| | For the Nine Months Ended September 30, |
| | | |
| Cash Flows from Operating Activities | | |
| Net loss | $(11,428) | $(3,619) |
| Adjustments to reconcile net loss to net cash used in operating activities: | | |
| Depreciation | 295 | 236 |
| Amortization of right-of-use lease asset | 158
| - |
| �� Share-based compensation | 314 | 296 |
| Amortization of financing costs | 768 | 69 |
| Deferred rent | - | (11) |
| Change in fair value of derivative liability | - | (77) |
| Amortization of intangible assets | 965 | 557 |
| Impairment of intangible assets | 1,549 | - |
| Loss on extinguishment of debt | 1,158 | - |
| Loss on abandonment of lease | 70 | -
|
| Loss on sale of Secure Education | 3 | - |
| Changes in operating assets and liabilities: | | |
| Accounts receivable | (2,487) | (106) |
| Inventory | (312) | 31 |
| Deposits | 38 | - |
| Other current assets | 74 | 33 |
| Accounts payable and accrued expenses | 1,628 | 953 |
| Contract liabilities | 900 | (20) |
| Lease liability | (28) | - |
| Net cash used in operating activities - continuing operations | (6,335) | (1,658) |
| Net cash (used in) provided by operating activities - held for sale operations | (2,920) | 560 |
| Net cash used in operating activities | (9,255) | (1,098) |
| Cash Flows from Investing Activities | | |
| Proceeds from sale of note receivable | - | 1,475 |
| Proceeds from sale of Secure Education | 250 | - |
| Capital expenditures | (656) | (1,007) |
| Net cash (used in) provided by investing activities - continuing operations | (406) | 468 |
| Net cash provided by investing activities - held for sale operations | - | 51 |
| Net cash (used in) provided by investing activities | (406) | 519 |
| Cash Flows from Financing Activities | | |
| Proceeds from short-term borrowings | 2,315 | - |
| Repayments of short-term borrowings | (296) | (1,025) |
| Net proceeds from notes payable | 3,839 | 2,000 |
| Net proceeds from exercise of options | - | 23 |
| Net proceeds from exercise of warrants | 103 | - |
Net proceeds from exercise of warrants associated to series A preferred stock | 4 | - |
| Net proceeds from at-the-market agreement | 38
| - |
| Payment of preferred dividends | (108) | (345) |
| Net cash provided by financing activities - continuing operations | 5,895
| 653 |
| Net cash provided by (used in) financing activities - held for sale operations | 3,205
| (547) |
| Net cash provided by financing activities | 9,100
| 106 |
| Net decrease in cash, cash equivalents and restricted cash and cash equivalents - continuing operations | (846) | (537) |
| Net increase in cash, cash equivalents and restricted cash and cash equivalents - held for sale operations | 285 | 64 |
| Net decrease in cash, cash equivalents and restricted cash and cash equivalents | (561) | (473) |
| Cash, cash equivalents and restricted cash and cash equivalents at beginning of period | 2,768 | 1,957 |
| Cash, cash equivalents and restricted cash and cash equivalents at end of period | $2,207 | $1,484 |
| | | |
| Reconciliation of cash, cash equivalents and restricted cash: | | |
| Cash and cash equivalents at end of period - continuing operations | $1,273 | $1,393 |
| Restricted cash and cash equivalents at end of period - continuing operations | 708 | - |
| Cash and cash equivalents at end of period - held for sale operations | 226 | 91 |
| Cash, cash equivalents and restricted cash at end of period | $2,207 | $1,484 |
Novume Solutions, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
| | For the Nine Months ended September 30, |
| | | |
| CASH FLOWS FROM OPERATING ACTIVITIES | | |
| Net (loss) income | $(1,913,460) | $420,208 |
| Adjustments to reconcile net (loss) income to net cash used in operating activities: | | |
| Depreciation and amortization | 404,143 | 39,498 |
| Bad debt expense | 24,000 | - |
| Deferred taxes | (964,377) | - |
| Share-based compensation | 227,470 | - |
| Deferred rent | (18,588) | - |
| Warrant expense | 67,491 | - |
| Changes in operating assets and liabilities | | |
| Accounts receivable | (870,426) | (453,985) |
| Inventory | (1,460) | - |
| Deposits | (105) | - |
| Notes receivable | 51,000 | (24,000) |
| Prepaid expenses and other current assets | (50,909) | 20,932 |
| Other assets | - | (124,919) |
| Accounts payable | (196,460) | 542,077 |
| Accrued expenses and other current liabiltities | 987,522 | 139,724 |
| Deferred revenue | 50,007 | - |
| Net cash used in operating activities | (2,204,152) | 559,535 |
| CASH FLOWS FROM INVESTING ACTIVITIES | | |
| Capital expenditures | (52,985) | (35,377) |
| Net cash used in investing activities | (52,985) | (35,377) |
| CASH FLOWS FROM FINANCING ACTIVITIES | | |
| Stockholders' distributions | - | (125,615) |
| Deferred stock offering costs | 75,655 | (670,091) |
| Proceeds from notes payable | 47,341 | 500,000 |
| Loan origination costs | - | (38,285) |
| Acquisition of Firestorm - net of cash acquired | (417,704) | - |
| Acquisition of Brekford - net of cash acquired | 1,943,777 | - |
| Net proceeds from issuance of preferred stock | 1,745,347 | - |
| Payment of preferred dividends | (163,601) | - |
| Net cash provided by financing activities | 3,230,815 | (333,991) |
| Net increase in cash and cash equivalents | 973,678 | 190,167 |
| Cash and cash equivalents at beginning of year | 2,788,587 | 567,866 |
| Cash and cash equivalents at end of period | $3,762,265 | $758,033 |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
Novume Solutions, Inc. and SubsidiariesNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSNotes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017 and 2016
NOTE 1 – NATUREGENERAL, BASIS OF OPERATIONSPRESENTATION, AND RECAPITALIZATION
Nature of Operations
Novume Solutions, Inc. (the “Company” or “Novume”) was formed in February 2017 and began operations upon the merger of KeyStone Solutions, Inc. (“KeyStone”) and Brekford Traffic Safety, Inc. (“Brekford”) in August 2017 (the “Brekford Merger”) and is headquartered in Chantilly, Virginia. The financial results of Brekford are included in the results of operations from August 28, 2017 through September 30, 2017. For narrative purposes, Company and Novume references will include the Brekford, KeyStone and Firestorm entities. The historical financial statements for Novume prior to the merger with Brekford reflect the historical financial statements of KeyStone.
KeyStone was formed in March 2016 as a holding company for its wholly-owned subsidiary AOC Key Solutions, Inc. (“KSI”), which is headquartered in Chantilly, Virginia. KSI provides consulting and technical support services to assist clients seeking U.S. Federal government contracts in the technology, telecommunications, defense, and aerospace industries.
On January 25, 2017, Novume (KeyStone) acquired Firestorm (See Note 2), a nationally-recognized leader in crisis management, crisis communications, emergency response, and business continuity, including workplace violence prevention, cyber-breach response, communicable illness/pandemic planning, predictive intelligence, and other emergency, crisis and disaster preparedness initiatives. Firestorm is headquartered in Roswell, Georgia.
Brekford, headquartered in Hanover, Maryland, is a leading public safety technology service provider of fully-integrated automated traffic safety enforcement (“ATSE”) solutions, including speed, red light, and distracted driving camera systems.
Recapitalization
On March 15, 2016, the stockholders of KSI formed KeyStone as a holding company with the same proportionate ownership percentage as KSI. On that same date KSI entered into a merger agreement (the “KSI Merger Agreement”) with KeyStone and KCS Merger Sub, Inc. (“Merger Sub”), a wholly-owned subsidiary of KeyStone with no activity. Pursuant to the KSI Merger Agreement, on March 15, 2016, Merger Sub was merged with and into KSI, and thus KSI became a wholly-owned subsidiary of KeyStone (the “KSI Merger”). To complete the KSI Merger, the stockholders exchanged 100% of the outstanding common stock of KSI for newly issued common stock of KeyStone, representing 100% of the outstanding common stock. This effectively transferred 100% of the voting equity interest and control of KSI to KeyStone. The undistributed earnings totaling $1,192,844 of KSI as of that date were considered a capital contribution to KeyStone and were therefore reclassified to additional paid-in capital. The operations of KSI did not change, nor have any assets or operations transferred to either KeyStone or Merger Sub. The KSI Merger transaction resulted in no gain or loss to either entity. The stockholders’ proportionate ownership of KeyStone remained the same as it was for KSI. KeyStone accounted for the merger transaction as a recapitalization in the accompanying consolidated financial statements.
NOTE 2 – ACQUISITION
Brekford Acquisition
On August 28, 2017, the mergers by and among Novume, KeyStone, Brekford, Brekford Merger Sub, Inc. (“Brekford Merger Sub”), and KeyStone Merger Sub, LLC (“KeyStone Merger Sub”), were consummated as a result of a merger agreement (the “Brekford Merger Agreement”). As a result, Brekford became a wholly-owned subsidiary of the Novume, and Brekford Merger Sub ceased to exist. KeyStone Merger Sub also became a wholly-owned subsidiary of Novume, and KeyStone Solutions, Inc. ceased to exist. When KeyStone Merger Sub filed its certificate of merger with the Secretary of State of the State of Delaware, it immediately effectuated a name-change to KeyStone Solutions, LLC, the name by which it is now known. For the purposed of this document any references to KeyStone are to KeyStone Solutions, Inc. prior to August 28, 2017 and to KeyStone Solutions, LLC on and after August 28, 2017.
Upon completion of the Brekford Merger, the merger consideration was issued in accordance with the terms of the Brekford Merger Agreement. Immediately upon completion of the Brekford Merger, the pre-merger stockholders of KeyStone owned approximately 80% of the issued and outstanding capital stock of Novume on a fully-diluted basis, and the pre-merger stockholders of Brekford owned approximately 20% of the issued and outstanding capital stock of Novume on a fully-diluted basis.
As the Brekford Merger has recently been completed, the Company is currently in the process of completing the purchase price allocation treating the Brekford Merger as a business combination. The final purchase price allocation for Brekford will be included in the Company’s consolidated financial statements in future periods. The table below shows the preliminary analysis related to the Brekford acquisition:
Common stock issued | $5,851,193
|
Total consideration | 5,851,193
|
Less cash received | (1,943,778)
|
Less other assets | (3,139,007)
|
Plus liabilities assumed | 1,191,937
|
Net goodwill/intangible recorded | $1,960,345
|
The initial determination of the fair value of the assets acquired and liabilities assumed, which includes approximately $2.0 million of goodwill, is based on a preliminary valuation and the estimates and assumptions for these items are subject to change as we obtain additional information during the measurement period. Subsequent changes to the purchase price or other fair value adjustments determined during the measurement period will be recorded as an adjustment to goodwill and possibly intangibles.
Firestorm Acquisition
On January 25, 2017 (the “Firestorm Closing Date”), Novume acquired Firestorm Solutions, LLC and Firestorm Franchising, LLC (collectively, the “Firestorm Entities” or “Firestorm”).
Membership Interest Purchase Agreement
Pursuant to the terms of the Membership Interest Purchase Agreement (the “MIPA”), by and among Novume, each of the Firestorm Entities, each of the Members of the Firestorm Entities (described below), and a newly-created acquisition subsidiary of Novume, Firestorm Holdings, LLC, a Delaware limited liability company (“Firestorm Holdings”), Novume acquired all of the membership interests in each of the Firestorm Entities for the following consideration:
●
$500,000 in cash in the aggregate paid by Novume as of the Firestorm Closing Date to the three principals (Harry W. Rhulen, Suzanne Loughlin, and James W. Satterfield, collectively the “Firestorm Principals”) of Firestorm. Of that aggregate amount $250,000 was paid to Mr. Satterfield, and $125,000 was paid to each of Mr. Rhulen and Ms. Loughlin;
●
$1,000,000 in the aggregate in the form of four unsecured, subordinated promissory notes issued by Novume payable over five years after the Firestorm Closing Date, to all the Members of the Firestorm Entities (consisting of the Firestorm Principals and Lancer Financial Group, Inc. (“Lancer”)). The principal amount of the note payable to Lancer is $500,000 (the “Lancer Note”). The principal amount of the note payable to Mr. Rhulen is $166,666.66. The principal amount of the notes payable to each of Mr. Satterfield and Ms. Loughlin is $166,666.67. (The notes payable to Mr. Rhulen, Ms. Loughlin and Mr. Satterfield are individually referred to herein as a “Firestorm Principal Note” and collectively, as the “Firestorm Principal Notes”). The Firestorm Principal Notes are payable at an interest rate of 2% and the Lancer Note is payable at an interest rate of 7%. $907,407 was recorded to notes payable to reflect the net fair value of the notes issued due to the difference in interest rates. The Lancer Note also has a capped subordination of $7,000,000, subject to the consent of Lancer;
●
Each of the Firestorm Principals was issued 162,698 (315,625 post Brekford Merger) shares of the common stock, par value $0.0001 per share, of Novume (“Novume Common Shares”), for an aggregate issuance of 488,094 (946,875 post Brekford Merger) Novume Common Shares;
●
Each of the Firestorm Principals received warrants to purchase 105,209 Novume Common Shares, exercisable over a period of five years after the Firestorm Closing Date, at an exercise price of $2.58 per share; and
●
Each of the Firestorm Principals received warrants to purchase 105,209 Novume Common Shares, exercisable over a period of five years after the Firestorm Closing Date, at an exercise price of $3.60 per share.
The Company has completed its analysis of the purchase price allocation. The table below shows the final breakdown related to the Firestorm acquisition.
Cash paid | $500,000
|
Notes payable issued | 907,407
|
Common stock issued | 976,286
|
Warrants issued, at $2.58 | 125,411
|
Warrants issued, at $3.61 | 102,289
|
Total consideration | 2,611,393
|
Less cash received | (82,296)
|
Less other assets | (137,457)
|
Less intangible and intellectual property | (2,497,686)
|
Plus liabilities assumed | 106,046
|
Net goodwill recorded | $-
|
The determination of the fair value of the assets acquired and liabilities assumed includes approximately $2.5 million of intangible and intellectual property which will be amortized over the useful life of five years. In connection with the acquistion, Novume has also entered into employment agreements with three of the founders of the Firestorm Entities as set forth below.
Harry W. Rhulen Employment Agreement
The Rhulen Employment Agreement provides that upon the Firestorm Closing Date his employment agreement will become effective for an initial five-year term as President of Novume Solutions, Inc. His base salary will be $275,000 per annum, and he will be eligible for a bonus as determined by Novume’s compensation committee. Mr. Rhulen will also be eligible to receive all such other benefits as are provided by Novume to other management employees that are consistent with Novume’s fringe benefits available to any other officer or executive of Novume. Mr. Rhulen has been granted options to purchase 155,195 Novume Common Shares, which shall begin vesting on the one-year anniversary of the Firestorm Closing Date and continue vesting monthly over the following two years, at an exercise price of $1.55 per share.
Suzanne Loughlin Employment Agreement
The Loughlin Employment Agreement provides that upon the Firestorm Closing Date her employment agreement will become effective for an initial five-year term as General Counsel and Chief Administrative Officer of Novume Solutions, Inc. Her base salary will be $225,000 per annum, and she will be eligible for a bonus as determined by Novume’s compensation committee. Ms. Loughlin will also be eligible to receive all such other benefits as are provided by Novume to other management employees that are consistent with Novume’s fringe benefits available to any other officer or executive of Novume. Ms. Loughlin has been granted options to purchase 155,195 Novume Common Shares, which shall begin vesting on the one-year anniversary of the Firestorm Closing Date and continue vesting monthly over the following two years, at an exercise price of $1.55 per share.
James W. Satterfield Employment Agreement
The Satterfield Employment Agreement provides that upon the Firestorm Closing Date his employment agreement will become effective for an initial five-year term as President and Chief Executive Officer of each of the Firestorm Entities. His base salary will be $225,000 per annum, and he will be eligible for a bonus as determined by Novume’s compensation committee. Mr. Satterfield will also be eligible to receive all such other benefits as are provided by Novume to other management employees that are consistent with Novume’s fringe benefits available to any other officer or executive of Novume or its subsidiaries. Mr. Satterfield has been granted options to purchase 96,997 Novume Common Shares, which shall begin vesting on the one-year anniversary of the Firestorm Closing Date and continue vesting monthly over the following two years, at an exercise price of $1.55 per share, in connection with the Acquisition.
The following unaudited pro-forma combined financial information gives effect to the acquisition of Firestorm and the merger with Brekford as if they were consummated January 1, 2016. This unaudited pro-forma financial information is presented for information purposes only, and is not intended to present actual results that would have been attained had the acquisition been completed as of January 1, 2016 (the beginning of the earliest period presented) or to project potential operating results as of any future date or for any future periods.
| For the three months ended September 30, | For the nine months ended September 30, |
| | | | | |
| Revenues | $4,906,343 | $3,345,473 | $13,353,752 | $12,194,573 |
| Net income (loss) | $(1,065,371) | $(394,760) | $(2,815,977) | $(591,347) |
| Basic earnings (loss) per share | $(0.09) | $(0.04) | $(0.26) | $(0.08) |
| Diluted earnings (loss) per share | $(0.09) | $(0.04) | $(0.26) | $(0.08) |
| | | | | |
| Basic Number of Shares | 11,756,560 | 9,713,956 | 10,920,866
| 7,016,373 |
| Diluted Number of Shares | 11,756,560 | 9,713,956 | 10,920,866
| 7,016,373 |
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
TheThese unaudited condensed consolidated interim financial statements include the accounts of Novume, the parent company,Rekor Systems, Inc. and its wholly-owned subsidiaries AOC Key Solutions, Inc., Brekford Traffic Safety Inc., Novume Media, Inc., Chantilly Petroleum, LLC, Firestorm Solutions, LLC and Firestorm Franchising, LLC.
The consolidated financial statements(collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and in accordance withpursuant to the accounting rules under Regulation S-X, as promulgated byand regulations of the Securities and Exchange Commission (“SEC”). All significant intercompany accounts for interim financial statements. Accordingly, they do not contain all information and transactions have been eliminated in consolidation.
Cash Equivalents
Novume considersnotes required by U.S. GAAP for annual financial statements. In the opinion of management, these unaudited condensed consolidated interim financial statements reflect all highly liquid debt instruments purchased with the maturityadjustments, which include normal recurring adjustments, necessary for a fair statement of three months or less to be cash equivalents.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are customer obligations due under normal trade terms. The Company performs continuing credit evaluations of its clients’ financial condition, and the Company generally does not require collateral.
Management reviews accounts receivable to determine if any receivables will potentially be uncollectible. Factors considered in the determination include, among other factors, number of days an invoice is past due, client historical trends, available credit ratings information, other financial data and the overall economic environment. Collection agencies may also be utilized if management so determines.
The Company records an allowance for doubtful accounts based on specifically identified amounts that are believed to be uncollectible. The Company also considers recording as an additional allowance a certain percentage of aged accounts receivable, based on historical experience and the Company’s assessmentconsolidated financial position as of the general financial conditions affecting its customer base. If actual collection experience changes, revisions to the allowance may be required. After all reasonable attempts to collect an account receivable have failed, the amount of the receivable is written off against the allowance. Based on the information available, the Company had an allowance for doubtful accounts of $24,000 at September 30, 20172019, the consolidated results of operations, consolidated statements of shareholders’ (deficit) equity and determined that an allowance was not required at December 31, 2016.
Inventory
Inventory principally consistsconsolidated statements of hardware and third-party packaged software that is modified to conform to customer specifications and held temporarily until the completion of a contract. Inventory is valued at the lower of cost or market value. The cost is determined by the lower of first-in, first-out (“FIFO”) method, while market value is determined by replacement cost for raw materials and parts and net realizable value for work-in-process.
Property and Equipment
The cost of furniture and fixtures, and office equipment is depreciated over the useful lives of the related assets. Leasehold improvements are amortized over the shorter of their estimated useful lives or the terms of the lease. Depreciation and amortization is recorded on the straight-line basis.
The range of estimated useful lives used for computing depreciation are as follows:
Furniture and fixtures | 2 - 10 years |
Office equipment | 2 - 5 years |
Leasehold improvements | 3 - 10 years |
Automobiles | 3 - 5 years |
Camera systems | 3 years |
Depreciation and amortization expensecash flows for the three months ended September 30, 2017 and 2016 was $353,982 and 9,833, respectively, and for the nine months ended September 30, 20172019 and 2016 was $404,143 and $39,498, respectively.
Revenue Recognition2018.
The Company recognizes revenues for the provision of services when persuasive evidence of an arrangement exists, services have been rendered or delivery has occurred, the fee is fixed or determinablefinancial data and the collectability of the related revenue is reasonably assured. The Company principally derives revenues from fees for services generated on a project-by-project basis. Revenues for time-and-materials contracts are recognized based on the number of hours worked by the employees or consultants at an agreed-upon rate per hour set forthother information disclosed in the Company’s standard rate sheet or as written from timenotes to time in the Company’s contracts or purchase orders. Revenuesunaudited condensed consolidated financial statements related to firm-fixed-price contractsthese periods are primarily recognized upon completion of the project as these projects are typically short-term in nature. Revenue from the sale of individual franchises is recognized when the contract is signed and collectability is assured, unless the franchisee is required to perform certain training before operations commence.unaudited. The franchisor has no obligation to the franchisee relating to facilitiess development and the franchisee is considered operational at the time the franchise agreement is signed or when required training is completed, if applicable. Royalties from individual franchises are earned based upon the terms in the franchising agreement which are generally the greater of $1,000 or 8% of the franchisee’s monthly gross sales.
For automated traffic safety enforcement revenue, the Company recognizes the revenue when the required efforts to collect from citizens are completed and posted to the municipality’s account. The respective municipality is then billed depending on the terms of the respective contract, typically 15 days after the preceding month while collections are reconciled. For contracts where the Company receives a percentage of collected fines, revenue is calculated based upon the posted payments from citizens multiplied by the Company’s contractual percentage. For contracts where the Company receives a specific fixed monthly fee regardless of citations issued or collected, revenue is recorded once the amount collected from citizens exceeds the monthly fee per camera. Brekford’s fixed-fee contracts typically have a revenue neutral provision whereby the municipality’s payment to Brekford cannot exceed amounts collected from citizens within a given month.
Advertising
The Company expenses all non-direct-response advertising costs as incurred. Such costs were not materialresults for the three orand nine months ended September 30, 2019 are not necessarily indicative of the results to be expected for the year ending December 31, 2019.
These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The unaudited condensed consolidated balance sheet data as of December 31, 2018 was derived from the Company’s audited consolidated financial statements for the year ended December 31, 2018 but does not include all disclosures required by U.S. GAAP for annual financial statements.
Dollar amounts, except per share data, in the notes to these financial statements are rounded to the closest $1,000.
Certain prior year amounts have been reclassified to conform with the current year presentation. Beginning in the second quarter of 2019, sales and marketing expenses and research and development expenses have been presented separately from general and administrative expenses on the unaudited condensed consolidated statements of operations, whereas in prior periods these amounts were included in one caption titled "selling, general and administrative expenses." Amounts for the first quarter of 2019 and for the period ending December 31, 2018, have been reclassified to conform to the current year presentation.
Rekor Systems, Inc. (the “Company” or “Rekor”), (formerly Novume Solutions, Inc.) was formed in February 2017 to effectuate the mergers of, and 2016.become a holding company for KeyStone Solutions, LLC. (“KeyStone”) and Brekford Traffic Safety, Inc. (“Brekford”). On February 28, 2019, the Company changed the name of its wholly owned subsidiary, Brekford Traffic Safety, Inc. to Rekor Recognition Systems, Inc. (“Rekor Recognition”). On April 26, 2019, the Company changed its name from Novume Solutions, Inc. to Rekor Systems, Inc.
In March 2019, Rekor acquired certain assets and certain liabilities of OpenALPR Technology, Inc. (such assets and liabilities being referred to herein as “OpenALPR Technology”) through its subsidiary, OpenALPR Software Solutions, LLC (“OpenALPR”). The financial information in this Quarterly Report only includes OpenALPR in the results of operations beginning as of March 12, 2019 (see Note 4).
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
During the third quarter of 2019, the Company began to separately report the results of Global Technical Services, Inc. and Global Contract Professionals, Inc. (together “Global”), the Company’s wholly owned subsidiaries, including substantially all of the assets and liabilities comprising Global, as operations held for sale. The Company is reporting the operating results and cash flows of Global as operations held for sale, and thus they have been excluded from continuing operations and segment results for all periods presented. Prior to the third quarter of 2019, the operating results for Global were presented in the Professional Services segment. The assets and liabilities of Global are presented as current and long-term assets and liabilities held for sale in the unaudited condensed consolidated balance sheets and its results are presented as income (loss) from operations held for sale in the unaudited condensed consolidated statement of operations. In cases where the carrying value amount exceeds the fair value, less costs to sell, an impairment loss is recognized. Due to the held for sale classification of Global, certain amounts have been reclassified in order to conform to the current period presentation. See Note 16 for additional information regarding the Company's held for sale operations.
Use of Estimates
Management uses estimates and assumptions in preparing financial statements. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual amounts may differ from these estimates. On an on-going basis, the Company evaluates its estimates, including those related to collectability of accounts receivable, fair value of debt and equity instruments, goodwill, intangible assets and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of whichcircumstances. These form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions.
Going Concern Assessment
Income Taxes
Through March 15, 2016, KSI electedFor all annual and interim periods, management will assess going concern uncertainty in the Company’s unaudited condensed consolidated financial statements to determine whether there is sufficient cash on hand and working capital, including available borrowings on loans, to operate for a period of at least one year from the date the unaudited condensed consolidated financial statements are issued or available to be taxed underissued, which is referred to as the provisions“look-forward period”, as defined in U.S. GAAP. As part of Subchapter Sthis assessment, based on conditions that are known and reasonably knowable to management, management will consider various scenarios, forecasts, projections, estimates and will make certain key assumptions. These assumptions including among other factors, the expected timing and nature of the Internal Revenue Code. UnderCompany’s programs and projected cash expenditures, its ability to delay or curtail these expenditures or programs and its ability to raise additional capital, if necessary, to the extent management has the proper authority to execute them and considers it probable that those provisions, KSI did not pay U.S. Federal corporate income taxes, and in most instances state income tax, on its taxable income. Instead, the KSI stockholders were liable for individual income taxes on their respective shares of KSI’s net income. KSI effectively revoked its S Corporation election upon the March 15, 2016 merger with the KeyStone. Novume is currently subject to corporate income taxes.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected toimplementations can be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company’s evaluation as of September 30, 2017 revealed no uncertain tax positions that would have a material impact on the consolidated financial statements. The 2013 through 2015 tax years remain subject to examination by the IRS and various states. Management does not believe that any reasonably possible changes will occurachieved within the next twelve months that will have a material impact on the consolidated financial statements.
Equity-Based Compensationlook-forward period.
The Company recognizes equity-based compensation based on the grant-date fair value of the award on a straight-line basis over the requisite service period, net of estimated forfeitures. Total equity-based compensation expense includedhas generated losses since its inception in selling, general and administrative expenses in the accompanying consolidated statements of operations for the three months ended September 30,August 2017 and 2016 was $107,321has relied on cash on hand, secured borrowing arrangements, the sale of a note, debt financing, and $0, respectively,public offering of its common stock, including its on-going At-the-Market Issuance Sales Agreement (the "Sales Agreement") offering as disclosed below, to support cash flows from operations. As of and for the nine months ended September 30, 20172019, the Company had a net loss from continuing operations of $11,428,000 and 2016a working capital deficit of $107,000. The Company's net cash position was $227,470decreased by $561,000 for the nine months ended September 30, 2019 due to the net loss from operations, offset by the proceeds of $20,000,000 senior secured notes, of which $5,000,000 was issued as a note payable to the seller, offset by $7,000,000 of cash paid for the acquisition of OpenALPR, and $51,380, respectively.approximately $6,227,000 related to the extinguishment of debt and associated fees related to acquiring new debt (see Note 7).
