Table of Contents

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 SeptemberJune 30, 20172019

 

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)

 

Utah87-0627421
(State (State or Other Jurisdiction of Incorporation or Organization)(I.R.S. (I.R.S. Employer Identification No.)
  
20800 Swenson Drive, Suite 175, Waukesha, WI53186
(Address of Principal Executive Offices)(Zip Code)

 

(414) 302-2299

(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each classTrading Symbol(s)Name of each exchange on which registered
NoneNoneNone

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value

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, a 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 fileroAccelerated filero
Non-accelerated filerxo(Do not check if a smaller reporting company)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 OctoberJuly 31, 20172019 is 133,440,111.135,331,951.

  

 

 

   

 

 

TELKONET, INC.

FORM 10-Q for the NineSix Months Ended SeptemberJune 30, 20172019

 

Index

 

 Page
  
PART I. FINANCIAL INFORMATION3
  
Item 1. Financial Statements3
  

Condensed Consolidated Balance Sheets (Unaudited): September
June 30, 20172019 and December 31, 20162018

3

  

Condensed Consolidated Statements of Operations (Unaudited):
Three and NineSix Months Ended SeptemberJune 30, 20172019 and 20162018

4

  

Condensed Consolidated Statement of Stockholders’ Equity (Unaudited):
January 1, 20172019 through SeptemberJune 30, 20172019

5

  

Condensed Consolidated Statements of Cash Flows (Unaudited): Nine
Six Months Ended SeptemberJune 30, 20172019 and 20162018

6

  
Notes to Condensed Consolidated Financial Statements (Unaudited)8
  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations2320
  
Item 4. Controls and Procedures32
  
PART II. OTHER INFORMATION3329
  
Item 1. Legal Proceedings3329
  
Item 1A. Risk Factors3329
  
Item 6. Exhibits3329

 

 

 

 

 

 

 

 

 

 2 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

TELKONET, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

September 30,

2017

 

December 31,

2016

  

June 30,

2019

 

December 31,

2018

 
ASSETS                
Current assets:                
Cash and cash equivalents $8,959,229  $791,858  $3,380,382  $4,678,891 
Restricted cash on deposit  800,000    
Accounts receivable, net  1,769,221   1,403,772   2,455,255   1,081,291 
Inventories  1,082,289   777,202   1,754,676   1,790,919 
Prepaid expenses and other current assets  260,269   205,328 
Current assets of discontinued operations     7,149,971 
Contract assets  515,080   314,749 
Prepaid expenses  441,667   577,386 
Income taxes receivable  25,336   19,695 
Total current assets  12,871,008   10,328,131   8,572,396   8,462,931 
                
Property and equipment, net  318,767   143,907   218,632   247,289 
                
Other assets:                
Deposits  17,130      17,130   17,130 
Operating lease right of use assets  968,485    
Total other assets  17,130      985,615   17,130 
                
Total Assets $13,206,905  $10,472,038  $9,776,643  $8,727,350 
                
LIABILITIES AND STOCKHOLDERS’ EQUITY                
Current liabilities:                
Accounts payable $1,137,632  $765,617  $1,055,301  $408,045 
Accrued liabilities and expenses  1,094,054   925,581 
Related party payable     97,127 
Accrued liabilities  895,608   656,611 
Line of credit  79,953   1,062,129   864,125   121,474 
Deferred revenues - current  444,110   184,793 
Deferred lease liability – current     3,942 
Customer deposits  215,576   165,830 
Income taxes payable  85,884    
Deferred income taxes     933,433 
Current liabilities of discontinued operations     869,604 
Contract liabilities – current  821,213   1,070,502 
Operating lease liabilities – current  218,614    
Total current liabilities  3,057,209   5,008,056   3,854,861   2,256,632 
                
Long-term liabilities:                
Deferred revenue - long term  190,896   120,421 
Deferred lease liability - long term  40,508   23,761 
Contract liabilities – long term  142,703   162,121 
Operating lease liabilities – long term  830,907    
Deferred lease liability – long term     71,877 
Total long-term liabilities  231,404   144,182   973,610   233,998 
Total liabilities $4,828,471  $2,490,630 
                
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 June 30, 2019 and December 31, 2018, preference in liquidation of $1,636,875 and $1,600,168 as of June 30, 2019 and December 31, 2018, respectively  1,340,566   1,340,566 
Series B, par value $.001 per share; 538 shares issued, 52 shares outstanding at June 30, 2019 and December 31, 2018, preference in liquidation of $445,406 and $435,081 as of June 30, 2019 and December 31, 2018, respectively  362,059   362,059 
Common stock, par value $.001 per share; 190,000,000 shares authorized; 135,331,951 and 134,793,211 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively  135,331   134,792 
Additional paid-in-capital  127,383,314   126,955,435   127,645,801   127,570,709 
Accumulated deficit  (119,301,087)  (123,471,034)  (124,535,585)  (123,171,406)
Total stockholders’ equity  9,918,292   5,319,800   4,948,172   6,236,720 
                
Total Liabilities and Stockholders’ Equity $13,206,905  $10,472,038  $9,776,643  $8,727,350 

 

See accompanying notes to the unaudited condensed consolidated financial statements


  

 3 

 


TELKONET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

  

Three Months Ended

June 30,

 

Six Months Ended

June 30,

 
 2017  2016  2017  2016  2019  2018  2019  2018 
Revenues, net:                                
Product $1,904,571  $1,360,887  $5,728,878  $6,356,437  $3,380,892  $2,820,805  $5,967,561  $4,324,463 
Recurring  131,665   143,028   344,708   340,412   189,143   153,357   365,676   254,895 
Total Net Revenue  2,036,236   1,503,915   6,073,586   6,696,849   3,570,035   2,974,162   6,333,237   4,579,358 
                                
Cost of Sales:                                
Product  1,160,019   770,830   3,233,978   3,194,094   2,077,066   1,376,729   3,767,664   2,370,966 
Recurring  55,702   36,618   118,347   92,324   77,072   66,482   163,114   126,479 
Total Cost of Sales  1,215,721   807,448   3,352,325   3,286,418   2,154,138   1,443,211   3,930,778   2,497,445 
                                
Gross Profit  820,515   696,467   2,721,261   3,410,431   1,415,897   1,530,951   2,402,459   2,081,913 
                                
Operating Expenses:                                
Research and development  500,656   429,622   1,323,669   1,321,007   425,670   431,856   912,296   870,636 
Selling, general and administrative  1,188,905   1,432,489   4,396,667   5,012,249   1,476,719   1,291,103   2,799,767   2,568,006 
Depreciation and amortization  14,616   8,382   34,405   24,366   17,043   16,628   33,975   33,543 
Total Operating Expenses  1,704,177   1,870,493   5,754,741   6,357,622   1,919,432   1,739,587   3,746,038   3,472,185 
                                
Operating Loss  (883,662)  (1,174,026)  (3,033,480)  (2,947,191)  (503,535)  (208,636)  (1,343,579)  (1,390,272)
                                
Other Income (Expenses):                                
Interest income (expense), net  8,722   (15,482)  2,797   (45,308)  (15,040)  4,054   (20,600)  1,524 
Total Other Income (Expense)  8,722   (15,482)  2,797   (45,308)  (15,040)  4,054   (20,600)  1,524 
                                
Loss from Continuing Operations before Provision (Benefit) for Income Taxes  (874,940)  (1,189,508)  (3,030,683)  (2,992,499)
Loss before Provision for Income Taxes  (518,575)  (204,582)  (1,364,179)  (1,388,748)
                                
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)
Provision for Income Taxes  0   2,000   0   2,000 
Net loss attributable to common stockholders $(518,575) $(206,582) $(1,364,179) $(1,390,748)
                                
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)
Basic – net (loss) attributable to common stockholders $(0.00) $(0.00) $(0.01) $(0.01)
                                
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)
Diluted – net (loss) attributable to common stockholders $(0.00) $(0.00) $(0.01) $(0.01)
                                
Weighted Average Common Shares Outstanding – basic  133,231,367   132,314,049   133,007,830   130,399,390   135,085,519   133,989,919   134,477,460   133,843,329 
Weighted Average Common Shares Outstanding –diluted  133,231,367   132,314,049   133,405,096   130,399,390   135,085,519   133,989,919   134,497,822   133,843,329 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

