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 September 30, 2017March 31, 2020

 

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 or Other Jurisdiction of Incorporation or Organization)(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.days YesxNo¨

 

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). YesxNo¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated fileroAccelerated filero
Non-accelerated filero(Do not check if a smaller reporting company)xSmaller 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 oNox

 

The number of shares outstanding of the registrant’s common stock, par value $0.001 per share, as of October 31, 2017April 30, 2020 is 133,440,111.136,311,335.

 

 

 

  

 

 

TELKONET, INC.

FORM 10-Q for the NineThree Months Ended September 30, 2017March 31, 2020

 

Index

 

 Page
  
PART I. FINANCIAL INFORMATION3
  
Item 1. Financial Statements3
  

Condensed Consolidated Balance Sheets (Unaudited): September 30, 2017March 31, 2020 and December 31, 20162019

3

  

Condensed Consolidated StatementsStatement of Operations (Unaudited):Three and Nine Months Ended September 30, 2017March 31, 2020 and 20162019

4

  

Condensed Consolidated Statement of Stockholders’ Equity (Unaudited): January 1, 20172020 through September 30, 2017March 31, 2020

5

  

Condensed Consolidated Statements of Cash Flows (Unaudited): NineThree Months Ended September 30, 2017March 31, 2020 and 20162019

6

  
Notes to Condensed Consolidated Financial Statements (Unaudited)8
  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations2324
  
Item 4. Controls and Procedures32
  
PART II. OTHER INFORMATION3334
  
Item 1. Legal Proceedings3334
  
Item 1A. Risk Factors3334
  
Item 6. Exhibits3334

 

 

 

 

 2 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

TELKONET, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 

September 30,

2017

 

December 31,

2016

  

March 31,

2020

 

December 31,

2019

ASSETS                
Current assets:                
Cash and cash equivalents $8,959,229  $791,858  $3,084,828  $3,300,600 
Restricted cash on deposit  800,000    
Accounts receivable, net  1,769,221   1,403,772   1,322,590   2,283,587 
Inventories  1,082,289   777,202   1,041,813   1,373,074 
Prepaid expenses and other current assets  260,269   205,328 
Current assets of discontinued operations     7,149,971 
Contract assets  72,764   188,120 
Prepaid expenses  340,933   251,619 
Income taxes receivable  85,467   85,070 
Total current assets  12,871,008   10,328,131   5,948,395   7,482,070 
                
Property and equipment, net  318,767   143,907   171,730   186,525 
                
Other assets:                
Deposits  17,130      7,000   17,130 
Operating lease right of use assets  853,624   892,170 
Deferred tax asset  28,021   28,021 
Total other assets  17,130      888,645   937,321 
                
Total Assets $13,206,905  $10,472,038  $7,008,770  $8,605,916 
                
LIABILITIES AND STOCKHOLDERS’ EQUITY                
Current liabilities:                
Accounts payable $1,137,632  $765,617  $683,814  $1,265,560 
Accrued liabilities and expenses  1,094,054   925,581 
Related party payable     97,127 
Accrued liabilities  442,856   527,826 
Line of credit  79,953   1,062,129   518,463   624,347 
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  515,530   653,053 
Operating lease liabilities – current  226,464   223,835 
Total current liabilities  3,057,209   5,008,056   2,387,127   3,294,621 
                
Long-term liabilities:                
Deferred revenue - long term  190,896   120,421 
Deferred lease liability - long term  40,508   23,761 
Contract liabilities – long-term  91,590   111,131 
Operating lease liabilities – long-term  720,890   758,315 
Total long-term liabilities  231,404   144,182   812,480   869,446 
Total liabilities $3,199,607  $4,164,067 
                
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 authorized, 185 shares outstanding at March 31, 2020 and December 31, 2019, preference in liquidation of $1,692,649 and $1,674,195 as of March 31, 2020 and December 31, 2019, respectively  1,340,566   1,340,566 
Series B, par value $.001 per share; 567 shares authorized, 52 shares outstanding at March 31, 2020 and December 31, 2019, preference in liquidation of $461,094 and $455,904 as of March 31, 2020 and December 31, 2019, respectively  362,059   362,059 
Common stock, par value $.001 per share; 190,000,000 shares authorized; 136,311,335 and 135,990,491 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively  136,311   135,990 
Additional paid-in-capital  127,383,314   126,955,435   127,728,267   127,708,773 
Accumulated deficit  (119,301,087)  (123,471,034)  (125,758,040)  (125,105,539)
Total stockholders’ equity  9,918,292   5,319,800   3,809,163   4,441,849 
                
Total Liabilities and Stockholders’ Equity $13,206,905  $10,472,038  $7,008,770  $8,605,916 

 

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,

 
  2017  2016  2017  2016 
Revenues, net:                
Product $1,904,571  $1,360,887  $5,728,878  $6,356,437 
Recurring  131,665   143,028   344,708   340,412 
Total Net Revenue  2,036,236   1,503,915   6,073,586   6,696,849 
                 
Cost of Sales:                
Product  1,160,019   770,830   3,233,978   3,194,094 
Recurring  55,702   36,618   118,347   92,324 
Total Cost of Sales  1,215,721   807,448   3,352,325   3,286,418 
                 
Gross Profit  820,515   696,467   2,721,261   3,410,431 
                 
Operating Expenses:                
Research and development  500,656   429,622   1,323,669   1,321,007 
Selling, general and administrative  1,188,905   1,432,489   4,396,667   5,012,249 
Depreciation and amortization  14,616   8,382   34,405   24,366 
Total Operating Expenses  1,704,177   1,870,493   5,754,741   6,357,622 
                 
Operating Loss  (883,662)  (1,174,026)  (3,033,480)  (2,947,191)
                 
Other Income (Expenses):                
Interest income (expense), net  8,722   (15,482)  2,797   (45,308)
Total Other Income (Expense)  8,722   (15,482)  2,797   (45,308)
                 
Loss from Continuing Operations before Provision (Benefit) for Income Taxes  (874,940)  (1,189,508)  (3,030,683)  (2,992,499)
                 
Provision (Benefit) for Income Taxes  (3,600)  2,575   4,301   3,200 
Net loss from continuing operations  (871,340)  (1,192,083)  (3,034,984)  (2,995,699)
Discontinued Operations:                
Gain from sale of discontinued operations (net of tax)  218,000      6,602,871    
Income from discontinued operations (net of tax)  11,403   798,887   602,060   2,050,998 
Net income (loss) attributable to common stockholders $(641,937) $(393,196) $4,169,947  $(944,701)
                 
Net income (loss) per common share:                
Basic - continuing operations $(0.01) $(0.01) $(0.02) $(0.02)
Basic - discontinued operations $0.00  $0.01  $0.05  $0.02 
Basic – net income (loss) attributable to common stockholders $(0.01) $(0.00) $0.03  $(0.00)
                 
Diluted - continuing operations $(0.01) $(0.01) $(0.02) $(0.02)
Diluted - discontinued operations $0.00  $0.01  $0.05  $0.02 
Diluted – net income (loss) attributable to common stockholders $(0.01) $(0.00) $0.03  $(0.00)
                 
Weighted Average Common Shares Outstanding – basic  133,231,367   132,314,049   133,007,830   130,399,390 
Weighted Average Common Shares Outstanding –diluted  133,231,367   132,314,049   133,405,096   130,399,390 
  For the Three Months Ended
  March 31,
  2020 2019
Revenues, net:        
Product $1,609,262  $2,586,669 
Recurring  194,162   176,533 
Total Net Revenue  1,803,424   2,763,202 
         
Cost of Sales:        
Product  966,603   1,690,598 
Recurring  22,772   86,042 
Total Cost of Sales  989,375   1,776,640 
         
Gross Profit  814,049   986,562 
         
Operating Expenses:        
Research and development  369,243   486,626 
Selling, general and administrative  1,070,610   1,323,049 
Depreciation and amortization  14,795   16,931 
Total Operating Expenses  1,454,648   1,826,606 
         
Operating Loss  (640,599)  (840,044)
         
Other Expenses:        
Interest expense, net  (8,680)  (5,560)
Total Other Expenses  (8,680)  (5,560)
         
Loss before Provision for Income Taxes  (649,279)  (845,604)
Income Taxes Provision  3,222    
Net Loss Attributable to Common Stockholders $(652,501) $(845,604)
         
Net Loss per Common Share:        
         
Basic – Net Loss Attributable to Common Stockholders $(0.01) $(0.01)
         
Diluted – Net Loss Attributable to Common Stockholders $(0.01) $(0.01)
         