Management believes that based on relevant conditions and events that are known and reasonably knowable, its current forecasts and projections, for one year from the date of the filing of the unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q, indicate the Company’s ability to continue operations as a going concern for that one-year period. The Company estimatesis actively monitoring its operations, the fair valuecash on hand and working capital. Additionally, as of stock options usingSeptember 30, 2019, the Black-Scholes option-pricing model. Company believes it has access to raise up to $14,706,000 through the Sales Agreement (see Note 9). The useCompany will continue to raise capital through the Sales Agreement to help fund operations. Should access to those funds be unavailable, the Company will need to seek out additional sources of funding. Furthermore, the Company has contingency plans to reduce or defer expenses and cash outlays should operations weaken in the Black-Scholes option-pricing model requires the use of subjective assumptions, including the fair value and projected volatility of the underlying common stock and the expected term of the award.look-forward period or additional financing, if needed, is not available.
TheREKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Goodwill and Intangible Assets
In applying the acquisition method of accounting, amounts assigned to identifiable assets and liabilities acquired were based on estimated fair value of each option granted has been estimatedvalues as of the date of the grant using the Black-Scholes option pricing modelacquisition, with the remainder recorded as goodwill. Identifiable intangible assets are initially valued at fair value using generally accepted valuation methods appropriate for the type of intangible asset. Identifiable intangible assets with definite lives are amortized over their estimated useful lives and are reviewed for impairment, if indicators of impairment arise. Intangible assets with indefinite lives are tested for impairment within one year of acquisitions or annually and whenever indicators of impairment exist. The Company is currently in the process of its annual impairment test. The fair value of intangible assets is compared with their carrying values, and an impairment loss would be recognized for the amount by which a carrying amount exceeds its fair value.
During the second quarter of 2019 the Company wrote-off $1,549,000 of intangible assets associated with the Company's wholly owned subsidiaries Firestorm Solutions, LLC and Firestorm Franchising LLC (collectively, “Firestorm”), and BC Management, Inc. (“BC Management”) (see Note 5).
Revenue Recognition
The Company derives its revenues substantially from two sources: (1) subscription revenues for software licenses, technology products and services, and (2) and professional services to clients.
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. If the consideration promised in the contract includes a variable amount, for example maintenance fees, the Company includes an estimate of the amount it expects to receive for the total transaction price, if it is probable that a significant reversal of cumulative revenue recognized will not occur.
The Company determines the amount of revenue to be recognized through application of the following assumptionssteps:
●
Identification of the contract, or contracts, with a customer
●
Identification of the performance obligations in the contract
●
Determination of the transaction price
●
Allocation of the transaction price to the performance obligations in the contract
●
Recognition of revenue when, or as, performance obligations are satisfied
The subscription revenues for software licenses, technology products and services revenues are comprised of fees that provide customers with access to the software licenses and related support and updates during the term of the arrangement. Revenue is generally recognized ratably over the contract term. During the second quarter of 2019, the Company changed its method of selling in the Technology Segment from perpetual software licenses to monthly service subscriptions. This change is expected to impact the Company's revenue in the short term. However, the amount of contract revenue received over the long term impact is expected to be relatively consistent. The Company’s subscription services arrangements are non-cancelable and do not contain refund-type provisions.
The Company’s professional services contracts recognize revenue based on a time and materials or fixed fees basis. These revenues are recognized as the services are rendered for time and materials contracts, on a proportional performance basis for fixed price contracts, or ratably over the contact term for fixed price contracts with subscription services.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (included within accounts receivable, net), and contract liabilities (deferred revenue) on the unaudited condensed consolidated balance sheets. When billings occur after the work has been performed, such unbilled amounts will generally be billed and collected within 60 to 120 days but typically no longer than over the next twelve months. Unbilled receivables of $963,000 and $824,000 were included in accounts receivable, net, in the unaudited condensed consolidated balance sheets as of September 30, 2019 and December 31, 2018, respectively. Additionally, unbilled receivables of $469,000 and $301,000 were included in current assets held for sale in the unaudited condensed consolidated balance sheets as of September 30, 2019 and December 31, 2018, respectively.
When the Company advance bill clients prior to the work being performed, generally, such amounts will be earned and recognized in revenue within the next six months to five years, depending on the subscription or licensing period. These assets and liabilities are reported on the unaudited condensed consolidated balance sheet on a contract-by-contract basis at the end of each reporting period. Changes in the contract asset and liability balances during the nine months ended September 30, 2017:2019 were not materially impacted by any other factors. Contract liabilities from the period ended September 30, 2019 and December 31, 2018 were $1,495,000 and $207,000 respectively. All contract liabilities as of September 30, 2019 and December 31, 2018 were attributable to continued operations. During the nine months ended September 30, 2019 all of the contract liabilities balance as of December 31, 2018 was recognized as revenue.
The services due for contract liabilities described above are shown below as of September 30, 2019 (dollars in thousands):
| Nine months ended September 30, 2017 |
Risk-free interest rate | 1.00% - 1.99% |
Expected term | ..3 – 6 years |
Volatility | 70% |
Dividend yield | 0% |
Estimated annual forfeiture rate at time of grant | 0% - 30% |
| 2019 | $246 |
| 2020 | 544 |
| 2021 | 223 |
| 2022 | 200 |
| 2023 | 189 |
| Thereafter | 93 |
Total | $1,495 |
Segment Reporting
Risk-Free Interest RateThe Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 280, –Segment Reporting, requires that an enterprise report selected information about reportable segments in its financial reports issued to its stockholders. The yield on actively traded non-inflation indexed U.S. Treasury notesBeginning with the samefirst quarter of 2019, the Company changed its operating and reportable segments from one segment to two segments: the Technology Segment and the Professional Services Segment.The two segments reflect the Company’s separate focus on technology products and services versus professional services. (See Note 3).
The Technology Segment is responsible for the activities in developing technology and distributing and licensing products and services with vehicle recognition features. In connection with this effort in March 2019, the Company acquired OpenALPR Technology (See Note 4). The Professional Services Segment is responsible for the activities that provide professional services for government contracting market, as well as staffing services for the aerospace and aviation markets.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Cash, Cash Equivalents and Restricted Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with the maturity as the expected term of the underlying grants was used as the average risk-free interest rate.three months or less to be cash equivalents.
Expected Term –Cash subject to contractual restrictions and not readily available for use is classified as restricted cash and cash equivalents. The Company’s restricted cash balances are primarily made up of cash collected on behalf of certain client jurisdictions. Restricted cash and cash equivalents for these client jurisdictions as of September 30, 2019 and December 31, 2018 were $708,000 The expected termand $609,000, respectively, and correspond to equal amounts of options granted was determined based on management’s expectationsrelated accounts payable and are presented as part of the options granted which are expected to remain outstanding.
Expected Volatility – Because the Company’s common stock has only been publicly traded since late August 2017, there has not been a substantive share price history to calculate volatilityaccounts payable and as such, the Company has elected to use the calculated value method.
Dividend Yield – The Black-Scholes option pricing model includes an expected dividend yield (which may be 0.00%) as an input. The Company has not issued common stock dividendsaccrued expenses in the past nor does the Company expect to issue common stock dividends in the future.accompanying unaudited condensed consolidated balance sheets.
Forfeiture Rate – This is the estimated percentage of equity grants that are expected to be forfeited or cancelled on an annual basis before becoming fully vested. The Company estimates the forfeiture rate based on past turnover data, level of employee receiving the equity grant, and vesting terms, and revises the rate if subsequent information indicates that the actual number of instruments that will vest is likely to differ from the estimate. The cumulative effect on current and prior periods of a change in the estimated number of awards likely to vest is recognized in compensation cost in the period of the change.
Fair Value of Financial Instruments
The carrying amounts reported in the unaudited condensed consolidated balance sheets for cash and cash equivalents, restricted cash and cash equivalents, inventory, accounts receivable and accounts payable approximate fair value as of September 30, 20172019 and December 31, 2016,2018 because of the relatively short-term maturity of these financial instruments. The carrying amount reported for long-term debt approximates fair value as of September 30, 2017,2019 and December 31, 2018 given management’s evaluation of the instrument’s current rate compared to market rates of interest and other factors.
The determination of fair value is based upon the fair value framework established by Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“(“ASC 820”). Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. ASC 820 also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect ourthe Company’s assumptions about the factors market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value:
Level 1—Observable inputs that reflect quoted–Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2—–Inputs other than Level 1 that are observable, either directly or can be derived from observable market data,indirectly, such as quoted prices for similar assets or liabilitiesliabilities; quoted prices in markets that are active or not active; or model-based valuation techniques for which all significant inputother inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3—–Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.
The Company’s goodwill and other intangible assets are measured at fair value at the time of acquisition and analyzed on a recurring and non-recurring basis for impairment, respectively, using Level 2 and Level 3 inputs.
The Company has concluded that its Series A Preferred Stock is a Level 3 financial instrument and that the fair value approximates the carrying value, due towhich includes the proximityaccretion of the date of the sale of the Series A Preferred Stock to independent third-parties as compared todiscounted interest component through September 30, 2017.2019. There were no changes in levels during the three orand nine months ended September 30, 20172019 and the Company did not have any financial instruments prior to 2016.2018.
Concentrations of Credit Risk
Financial instruments that potentially subjectThe Company places its temporary cash investments with higher rated quality financial institutions located in the United States (“U.S.”). As of September 30, 2019 and December 31, 2018, the Company had deposits from continuing operations totaling $1,981,000 and $2,678,000 from continuing operations, respectively, in two and three U.S. financial institutions that were federally insured up to concentrations$250,000 per account, respectively.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company has a market concentration of credit risk consist principally of cash and cash equivalents,revenue and accounts receivable. Concentrations of credit risk with respectreceivable, from continuing operations, in its Professional Services Segment related to accounts receivable are minimal due to the collection historyits customer base.
Company A accounted for 21% and due to the nature17% of the Company’s client base. The Company limits its credit risk with respect to cash by maintaining cash balances with high-quality financial institutions. At times,total revenues for the nine months ended September 30, 2019 and 2018, respectively, and 17% and 22% of the Company’s cash may exceed U.S. Federally insured limits,total revenue for the three months ended September 30, 2019 and 2018, respectively.
Company B accounted for 16% and less than 10% of the Company’s total revenues for the nine months ended September 30, 2019 and 2018, respectively, and 12% and 11% of the Company’s total revenue for the three months ended September 30, 2019 and 2018, respectively.
As of September 30, 2019, accounts receivable from Company A totaled $902,000 or 19% of the unaudited condensed consolidated accounts receivable balance. As of December 31, 2018, Company A and Company B accounted for $1,043,000, or 35%, and $483,000, or 16%, respectively, of the unaudited condensed consolidated accounts receivable balance.
No other single customer accounted for more than 10% of the Company’s unaudited condensed consolidated revenue for the nine months ended September 30, 2019 or unaudited condensed consolidated accounts receivable balance as of September 30, 2017 and December 31, 2016, the Company had $3,762,265 and $2,788,587, respectively, of cash and cash equivalents on deposit that exceeded the federally insured limit.2019.
Earnings per Share
Basic earnings per share, or EPS, is computed using the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common and potentially dilutive securities outstanding during the period, except for periods of net loss for which no potentially dilutive securities are included because their effect would be anti-dilutive. Potentially dilutive securities consist of common stock issuable upon exercise of stock options or warrants using the treasury stock method. Potentially dilutive securities issuable upon conversion of the Series A Preferred Stock are calculated using the if-converted method.
The Company calculates basic and diluted earnings per common share using the two-class method. Under the two-class method, net earnings are allocated to each class of common stock and participating security as if all of the net earnings for the period had been distributed. Participating securities consist of Series A Preferred Stock and warrants that contain a nonforfeitable right to receive dividends and therefore are considered to participate in undistributed earnings with common stockholders.
Foreign Currency TransactionsREKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Brekford has certain revenue and expense transactions with a functional currency in Mexican pesos and the Company's reporting currency is the U.S. dollar. Assets and liabilities are translated from the functional currency to the reporting currency at the exchange rate in effect at the balance sheet date and equity at the historical exchange rates. Revenue and expenses are translated at rates in effect at the time of the transactions. Any resulting translation gains and losses are accumulated in a separate component of stockholders' equity - other comprehensive income (loss). Realized foreign currency transaction gains and losses are credited or charged directly to operations.
Segment Reporting
The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 280, Segment Reporting, requires that an enterprise report selected information about operating segments in its financial reports issued to its stockholders. Based on its analysis of current operations, management has determined that the Company has only one operating segment, which is Novume. Management will continue to reevaluate its segment reporting as the Company grows and matures. However, the chief operating decision-makers currently use combined results to make operating and strategic decisions, and, therefore, the Company believes its entire operation is currently covered under a single segment.
Going Concern Assessment
Beginning with the year ended December 31, 2016 and all annual and interim periods thereafter, management will assess going concern uncertainty in the Company’s consolidated financial statements to determine there is sufficient cash on hand and working capital, including available borrowings on loans, to operate for a period of at least one year from the date the consolidated financial statements are issued or available to be issued, which is referred to as the “look-forward period”, as defined in GAAP. As part of this assessment, based on conditions that are known and reasonably knowable to management, management will consider various scenarios, forecasts, projections, estimates and will make certain key assumptions, including the timing and nature of projected cash expenditures or programs, its ability to delay or curtail expenditures or programs and its ability to raise additional capital, if necessary, among other factors. Based on this assessment, as necessary or applicable, management makes certain assumptions around implementing curtailments or delays in the nature and timing of programs and expenditures to the extent it deems probable those implementations can be achieved and management has the proper authority to execute them within the look-forward period. Management’s assessment determined the Company is a going concern.NOTE 2 – NEW ACCOUNTING PRONOUNCEMENTS
New Accounting Pronouncementsaccounting pronouncements effective in the nine months ended September 30, 2019
Recently Issued Accounting Pronouncements
Not Yet Adopted
In August 2017,February 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02,Leases (Topic 842)(“ASU 2016-02”).ASU 2016-02 requires lessees to recognize lease assets and lease liabilities on the balance sheet and requires expanded disclosures about leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 and interim periods in fiscal years beginning after December 15, 2018, with early adoption permitted. In July 2018, the FASB issued ASU No. 2018-11,Leases (Topic 842): Targeted Improvements(“ASU 2018-11”). ASU 2018-11 provides entities another option for transition,allowing entities to not apply the new guidance relatedstandard in the comparative periods they present in their financial statements in the year of adoption. Effective January 1, 2019, the Company adopted ASU 2016-02, as amended, which requires lessees to recognize a right-of-use (“ROU”) lease assets and lease liability on the balance sheet for most lease arrangements and expands disclosures about leasing arrangements for both lessees and lessors, among other items. The Company adopted ASU 2016-02 using the optional transition method whereby the Company applied the new lease requirements under ASU 2016-02 through a cumulative-effect adjustment, which after completing the Company’s implementation analysis, resulted in no adjustment to its January 1, 2019 beginning retained earnings balance. On January 1, 2019, the Company recognized $921,000 of ROU operating lease assets and $951,000 of operating lease liabilities, including noncurrent operating lease liabilities of $728,000, as a result of adopting this standard. The difference between ROU operating lease assets and operating lease liabilities was primarily due to previously accrued rent expense relating to periods prior to January 1, 2019. The new standard provides several optional practical expedients for use in transition. The Company elected to use what the FASB has deemed the “package of practical expedients,” which allows the Company not to reassess the Company’s previous conclusions about lease identification, lease classification and the accounting treatment for initial direct costs. The ASU also provides several optional practical expedients for the ongoing accounting for hedging activities. This guidance expands strategiesleases. The Company has elected the short-term lease recognition exemption for all leases that qualify, meaning that for hedge accounting, changes how many hedging relationshipsleases with terms of twelve months or less, the Company will not recognize ROU assets or lease liabilities on the Company’s unaudited condensed consolidated balance sheet. Additionally, the Company has elected to use the practical expedient to not separate lease and non-lease components for leases of real estate, meaning that for these leases, the non-lease components are presentedincluded in the financial statements,associated ROU asset and simplifieslease liability balances on the applicationCompany’s unaudited condensed consolidated balance sheet. The comparative periods have not been restated for the adoption of hedgeASU 2016-02.
In June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718),Improvements to Nonemployee Share-Based Payment Accounting(“ASU 2018-07”), which is intended to simplify aspects of share-based compensation issued to non-employees by making the guidance consistent with the accounting in certain situations. The standard will befor employee share-based compensation. ASU 2018-07 is effective for usannualperiods beginning July 1, 2019,after December 15, 2018 andinterim periods within those annual periods, with early adoption permitted for any interim or annual period before the effective date. Adoptionbut no earlier than an entity’s adoption date of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date.Topic 606. The Company is currently evaluatingadopted the provisions of ASU 2018-07 effective January 1, 2019. Adopting ASU 2018-07 had no impact of this standard on ourthe Company’s unaudited condensed consolidated financial statements including accounting policies, processes, and systems.related disclosures.
In May 2017, the FASB issued Accounting Standards Update (“ASU”)ASU No. 2017-09, Compensation - Stock Compensation: Scope of Modification Accounting(“ASU 2017-09”), which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. An entity will account for the effects of a modification unless the fair value of the modified award is the same as the original award, the vesting conditions of the modified award are the same as the original award and the classification of the modified award as an equity instrument or liability instrument is the same as the original award. The updateASU 2017-09 is effective for fiscal year 2019. The update is to be adopted prospectively to an award modified on or after the adoptionadoption date. Early adoption is permitted. The Company is currently evaluatingadopted ASU 2017-09 in 2018 and the effectimpact of this update but doesthe adoption was not believe it will have a material impact onto itsunaudited condensed consolidated financial statements and related disclosures.
In January 2017, the FASB issued ASU No. 2017-04,New accounting pronouncements not yet effectiveIntangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment.To simplify the subsequent measurement of goodwill, the update requires only a single-step quantitative test to identify and measure impairment based on the excess of a reporting unit's carrying amount over its fair value. A qualitative assessment may still be completed first for an entity to determine if a quantitative impairment test is necessary. The update is effective for fiscal year 2021 and is to be adopted on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.
In October 2016, the FASB issued ASU No. 2016-16,Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory, as part of its simplification initiatives. The update requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than deferring the recognition until the asset has been sold to an outside party as is required under current GAAP. The update is effective for fiscal year 2019. The new standard will require adoption on a modified retrospective basis through a cumulative-effect adjustment to retained earnings, and early adoption is permitted. The Company is currently evaluating the effect that this update will have on its financial statements and related disclosures.
In June 2016, the FASB issued ASU 2016-13 Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss methodology, which will result in more timely recognition of credit losses. ASU 2016-13 is effective for annual reporting periods, and interim periods within those years beginning after December 15, 2019. We areThe Company is currently in the process of evaluating the impact of the adoption of ASU 2016-13 on ourits unaudited condensed consolidated financial statements.
In February 2016,August 2018, the FASB issued ASU 2016-02,No. 2018-13, Leases. This ASU is a comprehensive new leases standard that amends various aspects of existing guidance for leases and requires additional disclosures about leasing arrangements. It will require companies to recognize lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. Topic 842 retains a distinction between finance leases and operating leases. The classification criteria for distinguishing between finance leases and operating leases are substantially similarFair Value Measurement (Topic 820), Disclosure Framework-Changes to the classification criteriaDisclosure Requirements for distinguishing between capital leases and operating leases inFair Value Measurement(“ASU 2018-13”), which modifies the previous leases guidance. Thedisclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. ASU 2018-13 is effective for annual periods beginning after December 15, 2018, including2019 and interim periods within those fiscal years; earlierannual periods, with early adoption is permitted. InThe amendments on changes in unrealized gains and losses, the financial statements in whichrange and weighted averageof significant unobservable inputs used to develop Level 3 fair value measurements, and the ASU is firstnarrative description of measurement uncertainty should be applied leases shall be measured and recognized atprospectively for only the beginning of the earliest comparativemost recent interim or annual period presented with an adjustment to equity. Practical expedients are available for election as a package and ifin the initial fiscal year of adoption. All other amendments should be applied consistentlyretrospectively to all leases.periods presented upon their effective date. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated financial condition, results of operations and cash flows.
In January 2016, the FASB, issuedeffect that ASU 2016-01,Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amends the guidance in U.S. generally accepted accounting principles on the classification and measurement of financial instruments. Changes to the current guidance primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the ASU clarifies guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The new standard is effective for fiscal years and interim periods beginning after December 15, 2017, and are to be adopted by means of a cumulative-effect adjustment to the balance sheet at the beginning of the first reporting period in which the guidance is effective. Early adoption is not permitted except for the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income. The Company is currently evaluating the impact of adopting this standard.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, as a new Topic, ASC Topic 606, which supersedes existing accounting standards for revenue recognition and creates a single framework. Additional updates to Topic 606 issued by the FASB in 2015 and 2016 include the following:
●
ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of the new guidance such that the new provisions will now be required for fiscal years, and interim periods within those years, beginning after December 15, 2017.
●
ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations, which clarifies the implementation guidance on principal versus agent considerations (reporting revenue gross versus net).
●
ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies the implementation guidance on identifying performance obligations and classifying licensing arrangements.
●
ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which clarifies the implementation guidance in a number of other areas.
The underlying principle is to use a five-step analysis of transactions to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The standard permits the use of either a retrospective or modified retrospective application. The Company is currently in the process of completing its assessment of any significant contract and assessing the impact the adoption of the new revenue standard2018-13 will have on its consolidated financial statements and related disclosures. The standard update, as amended, will be effective for annual periods beginning after December 15, 2017. The Company performed an initial assessment of the impact of the ASU and is developing a transition plan, including necessary changes to policies, processes, and internal controls as well as system enhancements to generate the information necessary for the new disclosures. The project is on schedule for adoption on January 1, 2018 and the Company will apply the modified retrospective method. The Company expects revenue recognition across its portfolio of services to remain largely unchanged. However, the Company expects to recognize revenue earlier than it does under current guidance in a few areas, including accounting for variable fees and for certain consulting services, which will be recognized over time rather than at a point in time. While the Company has not finalized its assessment of the impact of the ASU, based on the analysis completed to date, the Company does not currently anticipate that the ASU will have a material impact on its Consolidated Financial Statements.
There are currently no other accounting standards that have been issued, but not yet adopted, that will have a significant impact on the Company’s consolidated financial position, results of operations or cash flows upon adoption.REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Recently Adopted
In January 2017, the FASB issued ASU 2017-01No. 2017-04, Business Combinations (Topic 805): ClarifyingIntangibles - Goodwill and Other: Simplifying the DefinitionTest for Goodwill Impairment(“ASU 2017-04”). To simplify the subsequent measurement of goodwill, ASU 2017-04 requires only a single-step quantitative test to identify and measure impairment based on the excess of a Business.reporting unit's carrying amount over its fair value. A qualitative assessment may still be completed first for an entity to determine if a quantitative impairment test is necessary. ASU 2017-01 provides guidance to evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. If substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single asset or a group of similar assets, the assets acquired (or disposed of) are not considered a business. We adopted ASU 2017-01 as of January 1, 2017.
In March 2016, FASB issued ASU ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The standard reduces complexity in several aspects of the accounting for employee share-based compensation, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The ASU2017-04 is effective for fiscal years beginningyear 2021 and is to be adopted on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted.January 1, 2017. The Company adopted this standard and the impact of the adoption was not material to the consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes. ASU 2015-17 is aimed at reducing complexity in accounting standards. Currently, GAAP requires the deferred taxeswill test goodwill for each jurisdiction to be presented as a net current asset or liability and net noncurrent asset or liability. This requires a jurisdiction-by-jurisdiction analysis based on the classification of the assets and liabilities to which the underlying temporary differences relate, or, in the case of loss or credit carryforwards, based on the period in which the attribute is expected to be realized. Any valuation allowance is then required to be allocated on a pro rata basis, by jurisdiction, between current and noncurrent deferred tax assets. To simplify presentation, the new guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. As a result, each jurisdiction will now only have one net noncurrent deferred tax asset or liability. The guidance does not change the existing requirement that only permits offsetting within a jurisdiction; companies are still prohibited from offsetting deferred tax liabilities from one jurisdiction against deferred tax assets of another jurisdiction. The new guidance is effective in fiscal years beginning after December 15, 2016, including interim periods within those years, with early adoption permitted. The Company early adopted and applied the new standard retrospectively to the prior period presented in the consolidated balance sheets and it did not have a material impact.
In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs. The update requires that deferred debt issuance costs be reported as a reduction to long-term debt (previously reported in other noncurrent assets). The Company adopted ASU 2015-03 in 2016 and for all retrospective periods, as required, and the impact of the adoption was not material to the consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern, which requires management to perform interim and annual assessments of an entity’s ability to continue as a going concernimpairment within one year of the dateacquisition or annually as of October 1, and whenever indicators of impairment exist. The Company is currently evaluating the effect that ASU 2017-04 will have on its financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. This accounting standard update applies to all entities and was effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter, with early adoption permitted. The Company adopted this standard during fiscal year 2016.related disclosures.
The Company does not believe that any recently issued, but not yet effective, accounting standards in addition to those referenced above, wouldcould have a material effect on its consolidatedthe accompanying financial statements. As new accounting pronouncements are issued, the Company will adopt those that are applicable under the circumstances.
NOTE 3 – BUSINESS SEGMENTS
FASB ASC Topic 280,Segment Reporting, requires that an enterprise report selected information about reportable segments in its financial reports issued to its stockholders.Beginning with the first quarter of 2019, the Company changed its operating and reportable segments from one segment to two segments: the Technology Segment and the Professional Services Segment.The two segments reflect the Company’s separate focus on technology products and services versus professional services.
The Company providesgeneral corporate services to its segments; however, these services are not considered when making operating decisions and assessing segment performance. These services are reported under “Corporate Services” below and these include costs associated with executive management, financing activities and public company compliance.
Summarized financial information concerning the Company’s reportable segments is presented below (dollars in thousands):
| | | | | |
| Three Months Ended September 30, 2019 | | | | |
| Revenues | $1,536 | $3,447 | $- | $4,983 |
| Gross profit | 1,146 | 1,605 | - | 2,751 |
| Income (loss) from operations | (722) | 365 | (1,724) | (2,081) |
| Loss from operations held for sale | - | (21) | - | (21) |
| | | | | |
| Three Months Ended September 30, 2018 | | | | |
| Revenues | $892 | $5,015 | $- | $5,907 |
| Gross profit | 487 | 2,454 | - | 2,941 |
| Income (loss) from operations | (83) | 446 | (678) | (315) |
| Income from operations held for sale | - | 77 | - | 77 |
| | | | | |
| Nine Months Ended September 30, 2019 | | | | |
| Revenues | $3,962 | $10,922 | $- | $14,884 |
| Gross profit | 2,810 | 5,054 | - | 7,864 |
| Loss from operations* | (1,312) | (1,606) | (3,971) | (6,889) |
| Loss from operations held for sale | - | (177) | - | (177) |
| * Including intangible assets impairment | - | 1,549 | - | 1,549 |
| | | | | |
| Nine Months Ended September 30, 2018 | | | | |
| Revenues | $2,639 | $12,632 | $- | $15,271 |
| Gross profit | 1,538 | 6,199 | - | 7,737 |
| Loss from operations | (332) | (48) | (3,058) | (3,438) |
| Income from operations held for sale | - | 148 | - | 148 |
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 4 – INVESTMENT AT COST AND NOTES RECEIVABLEACQUISITIONS
Secure Education Consultants Acquisition
On January 1, 2018, the Company completed its acquisition of certain assets of Secure Education Consultants through Firestorm. Consideration paid as part of this acquisition included: $100,000 in cash; 33,333 shares of Rekor common stock valued at $163,000; warrants to purchase 33,333 shares of Rekor common stock, exercisable over a period of five years, at an exercise price of $5.44 per share, valued at $66,000; and warrants to purchase 33,333 of Rekor common stock, exercisable over a period of five years, at an exercise price of $6.53 per share, valued at $57,000.