 

 

 4 

 

  

TELKONET, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

NINESIX MONTHS FROM JANUARY 1, 2017 THROUGH SEPTEMBERENDED JUNE 30, 20172018

 

  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 
 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             3,061    3,061 
                            
Net loss               (1,390,748) (1,390,748)
                            
Balance at June 30, 2018 185 $1,340,566  52 $362,059  133,989,919 $133,989 $127,460,169 $(121,545,404)$7,751,379 

TELKONET, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2019

 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, 2018 185 $1,340,566  52 $362,059  134,793,211 $134,792 $127,570,709 $(123,171,406)$6,236,720 
                            
Shares issued to directors         538,740  539  71,461    72,000 
                            
Stock-based compensation expense related to employee stock options             3,631    3,631 
                            
Net loss attributable to common stockholders               (1,364,179) (1,364,179)
                            
Balance at June 30, 2019 185 $1,340,566  52 $362,059  135,331,951 $135,331 $127,645,801 $(124,535,585)$4,948,172 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

 

 

 5 

 

 

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  $912,053 
 For the Six Months Ended 
 June 30, 
 2019 2018 
Cash Flows from Operating Activities:      
Net loss$(1,364,179)$(1,390,748)
       
Adjustments to reconcile net loss to cash used in operating activities:      
Stock-based compensation expense related to employee stock options 3,631  3,061 
Stock issued to directors as compensation 72,000  36,000 
Depreciation and amortization 33,975  33,543 
Provision for doubtful accounts, net of recoveries 19,174  (75)
Reserve for inventory obsolescence 197,440  (5,900)
Noncash operating lease expense 118,950   
       
Changes in operating assets and liabilities:      
Accounts receivable (1,393,138) (373,066)
Inventories (161,194) 282,868 
Prepaid expenses and other current assets 135,721  (452,538)
Accounts payable 647,256  (17,997)
Accrued liabilities and expenses 238,997  65,966 
Contract liability (268,707) (368,436)
Contract assets (200,331) (4,684)
Operating lease liability (109,791)  
Income tax receivable (5,646)  
Deferred lease liability   13,002 
Net Cash Used In Operating Activities (2,035,842) (2,179,004)
       
Cash Flows From Investing Activities:      
Purchase of property and equipment (5,318) (7,493)
Net Cash Used In Investing Activities (5,318) (7,493)
       
Cash Flows From Financing Activities:      
Proceeds from line of credit 5,604,000  200,000 
Payments on line of credit (4,861,349) (882,211)
Net Cash Provided (Used) In Financing Activities 742,651  (682,211)
       
Net decrease in cash and cash equivalents (1,298,509) (2,868,708)
Cash and cash equivalents at the beginning of the period 4,678,891  9,195,595 
Cash, cash equivalents and restricted cash at the end of the period$3,380,382 $6,326,887 
       
Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets:    
Cash and cash equivalents$3,380,382 $6,316,887 
Restricted cash   10,000 
Total cash, cash equivalents, and restricted cash$3,380,382 $6,326,887 

 

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,

 

Six Months Ended

June 30,

 
 2017  2016 2019 2018 
Supplemental Disclosures of Cash Flow Information:         
         
Cash transactions:             
Cash paid during the period for interest $11,485  $30,980 $35,650 $17,554 
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

 

 

 

 

 

 

 

 

 

 7 

 

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBERJUNE 30, 20172019

(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 ninesix months ended SeptemberJune 30, 2017,2019, are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2019. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated December 31, 20162018 financial statements and footnotes thereto included in the Company's Form 10-K filed with the SEC.

 

Business and Basis of Presentation

 

Telkonet, Inc. (the “Company”, “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 whilewhilst improving occupant comfort and convenience.

 

On March 28, 2017,The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Telkonet Communications, Inc. We currently operate in a single reportable business segment.

Going Concern and Management’s Plan

The accompanying financial statements have been prepared on a going concern basis which assumes the Company will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future and, thus, do not include any adjustments relating to the recoverability and classification of assets and liabilities that may be necessary if the Company is unable to continue as a going concern.

Since inception through June 30, 2019, we have incurred cumulative losses of $124,535,585 and have never generated enough funds through operations to support our business. For the six-month period ended June 30, 2019, we had an operating cash flow deficit of $2,035,842 from operations. The Company’s ability to continue as a going concern is dependent upon generating profitable operations in the future and obtaining the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. There can be no assurance that the Company will be able to secure such financing at commercially reasonable terms, if at all. If cash resources become insufficient to meet 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,ongoing obligations, the Company will be required to scale back or discontinue portions of its operations or discontinue operations entirely, whereby, DCI would acquirethe Company’s shareholders may lose some or all of the assets and certain liabilities of EthoStream 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.their investment.

 

 

 

 8 

 

 

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)

The condensed consolidated financial statements includeWe have not identified, and cannot be certain we will be able to identify, a course of action that guarantees the accountsachievement of profitable operations in the foreseeable future. In June 2018, the Company’s Board engaged an investment bank to identify strategic alternatives to maximize shareholder value, including but not limited to, a sale of the Company, and its wholly-owned subsidiaries, Telkonet Communications, Inc., and EthoStream. The current and prior period accountsan investment in the Company, a merger or other business combination, a sale of Ethostream haveall or substantially all assets or a strategic joint venture. At August 13, 2019, no definitive alternatives had been classified as discontinued operations onidentified.

At June 30, 2019, the condensed consolidated balance sheet, the condensed consolidated statement of operations and the condensed consolidated statementCompany had $3,380,382 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

approximately $1,056,000 of availability on its credit facility. The Company reported a net loss of $3,034,984 from continuing operations forcurrently expects to draw on these cash reserves and utilize the nine months ended September 30, 2017, had cash used in operating activities from continuing operations of $2,459,746 and had an accumulated deficit of $119,301,087. Since inception, the Company’s primary sources of ongoing liquidity for operations have come through private 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 Bankto finance its near term working capital needs. It expects to continue to incur operating losses and negative operating cash flows for one year beyond the date of Commerce, a California state chartered bank (“Heritage Bank”), was executed to amend certain terms of the Loanthese financial statements. Accordingly, and Security Agreement (the “Heritage Bank Loan Agreement”) following the sale of certain assetsin light 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 ifhistoric and continuing losses, there is substantial doubt about 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 yearability to September 30, 2019.

The outstanding balance of the revolving credit facility was $79,953continue 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.

9

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)going concern.

 

Income (Loss) per Common Share

 

The Company computes earnings per share under ASC 260-10, “Earnings Per Share”. Basic net income (loss) per common share is computed using the weighted average shares outstanding. Diluted 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 ninesix months ended SeptemberJune 30, 20172019 and 2016,2018, there were 5,621,8003,599,793 and 2,240,2253,557,399 shares of common stock underlying options and warrants excluded due to these instruments being anti-dilutive, respectively.

 

Use of Estimates

 

The preparation of financial statements in conformity with United States of America (U.S.) generally accepted accounting principles (“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 and 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,de-recognition, classification, treatment of interest and penalties, and disclosure of such positions.

 

9

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, the Standard outlines a comprehensive five-step revenue recognition model based on the principle that an entity should recognize revenue based on when 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 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 revenuethe customer and both parties are committed to perform their respective obligations, (2) the Company can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred;identify each party’s rights regarding goods or services transferred, (3) the sellingCompany 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.

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 technical phone support services to customers. This service is considered a separate performance obligation.

Determine the transaction price

The Company generally enters into contracts containing fixed prices. It is fixednot 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 determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regardingadjust the fixed naturetransaction 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. 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 to be recognized over the extended service periods. Contracts involving an extended warranty are immaterial and will continue to be combined with technical phone support services revenue and recognized on a straight-line basis over the term 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.contract.

 

 

 

 10 

 

 

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)Allocate the transaction price to the performance obligations

 

Multiple-Element Arrangements (“MEAs”): The Company accounts forRevenues from customer 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 valueallocated 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,separate performance obligations based on thetheir relative stand-alone selling price of each unit of accounting based first on vendor-specific objective evidence (“VSOE”SSP”) if it exists, second on third-party evidence (“TPE”) if it exists and on estimated selling price (“ESP”) if neither VSOE or TPE exist.

