Earnings Call Transcript - REKR Q1 2022

Operator, Operator

Good afternoon, ladies and gentlemen, and welcome to today’s Rekor Systems Inc. Conference Call. My name is Diego and I will be your coordinator for today. As a reminder, this conference call is being recorded for replay purposes. Before we get started, I would like to read you the company's abbreviated Safe Harbor statement. I would like to remind you that statements made in this conference call concerning future revenues, results of operations, financial position, markets, economic conditions, product and product releases, partnerships and any other statements that may be construed as a prediction of future performance or events are forward-looking statements. Such statements can involve known and unknown risks, uncertainties, and other factors which may cause actual results to differ materially from those expressed or implied by such statements. We ask that you refer to the full disclaimer in our earnings release. You should also review the description of the risk factors contained in our annual and quarterly filings with the SEC. Non-GAAP results will be discussed on the call. The company believes the presentation of non-GAAP information provides useful supplementary data concerning the company's ongoing operations and is provided for informational purposes only. I would now like to turn the presentation over to Mr. Eyal Hen, CFO of Rekor Systems.

Eyal Hen, CFO

Good afternoon and thank you for joining us. Today we will discuss Rekor’s results for the quarter ended March 31, 2022 and provide you with an update on key business topics. On the call with me today is Robert Berman, CEO, and he will speak briefly on the exciting news we announced just this morning regarding our acquisition of STS and be giving you additional color on our business after I go over our relevant message. In the first quarter of 2022, we continued to show growth in recurring revenue under our new sales model, compared to the fourth quarter of 2021. We shifted our emphasis from point-in-time revenue to recurring revenue in the third quarter of 2021. While we will continue to engage in point-in-time hardware sales in appropriate circumstances, our new sales model provides for retaining ownership of hardware and providing software and data services on a subscription basis. This has had a near-term impact on our overall revenue. But with the strong growth we're seeing in recurring revenue, we are confident that the emphasis on developing subscription revenues will have a positive impact on our overall growth for the long term. With that, let me get into some of the details in the financial results for the quarter ended March 31, 2022, compared to the first quarter of 2021. Revenues for the quarter ended March 31, 2022 was $3.6 million compared to $4.2 million in the same period last year, a decrease of 14%. Recurring revenue was $1.7 million for the quarter ended March 31, 2022, which represented an increase of $0.8 million, or 96%, compared to $0.9 million for the quarter ended March 31, 2021. The quarter-over-quarter decrease in total revenue reflects a 43% decrease in products and services revenues, primarily due to a quarter-to-quarter reduction in point-in-time hardware sales, which was only partially offset during the quarter by the 26% increase in recurring revenue. As I just mentioned, we expect to continue point-in-time hardware sales in appropriate circumstances. And this may result in strong increases in product revenue in future quarters, like the increase we saw in the first quarter of 2021. But with our current emphasis on building SaaS-based revenue through subscription sales, we expect to generate a stable base for long-term growth well beyond what we could have achieved under the previous model. Total operating expenses for the quarter ended March 31, 2022 were $14.2 million compared to $7.6 million during the same period in 2021. We recorded a significant increase in payroll and payroll-related expenses. The addition of headcount due to the Waycare acquisition played a part in this increase, and we continue to add important new hires to our engineering and sales and marketing teams. We've expanded and will continue to expand our sales and marketing efforts as we add additional resources to promote our growing suite of product and service offerings. Finally, we continue to make strategic investments in research and development to develop new solutions and improve our line of products. This investment will enhance our competitive edge as we continue developing additional state-of-the-art solutions that address our customer's growing needs. Our adjusted gross margin for the quarter ended March 31, 2022 was 45%, a decline from the 54.4% reported on March 31, 2021. The declining margin for the quarter ended March 31, 2022 is primarily attributable to increased investments in winning and implementing new projects as we make efforts to quickly expand our presence in key areas. You should expect to see an improvement in our adjusted gross margin as our lands and expense strategy continues to evolve in the future. Adjusted EBITDA for the quarter ended March 31, 2022 was a loss of $9.3 million as compared to a loss of $3.9 million in the same period last year. This increase in loss was due to the investment into positioning Rekor for future growth that I've just discussed. Since we changed the revenue model, we have released enhanced key performance indicators to help provide visibility and more concise view into our success and progress. We hope that over time, these KPIs will provide our shareholders a better insight into our business. As explained before, recurring revenue for the first quarter of 2022 increased by 96% to $1.7 million from $0.9 million in the same period in 2021. In the first quarter of 2022, we won $1.5 million of new contracts. This is a decrease of 40% compared to $2.5 million of total contract value won during the quarter ended March 31, 2021, related primarily to the decrease in point-in-time hardware sales discussed earlier. As of March 31, 2022, remaining contract performance obligations were $21.3 million, and we expect to recognize approximately 41% of this amount over the succeeding 12 months. This represents a decrease of $1.6 million or 6% compared to $22.6 million of performance obligation as of December 31, 2021. The decrease in total contract value and performance obligations is partially related to our go-to-market strategy. This includes our willingness based on our experience within Europe to accommodate customers whose budget constraints requires shorter-term subscription than we have previously used. Also, as we continue to focus on building relationships and expanding our public safety network, we aim to bring customers in through pilot programs which are typically short in nature. As we continue to convert and expand our pilot programs to large-scale contracts, we expect to see these KPIs improve. Moving to our financial condition liquidity, our cash balance on March 31, 2022 was $14.6 million down from $25.8 million as of December 31, 2021. Working capital on March 31, 2022 was $9.3 million, down from $17 million as of December 31, 2021. The decrease in cash and cash equivalents was primarily due to the increase in our loss from operations as we build the company for future growth. This decrease in cash was partially offset by a net cash inflow of $3.1 million as part of our 2022 at-the-market sales agreement. The decrease in working capital was primarily due to the decrease in our cash position described above. In summary, we are enthusiastic about our growth prospects. The enhanced sales team has been extremely busy winning new client relationships, deepening existing ones, and forming new partnerships. We continue to feel a strong momentum in our market. While the investments we are making now to rapidly increase our market share will restrain our margins in the near term. We fully expect our margin to improve significantly as we reap the benefits of this investment. There is significant operating leverage embedded in our business model and we will remain focused on creating shareholder value and making decisions that will benefit our long-term shareholders. With that, I will now turn the call over to Robert.

