U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017March 31, 2018
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from __________ to __________.
Commission file number 001-31972
TELKONET, INC.
(Exact name of Registrant as specified in its charter)
| Utah | 87-0627421 |
| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
| 20800 Swenson Drive, Suite 175, Waukesha, WI | 53186 |
| (Address of Principal Executive Offices) | (Zip Code) |
(414) 302-2299
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filero | Accelerated filero |
| Non-accelerated filero | Smaller reporting companyx |
| Emerging growth companyo |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.o
Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes o Nox
The number of shares outstanding of the registrant’s common stock, par value $0.001 per share, as of October 31, 2017April 30, 2018 is 133,440,111.
133,989,919.
TELKONET, INC.
FORM 10-Q for the NineThree Months Ended September 30, 2017March 31, 2018
| 2 |
TELKONET, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, 2017 | December 31, 2016 | March 31, 2018 | December 31, 2017 | |||||||||||||
| ASSETS | ||||||||||||||||
| Current assets: | ||||||||||||||||
| Cash and cash equivalents | $ | 8,959,229 | $ | 791,858 | $ | 8,126,859 | $ | 8,385,595 | ||||||||
| Restricted cash on deposit | 800,000 | – | 10,000 | 810,000 | ||||||||||||
| Accounts receivable, net | 1,769,221 | 1,403,772 | 1,284,275 | 1,610,286 | ||||||||||||
| Inventories | 1,082,289 | 777,202 | 843,488 | 1,259,536 | ||||||||||||
| Contract assets | 644,479 | – | ||||||||||||||
| Prepaid expenses and other current assets | 260,269 | 205,328 | 362,882 | 143,566 | ||||||||||||
| Current assets of discontinued operations | – | 7,149,971 | ||||||||||||||
| Income taxes receivable | 17,300 | 17,300 | ||||||||||||||
| Total current assets | 12,871,008 | 10,328,131 | 11,289,283 | 12,226,283 | ||||||||||||
| Property and equipment, net | 318,767 | 143,907 | 294,748 | 304,170 | ||||||||||||
| Other assets: | ||||||||||||||||
| Deposits | 17,130 | – | 17,130 | 17,130 | ||||||||||||
| Total other assets | 17,130 | – | 17,130 | 17,130 | ||||||||||||
| Total Assets | $ | 13,206,905 | $ | 10,472,038 | $ | 11,601,161 | $ | 12,547,583 | ||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||||||
| Current liabilities: | ||||||||||||||||
| Accounts payable | $ | 1,137,632 | $ | 765,617 | $ | 694,722 | $ | 978,207 | ||||||||
| Accrued liabilities and expenses | 1,094,054 | 925,581 | 601,260 | 668,814 | ||||||||||||
| Related party payable | – | 97,127 | ||||||||||||||
| Line of credit | 79,953 | 1,062,129 | 622,852 | 682,211 | ||||||||||||
| Contract liabilities-current | 1,480,190 | – | ||||||||||||||
| Deferred revenues - current | 444,110 | 184,793 | – | 292,106 | ||||||||||||
| Deferred lease liability – current | – | 3,942 | ||||||||||||||
| Customer deposits | 215,576 | 165,830 | – | 124,380 | ||||||||||||
| Income taxes payable | 85,884 | – | ||||||||||||||
| Deferred income taxes | – | 933,433 | ||||||||||||||
| Current liabilities of discontinued operations | – | 869,604 | ||||||||||||||
| Total current liabilities | 3,057,209 | 5,008,056 | 3,399,024 | 2,745,718 | ||||||||||||
| Long-term liabilities: | ||||||||||||||||
| Deferred revenue - long term | 190,896 | 120,421 | ||||||||||||||
| Contract liabilities - long term | 190,426 | – | ||||||||||||||
| Deferred revenues – long term | – | 219,960 | ||||||||||||||
| Deferred lease liability - long term | 40,508 | 23,761 | 55,280 | 48,839 | ||||||||||||
| Total long-term liabilities | 231,404 | 144,182 | 245,706 | 268,799 | ||||||||||||
| Commitments and contingencies | ||||||||||||||||
| Stockholders’ Equity | ||||||||||||||||
| Series A, par value $.001 per share; 215 shares issued, 185 shares outstanding at September 30, 2017 and December 31, 2016, preference in liquidation of $1,507,481 and $1,452,114 as of September 30, 2017 and December 31, 2016, respectively | 1,340,566 | 1,340,566 | ||||||||||||||
| Series B, par value $.001 per share; 538 shares issued, 52 shares outstanding at September 30, 2017 and December 31, 2016, preference in liquidation of $409,009 and $393,435 as of September 30, 2017 and December 31, 2016, respectively | 362,059 | 362,059 | ||||||||||||||
| Common stock, par value $.001 per share; 190,000,000 shares authorized; 133,440,111 and 132,774,475 shares issued and outstanding at September 30, 2017 and December 31, 2016 , respectively | 133,440 | 132,774 | ||||||||||||||
| Series A, par value $.001 per share; 215 shares issued, 185 shares outstanding at March 31, 2018 and December 31, 2017, preference in liquidation of $1,544,394 and $1,526,141 as of March 31, 2018 and December 31, 2017, respectively | 1,340,566 | 1,340,566 | ||||||||||||||
| Series B, par value $.001 per share; 538 shares issued, 52 shares outstanding at March 31, 2018 and December 31, 2017, preference in liquidation of $419,393 and $414,258 as of March 31, 2018 and December 31, 2017, respectively | 362,059 | 362,059 | ||||||||||||||
| Common stock, par value $.001 per share; 190,000,000 shares authorized; 133,989,919 and 133,695,111 shares issued and outstanding at March 31, 2018 and December 31,2017, respectively | 133,989 | 133,695 | ||||||||||||||
| Additional paid-in-capital | 127,383,314 | 126,955,435 | 127,458,639 | 127,421,402 | ||||||||||||
| Accumulated deficit | (119,301,087 | ) | (123,471,034 | ) | (121,338,822 | ) | (119,724,656 | ) | ||||||||
| Total stockholders’ equity | 9,918,292 | 5,319,800 | 7,956,431 | 9,533,066 | ||||||||||||
| Total Liabilities and Stockholders’ Equity | $ | 13,206,905 | $ | 10,472,038 | $ | 11,601,161 | $ | 12,547,583 | ||||||||
See accompanying notes to the unaudited condensed consolidated financial statements
| 3 |
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
| For the Three Months Ended | ||||||||
| March 31, | ||||||||
| 2018 | 2017 | |||||||
| Revenues, net: | ||||||||
| Product | $ | 1,503,658 | $ | 1,810,385 | ||||
| Recurring | 101,538 | 102,842 | ||||||
| Total Net Revenues | 1,605,196 | 1,913,227 | ||||||
| Cost of Sales: | ||||||||
| Product | 994,237 | 1,008,045 | ||||||
| Recurring | 59,997 | 30,018 | ||||||
| Total Cost of Sales | 1,054,234 | 1,038,063 | ||||||
| Gross Profit | 550,962 | 875,164 | ||||||
| Operating Expenses: | ||||||||
| Research and development | 438,780 | 378,456 | ||||||
| Selling, general and administrative | 1,276,903 | 1,769,693 | ||||||
| Depreciation and amortization | 16,915 | 9,909 | ||||||
| Total Operating Expenses | 1,732,598 | 2,158,058 | ||||||
| Operating Loss | (1,181,636 | ) | (1,282,894 | ) | ||||
| Other (Expenses) Income: | ||||||||
| Interest (expense), net | (2,530 | ) | (10,353 | ) | ||||
| Total Other (Expenses) | (2,530 | ) | (10,353 | ) | ||||
| Loss from Continuing Operations before Provision for Income Taxes | (1,184,166 | ) | (1,293,247 | ) | ||||
| Provision for Income Taxes | – | 991 | ||||||
| Net loss from continuing operations | (1,184,166 | ) | (1,294,238 | ) | ||||
| Discontinued Operations: | ||||||||
| Gain from sale of discontinued operations (net of tax) | – | 6,384,871 | ||||||
| Income from discontinued operations (net of tax) | – | 571,802 | ||||||
| Net (loss) income attributable to common stockholders | $ | (1,184,166 | ) | $ | 5,662,435 | |||
| Net (loss) income per common share: | ||||||||
| Basic - continuing operations | $ | (0.01 | ) | $ | (0.01 | ) | ||
| Basic - discontinued operations | $ | – | $ | 0.05 | ||||
| Basic – net (loss) income attributable to common stockholders | $ | (0.01 | ) | $ | 0.04 | |||
| Diluted - continuing operations | $ | (0.01 | ) | $ | (0.01 | ) | ||
| Diluted - discontinued operations | $ | – | $ | 0.05 | ||||
| Diluted – net (loss) income attributable to common stockholders | $ | (0.01 | ) | $ | 0.04 | |||
| Weighted Average Common Shares Outstanding used in computing basic net loss per share | 133,695,111 | 132,774,475 | ||||||
| Weighted Average Common Shares Outstanding used in computing diluted net loss per share | 133,695,111 | 133,520,471 | ||||||
See accompanying notes to the unaudited condensed consolidated financial statements
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||||||
| Revenues, net: | ||||||||||||||||
| Product | $ | 1,904,571 | $ | 1,360,887 | $ | 5,728,878 | $ | 6,356,437 | ||||||||
| Recurring | 131,665 | 143,028 | 344,708 | 340,412 | ||||||||||||
| Total Net Revenue | 2,036,236 | 1,503,915 | 6,073,586 | 6,696,849 | ||||||||||||
| Cost of Sales: | ||||||||||||||||
| Product | 1,160,019 | 770,830 | 3,233,978 | 3,194,094 | ||||||||||||
| Recurring | 55,702 | 36,618 | 118,347 | 92,324 | ||||||||||||
| Total Cost of Sales | 1,215,721 | 807,448 | 3,352,325 | 3,286,418 | ||||||||||||
| Gross Profit | 820,515 | 696,467 | 2,721,261 | 3,410,431 | ||||||||||||
| Operating Expenses: | ||||||||||||||||
| Research and development | 500,656 | 429,622 | 1,323,669 | 1,321,007 | ||||||||||||
| Selling, general and administrative | 1,188,905 | 1,432,489 | 4,396,667 | 5,012,249 | ||||||||||||
| Depreciation and amortization | 14,616 | 8,382 | 34,405 | 24,366 | ||||||||||||
| Total Operating Expenses | 1,704,177 | 1,870,493 | 5,754,741 | 6,357,622 | ||||||||||||
| Operating Loss | (883,662 | ) | (1,174,026 | ) | (3,033,480 | ) | (2,947,191 | ) | ||||||||
| Other Income (Expenses): | ||||||||||||||||
| Interest income (expense), net | 8,722 | (15,482 | ) | 2,797 | (45,308 | ) | ||||||||||
| Total Other Income (Expense) | 8,722 | (15,482 | ) | 2,797 | (45,308 | ) | ||||||||||
| Loss from Continuing Operations before Provision (Benefit) for Income Taxes | (874,940 | ) | (1,189,508 | ) | (3,030,683 | ) | (2,992,499 | ) | ||||||||
| Provision (Benefit) for Income Taxes | (3,600 | ) | 2,575 | 4,301 | 3,200 | |||||||||||
| Net loss from continuing operations | (871,340 | ) | (1,192,083 | ) | (3,034,984 | ) | (2,995,699 | ) | ||||||||
| Discontinued Operations: | ||||||||||||||||
| Gain from sale of discontinued operations (net of tax) | 218,000 | – | 6,602,871 | – | ||||||||||||
| Income from discontinued operations (net of tax) | 11,403 | 798,887 | 602,060 | 2,050,998 | ||||||||||||
| Net income (loss) attributable to common stockholders | $ | (641,937 | ) | $ | (393,196 | ) | $ | 4,169,947 | $ | (944,701 | ) | |||||
| Net income (loss) per common share: | ||||||||||||||||
| Basic - continuing operations | $ | (0.01 | ) | $ | (0.01 | ) | $ | (0.02 | ) | $ | (0.02 | ) | ||||
| Basic - discontinued operations | $ | 0.00 | $ | 0.01 | $ | 0.05 | $ | 0.02 | ||||||||
| Basic – net income (loss) attributable to common stockholders | $ | (0.01 | ) | $ | (0.00 | ) | $ | 0.03 | $ | (0.00 | ) | |||||
| Diluted - continuing operations | $ | (0.01 | ) | $ | (0.01 | ) | $ | (0.02 | ) | $ | (0.02 | ) | ||||
| Diluted - discontinued operations | $ | 0.00 | $ | 0.01 | $ | 0.05 | $ | 0.02 | ||||||||
| Diluted – net income (loss) attributable to common stockholders | $ | (0.01 | ) | $ | (0.00 | ) | $ | 0.03 | $ | (0.00 | ) | |||||
| Weighted Average Common Shares Outstanding – basic | 133,231,367 | 132,314,049 | 133,007,830 | 130,399,390 | ||||||||||||
| Weighted Average Common Shares Outstanding –diluted | 133,231,367 | 132,314,049 | 133,405,096 | 130,399,390 | ||||||||||||
| 4 |
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
THREE MONTHS FROM JANUARY 1, 2018 THROUGH MARCH 31, 2018
| Series A Preferred Stock | Series A Preferred Stock | Series B Preferred Stock | Series B Preferred Stock | Common | Common Stock | Additional Paid-in | Accumulated | Total Stockholders’ | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | Capital | Deficit | Equity | ||||||||||||||||||||||||||||
| Balance at December 31, 2017 | 185 | $ | 1,340,566 | 52 | $ | 362,059 | 133,695,111 | $ | 133,695 | $ | 127,421,402 | $ | (119,724,656 | ) | $ | 9,533,066 | ||||||||||||||||||||
| January 1, 2018, Cumulative effect of a change in accounting principle related to ASC 606, net of tax | – | – | – | – | – | – | – | (430,000 | ) | (430,000 | ) | |||||||||||||||||||||||||
| Shares issued to directors | – | – | – | – | 294,808 | 294 | 35,706 | – | 36,000 | |||||||||||||||||||||||||||
| Stock-based compensation expense related to employee stock options | – | – | – | – | – | – | 1,531 | – | 1,531 | |||||||||||||||||||||||||||
| Net loss | – | – | – | – | – | – | – | (1,184,166 | ) | (1,184,166 | ) | |||||||||||||||||||||||||
| Balance at March 31, 2018 | 185 | $ | 1,340,566 | 52 | $ | 362,059 | 133,989,919 | $ | 133,989 | $ | 127,458,639 | $ | (121,338,822 | ) | $ | 7,956,431 | ||||||||||||||||||||
See accompanying notes to the unaudited condensed consolidated financial statements
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENTSTATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)CASH FLOWS
NINE MONTHS FROM JANUARY 1, 2017 THROUGH SEPTEMBER 30, 2017(UNAUDITED)
| Series A Preferred Stock | Series A Preferred Stock | Series B Preferred Stock | Series B Preferred Stock | Common | Common Stock | Additional Paid-in | Accumulated | Total Stockholders’ | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | Capital | Deficit | Equity | ||||||||||||||||||||||||||||
| Balance at January 1, 2017 | 185 | $ | 1,340,566 | 52 | $ | 362,059 | 132,774,475 | $ | 132,774 | $ | 126,955,435 | $ | (123,471,034 | ) | $ | 5,319,800 | ||||||||||||||||||||
| Shares issued to directors | – | – | – | – | 665,636 | 666 | 107,334 | – | 108,000 | |||||||||||||||||||||||||||
| Stock-based compensation expense related to employee stock options | – | – | – | – | – | – | 320,545 | – | 320,545 | |||||||||||||||||||||||||||
| Net income | – | – | – | – | – | – | – | 4,169,947 | 4,169,947 | |||||||||||||||||||||||||||
| Balance at September 30, 2017 | 185 | $ | 1,340,566 | 52 | $ | 362,059 | 133,440,111 | $ | 133,440 | $ | 127,383,314 | $ | (119,301,087 | ) | $ | 9,918,292 | ||||||||||||||||||||
| For the Three Months Ended | ||||||||
| March 31, | ||||||||
| 2018 | 2017 | |||||||
| Cash Flows from Operating Activities: | ||||||||
| Net (loss) income | $ | (1,184,166 | ) | $ | 5,662,435 | |||
| Less: Net income from discontinued operations | – | (571,802 | ) | |||||
| Gain on sale of discontinued operations | – | (6,384,871 | ) | |||||
| Net loss from continuing operations | (1,184,166 | ) | (1,294,238 | ) | ||||
| Adjustments to reconcile net loss from continuing operations to cash used in operating activities of continuing operations: | ||||||||
| Stock-based compensation expense | 1,531 | 314,686 | ||||||
| Stock issued to directors as compensation | 36,000 | 36,000 | ||||||
| Depreciation | 16,915 | 9,909 | ||||||
| Provision for doubtful accounts, net of recoveries | (3,356 | ) | 17,948 | |||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | 329,367 | (323,644 | ) | |||||
| Inventories | 416,048 | 88,484 | ||||||
| Contract assets | (295,479 | ) | – | |||||