VSOE – In most instances, products are sold separately in stand-alone arrangements. Services are also sold separately through renewals of contracts with varying periods.at contract inception. The Company determines VSOE based on pricing and discounting practices for the specific product or service when sold separately, considering geographical, customer, and other economic or marketing variables, as well as renewal rates or stand-alone prices for the service element(s).

TPE – If the Company cannot establish VSOE of selling price for a specific product or service included in a multiple-element arrangement, the Company uses third-party evidence of selling price. The Company determines TPE based on sales of a comparable amount of similar product or service offered by multiple third parties considering the degree of customization and similarity of product or service sold.

ESP – The estimated selling price representsSSP is the price at which the Company would sell a productpromised good or service if it wereseparately. The best evidence of an SSP is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers. However, turnkey solutions are sold onfor a stand-alone basis. When neither VSOE nor TPE existsbroad range of amounts resulting from, but not limited to, tiered discounting for all elements,value added resellers (“VAR”) based upon committed volumes and other economic factors. Due to the high variability of our pricing, the Company determines ESP forcannot establish a reliable SSP using observable data. Accordingly, the arrangement element based on sales, costCompany uses the residual approach to allocate the transaction price to performance obligations related to its turnkey solutions. When support services are not included within the turnkey solution, the residual method is not utilized and margin analysis, as well as other inputs based on the Company’s pricing practices. Adjustments for other market and Company-specific factors are made as deemed necessary in determining ESP.

Under the estimated selling price method, revenue is recognized in MEAs based on estimated selling prices for allno allocation of the elements intransaction price to 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.performance obligation is necessary.

 

When MEAs includeAll 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 consistently priced and therefore would support the use of SRP as the best estimate of 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. AsSSP for 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.performance obligations.

Revenue Recognition

 

The Company provides call centerrecognizes revenues from product only sales at a point in time, when control over the product has transferred to the customer. As the Company’s principal terms of sale are FOB shipping point, the Company primarily transfers control and records revenue for product only sales upon shipment.

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 uses an outputs measure based on the number of rooms installed to recognize revenues from turnkey solutions.

Revenues 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 servicescontract, and are fixed and determinable prior to deliverypresented as “Recurring Revenue” in the Statement 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 includesOperations.

Contract liabilities include deferrals for the monthly support service fees. Long-term deferred revenue representscontract liabilities represent support service fees tothat will be earned or provided beginningrecognized as revenue after SeptemberJune 30, 2018. Revenue recognized that has not yet been billed to a customer results in an asset as2020.

Contract Fulfillment Cost

The Company recognizes related costs of the endcontract over time in relation to the revenue recognized. Costs included within the projects relate to the cost of the period. Asmaterial, direct labor and costs of September 30, 2017 and December 31, 2016, there was $68,855 and $193,400 recorded within accounts receivable, respectively, relatedoutside services utilized to revenue recognized that has not yet been billed.

11

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)complete projects. These are represented as “Contract assets” in the condensed consolidated balance sheets.

  

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 ninesix months ended SeptemberJune 30, 20172019 and the year ended December 31, 2016,2018, the Company experienced returns of approximately 1.0%1% to 2.5%2% of materials included in the cost of sales. As of SeptemberJune 30, 20172019 and December 31, 2016,2018, the Company recorded warranty liabilities in the amount of $77,810$32,503 and $95,540,$46,103, respectively, using this experience factor range.

 

11

Product warranties for the ninesix months ended SeptemberJune 30, 20172019 and the year ended December 31, 20162018 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.

 June 30,
2019
 December 31,
2018
 
Beginning balance$46,103 $59,892 
Warranty claims incurred (37,658) (28,000)
Provision charged to expense 24,058  14,211 
Ending balance$32,503 $46,103 

 

NOTE B – NEW ACCOUNTING PRONOUNCEMENTS

 

In May 2014,June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 provides guidance for estimating credit losses on certain types of financial instruments, including trade receivables, by introducing an approach based on expected losses. The expected loss approach will require entities to incorporate considerations of 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 guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The 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 BoardRecently Adopted

Effective January 1, 2019, the Company has adopted ASU 2016-02, Leases (“FASB”ASU 2016-02”) 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 ofsubsequently amended in 2018 by ASU 2014-092018-10, ASU 2018-11 and ASU 2018-20 and codified in ASC 842, Leases (“ASC 842”). ASC 842 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, including2018 and interim periods within that reporting period,thereafter. Earlier application was permitted, however the Company did not elect to do so. ASC 842 supersedes current lease guidance in August 2015ASC 840 and requires a lessee to recognize a right-of-use asset and a corresponding lease liability for substantially all leases. The lease liability will be equal to the FASB delayedpresent value of the effectiveremaining lease payments while the right-of-use asset will be similarly calculated and then adjusted for initial direct costs. In addition, ASC 842 expands the disclosure requirements to increase the transparency and comparability of the amount, timing and uncertainty of cash flows arising from leases.

We chose to elect available practical expedients permitted under the guidance, which among other items, allowed the Company to carry forward its historical lease classification to not reassess leases for the definition of lease under the new standard, and to not reassess initial direct costs for existing leases. Refer below for practical expedient package adopted:

·Whether expired or existing contracts contain leases under the new definition of the lease;

·Lease classification for expired or existing leases; and

·Whether previously capitalized initial direct costs would qualify for capitalization under ASC 842.

Upon the adoption of ASC 842, we have elected to not recognize a right-of-use asset and related lease liability for leases with an initial term of 12 months or less as an accounting policy choice and elected to account for lease and non-lease components as a single lease component.

The Company elected to utilize the new alternative transition approach introduced by ASU 2018-11, under which the standard is adopted and measured from the first 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 standardfiscal year under adoption, 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 ofthis case January 1, 20182019. Comparative periods are presented in accordance with a cumulative effect adjustmentTopic 840 and do not include any retrospective adjustments to opening retained earnings, if necessary, undercomparative periods to reflect the modified retrospective approach. The Company has developed a project plan for the implementationadoption 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.Topic 842.

 

 

 

 12 

 

 

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBERAs of June 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 lessee2019, $1.0 million was included in total other assets, $0.2 million in total current liabilities, and $0.8 million in total long-term liabilities. There was no impact on our Condensed Consolidated Statements of Operations. Refer to record a ROU asset and a lease liability on the balance sheetNote K 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.

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). The new standard provides guidance 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 changes to terms or conditions of a share-based payment award that would require an entity to apply modification accounting. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The amendments in this update should be applied prospectively to an award modified on or after the adoption date.further discussion.

  

NOTE C– ACCOUNTS RECEIVABLEREVENUE

 

Components of accounts receivable as of SeptemberThe following table presents the Company’s product and recurring revenues disaggregated by industry for the three months ended June 30, 2017 and December 31, 2016 are as follows:2019.

   

  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 
 Hospitality Education Multiple Dwelling Units Government Total 
Product$2,326,641 $452,417 $111,624 $490,210 $3,380,892 
Recurring 149,224  21,604  18,315    189,143 
 $2,475,865 $474,021 $129,939 $490,210 $3,570,035 

 

NOTE D – ACCRUED LIABILITIES AND EXPENSESThe following table presents the Company’s product and recurring revenues disaggregated by industry for the six months ended June 30, 2019.

 Hospitality Education Multiple Dwelling Units Government Total 
Product$4,021,290 $708,153 $312,050 $926,068 $5,967,561 
Recurring 305,496  41,049  19,131    365,676 
 $4,326,786 $749,202 $331,181 $926,068 $6,333,237 

Sales taxes and other usage-based taxes are excluded from revenues.

 

Accrued liabilities and expenses at September 30, 2017 and December 31, 2016 are as follows:Remaining performance obligations

 

  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 

As of June 30, 2019, the aggregate amount of the transaction price allocated to remaining performance obligations was approximately $0.6 million. Except for support services, the Company expects to recognize 100% of the remaining performance obligations over the next six months.

