and providing untapped transportation information in more rural areas, that are not currently available from the current ITS infrastructure. Our utilization and greater use of cellular-enabled connected vehicle data can be another step towards vehicle safety as the Federal Communications Commissions and the U.S. Department of Transportation sort out the next iteration in connectivity. ● 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 a number of 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 and municipalities that are testing automated license plate recognition (“ALPR”) systems or that issued requests for proposals to install a network of ALPR cameras. 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 Current ALPR 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 in almost every metric. However, large users of existing ALPR technology, such as toll roads, 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 or secure their advanced vehicle recognition systems. 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 believe that future legislation will allow for automated enforcement of motor vehicle regulations, including insurance requirements, to be expanded as the types of violations authorized for automated enforcement increase and experience provides localities with a better understanding of the circumstances where automated enforcement is beneficial. In addition, 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. Legislative implementation is a deliberative and necessarily time-consuming process. However, as states expand auto enforcement, the market for our products and services should increase and 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 camera resolutions. Over the last several decades, cameras have evolved from 25K pixels to 8.3 million pixels and beyond, with each advancement unlocking new capabilities thereby fueling growth. Further, cellular networks are optimized for downloading data not for uploading data, and while speeds have improved over time, what amounts to large infrastructure changes has resulted in relatively small improvements to cellular upload speeds. With road-side deployments experiencing explosive growth in count and density, scalability has become an obstacle for competition in the market. All of these factors mean that scalability, latency and bandwidth concerns require edge processing which are enabled by the continued growth of the increasingly effective graphic processing units and continual improvements in the efficiency of our AI algorithms. Edge processing ingests local high definition (“HD”) video streams and converts the raw video data to text data, thus reducing the volume of data that needs to be transferred. Edge processing allows massive scale without the bandwidth, cost, latency and dependability limitations that would be experienced with streaming to the cloud solution. ● 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 leadership position. As a result, we have accelerated our business development marketing and eCommerce activities to increase awareness and market adoption of our new technology and products within the market. We anticipate that an increased presence in the market, the continued development of strategic partnerships and other economies of scale will significantly 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 ● COVID 19 - The spread of a novel strain of COVID-19 around the world since the first quarter of 2020 has caused significant volatility in U.S. and international markets. Despite the roll-out of vaccinations, there continues to be significant uncertainty around the breadth and duration of business disruptions related to COVID-19, as well as its impact on the U.S. and international economies and, as such, we are unable to determine the full impact to our operations. However, we have also seen a positive impact of COVID-19 on the technology sector, in which we are competing. The pandemic has accelerated adoption of technology across businesses by several years. According to a McKinsey Global Survey of executives, their companies have accelerated the digitization of their customer and supply-chain interactions and of their internal operations by three to four years. Funding for digital initiatives has increased, creating opportunities for innovate solution providers such as Rekor. ● Pressure on Government Budgets – COVID-19 has caused significant strain on government budgets. With less money to spend and more need for resources, government agencies need affordable, effective, and scalable solutions for revenue recovery and discovery. With subscription pricing and an intelligent infrastructure platform that accomplishes multiple agency missions, we are uniquely positioned to provide agencies force-multiplying tools when money and human resources are limited. Agencies can be better positioned to improve public