Weighted Average Common Shares Outstanding used in Computing Basic Net Loss Per Share  135,990,491   134,793,211 
Weighted Average Common Shares Outstanding used in Computing Diluted Net Loss Per Share  135,990,491   134,793,211 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

 

 

 4 

 

 

TELKONET, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

NINETHREE MONTHS FROM JANUARY 1, 20172019 THROUGH SEPTEMBER 30, 2017MARCH 31, 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 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, 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              292,308   294   35,708      36,002 
                                     
Stock-based compensation expense related to employee stock options                    1,815      1,815 
                                     
Net loss attributable to common stockholders                       (845,604)  (845,604)
                                     
Balance at March 31, 2019  185  $1,340,566   52  $362,059   135,085,519  $135,086  $127,608,232  $(124,017,010) $5,428,933 

TELKONET, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

THREE MONTHS FROM JANUARY 1, 2020 THROUGH MARCH 31, 2020

  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, 2019  185  $1,340,566   52  $362,059   135,990,491  $135,990  $127,708,773  $(125,105,539) $4,441,849 
                                     
Shares issued to directors              320,844   321   17,679      18,000 
                                     
Stock-based compensation expense related to employee stock options                    1,815      1,815 
                                     
Net loss attributable to common stockholders                       (652,501)  (652,501)
                                     
Balance at March 31, 2020  185  $1,340,566   52  $362,059   136,311,335  $136,311  $127,728,267  $(125,758,040) $3,809,163 

 

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 Three Months Ended
March 31,
  2020 2019
Cash Flows from Operating Activities:        
Net loss $(652,501) $(845,604)
         
Adjustments to reconcile net loss to cash used in operating activities:        
Stock-based compensation expense related to employee stock options  1,815   1,815 
Stock issued to directors as compensation  18,000   36,002 
Depreciation and amortization  14,795   16,931 
Reserve for inventory obsolescence  (91,994)  171,901 
Noncash operating lease expense  58,779   59,476 
         
Changes in operating assets and liabilities:        
Accounts receivable  960,997   (1,465,002)
Inventories  423,255   5,061 
Prepaid expenses and other current assets  (89,314)  15,020 
Deposits and other long term assets  10,130    
Accounts payable  (581,746)  462,605 
Accrued liabilities and expenses  (84,970)  187,127 
Contract liabilities  (157,064)  (169,347)
Contract assets  115,356   (131,913)
Operating lease liability  (55,029)  (54,788)
Income taxes receivable  (397)  (5,641)
Net Cash Used In Operating Activities  (109,888)  (1,716,357)
         
Cash Flows From Investing Activities:        
Purchase of property and equipment     (2,302)
Net Cash Used In By Investing Activities     (2,302)
         
Cash Flows From Financing Activities:        
Proceeds from line of credit  2,820,000   2,339,000 
Payments on line of credit  (2,925,884)  (1,553,234)
Net Cash (Used In) Provided By Financing Activities  (105,884)  785,766 
         
Net decrease in cash and cash equivalents  (215,772)  (932,893)
Cash, cash equivalents at the beginning of the period  3,300,600   4,678,891 
Cash and cash equivalents at the end of the period $3,084,828  $3,745,998 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

 

 

 6 

 

 

TELKONET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(UNAUDITED)

 

 

Nine Months Ended

September 30,

  

Three Months Ended

March 31,

 2017  2016  2020 2019
Supplemental Disclosures of Cash Flow Information:         
         
Cash transactions:                
Cash paid during the period for interest $11,485  $30,980  $15,565  $10,937 
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

SEPTEMBER 30, 2017MARCH 31, 2020

(UNAUDITED)

 

NOTE A – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

A summary of the significant accounting policies applied in the preparation of the accompanying condensed consolidated financial statements follows.

 

General

 

The accompanying unaudited condensed consolidated financial statements of Telkonet, Inc. (the “Company”, “Telkonet”) have been prepared in accordance with Rule S-X of the Securities and Exchange Commission (the “SEC”) and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. However, the results from operations for the ninethree months ended September 30, 2017,March 31, 2020, are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2020. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated December 31, 20162019 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 the Company’sits wholly-owned subsidiary, EthoStream LLC,Telkonet Communications, Inc. We currently operate in a Wisconsin limited liability company (“EthoStream”), entered into an Asset Purchase Agreement (the “Purchase Agreement”) with DCI-Design Communications LLC (“DCI”),single reportable business segment.

Going Concern and Management’s Plan

The accompanying financial statements have been prepared on a Delaware limited liability company, whereby DCI would acquire all ofgoing concern basis which assumes the Company will be able to realize its assets and certaindischarge its liabilities in the normal course of EthoStreambusiness for a base purchase pricethe foreseeable future and, thus, do not include any adjustments relating to the recoverability and classification of $12,750,000. The Purchase Agreement providedassets and liabilities that proceeds of $900,000 weremay be necessary if the Company is unable 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 assetscontinue 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.going concern.

 

 

 

 8 

 

 

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)Since inception through March 31, 2020, we have incurred cumulative losses of $125,758,040 and have never generated enough cash through operations to support our business. For the three-month period ended March 31, 2020, we had a cash flow deficit from operations of $109,888. 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 previous independent registered public accounting firm on our consolidated financial statements for the year ended December 31, 2019 stated there is substantial doubt about our ability to continue as a going concern.

 

The condensed consolidated financial statements includeCompany’s ability to continue as a going concern is dependent upon generating profitable operations in the accounts offuture 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 and its wholly-owned subsidiaries, Telkonet Communications, Inc., and EthoStream. The current and prior period accounts of Ethostream have been classified as discontinued operations on the condensed consolidated balance sheet, the condensed consolidated statement of operations and the condensed consolidated statement ofwill be able to secure such financing at commercially reasonable terms, if at all. If 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 reflectresources become insufficient to meet the Company’s results from continuing operations.

Liquidity and Financial Conditionongoing 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.

 

The Company’s operations and financial results have also been impacted by the COVID-19 pandemic. On January 30, 2020 the World Health Organization (“WHO”) announced a global health emergency because of a new strain of a novel coronavirus in Wuhan, China (the “COVID-19 outbreak”) and the risks to the international community as the virus spreads globally. In March 2020, the WHO classified the COVID-19 outbreak a pandemic, based on the rapid increase in exposure globally. The spread of the COVID-19 outbreak has caused significant volatility and uncertainty in U.S. and international markets.

The Company’s sales have been disrupted as a result of its customers furloughing and laying off their employees and/or suspending projects. Despite these challenges, quoting remains active and the aggregate pipeline has not contracted significantly. Thus far, the impact has been delays as opposed to cancellations. Due to travel restrictions, social distancing and shelter at home edicts, the hospitality industry, our largest market that generally contributes more than 50% of our revenue, has suffered as much as any. At this time, the disruption is expected to be temporary; however, the length or severity of this pandemic is unknown. Depending on the length and severity, the demand for our products, our customers’ ability to meet payment obligations to the Company, reportedour supply chain and production capabilities, and our workforces’ ability to deliver our products and services could be impacted. Management is actively monitoring the impact of the global situation on its financial condition, liquidity, operations, suppliers, industry, and workforce. While we expect this disruption to have a net lossmaterial adverse impact our results of $3,034,984 from continuing operations, financial condition and cash flows for the nine months ended September 30, 2017, had cash used in operating activities from continuing operations of $2,459,746year 2020, the Company is unable to reasonably determine the impact at this time.

In response to the COVID-19 pandemic and had an accumulated deficit of $119,301,087. Since inception,its effects (and potential further effects) on the Company’s primary sourcesoperations and financial results, the Company has taken and is continuing to take a number of ongoing liquidity for operations have come through privateactions to preserve cash. These actions include suspending the use of engineering consultants, and public offerings of equity securities,cancelling all travel and the issuanceCompany’s attendance at tradeshows (implemented prior to applicable government stay-at-home orders being put in place). In addition, in early April of various debt instruments, asset-based lending2020, management made the decision to furlough certain employees, instituted pay cuts for certain other employees and suspended the saleCompany’s 401(k) match through the end of assets.2020. With the receipt of the PPP Loan (discussed below), the Company was able to bring back the furloughed employees, restore payroll to prior levels and delay suspension of the 401(k) match. The actions taken in response to the COVID-19 pandemic are in addition to the cost elimination and liquidity management actions that the Company began implementing in the second half of 2019, including reviewing opportunities to decrease spend with third party consultants and providers, strategically reviewing whether or not to fill employee positions in the event of vacancies, and implementing sales campaigns to sell slow-moving inventory and reducing existing inventory volumes. There is no guarantee, however, that these actions, nor any other actions identified, will yield profitable operations in the foreseeable future.