The Company has completed its analysis of the purchase price allocation. The Company recorded $386,000 of customer relationships to intangible assets.
The table below shows the final breakdown related to the Secure Education acquisition (dollars in thousands):
| Cash paid | $100 |
| Common stock issued | 163 |
| Warrants issued at $5.44 | 66 |
| Warrants issued at $6.53 | 57 |
| Total consideration | 386 |
| Less intangible assets and intellectual property | (386) |
Net goodwill recorded | $- |
On June 1, 2019, the Company sold all its interest in Secure Education for consideration of $250,000. As a result of the Secure Education sale, the Company disposed of $249,000 of net intangible assets, $58,000 of accounts receivables, and $54,000 of accounts payables. This resulted in a loss of $3,000 that is presented as part of general and administrative expenses in the accompanying unaudited condensed consolidated statement of operations.
OpenALPR Acquisition
On November 14, 2018, the Company entered into an Asset Purchase Agreement (the “OpenALPR Purchase Agreement”) by and among the Company, OpenALPR Technology, Inc. and Matthew Hill pursuant to which the Company agreed to purchase all of the assets of OpenALPR Technology Inc. and its subsidiaries, except for certain excluded assets, and assumed certain liabilities as provided for in the OpenALPR Purchase Agreement. The Company agreed to pay $15,000,000, subject to certain adjustments, provided that OpenALPR Technology, Inc. could elect to receive up to 1,000,000 shares of the Company’s common stock, par value, $0.0001 per share, in lieu of up to $5,000,000 in cash valued at a price per share of $5.00.
On February 6, 2017, prior to the Brekford Merger,15, 2019, the Company entered into a Contribution and UnitAmendment No. 1 to the OpenALPR Purchase Agreement, pursuant to which the parties agreed to amend the Base Purchase Price to $7,000,000, subject to adjustment after closing, issue a promissory note in the amount of $5,000,000, and issue 600,000 shares of Rekor common stock as consideration for the acquisition of OpenALPR Technology’s assets.
On March 8, 2019, the Company entered into Amendment No. 2 to the OpenALPR Asset Purchase Agreement which eliminated the working capital adjustment set forth in the OpenALPR Asset Purchase Agreement, as amended, and replaced it with an adjustment for prepaid maintenance contracts.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
On March 12, 2019, the Company completed the acquisition of the of OpenALPR Technology and assumed certain assets and liabilities (the “CUP Agreement”“OpenALPR Acquisition”). Consideration paid as part of the OpenALPR Acquisition was: $7,000,000 in cash, subject to adjustment after closing; 600,000 shares of Rekor common stock, valued at $397,000; and $5,000,000 of the 2019 Promissory Notes (see Note 7) principal amount, together with LB&B Associates Inc. (“LB&B”) and Global Public Safety, LLC (“GPS”),an accompanying warrant to purchase 625,000 shares of Rekor common stock, exercisable over a 100%-owned subsidiaryperiod of Brekford.five years, at an exercise price of $0.74 per share, valued at $208,000 (see Note 9).
The closingpurchase price allocation to the assets acquired and liabilities assumed based on fair values as of the acquisition date. Since the acquisition of the OpenALPR Technology occurred on March 12, 2019, the results of operations for OpenALPR from the date of acquisition have been included in the Company’s unaudited condensed consolidated statement of operations for the transaction set forth in the CUP Agreement occurred on February 28, 2017 (the “GPS Closing”)three and on such date the Company contributed substantially all of the assets and certain liabilities related to its vehicle services business to GPS. On the GPS Closing, the Company sold units representing 80.1% of the units of GPS to the LB&B for $6,048,394, after certain purchase price adjustments of prepaid expenses and unbilled customer deposits. $4,048,394 was paid in cash, including a $250,000 deposit that was paid on February 6, 2017, and $2,000,000 was paid by LB&B issuing the Company a promissory note receivable (the “GPS Promissory Note”). After the GPS Closing, the Company continues to own 19.9% of the units of GPS after the transaction. The Company is accounting for this as an investment at cost.nine-months ended September 30, 2019.
The GPS Promissory Notefinal purchase price allocation, completed in the second quarter of 2019, resulted in adjustments to intangible assets of approximately $4,934,000, since the Company's previous estimates as of March 31, 2019, and primarily related to fair value adjustments to technology-based intangible assets. The final purchase price allocation of the acquisition of OpenALPR is subordinatedas follows: intangible assets of $7,436,000 and goodwill of $4,934,000 along with net assets acquired of $415,000, and contract obligations assumed of $388,000.
The table below shows the breakdown related to the LB&B’s senior lender and accrues interest at a ratefinal purchase price allocation for the OpenALPR Technology acquisition (dollars in thousands):
| Assets acquired | $415 |
| Liabilities acquired | (388) |
| Net assets acquired | 27 |
| Less intangible assets | 7,436 |
| Consideration paid (see below) | (12,397) |
| Net Goodwill recorded | $4,934 |
| |
| Cash consideration | $7,000 |
| Notes payable | 5,000 |
| Common stock consideration | 397 |
| Total acquisition consideration | $12,397 |
Hill Employment Agreement
On November 14, 2018, concurrent with the execution of 3% per annum. The maturitythe OpenALPR Purchase Agreement, the Company entered into an employment agreement with Matthew Hill (the “Hill Employment Agreement”) which became effective as of March 12, 2019, the closing date of the GPS Promissory NoteOpenALPR Purchase Agreement.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Operations of Combined Entities
The following unaudited pro forma combined financial information gives effect to the acquisition of Secure Education and OpenALPR Technology as if they were consummated as of January 1, 2018. This unaudited pro forma financial information is March 31, 2022. The GPS Promissory Note is to be repaid as follows: (a) $75,000 plus all accrued interest on each of September 30, 2017; December 31, 2017; March 31, 2018, June 30, 2018presented for information purposes only and September 30, 2018 (or, in the event any such date is not a business day,intended to present actual results that would have been attained had the first business day after such date), (b) $100,000 plus all accrued interest on eachacquisition been completed as of December 31, 2018; March 31, 2019; June 30, 2019 and September 30, 2019 (or, in the event any such date is not a business day, the first business day after such date) (c) $125,000 plus all accrued interest on each of December 31, 2019; March 31, 2020; June 30, 2020; September 30, 2020, December 31, 2020; March 31, 2021, June 31, 2021; September 30, 2021; and December 31, 2021 (or, in the event any such date is not a business day, the first business day after such date), and (d) $100,000 on March 31, 2022. The GPS Promissory Note is secured pursuant to the terms of a Pledge AgreementJanuary 1, 2018 (the “LB&B Pledge Agreement”) between the Company and LB&B. Pursuant to the LB&B Pledge Agreement LB&B, granted the Company a continuing second priority lien and security interest in the LB&B’s units of GPS subject to liensbeginning of the LB&B’s senior lender. The current portion of notes receivable was $300,000 and zeroearliest period presented) or to project potential operating results as of September 30, 2017 and December 31, 2016, respectively. The long-term portion of the notes receivable was $1,649,000 and zero as of September 30, 2017 and December 31, 2016, respectively.any future date or for any future periods.
| | Three Months Ended September 30, | Nine Months Ended September 30, |
| | | | | |
| | (Dollars in thousands, except per share data) | (Dollars in thousands, except per share data) |
| Revenues from continuing operations | $4,983 | $6,352 | $15,853 | $16,472 |
| Net loss from continuing operations | (3,456) | (104) | (10,170) | (2,817) |
| Basic and diluted loss per share | $(0.19) | $(0.03) | $(0.56) | $(0.24) |
| Basic and diluted number of shares | 19,878,518 | 15,142,362 | 19,761,363 | 15,124,030 |
NOTE 5 —– INTANGIBLE ASSETS
Goodwill
Changes in the carrying amount of goodwill by reportable business segment for the nine months ended September 30, 2019 were as follows (dollars in thousands):
| | Segment | Balance as of December 31, 2018 | | Balance as of September 30, 2019 |
| Goodwill from continuing operations | Technology | $1,402 | $4,934 | $6,336 |
| Goodwill from held for sale operations | Professional Services | 1,691 | - | 1,691 |
| Total goodwill | | $3,093 | $4,934 | $8,027 |
Intangible Assets Subject to Amortization
The following summarizes the change in intangible assets from December 31, 2018 to September 30, 2019 (dollars in thousands):
| | Balance as of December 31, 2018 | | | | | Balance as of September 30, 2019 |
| Intangible assets subject to amortization from continuing operations |
| | | | | |
| Customer relationships | $2,475 | $90 | $(363) | $(1,549) | $(249) | $404 |
| Marketing related | 69 | 223 | (45) | - | - | 247 |
| Technology based | 83 | 7,123 | (557) | - | - | 6,649 |
| Intangible assets subject to amortization from continuing operations | 2,627 | 7,436 | (965) | (1,549) | (249) | 7,300 |
| Intangible assets subject to amortization from held for sale operations | 2,208 | - | (214) | - | - | 1,994 |
| Total intangible assets subject to amortization | $4,835 | $7,436 | $(1,179) | $(1,549) | $(249) | $9,294 |
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following provides a breakdown of identifiable intangible assets as of September 30, 2019 (dollars in thousands):
| | | | | |
| Identifiable intangible assets | $461 | $327 | $7,207 | $7,995 |
| Accumulated amortization | (57) | (80) | (558) | (695) |
| Identifiable intangible assets from continuing operations, net | 404 | 247 | 6,649 | 7,300 |
| Identifiable intangible assets from operations held for sale, net | 1,685 | 309 | - | 1,994 |
| Identifiable intangible assets, net | $2,089 | $556 | $6,649 | $9,294 |
With the acquisition of OpenALPR Technology, the Company identified technology-based intangible assets of $11,845,000 in its preliminary purchase price allocation. The final purchase price allocation, completed in the second quarter of 2019, resulted in adjustments to intangible assets of approximately $4,934,000, since the Company's previous estimates as of March 31, 2019, and primarily related to fair value adjustments to technology-based intangible assets. The final purchase price allocation of the acquisition of OpenALPR is as follows: technology-based intangible assets of $7,123,000, marketing-related intangible assets of $223,000, customer-related intangible assets of $90,000 and goodwill of $4,934,000 along with net assets acquired of $27,000.
These intangible assets are being amortized on a straight-line basis over their weighted average estimated useful life of 6.7 years. Amortization expense attributable to continuing operations for the three months ended September 30, 2019 and 2018 was $280,000 and $127,000, respectively, and for the nine months ended September 30, 2019 and 2018 was $965,000 and $557,000, respectively, and is presented as part of general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations. Amortization expense attributable to operations held for sale for the three months ended September 30, 2019 and 2018 was $72,000, respectively, and for the nine months ended September 30, 2019 and 2018 was $214,000, and is presented as part of income (loss) from operations held for sale in the accompanying unaudited condensed consolidated statements of operations.
Firestorm, the Company's wholly owned subsidiary, provided services related to crisis management, crisis communications, emergency response, and business continuity and other emergency, crisis and disaster preparedness initiatives. Its fully owned subsidiary, BC Management was an executive search firm for business continuity, disaster recovery, crisis management and risk management professionals and a provider of business continuity research with annual studies covering compensation assessments, program maturity effectiveness, event impact management reviews, IT resiliency and critical supply analyses. Its other wholly owned subsidiary, Secure Education was comprised of an expert team of highly trained, former U.S. Secret Service Agents and assists clients by designing customized plans, conducting security assessments, delivering training, and responding to critical incidents.
On June 1, 2019, the Company completed the sale of Secure Education, which included $249,000 of intangible assets (see Note 4).
On June 28, 2019 the Company discontinued the operations ofBC Management, resulting in an impairment of $242,000 of intangible assets related to its acquisition in December 2018. The discontinued operation ofBC Managementdoes not constitute a significant strategic shift that will have a material impact on the Company’s ongoing operations and financial results.
On June 30, 2019, the Company recorded an intangible assets impairment of $1,307,000 of customer relationship intangible assets from the Firestorm acquisition. In the second quarter of 2019, the Company evaluated the performance of all the franchisees of Firestorm Franchising, LLC and notified them of the termination of their agreements on the basis of non-performance. The discontinued operation of Firestorm Franchising, LLC does not constitute a significant strategic shift that will have a material impact on the Company's ongoing operations and financial results.
As of September 30, 2019, the estimated annual amortization expense from continuing operations for each of the next five fiscal years and thereafter is as follows (dollars in thousands):
| 2019 | $287 |
| 2020 | 1,150 |
| 2021 | 1,141 |
| 2022 | 1,117 |
| 2023 | 1,096 |
| Thereafter | 2,509 |
| Total | $7,300 |
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 6 – SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Supplemental disclosures of cash flow information for the nine months ended September 30, 20172019 and 2016 was2018 were as follows:
| | For the Nine Months Ended |
| | | |
| Cash paid for interest | $33,429 | $29,083 |
| Cash paid for taxes | $-
| $- |
| | | |
| Warrants issued in connection with note payable | $- | $58,520 |
| Warrants issued in connection with issuance of Series A Preferred Stock | $67,491 | $- |
| | | |
| Business Combinations: | | |
| Current Assets | $1,044,893 | $- |
| Property and equipment, net | $268,398 | $- |
| Intangible assets | $2,498,737 | $- |
| Goodwill | $1,960,328 | $- |
| Other non-current assets | $1,962,140 | $- |
| Assumed liabilities | $(1,258,905) | $- |
| Deferred revenue | $(22,493) | $- |
| Other non-current liabilities | $(16,584) | $- |
| Issuance of common stock | $(7,055,179) | $- |
| Notes payable | $(907,407) | $- |
| | For the Nine Months Ended September 30, |
| | | |
| | |
| Cash paid for interest - continuing operations | $1,544 | $298 |
Cash paid for interest - held for sale operations | 220 | 96 |
| Cash paid for taxes - held for sale operations | 12 | - |
| Non-cash investing and financing activities | | |
| Property and equipment - continuing operations | 39 | - |
| Accounts payable - continuing operations | (39) | - |
| Property and equipment - held for sale operations | - | 32 |
| Notes payable - held for sale operations | - | (32) |
| Proceeds from short-term borrowing arrangement transferred to settle line of credit | 312 | - |
| Repayment of line of credit | (312) | - |
| Business combinations, net of cash | | |
| Current assets | 415 | - |
| Intangible assets | 7,436 | 386 |
| Goodwill | 4,934 | - |
| Current liabilities | (388) | - |
| Cash paid acquisition of OpenALPR Technology | (7,000) | - |
| Note issued acquisition of OpenALPR Technology | (5,000) | |
| Issuance of common stock | (397) | (163) |
| Issuance of common stock warrants | - | (123) |
| Sale of Secured Education | | |
| Current assets | (58) | - |
| Intangible assets sold | (250) | - |
| Current liabilities | 54 | - |
| Loss on sale | 3 | - |
| Financing | | |
| Notes payable - continuing operations | 21,000 | |
| Debt discount financing costs | (2,599) | - |
| Extinguishment of debt | (1,113) | - |
| Repayment of notes payable and interest expense, net of debt discount | (2,515) | - |
| Investment in OpenALPR Technology | (12,000) | - |
| Issuance of warrants in conjunction with notes payable | 706 | |
| Accounts Payable | 360 | - |
| Proceeds from notes payable | 3,839 | |
| Common stock issued in connection with note payable | - | 126 |
| Adoption of ASC-842 Lease Accounting: | | |
| Right-of-use lease asset | 1,212 | - |
| Deferred rent | 30 | - |
| Lease liability | $(1,242) | $- |
Dividends onFor the Series A Preferred Stock totaling $5,286 were approvednine months ended September 30, 2019 and declared in 2016. On April 7, 2017,2018, the Company paid cash dividends of $75,694$0 and $264,000, respectively, to shareholders of record of Series A Preferred Stock. Accrued dividends payable to Series A Preferred Stockshareholders were $440,000 and $176,000 as of MarchSeptember 30 2017. On July 8, 2017,, 2019 and December 31, 2018, respectively, and is presented as part of accounts payable and accrued expenses on the accompanying unaudited condensed consolidated balance sheets.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
For the nine months ended September 30, 2019 and 2018, the Company paid cash dividends of $87,907$108,000 and $81,000, respectively, to shareholders of record as of June 30, 2017. On September 30, 2017, the Company declared and accruedSeries B Preferred Stock.Accrued dividends of $87,907 payable to Series B Preferred Stock shareholders of recordwere $27,000 and $54,000 as of September 30, 2017.2019 and December 31, 2018, respectively, and is presented as part of accounts payable and accrued expenses on the accompanying unaudited condensed consolidated balance sheets.
NOTE 6 —7 – DEBT
Line of CreditShort-Term Borrowings
KSIOn August 9, 2019, Global, entered an agreement with an unrelated third party, LSQ Funding Group, L.C. (“LSQ”), pursuant to which Global sells its accounts receivable to LSQ and LSQ advances Global 90% of the value of the receivable. Global can advance up to $10,000,000 at one time. The term of the agreement is for 12 months and automatically renews for additional 12-month periods. The agreement is presented as secured borrowings, as the accounts receivable are sold with recourse back to Global, meaning that Global bears the risk of non-payment by the account debtor. The funded amount of accounts receivables that LSQ has provided to Global was a party to a business loan agreement (the “2015 Loan Agreement”) with Sandy Spring Bank (“SSB”) dated$1,629,000 as of September 25, 2015. The primary credit facility was an asset-based revolving line30, 2019 and is presented as part of credit up to $1,000,000 which was due to maturecurrent liabilities held for sale on September 30, 2016.the unaudited condensed consolidated balance sheets. To secure its obligations under the 2015 Loan Agreement, KSI hadto LSQ, Global has granted to SSB a first priority security interest in its accounts receivable. SSB was required to advance funds to KSI up to the lesser of (1) $1,000,000 or (2) eighty percent (80%) of the aggregate amount of all of itsGlobal’s accounts receivable aged 90-days or less which contained selling terms and conditions acceptable to the SSB. KSI’s obligations under the 2015 Loan Agreement were guaranteed by James McCarthy, Chairman of the Board of KSI, and his wife. KSI did not draw any funds from this credit facility in 2015. Pursuant to First Amendment to Business Loan Agreement (Asset Based), dated May 9, 2016, SSB had waived the restrictions in the 2015 Loan Agreement on KSI’s ability to make dividends to the Company. There was no outstanding balance on the 2015 Loan Agreement at December 31, 2016.
On August 11, 2016, Novume entered into Loan and Security Agreement (the “2016 Line of Credit”) with SSB that replaced the 2015 Loan Agreement. The 2016 Line of Credit is comprised of: 1) an asset-based revolving line of credit up to $1,000,000 for short-term working capital needs and general corporate purposes which was due to mature on July 31, 2017, bears interest at the Wall Street Journal Prime Rate, floating, plus 0.50% and is secured by a first lien on all of Novume’s business assets; and 2) an optional term loan of $100,000 which must be drawn by July 31, 2017, which is for permanent working capital, bears interest at the Wall Street Journal Prime Rate, floating, plus 0.75%, requires monthly payments of principal plus interest to fully amortize the loan over four (4) years, is secured by a first lien on all of Novume’s business assets, cross-collateralized and cross-defaulted with the revolving line of credit, and matures on February 15, 2019. The 2016 Line of Credit did not require any personal guarantees.
The borrowing base for the 2016 Line of Credit was up to the lesser of (1) $1,000,000 or (2) eighty percent (80%) of the aggregate amount of all of Novume’s eligible accounts receivable as defined by SSB. The borrowing base for the $100,000 term loan was fully reserved under the borrowing base for the revolving line of credit. The 2016 Line of Credit had periodic reporting requirements, balance sheet and profitability covenants, as well as affirmative and negative operational and ownership covenants. Novume was in compliance with all 2016 Line of Credit covenents at December 31, 2016. In August 2017, the Company terminated the 2016 Line of Credit with SSB. As such, there was no outstanding balance on the 2016 Line of Credit at September 30, 2017.
proceeds thereof. As of September 30, 20172019, there were approximately $2,515,000 of receivables that are subject to collateral as part of this agreement. The receivables held as collateral are presented in assets held for sale on the unaudited condensed consolidated balance sheets.
On August 9, 2019, AOC Key Solutions, Inc. (“AOC”), the Company’s wholly owned subsidiary, also entered into anagreement with LSQ, as an unrelated third party, pursuant to which AOC sells its accounts receivable to LSQ and LSQ advances AOC 90% of the value of the receivable. AOC can advance up to $5,000,000 at one time. The term of the agreement is for 12 months and automatically renews for additional 12-month periods. The agreement is presented as secured borrowings, as the accounts receivable are sold with recourse back to the Company, meaning that AOC bears the risk of non-payment by the account debtor. The funded amount of accounts receivables that LSQ has provided fund to AOC was $1,558,000 as of September 30, 2019 and is presented as part of short-term borrowings on the unaudited condensed consolidated balance sheets. To secure its obligations to LSQ, AOC has granted a first priority security interest in the AOC’s accounts receivable and proceeds thereof. As of September 30, 2019, there were approximately $2,451,000 of receivables that are subject to collateral as part of this agreement. The receivables held as collateral are presented in the accounts receivable, net on the unaudited condensed consolidated balance sheets.
During the three and nine months ended September30, 2019, the Company recorded $33,000, in interest expense, related to the agreement with LSQ. Additionally, during the three and nine months ended September 30, 2019, the Company recorded $80,000 in interest expense from operations held for sale, related to the agreement with LSQ.
Global had revolving lines of credit with Wells Fargo Bank National Association (“WFB”) (“Wells Fargo Credit Facilities”).WFB agreed to advance toGlobal90% of all eligible accounts with a maximum facility amount of $5,000,000. Interest was payable under theWells Fargo Credit Facilitiesat a monthly rate equal to the Three-Month LIBOR, (as such term is defined under the Wells Fargo Credit Facilities), in effect from time to time plus 3%, plus an additional margin of 3%. Payment of the revolving lines of credit was secured by the accounts receivable of Global. The term of the Wells Fargo Credit Facilities was through December 31, 2019, with automatic renewal terms of 12 months. In August 2019, Global entered in a payoff and termination agreement with WFB in which Global paid WFB $1,477,000 to retire all indebtedness and obligation to WFB. As part of payoff of the debt Global recognized $31,000 of costs in excess of the net carrying amount of the outstanding debt, which is presented in the loss on extinguishment of debt on the unaudited condensed consolidated statement of operations. The principal balance as of September 30, 2019 and December 31, 2016, Novume had no balances due, respectively, for the 2016 Line of Credit2018 was $0 and the 2015 Loan$1,095,000, respectively.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In November 2017, AOC,entered into an Account Purchase Agreement and there arerelated agreements (the “AOC Wells Agreement”) with WFB. Pursuant to the AOC Wells Agreement,AOC Key Solutionsagreed to sell and assign to WFB all of its Accounts (as such term is defined in Article 9 of the Uniform Commercial Code), constituting accounts arising out of sales of Goods (as such term is defined in Article 9 of the Uniform Commercial Code) or rendition of services that WFB deemed to be eligible for borrowing under the AOC Wells Agreement. WFB agreed to advance toAOC Key Solutions90% of all eligible accounts with a maximum facility amount of $3,000,000. Interest was payable under the AOC Wells Agreement at a monthly rate equal to the Daily One Month LIBOR, (as such term was defined under the AOC Wells Agreement), in effect from time to time plus 5%. The AOC Wells Agreement also provided for a deficit interest rate equal to the then applicable interest rate plus 50% and a default interest rate equal to the then applicable interest rate or deficit interest rate, plus 50%. The initial term of the AOC Wells Agreement ran through December 31, 2018 (the “Initial Term”), with automatic renewal terms of 12 months (the “Renewal Term”), commencing on the first day after the last day of the Initial Term.The current term of the AOC Wells Agreement ran through December 31, 2019. AOC Key Solutionswas able to terminate the AOC Wells Agreement upon at least 60 days’ prior written notice, but no amounts outstandingmore than 120 days’ written notice, prior to and effective as of the datelast day of this Form 10-Q. When Novume replaced the 2015 Loan AgreementInitial Term or the Renewal Term, as the case may be.In August 2019, AOC entered in a payoff and termination agreement with WFB in which AOC paid WFB $341,000 to retire all indebtedness and obligation to WFB. As part of payoff of the 2016 Linedebt AOC recognized $45,000 of Creditcosts in excess of the net carrying amount of the outstanding debt, which is presented in the loss on August 11, 2016, neither lineextinguishment of credit had adebt on the unaudited condensed consolidated statement of operations. The principal balance due. The Company terminated its lineas of credit in August 2017.September 30, 2019 and December 31, 2018 was $0 and $566,000, respectively.
Long-Term Debt
On March 16, 2016, Novumethe Company entered into a Subordinated Note and Warrant Purchase Agreement (the “Avon Road Note Purchase Agreement”) pursuant to which Novume agreed to issue up to $1,000,000$500,000 in subordinated debt and warrants to purchase up to 242,493 shares of Novume’s common stock (“Avon(the "Avon Road Subordinated Note Warrants”Note"). The exercise price for was issued by the Avon Road Subordinated Note Warrants is equal to $1.03 per share of common stock. Subordinated notes with a face amount of $500,000 and Avon Road Subordinated Note Warrants to purchase 121,247 shares of Novume’s common stock have been issued pursuant to the Avon Road Note Purchase AgreementCompany to Avon Road Partners, L.P. (“Avon Road”), an affiliate of Robert Berman, Novume’sthe Company’s President and CEO and a member of Novume’sthe Company’s Board of Directors. The Avon Road Subordinated Note Warrants havehad an expiration date of March 16, 2019 and qualified for equity accounting as the warrant did not fall within the scope of ASC Topic 480, Distinguishing Liabilities from Equity. The fair value was determined to be $58,520 and is recorded as a debt discount and additional paid-in capital in the accompanying consolidated balance sheet as of December 31, 2016. The debt discount is being amortized as interest expense on a straight-line basis, which approximates the effective interest method, through the maturity date of the note payable.
The note is subordinated to the 2016 Line of Credit with SSB and any successor financing facility. Simple interest accrues on the unpaid principal of the note at a rate equal to the lower of (a) 9% per annum, or (b) the highest rate permitted by applicable law. Interest is payable monthly, and the note matures on March 16, 2019. The Company terminated the 2016 Loan Agreementwarrants associated to this agreement were exercised in August 2017.
PursuantOn March 12, 2019, the $500,000 balance due on the Avon Road Note was retired in its entirety in exchange for an equivalent principal amount of the 2019 Promissory Notes (see below).