| Prepaid expenses and other current assets | (219,316 | ) | (171,854 | ) | ||||
| Deposits and other long term assets | – | (10,130 | ) | |||||
| Accounts payable | (283,485 | ) | 131,867 | |||||
| Accrued liabilities and expenses | (67,554 | ) | (74,142 | ) | ||||
| Contract liabilities | 653,190 | – | ||||||
| Deferred revenue | (273,640 | ) | 50,313 | |||||
| Related party payable | – | (48,382 | ) | |||||
| Customer deposits | (124,380 | ) | 60,793 | |||||
| Income tax payable | – | 139,884 | ||||||
| Deferred lease liability | 6,441 | (987 | ) | |||||
| Net Cash Used In Operating Activities of Continuing Operations | (991,884 | ) | (1,073,493 | ) | ||||
| Net Cash Provided By Operating Activities of Discontinued Operations | – | 517,242 | ||||||
| Net Cash Used In Operating Activities | (991,884 | ) | (556,251 | ) | ||||
| Cash Flows From Investing Activities: | ||||||||
| Purchase of property and equipment | (7,493 | ) | – | |||||
| Net proceeds from sale of subsidiary | – | 12,431,521 | ||||||
| Net Cash (Used In) Provided By Investing Activities of Continuing Operations | (7,493 | ) | 12,431,521 | |||||
| Cash Flows From Financing Activities: | ||||||||
| Proceeds from line of credit | 220,610 | 3,282,500 | ||||||
| Payments on line of credit | (279,969 | ) | (4,344,629 | ) | ||||
| Net Cash (Used In) Financing Activities of Continuing Operations | (59,359 | ) | (1,062,129 | ) | ||||
| Net (decrease) increase in cash, cash equivalents and restricted cash | (1,058,736 | ) | 10,813,141 | |||||
| Cash, cash equivalents and restricted cash at the beginning of the period | 9,195,595 | 791,858 | ||||||
| Cash, cash equivalents and restricted cash at the end of the period | $ | 8,136,859 | $ | 11,604,999 | ||||
See accompanying notes to the unaudited condensed consolidated financial statements
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| For the Nine Months Ended | ||||||||
| September 30, | ||||||||
| 2017 | 2016 | |||||||
| Cash Flows from Operating Activities: | ||||||||
| Net income (loss) | $ | 4,169,947 | $ | (944,701 | ) | |||
| Less: Net income from discontinued operations | (602,060 | ) | (2,050,998 | ) | ||||
| Gain on sale of discontinued operations | (6,602,871 | ) | – | |||||
| Net loss from continuing operations | (3,034,984 | ) | (2,995,699 | ) | ||||
Adjustments to reconcile net loss from continuing operations to cash used in operating activities of continuing operations: | ||||||||
| Stock-based compensation expense | 320,545 | 10,204 | ||||||
| Stock issued to directors as compensation | 108,000 | 36,000 | ||||||
| Amortization of deferred financing costs | – | 14,210 | ||||||
| Depreciation | 34,405 | 24,366 | ||||||
| Provision for doubtful accounts, net of recoveries | 15,013 | 7,047 | ||||||
| Related party payable | – | 161,075 | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (380,462 | ) | 468,589 | |||||
| Inventories | (305,087 | ) | (410,202 | ) | ||||
| Prepaid expenses and other current assets | (54,941 | ) | 60,271 | |||||
| Deposits and other long term assets | (17,130 | ) | 23,871 | |||||
| Accounts payable | 305,322 | (535,016 | ) | |||||
| Accrued liabilities and expenses | 168,473 | 299,919 | ||||||
| Deferred revenue | 329,792 | 56,825 | ||||||
| Related party payable | (97,127 | ) | (15,928 | ) | ||||
| Customer deposits | 49,746 | 27,985 | ||||||
| Income taxes payable | 85,884 | – | ||||||
| Deferred lease liability | 12,805 | (1,818 | ) | |||||
| Net Cash Used In Operating Activities of Continuing Operations | (2,459,746 | ) | (2,768,301 | ) | ||||
| Net Cash Provided By Operating Activities of Discontinued Operations | 517,242 | 2,023,820 | ||||||
| Net Cash Used In Operating Activities | (1,942,504 | ) | (744,481 | ) | ||||
| Cash Flows From Investing Activities: | ||||||||
| Purchase of property and equipment | (142,572 | ) | (33,629 | ) | ||||
| Net proceeds from sale of subsidiary | 12,034,623 | – | ||||||
| Change in restricted cash | (800,000 | ) | 31,277 | |||||
| Net Cash Provided By (Used In) Investing Activities of Continuing Operations | 11,092,051 | (2,352 | ) | |||||
| Cash Flows From Financing Activities: | ||||||||
| Payments on notes payable | – | (79,864 | ) | |||||
| Proceeds from exercise of warrants | – | 677,501 | ||||||
| Proceeds from line of credit | 3,572,500 | 4,327,068 | ||||||
| Payments on line of credit | (4,554,676 | ) | (4,217,068 | ) | ||||
| Net Cash (Used In) Provided By Financing Activities of Continuing Operations | (982,176 | ) | 707,637 | |||||
| Net increase (decrease) in cash and cash equivalents | 8,167,371 | (39,196 | ) | |||||
| Cash and cash equivalents at the beginning of the period | 791,858 | 951,249 | ||||||
| Cash and cash equivalents at the end of the period | $ | 8,959,229 | $ | 912,053 | ||||
See accompanying notes to the unaudited condensed consolidated financial statements
| 6 |
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(UNAUDITED)
Nine Months Ended September 30, | Three Months Ended March 31, | |||||||||||||||
| 2017 | 2016 | 2018 | 2017 | |||||||||||||
| Supplemental Disclosures of Cash Flow Information: | ||||||||||||||||
| Cash transactions: | ||||||||||||||||
| Cash paid during the period for interest | $ | 11,485 | $ | 30,980 | $ | 12,228 | $ | 10,484 | ||||||||
| Cash paid during the period for income taxes, net of refunds | 58,551 | – | ||||||||||||||
| Schedule of Non-Cash Investing Activities: | ||||||||||||||||
| Unpaid purchases of property and equipment included in accounts payable | $ | 66,693 | – | |||||||||||||
See accompanying notes to the unaudited condensed consolidated financial statements
See accompanying notes to the unaudited condensed consolidated financial statements
| 7 |
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017MARCH 31, 2018
(UNAUDITED)
NOTE A – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation of the accompanying condensed consolidated financial statements follows.
General
The accompanying unaudited condensed consolidated financial statements of Telkonet, Inc. (the “Company”, “Telkonet”) have been prepared in accordance with Rule S-X of the Securities and Exchange Commission (the “SEC”) and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. However, the results from operations for the ninethree months ended September 30, 2017,March 31, 2018, are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2018. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated December 31, 20162017 financial statements and footnotes thereto included in the Company's Form 10-K filed with the SEC. Refer to Note C – Revenue, for the adoption of a new revenue recognition standard in the first quarter of 2018.
Business and Basis of Presentation
Telkonet, formed in 1999 and incorporated under the laws of the state of Utah, is the creator of the EcoSmart Platform of intelligent automation solutions designed to optimize energy efficiency, comfort and analytics in support of the emerging Internet of Things (“IoT”).
In 2007, the Company acquired substantially all of the assets of Smart Systems International (“SSI”), which was a provider of energy management products and solutions to customers in the United States and Canada and the precursor to the Company’s EcoSmart platform. The EcoSmart platform provides comprehensive savings, management reporting, analytics and virtual engineering of a customer’s portfolio and/or property’s room-by-room energy consumption. Telkonet has deployed more than a half million intelligent devices worldwide in properties within the hospitality, military, educational, healthcare and other commercial markets. The EcoSmart platform is rapidly being recognized as a leading solution for reducing energy consumption, operational costs and carbon footprints, and eliminating the need for new energy generation in these marketplaces – all while improving occupant comfort and convenience.
On March 28, 2017, the Company and the Company’s wholly-owned subsidiary, EthoStream LLC, a Wisconsin limited liability company (“EthoStream”), entered into an Asset Purchase Agreement (the “Purchase Agreement”) with DCI-Design Communications LLC (“DCI”), a Delaware limited liability company, whereby DCI would acquiresold substantially all of the assets and certain liabilities of its wholly-owned subsidiary, EthoStream, LLC. Refer to Note M for a base purchase price of $12,750,000. The Purchase Agreement provided that proceeds of $900,000 were to be withheld from the $12,750,000 base purchase price and placed into an escrow account to support potential indemnification obligations of up to $800,000 and net working capital adjustments of up to $100,000. Another $93,000 is classified in other current assets as a net working capital receivable. The escrow amount, net of potential claims, will be fully released after an escrow period not to exceed 12 months after closing. The assets included, among other items, certain inventory, contracts and intellectual property. DCI acquired only the liabilities provided for in the Purchase Agreement. On March 29, 2017, pursuant to the terms and the conditions of the Purchase Agreement, the Company closed on the sale. The income from discontinued operations (net of tax) represents the activity of EthoStream from January 1, 2017 through the date of the sale on March 28, 2017. The gain from sale of discontinued operations (net of tax) represents the gain recognized from the EthoStream selling price that was in excess of the assets sold to DCI and liabilities assumed by DCI on March 28, 2017. On September 27, 2017, the Company reached a final settlement with DCI on net working capital as set forth in the Purchase Agreement. On September 29, 2017, the Company received $100,000 from the escrow account for the portion of the escrow account set aside for net working capital adjustments and cash proceeds of $311,000 from DCI in the settlement of net working capital adjustments. The net working capital receivable of $93,000 in other current assets was applied against the cash proceeds of $311,000 received on September 29, 2017 resulting in a gain from sale of discontinued operations of $218,000 recognized during the three months ended September 30, 2017.
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)further details.
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Telkonet Communications, Inc., and EthoStream. The current and prior periodyear accounts of EthostreamEthoStream LLC have been classified as discontinued operations on the condensed consolidated balance sheet, the condensed consolidated statement of operations and the condensed consolidated statement of cash flows. All significant intercompany balances and transactions have been eliminated in consolidation.
Unless otherwise noted, all financial information in the consolidated financial statement footnotes reflect the Company’s results from continuing operations.
Liquidity and Financial Condition
We have financed our operations since inception primarily through private and public offerings of our equity securities, the issuance of various debt instruments and asset based lending.
The Company reported a net loss of $3,034,984 from continuing operations of $1,184,166 for the ninethree months ended September 30, 2017,March 31, 2018, had cash used in operating activities from continuing operations of $2,459,746 and$991,884, had an accumulated deficit of $119,301,087. Since inception, the Company’s primary sources of ongoing liquidity for operations have come through private$121,338,822 and public offerings of equity securities, and the issuance of various debt instruments, asset-based lending and the sale of assets.
On March 29, 2017, an amendment to the revolving credit facility with Heritage Bank of Commerce, a California state chartered bank (“Heritage Bank”), was executed to amend certain terms of the Loan and Security Agreement (the “Heritage Bank Loan Agreement”) following the sale of certaintotal current assets of the Company’s wholly-owned subsidiary, EthoStream. Heritage Bank amended the EBITDA compliance measurement.
On October 23, 2017, an amendment to the revolving credit facility with Heritage Bank was executed to amend certain terms of the Heritage Bank Loan Agreement. Among the terms of the amendment was that if the Company deviates from its projected EBITDA for the quarters ended September 30, 2017 or December 31, 2017, the Company will be deemed to be in compliance as of the measurement date if the Company’s unrestricted cash maintained at Heritage Bank is in excess of $5,000,000. The amendment also extends the revolving credit facility’s maturity date by one year to September 30, 2019.
The outstanding balancecurrent liabilities of the revolving credit facility was $79,953$7,890,259 as of September 30, 2017 and the remaining available borrowing capacity was approximately $1,304,000. As of September 30, 2017, the Company was in compliance with all financial covenants.
On March 28, 2017, the Company and EthoStream, entered into the Purchase Agreement with DCI whereby DCI acquired all of the assets and certain liabilities of EthoStream for a base purchase price of $12,750,000, subject to an adjustment based on the net working capital of EthoStream on the closing date of the sale transaction. The Company’s liquidity for the remainder of 2017 remains strong due to the net proceeds received from the sale of EthoStream.
Restricted Cash on Deposit
The restricted cash on deposit of $800,000 as of September 30, 2017 reflects amounts placed into an escrow account to support potential indemnification obligations associated with the sale of the Company’s wholly-owned subsidiary, EthoStream. The escrow amount, net of potential claims, would be fully released after an escrow period not to exceed 12 months from the transaction closing on March 29, 2017. On September 29, 2017, the Company received $100,000 from the escrow account for the portion of the escrow account set aside for net working capital adjustments.
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)31, 2018.
Income (Loss) per Common Share
The Company computes earnings per share under ASCAccounting Standards Codification (“ASC”) 260-10, “Earnings Per Share”. Basic net income (loss) per common share is computed using the treasury stock method, which assumes that the proceeds to be received on exercise of outstanding stock options and warrants are used to repurchase shares of the Company at the average market price of the common shares for the year. Dilutive common stock equivalents consist of shares issuable upon the exercise of the Company's outstanding stock options and warrants. For the ninethree months ended September 30,March 31, 2018 and 2017, and 2016, there were 5,621,8003,557,399 and 2,240,2256,132,725 shares of common stock underlying options and warrants excluded due to these instruments being anti-dilutive, respectively.