 

On March 29, 2017,In addition, on April 21, 2020, the Company entered into an amendment to unsecured promissory note, dated as of April 17, 2020 (“the revolving credit facilityPPP Loan”), with Heritage Bank of Commerce for a California state chartered bank$913,063 loan under the Paycheck Protection Program (“Heritage Bank”PPP”), SBA 7(a) loan. The PPP SBA 7(a) loan program is being administered by the United States Small Business Administration (“SBA”) and was executed to amend certain termsauthorized by the Keeping American Workers Employed and Paid Act, which is part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act that was signed into law on March 27, 2020. The principal amount of the Loan is $913,063, bears interest of 1.0% per annum and Security Agreement (the “Heritage Bank Loan Agreement”) following the salehas a maturity date of certain assetsApril 21, 2022. See Note N – Subsequent Event for a summary of the Company’s wholly-owned subsidiary, EthoStream. Heritage Bank amended the EBITDA compliance measurement.

On October 23, 2017, an amendment to the revolving credit facility with Heritage Bank was executed to amend certain terms of the Heritage Bank Loan Agreement. Among the terms of the amendment was that if the Company deviates from its projected EBITDA for the quarters ended September 30, 2017 or December 31, 2017, the Company will be deemed to be in compliance as of the measurement date if the Company’s unrestricted cash maintained at Heritage Bank is in excess of $5,000,000. The amendment also extends the revolving credit facility’s maturity date by one year to September 30, 2019.PPP Loan.

 

The outstanding balance of the revolving credit facility was $79,953 as of September 30, 2017 and the remaining available borrowing capacity was approximately $1,304,000. As of September 30, 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.At March 31, 2020, the Company had $3,084,828 of cash and approximately $153,000 of availability on its credit facility. However, the credit facility requires that the Company maintain an unrestricted cash balance of $2,000,000, limiting the ability of the Company to use its cash reserves to fund its operations. As of March 31, 2020, the outstanding balance on the credit facility was $518,463. On average, during the twelve-month period between April 1, 2019 and March 31, 2020, the Company’s cash balance decreased $55,000 per month.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017The Company is using the proceeds of the PPP Loan to support its ongoing operations and currently expects to also draw on its cash reserves and utilize the credit facility to 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 these financial statements. The Credit Facility provides us with needed liquidity to assist in meeting our obligations or pursuing strategic objectives. Continued operating losses will deplete these cash reserves and could result in a violation of the financial covenants. Consequently, repayment of amounts borrowed 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 occurrence of any of these events could have a material adverse effect on our business and results of operations.

(UNAUDITED)

The Company’s Board also continues to consider 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. However, these actions are not solely within the control of the Company. At May 15, 2020, no definitive alternatives had been identified.

Accordingly, and in light of the Company’s historic losses, there is substantial doubt about the Company’s ability to continue as a 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 both the ninethree months ended September 30, 2017March 31, 2020 and 2016,2019, there were 5,621,800 and 2,240,2253,599,793 shares of common stock underlying options and warrants excluded due to these instruments being anti-dilutive, respectively.anti-dilutive.

 

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, 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.

 

10

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 adoptedfollows 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.

 

Revenue Recognitionfrom Contracts with Customers

 

For revenueAccounting Standards Codification Topic 606, Revenue from product sales,Contracts with Customers (“ASC 606, 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. AssumingStandard”) supersedes nearly all conditions forlegacy revenue recognition have been satisfied, productguidance. ASC 606, the Standard outlines a comprehensive five-step 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.

10

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)

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,recognition model 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 VSOEprinciple that an entity should recognize revenue based on pricing and discounting practices forwhen it satisfies its performance obligations by transferring control of promised goods or services in an amount that reflects 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 atconsideration to which the Company would sell a productentity expects to be entitled in exchange for said goods 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.services.

 

When MEAs include an element ofIdentify the 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.contracts

 

The Company provides call centeraccounts 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 and the customer and both parties are committed to perform their respective obligations, (2) the Company can identify each party’s rights regarding goods or services transferred, (3) the Company can identify payment terms for goods or services transferred, (4) the contract has commercial substance, and (5) collectability of all the consideration to which the Company is entitled in exchange for the goods or services transferred is probable.

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 properties installed by the Company. The Company receives monthlycustomers. This 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 toconsidered 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.separate performance obligation.

 

 

 

 11 

 

 

Determine the transaction price

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSThe Company generally enters into contracts containing fixed prices. It is not customary for the Company to include contract terms that would result in variable consideration. In the rare situation that a contract does include this type of provision, it is not expected to result in a material adjustment to the transaction price. The Company regularly extends pricing discounts; however, they are negotiated up front and adjust the fixed transaction price set out in the contract.

SEPTEMBER 30, 2017

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 contract.

Allocate the transaction price to the performance obligations

Revenues from customer contracts are allocated to the separate performance obligations based on their relative stand-alone selling price (“SSP”) at contract inception. The SSP is the price at which the Company would sell a promised good or service separately. The best evidence of an 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 for a broad range of amounts resulting from, but not limited to, tiered discounting for value added resellers (“VAR”) based upon committed volumes and other economic factors. Due to the high variability of our pricing, the Company cannot establish a reliable SSP using observable data. Accordingly, the Company uses the residual approach to allocate the transaction price to performance obligations related to its turnkey solutions. When support services are not included within the turnkey solution, the residual method is not utilized and no allocation of the transaction price to the performance obligation is necessary.

All support service agreements, whether single or multi-year terms, automatically renew for one-year terms at a suggested retail price (“SRP”). Support service renewals are consistently priced and therefore would support the use of SRP as the best estimate of an SSP for such performance obligations.

Revenue Recognition

The Company recognizes 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.

12

Revenues from support services are recognized over time, in even daily increments over the term of the contract, and are presented as “Recurring Revenue” in the Statement of Operations.

Contracts are billed in accordance with the terms and conditions, either at periodic intervals or upon substantial completion. This can result in billing occurring subsequent to revenue recognition, resulting in contract assets. Contract assets are presented as current assets in the Condensed Consolidated Balance Sheet.

Contract liabilities include deferrals for the monthly support service fees. Long-term contract liabilities represent support service fees that will be recognized as revenue after March 31, 2021.

Contract Completion Cost

The Company recognizes related costs of the contract over time in relation to the revenue recognition. Costs included within the projects relate to the cost of material, direct labor and costs of outside services utilized to complete projects. These are presented as “Contract assets” in the consolidated balance sheets.

(UNAUDITEDSales Taxes)

Unless provided with a resale or tax exemption certificate, the Company assesses and collects sales tax on sales transactions and records the amount as a liability. It is recognized as a liability until remitted to the applicable state. Total revenues do not include sales tax as the Company is considered a pass through conduit for collecting and remitting sales taxes.

 

Guarantees and Product Warranties

 

The Company records a liability for potential warranty claims in cost of sales at the time of sale. The amount of the liability is based on the trend in the historical ratio of claims to sales, the historical length of time between the sale and resulting warranty claim, new product introductions and other factors. The products sold are generally covered by a warranty for a period of one year. In the event the Company determines that its current or future product repair and replacement costs exceed its estimates, an adjustment to these reserves would be charged to earnings in the period such determination is made. For the ninethree months ended September 30, 2017March 31, 2020 and the year ended December 31, 2016,2019, the Company experienced returns of approximately 1.0%1% to 2.5%3% of materials included in the cost of sales. As of September 30, 2017March 31, 2020 and December 31, 2016,2019, the Company recorded warranty liabilities in the amount of $77,810$61,742 and $95,540,$58,791, respectively, using this experience factor range.

 

Product warranties for the ninethree months ended September 30, 2017March 31, 2020 and the year ended December 31, 20162019 are as follows:

 

 September 30,
2017
 December 31,
2016
  March 31,
2020
 December 31,
2019
Beginning balance $95,540  $66,555  $58,791  $46,103 
Warranty claims incurred  (48,767)  (115,120)  (2,947)  (66,803)
Provision charged to expense  31,037   144,105   5,898   79,491 
Ending balance $77,810  $95,540  $61,742  $58,791 

 

ReclassificationsAdvertising

 

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 assetsfollows the policy of discontinued operationscharging the costs of advertising to cash and cash equivalents for certain EthoStream assets not sold to DCI on March 28, 2017.expenses as incurred. The Company reclassified $150,936 from current liabilities of discontinued operations to accrued liabilitiesincurred $5,893 and expenses for certain EthoStream liabilities not assumed by DCI on$10,805 in advertising costs during the three months ended March 28, 2017. The reclassifications were not material31, 2020 and had no effect on the Company’s total current assets, current liabilities or stockholders’ equity as of December 31, 2016.2019, respectively.