On January 25, 2017, pursuant to the terms of theits acquisition of the membership interests in the Firestorm, Entities, the Company issued $1,000,000 in the aggregate in the form of four unsecured, subordinated promissory notes issued by Novume andwith interest payable over five years after the Firestorm Closing Date, to all the Members of the Firestorm Entities.years. The principal amount of the note payable to Lancer is $500,000. The principal amount of the note payable to Mr. Rhulen is $166,666.66. The principal amountone of the notes payable to each of Mr. Satterfield and Ms. Loughlin is $166,666.67. The Firestorm Principal Notes are$500,000 payable at an interest rate of 2% and the Lancer Note isremaining three notes are evenly divided over the remaining $500,000 and payable at an interest rate of 7%. The notes mature on January 25, 2022. The balance of these notes payable was $956,000 and $938,000, net of unamortized interest, as of September 30, 2017was $919,7532019 and December 31, 2018, respectively, to reflect the amortized fair value of the notes issued due to the difference in interest rates.rates of $44,000 and $62,000, respectively.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
On April 3, 2018, the Company entered into a transaction pursuant to which an institutional investor (the “2018 Lender”) loaned $2,000,000 to the Company (the “2018 Promissory Note”). The loan was originally due and payable on May 1, 2019 and bore interest at 15% per annum, with a minimum of 15% interest payable if the loan is repaid prior to May 1, 2019. In addition, the Company issued 35,000 shares of common stock to the 2018 Lender, which shares contained piggy-back registration rights. If the shares were not registered on the next selling shareholder registration statement, the Company would have been obligated to issue an additional 15,000 shares to the 2018 Lender. Upon the sale of Rekor Recognition Systems, Inc. (“Rekor Recognition”), the company’s wholly owned subsidiary, or its assets, the 2018 Lender was entitled to receive 7% of any proceeds received by the Company or Rekor Recognition in excess of $5,000,000 (the “Lender’s Participation”). In addition, commencing January 1, 2020, the 2018 Lender was to be paid 7% of Rekor Recognition’s earnings before interest, taxes, depreciation and amortization, less any capital expenditures, which amount was to be credited for any payments that might ultimately be paid to the 2018 Lender as its Lender’s Participation, if any. At April 3, 2018, the fair value of shares issued was $126,000. On October 24, 2018, the Company and Rekor Recognition entered a note amendment with the 2018 Lender by which the maturity date of the note was extended to May 1, 2020 (the “2018 Promissory Note Amendment”). The 2018 Promissory Note Amendment further provided for payment of interest through May 1, 2019, if the principal was repaid before May 1, 2019. At October 24, 2018, an additional $62,500 fee was paid as consideration for extending the maturity date to May 1, 2020 and designated as financing costs related to the 2018 Promissory Note Amendment. Amortized financing cost for the three months ended September 30, 2019 and 2018 was determined to be $0 and $29,000, respectively, and for the nine months ended September 30, 2019 and 2018 was determined to be $31,000 and $58,000, respectively. Amortized financing cost is presented as part of interest expense in the accompanying unaudited condensed consolidated statement of operations. The 2018 Promissory Note had an effective interest rate of 19.5%. On March 12, 2019, the $2,000,000 balance due on the 2018 Promissory Note was retired in its entirety in exchange for an equivalent principal amount of the 2019 Promissory Notes (see below). In addition, Rekor paid to the 2018 Lender $1,050,000 of consideration for the re-acquisition by the Company of the Lender’s Participation and $75,000 of interest due through May 1, 2019. All amounts paid were obtained from the proceeds of the 2019 Promissory Notes. The 2018 Lender consideration of $1,050,000 for the Lender’s Participation and unamortized financing costs of $63,000 are recorded as costs in connection with the loss on the extinguishment of debt of $1,113,000 for the nine months ended September 30, 2019.
2019 Promissory Notes
On March 12, 2019, the Company entered into a note purchase agreement pursuant to which investors, including OpenALPR Technology, Inc. (see Note 4) (the “2019 Lenders”) loaned $20,000,000 to Rekor (the “2019 Promissory Notes”) and the Company issued to the 2019 Lenders warrants to purchase 2,500,000 shares of Rekor common stock (the “March 2019 Warrants”)(See Note 4). The loan is due and payable on March 11, 2021 and bears interest at 16% per annum, of which at least 10% per annum is required to be paid in cash. Any remaining interest accrues to be paid at maturity or earlier redemption. The notes also require a $1,000,000 exit fee due at maturity, or a premium if paid before the maturity date, and compliance with affirmative, negative and financial covenants, including a fixed charge coverage ratio, minimum liquidity and maximum capital expenditures. The fixed charge coverage ratio covenant related to this note has been deferred through December 31, 2019. Transaction costs included $403,000 for a work fee payable over 10 months, $290,000 in legal fees and a $200,000 closing fee. The loan is secured by a security interest in substantially all of the assets of Rekor. The March 2019 Warrants are exercisable over a period of five years, at an exercise price of $0.74 per share, and are valued at$706,000. The warrants were exercisable commencing March 12, 2019 and expire on March 12, 2024. Amortized financing cost for the three and nine months ended September 30, 2019 were $328,000 and $719,000, respectively, and are included in interest expense on the unaudited condensed consolidated statement of operations. The 2019 Promissory Notes has an effective interest rate of 24.87%.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The principal amounts due for long-term notes payable described above are shown below as of September 30, 2019 (dollars in thousands):
| 2019 | $- |
| 2020 | - |
| 2021 | 21,000 |
| 2022 | 1,000 |
| 2023 | - |
| Thereafter | - |
| Total | $22,000 |
| | |
| Less unamortized interest | (44) |
| Less unamortized financing costs | (1,880) |
Notes payable
| $20,076 |
NOTE 7 —8 – INCOME TAXES
The Company accounts for income taxes in accordance with ASC Topic 740. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. In determining the need for a valuation allowance, management reviews both positive and negative evidence pursuant to the requirements of ASC Topic 740, including current and historical results of operations, future income projections and the overall prospects of the Company’s business.
The 2017 Tax Cut and Jobs Act ("2017 Act") changed U.S. tax law and included various provisions that impacted the Company. The 2017 Act affected the Company by changing U.S. tax rates, increasing the Company’s ability to utilize accumulated net operating losses generated after December 31, 2017, and impacted the estimates of deferred tax assets and liabilities.
The benefit fromCompany’s income taxestax provision for the three and nine months ended September 30, 2017 consists2019 and 2018 was $35,000 and $22,000, respectively. The increase in the tax expense is primarily related to state minimum taxes and the state of the following:
| | Three Months ended September 30, 2017 | Nine Months ended September 30, 2017 |
| Deferred: | | |
| Federal | $(168,767) | $(812,223) |
| State | (56,375) | (152,154) |
| Benefit from income taxes | $(225,142) | $(964,377) |
| | | |
Texas gross receipts tax. The components ofCompany established a valuation allowance against deferred income tax assets during 2017 and liabilities are as follows at September 30, 2017:
Deferred tax assets: | |
Amortizable start-up costs | $110,729
|
Amortizable intangibles | 81,034
|
Accrued bonuses | 53,998
|
Net operating loss carryforward | 1,166,042
|
| 1,411,803
|
Deferred tax liabilities: | |
Permanent differences
| (137,205)
|
Fixed assets | (90,239)
|
Total deferred tax assets, net | $1,184,359
|
The difference betweenhas continued to maintain a full valuation allowance through the income tax provision computed at the U.S. Federal statutory rate and the actual tax benefit is accounted for as follows for the three and nine months ended September 30, 2017:
| | Three Months ended September 30, 2017 | Nine Months ended September 30, 2017 |
| U.S. statutory federal rate | 34.00% | 34.00% |
| (Decrease) increase in taxes resulting from: | | |
| State income tax rate, net of U.S. Federal benefit | 3.97% | 3.96% |
| Net effect of permanent and temporary reconciling items | -4.44% | -4.44% |
| Effective tax rate | 33.52% | 33.52% |
The Company files income tax returns in the United States and in various state and foreign jurisdictions.states. No U.S. Federal, state or foreign income tax audits were in process as of September 30, 2017. 2019.
As more fully disclosed in Note 2, through March 15, 2016, KSI elected to be taxed underManagement has evaluated the provisions of Subchapter Srecoverability of the Internal Revenue Code. Under those provisions, KSI did not pay federal corporate income taxes, and in most instances statenet deferred income tax on its taxable income. Thus, forassets and the year ended December 31, 2016, KSI did not have any provision for income taxes.
There was nolevel of the valuation allowance required with respect to such net deferred income tax assets. After considering all available facts, the Company fully reserved for its net deferred tax assets at September 30, 2017, asbecause management believes that theit is more-likely-than-not that their benefits will not be realized in future periods. The Company will continue to evaluate its deferred tax assets to determine whether any changes in circumstances could affect the realization of their future benefit. If it is determined in future periods that portions of the Company’s net deferred income tax assets satisfy the realization standard, the valuation allowance will be realized through future operations. At September 30, 2017, Novume had net operating loss carryforwards of approximately $2,658,947.reduced accordingly.
For the three and nine months ended September 30, 2017 and 2016, Novume2019 the Company did not record any interest or penalties related to unrecognized tax benefits. It is the Company’s policy to record interest and penalties related to unrecognized tax benefits as part of income tax expense. The 2015 through 2018 tax years remain subject to examination by the Internal Revenue Service.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 8 —9 – STOCKHOLDERS’ (DEFICIT) EQUITY
Common Stock
The Company is authorized to issue 30,000,000 shares of common stock, $0.0001 par value. As of September 30, 20172019, and December 31, 2016,2018, the issued and outstanding common shares of NovumeRekor were 13,933,78420,406,489 and 5,000,000 (9.699,722 shares post Brekford Merger),18,767,619, respectively.
As described in more detail in Note 1, on March 15, 2016, the stockholders of KSI formed KeyStone as a holding company with the same proportionate ownership percentage as KSI. Pursuant to the Keystone Merger Agreement, the stockholders exchanged 100% of the outstanding common stock of KSI for 5,000,000 (9.699,720 post merger split) shares newly issued KeyStone common stock, representing 100% of the outstanding common stock. The formation of KeyStone provided for 25,000,000 authorized shares of KeyStone $.0001 par value common stock. As of December 31, 2016, 5,000,000 (9.699,720 post merger split) shares of KeyStone common stock were issued and outstanding.
In January 2017,2018, the Company issued 488,094 (946,875 post Brekford Merger)33,333 shares of NovumeRekor common stock as consideration as part of its acquisition of Firestorm.Secure Education.
In April 2018, the Company issued 35,000 shares of Rekor common stock as additional consideration to the 2018 Lender in connection with the 2018 Promissory Note.
On November 1, 2018, the Company issued 4,125,000 shares of common stock through an underwritten public offering at a public offering price of $0.80 per share. Net proceeds to the Company was approximately $2,800,000. In addition, the Company granted underwriters a 45-day option to purchase up to 618,750 additional shares of common stock to cover over-allotment, if any. The underwriters did not exercise this option and the options were cancelled. As part of the consideration to the underwriters, the Company issued to the underwriters warrants to purchase an aggregate of 206,250 shares of common stock, exercisable over a period of five years, at an exercise price of $1.00 per share. As of September 30, 2019, the underwriter warrants had an estimated value of approximately $200,000 and became exercisable commencing April 27, 2019 and expire on October 29, 2023.
Upon completionFor the nine months ended September 30, 2018, the Company issued 13,998shares of Rekor common stock related to the exercise of common stock options. There were no stock options exercised for the nine months ended September 30, 2019.
On February 15, 2019, the Company entered into Amendment No. 1 to the OpenALPR Purchase Agreement, pursuant to which the Company agreed to issue 600,000 shares of Rekor common stock as partial consideration for the acquisition of the KeyStoneOpenALPR Technology. On March 12, 2019, the Company issued 600,000 shares of Rekor common stock as part of the consideration for the acquisition of the OpenALPR Technology.
For the nine months ended September 30, 2019 and Brekford merger2018, the Company issued 1,638,870and 82,331shares of Rekor common stock, respectively. Out of these, 931,666 shares of Rekor common stock were issued in exchange for cash and cashless exercise of 1,149,806 warrants during 2019, 600,000 shares were issued in connection the acquisition of OpenALPR, 3,638 shares were issued as part of the exercise of warrants related to series A preferred stock and 103,566 shares were issued in connection with the Sales Agreement.
At-the-Market Offering
On August 14, 2019, the Company entered into the Sales Agreement with B. Riley FBR, Inc. (“B. Riley FBR”) to create an at-the-market equity program under which the Company from time to time may offer and sell shares of its common stock, having an aggregate offering price of up to $15,000,000, through or to B. Riley FBR. Subject to the terms and conditions of the Sales Agreement, B. Riley FBR will use its commercially reasonable efforts to sell the shares of the Company’s common stock from time to time, based upon the Company’s instructions. B. Riley FBR will be entitled to a commission equal to 3.0% of the gross proceeds from each sale. The Company incurred issuance costs of approximately $256,000 related to legal, accounting, and other fees in connection with the Sales Agreement. These costs were charged against the gross proceeds of the Sales Agreement and presented as a reduction to additional paid-in capital on August 28, 2017, consideration wasthe unaudited condensed consolidated balance sheets.
Sales of the Company’s common stock under the Sales Agreement are to be issued and sold pursuant to the Company’s shelf registration statement on Form S-3 (File No 333-224423), previously filed with the Securities and Exchange Commission (“SEC”) on April 24, 2018 and declared effective by the SEC on April 30, 2018. In September 2019, based on settlement date, the Company sold 103,566 shares of common stock at a weighted-average selling price of $2.84 per share in accordance with the termsSales Agreement. Net cash provided from the Sales Agreement was $29,000 after paying $256,000 related to the issuance costs stated above, as well as, 3.0% or $9,000 related to cash commissions provided to B. Riley FBR. As of September 30, 2019, $14,706,000 remained available for sale under the BrekfordMerger Agreement. Immediately upon completionSales Agreement.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Preferred Stock
The Company is authorized to issue up to 2,000,000 shares of preferred stock, $0.0001 par value. The Company’s preferred stock may be entitled to preference over the Brekford Merger,common stock with respect to the pre-merger stockholdersdistribution of KSI owned approximately 80% of the issued and outstanding capital stockassets of the Company on a fully-diluted basis, andin the pre-merger stockholdersevent of Brekford owned approximately 20%liquidation, dissolution or winding-up of the Company, whether voluntarily or involuntarily, or in the event of any other distribution of assets of the Company among its shareholders for the purpose of the winding-up of its affairs. The authorized but unissued shares of the preferred stock may be divided into, and issued in, designated series from time to time by one or more resolutions adopted by the Board of Directors of the Company. The Board of Directors of the Company, in its sole discretion, has the power to determine the relative powers, preferences and outstanding capital stockrights of Novume on a fully-diluted basis.each series of preferred stock.
Series A Cumulative Convertible Redeemable Preferred Stock
The Company isOf the 2,000,000 authorized to issue 7,500,000 shares of Preferred Stock, of which 500,000preferred stock, 505,000 shares were initiallyare designated as $.0001$0.0001 par value KeyStone Series A Cumulative Convertible Redeemable Preferred Stock (the “Series A Preferred Stock”). The number of designated shares of the Series A Preferred Stock was increased to 505,000 shares on March 20, 2017.
In November 2016, Novume commenced its Reg 1A Offering (the “Reg 1A Offering”) of up to 3,000,000 Units. Each Unit, after the Brekford Merger, consisted of one shareholders of Series A Preferred Stock which is convertible to 1.94 shares of Novume Common Stock and one Unit Warrant to purchase 0.48 shares of the Novume Common Stock at an exercise price of $1.03 per share. The Series A Preferred Stock holders are entitled to quarterly dividends of 7.0% per annum per share.
The holders of Series A Preferred Stock holder hashave a put right to convert each share into common stock at an initial conversion price and a specified conversion price which increases annually based on the passage of time beginning in November 2019. The holders of Series A Preferred Stock holder also hashave a put right after 60 months from the issuance date to redeem any or all of the Series A Preferred Stock at a redemption price of $7.73$15.00 per share plus any accrued but unpaid dividends. NovumeThe Company has a call right after 36 months from the issuance date to redeem all of the Series A Preferred Stock at a redemption price which increases annually based on the passage of time beginning in November 2019. The Series A Preferred Stock contains an automatic conversion feature based on a qualified initial public offering in excess of $30,000,000 or a written agreement by at least two-thirds of the holders of Series A Preferred Stock holders at an initial conversion price and a specified price which increases annually based on the passage of time beginning in November 2016. Based on the terms of the Series A Preferred Stock, the Company concluded that the Series A Preferred Stock should be classified as temporary equity in the accompanying unaudited condensed consolidated balance sheetsheets as of September 30, 2017.2019 and December 31, 2018.
The Reg 1A Offering Units were sold at $10 per Unit in minimum investment amounts of $5,000. There were three closings related to the sales of the Units. The gross proceeds, which the Company deemed to be fair value, from the first closing on December 23, 2016 totaled $3,015,700 with the issuance of 301,570 shares of Series A Preferred Stock and 301,570 Unit Warrants. On January 23, 2017, the Company completed its second closing of the Reg 1A Offering for the issuance of 119,757 shares of Series A Preferred Stock and 119,757 Unit Warrants with the Company receiving aggregate gross proceeds of $1,197,570.
On March 21, 2017, the Company completed its third and final closing of the Reg 1A Offering with the issuance of 81,000 shares of Series A Preferred Stock and 81,000 Unit Warrants with the Company receiving aggregate gross proceeds of $810,000.
The aggregate total sold in the Reg 1A Offering through and including the third and final closing was 502,327 Units, or 502,327 shares of Series A Preferred Stock and 502,327 Unit Warrants, for total gross proceeds to the Company of $5,023,270. The Reg 1A Offering is now closed.
Novume will adjustadjusts the value of the Series A Preferred Stock to fair (redemption)redemption value at December 31, 2017.the end of each reporting period. The adjustment to the redemption value will bewas recorded through equity. additional-paid-in-capital of $191,000 and $167,000 for the three months ended September 30, 2019 and 2018, respectively and $554,000 and $483,000 for the nine months ended September 30, 2019 and 2018, respectively.
As of September 30, 2017,2019, and December 31, 2018, 502,327 shares of Series A Preferred Stock were issued and outstanding.
outstanding, respectively.
The Novumeholders of Series A Preferred Stock isare entitled to quarterly cash dividends of $0.175 (7% per annum) per share. On April 7, 2017,Dividends accrue quarterly and dividend payments for declared dividends are due within five business days following the end of a quarter.For the nine months ended September 30, 2019 and 2018, the Company paid cash dividends of $75,694$0 and $264,000, respectively, to shareholders of record as of March 30, 2017. On July 8, 2017, the Company paid cashSeries A Preferred Stock. Accrued dividends of $87,907 to shareholders of record as of June 30, 2017. On September 30, 2017, the Company declared and accrued dividends of $87,907 payable to Series A Preferred Stock shareholders of recordwere $440,000 and $176,000 as of September 30, 2017.2019 and December 31, 2018, respectively, and are presented as part of the accounts payables and accrued expenses on the accompanying unaudited condensed consolidated balance sheets.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Series B Cumulative Convertible Preferred Stock
Of the 2,000,000 authorized shares of preferred stock, 240,861 shares are designated as $0.0001 par value Series B Cumulative Convertible Preferred Stock (the "Series B Preferred Stock"). The Series B Preferred Stock has a conversion price of $5.00 per share. Each Series B Preferred Stock has an automatic conversion feature based on the share price of the Company. The holders of Series B Preferred Stock are entitled to quarterly cash dividends of 1.121% (4.484% per annum) per share. Dividends accrue quarterly and dividend payments for declared dividends are due within five business days following the end of a quarter. Accrued dividends payable to Series B Preferred Stock shareholder were $27,000 and $54,000 as of September 30, 2019 and December 31, 2018, respectively and are included in accrued expenses on the accompanying unaudited condensed consolidated balance sheets.
Warrants
The Company had warrants outstanding that are exercisable into a total of 2,251,232 and 1,214,491 shares of Rekor common stock as of September 30, 2019 and December 31, 2018, respectively.
As part of its acquisition of Brekford on August 29, 2017, the Company assumed Brekford’s obligations with respect to the Brekford Warrants.The exercise price for theBrekfordWarrants was $7.50 and they expired on March 31, 2020. Effective October 16, 2018, the Company entered into exchange agreements with holders of theBrekfordWarrants pursuant to which the Company issued to the holders an aggregate of 96,924 shares of common stock in exchange for the return of the warrants to the Company for cancellation. As of September 30, 2019, and December 31, 2018, noBrekfordWarrants were outstanding.
As part of a Regulation A Offering in fiscal year 2016 and 2017, the Company issued warrants to the holders of Series A Preferred Stock. The exercise price for these warrants is $1.03 and they are exercisable into a total of 240,015 and 243,655 shares of Rekor common stock as of September 30, 2019 and December 31, 2018, respectively. The warrants expire on November 23, 2023.In August 2019, 7,500 of the outstanding warrants were exercised and converted into 3,638 shares of the Company's common stock.
As part of the acquisition of Firestorm on January 24, 2017, the Company issued: warrants to purchase 315,627 shares of its common stock, exercisable over a period of five years, at an exercise price of $2.5744 per share; and warrants to purchase 315,627 shares of its common stock, exercisable over a period of five years, at an exercise price of $3.6083 per share (the “Firestorm Warrants”). The expiration date of the UnitFirestorm Warrants is seven years from the date of issuance. The Unit Warrants are required to be measured at fair value at the time of issuance and classified as equity. The Company determined that under the Black-Scholes option pricing model, the fair value at the date of issuance was $169,125.January 24, 2022. As of September 30, 2017, 502,327 Unit2019, and December 31, 2018, there were 631,254 Firestorm Warrants are outstanding.
NOTE 9 – WARRANT DERIVATIVE LIABILITY
On March 17, 2015, Brekford issued a Warrant (“Brekford Warrant”), which permitsPursuant to its acquisition of BC Management on December 31, 2017, the holderCompany issued: warrants to purchase 56,00033,333 shares of Common Stock withits common stock, exercisable over a period of five years, at an exercise price of $7.50$5.44 per share; and warrants to purchase 33,333 shares of its common stock, exercisable over a period of five years, at an exercise price of $6.53 per share (the “BC Management Warrants”). The expiration date of the BC Management Warrants was December 31, 2022. As of December 31, 2018, there were 66,666 BC Management Warrants outstanding. The BC Management Warrants were surrendered on May 17, 2019, due to the discontinuance of operations of BC Management, and as of September 30, 2019 there were no BC Management Warrants outstanding.
Pursuant to its acquisition of Secure Education on January 1, 2018, the Company issued: warrants to purchase 33,333 shares of its common stock, exercisable over a lifeperiod of five years.
The Brekford Warrantyears, at an exercise price is subjectof $5.44 per share; and warrants to anti-dilution adjustments that allow for its reduction in the event the Company subsequently issues equity securities, includingpurchase 33,333 shares of Common Stock or any security convertible or exchangeable for sharesits common stock, exercisable over a period of Common Stock, for no consideration or for consideration less than $7.50 a share.five years, at an exercise price of $6.53 per share (the “Secure Education Warrants”). The Company accounted for the conversion optionexpiration date of the Brekford Warrant in accordance with ASC Topic 815. Accordingly, the conversion optionSecure Education Warrants is not considered to be solely indexed to the Company’s own stock and, as such, is recorded as a liability. The derivative liability associated with the Brekford Warrant has been measured at fair value atJanuary 1, 2023. As of September 30, 20172019, and December 31, 2016 using2018, there were 66,666 Secure Education Warrants outstanding.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
On November 1, 2018, in connection with an underwritten public offering of its common stock, the Black Scholes option-pricing model. The assumptions usedCompany issued to the underwriters warrants to purchase 206,250 shares of its common stock, exercisable over a period of five years, at an exercise price of $1.00 per share. These warrants have a value of approximately $200,000 and are exercisable commencing April 27, 2019 and expire on October 29, 2023. During the nine months ended September 30, 2019, 186,681 warrants were exercised in cash and cashless transactions resulting in the Black-Scholes model are as follows: (i) dividend yieldissuance of 0%; (ii) expected volatility148,279 shares of 80.5-105.1%; (iii) weighted average risk-free interest ratecommon stock. As of 1.14-1.93%; (iv) expected life of five years; and (v) estimated fair value of the Common Stock of $0.10-$0.26 per share.
At September 30, 20172019, and December 31, 2016,2018, 16,437 and 206,250 warrants related to the 2018 underwritten public offering remain outstanding, fair valuerespectively.
On March 12, 2019, in connection with the 2019 Promissory Notes, the Company issued warrants to purchase 2,500,000 shares of its common stock, which are immediately exercisable at an exercise price of $0.74 per share, to certain individuals and entities (see Note 7).Of the2,500,000 warrants, 625,000were issuedas partial consideration for its acquisition of the derivative liability was $18,228 and $24,360, respectively.OpenALPR Technology (see Note 4).During the nine months ended September 30, 2019, 963,125 warrants were exercised in cashless transactions resulting in the issuance of 783,387 shares of common stock.As of September 30, 2019, 1,536,875 warrants related to the 2019 Promissory Notes remain outstanding.
NOTE 10 – RESTRUCTURING
In June 2019, the Company implemented a new organizational structure and plan to improve operating results by reducing operating costs by eliminating redundant positions, and the Company initiated restructuring and transition activities to improve operational efficiency, reduce costs and better position the Company to drive future revenue growth. For the nine months ended September 30, 2019, the Company recorded $333,000 of charges, related to one-time employee termination benefits, in connection with these activities. These charges were related to the Professional Services Segment and are included as part of general and administrative expenses in the accompanying unaudited condensed consolidated statement of operations. As of September 30, 2019, the remaining liability related to the restructuring activities was $253,000 and is presented as part of accounts payable and accrued expenses in the accompanying unaudited condensed consolidated balance sheets. The amounts due are expected to be paid within the next 12 months.
NOTE 1011 – COMMON STOCK OPTION AGREEMENT
On March 16, 2016, two stockholders of the Company entered into an option agreement with Avon Road (collectively, the “Avon Road Parties”). Under the terms of this agreement Avon Road paid the stockholders $10,000 each (a total of $20,000) for the right to purchase, on a simultaneous and pro-rata basis, up to 4,318,856 shares of Novume’sRekor’s common stock owned by those two shareholders at $0.52 per share, which was determined to be the fair value. The option agreement had a two-year term which expireswould have expired on March 16, 2018. On September 7, 2017, the Avon Road Parties entered into an amended and restated option agreement which extended the right to exercise the option up to and including March 21, 2019.2019 (the “Amended and Restated Option Agreement”). Pursuant to the Amended and Restated Option Agreement, on December 10, 2018, Avon Road exercised the option to purchase 4,318,856 shares of Rekor’s common stock.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1112 – COMMITMENTSOPERATING LEASES
Operating Leases
KSIThe Company leases facilities for office space in Chantilly, Virginia undervarious locations throughout the United States. The office leases have remaining lease terms of a ten-year lease expiring October 31, 2019. The lease contains one five-year renewal option. The lease termsto five years, some of which include an annual increase in base rent and expenses of 2.75%. KSI also leases office space in New Orleans, Louisiana under the terms of a three-year lease expiring May 31, 2018.options to terminate within one year.