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TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018
(UNAUDITED)
The U.S. Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017. The Tax Act makes broad complex changes to the U.S. tax code including, but not limited to, reducing the U.S. federal corporate tax rate from 35% to 21%, requiring companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creating new taxes on certain foreign sourced earnings and additional limitations on the deductibility of interest.
The SEC issued Staff Accounting Bulletin No. 118 (SAB 118) in December, 2017, to provide guidance on accounting for the effects of the Tax Act. SAB 118 provides for a measurement period of up to one year from the Tax Act enactment date for companies to complete their assessment of and accounting for those effects of the Tax Act. Under SAB 118, a company must first reflect the income tax effects of the Tax Act for which the accounting is complete in the period of the date of enactment. To the extent the accounting for other income tax effects is incomplete, but a reasonable estimate can be determined, companies must record a provisional estimate to be included in their financial statements. For any income tax effect for which a reasonable estimate cannot be determined, an entity must continue to apply ASC 740 based on the provisions of the tax laws in effect immediately prior to the Tax Act being enacted until such time as a reasonable estimate can be determined. The Company requires additional time to complete its analysis of the impacts of the Tax Act and therefore its accounting for the Tax Act is provisional but is a reasonable estimate based on available information. The Company will complete its analysis and finalize its accounting for this provisional estimate during the one year measurement period as prescribed by SAB 118.
Use of Estimates
The preparation of financial statements in conformity with United States of America (U.S.) generally accepted accounting principles (“GAAP”)(GAAP) requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates are used when accounting for items and matters such as revenue recognition and allowances for uncollectible accounts receivable, inventory obsolescence, depreciation and amortization, long-lived assets, taxes and related valuation allowance, income tax provisions, stock-based compensation, and contingencies. The Company believes that the estimates, judgments and assumptions are reasonable, based on information available at the time they are made. Actual results may differ from those estimates.
Income Taxes
The Company accounts for income taxes in accordance with ASC 740-10 “Income Taxes.” Under this method, deferred income taxes (when required) are provided based on the difference between the financial reporting and income tax bases of assets and liabilities and net operating losses at the statutory rates enacted for future periods. The Company has a policy of establishing a valuation allowance when it is more likely than not that the Company will not realize the benefits of its deferred income tax assets in the future.
The Company adopted ASC 740-10-25, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740-10-25 also provides guidance on derecognition, classification, treatment of interest and penalties, and disclosure of such positions.
Revenue Recognitionfrom Contracts with Customers
ForAccounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606, the Standard”) supersedes nearly all legacy revenue from product sales,recognition guidance. ASC 606 outlines a comprehensive five-step revenue recognition model based on the principle that an entity should recognize revenue based on when an it satisfies its performance obligations by transferring control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for said goods or services.
Identify the customer contracts
The Company accounts for a customer contract under ASC 606 when the contract is legally enforceable. A contract is legally enforceable when all of the following criteria are met: (1) the contract has been approved by the Company recognizesand the customer and both parties are committed to perform their respective obligations, (2) the Company can identify each party’s rights regarding goods or services transferred, (3) the Company can identify payment terms for goods or services transferred, (4) the contract has commercial substance, and (5) collectability of all the consideration to which the Company is entitled in exchange for the goods or services transferred is probable.
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TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018
(UNAUDITED)
A contract does not exist if each party to the contract has the unilateral right to terminate a wholly unperformed contract without compensating the other party (or parties). Nearly all of the Company’s contracts do not contain such mutual termination rights for convenience. All contracts are in written form.
Identify the performance obligations
The Company will enter into product only contracts that contain a single performance obligation related to the transfer of EcoSmart products to a customer.
The Company will also enter into certain customer contracts that encompass product and installation services, referred to as “turnkey” solutions. These contracts ultimately provide the customer with a solution that enhances the functionality of the customer’s existing equipment. For this reason, the Company has determined that the product and installation services are not separately identifiable performance obligations, but in essence represent one, combined performance obligation (“turnkey”).
The Company also offers post-installation support services to customers. Support services are considered a separate performance obligation.
Determine the transaction price
The Company generally enters into contracts containing fixed prices. It is not customary for the Company to include contract terms that would result in variable consideration. In the rare situation that a contract does include this type of provision, it is not expected to result in a material adjustment to the transaction price. The Company regularly extends pricing discounts; however, they are negotiated up front and adjust the fixed transaction price set out in the contract.
Customer contracts will typically contain upfront deposits that will be applied against future invoices, as well as customer retainage. The intent of any required deposit or retainage is to ensure that the obligations of either party are honored and follow customary industry practices. In addition, the Company will typically be paid in advance at the beginning of any support contracts, consistent with industry practices. None of these payment provisions are intended to represent significant implicit financing. The Company’s standard payment terms are thirty days from invoice date. Products are fully refundable when returned in their original packaging without damage or defacing less a restocking fee not to exceed fifty (50%) percent of the product’s price. Historical returns have shown to be immaterial. The Company offers a standard one-year assurance warranty. However customers can purchase an extended warranty. Under the new standard, extended warranties are accounted for as a service warranty, requiring the revenue in accordanceto be recognized over the extended service periods. Contracts involving an extended warranty are immaterial and will continue to be combined with ASC 605-10, “Revenue Recognition”support revenue and ASC 605-10-S99 guidelines that require that four basic criteria must be met beforerecognized on a straight-line basis over the support revenue can be recognized: (1) persuasiveterm.
Allocate the transaction price to the performance obligations
Revenues from customer contracts are allocated to the separate performance obligations based on their relative stand-alone selling price (“SSP”) at contract inception. The SSP is the price at which the Company would sell a promised good or service separately. The best evidence of an arrangement exists; (2) delivery has occurred; (3)SSP is the sellingobservable price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Assuming all conditions for revenue recognition have been satisfied, product revenue is recognized when products are shipped and installation revenue is recognizeda good or service when the servicesentity sells that good or service separately in similar circumstances and to similar customers. However, turnkey solutions are completed. Provisionssold for discounts and rebatesa broad range of amounts resulting from, but not limited to, customers, estimated returns and allowances,tiered discounting for value added resellers (“VAR”) based upon committed volumes and other adjustmentseconomic factors. Due to the high variability of our pricing, the Company cannot establish a reliable SSP using observable data. Accordingly, the Company uses the residual approach to allocate the transaction price to performance obligations related to its turnkey solutions.
All support service agreements, whether single or multi-year terms, automatically renew for one-year terms at a suggested retail price (“SRP”). Support service renewals are providedconsistently priced and therefore would support the use of SRP as the best estimate of an SSP for such performance obligations.
Recognize Revenue
The Company recognizes revenues from product only sales at a point in time, when control over the same periodproduct has transferred to the relatedcustomer. As the Company’s principal terms of sale are FOB shipping point, the Company primarily transfers control and records revenue for product only sales are recorded. The guidelines also address the accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets.upon shipment.
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TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017MARCH 31, 2018
(UNAUDITED)
Multiple-Element Arrangements (“MEAs”):
A typical turnkey project involves the installation and integration of 200-300 rooms in a customer-controlled facility and usually takes sixty days to complete. Since control over goods and services transfers to a customer once a room is installed, the Company recognizes revenue for turnkey solutions over time. The Company accounts for contracts that have both product and installation under the MEAs guidance in ASC 605-25. Arrangements under such contracts may include multiple deliverables consisting of a combination of equipment and services. The deliverables included in the MEAs are separated into more than one unit of accounting when (i) the delivered equipment has value to the customer on a stand-alone basis, and (ii) delivery of the undelivered service element(s) is probable and substantially in the Company’s control. Arrangement consideration is then allocated to each unit, delivered or undelivered,uses an outputs measure based on the relative selling pricenumber of each unit of accounting based first on vendor-specific objective evidence (“VSOE”) if it exists, second on third-party evidence (“TPE”) if it exists and on estimated selling price (“ESP”) if neither VSOE or TPE exist.
Under the estimated selling price method, revenue is recognized in MEAs based on estimated selling prices for all of the elements in the arrangement, assuming all other conditions for revenue recognition have been satisfied. To determine the estimated selling price, the Company establishes the selling price for its products and installation services using the Company’s established pricing guidelines, and the proceeds are allocated between the elements and the arrangement.rooms installed to recognize revenues from turnkey solutions.
When MEAs include an element of customer training, the Company determined it is not essential to the functionality, efficiency or effectiveness of the MEA due to its perfunctory nature in relation to the entire arrangement. Therefore the Company has concluded that this obligation is inconsequential and perfunctory. As such, for MEAs that include training, customer acceptance of said training is not deemed necessary in order to record the related revenue, but is recorded when the installation deliverable is fulfilled. Historically, training revenues have not been significant.
The Company provides call centerRevenues from support services to properties installed by the Company. The Company receives monthly service fees from such properties for its services. The Company recognizes the service fee ratablyare recognized over time, in even daily increments over the term of the contract. The prices for these services are fixed and determinable prior to delivery of the service. The fair value of these services is known due to objective and reliable evidence from standalone executed contracts. The Company reports such revenues as recurring revenues.
Deferred revenue includes deferrals for the monthly support service fees. Long-term deferred revenue represents support service fees tothat will be earned or provided beginningrecognized as revenue after September 30, 2018. Revenue recognized that has not yet been billed to a customer results in an asset as of the end of the period. As of September 30, 2017 and DecemberMarch 31, 2016, there was $68,855 and $193,400 recorded within accounts receivable, respectively, related to revenue recognized that has not yet been billed.2019.
Transition
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)The Company adopted ASC 606 using a modified retrospective approach to all contracts not completed as of January 1, 2018. Results for reporting periods beginning January 1, 2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under Topic 605, Revenue Recognition. The Company recorded a net decrease to beginning retained earnings of $0.43 million as of January 1, 2018 due to the cumulative impact of adopting ASC 606. The impact to beginning retained earnings was primarily driven by the deferral of revenue for unfulfilled performance obligations related to the Company’s turnkey solutions.
Guarantees and Product Warranties
The Company records a liability for potential warranty claims in cost of sales at the time of sale. The amount of the liability is based on the trend in the historical ratio of claims to sales, the historical length of time between the sale and resulting warranty claim, new product introductions and other factors. The products sold are generally covered by a warranty for a period of one year. In the event the Company determines that its current or future product repair and replacement costs exceed its estimates, an adjustment to these reserves would be charged to earnings in the period such determination is made. For the ninethree months ended September 30, 2017March 31, 2018 and the year ended December 31, 2016,2017, the Company experienced returns of approximately 1.0%1% to 2.5%2% of materials included in the cost of sales. As of September 30, 2017March 31, 2018 and December 31, 2016,2017, the Company recorded warranty liabilities in the amount of $77,810$55,316 and $95,540,$59,892, respectively, using this experience factor range.
Product warranties for the ninethree months ended September 30, 2017March 31, 2018 and the year ended December 31, 20162017 are as follows:
| September 30, 2017 | December 31, 2016 | |||||||
| Beginning balance | $ | 95,540 | $ | 66,555 | ||||
| Warranty claims incurred | (48,767 | ) | (115,120 | ) | ||||
| Provision charged to expense | 31,037 | 144,105 | ||||||
| Ending balance | $ | 77,810 | $ | 95,540 | ||||
Reclassifications
Certain amounts on the condensed consolidated balance sheets as of December 31, 2016 and statements of cash flows have been reclassified to conform to the current year presentation. The Company reclassified $106,743 from current assets of discontinued operations to cash and cash equivalents for certain EthoStream assets not sold to DCI on March 28, 2017. The Company reclassified $150,936 from current liabilities of discontinued operations to accrued liabilities and expenses for certain EthoStream liabilities not assumed by DCI on March 28, 2017. The reclassifications were not material and had no effect on the Company’s total current assets, current liabilities or stockholders’ equity as of December 31, 2016.
| March 31, 2018 | December 31, 2017 | |||||||
| Beginning balance | $ | 59,892 | $ | 95,540 | ||||
| Warranty claims incurred | (6,023 | ) | (84,087 | ) | ||||
| Provision charged to expense | 1,447 | 48,439 | ||||||
| Ending balance | $ | 55,316 | $ | 59,892 | ||||
NOTE B – NEW ACCOUNTING PRONOUNCEMENTS
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The guidance for this standard was initially effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, however in August 2015 the FASB delayed the effective date of the standard for one full year. Companies will adopt the standard using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a modified retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company expects to adopt ASU 2014-09 as of January 1, 2018 with a cumulative effect adjustment to opening retained earnings, if necessary, under the modified retrospective approach. The Company has developed a project plan for the implementation of the new standard including a review of all revenue streams to identify any differences in the performance obligations, timing, measurement or presentation of revenue recognition. The Company’s implementation of this ASU includes the evaluation of its customer agreements to identify terms or conditions that could be considered a performance obligation such that, if material to the terms of the contract, consideration would be allocated to the performance obligation and could accelerate or defer the timing of recognizing revenue. The Company also continues to evaluate the presentation of its principal versus agent arrangements. The Company’s evaluation of its revenue streams and the treatment under the new guidance on the timing of revenue recognition and the allocation of revenue to the Company’s goods and services is in process and any effect cannot be determined at this time.
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)
In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact of its pending adoption of ASU 2016-02 on its consolidated financial statements. Upon adoption, the Company expects that the ROU asset and lease liability will be recognized in the balance sheets in amounts that will be material.
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TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018
(UNAUDITED)
In AugustJune 2016, the FASB issued ASU No. 2016-15, Classification2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Certain Cash Receipts and Cash Payments (“Credit Losses on Financial Instruments. ASU 2016-15”). The new standard2016-13 provides guidance for estimating credit losses on the classification of certain transactions in the statement of cash flows, such as contingent consideration payments made in connection with a business combination and debt prepayment or extinguishment costs. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within that fiscal year. When adopted, the new guidance will be applied retrospectively. The Company is currently evaluating the impact of its pending adoption of ASU 2016-15 on its consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, Compensation — Stock Compensation — Scope of Modification Accounting (“ASU 2017-09”), which provides guidance about the types of changesfinancial instruments, including trade receivables, by introducing an approach based on expected losses. The expected loss approach will require entities to terms or conditionsincorporate considerations of a share-based payment award that would require an entity to apply modification accounting.historical information, current information and reasonable and supportable forecasts. ASU 2016-13 also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The new guidance is effective for fiscal years beginning after December 15, 2017,2019, including interim periods within those fiscal years. EarlyThe guidance requires a modified retrospective transition method and early adoption is permitted. The Company does not expect the adoption of ASU 2016-13 to have a material impact on its consolidated financial statements.
Management has evaluated other recently issued accounting pronouncements and does not believe that any of these pronouncements will have a significant impact on our consolidated financial statements and related disclosures.
Accounting Standards Recently Adopted
Effective January 1, 2018, the Company has adopted Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606, the Standard”), which supersedes nearly all legacy revenue recognition guidance. ASC 606 outlines a comprehensive five-step revenue recognition model based on the principle that an entity should recognize revenue based on when an it satisfies its performance obligations by transferring control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for said goods or services.