NOTE B – NEW ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The guidance for this standard was initially effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, however in August 2015 the FASB delayed the effective date of the standard for one full year. Companies will adopt the standard using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a modified retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company expects to adopt ASU 2014-09 as of January 1, 2018 with a cumulative effect adjustment to opening retained earnings, if necessary, under the modified retrospective approach. The Company has developed a project plan for the implementation of the new standard including a review of all revenue streams to identify any differences in the performance obligations, timing, measurement or presentation of revenue recognition. The Company’s implementation of this ASU includes the evaluation of its customer agreements to identify terms or conditions that could be considered a performance obligation such that, if material to the terms of the contract, consideration would be allocated to the performance obligation and could accelerate or defer the timing of recognizing revenue.  The Company also continues to evaluate the presentation of its principal versus agent arrangements. The Company’s evaluation of its revenue streams and the treatment under the new guidance on the timing of revenue recognition and the allocation of revenue to the Company’s goods and services is in process and any effect cannot be determined at this time.

12

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact of its pending adoption of ASU 2016-02 on its consolidated financial statements. Upon adoption, the Company expects that the ROU asset and lease liability will be recognized in the balance sheets in amounts that will be material.

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.

NOTE C– ACCOUNTS RECEIVABLE

Components of accounts receivable as of September 30, 2017 and December 31, 2016 are as follows:

  September 30,
2017
  December 31,
2016
 
Accounts receivable $1,781,394  $1,438,345 
Allowance for doubtful accounts  (12,173)  (34,573)
Accounts receivable, net $1,769,221  $1,403,772 

NOTE D – ACCRUED LIABILITIES AND EXPENSES

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

  September 30,
2017
  December 31,
2016
 
Accrued liabilities and expenses $589,288  $223,011 
Accrued payroll and payroll taxes  354,293   331,908 
Accrued sales taxes, penalties, and interest  72,331   274,869 
Accrued interest  332   253 
Product warranties  77,810   95,540 
Total accrued liabilities and expenses $1,094,054  $925,581 

 

 

 

 

 13 

 

 

Research and Development

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSThe Company accounts for research and development costs in accordance with the ASC 730-10, “Research and Development”. Under ASC 730-10, all research and development costs must be charged to expense as incurred. Accordingly, internal research and development costs are expensed as incurred. Third-party research and development costs are expensed when the contracted work has been performed or as milestone results have been achieved. Company-sponsored research and development costs related to both present and future products are expensed in the period incurred. Total expenditures on research and product development for the three months ended March 31, 2020 and 2019 were $369,243 and $486,626, respectively.

SEPTEMBER 30, 2017

(UNAUDITEDStock-Based Compensation

The Company accounts for stock-based awards in accordance with ASC 718-10, “Share-Based Compensation”, which requires a fair value measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors, including employee stock options and restricted stock awards. The Company estimates the fair value of stock options granted using the Black-Scholes valuation model. This model requires the Company to make estimates and assumptions including, among other things, estimates regarding the length of time an employee will hold vested stock options before exercising them, the estimated volatility of the Company’s common stock price and the number of options that will be forfeited prior to vesting. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Changes in these estimates and assumptions can materially affect the determination of the fair value of stock-based compensation and consequently, the related amount recognized in the Company’s consolidated statements of operations.

The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. For 2019 and prior years, expected stock price volatility is based on the historical volatility of the Company’s stock for the related expected term.

Stock-based compensation expense in connection with options granted to employees for both the three months ended March 31, 2020 and 2019 was $1,815.

NOTE B – NEW ACCOUNTING PRONOUNCEMENTS

In 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 requires a modified retrospective transition method and early adoption is permitted. In November 2019, FASB issued ASU No. 2019-10, Financial Instruments – Credit Losses, Derivatives and Hedging, and Leases (“ASU 2019-10”), which defers the adoption of ASU 2016-13 for smaller reporting companies until January 1, 2023. The Company will continue to evaluate the impact of ASU 2016-13 on its consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This guidance modifies, removes, and adds certain disclosure requirements on fair value measurements. This ASU is effective for annual periods beginning after December 15, 2019, including interim periods therein. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

14

Management has evaluated other recently issued accounting pronouncements and does not believe any will have a significant impact on our consolidated financial statements and related disclosures.

NOTE C – REVENUE

The following table presents the Company’s product and recurring revenues disaggregated by industry for the three months ended March 31, 2020.

  Hospitality Education Multiple Dwelling Units Government Total
Product $1,202,342  $249,432  $93,072  $64,416  $1,609,292 
Recurring  173,572   20,263   327      194,162 
  $1,375,914  $269,695  $93,399  $64,416  $1,803,424 

The following table presents the Company’s product and recurring revenues disaggregated by industry for the three months ended March 31, 2019.

  Hospitality Education Multiple Dwelling Units Government Total
Product $1,694,649  $255,736  $200,426  $435,858  $2,586,669 
Recurring  156,272   19,445   816      176,533 
  $1,850,921  $275,181  $201,242  $435,858  $2,763,202 

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

Remaining performance obligations

As of March 31, 2020, the aggregate amount of the transaction price allocated to remaining performance obligations was approximately $0.29 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

  March 31,
2020
 December 31,
2019
Contract assets $72,764  $188,120 
Contract liabilities  607,120   764,184 
Net contract liabilities $534,356  $576,064 

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.

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 three-month period ended March 31, 2020 is the result of cash payments received and billing in advance of satisfying performance obligations.

15

Contract costs

Costs to complete a turnkey contract primarily relate to the materials cost and direct labor and are recognized proportionately as the performance obligation is satisfied. The Company will defer costs to complete a contract when materials have shipped (and control over the materials has transferred to the customer), but an insignificant amount of rooms have been installed. The Company will recognize any deferred costs in proportion to revenues recognized from the related turnkey contract. The Company does not expect deferred contract costs to be long-lived since a typical turnkey project takes sixty days to complete. Deferred contract costs are generally presented as other current assets in the condensed consolidated balance sheets.

The Company incurs incremental costs to obtain a contract in the form of sales commissions. These costs, whether related to performance obligations that extend beyond twelve months or not, are immaterial and will continue to be recognized in the period incurred within selling, general and administrative expenses.

NOTE D – ACCOUNTS RECEIVABLE

Components of accounts receivable as of March 31, 2020 and December 31, 2019 are as follows:

  March 31,
2020
 December 31,
2019
Accounts receivable $1,396,924  $2,338,626 
Allowance for doubtful accounts  (74,334)  (55,039)
Accounts receivable, net $1,322,590  $2,283,587 

 

NOTE E – DEBTINVENTORIES

 

Kross Promissory Note

On August 4, 2016, the BoardComponents 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 Noteinventories as of September 30, 2017March 31, 2020 and December 31, 2016 was zero2019 are as follows:

  March 31,
2020
 December 31,
2019
Product purchased for resale $1,374,466  $1,613,733 
Reserve for obsolescence  (332,653)  (240,659)
Inventory, net $1,041,813  $1,373,074 

NOTE F – ACCRUED LIABILITIES AND EXPENSES

Accrued liabilities at March 31, 2020 and $97,127, respectively.December 31, 2019 are as follows:

  March 31,
2020
 December 31,
2019
Accrued liabilities and expenses  106,915   214,925 
Accrued payroll and payroll taxes  265,309   227,153 
Accrued sales taxes, penalties, and interest  8,890   26,957 
Product warranties  61,742   58,791 
Total accrued liabilities and expenses $442,856  $527,826 

16

NOTE G – DEBT

 

Revolving Credit Facility

 

On September 30, 2014, the Company and its wholly-owned subsidiary, EthoStream, as co-borrowers (collectively, the “Borrowers”), entered into a loan and security agreement (the “Heritage Bank Loan Agreement”), with Heritage Bank of Commerce, a California state chartered bank (“Heritage Bank”), governing a new revolving credit facility in a principal amount not to exceed $2,000,000 (the “Credit Facility”). Availability of borrowings under the Credit Facility from time to time is subject to a borrowing base calculation based on the Company’s eligible accounts receivable and eligible inventory each multiplied by an applicable advance rate, with an overall limitation tied to the Company’s eligible accounts receivable. The Heritage Bank Loan Agreement is available for working 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%6.25% at September 30, 2017March 31, 2020 and 6.75% at7.75% December 31, 2016.2019. 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 J. The warrant has an exercise price of $0.20 and expires October 9, 2021. On February 17, 2016, anNovember 6, 2019, the eleventh amendment to the Credit Facility was executed extendingto extend the maturity date to September 30, 2018,2021, unless earlier accelerated under the terms of the Heritage Bank Loan Agreement.Agreement, and eliminate the maximum EBITDA loss covenant.  The eleventh amendment was effective as of September 30, 2019.