Firestorm leases office spaceEffective January 1, 2019, the Company adopted Topic 842, as amended, which requires lessees to recognize a ROU asset and lease liability on the balance sheet for most lease arrangements and expands disclosures about leasing arrangements for both lessees and lessors, among other items. The Company adopted ASU 2016-02 using the optional transition method whereby the Company applied the new lease requirements under ASU 2016-02 through a cumulative-effect adjustment, which after completing its implementation analysis, resulted in Roswell, Georgia underno adjustment to the termsCompany’s January 1, 2019 beginning retained earnings balance. On January 1, 2019, the Company recognized $921,000 of ROU operating lease assets and $951,000 of operating lease liabilities, including noncurrent operating lease liabilities of $728,000 as a result of adopting this standard. The difference between ROU operating lease expiring on October 31, 2017.assets and operating lease liabilities was primarily due to previously accrued rent expense relating to periods prior to January 1, 2019. As part of adopting ASU 2016-02, the Company elected several practical expedients as discussed in Note 2. The comparative periods have not been restated for the adoption of ASU 2016-02.
Brekford leases office spaceOperating lease expense from Global Public Safety on a month-to-month basis. Brekford also leases space under an operating lease expiring on December 31, 2017.
Rent expense continuing operationsfor the three months ended September 30, 20172019 and 20162018 was $193,985$85,000 and $178,946 , respectively,$180,000, and for the nine months ended September 30, 20172019 and 20162018 was $575,181$268,000 and $533,168 ,$516,000, respectively, and is included in selling,part of general and administrative expenses.expenses in the accompanying unaudited condensed consolidated statement of operations.
AsCash paid for amounts included in the measurement of September 30, 2017, the future obligations over the primary terms of Novume’s long-term leases expiring through 2020 are as follows:
| 2017 | $188,854 |
| 2018 | 697,153 |
| 2019 | 624,024 |
| 2020 | 64,475 |
| Total | $1,574,506 |
The Company is the lessor in an agreement to sublease office space in Chantilly, Virginia with an initial term of two years with eight one-year options to renew the sublease through October 31, 2019. Theoperating lease provides for an annual increase in base rentliabilities from continuing operations was $48,000 and expenses of 2.90%. The initial term ended October 31, 2011 and the subtenant exercised the renewal options through 2015. On April 7, 2015, the lease was amended to sublease more space to the subtenant and change the rental calculation.
Rent income$56,000 for the three months ended September 30, 2017 and 2016 was $46,957 and $45,634, respectively, and for the nine months ended September 30, 20172019, respectively.
During the third quarter of 2019 the Company performed an assessment and 2016 was $140,871determined that one of its operating leases met the criteria to be classified as a lease abandonment. For the three and $136,901, respectively, andnine months ended September 30, 2019 the Company recognized $70,000 of expense related to the loss of lease abandonment which is included in other incomeexpenses in the accompanyingunaudited condensed consolidated statementsstatement of operations.
On May 9, 2019, the Company entered into a sublease agreement to lease office space in Columbia, Maryland expiring on August 31, 2021. The Company recognized $291,000 of ROU operating lease assets and $291,000 of operating lease liabilities, including noncurrent operating lease liabilities of $232,000.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Supplemental balance sheet information related to leases as of September 30, 2019 was as follows (dollars in thousands):
| Operating lease right-of-use lease assets from continuing operations | $761 |
| Operating lease right-of-use lease assets from operations held for sale | 154 |
| Total operating lease right-of-use assets | $915 |
| |
| Lease liability, short-term | $296 |
| Lease liability, long-term | 673 |
| Lease liability from operations held for sale | 169 |
| Total operating lease liabilities | $1,138 |
| |
| Weighted average remaining lease term - operating leases from continuing operations | 3.8 |
| |
| Weighted average discount rate - operating leases | 9% |
Maturities of lease liabilities were as follows (dollars in thousands):
| 2019 (October to December) | $156 |
| 2020 | 451 |
| 2021 | 319 |
| 2022 | 158 |
| 2023 | 159 |
| 2024 | 81 |
| Total lease payments | 1,324 |
| Less imputed interest | 186 |
| Maturities of lease liabilities | $1,138 |
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 13 – COMMITMENTS AND CONTINGENCIES
Firestorm
On June 25, 2019, the Company sent a letter to three former executives of the Company and Firestorm (the Firestorm Principals). The letter described the Company's position that, because the Company believes that the Firestorm Principals fraudulently induced the execution of the Membership Interest Purchase Agreement pursuant to which Firestorm was acquired by the Company, the entire Membership Interest Purchase Agreement and the transactions contemplated thereby, including the issuance of the warrants, are subject to rescission. On August 17, 2019, the Company filed suit in the United States District Court for the Southern District of New York against three former executives of the Company and Firestorm (the Firestorm Principals). The Complaint alleges that the Firestorm Principals fraudulently induced the execution of the Membership Interest Purchase Agreement pursuant to which Firestorm was acquired by the Company, and seeks rescission of the Membership Interest Purchase Agreement and certain transactions contemplated thereby, including the issuance of notes and warrants to the Firestorm Principals. On October 9, 2019, the Company filed an Amended Complaint. On November 4, 2019, the Firestorm Principals filed an answer to the Amended Complaint and asserted counterclaims against the Company, Firestorm, and certain executives of the Company.
NOTE 1214 – EQUITY INCENTIVE PLAN
In August 2017, the Company approved and adopted the 2017 Equity Award Plan (the “2017 Plan”) which replaced the 2016 Equity Award Plan (the “2016 Plan”). The 2017 Plan permits the granting of stock options, stock appreciation rights, restricted and unrestricted stock awards, phantom stock, performance awards and other stock-based awards for the purpose of attracting and retaining quality employees, directors and consultants. Maximum awards available under the 2017 Plan were initially set at 3,000,000 shares. To date, only stock options have been issued under the 2016 Plan and the 2017 Plan.
Stock Options
Stock options granted under the 2017 Plan may be either incentive stock options (“ISOs”) or non-qualified stock options (“NSOs”). ISOs may be granted to employees and NSOs may be granted to employees, directors, or consultants. Stock options are granted at exercise prices as determined by the Board of Directors. The vesting period is generally three to four years with a contractual term of 10ten years.
The 2017 Plan is administered by the Administrator, which is currently the Board of Directors of the Company. The Administrator has the exclusive authority, subject to the terms and conditions set forth in the 2017 Award Plan, to determine all matters relating to awards under the 2017 Plan, including the selection of individuals to be granted an award, the type of award, the number of shares of NovumeRekor common stock subject to an award, and all terms, conditions, restrictions and limitations, if any, including, without limitation, vesting, acceleration of vesting, exercisability, termination, substitution, cancellation, forfeiture, or repurchase of an award and the terms of any instrument that evidences the award.
Novume has also designed the 2017 Plan to include a number of provisions that Novume’s management believes promote best practices by reinforcing the alignment of equity compensation arrangements for nonemployee directors, officers, employees, consultants and stockholders’ interests. These provisions include, but are not limited to, the following:
No Discounted Awards. Awards that have an exercise price cannot be granted with an exercise price less than the fair market value on the grant date.
No Repricing Without Stockholder Approval. Novume cannot, without stockholder approval, reduce the exercise price of an award (except for adjustments in connection with a Novume recapitalization), and at any time when the exercise price of an award is above the market value of Novume common stock, Novume cannot, without stockholder approval, cancel and re-grant or exchange such award for cash, other awards or a new award at a lower (or no) exercise price.
No Evergreen Provision. There is no evergreen feature under which the shares of common stock authorized for issuance under the 2017 Plan can be automatically replenished.
No Automatic Grants. The 2017 Plan does not provide for “reload” or other automatic grants to recipients.
No Transferability. Awards generally may not be transferred, except by will or the laws of descent and distribution or pursuant to a qualified domestic relations order, unless approved by the Administrator.
No Tax Gross-Ups. The 2017 Plan does not provide for any tax gross-ups.
No Liberal Change-in-Control Definition. The change-in-control definition contained in the 2017 Plan is not a “liberal” definition that would be activated on mere stockholder approval of a transaction.
“Double-trigger” Change in Control Vesting. If awards granted under the 2017 Plan are assumed by a successor in connection with a change in control of Novume, such awards will not automatically vest and pay out solely as a result of the change in control, unless otherwise expressly set forth in an award agreement.
No Dividends on Unearned Performance Awards. The 2017 Plan prohibits the current payment of dividends or dividend equivalent rights on unearned performance-based awards.
Limitation on Amendments. No amendments to the 2017 Plan may be made without stockholder approval if any such amendment would materially increase the number of shares reserved or the per-participant award limitations under the 2017 Plan, diminish the prohibitions on repricing stock options or stock appreciation rights, or otherwise constitute a material change requiring stockholder approval under applicable laws, policies or regulations or the applicable listing or other requirements of the principal exchange on which Novume’s shares are traded.
Clawbacks. Awards based on the satisfaction of financial metrics that are subsequently reversed, due to a financial statement restatement or reclassification, are subject to forfeiture.
When making an award under the 2017 Plan, the Administrator may designate the award as “qualified performance-based compensation,” which means that performance criteria must be satisfied in order for an employee to be paid the award. Qualified performance-based compensation may be made in the form of restricted common stock, restricted stock units, common stock options, performance shares, performance units or other stock equivalents. The 2017 Plan includes the performance criteria the Administrator has adopted, subject to stockholder approval, for a “qualified performance-based compensation” award.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A summary of stock option activity under the Company’s 2016 Plan and 2017 Plan for the nine months ended September 30, 20172019 is as follows:
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| Balance at December 31, 2016 | 58,499 | $1.68 | 9.29 | |
| Granted | 1,161,313 | 1.56 | 9.30 | |
| Exercised | - | - | - | |
| Canceled | - | - | - | |
| Balance at September 30, 2017 | 1,219,812 | $1.56 | 9.26 | $430,190 |
| | | | | |
| Exercisable at September 30, 2017 | 262,645 | $1.57 | 8.72 | $102,397 |
| | | | | |
| Vested and expected to vest at September 30, 2017 | 1,131,991 | $1.56 | 9.26 | $399,140 |
| | Number of Shares Subject to Option | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value |
| Outstanding balance at December 31, 2018 | 1,227,557
| $2.13 | 8.39 | - |
| Granted | 862,049
| 1.02 | 9.43 | |
| Exercised | - | - | - | |
| Forfeited | (66,930) | 2.62 | - | |
| Expired | �� - | - | - | |
Canceled | (315,520) | 1.96 | - | |
| Outstanding balance at September 30, 2019 | 1,707,156
| $1.68 | 8.57 | $1,407 |
| Exercisable at September 30, 2019 | 776,963
| $1.67 | 7.88 | $575 |
Stock compensation expense for the three months ended September 30, 20172019 and 20162018 was $107,321$76,000 and $0,$87,000, respectively, and for the nine months ended September 30, 20172019 and 20162018 was $227,470$314,000 and zero,$296,000, respectively, and is included in selling,presented as part of general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations.
The weighted average grant date fair value of options granted, to employees and non-employees, for the nine months ended September 30, 2019 was $0.52. The intrinsic value of the stock options granted during the nine months ended September 30, 20172019 was $400,543.$1,030,000. No stock options were granted or outstanding prior to 2016. The total fair value of shares that became vested after grant duringfor the nine months ended September 30, 20172018. The total fair value of options that are vested as of September 30, 2019 and 2018 was $72,750.$684,000 and $735,000, respectively.
As of September 30, 2017,2019, there was $527,347$634,000 of unrecognized stock compensation expense related to unvested stock options granted under the 20162017 Plan that will be recognized over a weightedan average remaining period of 2.58 1.77years.
REKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTE 13 – EMPLOYEE BENEFIT PLANNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
KSI has a defined contribution savings plan under Section 401(k) of the Internal Revenue Code (the “Code”) (the “401(k) Plan”) which was amended on January 1, 2013, as required by the Code. Pursuant to the amended 401(k) Plan, KSI will make nondiscretionary “safe harbor” matching contributions of 100% of the participant’s salary deferrals up to 3%, and 50% of the next 2%, of a participant’s compensation for all participants. The amount of contributions recorded by Novume during the three months ended September 30, 2017 and 2016 were $25,122 and $31,955, respectively, and during the nine months ended September 30, 2017 and 2016 were $60,875 and $69,387, respectively.
NOTE 14 – INVENTORY
As of September 30, 2017 and December 31, 2016, inventory consisted entirely of raw materials of $169,232 and $0, respectively.(Unaudited)
NOTE 15 – EARNINGS (LOSS)LOSS PER SHARE
The following table provides information relating to the calculation of earnings (loss)loss per common share:
| | Three Months Ended September 30, | Nine Months Ended September 30, |
| | | | | |
| Basic and diluted (loss) earnings per share | | | | |
| Net (loss) earnings from continuing operations | $(791,360) | $(55,542) | $(1,913,460) | $420,208
|
| Less: preferred stock dividends | (87,907) | - | (251,508) | - |
| Net income (loss) attributable to shareholders | (879,267) | (55,542) | (2,164,968) | 420,208
|
| Weighted average common shares outstanding - basic | 11,756,560 | 9,713,956 | 10,920,866
| 7,016,373 |
| Basic (loss) earnings per share | $(0.07) | $(0.01) | $(0.20) | $0.06 |
| | | | | |
| Weighted average common shares outstanding - diluted | 11,756,560 | 9,713,956 | 10,920,866
| 7,123,160 |
| Diluted (loss) earnings per share | $(0.07) | $(0.01) | $(0.20) | $0.06 |
| | | | | |
| Common stock equivalents excluded due to anti-dilutive effect | 2,105,295
| 121,247 | 1,960,282
| - |
| | Three Months Ended September 30, | Nine Months Ended September 30, |
| | | | | |
| | (Dollars in thousands, except per share data) | (Dollars in thousands, except per share data) |
| Basic and diluted loss per share | | | | |
| Net loss from continuing operations | $(3,456) | $(528) | $(10,978) | $(3,649) |
| Less: preferred stock accretion | (191) | (167) | (554) | (483) |
| Less: preferred stock dividends | (114) | (115) | (344) | (345) |
| Net loss attributable to shareholders from continuing operations | (3,761) | (810) | (11,876) | (4,477) |
| Net income (loss) from operations held for sale | (172) | 25
| (450) | 30
|
| Net loss attributable to shareholders | $(3,993) | $(785) | $(12,326) | $(4,447) |
| Weighted average common shares outstanding - basic and diluted | 19,878,518 | 14,542,362 | 19,592,679 | 14,524,030 |
| Basic and diluted loss per share from continuing operations | $(0.19) | $(0.06) | $(0.61) | $(0.31) |
| Basic and diluted (loss) earnings per share from operations held for sale | (0.01) | 0.01 | (0.02) | - |
| Basic and diluted loss per share | $(0.20) | $(0.05) | $(0.63) | $(0.31) |
| Common stock equivalents excluded due to anti-dilutive effect | 5,400,047
| 2,675,906 | 5,400,047
| 2,690,768 |
ForAs the Company had a net loss for the three and nine months ended September 30, 2017,2019, the following 5,400,047 potentially dilutive securities were excluded from diluted loss per share as the Company had a net loss: 1,052,122 common stock equivalents related to theshare: 2,251,232 for outstanding warrants, 974,487 common stock equivalents959,937 related to the Series A Preferred Stock, 481,722 related to the Series B Preferred Stock and 78,6861,707,156 related to outstanding options. In addition, 10,000 options were excluded from
As the dilutedCompany had a net loss per share calculations asfor the exercise price of these shares exceeded the per share value of the common stock. For the three and nine months ended September 30, 2016,2018, the following potentially 2,675,906 and 2,690,768 dilutive securities, respectively, were excluded from diluted loss per share as the Company had a net loss: 121,247 common stock equivalents related to the outstanding warrants. A total of 4,167 options were excluded from the diluted loss per share calculations during the three months ended September 30, 2016 as the exercise price of these shares exceeded the per share value of the common stock.
For the nine months ended September 30, 2017, the following potentially dilutive securities were excluded from diluted loss per share as the Company had a net loss: 967,845 common stock equivalents related to theshare: 917,950 for outstanding warrants, 917,931974,487 common stock equivalentsrelated to the Series A Preferred Stock, 481,722 related to the Series B Preferred Stock and 74,506301,747and 316,609 related to outstanding options. In addition, 15,707 options were excluded from the diluted loss per share calculations as the exercise price of these shares exceeded the per share value of the common stock. A total of 11,923 options were excluded from the diluted loss per share calculations during the nine months ended September 30, 2016 as the exercise price of these shares exceeded the per share value of the common stock.
(Loss) EarningsLoss Per Share under Two – Class Method
The Series A Preferred Stock hasand Series B Preferred Stock have the non-forfeitable right to participate on an as converted basis at the conversion rate then in effect in any common stock dividends declared and, as such, is considered a participating security. The Series A Preferred Stock isand Series B Preferred Stock are included in the computation of basic and diluted loss per share pursuant to the two-class method. Holders of the Series A Preferred Stock and Series B Preferred Stock do not participate in undistributed net losses because they are not contractually obligated to do so.
The computation of diluted (loss) earnings per share attributable to common stockholders reflects the potential dilution that could occur if securities or other contracts to issue shares of common stock that are dilutive were exercised or converted into shares of common stock (or resulted in the issuance of shares of common stock) and would then share in our earnings. During the periods in which we record a loss attributable to common stockholders, securities would not be dilutive to net loss per share and conversion into shares of common stock is assumed not to occur.
The following table providesREKOR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 16 – HELD FOR SALE OPERATIONS
In September 2019, the Company determined that the Global business met the criteria for held for sale accounting because it expects to complete the sale of Global during the next 12 months. Historically, Global has been presented as part of the Professional Services Segment.
This pending disposition is a reconciliationresult of net (loss)the Company’s strategic decision to preferred shareholdersconcentrate resources on the development of its Technology Segment and common stockholderswill result in material changes in the Company's operations and financial results. As a consequence, the Company is reporting the operating results and cash flows of Global as held for purposessale, including for all prior periods reflected in the unaudited condensed consolidated financial statements and these notes.
Pursuant to ASC Topic 205-20, Presentation of computing net (loss) per shareFinancial Statements - Discontinued Operations, the results of operations from Global for the three and nine months ended September, 30, 2017. There were no outstanding participating securities during2019 and 2018 has been classified as held for sale and presented as part of income (loss) from operations held for sale in the threeaccompanying unaudited condensed consolidated statements of operations presented herein. The assets and nine months endedliabilities also have been classified as held for sale under the line captions of current assets held for sale and current liabilities held for sale in the Company's unaudited condensed consolidated balance sheets as of September 30, 2016.2019 and December 31, 2018.
| | Three Months Ended September 30, | Nine Months Ended September 30, |
| | | | | |
| Numerator: | | | | |
| Net (loss) earnings from continuing operations | $(791,360) | $(55,542) | $(1,913,460) | $420,208
|
| Less: preferred stock dividends | (87,907) | - | (251,508) | - |
| Net income (loss) attributable to shareholders | $(879,267) | $(55,542) | $(2,164,968) | $420,208
|
| | | | | |
| Denominator (basic): | | | | |
| Weighted average common shares outstanding | 11,756,560 | 9,713,956 | 10,920,866
| 7,016,373 |
| Participating securities - Series A preferred stock | 974,487 | - | 473,174 | - |
| Weighted average shares outstanding | 12,731,047 | 9,713,956 | 11,838,797
| 7,016,373 |
| | | | | |
| Loss per common share - basic under two-class method | $(0.07) | $(0.01) | $(0.18) | $0.06 |
| | | | | |
| Denominator (diluted): | | | | |
| Weighted average common shares outstanding | 11,756,560 | 9,713,956 | 10,920,866
| 7,123,160 |
| Participating securities - Series A preferred stock (1) | 974,487 | - | 917,931
| - |
| Weighted average shares outstanding | 12,731,047 | 9,713,956 | 11,838,797
| 7,123,160 |
| | | | | |
| Loss per common share - basic under two-class method | $(0.07) | $(0.01) | $(0.18) | $0.06 |
| | | |
| ASSETS | | |
| Cash and cash equivalents | $226 | $90 |
| Accounts receivable, net | 2,981 | 2,289 |
| Other current assets, net | 322 | 257 |
Total current assets | 3,529 | 2,636 |
| Property and equipment, net | 138 | 176 |
| Right-of-use lease assets, net | 154 | - |
| Goodwill | 1,691 | 1,691 |
| Intangible assets, net | 1,994 | 2,208 |
| Deposits and other long-term assets | 9 | 79 |
| Total assets held for sale | $7,515 | $6,790 |
| LIABILITIES | | |
| Accounts payable and accrued expenses | $942
| $800
|
Short-term borrowings
| 1,623 | 1,095 |
| Lease liability, short term | 110 | - |
| Other liabilities, current portion | 5 | - |
| Total current liabilities held for sale | 2,680 | 1,895 |
| Other long-term liabilities | 120 | 90 |
| Lease liability, long term | 59 | - |
| Total liabilities held for sale | $2,859 | $1,985 |
(1) REKOR SYSTEMS, INC. AND SUBSIDIARIES
As these shares are participating securities that participate in earnings, but do not participate in losses based on their contractual rights and obligations, this calculation demonstrates that there is no allocationNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The major components of the loss to these securities.
Executive Summary●
U.S. Government Spending – In July 2019, the White House and bi-partisan congressional negotiators announced they had reached agreement on a two-year federal budget. The proposed plan would raise federal spending by $320 billion over existing caps previously imposed by the Budget Control Act of 2011. Absent a new agreement, the 2011 legislation would have automatically triggered deep spending cuts next year under a process known as sequestration. Instead, the recent agreement would increase spending on domestic and military programs, partially funded by $77.4 billion in spending cuts from other budget categories. Additional provisions of the announcement would allow the government to continue to borrow, most likely averting a debt ceiling fiscal crisis. On August 2, 2019, the President signed the two-year budget agreement which wards off automatic spending cuts and suspends the debt ceiling through July 2021. Agreement on the July spending plan is intended to result in more funding consistency and may reduce the possibility of another government shutdown until after the 2020 elections. Many contractors have geared up for the anticipated increases in spending. We believe this agreement will reduce government spending seasonality and this has begun to lead to a stronger fourth quarter in 2019 and a more robust first quarter in 2020.
Our Company
Novume Solutions, Inc. (the “Company”We believe that recent developments in computing capabilities, such as GPU advances, and new techniques of analysis, sometimes referred to broadly as artificial intelligence or “Novume”) was formed“AI”, have broadened the market for vehicle identification technology and created new opportunities in February 2017existing markets. With Rekor’s new line of products and began operations upon the merger of KeyStone Solutions, Inc. (“KeyStone”) and Brekford Traffic Safety, Inc. (“Brekford”) in August 2017. For narrative purposes, Company and Novume references include the Brekford, KeyStone and Firestorm entities. KeyStone was formed in March 2016 as a holding company for its wholly-owned subsidiary AOC Key Solutions, Inc. (“KSI”). KSI provides consulting and technical support services, our Technology Segment is working to assist clients seeking U.S. Federal government contractsactively exploit these opportunities. With our FirstSightTM program, we are also pursuing opportunities created by AI in the technology, telecommunications, defense, and aerospace industries. On January 25, 2017, Novume (KeyStone) acquired Firestorm,school safety area. With the anticipated continuation of a nationally recognized leaderstable economic outlook for the government contracting, we believe that the outlook for the operations of our subsidiaries in crisis management, crisis communications, emergency response, and business continuity, including workplace violence prevention, cyber-breach response, communicable illness/pandemic planning, predictive intelligence, and other emergency, crisis and disaster preparedness initiatives. Firestorm is headquartered in Roswell, Georgia. Brekford, headquartered in Hanover, Maryland, is a leading public safety technology service provider of fully integrated automated traffic safety enforcement (“ATSE”) solutions, including speed, red light, and distracted driving cameras.the Professional Services Segment remains positive.
Novume is headquartered in Chantilly, VirginiaOther than as discussed above and as of December 31, 2016 had a satellite office in New Orleans, Louisiana. As of December 31, 2016, Novume had 29 employees and access to approximately 350 consultants. Through the acquisition of Firestorm, the Company added a satellite office in Roswell, Georgia. Through the merger with Brekford, Novume added an office in Hanover, Maryland. As of September 30, 2017, Novume had 77 employees and access to approximately 400 consultants.
As an effort to create specific awareness about Novume in the GovCon industry, Novume through its recently-formed subsididary Novume Media developed a television show called The Bridge -- a weekly 30-minute program featuring panel discussions and interviews with leaders from the government, business, academia and associations. The show premiered on April 2, 2017 in the Washington, DC market.
In selective situations, Novume will also seek to serve as a partner or incubator for emerging businesses, like Brekford’s automated traffic safety enforcement business, where an understanding of government contracting procedures and contacts with other seasoned providers of government services or products can be critical to success.
General
The information providedelsewhere in this discussion and analysisQuarterly Report on Form 10-Q, we are not aware of Novume’sany trends, events or uncertainties that are likely to have a material effect on our financial condition and results of operations covers the three and nine months ended September 30, 2017 and 2016. During fiscal year 2017, the Company completed the acquisition of Firestorm (described below) and the Brekford Merger (described below). As of the date of hereof, Novume has not completed the detailed valuation study necessary to arrive at the required final estimates of the fair value of the Brekford assets to be acquired and the liabilities to be assumed and the related allocations of purchase price. It has not identified all adjustments necessary to conform Novume’s and Brekford’s accounting policies to Novume’s accounting policies.As of the date of hereof, Novume has completed the detailed valuation study necessary to arrive at the required final estimates of the fair value of the Firestormassets acquired and the liabilities assumed and the related allocations of purchase price. Any increases or decreases in the fair value of assets acquired and liabilities assumed upon completion of the final valuations will result in adjustments to the Novume’s consolidated balance sheet and/or statements of operations, which will include operations of Novume, KSI, Firestorm, Brekford and Novume Media.condition.
In connection with the audit of its consolidated financial statements for the years ended December 31, 2016 and 2015, Novume’s management concluded that it had material weaknesses in its internal controls because Novume does not currently have adequately designed internal controls to ensure the timely preparation and review of the accounting for certain complex, non-routine transactions by those with appropriate technical expertise, which was necessary to provide reasonable assurance that the Company’s consolidated financial statements and related disclosures would be prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). In addition, Novume did not have adequately designed and documented financial close and management review controls to properly detect and prevent certain accounting errors and omitted disclosures in the footnotes to the consolidated financial statements. As defined in the Standards of the Public Company Accounting Oversight Board, a material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim consolidated financial statements will not be prevented or detected on a timely basis. Novume’s management is developing a plan to remediate the material weaknesses although there can be no assurance that such plans, when enacted, will be successful.Revenues
While Novume has no direct current business operations, its significant assetsWe generate our revenues substantially from two sources: (1) subscription revenues for software licenses, technology products and services and (2) professional services to clients. Our revenues are subject to seasonal variation, as of September 30, 2017 are its cash and equity interestmore fully described in its principal operating subsidiaries, KSI, Brekford and Firestorm. Thus, the financial information in this section for periods prior to March 15, 2016 is for KSI prior to the recapitalization into KeyStone. The financial information in this section for all periods subsequent to March 15, 2016 and prior to the January 25, 2017 acquisition of Firestorm is prepared on a consolidated basis for KeyStone and KSI. The financial information for periods subsequent to January 25, 2017 is prepared on a consolidated basis for KeyStone, KSI and Firestorm. For periods subsequent to the Brekford Merger on August 28, 2017, the financial information is prepared on a consolidated basis for Novume, KSI, Brekford and Firestorm.“Seasonality” below.