safety, manage resources more effectively, and make an impact on their citizens quality of life with limited capital expenditure. In addition, states adopting contactless compliance programs may be able to garner significant net cash contributions to their annual budgets while reducing the number of noncompliant vehicles on their roadways. ● American Jobs Plan (“AJP”) - Through the AJP, President Biden is calling on Congress to make a national investment in the transit systems in the United States. The current legislative text provides approximately $1 trillion in total spending, with approximately $550 billion in new spending over the five year period between 2022 and 2026. This includes more than $50 billion annually during this period on surface transportation. It also includes $250 million in funding, for each year 2022-2026, for transportation infrastructure finance and innovation; $50 million in funding, for each year 2022-2026, for congestion relief; more than $2 billion over the five year period for charging and fueling infrastructure; $147 million in funding, for each year 2022-2026, for highway research and development; $110 million in funding, for each year 2022-2026, for technology innovation and deployment; and $110 million in funding, for each year 2022-2026, for intelligent transportation systems. The Senate has passed this legislation and it is now awaiting action in the House. We believe that our offerings with Rekor One, and its ability to provide a comprehensive offering of solutions position the Company well to emerge as a technology leader in this proposed transformation and development of this nascent and rapidly expanding market of intelligent infrastructure. Components of Operating Results Revenues We derive revenues substantially from Software-as-a-Service products (“SaaS”), licensing and subscriptions, customer support services, contactless compliance solutions, implementation services, perpetual license sales, and the sale of hardware in connection with our software solutions. Revenue is recognized upon transfer of control of promised products and services to our 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 incurred. 38 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 depreciation, amortization and impairment of assets. General and Administrative General and administrative expense 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 increase in absolute dollars for the foreseeable future due to additional costs associated with accounting, compliance, insurance and investor relations as a public company. However, we expect our general and administrative expense to decrease as a percentage of our revenue over the long term, although our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. Sales and Marketing Sales and marketing expenses consist of personnel costs, marketing programs, travel and entertainment associated with sales and marketing personnel, expenses for conferences and trade shows. We intend to make significant investments in our sales and marketing expenses to grow revenue, further penetrate the market and expand our customer base. Research and Development Research and development expenses consists of personnel costs, software used to develop our products and consulting and professional fees for third-party development resources. Our research and development expenses support our efforts to continue to add capabilities to and improve the value of our existing products and services, as well as develop new products and services. We expect our research and development expenses to continue to increase in absolute dollars for the foreseeable future as we continue to invest in research and development efforts to enhance the functionality of our AI solutions. However, we expect our research and development expenses to decrease as a percentage of our revenue over the long term, although our research and development expense may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. Depreciation and Amortization Depreciation and amortization expenses are primarily attributable to our capital investments and consist of fixed asset depreciation, amortization of right-of-use assets, 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 interest 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, and 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. 