Effective January 1, 2018, the Company has adopted ASU No. 2016-18, Statement of Cash Flows: Restricted Cash, (“Update 2016-18”). Update 2016-18 provides guidance on the classification of restricted cash in the statement of cash flows. The amendments are effective for interim and annual periods beginning after December 15, 2017. The amendments in this update should be applied prospectivelyUpdate 2016-18 was adopted on a retrospective basis. Due to an award modified on or after the adoption date.of ASU 2016-18, the cash, cash equivalents and restricted cash presented in the Condensed Consolidated Statement of Cash Flows for the three months ended March 31, 2018 and 20147 increased by $10,000 and $900,000 of restricted cash held as of March 31, 2018 and 2017, respectively.
NOTE C– ACCOUNTS RECEIVABLEREVENUE
ComponentsThe following table presents the Company’s product and recurring revenues disaggregated by industry for the three months ended March 31, 2018. Sales taxes and other usage-based taxes are excluded from revenues.
| Hospitality | Education | Multiple Dwelling Units | Government | Total | ||||||||||||||||
| Recurring | $ | 90,924 | $ | 10,460 | $ | 154 | $ | – | $ | 101,538 | ||||||||||
| Product | 1,249,228 | 227,507 | 19,441 | 7,482 | 1,503,658 | |||||||||||||||
| $ | 1,340,152 | $ | 237,967 | $ | 19,595 | $ | 7,482 | $ | 1,605,196 | |||||||||||
Contract assets
Contracts are billed in accordance with the terms and conditions, either at periodic intervals or upon substantial completion. This can result in billing occurring subsequent to revenue recognition, resulting in contract assets. Contract assets are presented as other current assets in the Condensed Consolidated Balance Sheet. The balance of accounts receivablecontract assets as of September 30, 2017March 31, 2018 and December 31, 2016 are as follows:
| September 30, 2017 | December 31, 2016 | |||||||
| Accounts receivable | $ | 1,781,394 | $ | 1,438,345 | ||||
| Allowance for doubtful accounts | (12,173 | ) | (34,573 | ) | ||||
| Accounts receivable, net | $ | 1,769,221 | $ | 1,403,772 | ||||
NOTE D – ACCRUED LIABILITIES AND EXPENSESat the date of adoption of ASC 606 was $0.64 million and $0.35 million, respectively. There were $0.33 million of costs incurred to fulfill a contract in the closing balance of contract assets.
AccruedContract liabilities and expenses at September 30, 2017 and December 31, 2016 are as follows:
| September 30, 2017 | December 31, 2016 | |||||||
| Accrued liabilities and expenses | $ | 589,288 | $ | 223,011 | ||||
| Accrued payroll and payroll taxes | 354,293 | 331,908 | ||||||
| Accrued sales taxes, penalties, and interest | 72,331 | 274,869 | ||||||
| Accrued interest | 332 | 253 | ||||||
| Product warranties | 77,810 | 95,540 | ||||||
| Total accrued liabilities and expenses | $ | 1,094,054 | $ | 925,581 | ||||
Contracts are billed in accordance with the terms and conditions, either at periodic intervals or upon substantial completion. Often, the Company will require customers to pay a deposit upon contract signing that will be applied against work performed or products shipped. In addition, the Company will often invoice the full term of support at the start of the support period. Billings that occur prior to revenue recognition result in contract liabilities. As of March 31, 2018 and at the date of adoption of ASC 606, contract liabilities were $1.67 million and $0.78 million, respectively. The change in the contract liability balance during the three-month period ended March 31, 2018 is the result of cash payments received and billing in advance of satisfying performance obligations, less $0.15 million of revenue recognized during the period that was included in the contract liability balance at the date of adoption.
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TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018
(UNAUDITED)
Contract costs
Costs to fulfill a turnkey contract primarily relate to the materials cost and direct labor and are recognized proportionately as the performance obligation is satisfied. The Company will defer cost to fulfill a contract when materials have shipped (and control over the materials has transferred to the customer), but an insignificant amount of rooms have been installed. The Company will recognize any deferred costs in proportion to revenues recognized from the related turnkey contract. The Company does not expect deferred contract costs to be long-lived since a typical turnkey project takes sixty days to complete. Deferred contract costs are generally presented as other current assets in the condensed consolidated balance sheets.
The Company incurs incremental costs to obtain a contract in the form of sales commissions. These costs, whether related to performance obligations that extend beyond twelve months or not, are immaterial and will continue to be recognized in the period incurred within selling, general and administrative expenses.
The tables below present the impacts of our adoption of the new revenue standard on our income statement and balance sheet.
For the Three Months Ended March 31, 2018 | ||||||||||||
| As Reported | Balance Without Adoption of ASC 606 | Effect of Change Higher/(Lower) | ||||||||||
| Income Statement: | ||||||||||||
| Sales | $ | 1,605,196 | $ | 1,708,196 | $ | (103,000 | ) | |||||
| Cost of Goods Sold | 1,054,234 | 1,088,734 | (34,500 | ) | ||||||||
| Net loss | $ | 1,184,166 | $ | 1,115,666 | $ | 68,500 | ||||||
| March 31, 2018 | ||||||||||||
| As Reported | Balance Without Adoption of ASC 606 | Effect of Change Higher/(Lower) | ||||||||||
| Balance Sheet: | ||||||||||||
| Assets | ||||||||||||
| Contract Assets | $ | 644,479 | – | $ | 644,479 | |||||||
| Accounts Receivable, net | – | 65,400 | (65,400 | ) | ||||||||
| Inventories | 843,488 | 1,046,335 | (202,847 | ) | ||||||||
| Liabilities | ||||||||||||
| Contract Liabilities | 1,670,616 | – | 1,670,616 | |||||||||
| Customer Deposits | – | 199,483 | (199,483 | ) | ||||||||
| Deferred Revenue - Current | – | 357,975 | (357,975 | ) | ||||||||
| Deferred Revenue – Long Term | – | 238,426 | (238,426 | ) | ||||||||
| Equity | ||||||||||||
| Accumulated Deficit | – | 498,500 | $ | (498,500 | ) | |||||||
| 13 |
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017MARCH 31, 2018
(UNAUDITED)
NOTE E – DEBT
The table below presents the cumulative effect of the changes made to our consolidated balance sheet as of January 1, 2018 after the adoption of ASU 2014-09.
| December 31, 2017 | Transition Adjustments | January 1, 2018 | ||||||||||
| Balance Sheet: | ||||||||||||
| Assets | ||||||||||||
| Contract Assets | – | 110,000 | $ | 110,000 | ||||||||
| Inventories | 777,202 | 239,000 | 1,016,202 | |||||||||
| Liabilities | ||||||||||||
| Contract Liabilities | – | 779,000 | 779,000 | |||||||||
| Equity | ||||||||||||
| Accumulated Deficit | $ | (119,724,656 | ) | (430,000 | ) | $ | (120,154,656 | ) | ||||
Kross Promissory NoteRemaining performance obligations
On August 4, 2016,As of March 31, 2018, the Boardaggregate amount of Directors authorizedthe transaction price allocated to remaining performance obligations was approximately $1.0 million. Except for support services, the Company expects to reimburse Peter T. Kross (“Mr. Kross”) $161,075 for expenses incurred related to his successful contested proxy. Effective June 27, 2016, Mr. Kross became a directorrecognize 100% of the Company and is considered a related party. On August 30, 2016, Mr. Kross accepted an unsecured promissory note (“Kross Note”) for $161,075 fromremaining performance obligations over the Company. The outstanding principal balance bore interest at the annual ratenext six months.
NOTE D– ACCOUNTS RECEIVABLE
Components of 3.00%. Payment of interest and principal began on September 1, 2016 and continued monthly on the first day of each month thereafter through and including June 1, 2017. The Company was required to pay equal monthly installments of $16,330 which included all remaining principal and accrued interest owed by the Company to Mr. Kross under the Kross Note. The Company could prepay in advance any unpaid principal or interest due under the Kross Note without premium or penalty. The principal balance of the Kross Noteaccounts receivable as of September 30, 2017March 31, 2018 and December 31, 2016 was zero2017 are as follows:
| March 31, 2018 | December 31, 2017 | |||||||
| Accounts receivable | $ | 1,294,017 | $ | 1,632,459 | ||||
| Allowance for doubtful accounts | (9,742 | ) | (22,173 | ) | ||||
| Accounts receivable, net | $ | 1,284,275 | $ | 1,610,286 | ||||
NOTE E – ACCRUED LIABILITIES AND EXPENSES
Accrued liabilities and $97,127, respectively.expenses at March 31, 2018 and December 31, 2017 are as follows:
| March 31, 2018 | December 31, 2017 | |||||||
| Accrued liabilities and expenses | $ | 186,965 | $ | 294,709 | ||||
| Accrued payroll and payroll taxes | 314,830 | 230,931 | ||||||
| Accrued sales taxes, penalties, and interest | 44,149 | 83,282 | ||||||
| Product warranties | 55,316 | 59,892 | ||||||
| Total accrued liabilities and expenses | $ | 601,260 | $ | 668,814 | ||||
NOTE F – DEBT
Revolving Credit Facility
On September 30, 2014, the Company and its wholly-owned subsidiary, EthoStream, as co-borrowers (collectively, the “Borrowers”), entered into a loan and security agreement (the “Heritage Bank Loan Agreement”), with Heritage Bank of Commerce, a California state chartered bank (“Heritage Bank”), governing a new revolving credit facility in a principal amount not to exceed $2,000,000 (the “Credit Facility”). Availability of borrowings under the Credit Facility from time to time is subject to a borrowing base calculation based on the Company’s eligible accounts receivable and eligible inventory each multiplied by an applicable advance rate, with an overall limitation tied to the Company’s eligible accounts receivable. The Heritage Bank Loan Agreement is available for working capitalcontains representations and warranties, covenants, and other general business purposes.provisions customary to transactions of this nature. As of March 31, 2018, the Company was in compliance with all financial covenants. The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 7.25%7.75% at September 30, 2017March 31, 2018 and 6.75%7.50% at December 31, 2016. On October 9, 2014, as part of the Heritage Bank Loan Agreement, Heritage Bank was granted a warrant to purchase 250,000 shares of Telkonet common stock. The warrant has an exercise price of $0.20 and expires October 9, 2021. On February 17, 2016, an amendment to the Credit Facility was executed extending the maturity date to September 30, 2018, unless earlier accelerated under the terms of the Heritage Bank Loan Agreement.
The Heritage Bank Loan Agreement also contains financial covenants that place restrictions on, among other things, the incurrence of debt, granting of liens and sale of assets. The Heritage Bank Loan Agreement and amendments also contain financial covenants that require the Borrowers to maintain a minimum EBITDA level, measured quarterly, a minimum asset coverage ratio, measured monthly and minimum cash account balances. A violation of any of these covenants could result in an event of default under the Heritage Bank Loan Agreement. Upon the occurrence of such an event of default or certain other customary events of defaults, payment of any outstanding amounts under the Credit Facility may be accelerated and Heritage Bank’s commitment to extend credit under the Heritage Bank Loan Agreement may be terminated. The Heritage Bank Loan Agreement contains other representations and warranties, covenants, and other provisions customary to transactions of this nature. As of September 30, 2017, the Company was in compliance with all financial covenants.2017. The outstanding balance on the Credit Facility was $79,953$622,852 and $1,062,129$682,211 at September 30, 2017March 31, 2018 and December 31, 2016,2017, respectively. The remaining available borrowing capacity was approximately $1,304,000$429,000 and $107,000$202,000 at September 30, 2017March 31, 2018 and December 31, 2016,2017, respectively.
On March 28, 2017, the Company and the Company’s wholly-owned subsidiary, EthoStream, entered into an Asset Purchase Agreement with DCI-Design Communications LLC (“DCI”), whereby DCI would acquire all of the assets and certain liabilities of EthoStream. Heritage Bank had provided the Company with its consent to the sale transaction. Upon closing of the sale transaction on March 29, 2017, the entire balance outstanding on the Credit Facility was repaid. On March 29, 2017an amendment to the Credit Facility was executedamending the quarterly and year to date EBITDA compliance measurements for 2017.
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)
On August 29, 2017, an amendment to the Credit Facility with Heritage Bank was executed to amend certain terms of the Heritage Bank Loan Agreement allowing for the issuance of corporate credit cards providing credit not to exceed $100,000. The Borrower may request credit advances in an aggregate outstanding amount not to exceed the borrowing limits set forth in the amendment.
On October 23, 2017,31, 2018, an amendment to the revolving credit facility with Heritage Bank was executed to amend certain terms of the Heritage Bank Loan Agreement. Among the terms of the amendment was that if the Company deviates from its projectedfails to comply with required EBITDA for the quarters ended September 30, 2017 or December 31, 2017,covenants as of any particular quarterly measurement date, the Company will be deemed to be in compliance as of the measurement date if the Company’s unrestricted cash maintained at Heritage Bank is in excess of $5,000,000. The amendment also extends the revolving credit facility’s maturity date by one year to September 30, 2019.
| 14 |
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018
(UNAUDITED)
NOTE FG – PREFERRED STOCK
Series A
The Company has designated 215 shares of preferred stock as Series A Preferred Stock (“Series A”). Each share of Series A is convertible, at the option of the holder thereof, at any time, into shares of the Company’s common stock at a conversion price of $0.363 per share. On November 16, 2009, the Company sold 215 shares of Series A with attached warrants to purchase an aggregate of 1,628,800 shares of the Company’s common stock at $0.33 per share. The Series A shares were sold at a price per share of $5,000 and each Series A share is convertible into approximately 13,774 shares of common stock at a conversion price of $0.363 per share. The Company received $1,075,000 from the sale of the Series A shares. In prior years, 30 of the preferred shares issued on November 16, 2009 were converted to shares of the Company’s common stock. In a prior year, the redemption feature available to the Series A holders expired.
Series B
The Company has designated 538 shares of preferred stock as Series B Preferred Stock (“Series B”). Each share of Series B is convertible, at the option of the holder thereof, at any time, into shares of the Company’s common stock at a conversion price of $0.13 per share. On August 4, 2010, the Company sold 267 shares of Series B with attached warrants to purchase an aggregate of 5,134,626 shares of the Company’s common stock at $0.13 per share. The Series B shares were sold at a price per share of $5,000 and each Series B share was convertible into approximately 38,461 shares of common stock at a conversion price of $0.13 per share. The Company received $1,335,000 from the sale of the Series B shares on August 4, 2010. On April 8, 2011, the Company sold 271 additional shares of Series B with attached warrants to purchase an aggregate of 5,211,542 shares of the Company’s common stock at $0.13 per share. The Series B shares were sold at a price per share of $5,000 and each Series B share was convertible into approximately 38,461 shares of common stock at a conversion price of $0.13 per share. The Company received $1,355,000 from the sale of the Series B shares on April 8, 2011. In prior years, 486 of the preferred shares issued on August 4, 2010 and April 8, 2011 were converted to shares of the Company’s common stock. In a prior year, the redemption feature available to the Series B holders expired.