Robert Berman, CEO

Thank you, Eyal. Good afternoon everyone and welcome. I will first briefly speak about the exciting news we issued this morning regarding Southern Traffic Services, STS. The addition of STS accelerates the company's urban mobility strategy while adding high growth, highly recurring revenue that combined with Rekor Solutions offers tremendous value for its clients and the communities they serve. STS is a company that shares our vision of enabling an entire transportation industry that is just beginning to undergo a once-in-a-lifetime transformation. We have always said the company is and remains opportunistic when it comes to potential acquisitions, and STS is an absolutely perfect fit for Rekor. Southern Traffic Systems is a trusted traffic engineering firm specializing in data collection. Founded in 1988, STS is a leading traffic data collection company that pioneered pay-for-data contracts with departments of transportation. In addition to the traffic data collection STS provides traffic engineering services that include design, planning, and traffic study services primarily to government agencies across the United States with a strong footprint in the southeast. A key growth accelerator for Rekor centers around acquisitions precisely like STS. Companies that are aligned to high-growth markets with increasing margin profiles. STS's existing customer base across an impressive geographic footprint will be exposed to our urban mobility technology to create expanded market penetration, growth opportunities, and solutions. We are absolutely over the moon with this acquisition that follows our acquisition of the company formerly known as Waycare last fall. I know you have many questions and the company will set a date in near future for a special conference call to discuss STS and our overall vision when it comes to acquisitions. Now allow me to change gears here and talk to you about Q1. During this quarter, we made significant investments to accelerate the advancement of our AI ML models, algorithms, and other proprietary IP. It is our algorithms that extract, transform, recognize patterns, and identify objects. Nobody sees it but we are constantly evolving our algorithms and training our Rekor 1 platform to simultaneously accomplish multiple missions. We take information from multiple sources, triangulate the data to draw better and better insights that create new and better solutions and applications for our customers. Our platform is designed to continuously improve as we apply what we're learning from new data. Rekor 1 delivers knowledge in the form of insights, actions, and recommendations to our users. It's a constant feedback loop that increases roadway intelligence. Simply put, Rekor 1 is our brain, the intelligence engine that powers our products. It takes in comprehensive data, processes it, and serves three key markets: public safety, urban mobility, and transportation management. Rekor is an early-stage technology company in a massive, massive market. Our rapid growth demonstrates proof-of-concept and shows that we are poised to expand exponentially. We develop mission-critical solutions, services, and devices that have different capabilities. We deliver vertical analytics and insights through our specialized platform. We generate dynamic and intelligent infrastructure through trusted relationships that help us acquire valuable real estate. Finally, our intelligent infrastructure solutions have provided us with a significant go-to-market operating and strategic advantages, which at the end of the day lead to a significant market advantage. So now I'd like to turn the call back to our operator, who will moderate the Q&A session.

Operator, Operator

Thank you. First question comes from Zach Cummins with B. Riley Securities. Please state your question.