Contract assets and liabilities

 June 30,
2019
 December 31,
2018
 Variance 
Contract assets$515,080 $314,749 $200,331 
Contract liabilities 963,916  1,232,623  (268,707)
Net contract liabilities$448,836 $917,874 $(469,038)

Contracts are billed in accordance with the terms and conditions, either at periodic intervals or upon substantial completion. This can result in billings occurring subsequent to revenue recognition, resulting in contract assets. Contract assets are presented as current assets in the Condensed Consolidated Balance Sheet. There were $0.2 million of costs incurred to fulfill contracts in the closing balance of contract assets.

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. The change in the contract liability balance during the six-month period ended June 30, 2019 is the result of cash payments received and billing in advance of satisfying performance obligations.

 

 

 

 

 13 

 

 

NOTE D – ACCOUNTS RECEIVABLE

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSComponents of accounts receivable as of June 30, 2019 and December 31, 2018 are as follows:

SEPTEMBER 30, 2017

(UNAUDITED)

 June 30,
2019
 December 31,
2018
 
Accounts receivable$2,523,149 $1,146,832 
Allowance for doubtful accounts (67,894) (65,541)
Accounts receivable, net$2,455,255 $1,081,291 

  

NOTE E – DEBTACCRUED LIABILITIES AND EXPENSES

 

Kross Promissory Note

On August 4, 2016, the Board of Directors authorized the Company to reimburse Peter T. Kross (“Mr. Kross”) $161,075 forAccrued liabilities and expenses incurred related to his successful contested proxy. Effectiveat 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, 20172019 and December 31, 2016 was zero and $97,127, respectively.2018 are as follows:

 June 30,
2019
 December 31,
2018
 
Accrued payroll and payroll taxes$254,677 $241,253 
Accrued expenses 451,122  239,793 
Accrued professional 88,930  86,062 
Accrued sales taxes, penalties, and interest 68,376  43,400 
Product warranties 32,503  46,103 
Total accrued liabilities$895,608 $656,611 

NOTE F – DEBT

 

Revolving Credit Facility

 

On September 30, 2014, theThe Company and its wholly-owned subsidiary, EthoStream, as co-borrowers (collectively, the “Borrowers”), entered intois a party to 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 capital and other general business purposes. The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 7.25%8.50% at SeptemberJune 30, 20172019 and 6.75%8.50% at December 31, 2016.2018. 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.stock, for further information on the accounting for warrants, refer to Note I. The warrant has an exercise price of $0.20 and expires October 9, 2021. On February 17, 2016, an13, 2019, the tenth amendment to the Credit Facility was executed extending the maturity date to September 30, 2018,2020, 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 containcontains financial covenants, that require the Borrowers to maintainincluding a minimummaximum EBITDA level,loss covenant, measured quarterly, a minimum asset coverage ratio, measured monthly, and a minimum unrestricted cash account balances.balance of $2 million. During the year ended December 31, 2018 and the quarter ended March 31, 2019, the Company and Heritage Bank entered into several amendments to the Credit Facility to adjust these covenant levels. As long as the Company maintains the minimum unrestricted cash balance of $2 million, a violation of the minimum EBITDA level will not trigger an event of default. 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. The outstanding balance on the Credit Facility was $79,953 and $1,062,129 at September 30, 2017 and December 31, 2016, respectively. The remaining available borrowing capacity was approximately $1,304,000 and $107,000 at September 30, 2017 and December 31, 2016, 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.

 

 

 14 

 

  

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)

On August 29, 2017, an amendment toThe outstanding balance on the Credit Facility with Heritage Bank was executed to amend certain terms$864,125 and $121,474 at June 30, 2019 and December 31, 2018 and the remaining available borrowing capacity was approximately $1,056,000 and $499,000, respectively. As 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, 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 ifJune 30, 2019, the Company deviates from its projected EBITDA for the quarters ended September 30, 2017 or December 31, 2017, the Company will be deemed to bewas 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.with all financial covenants.

 

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 and Restated 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 SeptemberJune 30, 2017,2019, the liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $409,009,$445,406, which includes cumulative accrued unpaid dividends of $149,009,$185,406, and second, Series A with a preference value of $1,507,481,$1,636,875, which includes cumulative accrued unpaid dividends of $582,481.$711,875. As of December 31, 2016,2018, the liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $393,435,$435,081, which includes cumulative accrued unpaid dividends of $133,435,$175,081, and second, Series A with a preference value of $1,452,114,$1,600,168, which includes cumulative accrued unpaid dividends of $527,114.

15

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)$675,168.

  

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 SeptemberAt June 30, 20172019 and December 31, 2016,2018, 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 SeptemberJune 30, 20172019 and December 31, 20162018 the Company had 133,440,111135,331,951 and 132,774,475134,793,211 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.outstanding, respectively.

  

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 SeptemberJune 30, 2017.2019.

 

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 

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   7.51  $0.14   2,000,000  $0.14 
 $0.16 - $0.99   1,349,793   4.35   0.18   1,171,488   0.18 
     3,349,793   6.24  $0.16   3,171,488  $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, 2018 4,376,474 $0.18 
Granted  1,300,000   0.17  67,394 0.14 
Exercised         
Cancelled or expired  (292,500)  0.69  (1,094,075) 0.17 
Outstanding at December 31, 2016  2,832,725  $0.18 
Outstanding at December 31, 2018 3,349,793 $0.16 
Granted  3,000,000   0.14    
Exercised         
Cancelled or expired  (280,925)  0.17     
Outstanding at September 30, 2017  5,551,800  $0.16 
Outstanding at June 30, 2019 3,349,793 $0.16 

 

The expected life of awards granted represents

15

During 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.

There were 3,000,000 and zero options granted and zero options exercised during the ninesix months ended SeptemberJune 30, 20172019 and 2016,2018, no options were granted nor were any options exercised. During the six months ended June 30, 2019 and 2018, zero and 1,069,075 options were cancelled or expired, 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 SeptemberJune 30, 20172019 and 20162018 was $2,343$1,815 and $2,703, respectively,$1,531, respectively. Total stock-based compensation expense in connection with options granted to employees recognized in the condensed consolidated statements of operations for the six months ended June 30, 2019 was $3,631, and $320,545 and $10,204,$3,061, 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 

17

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  2.27  $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, 2018  250,000  $0.20 
Issued            
Exercised  (5,211,542)  0.13       
Cancelled or expired  (126,868)  3.00       
Outstanding at December 31, 2016  300,000   0.20 
Outstanding at December 31, 2018  250,000   0.20 
Issued            
Exercised            
Cancelled or expired            
Outstanding at September 30, 2017  300,000  $0.20 
Outstanding at June 30, 2019  250,000  $0.20 

 

There were no warrants granted, exercised, cancelled or forfeited during the ninesix months ended SeptemberJune 30, 20172019 and no warrants granted, 5,211,542 warrants exercised and 126,868 cancelled or forfeited during the nine months ended September 30, 2016, respectively.2018.

 

NOTE IJ – RELATED PARTY TRANSACTIONS

 

On August 4, 2016,During the Board of Directors authorizedsix months ended June 30, 2019 and during the year ended December 31, 2018, the Company agreed 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 nine months ended September 30, 2017, the Company issuedissue common stock in the amount of $108,000$72,000 and $144,000, respectively, 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 nine months ended September 30, 2017, each of Messrs. Tienor, Sobieski and Koch, were granted 1,000,000 stock options at fair market value and all were scheduled to vest over a three year period. However, pursuant to the terms of the employment agreements, the stock options vested immediately upon the sale of the Company’s subsidiary, EthoStream, in March 2017.

16

NOTE K – COMMITMENTS AND CONTINGENCIES

 

DuringLeases

On January 1, 2019 the nine months ended September 30, 2017, Messrs. Tienor, SobieskiCompany adopted ASC Topic 842 “Leases” (“ASC 842”), which supersedes ASC Topic 840 “Leases” (“ASC 840”), using the alternative transition method of adoption. Under this method of adoption, the Company has recognized and Koch, earnedmeasured all leases that exist as at January 1, 2019 (the effective date) using a bonusmodified retrospective transition approach. Comparative periods are presented in accordance with Topic 840 and do not include any retrospective adjustments to comparative periods to reflect the adoption of $29,250 contingentTopic 842. Any cumulative-effect adjustments to retained earnings is recognized as of January 1, 2019. Upon adoption, we recognized our leases with greater than one year in duration on the salebalance sheet as right-of-use assets and sale price amountlease liabilities. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Classification is based on criteria that are largely similar to those applied in prior lease accounting, but without explicit lines. We have made certain assumptions in judgments when applying ASC 842. Those judgments of Ethostream.most significance are as follows:

 

·We elected the package of practical expedients available for transition which allow us to not reassess the following:

From time to time

oWhether expired or existing contracts contain leases under the new definition of the lease;

oLease classification for expired or existing leases; and

oWhether previously capitalized initial direct costs would qualify for capitalization under ASC 842.