Historically, the primary focusRevenue is recognized upon transfer of our businesses has been on the federal government contracting and aerospace industries. We provide consulting, technical support, staffing and systems that help our clients exploit opportunities and meet challenges more efficiently and effectively than they can by relying on in-house resources alone. Our clients are typically well-established, financially-stable businesses. According to USASpending.gov, between fiscal years 2013 and 2017, the federal government in the United States spent an averagecontrol of over $450 billion annually for goodspromised products and services creating one ofto our customers, in an amount that reflects the largest and most stable markets in the world, and there are thousands of government contractors providing these goods and services. These contractors range from small privately-owned lifestyle companies to the Fortune 100. Through the years, Novume’s subsidiaries have served thousands of these entities, including 87 of the Top 100 federal contractors.
A unique characteristic of the industry is that many of these companies are concentrated in a geographic territory that stretches from Southern Maryland to Northern Virginia, wrapping the nation’s Capital in what is known as the Beltway. Because of the geographic concentration of these clients, there is also a large, but fragmented, concentration of service providers for these companies. Although the businesses that provide resources to the government contracting sector are diverse and highly fragmented, their clients have many common needs resulting from the basic qualifications and standard requirements inherent in the government procurement process. Novume believes that there is a unique opportunity for consolidation in this sector. While our immediate goal is to improve our ability to serve this sector by pooling our existing subsidiaries’ resources and client contacts, our ultimate objective is to expand our ability to meet its unique needs by assembling, through organic growth and strategic acquisitions, a complimentary suite of service and systems providers with demonstrated ability to satisfy the needs of this sector for high value talent and support services. In addition to the benefits of shared costs and pooled resources,consideration we expect to benefit fromreceive in exchange for those products and services. If the increased client involvementconsideration promised in the contract includes a variable amount, for example maintenance fees, we include an estimate of the amount we expect to receive in the total transaction price, if it is probable that targeted expansiona significant reversal of our market segments can provide. cumulative revenue recognized will not occur.
We would like Novumedetermine the amount of revenue to be recognized asthrough application of the best place to go for outside help when a company has to meet an unusual need, whether it involves an unusual opportunity or an unusual threat.following steps:
Novume intends to fund organic growth and add both vertical and horizontal capabilities by acquiring service providers through●
Identification of the contract, or contracts, with a market-focused and disciplined strategy. Novume’s efforts to identify prospective target businesses will look for opportunities wherecustomer
●
Identification of the combinationperformance obligations in the contract
●
Determination of resources will be additivethe transaction price
●
Allocation of the transaction price to the existing capabilitiesperformance obligations in the contract
●
Recognition of revenue when, or as, performance obligations are satisfied
The subscription revenues for software licenses, technology products and services revenues are comprised of fees that provide customers with access to the software licenses and related support and updates during the term of the Companyarrangement. Revenue is generally recognized ratably over the contract term. During the second quarter of 2019, we changed our method of selling in the Technology Segment from perpetual software licenses to monthly service subscriptions. This change is expected to impact our revenue in the short term. However, the amount of contract revenue received over the long term is expected to be relatively consistent. Our subscription services arrangements are non-cancelable and willdo not be limited to any geographic region or any particular sector of the support or services industries. A primary consideration will be to improve the level of support Novume and its subsidiaries provides to its existing customers as well as carefully considered expansions of the customer base.
contain refund-type provisions.
Novume is an established provider of outsourced services to the GovCon market that generates revenues from fees and reimbursable expenses forThe professional services primarily billed on an hourly rate, time-and-materials basis. Clients are typically invoicedcontracts recognize revenue based on a monthly basis, with revenuetime and materials or fixed fees basis. These revenues are recognized as the services are provided. Inrendered for time and materials contracts, on a few cases, a fixed-fee engagementproportional performance basis for our services may be entered into. Fixed-fee engagements can be invoiced oncefixed price contracts, or ratably over the contact term for the entire job, or there could be several “progress” invoices for accomplishing various phases or reaching contractual milestones. Time-and-materialsfixed price contracts represent a majority of our client engagements and do not provide us with a high degree of predictability of future period performance.subscription services.
Seasonality
Novume’s financial resultsRevenues attributable to our Professional Services Segment are impacted principally by the:
1)
demand by clients for Novume’s services;
2)
the degreesubject to which full-time staff can be kept occupied in revenue-generating activities;
3)
success of the sales team in generating client engagements; and
4)
number of business days in each quarter.
The number of business days on which the revenue is generated by our staff and consultants is affected by the number of vacation days taken, as well as the number of holidays in each quarter.consultants. There are typically fewer business work daysworkdays available in the fourth quarter of the year, which can impact revenues during that period.year. The staff utilization rate can also be affected by seasonal variations in the demand for services from clients. Since earnings may be affected by these seasonal variations, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.
Unexpected changes in the demand for our services can result in significant variations in revenues, and present a challenge to optimal hiring, staffing and useCost of consultants. The volume of work performed can vary from period to period.Revenues
While we anticipate an increasing demand for Novume’sDirect costs of revenues consist primarily of that portion of technical and non-technical salaries and wages and payroll-related costs incurred in connection with fee generating projects. Direct costs of revenues also include production expenses, sub-consultant services, and other expenses that are incurred in 2017 based upon an expected increaseconnection with our fee generating projects. Direct costs of revenues exclude that portion of technical and non-technical salaries and wages related to marketing efforts, vacations, holidays, and other time not spent directly generating fees under existing contracts. Such costs are included in the volumeoperating expenses. We expense direct costs of federal government spending and as our clients elect to outsource their bid and proposal activities, it is still not clear how government spending will be impacted in 2018 and beyond. The federal government fiscal year starts on October 1 and ends on September 30. Thus, the bulk of our revenues for 2017 should be based on budget authorizations made in 2016, however, the new administration does have some discretion to delay spending on programs previously authorized and will establish the budgets for the new fiscal year beginning October 1, 2017.when incurred.
Although the new administration has expressed a desire to reduce the federal government bureaucracy, we cannot assume that this will reduce the demand for Novume’s services. A short-term result of a program to reduce bureaucracy may be to increase privatization initiatives. Moreover, the new administration’s emphasis on renewing the nation’s infrastructure, which appears to enjoy broad-based support, may result in a significant long-term increase in federal procurements.Cash, Cash Equivalent and Restricted Cash and Cash Equivalents
Thus, while changesOur cash and adjustments can undoubtedly be anticipated, Novume believescash equivalents from continuing operations decreased to $1,273,000 as of September 30, 2019 from $2,069,000 as of December 31, 2018. This decreased was primarily attributable to proceeds from short-term borrowings and financing offset by cash used in operating activities during the overall outlooknine months ended September 30, 2019. Our restricted cash and cash equivalents increased to $708,000 as of September 30, 2019 from $609,000 as of December 31, 2018. The increase is primarily attributable to the timing of cash collections of behalf of client jurisdictions which use our license plate recognition software in speed and red-light cameras.
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 GovCon sector remains promising. This is in part due to the changing nature of the contracting process. The volume and frequency of requests for proposals has been increasing during recent years as outdated and ill-conceived programs have been eliminated in favor of higher priority programs. Moreover, Low Price Technically Acceptable (LPTA) contracts have increasingly fallen into disfavor as the true long-term costs of these contracts have become apparent, and a more rigorous approach to government contracting has gained favor.
Brekford Acquisitionyear ended December 31, 2018.
On August 28, 2017, the mergers by and among Novume, KeyStone, Brekford, Brekford Merger Sub, Inc. ("Brekford Merger Sub"), and KeyStone Merger Sub, LLC ("KeyStone Merger Sub"), were consummated (the “Brekford Merger”) as a resultNew Accounting Pronouncement
See Note 2 to our unaudited condensed consolidated financial statements set forth in Item 1 of a merger agreement (the “Brekford Merger Agreement”). As a result, Brekford became a wholly-owned subsidiary of the Novume, and Brekford Merger Sub ceased to exist. KeyStone Merger Sub also became a wholly-owned subsidiary of the Novume, and KeyStone Solutions, Inc. ceased to exist. When KeyStone Merger Sub filed its certificate of merger with the Secretary of State of the State of Delaware, it immediately effectuated a name-change to KeyStone Solutions, LLC, the name by which it is now known.
this quarterly report for information regarding new accounting pronouncements.
Upon completion of the Brekford Merger, the merger consideration was issued in accordance with the terms of the Merger Agreement. Immediately upon completion of the Brekford Merger, the pre-merger stockholders of KeyStone owned approximately 80% of the issued and outstanding capital stock of the Novume on a fully-diluted basis, and the pre-merger stockholders of Brekford owned approximately 20% of the issued and outstanding capital stock of the Novume on a fully-diluted basis.
Firestorm Acquisition
Pursuant to the terms of the Membership Interest Purchase Agreement (the “MIPA”), by and among Novume, each of the Firestorm Entities, each of the Members of the Firestorm Entities (described below), and a newly-created acquisition subsidiary of Novume, Firestorm Holdings, LLC, a Delaware limited liability company (“Firestorm Holdings”), Novume acquired all of the membership interests in each of the Firestorm Entities for the following consideration:
●
$500,000 in cash in the aggregate paid by Novume as of the Firestorm Closing Date to the three principals (Harry W. Rhulen, Suzanne Loughlin, and James W. Satterfield, collectively the “Firestorm Principals”) of Firestorm. Of that aggregate amount $250,000 was paid to Mr. Satterfield, and $125,000 was paid to each of Mr. Rhulen and Ms. Loughlin;
●
$1,000,000 in the aggregate in the form of four unsecured, subordinated promissory notes issued by Novume payable over five years after the Firestorm Closing Date, to all the Members of the Firestorm Entities (consisting of the Firestorm Principals and Lancer Financial Group, Inc. (“Lancer”)). The principal amount of the note payable to Lancer is $500,000 (the “Lancer Note”). The principal amount of the note payable to Mr. Rhulen is $166,666.66. The principal amount of the notes payable to each of Mr. Satterfield and Ms. Loughlin is $166,666.67. (The notes payable to Mr. Rhulen, Ms. Loughlin and Mr. Satterfield are individually referred to herein as a “Firestorm Principal Note” and collectively, as the “Firestorm Principal Notes”). The Firestorm Principal Notes are payable at an interest rate of 2% and the Lancer Note is payable at an interest rate of 7%. $907,407 was recorded to notes payable to reflect the net fair value of the notes issued due to the difference in interest rates. The Lancer Note also has a capped subordination of $7,000,000, subject to the consent of Lancer;
●
Each of the Firestorm Principals was issued 162,698 shares of the common stock, par value $0.0001 per share, of Novume (“Novume Common Shares”), for an aggregate issuance of 946,875(946,875 post Brekford Merger) Novume Common Shares;
●
Each of the Firestorm Principals received warrants to purchase 105,209 Novume Common Shares, exercisable over a period of five years after the Firestorm Closing Date, at an exercise price of $2.58 per share; and
●
Each of the Firestorm Principals received warrants to purchase 105,209 Novume Common Shares, exercisable over a period of five years after the Firestorm Closing Date, at an exercise price of $3.60 per share.
Results of Operations –
Our historical operating results in dollars and as a percentage of total revenues are presented below. The results below and the analysis of operation is solely related to continuing operations.
| | For the Three Months ended September 30, | For the Nine Months ended September 30, |
| | | | | |
| Revenue: | (Dollars in thousands) | (Dollars in thousands) |
| Technology | $1,536 | $892 | $3,962 | $2,639 |
| Professional Services | 3,447 | 5,015 | 10,922 | 12,632 |
| Total revenue | 4,983 | 5,907 | 14,884 | 15,271 |
| | | | | |
| Cost of revenue: | | | | |
| Technology | 390 | 405 | 1,152 | 1,101 |
| Professional Services | 1,842 | 2,561 | 5,868 | 6,433 |
| Total cost of revenue | 2,232 | 2,966 | 7,020 | 7,534 |
| | | | | |
| Gross profit: | | | | |
| Technology | 1,146 | 487 | 2,810 | 1,538 |
| Professional Services | 1,605 | 2,454 | 5,054 | 6,199 |
| Gross profit | 2,751 | 2,941 | 7,864 | 7,737 |
| | | | | |
| Operating expenses: | | | | |
| General and administrative expenses | 3,039
| 2,954 | 10,435
| 9,953 |
| Selling and marketing expenses | 1,343 | 297 | 2,012 | 1,095 |
| Research and development expenses | 450 | 5 | 757 | 127 |
| Impairment of intangibles | - | - | 1,549 | - |
| Operating expenses | 4,832
| 3,256 | 14,753
| 11,175 |
| | | | | |
| Loss from operations | (2,081) | (315) | (6,889) | (3,438) |
| Other income (expense): | | | | |
| Loss on extinguishment of debt | (45) | - | (1,158) | - |
| Interest expense | (1,228) | (214) | (2,832) | (412) |
| Other income (expense) | (102) | 1 | (99) | 201 |
| Total other expense | (1,375) | (213) | (4,089) | (211) |
| Loss before income taxes | (3,456) | (528) | (10,978) | (3,649) |
| Income tax provision | - | - | - | - |
| Net loss from continuing operations | $(3,456) | $(528) | $(10,978) | $(3,649) |
| Income (loss) from operations held for sale | (160) | 47 | (415) | 52 |
| Income tax provision from operations held for sale | (12) | (22) | (35) | (22) |
| Net income (loss) from operations held for sale | (172) | 25 | (450) | 30 |
| Net loss | $(3,628) | $(503) | $(11,428) | $(3,619) |
Comparison of the Three and Nine Months Ended September 30, 20172019 and 2016the Three and Nine Months Ended September 30, 2018
Total Revenue
| | For the Three Months ended September 30, | | For the Nine Months ended September 30, | |
(dollars in thousands) | | | | | | | | |
| Revenue: |
| | | | | | |
| Technology | $1,536 | $892 | $644 | 72% | $3,962 | 2,639 | $1,323 | 50% |
| Professional Services | 3,447 | 5,015 | (1,568) | -31% | 10,922 | 12,632 | (1,710) | -14% |
| Total revenue from continuing operations | $4,983 | $5,907 | $(924) | -16% | $14,884 | $15,271 | $(387) | -3% |
As part of our strategic shift in 2019, we are focusing on our Technology Segment and management has been evaluating plans for our Professional Services Segment businesses AOC Key Solutions, Global and Firestorm. As part of evaluating the future of Firestorm, management decided to sell or transfer the Secure Education and BC Management lines of business to their founders in the second quarter of 2019 and classify Global as held for sale. In addition, management determined to discontinue the operation of Firestorm Franchising, LLC, a division of Firestorm, due to non-performance by the franchisees. As a result of these changes, the Professional Services Segment revenue was expected to decrease compared to the corresponding periods in 2018.
The unaudited resultsincrease in revenue in the Technology Segment was primarily attributable to the acquisition of OpenALPR in March 2019. During the three months ended September 30, 2019, total revenue attributable to OpenALPR was approximately $509,000 compared to no revenue recognized in the corresponding period in 2018. Additionally, $169,000 of the increase in revenue was attributable to the completion of two software and implementation projects in Canada. During the nine months ended September 30, 2019, total revenue attributable to OpenALPR was approximately $1,332,000 compared to no revenue recognized in the corresponding period in 2018. For information concerning pro-forma revenues attributable to OpenALPR during 2018, see Note 4 to the financial statements included in this report.
The decrease in revenues in the Professional Services Segment was primarily attributable to the repositioning of Firestorm. In the three months ended September 30, 2019, revenue related to Firestorm decreased $1,055,000 from $1,104,000 for the periods shown below should be reviewedthree months ended September 30, 2018 to $49,000 for the three months ended September 30, 2019. The additional decrease of $513,000 is attributable to a decrease in our professional services revenue related to creating proposals for clients. During the nine months ended September 30, 2019, revenue related to Firestorm decreased $1,286,000 from $2,292,000 for the nine months ended September 30, 2018 to $1,006,000 for the nine months ended September 30, 2019. The additional decrease of $424,000 is attributable to a decrease in our professional services revenue related to creating proposals for clients.
Cost of Revenue, Gross Profit and Gross Margin
| For the Three Months ended September 30, | | For the Nine Months ended September 30, | |
|
| (dollars in thousands) | | | | | | | | |
| Cost of revenue: |
| | | | | | |
| Technology | $390 | $405 | $(15) | -4% | $1,152 | $1,101 | $51 | 5% |
| Professional Services | 1,842 | 2,561 | (719) | -28% | 5,868 | 6,433 | (565) | -9% |
| Total cost of revenue | 2,232 | 2,966 | (734) | -25% | 7,020 | 7,534 | (514) | -7% |
| Gross profit: | | | | | | | | |
| Technology | 1,146 | 487 | 659
| 135% | 2,810 | 1,538 | 1,272 | 83% |
| Professional Services | 1,605 | 2,454 | (849) | -35% | 5,054 | 6,199 | (1,145) | -18% |
| Gross profit | $2,751 | $2,941 | $(190) | -6% | $7,864 | $7,737 | $127 | 2% |
| Gross margin: | | | | | | | | |
| Technology | 75% | 55% | 20% | 37% | 71% | 58% | 13% | 22% |
| Professional Services | 47% | 49% | -2% | -5% | 46% | 49% | -3% | -6% |
| Gross margin | 55% | 50% | 18% | 35% | 53% | 51% | 10% | 19% |
The increase in gross profit in the Technology Segment was primarily attributable to the inclusion of OpenALPR since its acquisition in March 2019. The revenues associated with OpenALPR are primarily related to software where we realize a higher margin as there are less labor costs incurred.
The decrease in the cost of revenues and gross profit in the Professional Services Segment was primarily related to the repositioning of Firestorm lines of business. During the three months ended September 30, 2019, the cost of revenue and gross profit associated with Firestorm decreased $495,000 and $559,000, respectively. During the nine months ended September 30, 2019, the cost of revenue and gross profit associated with Firestorm decreased $348,000 and $939,000, respectively.
Operating Expenses
| | For the Three Months ended September 30, | | For the Nine Months ended September 30, | |
| (dollars in thousands) | | | | | | | | |
Operating expenses: | |
|
|
|
|
| |
| General and administrative expenses | $3,039
| $2,954 | $85
| 3% | $10,435
| $9,953 | $482
| 5% |
| Selling and marketing expenses | 1,343 | 297 | 1,046 | 352% | 2,012 | 1,095 | 917 | 84% |
| Research and development expenses | 450 | 5 | 445 | 8,900% | 757 | 127
| 630
| 496% |
| Impairment of intangibles | - | - | - | - | 1,549 | - | 1,549 | - |
| Operating expenses | $4,832
| $3,256 | $1,576
| 48% | $14,753
| $11,175
| $3,578
| 32% |
General and Administrative Expenses
During the three months ended September 30, 2019, amortization expenses related to intangible assets increased by $97,000 compared to the three months ended September 30, 2018 due to the OpenALPR acquisition. Additionally, professional services fees and overhead salary fees increased by $528,000 and $300,000 which were incurred in conjunction with Novume’sstrategic initiatives such as the consulting fees associated to our remediation plan of our internal controls.
During the nine months ended September 30, 2019, amortization expenses related to intangible assets increased by $408,000 compared to the nine months ended September 30, 2018 due to the OpenALPR acquisition. Additionally, professional services fees increased by $370,000 which were incurred in conjunction with strategic initiatives in the current period. The majority of the remaining increase to general and administrative expenses is attributable to increase in the Technology Segment due the acquisition of OpenALPR along with increased staffing.
Selling and Marketing Expenses
The increase in the selling and marketing expenses during the year related to the Technology Segment can be attributable to the acquisition of OpenALPR and the increased marketing efforts to promote our products including trade shows, digital marketing, and other sales and marketing activities mainly for developing our Technology Segment. The overall increase in selling and marketing expenses was partially offset by a decrease in selling and marketing expenses related to the Professional Services Segment due to the realignment of Firestorm in the current year.
Research and Development Expense
The overall increase in research and development expenses is primarily attributable to new product development and the strategic shift to develop additional capabilities for the OpenALPR software in 2019, as a result of focusing on the Technology Segment.
Impairment of Intangibles
In June 2019, we discontinued the operations of BC Management and terminated agreements of all franchisees of Firestorm Franchising, LLC on the basis of non-performance. As a result, we re-evaluated the intangible assets related to these subsidiaries and recognized $1,549,000 in impairment charges related to intangible assets. The loss is presented as impairment of intangibles on the unaudited condensed consolidated financial statementsstatement of operations.
Other Expense
| | For the Three Months ended September 30,
| | For the Nine Months ended September 30,
| |
| (dollars in thousands) | | | | | | | | |
Other income (expense):
|
| | | | | | |
| Loss on extinguishment of debt | $(45) | $- | $(45) | 0% | (1,158) | $- | $(1,158) | 0% |
| Interest expense | (1,228) | (214) | (1,014) | -474% | (2,832) | (412) | (2,420) | -587% |
| Other income (expense) | (102) | 1 | (103) | -10,300% | (99) | 201 | (300) | -149% |
| Total other expense | $(1,375) | (213) | (1,162) | -546% | (4,089) | (211) | (3,878) | -1,838% |
The increase in other expenses is primarily attributable to an increase in interest expense related to the $20,000,000 2019 Promissory Note. Additionally, the increase in other expenses was attributable to fees associated with the extinguishment of debt of $45,000 and notes as of$1,158,000 during the three and nine months ended September 30, 2019, respectively.
Income Tax Provision
The income tax provision for the three and nine months ended September 30, 20172019, was $12,000 and 2016,$35,000, respectively, included elsewhere in this Form 10-Q. Consolidated operating resultsand is due primarily to the state taxes, including the state of Texas gross receipts tax, as compared to tax expense of $22,000 for the three and nine months ended September 30, 2017 include Firestorm2018. The expense related to the income tax provision is fully attributable to our operations held for sale. We established a valuation allowance against deferred tax assets in the period from January 25, 2017 through September 30,fourth quarter of 2017 and Brekford operations for the period from August 28, 2017have continued to maintain a full valuation allowance through September 30, 2017.
Novume Solutions, Inc. Consolidated Statements of Operations
for the Three and Nine Months Ended September 30, 2017 and 2016 (Unaudited)
| | Three Months ended September 30, | Nine Months ended September 30, |
| | | | | |
| REVENUE | $4,421,574 | $2,405,529 | $11,131,825 | $9,582,874 |
| Cost of revenue | 2,457,806 | 1,334,436 | 6,017,982 | 5,496,588 |
| Gross Profit | 1,963,768 | 1,071,093 | 5,113,843 | 4,086,286 |
| | | | | |
| OPERATING EXPENSES | | | | |
| Selling, general, and administrative expenses | 2,997,566 | 1,151,514 | 8,036,339 | 3,624,005 |
| Income (loss) from operations | (1,033,798) | (80,421) | (2,922,496) | 462,281 |
| OTHER (EXPENSE) INCOME | | | | |
| Interest expense | (33,720) | (15,656) | (97,624) | (28,693) |
| Other Income | 51,016 | - | 142,283 | - |
| Total other income | 17,296
| (15,656) | 44,659 | (28,693) |
| Income (loss) before taxes | (1,016,502) | (96,077) | (2,877,837) | 433,588 |
| Income tax benefit (expense) | 225,142
| 40,535 | 964,377
| (13,380) |
| Net (loss) income | $(791,360) | $(55,542) | $(1,913,460) | $420,208 |
Comparison of the Three Months Ended September 30, 2017 and 2016
Revenue
Consolidated revenue for the three months ended September 30, 2016 is mostly attributable to the Novume’s wholly-owned subsidiary, KSI. Consolidated revenue2019.
Non-GAAP Measures: EBITDA and Adjusted EBITDA
We calculate EBITDA as net income (loss) before interest, taxes, depreciation and amortization. We calculate Adjusted EBITDA as net income (loss) before interest, taxes, depreciation and amortization, adjusted for the three months ended September 30, 2017 includes revenue from Firestorm,(i) impairment of intangible assets, (ii) loss on extinguishment of debt, (iii) stock-based compensation, (iv) losses on sales of subsidiaries, and from Brekford after the August 28, 2017 Brekford Merger. Revenue increased by $2,016,045,(v) other unusual or 83.8%, to $4,421,574 for the three months ended September 30, 2017 compared to $2,405,529non-recurring items. EBITDA and Adjusted EBITDA are not measurements of financial performance or liquidity under accounting principles generally accepted in the comparable periodU.S. (U.S. GAAP) and should not be considered as an alternative to cash flow from operating activities or as a measure of liquidity or as an alternative to net earnings as indicators of our operating performance or any other measures of performance derived in 2016. Revenue attributable to Firestorm was $466,580 for the three months ended September 30, 2017. Revenue attributable to Brekford was $224,783 for the period from August 28, 2017 through September 30, 2017. The $1,324,682 increase in revenue attributable to legacy Novume was due to an increaseaccordance 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 numberevaluation of a company’s ability to service and/or incur debt. However, other companies in our industry may calculate EBITDA and dollar volume of contracts in KSI.
Cost of Revenue
Total cost of revenue for the three months ended September 30, 2017 increased by $1,123,370, or 84.2%, to $2,457,806 compared to $1,334,436 in the comparable period in 2016. Cost of revenue attributable to Firestorm was $183,803 for the three months ended September 30, 2017. Cost of revenue attributable to Brekford was $88,963 for the period from August 28, 2017 through September 30, 2017. The $850,604 increase in the cost of revenue of the legacy Novume was mostly attributable to revenue increase for KSI noted above.
Gross Profit
Gross profit for the three months ended September 30, 2017 increased by $892,675, or 83.3%, to $1,963,768 compared to $1,071,093 for the comparable period in 2016. Gross profit attributable to Firestorm was $282,776 for the three months ended September 30, 2017. Gross profit attributable to Brekford was $135,820 for the period from August 28, 2017 through September 30, 2017. The $474,079 increase in the gross profit of the legacy Novume was mostly attributable to the increased revenue offset by the use of consultants and non-billable expenses.Adjusted EBITDA differently than we do.
The gross profit margin was 44.4% forfollowing table set forth the three months ended September 30, 2017 compared to 44.5% in the comparable period in 2016. Excluding the gross profit margin for Firestorm and Brekford, the gross profit margin for legacy Novume for the three months ended September 30, 2017 and 2016 was 41.4% and 44.5%, respectively. The decrease in margin was the resultcomponents of the increase use of consultants, which are more expensive than employees,EBITDA and increased non-billable expenses for KSI.
Operating Costs and Expenses
Operating costs and expenses for the three months ended September 30, 2017 increased by $1,846,052, or 160.3%, to $ 2,997,566 compared to $1,151,514 in the comparable period in 2016. Operating cost and expenses attributable to Firestorm was $646,995 for the three months ended September 30, 2017. Operating costs and expenses attributable to Brekford was $173,466 for the three months ended September 30, 2017.The Company also launched a new television show in the second quarter which increased operating costs and expenses by approximately $192,200. The increase of $833,341 in operating costs and expenses of legacy Novume was primarily due to an increase in holding company salaries, professional and legal services related to organization and financial structuring, ramp up of operations and expenses related to initiating and maintaining compliance with applicable listing rules and SEC requirements that were not incurred during the three months ended September 30, 2016. As percentage of revenue, Novume operating costs and expenses for the three months ended September 30, 2017 increased to 67.8% of revenue compared to 47.9% in the comparable period in 2016 due to the items noted above.
Novume anticipates that its general and administrative expenses will continue to increase, however at a lower rate, in future periods. These increases will include costs related to hiring of personnel and fees to outside consultants, lawyers and accountants as well as expenses related to maintaining compliance with applicable listing rules and SEC requirements, insurance, and investor relations activities.