Preferred stock carries certain preference rights as detailed in the Company’s Amended Articles of Incorporation related to both the payment of dividends and as to payments upon liquidation in preference to any other class or series of capital stock of the Company. As of September 30,March 31, 2018, the liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $419,393, which includes cumulative accrued unpaid dividends of $159,393, and second, Series A with a preference value of $1,544,394, which includes cumulative accrued unpaid dividends of $619,394. As of December 31, 2017, the liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $409,009,$414,258, which includes cumulative accrued unpaid dividends of $149,009,$154,258, and second, Series A with a preference value of $1,507,481,$1,526,141, which includes cumulative accrued unpaid dividends of $582,481. As of December 31, 2016, the liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $393,435, which includes cumulative accrued unpaid dividends of $133,435, and second, Series A with a preference value of $1,452,114, which includes cumulative accrued unpaid dividends of $527,114.
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)$601,141.
NOTE GH – CAPITAL STOCK
The Company has authorized 15,000,000 shares of preferred stock (designated and undesignated), with a par value of $.001 per share. The Company has designated 215 shares as Series A preferred stock and 538 shares as Series B preferred stock. As of September 30, 2017 and December 31, 2016, there were 185 shares of Series A and 52 shares of Series B outstanding.
The Company has authorized 190,000,000 shares of common stock with a par value of $.001 per share. As of September 30, 2017March 31, 2018 and December 31, 20162017 the Company had 133,440,111133,989,919 and 132,774,475133,695,111 common shares issued and outstanding.
During the nine months ended September 30, 2016, 5,211,542 warrants were exercised for an aggregate of 5,211,542 shares of the Company’s common stock at $0.13 per share. These warrants were originally granted to shareholders of the April 8, 2011 Series B preferred stock issuance.
During the nine months ended September 30, 2016, 3 shares of Series B preferred stock were converted to, in aggregate, 115,385 shares of common stock.
NOTE HI – STOCK OPTIONS AND WARRANTS
Employee Stock Options
The Company maintains an equity incentive plan, (the “Plan”). The Plan was established in 2010 as an incentive plan for officers, employees, non-employee directors, prospective employees and other key persons. It is anticipated that providing such persons with a direct stake in the Company’s welfare will assure a better alignment of their interests with those of the Company and its stockholders.
The following table summarizes the changes in options outstanding and the related prices for the shares of the Company’s common stock issued to employees of the Company under the Plan as of September 30, 2017.March 31, 2018.
| Options Outstanding | Options Exercisable | |||||||||||||||||||||
| Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price | |||||||||||||||||
| $ | 0.01 - $0.15 | 3,075,000 | 6.19 | $ | 0.14 | 3,075,000 | $ | 0.14 | ||||||||||||||
| $ | 0.16 - $0.99 | 2,476,800 | 3.44 | 0.18 | 2,246,800 | 0.18 | ||||||||||||||||
| 5,551,800 | 4.97 | $ | 0.16 | 5,321,800 | $ | 0.16 | ||||||||||||||||
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)
| Options Outstanding | Options Exercisable | |||||||||||||||||||||
| Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price | |||||||||||||||||
| $ | 0.01 - $0.15 | 2,000,000 | 8.76 | $ | 0.14 | 2,000,000 | $ | 0.14 | ||||||||||||||
| $ | 0.16 - $0.99 | 1,307,399 | 5.23 | 0.20 | 1,112,399 | 0.20 | ||||||||||||||||
| 3,307,399 | 7.37 | $ | 0.16 | 3,112,399 | $ | 0.16 | ||||||||||||||||
Transactions involving stock options issued to employees are summarized as follows:
| Number of Shares | Weighted Average Price Per Share | Number of Shares | Weighted Average Price Per Share | |||||||||||||
| Outstanding at January 1, 2016 | 1,825,225 | $ | 0.28 | |||||||||||||
| Outstanding at January 1, 2017 | 2,832,725 | $ | 0.18 | |||||||||||||
| Granted | 1,300,000 | 0.17 | 3,000,000 | 0.14 | ||||||||||||
| Exercised | – | – | – | – | ||||||||||||
| Cancelled or expired | (292,500 | ) | 0.69 | (1,456,251 | ) | 0.17 | ||||||||||
| Outstanding at December 31, 2016 | 2,832,725 | $ | 0.18 | |||||||||||||
| Outstanding at December 31, 2017 | 4,376,474 | $ | 0.16 | |||||||||||||
| Granted | 3,000,000 | 0.14 | – | – | ||||||||||||
| Exercised | – | – | – | – | ||||||||||||
| Cancelled or expired | (280,925 | ) | 0.17 | (1,069,075 | ) | 0.14 | ||||||||||
| Outstanding at September 30, 2017 | 5,551,800 | $ | 0.16 | |||||||||||||
| Outstanding at March 31, 2018 | 3,307,399 | $ | 0.16 | |||||||||||||
The expected life of awards granted represents the period of time that they are expected to be outstanding. The Company determines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules, exercise patterns and pre-vesting and post-vesting forfeitures. The Company estimates the volatility of the Company’s common stock based on the calculated historical volatility of the Company’s own common stock using the trailing 24 months of share price data prior to the date of the award. The Company bases the risk-free interest rate used in the Black-Scholes option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award. The Company has not paid any cash dividends on the Company’s common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model. The Company uses historical data to estimate pre-vesting option forfeitures and record share-based compensation for those awards that are expected to vest. In accordance with ASC 718-10, the Company adjusts share-based compensation for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience.
| 15 |
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018
(UNAUDITED)
There were zero and 3,000,000 options granted, 1,069,075 and zero options grantedcancelled or expired and zero options exercised during the ninethree months ended September 30,March 31, 2018 and 2017, and 2016, respectively. Total stock-based compensation expense in connection with options granted to employees recognized in the condensed consolidated statements of operations for the three and nine months ended September 30,March 31, 2018 and 2017 was $1,531 and 2016 was $2,343 and $2,703, respectively, and $320,545 and $10,204,$314,686, respectively.
Warrants
The following table summarizes the changes in warrants outstanding and the related prices for the shares of the Company’s common stock issued to non-employees of the Company.
| Warrants Outstanding | Warrants Exercisable | |||||||||||||||||||||
| Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price | |||||||||||||||||
| $ | 0.18 | 50,000 | 0.16 | $ | 0.18 | 50,000 | $ | 0.18 | ||||||||||||||
| 0.20 | 250,000 | 4.02 | 0.20 | 250,000 | 0.20 | |||||||||||||||||
| 300,000 | 3.38 | $ | 0.20 | 300,000 | $ | 0.20 | ||||||||||||||||
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)
| Warrants Outstanding | Warrants Exercisable | |||||||||||||||||||||
| Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price | |||||||||||||||||
| $ | 0.20 | 250,000 | 3.52 | $ | 0.20 | 250,000 | $ | 0.20 | ||||||||||||||
Transactions involving warrants are summarized as follows:
| Number of Shares | Weighted Average Price Per Share | Number of Shares | Weighted Average Price Per Share | |||||||||||||
| Outstanding at January 1, 2016 | 5,638,410 | $ | 0.20 | |||||||||||||
| Outstanding at January 1, 2017 | 300,000 | $ | 0.20 | |||||||||||||
| Issued | – | – | – | – | ||||||||||||
| Exercised | (5,211,542 | ) | 0.13 | – | – | |||||||||||
| Cancelled or expired | (126,868 | ) | 3.00 | (50,000 | ) | 0.18 | ||||||||||
| Outstanding at December 31, 2016 | 300,000 | 0.20 | ||||||||||||||
| Outstanding at December 31, 2017 | 250,000 | 0.20 | ||||||||||||||
| Issued | – | – | – | – | ||||||||||||
| Exercised | – | – | – | – | ||||||||||||
| Cancelled or expired | – | – | – | – | ||||||||||||
| Outstanding at September 30, 2017 | 300,000 | $ | 0.20 | |||||||||||||
| Outstanding at March 31, 2018 | 250,000 | $ | 0.20 | |||||||||||||
There were no warrants granted, exercised, cancelled or forfeited during the ninethree months ended September 30,March 31, 2018 and 2017, and no warrants granted, 5,211,542 warrants exercised and 126,868 cancelled or forfeited during the nine months ended September 30, 2016, respectively.
NOTE IJ – RELATED PARTY TRANSACTIONS
On August 4, 2016, the Board of Directors authorized the Company to reimburse Peter T. Kross (“Mr. Kross”) $161,075 for expenses incurred related to his successful contested proxy. Effective June 27, 2016, Mr. Kross became a director of the Company and is considered a related party. On August 30, 2016, Mr. Kross accepted an unsecured promissory note (“Kross Note”) for $161,075 from the Company. The outstanding principal balance bore interest at the annual rate of 3.00%. Payment of interest and principal began on September 1, 2016 and continued monthly on the first day of each month thereafter through and including June 1, 2017. The Company was required to pay equal monthly installments of $16,330 which included all remaining principal and accrued interest owed by the Company to Mr. Kross under the Kross Note. The Company could prepay in advance any unpaid principal or interest due under the Kross Note without premium or penalty. The principal balance of the Kross Note as of September 30, 2017 and December 31, 2016 was zero and $97,127, respectively.
During the ninethree months ended September 30,March 31, 2018 and during the year ended December 31, 2017, the Company issuedagreed to issue common stock in the amount of $108,000$36,000 and $144,000 to the Company’s non-employee directors as compensation for their attendance and participation in the Company’s Board of Director and committee meetings.
On July 1, 2016, each newly elected Board of Director member, Mr. Kross, Mr. Blatt and Mr. Byrnes were granted 100,000 stock options pursuant to the Company’s Board of Director compensation plan. These options have an expiration period of ten years, vest quarterly over five years and have an exercise price of $0.19.
Upon execution of their employment agreements during the ninethree months ended September 30,March 31, 2017, each of Messrs. Tienor, Sobieski and Koch, werewas granted 1,000,000 stock options at their fair market value and all were scheduled to vest over a three year period. However, pursuant to the terms of thetheir employment agreements, the stock options vested immediately upon the sale of the Company’s subsidiary, EthoStream, in March 2017. Effective with the sale of the assets of EthoStream LLC, Mr. Koch was hired by DCI. In compliance with the terms of Mr. Koch’s stock option grant letter, Mr. Koch’s stock options were canceled during the period ended March 31, 2018.
During the ninethree months ended September 30,March 31, 2017, Messrs. Tienor, Sobieski and Koch, earned a bonus of $29,250 contingent on the sale and sale price amount of Ethostream.
From time to time the Company may receive advances from certain of its officers in the form of salary deferment or cash advances to meet short term working capital needs. These advances may not have formal repayment terms or arrangements. As of September 30, 2017 and December 31, 2016, there were no such arrangements.
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017MARCH 31, 2018
(UNAUDITED)
NOTE JK – COMMITMENTS AND CONTINGENCIES
Office Lease Obligations
In October 2013, the Company entered into a lease agreement for 6,362 square feet of commercial office space in Waukesha, Wisconsin for its corporate headquarters. The Waukesha lease would have expired in April 2021, but was subsequently amended and extended through April 2026. On April 7, 2017 the Company executed an amendment to its’ existing lease in Waukesha, Wisconsin to expand another 3,982 square feet, bringing the total leased space to 10,344 square feet. In addition, the lease term was extended from May 1, 2021 to April 30, 2026. The commencement date for this amendment was July 15, 2017.
In January 2016, the Company entered into a lease agreement for 2,237 square feet of commercial office space in Germantown, Maryland for its Maryland employees. The Germantown lease was set to expire at the end of January 2017. In December 2016, the Company entered into a first amendment to the lease agreement extending the lease through the end of January 2018.
In May 2017, the Company entered into a lease agreement for 5,838 square feet of floor space in Waukesha, Wisconsin for its inventory warehousing operations. The Waukesha lease expires in May 2027.
Commitments for minimum rentals under non-cancelable leases as of September 30, 2017March 31, 2018 are as follows:
| 2017 (remainder of) | $ | 43,738 | ||||
| 2018 | 153,063 | |||||
| 2019 | 154,496 | |||||
| 2020 | 164,903 | |||||
| 2021 | 182,512 | |||||
| 2022 and thereafter | 764,024 | |||||
| Total | $ | 1,462,736 |
| 2018 (remainder of) | $ | 156,383 | ||
| 2019 | 159,253 | |||
| 2020 | 164,903 | |||
| 2021 | 182,512 | |||
| 2022 | 190,141 | |||
| 2023 and thereafter | 573,883 | |||
| Total | $ | 1,427,075 |
Rental expenses charged to continuing operations for the three and nine months ended September 30,March 31, 2018 and 2017 was $83,882 and 2016 was $86,649 and $42,271 and $200,816 and $127,537,$34,020, respectively.
Litigation
The Company is subject to legal proceedings and claims which arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur, the Company believes that the final disposition of such matters should not have a material adverse effect on its financial position, results of operations or liquidity.
Sales Tax
During 2012, the Company engaged a sales tax consultant to assist in determining the extent of its potential sales tax exposure. Based upon this analysis, management determined the Company had probable exposure for certain unpaid obligations, including interest and penalty, of approximately $1,100,000 including and prior to the year ended December 31, 2011. The Company has approximately $72,000 and $275,000 accrued as of September 30, 2017 and December 31, 2016, respectively.
During the year ended December 31, 2016, the State of Wisconsin performed a sales and use tax audit covering the period from January 1, 2012 through December 31, 2015. The audit resulted in approximately $120,000 in additional use tax and interest. As of September 30, 2017, the Company paid in full the additional use tax liability and interest associated with the sales and use tax audit.
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)
Prior to 2017, the Company successfully executed and paid in full VDAs in thirty six states totaling approximately $765,000 and is current with the subsequent filing requirements.
The following table sets forth the change in the sales tax accrual as of September 30, 2017March 31, 2018 and December 31, 2016:2017:
September 30, 2017 | December 31, 2016 | March 31, 2018 | December 31, 2017 | ||||||||||||||
| Balance, beginning of year | $ | 274,869 | $ | 229,768 | $ | 83,282 | $ | 274,869 | |||||||||
| Sales tax collected | 235,091 | 452,016 | 35,133 | 297,673 | |||||||||||||
| Provisions (reversals) | (52,000 | ) | 151,000 | ||||||||||||||
| Provisions | 6,734 | (33,000 | ) | ||||||||||||||
| Interest and penalties | - | (3,017 | ) | – | (5,890 | ) | |||||||||||
| Payments | (385,629 | ) | (554,898 | ) | (81,000 | ) | (450,370 | ) | |||||||||
| Balance, end of period | $ | 72,331 | $ | 274,869 | $ | 44,149 | $ | 83,282 | |||||||||
NOTE KL – BUSINESS CONCENTRATION
For the ninethree months ended September 30, 2017 and 2016, no singleMarch 31, 2018, one customer represented 10% or moreapproximately 14% of total net revenues. For the three months ended March 31, 2017, one customer represented approximately 11% of total net revenues. As of September 30, 2017, one customerMarch 31, 2018, three customers accounted for approximately 10%38% of the Company’s net accounts receivable. As of December 31, 2016, two2017, three customers accounted for approximately 24%54% of the Company’s net accounts receivable.
Purchases from one supplier approximated $2,122,000,$760,000, or 86%82%, of purchases for the ninethree months ended September 30, 2017March 31, 2018 and $1,907,000,$595,000, or 77%68%, of purchases for the ninethree months ended September 30, 2016.March 31, 2017. Total due to this supplier, net of deposits, was approximately $525,858$23,142 as of September 30, 2017,March 31, 2018, and $45,037$32,697 as of December 31, 2016.2017.