·We did not elect to use hindsight for transition when considering judgments and estimates such as assessments of lessee options to extend or terminate a lease or purchase the underlying asset.

·For all asset classes, we elected to not recognize a right-of-use asset and lease liability for leases with a term of 12 months or less.

·For all asset classes, we elected to not separate non-lease components from lease components to which they relate and have accounted for the combined lease and non-lease components as a single lease component.

We determine if an arrangement is a lease at inception. Operating leases are included in our consolidated balance sheet as right-of-use assets, operating lease liabilities - current and operating lease liabilities – long term. Upon adoption, 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,determined there were no financing leases. Our current operating leases are for facilities and office equipment. Our leases may contain renewal options; however, we do not recognize right-of-use assets or lease liabilities for renewal periods unless it is determined that we are reasonably certain of renewing the lease at inception or when a triggering event occurs. Some of our lease agreements may contain rent escalation clauses, rent holidays, capital improvement funding, or other lease concessions. We recognize our minimum rental expense on a straight-line basis based on the fixed components of a lease arrangement. Payments are set on a pre-determined schedule within each lease agreement. We amortize this expense over the term of the lease beginning with the date of the standard adoption for current leases and beginning with the date of initial possession, which is the date we enter the leased space and begin to make improvements in the preparation for its intended use, for future leases. Variable lease components represent amounts that are not fixed in nature and are not tied to an index or rate, and are recognized as incurred. Variable lease components consist primarily of common area maintenance, taxes and insurance.

The Company does not, upon adoption of ASC 842, control a specific space or underlying asset used in providing a service by a third-party service provider, under any third party service agreements. There are no such arrangements.arrangements that meet the definition under ASC 842.

In determining our right-of-use assets and lease liabilities, we apply a discount rate to the minimum lease payments within each lease agreement. ASC 842 requires us to use the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. When we cannot readily determine the discount rate implicit in the lease agreement, we utilize our current borrowing rate on our outstanding line of credit. The Company’s line of credit utilizes market rates to assess an interest rate. Refer to Note F for further discussion.

 

 

 

 1817 

 

 

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)We lease certain property under non-cancelable operating leases, primarily facilities. The impact of the adoption of ASC 842 at January 1, 2019 created a right-of-use asset of $1,042,004, lease liability of $1,095,761 and unwound the $71,877 balance of the deferred lease liability account.

 

NOTE J – COMMITMENTS AND CONTINGENCIESThe components of lease expense for the six months ended June 30, 2019 were as follows:

 

Operating lease expense:   
Operating lease cost - fixed $118,949 
Variable lease cost  61,883 
Total operating lease cost $180,832 

Office Lease Obligations

Other information related to leases as of June 30, 2019 was as follows:

 

Operating lease liability - current $218,614 
Operating lease liability - long-term $830,907 
Operating cash outflows from operating leases $109,794 
     
Weighted-average remaining lease term of operating leases  6.1 years 
Weighted-average discount rate of operating leases  8.5% 

In October 2013, the Company entered into a

Future annual minimum operating lease agreement for 6,362 square feetpayments as 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 AprilJune 30, 2026. The commencement date for this amendment was July 15, 2017.2019 were as follows:

 

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.

2019 (excluding the six months ended June 30, 2019) $110,005 
2020  223,835 
2021  242,299 
2022  195,176 
2023  193,169 
2024 and thereafter  384,119 
Total minimum lease payments $1,348,603 
Less imputed interest  (299,082)
Total $1,049,521 

 

In May 2017, the Company entered into aFuture annual minimum 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 rentalspayments under non-cancelable leases as of September 30, 2017December 31, 2018 prior to our adoption of ASU 2016-02, Leases (Topic 842) 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 
2019 $211,448 
2020  223,417 
2021  242,785 
2022  195,176 
2023  193,168 
2024 and thereafter  380,714 
Total $1,446,708 

 

Rental expenses charged to continuing operations for the three ended June 30, 2019 and nine2018 was $91,306 and $87,067. Rental expenses charged to operations for the six months ended SeptemberJune 30, 20172019 and 20162018 was $86,649$180,832 and $42,271 and $200,816 and $127,537,$170,949, 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.

 

 

 1918 

 

 

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITEDSales Tax)

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 SeptemberJune 30, 20172019 and December 31, 2016:2018:

 

 

September 30,

2017

 December 31, 2016   June 30,
2019
 December 31,
2018
 
Balance, beginning of year $274,869  $229,768   $43,400  $83,282 
Sales tax collected 235,091 452,016    92,226   101,145 
Provisions (reversals) (52,000) 151,000  
Provisions  (3,544)  30,465 
Interest and penalties - (3,017)       
Payments  (385,629)  (554,898)   (63,707)  (171,492)
Balance, end of period $72,331 $274,869   $68,375  $43,400 

 

NOTE KL – BUSINESS CONCENTRATION

 

For the ninesix months ended SeptemberJune 30, 20172019, three customers represented 15%, 12% and 2016, no single11% of total net revenues. For the six months ended June 30, 2018, one customer represented 10% or moreapproximately 11% of total net revenues. As of SeptemberJune 30, 2017, one customer accounted for approximately 10%2019, three customers represented 17%, 15% and 13% of the Company’s net accounts receivable. As of December 31, 2016,2018, two customers accounted for approximately 24%represented 29% and 11% of the Company’s net accounts receivable.

 

Purchases from one supplier approximated $2,122,000,$1,855,000, or 86%83%, of purchases for the ninesix months ended SeptemberJune 30, 20172019 and $1,907,000,$1,975,000, or 77%88%, of purchases for the ninesix months ended SeptemberJune 30, 2016. Total2018. Totals due to this supplier, net of deposits, waswere approximately $525,858$440,000 as of SeptemberJune 30, 2017, and $45,0372019. Deposits paid exceeded totals due to this supplier by $320,352 as of December 31, 2016.

NOTE L – 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 for 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 all of the assets and certain liabilities of EthoStream for a base purchase price of $12,750,000. The Purchase Agreement includes that proceeds of $900,000 are 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. The escrow amount, net of potential claims, would be fully released after an escrow period not 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.  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.

20

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)

The following table summarizes the balance sheet information for 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 

21

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)

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 three 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.

2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

 2219 

 

 

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 ninesix months ended SeptemberJune 30, 2017,2019, 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, 2016,2018, filed with the U.S.US Securities and Exchange Commission (the “SEC”) on April 3, 2017.1, 2019.

 

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 We currently operate in a plan to offer for sale EthoStream LLC (“EthoStream”), its wholly-owned High-Speed Internet Access (“HSIA”) subsidiary. The sale will enable the Company to 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 months ended September 30, 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. The transaction closed on March 29, 2017.single reportable business segment.

  

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 20172019 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.

23

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.

VSOE – In most instances, products are sold separately in stand-alone arrangements. Services are also sold separately through renewals of contracts with varying periods. The Company determines VSOE based on pricing and discounting practices for the specific product or service when sold separately, considering geographical, customer, and other economic or marketing variables, as well as renewal rates or stand-alone prices for the service element(s).

TPE – If the Company cannot establish VSOE of selling price for a specific product or service included in a multiple-element arrangement, the Company uses third-party evidence of selling price. The Company determines TPE based on sales of a comparable amount of similar product or service offered by multiple third parties considering the degree of customization and similarity of product or service sold.

ESP – The estimated selling price represents the price at which the Company would sell a product or service if it were sold on a stand-alone basis. When neither VSOE nor TPE exists for all elements, the Company determines ESP for the arrangement element based on sales, cost and margin analysis, as well as other inputs based on the Company’s pricing practices. Adjustments for other market and Company-specific factors are made as deemed necessary in determining ESP.