 

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. As discussed above, the EBITDA loss covenant was eliminated in the eleventh amendment to the Credit Facility. The sole financial covenants that require the Borrowers to maintain a minimum EBITDA level, measured quarterly,are a minimum asset coverage ratio and a minimum unrestricted cash balance of $2 million, both of which are measured monthly and minimum cash account balances.at the end of each month. 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 on the Credit Facility was $518,463 and $624,347 at March 31, 2020 and December 31, 2019 and the remaining available borrowing capacity was approximately $153,000 and $424,000, respectively. As of September 30, 2017,March 31, 2020, 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 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.

 

NOTE FH – PREFERRED STOCK

 

Series A

 

The Company has designatedauthorized 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.

 

17

Series B

 

The Company has designated 538authorized 567 shares of preferred stock as Series B Preferred Stock (“Series B”). Each share of Series B is convertible, at the option of the holder thereof, at any time, into shares of the Company’s common stock at a conversion price of $0.13 per share. On August 4, 2010, the Company sold 267 shares of Series B with attached warrants to purchase an aggregate of 5,134,626 shares of the Company’s common stock at $0.13 per share. The Series B shares were sold at a price per share of $5,000 and each Series B share was convertible into approximately 38,461 shares of common stock at a conversion price of $0.13 per share. The Company received $1,335,000 from the sale of the Series B shares on August 4, 2010.  On April 8, 2011, the Company sold 271 additional shares of Series B with attached warrants to purchase an aggregate of 5,211,542 shares of the Company’s common stock at $0.13 per share. The Series B shares were sold at a price per share of $5,000 and each Series B share was convertible into approximately 38,461 shares of common stock at a conversion price of $0.13 per share. The Company received $1,355,000 from the sale of the Series B shares on April 8, 2011. In prior years, 486 of the preferred shares issued on August 4, 2010 and April 8, 2011 were converted to shares of the Company’s common stock. In a prior year, the redemption feature available to the Series B holders expired.

 

Preferred stock carries certain preference rights as detailed in the Company’s Amended Articles of Incorporation related to both the payment of dividends and as to payments upon liquidation in preference to any other class or series of capital stock of the Company. As of September 30, 2017,March 31, 2020, the liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $409,009,$461,094, which includes cumulative accrued unpaid dividends of $149,009,$201,094, and second, Series A with a preference value of $1,507,481,$1,692,649, which includes cumulative accrued unpaid dividends of $582,481.$767,649. As of December 31, 2016,2019, the liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $393,435,$455,904, which includes cumulative accrued unpaid dividends of $133,435,$195,904, and second, Series A with a preference value of $1,452,114,$1,674,195, which includes cumulative accrued unpaid dividends of $527,114.

15

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)$749,195.

 

NOTE GI – 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 designatedauthorized 215 shares as Series A preferred stock and 538567 shares as Series B preferred stock. As of September 30, 2017At March 31, 2020 and December 31, 2016,2019, there were 185 shares of Series A and 52 shares of Series B outstanding.outstanding, respectively.

 

The Company has authorized 190,000,000 shares of common stock with a par value of $.001 per share. As of September 30, 2017March 31, 2020 and December 31, 20162019, the Company had 133,440,111136,311,335 and 132,774,475135,990,491 common shares issued and outstanding.outstanding, respectively.

 

During the ninethree months ended September 30, 2016, 5,211,542March 31, 2020 and 2019, the Company issued 320,844 and 292,308 shares of common stock, respectively to directors for services performed during the three months ended March 31, 2020 and 2019. These shares were valued at $18,000 and $36,002, respectively, which approximated the fair value of the shares when they were issued.

During the three months ended March 31, 2020 and 2019, no warrants were exercised for an aggregate of 5,211,542 shares of the Company’s common stock at $0.13 per share.exercised. These warrants were originally granted to shareholders of the April 8, 2011 Series B preferred stock issuance.

 

During the ninethree months ended September 30, 2016, 3March 31, 2020 and 2019, no shares of Series A or B preferred stock were converted to in aggregate, 115,385 shares of common stock.

 

18

NOTE HJ – 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. The Plan is administered by the Board of Directors or the compensation committee, which is comprised of not less than two non-employee directors who are independent. A total of 10,000,000 shares of stock were reserved and available for issuance under the Plan. The exercise price per share for the stock covered by a stock option granted shall be determined by the administrator at the time of grant but shall not be less than 100 percent of the fair market value on the date of grant. The term of each stock option shall be fixed by the administrator, but no stock option shall be exercisable more than ten years after the date the stock option is granted. As of March 31, 2020, there were approximately 85,425 shares remaining for issuance in the Plan.

It is anticipated that providing such persons with a direct stake in the Company’s welfare will assure a better alignment of their interests with those of the Company and its stockholders.

 

The following table summarizes the changes in options outstanding and the related prices for the shares of the Company’s common stock issued to employees of the Company under the Plan as of September 30, 2017.March 31, 2020.

 

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   6.76  $0.14   2,000,000  $0.14 
$0.16 - $1.00   1,349,793   3.59   0.18   1,227,001   0.18 
     3,349,793   5.48  $0.16   3,227,001  $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, 2019  3,349,793  $0.16 
Granted  1,300,000   0.17       
Exercised            
Cancelled or expired  (292,500)  0.69       
Outstanding at December 31, 2016  2,832,725  $0.18 
Outstanding at December 31, 2019  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 March 31, 2020  3,349,793  $0.16 

  

The expected life of awardsNo options were granted, represents the period of time that they are expected to be outstanding. The Company determines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules, exercise patterns and pre-vesting and post-vesting forfeitures. The Company estimates the volatility of the Company’s common stock based on the calculated historical volatility of the Company’s own common stock using the trailing 24 months of share price data prior to the date of the award. The Company bases the risk-free interest rate used in the Black-Scholes option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award. The Company has not paid any cash dividends on the Company’s common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model. The Company uses historical data to estimate pre-vesting option forfeitures and record share-based compensation for those awards that are expected to vest. In accordance with ASC 718-10, the Company adjusts share-based compensation for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience.

There were 3,000,000 and zero options granted and zero options exercised, cancelled or expired during the ninethree months ended September 30, 2017 and 2016, respectively.March 31, 2020 or 2019. Total stock-based compensation expense in connection with options granted to employees recognized in the condensed consolidated statements of operations for both the three and nine months ended September 30, 2017March 31, 2020 and 20162019 was $2,343 and $2,703, respectively, and $320,545 and $10,204, respectively.$1,815.

 

19

Warrants

 

The following table summarizes the changes in warrants outstanding and the related exercise prices for the shares of the Company’s common stockwarrants issued to non-employees of the Company.debt holder in relation to the revolving credit facility. See Note G.

 

   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   1.52  $0.20   250,000  $0.20 

 

Transactions involving warrants are summarized as follows:

 

 Number of
Shares
 Weighted Average
Price Per Share
  Number of
Shares
 Weighted Average
Price Per Share
Outstanding at January 1, 2016  5,638,410  $0.20 
Outstanding at January 1, 2019  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, 2019  250,000   0.20 
Issued            
Exercised            
Cancelled or expired            
Outstanding at September 30, 2017  300,000  $0.20 
Outstanding at March 31, 2020  250,000  $0.20 

 

ThereNo warrants were no warrants granted, exercised, cancelled or forfeited during the ninethree months ended September 30, 2017 and no warrants granted, 5,211,542 warrants exercised and 126,868 cancelledMarch 31, 2020 or forfeited during the nine months ended September 30, 2016, respectively.2019.

 

NOTE IKRELATED PARTY TRANSACTIONS

On August 4, 2016, the Board of Directors authorized the Company to reimburse Peter T. Kross (“Mr. Kross”) $161,075 for expenses incurred related to his successful contested proxy. Effective June 27, 2016, Mr. Kross became a director of the Company and is considered a related party. On August 30, 2016, Mr. Kross accepted an unsecured promissory note (“Kross Note”) for $161,075 from the Company. The outstanding principal balance bore interest at the annual rate of 3.00%. Payment of interest and principal began on September 1, 2016 and continued monthly on the first day of each month thereafter through and including June 1, 2017. The Company was required to pay equal monthly installments of $16,330 which included all remaining principal and accrued interest owed by the Company to Mr. Kross under the Kross Note. The Company could prepay in advance any unpaid principal or interest due under the Kross Note without premium or penalty. The principal balance of the Kross Note as of September 30, 2017 and December 31, 2016 was zero and $97,127, respectively.STOCK ISSUANCE TO NON-EMPLOYEE DIRECTORS

 

During the ninethree months ended September 30, 2017,March 31, 2020 and during the year ended December 31, 2019, the Company issued common stock in the amount of $108,000$18,000 and $132,000 and paid cash consideration of $24,000 and $20,000, 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.