NOTE LM – DISCONTINUED OPERATIONS
In October of 2016, the Company, under the direction and authority of the Board of Directors, committed to a plan to offer for sale EthoStream, the Company’s wholly–owned High-Speed Internet Access (“HSIA”) subsidiary. As a result of this decision to sell EthoStream, the operating results of EthoStream as of and forDuring the year ended December 31, 2016 were reclassified as discontinued operations and as assets and liabilities held for sale in the consolidated financial statements as detailed in the table below. During the nine months ended September 30, 2017, the Company, and EthoStream, entered into an Asset Purchase Agreement (the “Purchase Agreement”) with DCI-Design Communications LLC (“DCI”), a Delaware limited liability company, whereby DCI acquired substantially all of the assets and certain liabilities of EthoStream for a base purchase price of $12,750,000. The Purchase Agreement includesprovided that proceeds$900,000 of $900,000 are to be withheld from the $12,750,000 base purchase price andwas placed into an escrow account to support potential indemnification obligations of up to $800,000 and net working capital adjustments of up to $100,000. On April 06, 2018, the Company received the $800,000 disbursement from the funds held in escrow. The escrow amount, net of potential claims, would be fully released after an escrow period notCompany reclassified the balance from restricted cash to exceed 12 months after closing. Another $93,000 is classified in other current assets as a net working capital receivable. The assets included, among other items, certain inventory, contracts and intellectual property. DCI acquired only the liabilities provided for in the Purchase Agreement. cash at March 31, 2018.
On March 29, 2017, pursuant to the terms and the conditions of the Purchase Agreement, the Company closed on the sale.
On September 27, 2017, the Company reached a final settlement with DCI on net working capital as set forth in the Purchase Agreement. On September 29, 2017, the Company received $100,000 from the escrow account for the portion of the escrow account set aside for net working capital adjustments and cash proceeds of $311,000 from DCI in the settlement of net working capital adjustments. The net working capital receivable of $93,000 in other current assets was applied against the cash proceeds of $311,000 received on September 29, 2017 resulting in a gain from sale of discontinued operations of $218,000 recognized during the three months ended September 30, 2017.
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017MARCH 31, 2018
(UNAUDITED)
The following table summarizes the balance sheet information for
As of March 31, 2018 and December 31, 2017 there were no assets or liabilities of discontinued operations.
| September 30, | December 31, | |||||||
| 2017 | 2016 | |||||||
| Accounts receivable, net | $ | – | $ | 456,478 | ||||
| Inventories | – | 350,506 | ||||||
| Other current assets | – | 12,980 | ||||||
| Other asset – goodwill | – | 5,796,430 | ||||||
| Other asset – intangible asset, net | – | 533,577 | ||||||
| Current assets of discontinued operations | – | 7,149,971 | ||||||
| Accounts payable | – | 465,346 | ||||||
| Accrued liabilities and expenses | – | 90,187 | ||||||
| Deferred revenues | – | 37,509 | ||||||
| Customer deposits | – | 200,466 | ||||||
| Deferred lease liability | – | 76,096 | ||||||
| Current liabilities of discontinued operations | – | 869,604 | ||||||
| Net assets of discontinued operations | $ | – | $ | 6,280,367 | ||||
The following table summarizes the statements of operations information for discontinued operations.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||||||
| Revenues, net: | ||||||||||||||||
| Product | $ | – | $ | 995,425 | $ | 653,839 | $ | 2,749,001 | ||||||||
| Recurring | – | 1,038,585 | 925,837 | 2,985,550 | ||||||||||||
| Total Net Revenue | – | 2,034,010 | 1,579,676 | 5,734,551 | ||||||||||||
| Cost of Sales: | ||||||||||||||||
| Product | (11,600 | ) | 565,276 | 403,004 | 1,753,994 | |||||||||||
| Recurring | – | 242,678 | 209,868 | 697,541 | ||||||||||||
| Total Cost of Sales | (11,600 | ) | 807,954 | 612,872 | 2,451,535 | |||||||||||
| Gross Profit | 11,600 | 1,226,056 | 966,804 | 3,283,016 | ||||||||||||
| Operating Expenses: | ||||||||||||||||
| Selling, general and administrative | 197 | 315,437 | 252,307 | 896,385 | ||||||||||||
| Depreciation and amortization | – | 60,420 | 60,420 | 181,697 | ||||||||||||
| Total Operating Expenses | 197 | 375,857 | 312,727 | 1,078,082 | ||||||||||||
| Income from Discontinued Operations before Provision for Income Taxes | 11,403 | 850,199 | 654,077 | 2,204,934 | ||||||||||||
| Provision for Income Taxes | – | 51,312 | 52,017 | 153,936 | ||||||||||||
| Income from Discontinued Operations (net of tax) | $ | 11,403 | $ | 798,887 | $ | 602,060 | $ | 2,050,998 | ||||||||
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(UNAUDITED)
For the Three Months Ended March 31, | ||||||||
| 2018 | 2017 | |||||||
| Revenues, net: | ||||||||
| Product | $ | – | $ | 653,839 | ||||
| Recurring | – | 925,837 | ||||||
| Total Net Revenues | – | 1,579,676 | ||||||
| Cost of Sales: | ||||||||
| Product | – | 424,829 | ||||||
| Recurring | – | 209,179 | ||||||
| Total Cost of Sales | – | 634,008 | ||||||
| Gross Profit | – | 945,668 | ||||||
| Operating Expenses: | ||||||||
| Selling, general and administrative | – | 262,034 | ||||||
| Depreciation and amortization | – | 60,420 | ||||||
| Total Operating Expenses | – | 322,454 | ||||||
| Income from Discontinued Operations before Provision for Income Taxes | – | 623,214 | ||||||
| Provision for Income Taxes | – | 51,412 | ||||||
| Income from Discontinued Operations (net of tax) | $ | – | $ | 571,802 | ||||
The consolidated statements of cash flows do not present the cash flows from discontinued operations for investing activities or financing activities because there were no investing or financing activities associated with the discontinued operations in threethe periods ended March 31, 2018 and nine months ended September 30, 2017 and 2016.
NOTE M - SUBSEQUENT EVENT
On October 24, 2017, the Company announced a share repurchase program authorized by its Board of Directors. The share repurchase program does not obligate the Company to acquire any specific number of shares, but authorizes the Company to repurchase up to ten million shares of the Company’s common stock. Under the program, shares may be repurchased in privately negotiated and/or open market transactions. The program does not have a specific expiration date and may be suspended or discontinued at any time. As of the date of this filing, no shares have been repurchased under the program.
2017.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the accompanying condensed consolidated financial statements and related notes thereto for the three and nine months ended September 30, 2017,March 31, 2018, as well as the Company’s consolidated financial statements and related notes thereto and management’s discussion and analysis of financial condition and results of operations in the Company’s Form 10-K for the year ended December 31, 2016,2017, filed with the U.S.US. Securities and Exchange Commission (the “SEC”) on April 3, 2017.2, 2018.
Business
Telkonet, Inc. (the “Company”, “Telkonet”, “we”, “our”), formed in 1999 and incorporated under the laws of the state of Utah, is the creator of the EcoSmart Platform of intelligent automation solutions designed to optimize energy efficiency, comfort and analytics in support of the emerging Internet of Things (“IoT”).
In October of 2016, the Company, under the direction and authority of the Board of Directors, committed to a plan to offer for sale EthoStream LLC (“EthoStream”), its wholly-owned High-Speed Internet Access (“HSIA”) subsidiary. The sale will enableWhile EthoStream is one of the largest public HSIA providers in the world, providing services to more than 12.0 million users monthly across a network of approximately 1,800 locations, the Company towill focus on its higher growth potential EcoSmart Platform line. As a result of this decision to sell EthoStream, the operating results of EthoStream for the three and nine monthsperiod ended September 30,March 31, 2017 and 2016 have been reclassified as discontinued operations in the condensed consolidated statement of operations and as assets and liabilities of discontinued operations in the condensed consolidated balance sheet for the year ended December 31, 2016.operations. The transactionsale closed on March 29, 2017.
The Company’s direct sales effort targets the hospitality, education, commercial, utility and government/military markets. Taking advantage of legislation, including the Energy Independence and Security Act of 2007, or EISA, the Energy Policy Act of 2005, and the American Recovery and Reinvestment Act the Company is focusing its sales efforts in areas with available public funding and incentives, such as rebate programs offered by utilities for efficiency upgrades. Through the Company’s proprietary platform, technology and partnerships with energy efficiency providers, the Company’s management intends to position the Company as a leading provider of energy management solutions.
Forward-Looking Statements
In accordance with the Private Securities Litigation Reform Act of 1995, the Company can obtain a “safe-harbor” for forward-looking statements by identifying those statements and by accompanying those statements with cautionary statements which identify factors that could cause actual results to differ materially from those in the forward-looking statements. Accordingly, the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations” may contain certain forward-looking statements regarding strategic growth initiatives, growth opportunities and management’s expectations regarding orders and financial results for the remainder of 20172018 and future periods. These forward-looking statements are based on current expectations and current assumptions which management believes are reasonable. However, these statements involve risks and uncertainties that could cause actual results to differ materially from any future results encompassed within the forward-looking statements. Factors that could cause or contribute to such differences include those risks affecting the Company’s business as described in the Company’s filings with the SEC, including the current reports on Form 8-K, which factors are incorporated herein by reference. The Company expressly disclaims a duty to provide updates to forward-looking statements, whether as a result of new information, future events or other occurrences.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. On an ongoing basis, the Company evaluates significant estimates used in preparing its condensed consolidated financial statements including those related to revenue recognition and allowances for uncollectible accounts receivable, inventory obsolescence, depreciation and amortization, long-lived asset valuations, impairment assessments, taxes and related valuation allowance, income tax provisions, stock-based compensation, and contingencies. The Company bases its estimates on historical experience, underlying run rates and various other assumptions that the Company believes to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results could differ from these estimates. The following are critical judgments, assumptions, and estimates used in the preparation of the condensed consolidated financial statements.
Revenue Recognition
For revenue from product sales, the Company recognizes revenue in accordance with ASC 605-10, “Revenue Recognition” and ASC 605-10-S99 guidelines that require that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Assuming all conditions for revenue recognition have been satisfied, product revenue is recognized when products are shipped and installation revenue is recognized when the services are completed. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. The guidelines also address the accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets.
Multiple-Element Arrangements (“MEAs”): The Company accounts for contracts that have both product and installation under the MEAs guidance in ASC 605-25. Arrangements under such contracts may include multiple deliverables consisting of a combination of equipment and services. The deliverables included in the MEAs are separated into more than one unit of accounting when (i) the delivered equipment has value to the customer on a stand-alone basis, and (ii) delivery of the undelivered service element(s) is probable and substantially in the Company’s control. Arrangement consideration is then allocated to each unit, delivered or undelivered, based on the relative selling price of each unit of accounting based first on vendor-specific objective evidence (“VSOE”) if it exists, second on third-party evidence (“TPE”) if it exists and on estimated selling price (“ESP”) if neither VSOE or TPE exist.
Under the estimated selling price method, revenue is recognized in MEAs based on estimated selling prices for all of the elements in the arrangement, assuming all other conditions for revenue recognition have been satisfied. To determine the estimated selling price, the Company establishes the selling price for its products and installation services using the Company’s established pricing guidelines, and the proceeds are allocated between the elements and the arrangement.
When MEAs include an element of customer training, the Company determined it is not essential to the functionality, efficiency or effectiveness of the MEA due to its perfunctory nature in relation to the entire arrangement. Therefore the Company has concluded that this obligation is inconsequential and perfunctory. As such, for MEAs that include training, customer acceptance of said training is not deemed necessary in order to record the related revenue, but is recorded when the installation deliverable is fulfilled. Historically, training revenues have not been significant.
The Company provides call center support services to properties installed by the Company. The Company receives monthly service fees from such properties for its services. The Company recognizes the service fee ratably over the term of the contract. The prices for these services are fixed and determinable prior to delivery of the service. The fair value of these services is known due to objective and reliable evidence from standalone executed contracts. The Company reports such revenues as recurring revenues. Deferred revenue includes deferrals for the monthly support service fees. Long-term deferred revenue represents support service fees to be earned or provided beginning after September 30, 2018. Revenue recognized that has not yet been billed to a customer results in an asset as of the end of the period. As of September 30, 2017 and December 31, 2016, there was $68,855 and $193,400 recorded within accounts receivable, respectively, related to revenue recognized that has not yet been billed.
New Accounting Pronouncements
Please refer to the Company’s form 10K filed April 2, 2018 for critical accounting policies and estimates. For information regarding recent accounting pronouncements and their effect on the Company, see “New Accounting Pronouncements” in Note B of the Notes to Unaudited Condensed Consolidated Financial Statements contained herein.
Revenues
The table below outlines product versus recurring revenues for comparable periods:
| Three Months Ended | ||||||||||||||||||||||||||
| September 30, 2017 | September 30, 2016 | Variance | ||||||||||||||||||||||||
| Product | $ | 1,904,571 | 94% | $ | 1,360,887 | 90% | $ | 543,684 | 40% | |||||||||||||||||
| Recurring | 131,665 | 6% | 143,028 | 10% | (11,363 | ) | -8% | |||||||||||||||||||
| Total | $ | 2,036,326 | 100% | $ | 1,503,915 | 100% | $ | 532,321 | 35% | |||||||||||||||||
| Three Months Ended | ||||||||||||||||||
| March 31, 2018 | March 31, 2017 | Variance | ||||||||||||||||
| Product | $ | 1,503,658 | 94% | $ | 1,810,385 | 95% | $ | (306,727 | ) | -17% | ||||||||
| Recurring | 101,538 | 6% | 102,842 | 5% | (1,304 | ) | -1% | |||||||||||
| Total | $ | 1,605,196 | 100% | $ | 1,913,227 | 100% | $ | (308,031 | ) | -16% | ||||||||
Nine Months Ended | ||||||||||||||||||||||||||
| September 30, 2017 | September 30, 2016 | Variance | ||||||||||||||||||||||||
| Product | $ | 5,728,878 | 94% | $ | 6,356,437 | 95% | $ | (627,559 | ) | -10% | ||||||||||||||||
| Recurring | 344,708 | 6% | 340,412 | 5% | 4,296 | 1% | ||||||||||||||||||||
| Total | $ | 6,073,586 | 100% | $ | 6,696,849 | 100% | $ | (623,263 | ) | -9% | ||||||||||||||||
| 19 |
Product Revenue
Product revenue principally arises from the sale and installation of the EcoSmart energy management platform. The EcoSmart Suite of products consists of thermostats, sensors, controllers, wireless networking products switches, outlets and a control platform.