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.

24

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 10-K filed April 1, 2019 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 
  June 30, 2019  June 30, 2018  Variance 
                   
Product $3,380,892   95%  $2,820,805   95%  $560,087   20% 
Recurring  189,143   5%   153,357   5%   35,786   23% 
Total $3,570,035   100%  $2,974,162   100%  $595,873   20% 

 

   

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% 

20

  Six Months Ended 
  June 30, 2019  June 30, 2018  Variance 
                   
Product $5,967,561   94%  $4,324,463   94%  $1,643,098   38% 
Recurring  365,676   6%   254,895   6%   110,781   44% 
Total $6,333,237   100%  $4,579,358   100%  $1,753,879   38% 

 

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 and six months ended SeptemberJune 30, 2017,2019, product revenue increased by 40%20% or $0.5$0.56 million and for38% or $1.64 million, respectively, when compared to the nine months ended September 30, 2017,prior year. Increases are primarily attributable to volume generated from value added resellers and distribution partners. Beginning in the third quarter of 2019, the Company began implementing portfolio pricing increases, which are expected to positively impact product revenue decreased 10% or $0.6 million. revenue.

For the three months ended SeptemberJune 30, 2017,2019, hospitality revenues increased $0.27 million to $2.33 million compared to the prior year period. For the three months ended June 30, 2019, education revenues decreased $0.19 million to $0.45 million compared to the prior year period. For the three months ended June 30, 2019, government revenues increased $0.43 million to $0.49 million compared to the prior year period. For the three months ended June 30, 2019, actual product revenues increased by $0.79 million while installation revenues decreased by $0.10 million.

For the six months ended June 30, 2019, hospitality market comprised $1.3revenues increased $0.48 million ofto $4.02 million compared to the prior year period. For the six months ended June 30, 2019, government revenues increased $0.85 million to $0.93 million compared to the prior year period. For the six months ended June 30, 2019, actual product salesrevenues increased by $2.06 million while installation revenues decreased by $0.30 million.

Product revenues derived from value added resellers and distribution partners were $2.65 million for the three months ended SeptemberJune 30, 2017, a $0.1 million decrease from2019, an increase of 12% compared to the prior year period. The education market sales for the three months ended September 30, 2017 increased $0.3 million to $0.4 millionProduct revenues derived from $0.1value added resellers and distribution partners were $4.73 million for the prior year period. The Multiple Dwelling Unit (“MDU”) market increased $0.2 million from $0.0 million during the threesix months ended SeptemberJune 30, 2016. The hospitality market sales for the nine months ended September 30, 2017 decreased $0.7 million2019, an increase of 30% compared to $4.2 million from $4.9 million for the prior year period. The education market sales for the nine months ended September 30, 2017 increased $0.1

Backlogs were approximately $4.00 million to $1.0 million from $0.9 million forbegin the prior year periodthree and six month periods ended June 30, 2019. The Company ended 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’s distribution channels through resellers and value added distribution partners decreased from $3.1 million for the nine months ended September 30, 2016 to $2.8 million at September 30, 2017.quarter with a backlog of approximately $3.60 million.

25

 

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 ninesix months ended SeptemberJune 30, 2017,2019, recurring revenue decreased by 8% and increased by 1%23% and 44%, respectively, when compared to the prior year period.   Increases were related to increased unit sales with call center support services included.

  

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% 
  Three Months Ended 
  June 30, 2019  June 30, 2018  Variance 
                   
Product $2,077,066   61%  $1,376,729   49%  $700,337   51% 
Recurring  77,072   41%   66,482   43%   10,590   16% 
Total $2,154,138   60%  $1,443,211   49%  $710,927   49% 

 

   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% 

 

21

  Six Months Ended 
  June 30, 2019  June 30, 2018  Variance 
                   
Product $3,767,664   63%  $2,370,966   55%  $1,396,698   59% 
Recurring  163,114   45%   126,479   50%   36,635   29% 
Total $3,930,778   62%  $2,497,445   55%  $1,433,333   57% 

Costs of Product RevenueSales

 

Costs of product revenue include equipment and installation labor related to EcoSmart technology. For the three and ninesix months ended SeptemberJune 30, 2017,2019, product costs increased by 50%51% and 1%59%, respectively, compared to the prior year periods.

For the three month comparison, the materialsvariance was primarily attributable to an increase of $0.34 million in material costs, an increase of $0.16 million in logistical expenses, inclusive of import tariffs, an increase of $0.15 million in the use of installation subcontractors and an increase of $0.07 million to the inventory obsolescence reserve. Material costs as a percentage of product sales increased 2%revenues was 50%, a decrease of 3%, compared to 45% for the three month ended September 30, 2017 from 43% for the three months ended September 30, 2016. 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 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.prior year period.

 

For the ninesix month comparison, the variance was primarily attributable to an increase of $0.75 million in material costs, an increase of $0.41 million in logistical expenses, inclusive of import tariffs and an increase of $0.27 million in the use of outside contractors for installations resulted in a $0.20 million decrease in salary, wages and travel expense.installation subcontractors. These decreasesincreases were partially offset by a $0.16 million adjustment in inventory costs, a $0.03 million increase in freightdecrease to the inventory obsolescence reserve. Material costs as a $0.03 million increase in outside services andpercentage of product revenues was 43%, a $0.02 million increase in parts and supplies and warranty expense.decrease of 3%, compared to the prior year period.

Costs of Recurring Revenue

 

Recurring costs are comprised primarily of labor and telecommunication services for our customer service department. For the three and ninesix months ended SeptemberJune 30, 2017,2019, recurring costs increased by 52%16% and 28%29%, respectively, when compared to the prior year periods. The threeThese variances were primarily due to salary, benefits and nine month variances are the result of a $0.02 million and a $0.03 million increase in salary and benefit costs for the period ended September 30, 2017. The Company added a support services supervisor.temporary staffing.

 

Gross Profit

  Three Months Ended 
  June 30, 2019  June 30, 2018  Variance 
                   
Product $1,303,826   39%  $1,444,076   51%  $(140,250)  (10%)
Recurring  112,071   59%   86,875   57%   25,196   29% 
Total $1,415,897   40%  $1,530,951   51%  $(115,054)  (8%)

  Six Months Ended 
  June 30, 2019  June 30, 2018  Variance 
                   
Product $2,199,897   37%  $1,953,497   45%  $246,400   13% 
Recurring  202,562   55%   128,416   50%   74,146   58% 
Total $2,402,459   38%  $2,081,913   45%  $320,546   15% 

 

 2622 

 

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% 

   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 six months ended June 30, 2019 decreased 10% and increased 13%, respectively, when compared to the prior year periods.

For the three months ended June 30, 2019, the actual gross profit percentage decreased 12% to 39%. Contributing to the decrease were increases in logistical expenses, use of installation subcontractors and the inventory obsolescence reserve, partially offset by a decrease in material costs as a percentage of product revenues.

For the six months ended June 30, 2019, the actual gross profit percentage decreased 8% to 37%. Contributing to the decrease were increases in logistical expenses and installation subcontractors, partially offset by a decrease in material costs as a percentage of product revenues.

Gross Profit on Recurring Revenue

 

Gross profit for the three and ninesix months ended SeptemberJune 30, 20172019 increased by 26%29% and decreased by 21%58%, respectively, when compared to the prior year periods. Increases were related to increased unit sales with call center support services included.

For the three months ended SeptemberJune 30, 2017,2019, the actual gross profit percentage declinedincreased 2% 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, 201759% when compared to the prior year period. The inventory valuation adjustment variance of $0.16 million duringFor the ninesix months ended SeptemberJune 30, 20172019, the actual gross profit percentage increased 5% to 55% when compared to the prior year period also contributed to gross profit decline.period.

 

Gross Profit on Recurring Revenue

The gross profit associated with recurring revenue decreased by 29% and 9%, respectively, for the three and nine months ended September 30, 2017 when compared to the prior year periods. For the three months ended September 30, 2017, the actual gross profit percentage decreased 16% compared to the prior year period, from 74% to 58%. The primary reason was a manager was added to the Company’s support department, increasing wages 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%.