Other Income (Expense)
Other income for the three months ended September 30, 2017 was $ 17,296 compared to other expense of ($15,656) in the comparable period in 2016. This change was related primarily to rental income.
Income Taxes
KSI initially elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code. Under those provisions, KSI did not pay federal corporate income tax, and in most instances state income tax, on its taxable income. KSI revoked its S Corporation election upon the March 15, 2016 merger with KeyStone, and Novume and is now subject to corporate income taxes. Firestorm is a single-member LLC with KeyStone as the sole member.
The benefit from income tax for the three months ended September 30, 2017 was $225,142 and is primarily related to the recognition of a deferred tax benefit. There was $40,535 of benefit from income tax recorded for the three months ended September 30, 2016.
Net Loss
Net loss for the three months ended September 30, 2017 was $791,360 compared to net loss of $55,542 for the comparable period in 2016. The net loss margin was 17.9% for the three months ended September 30, 2017 compared to a net loss margin of 2.3% for the comparable period in 2016, due to the factors noted above.
Comparison of the Nine Months Ended September 30, 2017 and 2016
Revenue
Consolidated revenue for the nine months ended September 30, includes revenue from Firestorm after the January 25, 2017 acquisition by the Company and from Brekford after the August 28, 2017 Brekford Merger. Revenue increased by $1,548,951, or 16.2%, to $11,131,825 for the nine months ended September 30, 2017, compared to $9,582,874 in the comparable period in 2016. Revenue attributable to Firestorm was $1,248,334 for the period from January 25, 2017 through September 30, 2017. Revenue attributable to Brekford was $224,783 for the period from August 28, 2017 through September 30, 2017. The $75,834 increase in revenue attributable to legacy Novume was due to a small increase in the number and dollar volume of contracts in KSI.
Cost of Revenue
Total cost of revenue for the nine months ended September 30, 2017 increased by $521,394, or 84.2%, to $6,017,982 compared to $ 5,496,588 in the comparable period in 2016. Cost of revenue attributable to Firestorm was $412,714 for the period from January 25, 2017 through September 30, 2017. Cost of revenue attributable to Brekford was $88,963 for the period from August 28, 2017 through September 30, 2017. The $19,717 increase in the cost of revenue of the legacy Novume was mostly attributable to increased revenue for KSI noted above.
Gross Profit
Gross profit for the nine months ended September 30, 2017 increased by $1,027,557, or 83.3%, to $5,113,843 compared to $ 4,086,286 for the comparable period in 2016. Gross profit attributable to Firestorm was $835,619 for the period from January 25, 2017 through September 30, 2017. Gross profit attributable to Brekford was $135,820 for the period from August 28, 2017 through September 30, 2017. The $56,118 increase in the gross profit of the legacy Novume was generally consistent with the increased revenue and costs of revenues at KSI noted above.
The gross profit margin was 45.9% for the nine months ended September 30, compared to 42.6% in the comparable period in 2016. Excluding the gross profit margin for Firestorm and Brekford, the gross profit margin for legacy Novume for the nine months ended September 30, and 2016 was relatively consistent at 42.9% and 42.6%, respectively.
Operating Costs and Expenses
Operating costs and expenses for the nine months ended September 30, increased by $4,412,334, or 121.8%, to $8,036,339 compared to $3,624,005 in the comparable period in 2016. Operating cost and expenses attributable to Firestorm was $1,161,075 for the period from January 25, 2017 through September 30, 2017. Operating cost and expenses attributable to Brekford was $173,466 for the period from August 28, 2017 through September 30, 2017. The Company also launched a new television show in the second quarter which increased operating costs and expenses by approximately $465,533. This television show airs locally in the Washington DC market. The increase of $2,612,260 operating costs and expenses of legacy Novume was primarily due to an increase in holding company salaries, professional and legal services, ramp up of operations and expenses related to maintaining compliance with applicable listing rules and SEC requirements that were lower during the nine months ended September 30, 2016 because the Company was formed in mid-March 2016 and spending increased during the nine months ended September 30, 2017. As percentage of revenue, Novume operating costs and expenses for the nine months ended September 30, increased to 72.2% compared to 37.8% in the comparable period in 2016.
Novume anticipates that its general and administrative expenses will continue to increase, however at a lower pace, in future periods. These increases will include costs related to hiring of personnel and fees to outside consultants, lawyers and accountants as well as expenses related to maintaining compliance with applicable listing rules and SEC requirements, insurance, and investor relations activities.
Other Income (Expense)
Other income for the nine months ended September 30, was $44,659 compared to other expense of $(28,693) in the comparable period in 2016. This change was related primarily to rental income.
Income Taxes
KSI initially elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code. Under those provisions, KSI did not pay federal corporate income tax, and in most instances state income tax, on its taxable income. KSI revoked its S Corporation election upon the March 15, 2016 merger with KeyStone and Novume and is now subject to corporate income taxes. Firestorm is a single-member LLC with KeyStone as the sole member.
The benefit from income tax for the nine months ended September 30, was $964,377 and is primarily comprised of a deferred tax benefit. There was $13,380 of income tax expense recorded for the nine months ended September 30, 2016.
Net (Loss) Income
Net loss for the nine months ended September 30, 2017, was $(1,913,460) compared to net income of $420,208 for the comparable period in 2016. The net loss margin was 17.2% for the nine months ended September 30, 2017, compared to a net income margin of 4.4% for the comparable period in 2016.
Cash Flow
Novume expects to finance its operations over the next twelve months from the date of this Form 10-Q primarily through existing cash flow and from the net proceeds of the Reg 1A Offering, supplemented as necessary by funds available through access to credit and through access to additional capital. The Reg 1A Offering is further described below in the Novume management discussion under Liquidity and Capital Resources.
The net cash flows from operating, investing and financing activitiesAdjusted EBITDA for the periods below were as follows:included:
| | Nine Months ended September 30, |
| | | |
| Net cash provided by (used for): | |
| Operating activities | $(2,204,152) | $559,535 |
| Investing activities | (52,985) | (35,377) |
| Financing activities | 3,230,815 | (333,991) |
| Net increase (decrease) in cash and cash equivalents: | $973,678 | $190,167 |
| | For the Three Months ended September 30, | For the Nine Months ended September 30, |
| | | | | |
| | | |
| Net loss from continuing operations | $(3,456) | $(528) | $(10,978) | $(3,649) |
| Interest | 1,228
| 214 | 2,832
| 412 |
| Depreciation and amortization | 503
| 269 | 1,418
| 793
|
| EBITDA | $(1,725) | $(45) | $(6,728) | $(2,444) |
| | | | | |
| Impairment of intangible assets | - | - | 1,549 | - |
| Loss on extinguishment of debt | 45 | - | 1,158 | - |
| Share-based compensation | 76 | 87 | 314 | 296 |
| Restructuring charges | - | - | 333 | - |
Loss on sale of Secure Education | - | - | 3 | - |
| Adjusted EBITDA | $(1,604) | $42 | $(3,371) | $(2,148) |
Cash (Used for) Provided by Operating Activities
For the nine months endedThe following activities have impacted our Adjusted EBITDA from continuing operations balance as of September 30, 2017, net cash used for operating2019. In March 2019, we recorded costs in connection with the extinguishment of its $2,000,000 2018 Promissory Note of $1,113,000. In July 2019, we recorded costs in connection with the extinguishment of its line of credit with Wells Fargo of $45,000. In June we initiated restructuring and transition activities was $(2,204,152). Cash was used primarily to fund our operationsimprove operational efficiency, reduce costs and working capital needs. Novume also incurred non-cash expenses including depreciation and amortization, bad debt expense, deferred taxes, deferred rent, share-based compensation, warrant expense and financing related costs.
For the nine months ended September 30, 2016, net cash provided by operatingbetter position us to drive future revenue growth. In connection with these activities, was $559,535. Cash was provided primarily by net income, increases in accounts payable and accrued expenses, offset by increases in accounts receivable and other assets. The Company also incurred non-cash expenses including depreciation and amortization.
Cash (Used for) Investing Activities
For the nine months ended September 30, 2017, net cash used for investing activitieswe recorded $333,000 of ($52,985)charges related to these restructuring activities. Additionally, in June, we discontinued the purchaseoperations of computer hardwareBC Management, Inc. (“BC Management”) and equipment.
Forterminated agreements of all franchisees of Firestorm Franchising, LLC on the nine months ended September 30, 2016, net cash used for investing activitiesbasis of ($35,377)non-performance. As a result, we re-evaluated the intangible assets related to the purchase of computer hardwarethese subsidiaries and equipment.
Cash Provided by (Used for) Financing Activities
For the nine months ended September 30, 2017, net cash provided by financing activities of $3,230,815recognized $1,549,000 in impairment charges related to the net proceeds from the issuance of preferred stock and cash acquired by the acquisition of Brekford, offset by the acquisition of Firestorm, net of cash acquired, and the payment of Series A Preferred Stock dividends.
For the nine months ended September 30, 2016, net cash used for financing activities of $(333,991) related to proceeds from a note payable offset by KSI stockholders’ distributions.
Non-Cash Financing Activities
In March 2016, the KSI’s stockholders exchanged 100% of their outstanding shares of common stock in KSI for proportionate shares of KeyStone’s outstanding common stock and $1,192,844 of undistributed earnings were contributed to KeyStone.
In January 2017, KeyStone acquired Firestorm as described above. The non-cash consideration for this acquisition included notes payable of $907,407 and the issuance of 946,875 shares of Novume common stock valued at $1,203,986.
In August 2017, the Company merged with Brekford as described above. The non-cash consideration for the Brekford Merger included the issuance of 3,287,187 shares of Novume common stock valued at $5,851,193.
intangible assets.
Lease Obligations
The Company leasesDuring 2018 and 2019, we leased office space in Chantilly, Virginia under the terms of a ten-year lease expiring October 31, 2019. The lease containscontained one five-year renewal option. The lease terms includeincluded an annual increase in base rent and expenses of 2.75%. The Company also leases office space in New Orleans, Louisiana under a three-year, which have been amortized ratably over the lease expiring May 31, 2018, and in Roswell, Georgia under a lease expiring October 31, 2017. In addition, the Company leases office space from Global Public Safety on a month-to-month basis and it leases space under an operating lease expiring on December 31, 2017.term.
Rent expense for the three months ended September 30, 2017 and 2016 was $193,985 and $178,946, respectively and for the nine months ended September 30, and 2016 was $575,181 and $533,168, respectively.
As of September 30, 2017, the future obligations over the primary termsDuring this same period, we subleased a portion of the long-term leases expiring between 2017 and 2020 are as follows:
| 2017 | $188,854 |
| 2018 | 697,153 |
| 2019 | 624,024 |
| 2020 | 64,475 |
| Total | $1,574,506 |
The Company is the lessor in an agreement to sublease office space in Chantilly, Virginia with an initial term of two years, with eight one-year options for the subtenant to renew the lease through October 31, 2019. The lease providesThis sublease provided for an annual increaseincreases in base rent and expenses of 2.90%. The initial term ended October 31, 2011 and the Companysubtenant exercised the renewal options through 2014. On April 7, 2015, the leasesublease was amended to sublease more space to the subtenant and change the rental calculation. Rent incomeThe sublease provided for an offset of $0 and $46,000 to rent expense for the three months ended September 30, 20172019 and 20162018, respectively, and $0 and $137,000 for the nine months ended September 30, 2019 and 2018, respectively.
Effective December 31, 2018, we terminated the original lease agreement for the Chantilly, Virginia space, and on January 1, 2019, we entered into a new agreement as sublessor for a portion of the original space occupied in this location. This sublease includes annual increases in base rent and expenses of 2.75% and expires on June 30, 2024, with a right to renew subject to the sublessor renewing its lease.
We also lease office space in: New Orleans, Louisiana on a month-to-month basis which we vacated on July 31, 2019; Roswell, Georgia under a lease expiring in January 2022; and Fort Worth, Texas under a lease expiring in March 2021. In addition, we leased office space from Global Public Safety on a month-to-month basis expiring August 2019 and we also leased separate space under an operating lease which expired on June 30, 2019. Furthermore, we leased office space in Grand Rapids, Michigan under a lease which expired on April 30, 2019.
On May 9, 2019, we entered into a sublease agreement to lease office space in Columbia, Maryland and expiring on August 31, 2021. This sublease includes annual increases in base rent and expenses of 4.0%. We recognized $291,000 of right-of-use (“ROU”) operating lease assets and $291,000 of operating lease liabilities, including noncurrent operating lease liabilities of $232,000.
Operating lease expense from continuing operationsfor the three months ended September 30, 2019 and 2018 was $46,957$85,000 and $45,634,$180,000, respectively, and for the nine months ended September 30, 2019 and 20162018 was $140,871$268,000 and $136,901,$516,000, respectively, and is part of general and administrative expenses in the accompanying unaudited condensed consolidated statement of operations.
Effective January 1, 2019, we adopted Accounting Standards Update (“ASU”) 2016-02,Leases(Topic 842), as amended, which requires lessees to recognize a right-of-use (“ROU”) lease assets, and lease liability on the balance sheet for most lease arrangements and expands disclosures about leasing arrangements for both lessees and lessors, among other items. We adopted ASU 2016-02 using the optional transition method whereby we applied the new lease requirements under ASU 2016-02 through a cumulative-effect adjustment, which after completing our implementation analysis, resulted in no adjustment to our January 1, 2019 beginning retained earnings balance. On January 1, 2019, we recognized $921,000 of ROU operating lease assets and $951,000 of operating lease liabilities, including noncurrent operating lease liabilities of $728,000 as a result of adopting this standard. The difference between ROU operating lease assets and operating lease liabilities was primarily due to previously accrued rent expense relating to periods prior to January 1, 2019. As part of our adoption, we elected the following practical expedients: we have not reassessed whether any expired or existing contracts are or contain leases; we have not reassessed lease classifications for any expired or existing leases; we have not reassessed initial direct costs for any existing leases; and we have not separated lease and non-lease components. The adoption of the standard did not have a material impact on our operating results or cash flows as of January 1, 2019. The comparative periods have not been restated for the adoption of ASU 2016-02.
Cash paid for amounts included in the measurement of operating lease liabilities from continuing operations was $48,000 and $56,000 for the three and nine months ended September 30, 2019, respectively.
Liquidity and Capital Resources
The Company hasfollowing table sets forth the components of our cash flows for the period included:
| | For the Nine Months Ended September 30, |
| | | | |
| (Dollars in thousands)
| $
| %
|
| Net cash used in operating activities - continuing operations | $(6,335) | $(1,658) | $(4,677) | -282% |
| Net cash (used in) provided by investing activities - continuing operations | (406) | 468 | (874) | -187% |
| Net cash provided by financing activities - continuing operations | 5,895
| 653 | 5,242
| 803% |
| Net decrease in cash, cash equivalents and restricted cash and cash equivalents - continuing operations | $(846) | $(537) | $(309) | -58% |
Net cash used in operating activities – continuing operations for the nine months ended September 30, 2019 had a net decrease of $4,677,000 which was primarily due to an increase in net loss from continuing operations to $10,978,000 for the nine months ended September 30, 2019, as compared to $3,646,000 for the nine months ended September 30, 2018. This was partially offset by (i) an impairment of intangible assets in the amount of $1,549,000 from Firestorm, (ii) $1,158,000 loss on extinguishment of debt we incurred in the first and third quarter of 2019, (iii) an increase in amortization of intangible assets of $965,000 in the nine months ended September 30, 2019, as compared to $557,000 in the nine months ended September 30, 2018, and (iv) an increase in contract liabilities of $900,000 in the nine months ended September 30, 2019, as compared to a $20,000 decrease in the nine months ended September 30, 2018, mainly a result of $800,000 we received from a customer for a five-year software license.
The net decrease of net cash (used in) provided by investment activities – continuing operations of $874,000 was primarily due to proceeds from sale of note receivable in the amount of $1,475,000 we sold during the nine months ended September 30, 2018. This was partially offset by proceeds of $250,000 from the sale of Secure Education to a third party and a reduction in capital expenditures during the nine months ended September 30, 2019.
Net cash used in financing activities – continuing operations for the nine months ended September 30, 2019 increased $5,242,000 from the prior nine-month period ended September 30, 2018. The increase was primarily due to (i) proceeds of $3,839,000 from the 2019 Promissory Notes issued the first quarter of 2019, (ii) proceeds from the at-the-market agreement, and (iii) proceeds of $2,315,000 from the secured borrowing arrangement withLSQ Funding Group, L.C. (“LSQ”). This was partially offset by the repayment of the Wells Fargo line of credit.
During 2019 and 2018, we funded itsour operations primarily through cash from operating activities from our subsidiaries, revolving lines of KSI, Firestorm, the $500,000 Avon Note (see below)credit, issuance of debt, sale of notes and the Reg 1A offering.sale of equity. As of September 30, 2017, Novume2019, we had unrestricted cash and cash equivalents from continuing operations of $3,762,265$1,273,000 and working capital deficit of $4,423,001,$107,000, as compared to unrestricted cash and cash equivalents $2,788,587of $2,069,000 and working capital deficit of $3,714,958$44,000 as of December 31, 2016.2018.
Operating assets and liabilities consist primarily of receivables from billed and unbilled services, accounts payable, accrued expenses, current portion of long-term debt and secured borrowing arrangements, and accrued payroll and related benefits. The volume of billings and timing of collections and payments affect these account balances.
In the Fall of 2016, the Company commenced its Reg 1A Offering of up to 3,000,000 Units. At the initial closing of the Reg 1A Offering, on December 23, 2016, the Company sold 301,570 Units and received aggregate gross proceeds of $3,015,700. At the second closing of the Reg 1A Offering, on January 23, 2017, the Company sold 119,757 Units and received aggregate gross proceeds of $1,197,570. At the third and final closing of the Reg 1A Offering, on March 21, 2017, the Company sold 81,000 Units and received aggregate gross proceeds of $810,000. As reported by KeyStone in its Current Report on Form I-U, as filed with the SEC on March 22, 2017, the Reg 1A Offering is now closed, effective as of the third closing.Series A Preferred Stock
Following the Brekford Merger, all outstanding sharesThe holders of KeyStoneRekor Series A Preferred Stock were exchanged for the right to receive one share of Novume Series A Preferred Stock. Novume Series A Preferred Stock will beare entitled to quarterly dividends in the amount of $0.175 (7% per annum) per share, being an identical per annum percentage per shareshare. Dividends accrue quarterly and dividend as received by holders of KeyStone Preferred Stock prior to the Brekford Merger. We anticipate that Novume will pay the quarterly cashpayments for declared dividends through cash flow from Novume, potential business growth from other acquired entities and access to additional credit or capital. The quarterly dividend payments are due within five (5) business days following the end of a quarter. On April 7, 2017, Novume
For the nine months ended September 30, 2019 and 2018, we paid cash dividends of $75,695$0 and $264,000, respectively, to holdersshareholders of record of NovumeSeries A Preferred Stock. Accrued dividends payable to Series A Preferred Stock as of March 30, 2017. On July 8, 2017, the Company paid cash dividends of $87,907 to shareholders of record as of June 30, 2017. On September 30, 2017, the Company declaredwere $440,000 and accrued dividends of $87,907 payable to shareholders of record$176,000 as of September 30, 2017.2019 and December 31, 2018, respectively, and are presented as part of the accounts payables and accrued expenses on the accompanying unaudited condensed consolidated balance sheets.
KSISeries B Preferred Stock
As part of the acquisition of Global, we issued 240,861 shares of $0.0001 par value Series B Preferred Stock. All Series B Preferred Stock was issued at a partyprice of $10.00 per share with a conversion price of $5.00 per share. Each Series B Preferred Stock has an automatic conversion feature based on the common stock share price of Rekor. The Series B Preferred Stock is entitled to quarterly cash dividends of 1.121% (4.484% per annum) per share. Dividends accrue quarterly and dividend payments for declared dividends are due within five business days following the end of a business loan agreement (the “2015 Loan Agreement”) with Sandy Spring Bank (“SSB”) datedquarter. As of September 30, 2019, we paid $108,000 related to accrued dividends for Series B Preferred Stock shareholders. Accrued dividends payable to Series B Preferred Stock shareholders were $27,000 and $54,000 as of September 25, 2015. The primary credit facility was30, 2019 and December 31, 2018, respectively.
Short-Term Borrowing
On August 9, 2019, Global Technical Services, Inc. and Global Contract Professionals, Inc, (together "Global"), our wholly owned subsidiaries, entered an asset based revolving lineagreement with an unrelated third party, LSQ, pursuant to which Global sells its accounts receivable to LSQ and LSQ advances Global 90% of creditthe value of the receivable. Global can advance up to $1,000,000 which$10,000,000 at one time. The term of the agreement is for 12 months and automatically renews for additional 12-month periods. The agreement is presented as secured borrowings, as the accounts receivable are sold with recourse back to Global, meaning that Global bears the risk of non-payment by the account debtor. The funded amount of accounts receivables that LSQ has provided to Global was due to mature on$1,629,000 as of September 30, 2016.2019 and is presented as part of current liabilities held for sale on the unaudited condensed consolidated balance sheets. To secure its obligations under the 2015 Loan Agreement, KSI hadto LSQ, Global has granted to SSB a first priority security interest in its accounts receivable. SSB was required to advance funds to KSI up to the lesser of (1) $1,000,000 or (2) eighty percent (80%) of the aggregate amount of all of itsGlobal's accounts receivable aged 90-days or less which contained selling terms and conditions acceptable to SSB. KSI’s obligations under the 2015 Loan Agreement were guaranteed by James McCarthy, the Chairman of Novume (and former chairman of KSI), and his wife. KSI did not draw any funds from this credit facility in 2015. Pursuant to First Amendment to Business Loan Agreement (Asset Based), dated May 9, 2016, SSB had waived the restrictions in the 2015 Loan Agreement on KSI’s ability to make dividends to the Company. There was no outstanding balance on the 2015 Loan Agreement at December 31, 2016.
On August 11, 2016, Novume entered into a Loan and Security Agreement (the “2016 Line of Credit”) with SSB that replaced the 2015 Loan Agreement. The 2016 Line of Credit was comprised of: 1) an asset-based revolving line of credit up to $1,000,000 for short-term working capital needs and general corporate purposes which is due to mature on July 31, 2017, bore interest at the Wall Street Journal Prime Rate, floating, plus 0.50% and wass secured by a first lien on all of Novume’s business assets; and 2) an optional term loan of $100,000 which must be drawn by July 31, 2017, was for permanent working capital, bore interest at the Wall Street Journal Prime Rate, floating, plus 0.75%, requires monthly payments of principal plus interest to fully amortize the loan over four (4) years and was secured by a first lien on all of Novume’s business assets, cross-collateralized and cross-defaulted with the revolving line of credit. The 2016 Line of Credit had a final maturity date of February 15, 2019 and did not require any personal guarantees.
The borrowing base for the 2016 Line of Credit was up to the lesser of (1) $1,000,000 or (2) eighty percent (80%) of the aggregate amount of all of Novume’s eligible accounts receivable as defined by SSB. The borrowing base for the $100,000 term loan was fully reserved under the borrowing base for the revolving line of credit. The 2016 Line of Credit hadd periodic reporting requirements and balance sheet covenants, as well as affirmative and negative operational and ownership covenants. Novume was in compliance with all 2016 Line of Credit covenents at December 31, 2016. In August 2017, the Company terminated the 2016 Line of Credit with SSB. As such, there was no outstanding balance on the 2016 Line of Credit at September 30, 2017.
proceeds thereof. As of September 30, 20172019, there were approximately $2,515,000 of receivables that are subject to collateral as part of this agreement. The receivables held as collateral are presented in assets held for sale on the unaudited condensed consolidated balance sheets.
On August 9, 2019, AOC Key Solutions, Inc. ("AOC"), our wholly owned subsidiary, also entered into an agreement with LSQ, as an unrelated third party, pursuant to which AOC sells its accounts receivable to LSQ and 2016, Novume had no balances due, respectively,LSQ advances AOC 90% of the value of the receivable. AOC can advance up to $5,000,000 at one time. The term of the agreement is for 12 months and automatically renews for additional 12-month periods. The agreement is presented as secured borrowings, as the 2016 Lineaccounts receivable are sold with recourse back to AOC, meaning that AOC bears the risk of Credit andnon-payment by the 2015 Loan Agreement. When Novume replaced the 2015 Loan Agreement with the 2016 Lineaccount debtor. The funded amount of Credit on August 11, 2016, neither line of credit had a balance due. The Company terminated the 2016 Line of Credit in August 2017 and consequently there are no amounts outstandingaccounts receivables that LSQ has provided fund to AOC was $1,588,000 as of September 30, 2019 and is presented as part of the dateshort-term borrowings on the unaudited condensed consolidated balance sheets. To secure its obligations to LSQ, AOC has granted a first priority security interest in the AOC’s accounts receivable and proceeds thereof. As of September 30, 2019, there were approximately $2,451,000 of receivables that are subject to collateral as part of this Reportagreement. The receivables held as collateral are presented in the accounts receivable, net on Form 10-Q.the unaudited condensed consolidated balance sheets.
During the three and nine months ended September 30, 2019, we recorded $33,000, in interest expense from continuing operations, related to the agreement with LSQ. Additionally, during the three and nine months ended September 30, 2019, we recorded $80,000 in interest expense from operations held for sale, related to the agreement with LSQ.
Promissory Notes
On March 12, 2019, we issued the 2019 Promissory Notes and the March 2019 Warrants. The loan is due and payable on March 11, 2021 and bears interest at 16% per annum, of which at least 10% per annum is required to be paid in cash. The full remaining portion of all interest, if any, accrues and is to be paid-in-kind. The notes also require a premium, if paid before the maturity date, a $1,000,000 exit fee due at maturity, and compliance with affirmative, negative and financial covenants. The covenants related to this note were deferred until September 2019. Transaction costs were approximately $403,000 for a work fee payable over 10 months, $290,000 in legal fees and a $200,000 closing fee. The loan is secured by a security interest in substantially all of the assets of Rekor. The March 2019 Warrants are exercisable over a period of five years, at an exercise price of $0.74 per share, and are valued at $706,000. The warrants were exercisable commencing March 12, 2019 and expire on March 12, 2024. The 2019 Promissory Notes have an effective interest rate of 24.87%. On March 12, 2019, we retired the entire $500,000 balance due on a promissory note issued under a March 16, 2016 Novume entered into a Subordinated Note and Warrant Purchase Agreement (the “Avon Road Note Purchase Agreement”) pursuant to which Novume agreed to issue up to $1,000,000 in subordinated debt and warrants to purchase up to 242,493 shares of Novume’s common stock (“Avon Road Subordinated Note Warrants”). The exercise price for the Avon Road Subordinated Note Warrants is equal to $1.03 per share of common stock. Subordinated notes with a face amount of $500,000 and Avon Road Subordinated Note Warrants to purchase 121,247 shares of Novume’s common stock have been issued pursuant to the Avon Road Note Purchase Agreement to Avon Road Partners, L.P. (“Avon Road”), an affiliate of Robert Berman, Novume’sRekor’s President and CEO and a member of Novume’sour Board of Directors. TheUnder this agreement, we also issued to Avon Road, Subordinated Note Warrants has an expiration datewarrants to purchase 121,247 shares of March 16, 2019our common stock. These warrants were exercised on December 11, 2017 for proceeds of $125,000 and qualified for equity accounting as the warrant did not fall within the scopenone of ASC Topic 480, Distinguishing Liabilities from Equity. The fair value was determined to be $58,520 and was recorded as a debt discount and additional paid-in capital in the accompanying consolidated balance sheet as of December 31, 2016. The debt discount is being amortized as interest expense on a straight-line basis, which approximates the effective interest method, through the maturity date of the note payable. The balancethese warrants were outstanding as of September 30, 20172019 and December 31, 2018. The promissory note to Avon Road was extinguished on March 12, 2019 from proceeds of the 2019 Promissory Notes. Amortized financing cost for the debt discount was $42,711.
three and nine months ended September 30, 2019 were $328,000 and $719,000, respectively, and are included in interest expense on the unaudited condensed consolidated statement of operations.