During the nine months ended September 30, 2017, Messrs. Tienor, Sobieski and Koch, earned a bonus of $29,250 contingent on the sale and sale price amount of Ethostream.

From time to time the Company may receive advances from certain of its officers in the form of salary deferment or cash advances to meet short term working capital needs. These advances may not have formal repayment terms or arrangements. As of September 30, 2017 and December 31, 2016, there were no such arrangements.

18

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)

NOTE JL – COMMITMENTS AND CONTINGENCIES

 

Office LeaseLeases Obligations

 

In October 2013, the Company entered into a lease agreement for 6,362 square feet of commercial office space in Waukesha, Wisconsin for its corporate headquarters. The Waukesha lease would have expired in April 2021, but was subsequently amended and extended through April 2026. On April 7, 2017 the Company executed an amendment to its’ existing lease in Waukesha, Wisconsin to expand another 3,982 square feet, bringing the total leased space to 10,344 square feet. In addition, the lease term was extended from May 1, 2021 to April 30, 2026. The commencement date for this amendment was July 15, 2017.

 

20

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, as amended, was set to expire at the end of January 2017.2018. In December 2016,November 2017, the Company entered into a firstsecond amendment to the lease agreement extending the lease through the end of January 2018.2019. In November 2018, the Company entered into a third amendment to the lease agreement extending the lease through the end of January 2022.

 

In May 2017, the Company entered into a lease agreement for 5,838 square feet of floor space in Waukesha, Wisconsin for its inventory warehousing operations. The Waukesha lease expires in May 2027.2024.

 

CommitmentsThe Company determines if an arrangement is a lease at inception. This determination generally depends on whether the arrangement conveys to the Company the right to control the use of an explicitly or implicitly identified fixed asset for a period of time in exchange for consideration. Control of an underlying asset is conveyed to the Company if the Company obtains the rights to direct the use of and to obtain substantially all of the economic benefits from using the underlying asset. The Company does not separate non-lease components from lease components to which they relate and accounts for the combined lease and non-lease components as a single lease component.

Operating leases are included in our condensed consolidated balance sheet as right-of-use assets, operating lease liabilities – current and operating lease liabilities – long-term. We do not recognize a right-of-use asset and lease liability for leases with a term of 12 months or less. Our current operating leases are for facilities. 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.

In determining our right-of-use assets and lease liabilities, we apply a discount rate to the minimum rentalslease 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 G for further discussion.

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 the Company's proportionate share of common area maintenance, utilities, taxes and insurance and are presented as operating expenses in the Company’s statements of operations in the same line item as expense arising from fixed lease payments.

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.

The components of lease expense for the three months ended March 31, 2020 were as follows:

Operating lease expense:  
Operating lease cost – fixed $58,779 
Variable lease cost  38,732 
Total operating lease cost $97,511 

21

Other information related to leases as of September 30, 2017 areMarch 31, 2020 was 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 
Operating lease liability – current $226,464 
Operating lease liability – long-term $720,890 
Operating cash outflows from operating leases $55,029 
     
Weighted-average remaining lease term of operating leases  5.43 years 
Weighted-average discount rate of operating leases  8.5 % 

Future annual minimum operating lease payments as of March 31, 2020 were as follows:

2020 (excluding the three months ended March 31, 2020) $168,806 
2021  242,299 
2022  195,176 
2023  193,169 
2024 and thereafter  384,119 
Total minimum lease payments  1,183,569 
Less imputed interest  (236,215)
Total $947,354 

 

Rental expenses charged to continuing operations for the three and nine months ended September 30, 2017March 31, 2020 and 20162019 was $86,649$97,511 and $42,271 and $200,816 and $127,537,

$89,526, 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,Unless provided with a resale or tax exemption certificate, the Company engaged aassesses and collects sales tax consultanton sales transactions and records the amount as a liability. It is recognized as a liability until remitted to assist in determining the extent of its potentialapplicable state. Total revenues do not include sales tax exposure. Based upon this analysis, management determinedas the Company had probable exposureis considered a pass through conduit for certain unpaid obligations, including interestcollecting 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 aremitting 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.

19

TELKONET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2017

(UNAUDITED)

Prior to 2017, the Company successfully executed and paid in full VDAs in thirty six states totaling approximately $765,000 and is current with the subsequent filing requirements.taxes.

 

The following table sets forth the change in the sales tax accrual as of September 30, 2017March 31, 2020 and December 31, 2016:2019:

 

  

September 30,

2017

  December 31, 2016  
Balance, beginning of year $274,869  $229,768  
Sales tax collected  235,091   452,016  
Provisions (reversals)  (52,000)  151,000  
Interest and penalties  -   (3,017) 
Payments  (385,629)  (554,898) 
Balance, end of period $72,331  $274,869  

NOTE K – BUSINESS CONCENTRATION

For the nine months ended September 30, 2017 and 2016, no single customer represented 10% or more of total net revenues. As of September 30, 2017, one customer accounted for approximately 10% of the Company’s net accounts receivable. As of December 31, 2016, two customers accounted for approximately 24% of the Company’s net accounts receivable.

Purchases from one supplier approximated $2,122,000, or 86%, of purchases for the nine months ended September 30, 2017 and $1,907,000, or 77%, of purchases for the nine months ended September 30, 2016. Total due to this supplier, net of deposits, was approximately $525,858 as of September 30, 2017, and $45,037 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.

  March 31,
2020
 December 31, 2019
Balance, beginning of year $26,957  $43,400 
Sales tax collected  20,449   167,233 
Provisions (reversals)  15,553   (10,664)
Payments  (54,069)  (173,012)
Balance, end of period $8,890  $26,957 

 

 

 

 

 22 

 

NOTE M – BUSINESS CONCENTRATION

For the three months ended March 31, 2020, there were two customers represented approximately 23% of total net revenues. For the three months ended March 31, 2019, two customers represented approximately 31% of total net revenues.

As of March 31, 2020, two customers accounted for approximately 29% of the Company’s net accounts receivable. As of December 31, 2019, two customers represented 36% of the Company’s net accounts receivable.

Purchases from one supplier approximated $385,000, or 84%, of total purchases for the three months ended March 31, 2020 and approximately $775,000, or 76%, of total purchases for the three months ended March 31, 2019. The amount due to this supplier, net of deposits paid, was approximately $71,000 and $579,000 as of March 30, 2020 and December 31, 2019, respectively.

NOTE N – SUBSEQUENT EVENT

On April 21, 2020, Telkonet, Inc. (the “Company”) entered into an unsecured promissory note, dated as of April 17, 2020 (“the PPP Loan”), with Heritage Bank of Commerce under the Paycheck Protection Program (the “PPP”) administered by the United States Small Business Administration (“SBA”) and authorized by the Keeping American Workers Employed and Paid Act, which is part of the Coronavirus Aid, Relief, and Economic Security Act, enacted on March 27, 2020. The principal amount of the PPP Loan is $913,063, bears interest of 1.0% per annum and was disbursed on April 21, 2020.

The PPP Loan has a maturity date of April 21, 2022. No payments of principal or interest are required during the first six months, but interest accrues during this period. After this period, monthly payments of principal and interest are required and continue until maturity with respect to any portion of the PPP Loan not forgiven, as discussed below. The PPP Loan may be prepaid, in full or in part, at any time prior to maturity with no prepayment penalties. The note contains events of default and other provisions customary for a loan of this type.

Under the terms of the PPP, the Company can apply for, and be granted, forgiveness for all or a portion of the PPP Loan. Such forgiveness will be determined, subject to limitations and ongoing rulemaking by the SBA, based on the use of loan proceeds for eligible purposes, including payroll costs, mortgage interest, rent, utility costs and the maintenance of employee and compensation levels. At least 75% of such forgiven amounts must be used for eligible payroll costs. The amount of loan forgiveness will be reduced if the Company terminates employees or reduces salaries during the eight-week period following the date the proceeds are disbursed. No assurance is provided that the Company will obtain forgiveness of the PPP Loan in whole or in part.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the accompanying condensed consolidated financial statements and related notes thereto for the three and nine months ended September 30, 2017,March 31, 2020, 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, 2016,2019, filed with the U.S.US. Securities and Exchange Commission (the “SEC”) on April 3, 2017.March 30, 2020.

 

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 20172020 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 March 30, 2020 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.