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 June 30, 
  2019  2018  Variance 
                 
Total $1,919,432  $1,739,587  $179,845   10% 

 

 

27

  Six Months Ended June 30, 
  2019  2018  Variance 
                 
Total $3,746,038  $3,472,185  $273,853   8% 

 

During the three and ninesix months ended SeptemberJune 30, 2017,2019, operating expenses decreasedincreased by 9%10% and 8%, respectively, when compared to the prior year periods as outlined below.

 

Research and Development

   Three Months Ended September 30 
   2017  2016  Variance 
                   
 Total  $500,656  $429,622  $71,034   17% 
  Three Months Ended June 30, 
  2019  2018  Variance 
                 
Total $425,670  $431,856  $(6,186)  (1%)

 

   Nine Months Ended September 30, 
   2017  2016  Variance 
                   
 Total  $1,323,669  $1,321,007  $2,662   0% 

  Six Months Ended June 30, 
  2019  2018  Variance 
                 
Total $912,296  $870,636  $41,660   5% 

23

 

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 ninesix months ended SeptemberJune 30, 2017,2019, research and development costs decreased by 1% and increased by 17% and 0%5%, respectively, when compared to the prior year periods. For the three month comparison, the variance is not attributable to any one specific expense. For the six month comparison the variance is due to an approximate $0.04 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$0.05 million increase in consulting and a $0.02 million increase for new product certification expenses, for the nine months ended September 30, 2017.partially offset by decreases in various other expenses.

  

Selling, General and Administrative Expenses

 

  Three Months Ended September 30, 
  2017  2016  Variance 
                 
Total $1,188,905  $1,432,489  $(243,584)   -17% 
  Three Months Ended June 30, 
  2019  2018  Variance 
                 
Total $1,476,719  $1,291,103  $185,616   14% 

 

  Nine Months Ended September 30, 
  2017  2016  Variance 
                 
Total $4,396,667  $5,012,249  $(615,582)   -12% 

 

  Six Months Ended June 30, 
  2019  2018  Variance 
                 
Total $2,799,767  $2,568,006  $231,761   9% 

During the three and ninesix months ended SeptemberJune 30, 2017,2019, selling, general and administrative expenses decreasedincreased over the prior year periods by 17%14% and 12%9%, respectively. For the three month comparison, the variance is due to a $0.04 million increase in professional services, a $0.04 million increase to the sale of EthoStream, the Company was able to decrease executive, accountingbad debt reserve and sales salaries, wages and benefits by $0.20 million. Aa $0.07 million decrease was a result of a refund received from a utility. The Company hadincrease in personnel expenses. For the six month comparison, the variance is due to a $0.09 million decreasenet increase due to changes 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 million of the variance is attributed to the costs associated 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, accountingsalary, recruiting efforts and sales salaries, wagescommissions and benefits of $0.61a $0.09 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, $0.04 million for insurance expense. These reductions in expense were offset by an increase in stock option expense of $0.31 million, marketinglegal 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.

28

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% 

Income from discontinued operations decreased $0.79 million or 99% and $1.45 million or 71% for the three and nine months ended September 30, 2017 over the prior year periods. On March 29, 2017, pursuant to the terms and the conditions of the Purchase Agreement, the Company closed on the sale of EthoStream. 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. After March 28, 2017, certain liabilities retained by the Company will be adjusted in future periods as these liability balances are paid.audit services.

  

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 ninesix months ended SeptemberJune 30, 20172019 and 2016,2018, 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 expense related to employee stock options 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 related to employee stock options allows for a more transparent comparison of its financial results to the previous period.
  
·Bonuses paid to executives upon sale of discontinued operations: The Company does not consider the bonuses of $87,750 associated with the sale of EthoStream to be indicative of current or future operating performance. Therefore, the Company does not consider the inclusion of these costs helpful in assessing its current financial performance compared to the previous year.

 

 

 

 2924 

 

 

RECONCILIATION OF NET LOSS FROM

CONTINUING OPERATIONS TO ADJUSTED EBITDA

(Unaudited)

 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

  

Three Months Ended

June 30,

 

Six Months Ended

June 30,

 
 2017  2016  2017  2016  2019  2018  2019  2018 
                  
Net loss from continuing operations $(871,340) $(1,192,083) $(3,034,984) $(2,995,699)
Net loss from operations $(518,575) $(206,582) $(1,364,180) $(1,390,748)
Interest (income) expense, net  (8,722)  15,482   (2,797)  45,308   15,040   (4,054)  20,600   (1,524)
Provision (benefit) for income taxes  (3,600)  2,575   4,301   3,200 
Provision for income taxes     2,000      2,000 
Depreciation and amortization  14,616   8,382   34,405   24,366   17,043   16,628   33,975   33,543 
EBITDA – continuing operations  (869,046)  (1,165,644)  (2,999,075)  (2,922,825)
EBITDA  (486,492)  (192,008)  (1,309,605)  (1,356,729)
Adjustments:                                
Stock-based compensation  2,343   2,703   320,545   10,204   1,815   1,531   3,631   3,061 
Bonuses paid to executives upon sale of discontinued operations        87,750    
Adjusted EBITDA $(866,703) $(1,162,941) $(2,590,780) $(2,912,621) $(484,677) $(190,478) $(1,305,974) $(1,353,668)

  

Liquidity and Capital Resources

 

For the six-month period ended June 30, 2019, the Company reported a net loss of $1,364,179 and had cash used in operating activities of $2,035,842 and ended the period with an accumulated deficit of $124,535,585 and total current assets in excess of current liabilities of $4,717,535. At June 30, 2019, the Company had $3,380,382 of cash and approximately $1,056,000 of availability on its credit facility. The credit facility is a $2,000,000 line of credit, which 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. As of June 30, 2019, we had borrowing capacity of $2,000,000 and an outstanding balance of approximately $864,000, resulting in the approximate availability of $1,056,000 on the credit facility.

Since inception, the Company has incurred operating losses and has reported negative cash flows from operating activities. Since 2012, the Company has made significant investments in the engineering, development and marketing of an intelligent automation platform, including but not limited to, hardware and software enhancements, support services and applications. The funding for these development efforts has contributed to the ongoing operating losses and use of cash. Operating losses have been financed by debt and equity transactions, credit facility capacity, the sale of a wholly-owned subsidiary and management of working capital levels. The report from our independent registered public accounting firm on our consolidated financial statements for the year ended December 31, 2018 stated there is substantial doubt about our ability to continue as a going concern.

The Company’s ability to continue as a going concern is dependent upon generating profitable operations in the future and/or securing the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. There can be no assurance that the Company will be able to secure such financing at commercially reasonable terms, if at all. If cash resources become insufficient to meet the Company’s ongoing obligations, the Company will be required to scale back or discontinue portions of its operations or discontinue operations entirely, whereby, the Company’s shareholders may lose some or all of their investment.

We have not identified, and cannot be certain we will be able to identify, a course of action that guarantees the achievement of profitable operations in the foreseeable future. In June 2018, the Company’s Board engaged an investment bank to identify strategic alternatives to maximize shareholder value, including but not limited to, a sale of the Company, an investment in the Company, a merger or other business combination, a sale of all or substantially all assets or a strategic joint venture. At August 13, 2019, no definitive alternatives had been identified.

The Company has financedexpects to draw on its’ cash reserves and utilize the credit facility to the extent availability exists to finance its operations since inception primarily through privatenear term working capital needs. We expect to continue to incur operating losses and public offeringsnegative operating cash flows for one year beyond the date of these financial statements. Accordingly, and in light of the Company’s equity securities,historic and continuing losses, there is substantial doubt about the issuance of various debt instruments and asset based lending, and the sale of assets.Company’s ability to continue as a going concern.

25

 

Working Capital

 

Working capital (current assets in excess of current liabilities) from continuing operations increaseddecreased by $9,840,658$1,488,766 during the ninesix months ended SeptemberJune 30, 20172019 from working capital deficit of $26,859$6,206,299 at December 31, 20162018 to working capital of $9,813,799$4,717,533 at SeptemberJune 30, 2017.2019.

 

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 December 31, 2016 was zero and $97,127, respectively.