Zach Cummins, Analyst

Yes. Hi, good afternoon Eyal and Robert, thanks for taking my questions. Robert, starting off with the STS acquisition, it seems to make a lot of strategic sense for Rekor just given the ability to sell into that existing customer base. Can you talk a little bit more about the strategic rationale for STS? And then part two of that question is really more on the financing side, just under $15 million acquisition price. Any sort of sense you can give us around the mix of cash stock and notes that we used to fund the acquisition?

Robert Berman, CEO

Yes, sure. Thanks. First on the industrial logic behind the acquisition. STS has been around since the mid-80s. Not too long ago, they pioneered contracts where they sell data to their DLT customers while keeping ownership of the equipment that they install roadside, which includes, if you were to look on their website, you'd see installations that look much like Master Edge that require installs. They put up camera systems, and things like inductive loops and other technology that no longer needs to be used, which can be replaced by video analytics. So they've got over 30,000 sites, they've got thousands of permanent collection sites. And this is real estate, that by adding video analytics to those existing sites, simple as installing the camera and maybe some additional solar power, we can see all of the traffic intelligence that we get from the algorithms to their customers, and then to others as well. Same system, multiple missions, that's the concept. I mean, they've spent 30 years building this company and aggregating 60,000 lines of coverage, and over several hundred thousand square miles. We've always said there are three pillars to our business. The first is technology, which is a combination of AI, machine learning, cloud, edge processing, cellular, and so forth. Then there's real estate; this is giving us tremendous real estate as a trusted partner through STS with their customers, which are primarily DLTs. And the third leg is expertise; they bring a level of engineering expertise and traffic management expertise that Rekor is pleased to have. So this was an acquisition that makes a lot of sense. They were top of the list of companies that we were looking at, and we're absolutely thrilled after engaging with them and meeting with them and seeing that they shared the same values, the same vision, and a similar understanding of where the market is headed. Tremendous leverage, and I can tell you from our perspective, we think that the STS acquisition is going to propel Rekor to profitability next year. And that's going to accelerate everything that we're doing here, by quite a considerable period of time. So again, the right acquisition, right time, right place. With respect to the mix of cash, stock, seller notes, I can't get into the details until we finalize definitive agreements and release those. But I will tell you that the principals of STS are excited about the combination. These are very smart people that know the industry. They've been out there for decades. They understand the transition that the industry is going through, and I think we're pleased that they've decided to let us continue to be the stewards of their company into the future because it would have been easy to sell to a competitor. It's better to sell to someone who's going to carry your company forward into the next generation of what technology is going to bring to infrastructure. They have been leaders in their space and have been very forward-thinking and ahead of the curve with respect to the business that they've built. We feel fortunate that they've chosen us to join forces with, so it's a great thing for us.

Zach Cummins, Analyst

Understood that's helpful. And Robert, any sort of update you can provide on many of these Rekor 1 pilots, in terms of them actually converting the contracts? I know some of these have been going on for six to nine months. Just curious any sort of update you can give us there?

Robert Berman, CEO

Well, we've had a number of some of the smaller pilots convert. Some of the larger pilots or implementations are just being completed and just up and running. But I will tell you that everywhere that we are, we're having success with our customers and I think that you're going to see over the next month or two, maybe some expansions with some of the existing customer base that we have. It's a really interesting time because this is not a very exciting business when you're talking about infrastructure and bridges and roads and tunnels and whatnot. But when you're moving from a static stage to the digital world, that is exciting. What we're seeing is just amazing, and it's transformational. When you think about the infrastructure built on top of it, it's just all good. We've got a bunch of happy customers, and we think this is just a great time for Rekor.

Zach Cummins, Analyst

Understood. And final question for me is just related to the new partnership you announced with AWS? Can you speak to how that partnership works between Rekor and AWS and what that could mean, in terms of expanding the potential adoption for Rekor 1?

Robert Berman, CEO

Yes, I think David's on the call with us. So David, are you here? If you want…

David Desharnais, AWS Representative

Sure. Yes. Can you hear me?

Robert Berman, CEO

Yes.

David Desharnais, AWS Representative

Yes, very good question. AWS represents a really strong partnership on the technology as well as distribution front. The Amazon Partner Network is really a gateway into multiple distribution points with large market opportunities, as well as the overall sales to open up those opportunities for us. What's really important is that not anyone is just allowed into that gate; you have to hit a very high bar of technical competence as well as solutions in order to trigger that kind of activity. Our admittance into the selection for the Amazon Partner Network is a very important milestone in our technology development, as well as the opportunity for us to expand into the market with a very strong endorsement and a motivated sales organization from our side and theirs. The other aspect of this is that from a public sector perspective on Amazon's side, there's the commercial sector and a public sector, very different in terms of go-to-market motions and even technology that underpins that. Being selected for the public sector program is also another big distinction for us. Again, there's a lot of credibility in the space for public sector. It eases the procurement process for public sector customers looking to buy technology, and really automates the adoption of that. So really, in summary, I'd say it really is a milestone for our technology. We have multiple solutions that are part of that and will continue to turn on more and more in that channel. But very exciting for technology and customers collected.