For the three months ended September 30, 2017, product revenue increased by 40% or $0.5 million and for the nine months ended September 30, 2017,March 31, 2018, product revenue decreased 10%by 17% or $0.6 million. For$0.30 million when compared to the three months ended September 30, 2017, theprior year period. The hospitality market comprised $1.3$1.20 million of product sales for the three months ended September 30, 2017,March 31, 2018, a $0.1$0.13 million decrease from the prior year period. The education market sales for the three months ended September 30, 2017 increased $0.3March 31, 2018 decreased $0.09 million to $0.4 million from $0.1 million for the prior year period. Theperiod to $0.29 million, and the Multiple Dwelling Unit (“MDU”) market increased $0.2decreased $0.07 million from $0.0$0.09 million during the three months ended September 30, 2016. The hospitality market sales for the nine months ended September 30,at March 31, 2017 decreased $0.7 million to $4.2 million from $4.9$0.02 million for the prior yearcurrent period. The education market sales for the nine months ended September 30, 2017 increased $0.1 millionCompany’s commitment to $1.0 million from $0.9 million for the prior year period and the Commercial and MDU market sales for the nine months ended September 30, 2017 remained at $0.5 million for the nine months ended September 30, 2017 and 2016. The Company’saccess distribution channels through resellers and value added distribution partners decreasedcontinued to grow. Product revenue derived from $3.1channel partners increased by $0.2 million for the ninethree months ended September 30, 2016March 31, 2018 compared to $2.8 million at September 30, 2017.the prior year period.
Recurring Revenue
Recurring revenue is attributed to our call center support services. The Company recognizes revenue ratably over the service month for monthly support revenues and defers revenue for annual support services over the term of the service period. Recurring revenue consists of Telkonet’s EcoCare service and support program.
For the three and nine months ended September 30, 2017,March 31, 2018, recurring revenue decreased by 8% and increased bynominal amount or 1%, respectively, when compared to the prior year period. Non renewals outpaced new sales.
Cost of Sales
| Three Months Ended | ||||||||||||||||||||||||||
| September 30, 2017 | September 30, 2016 | Variance | ||||||||||||||||||||||||
| Product | $ | 1,160,019 | 61% | $ | 770,830 | 57% | $ | 389,189 | 50% | |||||||||||||||||
| Recurring | 55,702 | 42% | 36,618 | 26% | 19,084 | 52% | ||||||||||||||||||||
| Total | $ | 1,215,721 | 60% | $ | 807,448 | 54% | $ | 408,273 | 51% | |||||||||||||||||
| Nine Months Ended | ||||||||||||||||||||||||||
| September 30, 2017 | September 30, 2016 | Variance | ||||||||||||||||||||||||
| Product | $ | 3,233,978 | 56% | $ | 3,194,094 | 50% | $ | 39,884 | 1% | |||||||||||||||||
| Recurring | 118,347 | 34% | 92,324 | 27% | 26,023 | 28% | ||||||||||||||||||||
| Total | $ | 3,352,325 | 55% | $ | 3,286,418 | 49% | $ | 65,907 | 2% | |||||||||||||||||
| Three Months Ended | ||||||||||||||||||
| March 31, 2018 | March 31, 2017 | Variance | ||||||||||||||||
| Product | $ | 994,237 | 66% | $ | 1,008,045 | 56% | $ | (13,808 | ) | -1% | ||||||||
| Recurring | 59,997 | 59% | 30,018 | 29% | 29,979 | 100% | ||||||||||||
| Total | $ | 1,054,234 | 66% | $ | 1,038,063 | 54% | $ | 16,171 | 2% | |||||||||
Costs of Product RevenueSales
Costs of product revenue include equipment and installation labor related to EcoSmart technology. For the three and nine months ended September 30, 2017,March 31, 2018, product costs increaseddecreased by 50% and 1%, respectively, compared to the prior year. Cost of materials decreased by 16% or $0.08 million compared to the prior year periods. Forperiod, the three month comparison, the materials costs asresult of a percentage of product sales increased 2% to 45% for the three month ended September 30, 2017 from 43% for the three months ended September 30, 2016.decrease in sales. The cost of materials increased $0.15 million, freight and warranty expense increased $0.04 million and inventory adjustments increased $0.08 million. For the three months ended September 30, 2017, the Company’s increased use of outside contractors for installations decreased resulting in a $0.13 million decrease in contractor services costs. The decrease in sales resulted in a $0.19 million variance in contractor services costs, consequently, salary, benefits and travel costs related to installations decreased by $0.07 million.
For the nine month comparison, the use of outside contractors for installations resulted in a $0.20$0.05 million decrease in salary, wages and travel expense. These decreases were offset by a $0.16 million adjustment in inventory costs, a $0.03$0.24 million increase in freight costs, a $0.03 million increase in outside services and a $0.02 million increase in parts and supplies and warranty expense.inventory write offs.
Costs of Recurring Revenue
Recurring costs are comprised of labor and telecommunication services for our customer service department. For the three and nine months ended September 30, 2017,March 31, 2018, recurring costs increased by 52% and 28%, respectively, when100% compared to the prior year periods. The three and nine month variances are the result of a $0.02period. This $0.03 million and a $0.03 millionvariance was due to an increase in salary, benefits and benefit costs for the period ended September 30, 2017. The Company added a support services supervisor.temporary staffing.
Gross Profit
| Three Months Ended | ||||||||||||||||||||||||||
| September 30, 2017 | September 30, 2016 | Variance | ||||||||||||||||||||||||
| Product | $ | 744,552 | 39% | $ | 590,057 | 43% | $ | 154,495 | 26% | |||||||||||||||||
| Recurring | 75,963 | 58% | 106,410 | 74% | (30,447 | ) | -29% | |||||||||||||||||||
| Total | $ | 820,515 | 40% | $ | 696,467 | 46% | $ | 124,048 | 18% | |||||||||||||||||
| Three Months Ended | ||||||||||||||||||
| March 31, 2018 | March 31, 2017 | Variance | ||||||||||||||||
| Product | $ | 509,421 | 34% | $ | 802,340 | 44% | $ | (292,919 | ) | -37% | ||||||||
| Recurring | 41,541 | 41% | 72,824 | 71% | (31,283 | ) | -43% | |||||||||||
| Total | $ | 550,962 | 34% | $ | 875,164 | 46% | $ | (324,202 | ) | -37% | ||||||||
| Nine Months Ended | ||||||||||||||||||||||||||
| September 30, 2017 | September 30, 2016 | Variance | ||||||||||||||||||||||||
| Product | $ | 2,494,900 | 44% | $ | 3,162,343 | 50% | $ | (667,443 | ) | -21% | ||||||||||||||||
| Recurring | 226,361 | 66% | 248,088 | 73% | (21,727 | ) | -9% | |||||||||||||||||||
| Total | $ | 2,721,261 | 45% | $ | 3,410,431 | 51% | $ | (689,170 | ) | -20% | ||||||||||||||||
Gross Profit on Product Revenue
Gross profit for the three and nine months ended September 30, 2017 increased by 26% andMarch 31, 2018 decreased by 21%, respectively, when compared to the prior year periods. For the three months ended September 30, 2017, the actual gross profit percentage declined to 39% from 43%. The majority of the variance was due to an approximate increase of 20% for outside services. For the nine months ended September 30, 2017, the actual gross profit percentage declined to 44% from 50%. Material costs as a percentage of sales increased 3% for the nine months ended September 30, 201737% when compared to the prior year period. The actual gross profit percentage decreased from 46% for the three months ended March 31, 2017 to 34% for the three months ended March 31, 2018. Contributing to the decrease in margin was a $0.24 million inventory valuation adjustment varianceas well as increased customer discounts on product sales. The inventory valuation adjustments were due to standard cost adjustments, the write down of $0.16 million during the nine months ended September 30, 2017 when compared to the prior year period also contributed to gross profit decline.obsolete inventory and a reclassification of parts that should have been expensed.
| 20 |
Gross Profit on Recurring Revenue
The gross profit associated with recurring revenue decreased by 29% and 9%, respectively,43% for the three and nine months ended September 30, 2017March 31, 2018 when compared to the prior year periods. For the three months ended September 30, 2017, the actual gross profit percentage decreased 16% comparedperiod. The decrease was directly related to the prior year period, from 74% to 58%. The primary reason was a manager was added to the Company’s support department, increasing wagescost of goods sold salary and benefits. For the nine months ended September 30, 2017, the actual gross profit percentage decreased 7% compared to the prior year period, from 73% to 66%.wage increases.
Operating Expenses
| Three Months Ended September 30, | ||||||||||||||||||
| 2017 | 2016 | Variance | ||||||||||||||||
| Total | $ | 1,704,177 | $ | 1,870,493 | $ | (166,316 | ) | -9% | ||||||||||
| Nine Months Ended September 30, | ||||||||||||||||||
| 2017 | 2016 | Variance | ||||||||||||||||
| Total | $ | 5,754,741 | $ | 6,357,622 | $ | (602,881 | ) | -9% | ||||||||||
| Three Months Ended March 31, | ||||||||||||||
| 2018 | 2017 | Variance | ||||||||||||
| Total | $ | 1,732,598 | $ | 2,158,058 | $ | (425,460 | ) | -20% | ||||||
During the three and nine months ended September 30, 2017,March 31, 2018, operating expenses decreased by 9%20% when compared to the prior year periodsperiod as outlined below.
Research and Development
| Three Months Ended September 30 | ||||||||||||||||||
| 2017 | 2016 | Variance | ||||||||||||||||
| Total | $ | 500,656 | $ | 429,622 | $ | 71,034 | 17% | |||||||||||
| Nine Months Ended September 30, | ||||||||||||||||||
| 2017 | 2016 | Variance | ||||||||||||||||
| Total | $ | 1,323,669 | $ | 1,321,007 | $ | 2,662 | 0% | |||||||||||
| Three Months Ended March 31, | ||||||||||||||
| 2018 | 2017 | Variance | ||||||||||||
| Total | $ | 438,780 | $ | 378,456 | $ | 60,324 | 16% | |||||||
Research and development costs are related to both present and future products and are expensed in the period incurred. Current research and development costs are associated with product development and integration. During the three and nine months ended September 30, 2017,March 31, 2018, research and development costs increased by 17% and 0%, respectively,16% when compared to the prior year periods. For the three month comparison, theperiod. The variance is due to an approximate $0.04$0.07 million increase in expenditures for consulting a $0.01 increase in personnel recruiting and an increase of $0.02 million for salary and benefits. For the nine month comparison, overall expense remained unchanged however there were changes within the research and development category. For the nine months ended September 30, 2017, a $0.06 million decrease was the result of retooling charges related to new product development for the prior year period. This was offset by a $0.04$0.01 million increasedecrease in consulting and a $0.02 million increase for new product certification expenses for the nine months ended September 30, 2017.expense.
Selling, General and Administrative Expenses
| Three Months Ended September 30, | ||||||||||||||||
| 2017 | 2016 | Variance | ||||||||||||||
| Total | $ | 1,188,905 | $ | 1,432,489 | $ | (243,584) | -17% | |||||||||
| Nine Months Ended September 30, | ||||||||||||||||
| 2017 | 2016 | Variance | ||||||||||||||
| Total | $ | 4,396,667 | $ | 5,012,249 | $ | (615,582) | -12% | |||||||||
| Three Months Ended March 31, | ||||||||||||||
| 2018 | 2017 | Variance | ||||||||||||
| Total | $ | 1,276,903 | $ | 1,769,693 | $ | (492,790 | ) | -28% | ||||||
During the three and nine months ended September 30, 2017,March 31, 2018, selling, general and administrative expenses decreased over the prior year periodsperiod by 17% and 12%, respectively.28%. For the three month comparison, due to the sale of EthoStream, the Company was able to decrease executive, accounting and sales salaries, wages and benefits by $0.20 million. A $0.07 million decrease was a result of a refund received from a utility. The Company had a $0.09 million decrease in sales and use tax, the result of a $0.10 million State of Wisconsin audit assessment during 2016 as well as a $0.06 million decrease in bad debt expense, the result of a collection previously reserved. These decreases were offset by increases for legal expense of $0.03 million, hardware/software expenses of $0.06 million, marketing and trade show expense of $0.05 million, rent expense of $0.04 million and commissions of $0.02 million.
For the nine month comparison, $0.29 millionmajority of the variance is attributed to the costs associatedbonus and stock options granted to certain executives for $0.4 million. Salaries and benefits decreased by $0.14 million as personal transitioned with the contested 2016 proxy contest as discussed in detail in the June 30, 2017 Form 10-Q as well as an additional $0.10 million in public company fees in 2016. Due to the sale of EthoStream, the Company was able to decrease temporary staffing, executive, accounting and sales salaries, wages and benefits of $0.61 million, $0.11 million for sales and use tax, related to the State of Wisconsin audit discussed above, a utility refund of $0.07 million, $0.03 million for director fees,LLC. The Company’s marketing expense decreased by $0.04 million, for insurance expense.a consulting firm was not retained and commission expense decreased. Bad debt also decreased by $0.02 million. These reductions in expensecosts were offset by an increase in stock option expense of $0.31 million, marketing and trade show expenses of $0.14 million, rent expense of $0.07 million, commissions of $0.02 million and hardware/software costs of $0.05 million.million, the Company now leases a warehouse for inventory storage and a $0.04 million increase in tradeshow expense.