The note is subordinated2019 Promissory Notes resulting in the following detailed transaction (dollars in thousands):
| Financing: | |
| Notes payable, includes exit fee | $21,000 |
| Debt discount financing costs | (2,599) |
| Extinguishment of debt | (1,113) |
| Repayment of notes payable and interest expense, net of debt discount | (2,515) |
| Investment in OpenALPR Technology, includes $7,000,000 cash paid and $5,000,000 note assumed by seller | (12,000) |
| Issuance of warrants in conjunction with notes payable | 706 |
| Accounts Payable | 360 |
| Net cash proceeds from notes payable | $3,839 |
Public Offering
On November 1, 2018, we issued 4,125,000 shares of common stock through an underwritten public offering at a public offering price of $0.80 per share. Net proceeds to us were approximately $2,800,000. In addition, we granted underwriters a 45-day option to purchase up to 618,750 additional shares of common stock to cover over-allotment, if any. The underwriters did not exercise this option and the options were cancelled. As part of this transaction, we also issued to the 2016 Lineunderwriters warrants to purchase an aggregate of Credit with SSB206,250 shares of common stock, exercisable over a period of five years, at an exercise price of $1.00 per share. The warrants are exercisable commencing April 27, 2019 and any successor financing facility. Simple interest accruesexpire on October 29, 2023. During the unpaid principalnine months ended September 30, 2019, 1,149,860 warrants were exercised in cash and cashless transactions and converted into 931,666 shares of the note at a rate equal to the lower of (a) 9% per annum, or (b) the highest rate permitted by applicable law. Interest is payable monthly, and the note matures on March 16, 2019. The Company terminated the 2016 Loan Agreement in August 2017.common stock.
At-the-MarketOffering
PursuantOn August 14, 2019, we entered into an At Market Issuance Sales Agreement (the “Sales Agreement”) with B. Riley FBR, Inc. (“B. Riley FBR”) to create an at the market equity program under which we from time to time may offer and sell shares of our common stock, having an aggregate offering price of up to $15,000,000, through or to B. Riley FBR. Subject to the terms and conditions of the acquisitionSales Agreement, B. Riley FBR will use its commercially reasonable efforts to sell the shares of our common stock from time to time, based upon our instructions. B. Riley FBR will be entitled to a commission equal to 3.0% of the membership interestsgross proceeds from each sale. We incurred issuance costs of approximately $256,000 related to legal, accounting, and other fees in connection with the Firestorm Entities,Sales Agreement. These costs were charged against the Company issued $1,000,000 in the aggregate in the form of four unsecured, subordinated promissory notes, issued by Novume and payable over five years after the Firestorm Closing Date, to all the Membersgross proceeds of the Firestorm Entities. The principal amountSales Agreement and presented as a reduction to additional paid-in capital on the unaudited condensed consolidated balance sheets.
Sales of our common stock under the Sales Agreement are to be issued and sold pursuant to our shelf registration statement on Form S-3 (File No 333-224423), previously filed with the Securities and Exchange Commission (“SEC”) on April 24, 2018 and declared effective by the SEC on April 30, 2018. In September 2019, based on settlement date, we sold 103,566 shares of common stock at a weighted-average selling price of $2.84 per share in accordance with the Sales Agreement.Net cash provided from the Sales Agreement was $29,000 after paying $256,000 related to the issuance costs stated above, as well as, 3.0% or $9,000 related to cash commissions provided to B. Riley FBR.As of September 30, 2019, $14,706,000 remained available for sale under the Sales Agreement.
We have generated losses since our inception in August 2017 and have relied on cash on hand, external bank lines of credit, short-term borrowing arrangements, issuance of debt, the sale of a note, payable to Lancer is $500,000. The principal amount of the note payable to Mr. Rhulen is $166,666.66. The principal amount of the notes payable to each of Mr. Satterfield and Ms. Loughlin is $166,666.67. The Firestorm Principal Notes are payable at an interest rate of 2%at-the-market agreement and the Lancer Note is payable at an interest ratesale of 7%. The balancecommon stock to provide cash for operations. We attribute losses to merger costs, financing costs, public company corporate overhead, lower than expected revenue, and lower gross profit of these notes payablesome of our subsidiaries. For the nine months ended September 30, 2019, we incurred a net loss from continuing operations of approximately $10,978,000 and used approximately $6,335,000 in net cash from operating activities from continuing operations. We had total cash and cash equivalents from continuing operations of approximately $1,273,000 as of September 30, 2017was $919,753 to reflect2019 and a working capital deficit of $107,000.
No additional sources of capital have been obtained or committed through the amortized fair valuedate of this Quarterly Report on Form 10-Q. There are currently no anticipated changes in the notes issuedmix and relative cost of capital resources. Although certain of our subsidiaries are profitable, due to the differenceoperating costs associated with being a public company and expenses related to product development and commercialization costs at other subsidiaries, we anticipate that we may operate at a loss in interest rates.the near-term, however, we anticipate this trend reversing during 2020.
As of September 30, 2017, Novume2019, we did not have any material commitments for capital expenditures.
Off-Balance Sheet Arrangements, Contractual Obligations and CommitmentsITEM 3. QUANTITAIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a “smaller reporting company” as defined by Item 10 of the date of this Form 10-Q, Novume didRegulation S-K, Rekor is not have any off-balance sheet arrangements that have had or are reasonably likely to have a material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital resources or capital expenditures.
Critical Accounting Policies and Estimates
The discussion and analysis of Novume’s financial condition and results of operations is based upon Novume’s consolidated financial statements which have been prepared in accordance with “GAAP”. The preparation of these consolidated financial statements requires the management of Novume to make estimates and judgments that affect the reported amounts in our consolidated financial statements.
Novume believes the application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when facts and circumstances dictate a change. Novume bases its estimates on historical experience and on various other assumptions that management of Novume 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.
Novume’s accounting policies are further described in its historical audited consolidated financial statements and the accompanying notes included in this Report on Form 10-Q. Novume has identified the following critical accounting policies:
Revenue Recognition
Novume recognizes its revenues for the provision of services when persuasive evidence of an arrangement exists, services have been rendered or delivery has occurred, the fee is fixed or determinable, and the collectability of the related revenue is reasonably assured. Novume principally derives revenues from fees for services generated on a project by project basis. Revenues for time-and-materials contracts are recognized based on the number of hours worked by our employees or consultants at an agreed upon rate per hour set forth in our standard rate sheet or as written from time to time in our contracts or purchase orders. These costs are recognized in the period in which services are performed.
Revenues related to firm-fixed-price contracts are recognized upon completion of the project as these projects are typically short-term in nature.
The agreements entered into in connection with a project, whether on a time-and-materials basis or firm-fixed-price basis, typically allow our clients to terminate early due to breach or for convenience with 30-days’ notice. In the event of termination, the client is contractually required to pay for all time, materials and expenses incurredprovide information required by us through the effective date of the termination.
For automated traffic safety enforcement revenue, the Company recognizes the revenue when the required collection efforts, from citizens, are completed and posted to the municipality’s account. The respective municipality is then billed depending on the terms of the respective contract, typically 15 days after the preceding month while collections are reconciled. For contracts where the Company receives a percentage of collected fines, revenue is calculated based upon the posted payments from citizens multiplied by the Company’s contractual percentage. For contracts where Company receives a specific fixed monthly fee regardless of citations issued or collected, revenue is recorded once the amount collected from citizens exceeds the monthly fee per camera. The Company’s fixed fee contracts typically have a revenue neutral provision whereby the municipality’s payment to Brekford cannot exceed amounts collected from citizens within a given month.
Accounts Receivable
Accounts receivable are customer obligations due under normal trade terms. Novume performs continuing credit evaluations of its clients’ financial condition, and Novume generally does not require collateral.
Management reviews accounts receivable to determine if any receivables will potentially be uncollectible. Factors considered in the determination include, among other factors, number of days an invoice is past due, client historical trends, available credit ratings information, other financial data and the overall economic environment. Collection agencies may also be utilized if management so determines.
Novume records an allowance for doubtful accounts based on specifically identified amounts that are believed to be uncollectible. Novume also records as an additional allowance a certain percentage of aged accounts receivable, based on historical experience and Novume’s assessment of the general financial conditions affecting its customer base. If actual collection experience changes, revisions to the allowance may be required. After all reasonable attempts to collect an account receivable have failed, the amount of the receivable is written off against the allowance. The balance in the allowance for doubtful accounts was $24,000 and $0 as of September 30, 2017 and 2016, respectively. Based on the information available, Novume determined that no allowance for doubtful accounts was necessary as of December 31, 2016 and 2015. However, actual write-offs might exceed the recorded allowance.
Income Taxes
Through March 15, 2016, KSI had elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code. Under those provisions, KSI did not pay U.S. federal corporate income taxes, and in most instances state income tax, on its taxable income. Instead, the stockholders of KSI were liable for individual income taxes on their respective shares of KSI’s net income. KSI effectively revoked its S Corporation election upon the March 15, 2016 merger with Novume. As a result, Novume is now subject to corporate income taxes. Firestorm is a single-member LLC with Novume as the sole member.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Novume’s evaluation as of September 30, 2017 and December 31, 2016 revealed no uncertain tax positions that would have a material impact on the financial statements. The 2013 through 2015 tax years remain subject to examination by the IRS. Management of Novume does not believe that any reasonably possible changes will occur within the next twelve months that will have a material impact on the financial statements.
New Accounting Pronouncements
Recently Issued Accounting Pronouncements
Not Yet Adopted
In August 2017, the Financial Accounting Standards Board (“FASB”) issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. The standard will be effective for us beginning July 1, 2019, with early adoption permitted for any interim or annual period before the effective date. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. The Company is currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems.Item.
In May 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-09,Compensation - Stock Compensation: Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. An entity will account for the effects of a modification unless the fair value of the modified award is the same as the original award, the vesting conditions of the modified award are the same as the original award and the classification of the modified award as an equity instrument or liability instrument is the same as the original award. The update is effective for fiscal year 2019. The update is to be adopted prospectively to an award modified on or after the adoption date. Early adoption is permitted. The Company is currently evaluating the effect of this update but does not believe it will have a material impact on its financial statements and related disclosures.ITEM 4. CONTROLS AND PROCEDURES
In January 2017, the FASB issued ASU No. 2017-04,Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurementLimitations on Effectiveness of goodwill, the update requires only a single-step quantitative test to identify and measure impairment based on the excess of a reporting unit's carrying amount over its fair value. A qualitative assessment may still be completed first for an entity to determine if a quantitative impairment test is necessary. The update is effective for fiscal year 2021 and is to be adopted on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.
In October 2016, the FASB issued ASU No. 2016-16,Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory, as part of its simplification initiatives. The update requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than deferring the recognition until the asset has been sold to an outside party as is required under current GAAP. The update is effective for fiscal year 2019. The new standard will require adoption on a modified retrospective basis through a cumulative-effect adjustment to retained earnings, and early adoption is permitted. The Company is currently evaluating the effect that this update will have on its financial statements and related disclosures.
In June 2016, the FASB issued ASU 2016-13 Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss methodology, which will result in more timely recognition of credit losses. ASU 2016-13 is effective for annual reporting periods, and interim periods within those years beginning after December 15, 2019. We are currently in the process of evaluating the impact of the adoption of ASU 2016-13 on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases. This ASU is a comprehensive new leases standard that amends various aspects of existing guidance for leases and requires additional disclosures about leasing arrangements. It will require companies to recognize lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. Topic 842 retains a distinction between finance leases and operating leases. The classification criteria for distinguishing between finance leases and operating leases are substantially similar to the classification criteria for distinguishing between capital leases and operating leases in the previous leases guidance. The ASU is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years; earlier adoption is permitted. In the financial statements in which the ASU is first applied, leases shall be measured and recognized at the beginning of the earliest comparative period presented with an adjustment to equity. Practical expedients are available for election as a package and if applied consistently to all leases. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated financial condition, results of operations and cash flows.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, as a new Topic, Accounting Standards Codification ("ASC") Topic 606, which supersedes existing accounting standards for revenue recognition and creates a single framework. Additional updates to Topic 606 issued by the FASB in 2015 and 2016 include the following:
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ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of the new guidance such that the new provisions will now be required for fiscal years, and interim periods within those years, beginning after December 15, 2017.
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ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations, which clarifies the implementation guidance on principal versus agent considerations (reporting revenue gross versus net).
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ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies the implementation guidance on identifying performance obligations and classifying licensing arrangements.
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ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which clarifies the implementation guidance in a number of other areas.
The underlying principle is to use a five-step analysis of transactions to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The standard permits the use of either a retrospective or modified retrospective application. The Company is currently in the process of completing its assessment of any significant contract and assessing the impact the adoption of the new revenue standard will have on its consolidated financial statements and related disclosures. The standard update, as amended, will be effective for annual periods beginning after December 15, 2017. The Company performed an initial assessment of the impact of the ASU and is developing a transition plan, including necessary changes to policies, processes, and internal controls as well as system enhancements to generate the information necessary for the new disclosures. The project is on schedule for adoption on January 1, 2018 and the Company will apply the modified retrospective method. The Company expects revenue recognition across its portfolio of services to remain largely unchanged. However, the Company expects to recognize revenue earlier than it does under current guidance in a few areas, including accounting for variable fees and for certain consulting services, which will be recognized over time rather than at a point in time. While the Company has not finalized its assessment of the impact of the ASU, based on the analysis completed to date, the Company does not currently anticipate that the ASU will have a material impact on its Consolidated Financial Statements.
There are currently no other accounting standards that have been issued but not yet adopted that will have a significant impact on Novume’s consolidated financial position, results of operations or cash flows upon adoption.
Recently Adopted
In January 2017, the FASB issued ASU 2017-01 Business Combinations (Topic 805): Clarifying the Definition of a Business. ASU 2017-01 provides guidance to evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. If substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single asset or a group of similar assets, the assets acquired (or disposed of) are not considered a business. We adopted ASU 2017-01 as of January 1, 2017.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The standard reduces complexity in several aspects of the accounting for employee share-based compensation, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The Company adopted this standard and the impact of the adoption was not material to the consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes. ASU 2015-17 is aimed at reducing complexity in accounting standards. Currently, GAAP requires the deferred taxes for each jurisdiction to be presented as a net current asset or liability and net noncurrent asset or liability. This requires a jurisdiction-by-jurisdiction analysis based on the classification of the assets and liabilities to which the underlying temporary differences relate, or, in the case of loss or credit carryforwards, based on the period in which the attribute is expected to be realized. Any valuation allowance is then required to be allocated on a pro rata basis, by jurisdiction, between current and noncurrent deferred tax assets. To simplify presentation, the new guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. As a result, each jurisdiction will now only have one net noncurrent deferred tax asset or liability. The guidance does not change the existing requirement that only permits offsetting within a jurisdiction; companies are still prohibited from offsetting deferred tax liabilities from one jurisdiction against deferred tax assets of another jurisdiction. The new guidance is effective in fiscal years beginning after December 15, 2016, including interim periods within those years, with early adoption permitted. KeyStone early adopted and applied the new standard retrospectively to the prior period presented in the accompanying consolidated balance sheets and it did not have a material impact.
In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs. The update requires that deferred debt issuance costs be reported as a reduction to long-term debt (previously reported in other noncurrent assets). The Company adopted ASU 2015-03 in 2016 and for all retrospective periods, as required, and the impact of the adoption was not material to our consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern, which requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. This accounting standard update applies to all entities and was effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter, with early adoption permitted. The Company adopted this standard during fiscal year 2016 and it did not have a material impact on the consolidated results of operations, financial position or cash flows.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The standard reduces complexity in several aspects of the accounting for employee share-based compensation, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The Company adopted this standard and the impact of the adoption was not material to the consolidated financial statements.
The Company does not believe that any recently issued accounting standards, in addition to those referenced above, would have a material effect on its consolidated financial statements.
Item 3.Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 4.Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(f) of the Exchange Act) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating theour disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.objectives.
Evaluation of Disclosure Controls and Procedures
We carried out an evaluation required by paragraph (b) of Rule 13a-15 or Rule 15d-15 under the Exchange Act, under the supervision and with the participation of management, including our Chief Executive Officerprincipal executive officer and Chief Financial Officer,principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this review, our Chief Executive Officerprincipal executive officer and Chief Financial Officerprincipal financial officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of September 30, 2017. The Company is in the process of executing a plan to address this lack of effectiveness.2019.
Changes toManagement’s Report on Internal Control overOver Financial Reporting
There have been no changesOur management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) of the Exchange Act.
Our management assessed the effectiveness of our internal control over financial reporting as of September 30, 2019, based on the criteria set forth in “Internal Control – Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment and due to the material weaknesses described below, our management concluded that, as of September 30, 2019, our internal control over financial reporting was not effective.
Management Progress on Addressing Material Weakness
Weidentified material weaknesses for the years ended December 31, 2018 and 2017, which were related to our internal control over financial reporting. To address the material weaknesses, we hired a Chief Financial Officer, formed a disclosure control committee, educated our Board of Directors on SEC filings and triggering events for financial reporting, implemented a financial reporting timetable, reviewed procedures for draft documents, implemented monthly certification of financial reports, tracked monthly financial activity, and had our executives review financial results and budgets. In addition, we augmented our accounting reporting staff by hiring an accounting manager and are realigning our accounting staff in order to strengthen internal controls over financial reporting as well as hiring an accounting firm to map our risks and initiate improved internal control processes. As part of these efforts, which are ongoing, we have mapped significant controls, implemented new control processes and, have improved the design and operational effectiveness of our control processes and systems for financial reporting, however, our management concluded that as of September 30, 2019, the material weaknesses identified for the years ended December 31, 2018 and 2017 had not been remediated. As of September 30, 2019, the we have implemented a remediation plan to remediate the material weakness as of December 31, 2019. Otherwise, there was no change in our internal control over financial reporting during our most recent fiscalthe quarter ended September 30, 2019 that havehas materially affected, or areis reasonably likely to materially affect, our internal controlscontrol over financial reporting.
Part II. Other Information
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS Item 1.We may from time to time be subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, we do not believe that the outcome of any of these legal matters will have a material adverse effect on our results of operations or financial condition. Legal Proceedings.Other than the matter described in the paragraph below, as of September 30, 2019, we were not aware of any material legal proceedings or claims.
None.On August 17, 2019, we filed suit in the United States District Court for the Southern District of New York against three former executives of the Company and Firestorm (the Firestorm Principals). The Complaint alleges that the Firestorm Principals fraudulently induced the execution of the Membership Interest Purchase Agreement pursuant to which Firestorm was acquired by us, and seeks rescission of the Membership Interest Purchase Agreement and certain transactions contemplated thereby, including the issuance of notes and warrants to the Firestorm Principals. On October 9, 2019, we filed an Amended Complaint. On November 4, 2019, the Firestorm Principals filed an answer to the Amended Complaint and asserted counterclaims against us, Firestorm, and certain of our executives.
ItemITEM 1A.Risk Factors. RISK FACTORS
There have been no material changes to the risk factors disclosed in “Risk Factors” in our S-4Annual Report on Form 10-K as filed with the SEC on August 2, 2017.April 11, 2019.
ItemITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDSUnregistered Sales of EquityUnregistered Securities
On March 12, 2019, as partial consideration for its acquisition of certain assets of OpenALPR, Rekor issued 600,000 shares of its common stock to the seller, valued at $397,000. On the same date, Rekor issued senior secured promissory notes in an aggregate principal amount of $20,000,000 and warrants to purchase 2,500,000 shares of its common stock, which are immediately exercisable at an exercise price of $0.74 per share, to certain individuals and entities.
The foregoing issuances were issued in reliance upon the exemptions from registration under the Securities Act of 1933, as amended, provided by Section 4(a)(2) and Rule 506 of Regulation D promulgated thereunder.
Public Offering and Shelf Registration
In November 2018, Rekor completed a public offering of its common stock (the “Offering”) and issued and sold 4,125,000 shares of its common stock at a public offering price of $0.80 per share.
The offer and sale of all of the shares in the Offering was registered under the Securities Act pursuant to a registration statement on Form S-3 (File No. 333-224423) (the “S-3 Registration Statement”), which was declared effective by the SEC on April 30, 2018, a preliminary prospectus supplement to the S-3 Registration Statement filed with the SEC on October 25, 2018 (the “Preliminary Prospectus Supplement”), a free writing prospectus filed with the SEC on October 24, 2018 (the “Free Writing Prospectus”), and a final prospectus supplement to the S-3 Registration Statement filed with the SEC on October 31, 2018 (the “Final Prospectus Supplement” and the S-3 Registration Statement as supplemented by the Preliminary Prospectus Supplement and the Final Prospectus Supplement, together with the Free Writing Prospectus, the “Registration Statement”). Under the Registration Statement, Rekor registered 4,125,000 shares of common stock and 618,750 shares of common stock issuable upon exercise of the underwriters’ option to purchase additional shares of common stock at a public offering price of $0.80 per share for a registered aggregate offering price of approximately $3,800,000. Following the sale of the shares in connection with the closing of the Offering on November 1, 2018, the Offering terminated. The Offering commenced on October 24, 2018 and did not terminate until the sale of all of the shares offered. ThinkEquity, a division of Fordham Financial Management, Inc. and The Benchmark Company, LLC acted as joint book-running managers of the Offering.
Rekor received aggregate gross proceeds from the Offering of approximately $3,300,000, and aggregate net proceeds of approximately $2,800,000 after deducting underwriting discounts and commissions of $200,000 and offering expenses of $300,000, for total expenses, including underwriting discounts and commissions of $500,000. No payments for such expenses were made directly or indirectly to any of Rekor’s officers, directors, or their associates, any persons owning 10% or more of any class of Rekor’s equity securities or any of Rekor’s affiliates.
There has been no material change in Rekor’s planned use of the net proceeds from the Offering as described in the Final Prospectus Supplement.
At-the-Market Agreement
On August 14, 2019, we entered into the Sales Agreement with B. Riley FBR, Inc. (“B. Riley FBR”) to create an at the market equity program under which we from time to time may offer and sell shares of our common stock, having an aggregate offering price of up to $15,000,000, through or to B. Riley FBR. Subject to the terms and conditions of the Sales Agreement, B. Riley FBR will use its commercially reasonable efforts to sell the shares of our common stock from time to time, based upon our instructions. B. Riley FBR will be entitled to a commission equal to 3.0% of the gross proceeds from each sale. We incurred issuance costs of approximately $256,000 related to legal, accounting, and other fees in connection with the Sales Agreement. These costs were charged against the gross proceeds of the Sales Agreement and presented as a reduction to additional paid-in capital on the unaudited condensed consolidated balance sheets.
Sales of our common stock under the Sales Agreement are to be issued and sold pursuant to our shelf registration statement on Form S-3 (File No 333-224423), previously filed with the Securities and Exchange Commission (“SEC”) on April 24, 2018 and declared effective by the SEC on April 30, 2018. In September 2019, based on settlement date, we sold 103,566 shares of common stock at a weighted-average selling price of $2.84 per share in accordance with the Sales Agreement.Net cash provided from the Sales Agreement was $29,000 after paying $256,000 related to the issuance costs stated above, as well as, 3.0% or $9,000 related to cash commissions provided to B. Riley FBR. As of September 30, 2019, $14,706,000 remained available for sale under the Sales Agreement.
Use of Proceeds.Proceeds
We have generated losses since our inception in August 2017 and have relied on cash on hand, external bank lines of credit, short-term borrowing arrangements, issuance of debt, the sale of a note, and the sale of common stock to provide cash for operations. We attribute losses to merger costs, financing costs, public company corporate overhead, lower than expected revenue, and lower gross profit of some of our subsidiaries. Our proceeds have been primarily used for research and development and sales and marketing expenses related to new product development and our strategic shift to develop and promote capabilities to the OpenALPR software in 2019.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES Not applicable.
Item 3.Defaults Upon Senior Securities.ITEM 5. OTHER INFORMATION
None.
Item 4.Mine Safety Disclosures.
Not applicable.
Item 5.Other Information.
None.
ItemITEM 6.Exhibits EXHIBITS
(a) Exhibits.Exhibits
Number | | Description |
| | |
| | Certification of Principal Executive Officer Required Under Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. |
| | Certification of Principal Financial Officer Required Under Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. |
| | Certification of Principal Executive Officer Required Under Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350. |
| | Certification of Principal Financial Officer Required Under Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350. |
| | | | | Incorporated by Reference | | |
| Exhibit Number | | Exhibit Description | | Form | | File No. | | Exhibit | | Filing Date | | Filed/ Furnished Herewith |
| | | | | | | | | | | | | |
| | Amended and Restated Certificate of Incorporation of Novume Solutions, Inc. as filed with the Secretary of State of Delaware on August 21, 2017 | | 8-K | | 333-216014 | | 3.1 | | 8/25/17 | | |
| | Certificate of Designations of Series A Cumulative Convertible Redeemable Preferred Stock as filed with the Secretary of State of Delaware on August 25, 2017 | | 8-K | | 333-216014 | | 4.1 | | 8/25/17 | | |
| | Certificate of Designations of Novume Series B Cumulative Convertible Preferred Stock as filed with the Secretary of State of Delaware on August 21, 2017 | | 8-K | | 000-55833 | | 4.2 | | 10/4/17 | | |
| | Certificate of Amendment to Amended and Restated Certificate of Incorporation of Novume Solutions, Inc. as filed with the Secretary of State of Delaware on April 26, 2019 | | 8-K | | 001-38338 | | 3.1 | | 4/30/19 | | |
| | Amended and Restated Bylaws of Rekor Systems, Inc. | | 8-K | | 001-38338 | | 3.2 | | 4/30/19 | | |
| | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer | | | | | | | | | | * |
| | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer | | | | | | | | | | * |
| | Section 1350 Certification of Chief Executive Officer | | | | | | | | | | ** |
| | Section 1350 Certification of Chief Financial Officer | | | | | | | | | | ** |
| 101.INS | | XBRL Instance Document | | | | | | | | | | * |
| 101.SCH | | XBRL Taxonomy Extension Schema Document | | | | | | | | | | * |
| 101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document | | | | | | | | | | * |
| 101.LAB | | XBRL Taxonomy Extension Label Linkbase Document | | | | | | | | | | * |
| 101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document | | | | | | | | | | * |
| 101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document | | | | | | | | | | * |
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | Novume Solutions,Rekor Systems, Inc. | |
| | /s/ Robert A. Berman | |
| Name: | Robert A. Berman | |
| Title: | Chief Executive Officer, Director (Principal Executive Officer and Authorized Signatory) | |
| Date: | November 14, 2019 | |
| | | |
| | | /s/ Carl Kumpf
Eyal Hen | |
| | Name: | Carl Kumpf
Eyal Hen | |
| | Title: | Chief Financial Officer Principal(Principal Financial and Accounting OfficerOfficer) | |
| | Date: | and Authorized SignatoryNovember 14, 2019 | |
Date: November 13, 2017