Robert Berman, CEO

David, thank you. Zach, just one additional thing. I was just reminded that the larger pilots that are underway in Chattanooga, Winchester, Virginia, and Philadelphia were all brought to us by AWS. The introductions were made through AWS, and they continue to work with us with all three of those clients.

Zach Cummins, Analyst

Understood, that's extremely helpful. Well, thanks for taking my questions. And best of luck for the rest of the quarter.

Robert Berman, CEO

Sure. Thank you.

Operator, Operator

Thank you. Our next question comes from Jaeson Schmidt with Lake Street. Please go ahead.

Jaeson Schmidt, Analyst

Hey, guys, thanks for taking my questions. Just following up on the questioning on STS, just curious if you could help us think about what type of growth rate they were seeing. I know in their release, you mentioned you're expected to contribute $15 million in revenue, but how should we think about their growth run rate? Were they at all constrained given their size to kind of growing? And do you think you'll be able to accelerate that growth rate under the broader Rekor umbrella?

Robert Berman, CEO

That's a really good question. And the answer is yes. Private company owned by a family made what I think was a brilliant decision years ago to make the investment to own the sites and then sell data, which is Rekor’s model, and we transitioned ourselves to that model. But given their size and their years in the business, it's a little bit scary when you expand because they have to do it with debt and personal guarantees on the bonding, the installation of systems, etc. So, I think they were being very careful with how they grew. Clearly the answer is yes, they were probably constrained by working capital and by available capital to install systems. And when you get to a certain point having built a business over three decades, you start thinking about securing the value of what you created as opposed to going in deeper to grow the business further. So, there's no question that their growth rate is going to accelerate under Rekor’s ownership because it's a lot easier for us as a public company to take on that burden than it is for them to take it on as a private owner.

Jaeson Schmidt, Analyst

Okay, that's helpful. And then just as a follow-up, I know you mentioned in prepared remarks continuing to make investments, implementing your strategy, sales and marketing, etc. Should we think about the operating expenditures being built upon the Q1 level throughout this year?

Robert Berman, CEO

Yes, as I said, we continue to grow, we continue to expand our headcount as we did in Q1. We'll see some growth during the year but less significant. Others will hire maybe a little bit more, and there will be headcount growth there.

Jaeson Schmidt, Analyst

Okay, that's helpful. Thanks a lot, guys.

Robert Berman, CEO

Okay, thank you.

Operator, Operator

Thanks. Our next question comes from Mike Latimore with Northland Capital. Please state your question.

Unidentified Analyst, Analyst

Hi, this is Aditya on behalf of Mike Latimore. Could you tell me how many miles some long state and local governments do you have under contract now?

Robert Berman, CEO

I'm not sure that we have that number off the top of our head, but I don't know that I can answer that question today.

Unidentified Analyst, Analyst

All right.

Robert Berman, CEO

I mean, includes if you are including pilots, contracts, and other things, certainly well above five figures.

Unidentified Analyst, Analyst

All right. And when could we expect the federal infrastructure bills to start flowing to your customers?

Robert Berman, CEO

That's a good question. What we're hearing is likely Q4 of this year. I think everyone is getting the sense that money is starting to flow this year, likely later in Q2, probably Q3, Q4. I think that we would expect that by 2023, there will be a lot of money flowing into certain components of the industry, not all of it will flow in equal installments over a period of five years. That's because a lot of these things are large projects that require multiyear environmental studies and other things. The good news on our side, which is really more related to soft infrastructure, I think you'll see that money flowing a lot sooner, and a lot faster, especially on the public safety side and on the traffic analytic side. That stuff can be implemented much quicker, and it doesn't require the same study in the same timeframe that the hard infrastructure requires. By the end of this year, you're going to see a considerable amount of money coming into the market, and that will continue into next year and beyond.

Unidentified Analyst, Analyst

All right, fine. Thank you.

Robert Berman, CEO

Thank you.

Operator, Operator

Thank you. There are no further questions at this time. I'll turn the floor back to management for closing remarks.

Robert Berman, CEO

Well, listen everyone, thanks for your time. We look forward to seeing you on our Q2 conference call. We're really excited about the news today. I think everyone here is focused on the markets and I know these are tough times, but we do believe that this acquisition today is going to propel Rekor toward profitability much earlier than we expected. We're glad we're here and looking forward to good things to come. Thank you.

Operator, Operator

Thank you. This concludes today's conference. All parties can disconnect. Have a great evening.