Income from Discontinued Operations, Net of Tax
| Three Months Ended September 30, | ||||||||||||||||
| 2017 | 2016 | Variance | ||||||||||||||
| Total | $ | 11,403 | $ | 798,887 | $ | (787,484) | -99% | |||||||||
| Nine Months Ended September 30, | |||||||||||||||
| 2017 | 2016 | Variance | ||||||||||||||
| Total | $ | 602,060 | $ | 2,050,998 | $ | (1,448,938) | -71% | |||||||||
| Three Months Ended March 31, | ||||||||||||||
| 2018 | 2017 | Variance | ||||||||||||
| Total | $ | – | $ | 571,802 | $ | (571,802 | ) | -100% | ||||||
Income from discontinued operations decreased $0.79$0.06 million or 99% and $1.45 million or 71% for the three and nine months ended September 30, 2017March 31, 2018 over the prior year periods. Onyear. For the three months ended March 29, 2017, pursuant to the terms and the conditions of the Purchase Agreement, the Company closed on the sale of EthoStream. The income31, 2018 there was no activity from discontinued operations (net of tax) represents the activity of EthoStream from January 1, 2017 through the date of the sale on March 28, 2017. After March 28, 2017, certain liabilities retained by the Company will be adjusted in future periods as these liability balances are paid.operations.
| 21 |
EBITDA from Continuing Operations
Management believes that certain non-GAAP financial measures may be useful to investors in certain instances to provide additional meaningful comparisons between current results and results in prior operating periods. Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is a metric used by management and frequently used by the financial community. Adjusted EBITDA provides insight into an organization’s operating trends and facilitates comparisons between peer companies, since interest, taxes, depreciation and amortization can differ greatly between organizations as a result of differing capital structures and tax strategies. Adjusted EBITDA is one of the measures used for determining our debt covenant compliance. Adjusted EBITDA excludes certain items that are unusual in nature or not comparable from period to period. While management believes that non-GAAP measurements are useful supplemental information, such adjusted results are not intended to replace our GAAP financial results. Adjusted EBITDA is not, and should not be considered, an alternative to net income (loss), income (loss) from operations, or any other measure for determining operating performance of liquidity, as determined under accounting principles generally accepted in the United States (GAAP). In assessing the overall health of its business for the three and nine months ended September 30,March 31, 2018 and 2017, and 2016, the Company excluded items in the following general category described below:
| · | Stock-based compensation: The Company believes that because of the variety of equity awards used by companies, varying methodologies for determining stock-based compensation and the assumptions and estimates involved in those determinations, the exclusion of non-cash stock-based compensation enhances the ability of management and investors to understand the impact of non-cash stock-based compensation on our operating results. Further, the Company believes that excluding stock-based compensation expense allows for a more transparent comparison of its financial results to the previous period. |
| · |
RECONCILIATION OF NET LOSS FROM
CONTINUING OPERATIONS TO ADJUSTED EBITDA
(Unaudited)FOR THE THREE MONTHS ENDED MARCH 31,
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||||||||||||||
| 2018 | 2017 | |||||||||||||||||||||||
| Net loss from continuing operations | $ | (871,340 | ) | $ | (1,192,083 | ) | $ | (3,034,984 | ) | $ | (2,995,699 | ) | $ | (1,184,166 | ) | $ | (1,294,238 | ) | ||||||
| Interest (income) expense, net | (8,722 | ) | 15,482 | (2,797 | ) | 45,308 | 2,530 | 10,353 | ||||||||||||||||
| Provision (benefit) for income taxes | (3,600 | ) | 2,575 | 4,301 | 3,200 | |||||||||||||||||||
| Provision for income taxes | – | 991 | ||||||||||||||||||||||
| Depreciation and amortization | 14,616 | 8,382 | 34,405 | 24,366 | 16,915 | 9,909 | ||||||||||||||||||
| EBITDA – continuing operations | (869,046 | ) | (1,165,644 | ) | (2,999,075 | ) | (2,922,825 | ) | (1,164,721 | ) | (1,272,985 | ) | ||||||||||||
| Adjustments: | ||||||||||||||||||||||||
| Stock-based compensation | 2,343 | 2,703 | 320,545 | 10,204 | 1,531 | 314,686 | ||||||||||||||||||
| Bonuses paid to executives upon sale of discontinued operations | – | – | 87,750 | – | ||||||||||||||||||||
| Adjusted EBITDA | $ | (866,703 | ) | $ | (1,162,941 | ) | $ | (2,590,780 | ) | $ | (2,912,621 | ) | ||||||||||||
| Bonus paid to executives upon sale of discontinued operations | – | 87,750 | ||||||||||||||||||||||
| Adjusted EBITDA – continuing operations | $ | (1,163,190 | ) | $ | (870,549 | ) | ||||||||||||||||||
Liquidity and Capital Resources
The Company has financed its operations since inception primarily through private and public offerings of the Company’s equity securities, the issuance of various debt instruments and asset based lending, and the sale of assets.
Working Capital
Working capital (current assets in excess of current liabilities) from continuing operations increaseddecreased by $9,840,658$1,590,306 during the ninethree months ended September 30, 2017March 31, 2018 from working capital deficit of $26,859$9,480,565 at December 31, 20162017 to a working capital of $9,813,799$7,890,259 at September 30, 2017.
Kross Promissory Note
On August 4, 2016, the Board of Directors authorized the Company to reimburse Peter T. Kross (“Mr. Kross”) $161,075 for expenses incurred related to his successful contested proxy. Effective June 27, 2016, Mr. Kross became a director of the Company and is considered a related party. On August 30, 2016, Mr. Kross accepted an unsecured promissory note (“Kross Note”) for $161,075 from the Company. The outstanding principal balance bore interest at the annual rate of 3.00%. Payment of interest and principal began on September 1, 2016 and continued monthly on the first day of each month thereafter through and including June 1, 2017. The Company was required to pay equal monthly installments of $16,330 which included all remaining principal and accrued interest owed by the Company to Mr. Kross under the Kross Note. The Company could prepay in advance any unpaid principal or interest due under the Kross Note without premium or penalty. The principal balance of the Kross Note as of September 30, 2017 and DecemberMarch 31, 2016 was zero and $97,127, respectively.2018.
Revolving Credit Facility
On September 30, 2014, the Company and its wholly-owned subsidiary, EthoStream, as co-borrowers (collectively, the “Borrowers”), entered into a loan and security agreement (the “Heritage Bank Loan Agreement”), with Heritage Bank of Commerce, a California state chartered bank (“Heritage Bank”), governing a new revolving credit facility in a principal amount not to exceed $2,000,000 (the “Credit Facility”). Availability of borrowings under the Credit Facility from time to time is subject to a borrowing base calculation based on the Company’s eligible accounts receivable and eligible inventory each multiplied by an applicable advance rate, with an overall limitation tied to the Company’s eligible accounts receivable. The Heritage Bank Loan Agreement is available for working capitalcontains representations and warranties, covenants, and other general business purposes.provisions customary to transactions of this nature. As of March 31, 2018, the Company was in compliance with all financial covenants. The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 7.25%7.75% at September 30, 2017March 31, 2018 and 6.75%7.50% at December 31, 2016. On October 9, 2014, as part of the Heritage Bank Loan Agreement, Heritage Bank was granted a warrant to purchase 250,000 shares of Telkonet common stock.2017. The warrant has an exercise price of $0.20 and expires October 9, 2021. On February 17, 2016, an amendment tooutstanding balance on the Credit Facility was executed extending the maturity date to September 30,$622,852 and $682,211 at March 31, 2018 unless earlier accelerated under the terms of the Heritage Bank Loan Agreement.
The Heritage Bank Loan Agreement also contains financial covenants that place restrictions on, among other things, the incurrence of debt, granting of liens and sale of assets.December 31, 2017, respectively. The Heritage Bank Loan Agreement also contains financial covenants that require the Borrowers to maintain a minimum EBITDA level, measured quarterly, and a minimum asset coverage ratio, measured monthly. A violation of any of these covenants could result in an event of default under the Heritage Bank Loan Agreement. Upon the occurrence of such an event of default or certain other customary events of defaults, payment of any outstanding amounts under the Credit Facility may be accelerated and Heritage Bank’s commitment to extend credit under the Heritage Bank Loan Agreement may be terminated. The Heritage Bank Loan Agreement contains other representations and warranties, covenants, and other provisions customary to transactions of this nature. The outstanding balance of the revolving credit facility was $79,953 as of September 30, 2017 and the remaining available borrowing capacity was approximately $1,304,000. As of September 30,$429,000 and $202,000 at March 31, 2018 and December 31, 2017, the Company was in compliance with all financial covenants.
On March 28, 2017, the Company and the Company’s wholly-owned subsidiary, EthoStream, entered into an Asset Purchase Agreement with DCI-Design Communications LLC (“DCI”), whereby DCI acquired all of the assets and certain liabilities of EthoStream. Heritage Bank provided the Company with its consent to the sale transaction. Upon closing of the sale transaction on March 29, 2017, the entire balance outstanding on the Credit Facility was repaid. On March 29, 2017an amendment to the Credit Facility was executedamending the quarterly and year to date EBITDA compliance measurements for 2017.
On August 29, 2017, an amendment to the Credit Facility with Heritage Bank was executed to amend certain terms of the Heritage Bank Loan Agreement allowing for the issuance of corporate credit cards providing credit not to exceed $100,000. The Borrower may request credit advances in an aggregate outstanding amount not to exceed the borrowing limits set forth in the amendment.respectively.
On October 23, 2017,March 31, 2018, an amendment to the revolving credit facility with Heritage Bank was executed to amend certain terms of the Heritage Bank Loan Agreement. Among the terms of the amendment was that if the Company deviates from its projectedfails to comply with required EBITDA for the quarters ended September 30, 2017 or December 31, 2017,covenants as of any particular quarterly measurement date, the Company will be deemed to be in compliance as of the measurement date if the Company’s unrestricted cash maintained at Heritage Bank is in excess of $5,000,000. The amendment also extends the revolving credit facility’s maturity date by one year to September 30, 2019.
| 22 |
Cash Flow Analysis
Cash used in continuing operations was $2,459,746$991,884 and $2,768,301$1,073,493 during the ninethree months ended September 30,March 31, 2018 and 2017, and 2016, respectively. As of September 30, 2017,March 31, 2018, our primary capital needs included costs incurred to increase energy management sales, inventory procurement and managing current liabilities. The working capital changes during the ninethree months ended September 30,March 31, 2018 were primarily related to an approximate $329,000 decrease in accounts receivable, a $416,000 decrease in inventory, a $283,000 decrease in accounts payable, a $295,000 increase in customer asset, a $124,000 decrease in customer deposits and a $273,000 decrease in deferred revenue that were both reclassified to contract liabilities which increased $653,000 and a $219,000 increase in prepaid expenses. The working capital changes during the three months ended March 31, 2017 were primarily related to an approximate $380,500$324,000 increase in accounts receivable, a $305,000 increaseoffset by an $88,000 decrease in inventory a $305,000 increase in accounts payable, a $330,000 increase in deferred revenue and a $168,000 increase$74,000 decrease in accrued liabilities and expenses. The working capital changes during the nine months ended September 30, 2016 were primarily related to an approximately $469,000 decreaseexpenses and a $132,000 increase in accounts receivable, a $410,000 increase in inventory, a $535,000 decrease in accounts payable and a $300,000 increase in accrued liabilities and expenses.payable. Accounts receivable fluctuates based on the negotiated billing terms with customers and collections. We purchase inventory based on forecasts and orders, and when those forecasts and orders change, the amount of inventory may also fluctuate. Accounts payable fluctuates with changes in inventory levels, volume of inventory purchases, and negotiated supplier and vendor terms.
Cash used in investing activities was $7,493 during the three months ended March 31, 2018. Cash provided by investing activities was $11,092,051$12,431,521 during the ninethree months ended September 30, 2017 and cash used in investing activities was $2,352 duringMarch 31, 2017. During the ninethree months ended September 30, 2016, respectively. March 31, 2018, the Company purchased approximately $7,493 of computer equipment.During the ninethree months ended September 30,March 31, 2017, the cash provided by investing activities reflects the proceeds less adjustments associated with the sale of the assets and certain liabilities assumed of the Company’s wholly-owned subsidiary, EthoStream and a decrease of $142,572 associated with the purchase of computer equipment and furniture, fixtures and equipment. Due to the sale of EthoStream, the Company extended the Waukesha lease, as discussed in Note J, and refurbished the corporate office to accommodate employee’s previously working at the Milwaukee operations office. During the nine months ended September 30, 2016, the Company purchased $33,629 of computer equipment and had $31,277 of restricted cash related to a bonding requirement releasedEthoStream..
Cash used in financing activities was $982,176$59,359 and $1,062,129 during the three months ended March 31, 2018 and 2017, respectively. Proceeds borrowed from the line of credit were $220,610 and cash provided by financing activities was $707,637used for payments on the line of credit were $279,969 during the ninethree months ended September 30, 2017 and 2016, respectively.March 31, 2018. The Heritage Bank Loan Agreement for the Company’s line of credit includedthe Company and EthoStream, as co borrowers. Upon closing the EthoStream sale transaction on March 29, 2017, the entire balance outstanding on the Credit Facility, $1,062,129 was repaid and a net balance of $79,953 was subsequently borrowed during the three months ended September 30, 2017. During the nine months ended September 30, 2016, 5,211,542 warrants were exercised for an aggregate of 5,211,542 shares of the Company’s common stock at $0.13 per share. These warrants were originally granted to shareholders of the April 8, 2011 Series B preferred stock issuance. Total proceeds received were $677,501. Cash used in financing activities to repay indebtedness was $79,864 and net cash paid on the line of credit was $110,000 during the nine months ended September 30, 2016.
We are working to manage our current liabilities while we continue to make changes in operations to improve our cash flow and liquidity position.
Management expects that global economic conditions, in particular the decreasing price of energy, along with competition will continue to present a challenging operating environment through 2017;2018; therefore working capital management will continue to be a high priority for 2017.2018. The Company’s estimated cash requirements for our operations for the next 12 months is not anticipated to differ significantly from our present cash requirements for our operations.
Off-Balance Sheet Arrangements
The Company has no material off-balance sheet arrangements.
Acquisition or Disposition of Property and Equipment
The Company does not anticipate significant purchases of property or equipment during the next twelve months. The amended and expanded Waukesha, Wisconsin lease requiresmay require additional furniture, shelving, computer equipment and peripherals to be used in the Company’s day-to-day operations.
Item 4. Controls and Procedures.
As of September 30, 2017,March 31, 2018, the Company performed an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. Management has identified control deficiencies regarding the lack of segregation of duties due to the limited size of the Company’s accounting department, a failure to implement adequate internal control over financial reporting including in our IT general control environment, and the need for a stronger internal control environment particularly in our financial reporting and close process. We lack sufficient personnel resources and technical accounting and reporting expertise to appropriately address certain accounting and financial reporting matters in accordance with generally accepted accounting principles. We did not have an adequate process or appropriate controls in place to support the accurate reporting of our financial results and disclosures on our Form 10-Q. Management of the Company believes that these material weaknesses are due to the small size of the Company’s accounting staff. The small size of the Company’s accounting staff may prevent adequate controls in the future, such as segregation of duties, due to the cost/benefit of such remediation. The Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were ineffective as of the end of the period covered by this report.
DuringWe are reviewing actions to remediate the nine months ended September 30, 2017, there were no changes in the Company’sidentified material weaknesses. As we continue to evaluate and work to improve our internal controlcontrols over financial reporting, our senior management may determine to take additional measures to address deficiencies or modify the remediation efforts. Until the remediation efforts that have materially affected, orour senior management identifies as necessary, are reasonably likelycompleted, tested and determined effective, the material weaknesses described above will continue to materially affect,exist.
In light of these material weaknesses, we performed additional analyses and procedures in order to conclude that our condensed consolidated financial statements as of March 31, 2018 and 2017 included in this Form 10-Q were fairly stated in accordance with GAAP. Accordingly, management believes that despite our material weaknesses, our condensed consolidated financial statements for the Company’s internal control over financial reporting.three months ended March 31, 2018 and 2017 are fairly stated, in all material respects, in accordance with GAAP.
The Company is subject to legal proceedings and claims which arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur, the Company believes that the final disposition of such matters should not have a material adverse effect on its financial position, results of operations or liquidity.
There have been no material changes to risk factors previously disclosed in our annual report on Form 10-K for the year ended December 31, 20162017 in response to Item 1A of Form 10-K.
| Exhibit Number | Description Of Document | |
| 31.1 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Jason L. Tienor | |
| 31.2 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Richard E. Mushrush | |
| 32.1 | Certification of Jason L. Tienor pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 32.2 | Certification of Richard E. Mushrush pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 101.INS | XBRL Instance Document | |
| 101.SCH | XBRL Schema Document | |
| 101.CAL | XBRL Calculation Linkbase Document | |
| 101.DEF | XBRL Definition Linkbase Document | |
| 101.LAB | XBRL Label Linkbase Document | |
| 101.PRE | XBRL Presentation Linkbase Document |
Pursuant to the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Telkonet, Inc. Registrant | ||
| Date: | By: | /s/ Jason L. Tienor |
Jason L. Tienor Chief Executive Officer (principal executive officer) | ||
| Date: | By: | /s/ Richard E. Mushrush |
Richard E. Mushrush Chief Financial Officer (principal financial officer) | ||