 

24

Revenues

 

The table below outlines product versus recurring revenues for comparable periods:

 

   Three Months Ended 
   September 30, 2017  September 30, 2016  Variance 
                    
 Product  $1,904,571   94%  $1,360,887   90%  $543,684   40% 
 Recurring   131,665   6%   143,028   10%   (11,363)  -8% 
 Total  $2,036,326   100%  $1,503,915   100%  $532,321   35% 
  Three Months Ended
  March 31, 2020 March 31, 2019 Variance
             
Product $1,609,262   89% $2,586,669   94% $(977,407)  (38%)
Recurring  194,162   11%  176,533   6%  17,629   10%
Total $1,803,424   100% $2,763,202   100% $(959,778)  (35%)

 

   

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% 

Product Revenue

 

Product revenue principally arises from the sale and installation of the EcoSmart energy management platform. The EcoSmart Suite of products consists of thermostats, sensors, controllers, wireless networking products, switches, outlets and a control platform.

 

For the three months ended September 30, 2017,March 31, 2020, product revenues decreased by 38% or $0.98 million when compared to the prior year. Product revenues derived from value added resellers and distribution partners were $1.1 million for the three months ended March 31, 2020, a decrease of 48% compared to the prior year period. The decrease was primarily driven by non-repeatable revenues in 2019 from three customers. Beginning in the third quarter of 2019, the Company began implementing portfolio pricing increases, which under normal circumstances would be expected to positively impact product revenue, increasedbut given the COVID-19 pandemic, the impact of these price increases has been offset by 40% or $0.5reduced demand for our products at this time.

For the three months ended March 31, 2020, all major industry sectors decreased when compared to the prior year. Hospitality revenues decreased $0.49 million to $1.2 million, government revenues decreased $0.37 million to $.06 million, education revenues decreased $0.01 million to $0.25 million and for the nine months ended September 30, 2017, product revenueMDU revenues decreased 10% or $0.6$0.10 million to $.09 million. For the three months ended September 30, 2017, the hospitality market comprised $1.3March 31, 2020, international revenues decreased $0.49 million of product sales for the three months ended September 30, 2017, a $0.1to $0.06 million decrease fromwhen compared to the prior year period. The education market sales for thedecrease in international revenues was primarily driven by non-repeatable revenues from three months ended September 30, 2017 increased $0.3 million to $0.4 million from $0.1 million for the prior year period. The Multiple Dwelling Unit (“MDU”) market increased $0.2 million from $0.0 million during the three months ended September 30, 2016. The hospitality market sales for the nine months ended September 30, 2017 decreased $0.7 million 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 million to $1.0 million from $0.9 million for the prior year periodcustomers in 2019 and the Commercial and MDU market sales for the nine months ended September 30, 2017 remained at $0.5 million for the nine months ended September 30, 2017 and 2016. The Company’s distribution channels through resellers and value added distribution partners decreased from $3.1 million for the nine months ended September 30, 2016 tolimited international revenues in 2020.

Backlogs were approximately $2.8 million and $4.0 million at September 30, 2017.March 31, 2020 and 2019, respectively.

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 nine months ended September 30, 2017,March 31, 2020, recurring revenue decreased by 8% and increased by 1%, respectively,10% when compared to the prior year period. The increase was related to increased unit sales of call center support services.

 

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% 

The table below outlines product versus recurring cost of sales, along with respective amounts of those costs as a percentage of revenue for the comparable periods:

 

   Nine Months Ended 
   September 30, 2017  September 30, 2016  Variance 
                    
 Product  $3,233,978   56%  $3,194,094   50%  $39,884   1% 
 Recurring   118,347   34%   92,324   27%   26,023   28% 
 Total  $3,352,325   55%  $3,286,418   49%  $65,907   2% 
  Three Months Ended
  March 31, 2020 March 31, 2019 Variance
             
Product $966,603   60% $1,690,598   65% $(723,995)  (43%)
Recurring  22,772   12%  86,042   49%  (63,270)  (74%)
Total $989,375   55% $1,776,640   64% $(787,265)  (44%)

25

 

Costs of Product RevenueSales

Costs of product revenue include equipment and installation labor related to EcoSmart technology. For the three and nine months ended September 30, 2017,March 31, 2020, product costs increased by 50% and 1%, respectively,decreased 43% compared to the prior year periods. For the three month comparison, the materialsperiod based upon lower revenues. The variance was primarily attributable to decreases in material costs of $0.35 million, logistical expenses of $0.22 million, inclusive of import tariffs and inventory adjustments of $0.08 million. Material costs as a percentage of product sales increased 2% to 45% for the three month ended September 30, 2017 fromrevenues were 43% for the three months ended September 30, 2016. The costquarter, an increase of materials increased $0.15 million, freight8%, compared to the prior year period. Our core products are manufactured in China 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 installationsas a result tariffs imposed on Chinese imports resulted in a $0.19 million variance in contractor services costs, consequently, salary, benefits and travel costs relatedan adverse impact of approximately 3% on the actual gross profit percentage for the quarter ended March 31, 2020, compared to installations decreased by $0.07 million.approximately 9% for the quarter ended March 31, 2019.

 

For the nine month comparison, the use of outside contractors for installations resulted in a $0.20 million decrease in salary, wages and travel expense. These decreases were offset by a $0.16 million adjustment in inventory costs, a $0.03 million increase in freight costs, a $0.03 million increase in outside services and a $0.02 million increase in parts and supplies and warranty expense.

Costs of Recurring Revenue

Recurring costs are comprised primarily of labor and telecommunication services for our customer service department.call center support labor. For the three and nine months ended September 30, 2017,March 31, 2020, recurring costs increaseddecreased by 52% and 28%, respectively,74% when compared to the prior year periods.period. The threevariance was primarily due to decreases in call center staffing as the Company evaluates internal staffing and nine month variances are the result of a $0.02 million and a $0.03 million increase in salary and benefit costsoutsourcing arrangements.

Gross Profit

The table below outlines product versus recurring gross profit, along with respective actual gross profit percentages for the periodcomparable periods:

  Three Months Ended
  March 31, 2020 March 31, 2019 Variance
             
Product $642,659   40% $896,071   35% $(253,412)  (28%)
Recurring  171,390   88%  90,491   51%  80,899   89%
Total $814,049   45% $986,562   36% $(172,513)  (17%)

Gross Profit on Product Revenue

Gross profit on product revenue for the three months ended September 30, 2017. The Company added a support services supervisor.March 31, 2020 decreased 28% when compared to the prior year period. For the three months ended March 31, 2020, the actual gross profit percentage increased 5% to 40%. Contributing to the increase were decreases in material costs of $0.35 million, logistical expenses of $0.22 million, inclusive of import tariffs and inventory adjustments of $0.08 million. Tariffs imposed on Chinese imports resulted in an adverse impact of approximately 3% on the actual gross profit percentage for the three months ended March 31, 2020, compared to approximately 9% for the prior year period.

 

Gross Profit on Recurring Revenue

Gross profit on recurring revenue for the three months ended March 31, 2020 increased 89% when compared to the prior year period. The increase was a combination of increased unit sales of call center support services and decreased call center staffing. For the three months ended March 31, 2020, the actual gross profit percentage increased 37% when compared to the prior year period.

 26 

 

Gross ProfitOperating Expenses

 

   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 RevenueThe tables below outline operating expenses for the comparable periods, along with percentage change:

 

  Three Months Ended March 31,
  2020 2019 Variance
         
Total $1,454,648  $1,826,606  $(371,958)  (20%)

Gross profit for

The Company’s operating expenses are comprised of research and development, selling, general and administrative expenses and depreciation and amortization expense. During the three and nine months ended September 30, 2017 increased by 26% andMarch 31, 2020, operating expenses decreased by 21%, respectively,20% when compared to the prior year periods. For the three months ended September 30, 2017, the actual gross profit percentage declined to 39% from 43%. The majority of the variance was due to an approximate increase of 20% for outside services. For the nine months ended September 30, 2017, the actual gross profit percentage declined to 44% from 50%. Material costs as a percentage of sales increased 3% for the nine months ended September 30, 2017 when compared to the prior year period. The inventory valuation adjustment variance of $0.16 million during the nine months ended September 30, 2017 when compared to the prior year period also contributed to gross profit decline.