Revolving Credit Facility

 

On September 30, 2014, theThe Company and its wholly-owned subsidiary, EthoStream, as co-borrowers (collectively, the “Borrowers”), entered intois a party to 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 capital and other general business purposes. The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 7.25%8.50% at SeptemberJune 30, 20172019 and 6.75% at December 31, 2016.2018. 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, an13, 2019, the tenth amendment to the Credit Facility was executed extending the maturity date to September 30, 2018,2020, unless earlier accelerated under the terms of the Heritage Bank Loan Agreement.

30

 

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 also contains financial covenants, that require the Borrowers to maintainincluding a minimummaximum EBITDA level,loss covenant, measured quarterly, and a minimum asset coverage ratio, measured monthly.monthly, and a minimum unrestricted cash balance of $2 million. During the year ended December 31, 2018 and the quarter ended March 31, 2019, the Company and Heritage Bank entered into several amendments to the Credit Facility to adjust these covenant levels. As long as the Company maintains the minimum unrestricted cash balance of $2 million, a violation of the minimum EBITDA level will not trigger an event of default. 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 ofon the revolving credit facilityCredit Facility was $79,953 as of September$864,125 and $121,474 at June 30, 20172019 and December 31, 2018 and the remaining available borrowing capacity was approximately $1,304,000.$1,056,000 and $499,000, respectively. As of SeptemberJune 30, 2017,2019, 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.

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.

Cash Flow Analysis

 

Cash used in continuing operations was $2,459,746$2,035,842 and $2,768,301$2,179,004 during the ninesix months ended SeptemberJune 30, 20172019 and 2016,2018, respectively. As of SeptemberJune 30, 2017,2019, our primary capital needs included costs incurred to increase energy management sales, inventory procurement, and managing current liabilities. The working capital changes during the ninesix months ended SeptemberJune 30, 20172019 were primarily related to an approximate $380,500$1,393,000 increase in accounts receivable, a $305,000$269,000 decrease in contract liabilities, $200,000 increase in inventory,contract assets, partially offset by$305,000$647,000 increase in accounts payable, a $330,000 increase in deferred revenue and a $168,000$239,000 increase in accrued liabilities, and expenses.a $136,000 decrease in prepaid and other current assets. The working capital changes during the ninesix months ended SeptemberJune 30, 20162018 were primarily related to an approximately $469,000 decreaseapproximate $373,000 increase in accounts receivable, a $410,000$453,000 increase in prepaid expense and other current assets, partially offset by a $277,000 decrease in inventory, a $535,000$124,000 decrease in customer deposits, a $512,000 decrease in deferred revenues and an $18,000 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 provided by investing activities was $11,092,051 during the nine months ended September 30, 2017 and cash used in investing activities was $2,352$5,318, and $7,493 during the ninesix months ended SeptemberJune 30, 2016,2019 and 2018, respectively. During the ninesix months ended SeptemberJune 30, 2017,2019, the cash providedused 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$5,318 associated with the purchase of computer equipment and furniture, fixturesproperty 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 ninesix months ended SeptemberJune 30, 2016,2018, the Company purchased $33,629cash used by investing activities reflects a decrease of computer equipment$7,493 associated with the purchase of property and had $31,277 of restricted cash related to a bonding requirement released.

equipment.

 

 

 

 3126 

 

 

Cash used inprovided from financing activities was $982,176 and$742,651 compared to cash provided by financing activities was $707,637used of $682,211 during the ninesix months ended SeptemberJune 30, 20172019 and 2016,2018, respectively. The Heritage Bank Loan Agreement forProceeds borrowed from the Company’s line of credit includedthe Companywere $5,604,000 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 exercisedcash used 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 paidpayments on the line of credit was $110,000were $4,861,349 during the ninesix months ended SeptemberJune 30, 2016.2019. Proceeds borrowed from the line of credit were $200,000 and cash used for payments on the line of credit were $882,211 during the six months ended June 30, 2018.

 

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 withthe adverse impact of tariffs and competition will continue to present a challenging operating environment through 2017;2019; therefore working capital management will continue to be a high priority for 2017.2019. 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, the Company performed an evaluation, under the supervisionOur management is responsible for establishing 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 implementmaintaining adequate internal control over financial reporting, includingas defined in Rule 13a-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurances regarding the reliability of financial reporting and the preparation of the financial statements of the Company in accordance with U.S. generally accepted accounting principles, or GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree or compliance with the policies or procedures may deteriorate.

With the participation of our IT generalChief Executive Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2018 based on the framework in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based on our evaluation and the material weaknesses described below, management concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2018 based on the COSO framework criteria.

Management did not properly design or maintain effective controls over the control environment and the need formonitoring components of COSO. We did not have a stronger internal control environment particularly in our financial reporting and close process. We lack sufficient personnel resources and technicalcomplement of accounting and reporting expertisefinancial personnel with an appropriate level of knowledge to appropriately address certaintechnical accounting and financial reporting matters in accordance with generally accepted accounting principles.principles and the Company’s overall financial reporting requirements. We also lack sufficient information technology resources to address our IT general control environment requirements. The failures within the control environment and monitoring components contributed to the following control activity level material weaknesses:

·Revenues – We did not properly design or maintain effective controls over the recording of revenue recognition for contracts whose performance obligations are fulfilled over time.
·Financial Statement Close and Reporting – We did not properly design or maintain effective controls over the period end financial close and reporting process. Specifically, we lacked control over the review of account reconciliations, journal entries, identification of related party transactions, and reporting of our financial results and disclosures.
·Information Technology – We did not properly design or maintain effective controls to prevent unauthorized access to certain systems, programs and data, and provide for periodic review and monitoring of access and changes in programs, including review of security logs and analysis of segregation of duties conflicts.
·Segregation of Duties – We did not maintain adequate segregation of duties within the Company’s business processes, financial applications, and IT systems. Specifically, we did not have an adequate process or appropriate controls in place to adequately assess the segregation of job responsibilities and system user access for initiating, authorizing, and recording transactions.

27

These control deficiencies could result in placea misstatement of account balances resulting in a more than remote likelihood that a material misstatement to support the accurate reporting of our financial resultsstatements may not be prevented or detected on a timely basis. Accordingly, we have determined that these control deficiencies as described above constitute material weaknesses.

We are reviewing actions to remediate the identified material weaknesses. As we continue to evaluate and disclosures onwork to improve our Form 10-Q. Management ofinternal controls 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 our senior management identifies as necessary, are completed, tested and determined effective, the material weaknesses described above will continue to exist. At present, the Company believes thatdoes not expect to hire additional personnel to remediate these control deficiencies in the near future.

In light of these material weaknesses, are duewe performed additional analyses and procedures in order 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 concludedconclude that our disclosure controls and procedures were ineffectiveconsolidated financial statements as of and for the end ofyear ended December 31, 2018 and 2017 included in this Annual Report on Form 10-K were fairly stated in accordance with GAAP. Accordingly, management believes that despite our material weaknesses, our financial statements for the period covered by this report.years ended December 31, 2018 and 2017 are fairly stated, in all material respects, in accordance with GAAP.

 

DuringUnder applicable Securities Law, the nine monthsCompany is not required to obtain an attestation report from the Company's independent registered public accounting firm regarding internal control over financial reporting, and accordingly, such an attestation has not been obtained or included in this Annual Report.

Changes in Internal Controls

Other than the material weaknesses discussed above, during the quarter ended SeptemberJune 30, 2017,2019, there werehave been no changes in the Company’sour internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’sour internal controlcontrols over financial reporting.

  

 

 

 

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PART II. OTHER INFORMATION

  

Item 1.  Legal Proceedings.

 

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.

   

Item 1A.  Risk Factors.

 

There have beenwere no material changes during the quarter to risk factors previouslythe Risk Factors disclosed in Item 1A – “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2016 in response to Item 1A of Form 10-K.2018.

 

Item 6.  Exhibits.

  

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

   

 

 

 

 

 3329 

 

 

SIGNATURES

 

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: November 14, 2017August 13, 2019By:/s/ Jason L. Tienor 
 

Jason L. Tienor

Chief Executive Officer

(principal executive officer)

Date: November 14, 2017August 13, 2019By:/s/ Richard E. Mushrush 
 

Richard E. Mushrush

Chief Financial Officer

(principal financial officer)

 

 

 

 

 

 

 

 

 

 

 3430