39 Table of Contents Critical Accounting Estimates and Assumptions A comprehensive discussion of our critical accounting estimates and assumptions is included in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section in our Annual Report on Form 10-K for the year ended December 31, 2020. New Accounting Pronouncements See Note 1 to our unaudited condensed consolidated financial statements set forth in Item 1 of this quarterly report for information regarding new accounting pronouncements. Results of Operations Our historical operating results in dollars are presented below. The analysis of operation is solely related to continuing operations and does not consider the results of discontinued operations. Three Months ended September 30, Nine Months ended September 30, (dollars in thousands) 2021 2020 2021 2020 Revenue $ 2,615 $ 2,126 $ 11,105 $ 6,399 Cost of revenue, excluding depreciation and amortization 1,402 979 4,705 2,745 Operating expenses: General and administrative expenses 6,813 2,676 16,094 7,518 Selling and marketing expenses 1,125 560 3,044 1,356 Research and development expenses 2,000 781 4,741 2,143 Depreciation and amortization 930 497 2,169 1,386 Operating expenses 10,868 4,514 26,048 12,403 Loss from operations (9,655 ) (3,367 ) (19,648 ) (8,749 ) Other income (expense): Loss on extinguishment of debt - (3,081 ) - (3,281 ) Interest expense (21 ) (218 ) (72 ) (2,468 ) Gain on the sale of business - - - 3,631 Other income 66 6 103 27 Total other income (expense) 45 (3,293 ) 31 (2,091 ) Loss before income taxes (9,610 ) (6,660 ) (19,617 ) (10,840 ) Income tax provision (3 ) (7 ) (10 ) (20 ) Equity in loss of investee - - (150 ) - Net loss from continuing operations (9,613 ) (6,667 ) (19,777 ) (10,860 ) Net loss from discontinued operations - (2 ) (4 ) (215 ) Net loss (9,613 ) (6,669 ) (19,781 ) (11,075 ) Comprehensive loss: Net loss from continuing operations (9,613 ) (6,667 ) (19,777 ) (10,860 ) Change in unrealized gain on short-term investments 3 - 6 - Total comprehensive loss from continuing operations (9,610 ) (6,667 ) (19,771 ) (10,860 ) Total comprehensive loss $ (9,610 ) $ (6,669 ) $ (19,775 ) $ (11,075 ) 40 Table of Contents Comparison of the Three and Nine months ended September 30, 2021 and the Three and Nine months ended September 30, 2020 Total Revenue Three Months ended September 30, Change Nine Months ended September 30, Change (dollars in thousands) 2021 2020 $ % 2021 2020 $ % Revenue $ 2,615 $ 2,126 $ 489 23 % $ 11,105 $ 6,399 $ 4,706 74 % The increase in revenue for the three and nine months ended September 30, 2021, compared to the three and nine months ended September 30, 2020, was a result of additional products and programs we offered, increases in our direct sales and Partners Program sales. In 2021, we initiated services for Oklahoma’s UVED Program which has generated revenue of $345,000 and $975,000 during the three and nine months ended September 30, 2021. During the three and nine months ended September 30, 2021, $260,000 of revenue was attributed to Waycare. Additionally, during the nine months ended September 30, 2021, we had a higher volume of agreements with significant customers in which the revenue recognition was bifurcated into point in time revenue recognition related to the sale of hardware and perpetual licenses, as well as recurring revenue recognition related to the software and customer support fees. Cost of Revenue, Excluding Depreciation and Amortization Three Months ended September 30, Change Nine Months ended September 30, Change (dollars in thousands) 2021 2020 $ % 2021 2020 $ % Cost of revenue, excluding depreciation and amortization $ 1,402 $ 979 $ 423 43 % $ 4,705 $ 2,745 $ 1,960 71 % For the three and nine months ended September 30, 2021, cost of revenue, excluding depreciation and amortization increased by $423,000 and $1,960,000 compared to the corresponding prior periods. The increase was primarily due to an increase in personnel and other direct costs such as hardware that were incurred to support our increase in revenue. Operating Expenses Three Months ended September 30, Change Nine Months ended September 30, Change (dollars in thousands) 2021 2020 $ % 2021 2020 $ % Operating expenses: General and administrative expenses $ 6,813 $ 2,676 $ 4,137 155 % $ 16,094 $ 7,518 $ 8,576 114 % Selling and marketing expenses 1,125 560 565 101 % 3,044 1,356 1,688 124 % Research and development expenses 2,000 781 1,219 156 % 4,741 2,143 2,598 121 % Depreciation and amortization 930 497 433 87 % 2,169 1,386 783 56 % Operating expenses $ 10,868 $ 4,514 $ 6,354 141 % $ 26,048 $ 12,403 $ 13,645 110 % General and Administrative Expenses The majority of the increase in general and administrative expenses is attributable to increased headcount and equity award expenses. Additionally, for the three and nine months ended September 30, 2021 compared to the three and nine months ended September 30, 2020, we saw an increase in professional fees mainly associated with our merger and acquisition initiatives. Selling and Marketing Expenses The increase in selling and marketing expenses during the year is attributable mainly to increased marketing efforts to promote our products and services including digital marketing and other sales efforts. In connection with these efforts, there was an increase in staffing to support the Company’s growth plan. Research and Development Expense The overall increase in research and development expenses is primarily attributable to the development of new products and additional software capabilities, as a result of our increased focus on technology offerings. The increase in research and development expenses is mainly attributable to an increase in headcount and hours associated with research and development activities. 41 Table of Contents Depreciation and Amortization The increase in depreciation and amortization during the year is attributable primarily to increased technology-based intangible assets that were acquired as part of our acquisition of Waycare. Other Expense Three Months ended September 30, Change Nine Months ended September 30, Change (dollars in thousands) 2021 2020 $ % 2021 2020 $ % Other income (expense): Loss on extinguishment of debt $ - $ (3,081 ) $ 3,081 -100 % $ - $ (3,281 ) $ 3,281 -100 % Interest expense (21 ) (218 ) $ 197 90 % (72 ) (2,468 ) 2,396 97 % Gain on the sale of business - - - 0 % - 3,631 (3,631 ) -100 % Other income 66 6 60 1000 % 103 27 76 281 % Total other income (expense) $ 45 $ (3,293 ) $ 3,338 -101 % $ 31 $ (2,091 ) $ 2,122 -101 % The decrease in interest expense and debt extinguishment costs for the three and nine months ended September 30, 2021 compared to the three and nine months ended September 30, 2020 is due to the retirement of the 2019 Promissory notes in 2020. Additionally, during the nine months ended September 30, 2020, we sold our non-core businesses which resulted in a gain of $3,631,000. Non-GAAP Measures: EBITDA and Adjusted EBITDA 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): Three Months ended September 30, Nine Months ended September 30, 2021 2020 2021 2020 Total comprehensive loss from continuing operations $ (9,610 ) $ (6,667 ) $ (19,771 ) $ (10,860 ) Income taxes 3 7 10 20 Interest 21 218 72 2,468 Depreciation and amortization 930 497 2,169 1,386 EBITDA $ (8,656 ) $ (5,945 ) $ (17,520 ) $ (6,986 ) Loss on extinguishment of debt $ - $ 3,081 $ - $ 3,281 Share-based compensation 694 202 2,600 539 Gain on sale of business - - - (3,631 ) Loss due to change in value of equity investments - - 150 - One-time consulting fees 1,249 - 2,025 - Adjusted EBITDA $ (6,713 ) $ (2,662 ) $ (12,745 ) $ (6,797 ) 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-selling and upselling 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. 42 Table of Contents The following table sets forth the components of the Adjusted Gross Profit and Adjusted Gross Margin for the periods included: Three Months ended September 30, Nine Months ended September 30, 2021 2020 2021 2020 (in thousands, except percentages) (in thousands, except percentages) Revenue $ 2,615 $ 2,126 $ 11,105 $ 6,399 Cost of revenue, excluding depreciation and amortization 1,402 979 4,705 2,745 Adjusted Gross Profit $ 1,213 $ 1,147 $ 6,400 $ 3,654 Adjusted Gross Margin 46.4 % 54.0 % 57.6 % 57.1 % Adjusted Gross Margin, for the nine months ended September 30, 2021 and 2020 increased to 57.6% from 57.1%, respectively, and Adjusted Gross Margin for the three months ended September 30, 2021 and 2020 decreased to 46.4% from 54.0%, respectively. The fluctuations in Adjusted Gross Margin were driven primarily by our mix of software and hardware sales. Software sales will carry a higher margin than hardware sales as there are fewer human costs associated with software sales. Additionally, as part of our planned go-to-market strategy, we offer our customers short-term pilot programs which range from three to six months. Our pilot programs generally have lower margins due to additional upfront costs we incur to lay the foundation for our solutions. 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 Growth 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. Three Months ended September 30, Change Nine Months ended September 30, Change (dollars in thousands) 2021 2020 $ % 2021 2020 $ % Recurring revenue $ 1,233 $ 964 $ 269 28 % $ 3,142 $ 2,876 $ 266 9 % 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. Total Contract Value The total contract value of contracts won in the current period provides us visibility into our future operating results and cash flows from operations. There are certain assumptions that we make when determining the total contract value of an agreement, such as, success rate of renewal periods, cancellations and usage estimates. For the nine months ended September 30, 2021 we won contracts valued at $7,663,000, compared to $3,682,000 of contracts won for the nine months ended September 30, 2020. This growth represents a $3,981,000 or 108% growth, period over period. 43 Table of Contents Unsatisfied Performance Obligations As of September 30, 2021, we had approximately $23,845,000 of contracts that were closed prior to September 30, 2021 but have a contractual period beyond September 30, 2021. These contracts generally cover a term of one to five years, in which the Company will recognize revenue ratably over the contract term. We currently expect to recognize approximately 36% 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. Lease Obligations At September 30, 2021, we leased building space at the following locations in the U.S. and Israel: ● Columbia, Maryland – The corporate headquarters ● Linthicum, Maryland ● Orlando, Florida ● 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. Liquidity and Capital Resources The following table sets forth the components of our cash flows for the period included (dollars in thousands): Nine Months ended September 30, 2021 2020 Change $ % Net cash used in operating activities - continuing operations $ (12,321 ) $ (7,860 ) $ (4,461 ) -57 % Net cash (used in) provided by investing activities - continuing operations (43,392 ) 5,081 (48,473 ) -954 % Net cash provided by financing activities - continuing operations 70,874 25,356 45,518 180 % Net increase in cash, cash equivalents and restricted cash and cash equivalents - continuing operations $ 15,161 $ 22,577 $ (7,416 ) -33 % Net cash used in operating activities – continuing operations for the nine months ended September 30, 2021 had a net decrease of $4,461,000, which was attributable to the increase in the loss from continuing operations of $8,871,000. This amount was partially offset by an increase in share-based compensation expense, a non-cash adjustment, which increased $2,061,000 from $2,600,000 for the nine months ended September 30, 2021 compared to $539,000 for the nine months ended September 30, 2020. This increase is due to the number of shares that were issued as well as the increase in our stock price. Additionally, for the nine months ended September 30, 2020, there was a $3,631,000 gain on the sale of AOC Key Solutions and TeamGlobal. The gain on the sale is shown as a decrease in cash flow from operations and an increase in cash flow from investing activities to reflect the nature of the transactions. The net increase in net cash used in investment activities – continuing operations of $48,473,000 was primarily due to the net cash outlay in relation to the acquisition of Waycare of $40,699,000 and the $1,000,000 SAFE investment in Roker. During the nine months ended September 30, 2020, the cash provided by investing activities from continuing operations was primarily due to the cash proceeds of the sale of AOC Key Solutions and TeamGlobal. Net cash provided by financing activities – continuing operations for the nine months ended September 30, 2021 increased $45,518,000 from the prior nine month period ended September 30, 2020. In the current year, through our Public Offering, we received net proceeds, after deducting the underwriting discounts and commissions and offering expenses payable by us, of $70,125,000. For the three and nine months ended September 30, 2021 and 2020, we funded our operations primarily through cash from operating activities, the sale of our subsidiaries and the sale of equity. As of September 30, 2021, we had cash and cash equivalents from continuing operations of $35,102,000 and working capital of $28,203,000, as compared to cash and cash equivalents of $20,595,000 and working capital of $18,324,000 as of December 31, 2020. 44 Table of Contents Public Offering On February 9, 2021, we issued and sold 6,126,939 shares of our common stock (which included 799,166 shares of common stock sold pursuant to the exercise of an overallotment option) (the “Public Offering”). The net proceeds to us, after deducting the underwriting discounts and commissions and offering expenses payable by the us, were approximately $70,125,000. Waycare Acquisition On August 18, 2021, we entered into a share purchase agreement (the “Purchase Agreement”) by and among the Company, Waycare, the sellers of Waycare named in the Purchase Agreement (the “Sellers”) and Shareholder Representative Services LLC, solely in its capacity as the representative of the Sellers, pursuant to which we acquired 100% of the issued and outstanding capital stock of Waycare from the Sellers (the “Acquisition”). The aggregate purchase price for the shares of Waycare was $61,100,000, less the amount of Waycare’s debt and certain transaction expenses and subject to a customary working capital adjustment. The purchase price was comprised of $40,813,000 of cash and 2,784,474 shares of our common stock, valued at $20,287,000. As a result of the transaction, Waycare became our wholly-owned subsidiary. As of September 30, 2021, we had commitments to purchase $2,479,000 in property and equipment. This commitment has been recognized and recorded in our financial statements as of September 30, 2021. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a “smaller reporting company” as defined by Item 10 of Regulation S-K, Rekor is not required to provide information required by this Item 3.