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% 

27

During the three and nine months ended September 30, 2017, operating expenses decreased by 9% 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% 

   Nine Months Ended September 30, 
   2017  2016  Variance 
                   
 Total  $1,323,669  $1,321,007  $2,662   0% 
  Three Months Ended March 31,
  2020 2019 Variance
         
Total $369,243  $486,626  $(117,383)  (24%)

 

Research and development costs are related to both present and future productsproduct development and integration and are expensed in the period incurred. CurrentDuring the three months ended March 31, 2020, research and development costs are associated with product development and integration. During the three and nine months ended September 30, 2017, research and development costs increased by 17% and 0%, respectively,decreased 24% when compared to the prior year periods. For the three month comparison, theperiod. The variance is dueprimarily attributable to an approximate $0.04 million increasedecreases in expenditures for consulting, a $0.01 increase in personnel recruitingexpenses incurred with third-party consultants 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 million increase in consulting and a $0.02 million increase for new product certification expenses for the nine months ended September 30, 2017.expense.

 

Selling, General and Administrative Expenses

  Three Months Ended September 30, 
  2017  2016  Variance 
                 
Total $1,188,905  $1,432,489  $(243,584)   -17% 

  Nine Months Ended September 30, 
  2017  2016  Variance 
                 
Total $4,396,667  $5,012,249  $(615,582)   -12% 
  Three Months Ended March 31,
  2020 2019 Variance
         
Total $1,070,610  $1,323,049  $(252,439)  (19%)

 

During the three and nine months ended September 30, 2017,March 31, 2020, selling, general and administrative expenses decreased over the prior year periodsperiod by 17%19%. The variance is primarily attributable to decreases in trade shows and 12%, respectively. For the three month comparison, due to the saleaudit fees of EthoStream, the Company was able to decrease executive, accounting$0.07 million each, salary and recruitment of $0.10 million and sales salaries, wages and benefits by $0.20 million. A $0.07 million decrease was a result of a refund received from a utility. The Company had a $0.09 million decrease in sales and use tax, the result of a $0.10 million State of Wisconsin audit assessment during 2016 as well as a $0.06 million decrease in bad debt expense, the result of a collection previously reserved. These decreases were offset by increases for legal expense of $0.03 million, hardware/software expenses of $0.06 million, marketing and trade show expensecommissions 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, accounting and sales salaries, wages and benefits of $0.61 million, $0.11 million for sales and use tax, related to the State of Wisconsin audit discussed above, a utility refund of $0.07 million, $0.03 million for director fees, $0.04 million for insurance expense. These reductions in expense werepartially offset by ana $0.05 million increase in stock option expense of $0.31 million, marketing and trade show expenses of $0.14 million, rent expense of $0.07 million, commissions of $0.02 million and hardware/software costs of $0.05 million.

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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.temporary staffing.

 

EBITDA from Continuing OperationsNon-GAAP Financial Measures

 

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, amortization and amortizationstock-based compensation (“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, amortization and amortizationstock-based compensation 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), operating income (loss) from operations,, or any other measure for determining operating performance ofor liquidity, as determined under accounting principles generally accepted in the United States (GAAP). In assessing the overall health of its business for the three and nine months ended September 30, 2017March 31, 2020 and 2016,2019, the Company excluded items in the following general categorycategories described below:

 

·Stock-based compensation: The Company believes that because of the variety of equity awards used by companies, varying methodologies for determining stock-based compensation and the assumptions and estimates involved in those determinations, the exclusion of non-cash stock-based compensation enhances the ability of management and investors to understand the impact of non-cash stock-based compensation on our operating results. Further, the Company believes that excluding stock-based compensation expense allows for a more transparent comparison of its financial results to the previous period.year.

 27 

RECONCILIATION OF NET LOSS

TO ADJUSTED EBITDA

FOR THE THREE MONTHS ENDED MARCH 31,

  2020 2019
Net loss $(652,501) $(845,604)
Interest expense, net  8,680   5,560 
Income tax provision  3,222    
Depreciation and amortization  14,795   16,931 
EBITDA  (625,804)  (823,113)
Adjustments:        
Stock-based compensation  1,815   1,815 
Adjusted EBITDA $(623,989) $(821,298)

Liquidity and Capital Resources

For the three-month period ended March 31, 2020, the Company reported a net loss of $652,501 and had cash used in operating activities of $109,888 and ended the period with an accumulated deficit of $125,758,040 and total current assets in excess of current liabilities of $3,561,268. At March 31, 2020, the Company had $3,084,828 of cash and approximately $153,000 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 March 31, 2020, we had a total borrowing base of approximately $720,000 and an outstanding balance of $518,463, resulting in the approximate availability of $153,000 on the credit facility.

Since inception through March 31, 2020, we have incurred cumulative losses of $125,758,040 and have never generated enough cash through operations to support our business. For the three-month period ended March 31, 2020, we had a cash flow deficit from operations of $109,888. 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 previous independent registered public accounting firm on our consolidated financial statements for the year ended December 31, 2019 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 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 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.

The Company’s operations and financial results have also been impacted by the COVID-19 pandemic. On January 30, 2020 the World Health Organization (“WHO”) announced a global health emergency because of a new strain of a novel coronavirus in Wuhan, China (the “COVID-19 outbreak”) and the risks to the international community as the virus spreads globally. In March 2020, the WHO classified the COVID-19 outbreak a pandemic, based on the rapid increase in exposure globally. The spread of the COVID-19 outbreak has caused significant volatility and uncertainty in U.S. and international markets.

·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.28

The Company’s sales have been disrupted as a result of its customers furloughing and laying off their employees and/or suspending projects. Despite these challenges, quoting remains active and the aggregate pipeline has not contracted significantly. Thus far, the impact has been delays as opposed to cancellations. Due to travel restrictions, social distancing and shelter at home edicts, the hospitality industry, our largest market that generally contributes more than 50% of our revenue, has suffered as much as any. At this time, the disruption is expected to be temporary; however, the length or severity of this pandemic is unknown. Depending on the length and severity, the demand for our products, our customers’ ability to meet payment obligations to the Company, our supply chain and production capabilities, and our workforces’ ability to deliver our products and services could be impacted. Management is actively monitoring the impact of the global situation on its financial condition, liquidity, operations, suppliers, industry, and workforce. While we expect this disruption to have a material adverse impact our results of operations, financial condition and cash flows for the year 2020, the Company is unable to reasonably determine the impact at this time.

In response to the COVID-19 pandemic and its effects (and potential further effects) on the Company’s operations and financial results, the Company has taken and is continuing to take a number of actions to preserve cash. These actions include suspending the use of engineering consultants, and cancelling all travel and the Company’s attendance at tradeshows (implemented prior to applicable government stay-at-home orders being put in place). In addition, in early April of 2020, management made the decision to furlough certain employees, instituted pay cuts for certain other employees and suspended the Company’s 401(k) match through the end of 2020. With the receipt of the PPP Loan (discussed below), the Company was able to bring back the furloughed employees, restore payroll to prior levels and delay suspension of the 401(k) match. The actions taken in response to the COVID-19 pandemic are in addition to the cost elimination and liquidity management actions that the Company began implementing in the second half of 2019, including reviewing opportunities to decrease spend with third party consultants and providers, strategically reviewing whether or not to fill employee positions in the event of vacancies, and implementing sales campaigns to sell slow-moving inventory and reducing existing inventory volumes. There is no guarantee, however, that these actions, nor any other actions identified, will yield profitable operations in the foreseeable future.

In addition, on April 21, 2020, the Company entered into an unsecured promissory note, dated as of April 17, 2020 (“the PPP Loan”), with Heritage Bank of Commerce for a $913,063 loan under the Paycheck Protection Program (“PPP”) SBA 7(a) loan. The PPP SBA 7(a) loan program is being administered by the United States Small Business Administration (“SBA”) and was authorized by the Keeping American Workers Employed and Paid Act, which is part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act that was signed into law on March 27, 2020. The principal amount of the Loan is $913,063, bears interest of 1.0% per annum and has a maturity date of April 21, 2022. See Note N – Subsequent Event for a summary of the terms of the PPP Loan.

At March 31, 2020, the Company had approximately $3,084,828 of cash and approximately $153,000 of availability on its credit facility. However, the credit facility requires that the Company maintain an unrestricted cash balance of $2,000,000, limiting the ability of the Company to use its cash reserves to fund its operations. As of March 31, 2020, the outstanding balance on the credit facility was $518,463. On average, during the twelve-month period between April 1, 2019 and March 31, 2020, the Company’s cash balance decreased $55,000 per month.

The Company is using the proceeds of the PPP Loan to support its ongoing operations and currently expects to also draw on its cash reserves and utilize the credit facility to 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 these financial statements. The Credit Facility provides us with needed liquidity to assist in meeting our obligations or pursuing strategic objectives. Continued operating losses will deplete these cash reserves and could result in a violation of the financial covenants. Consequently, repayment of amounts borrowed 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 occurrence of any of these events could have a material adverse effect on our business and results of operations.

 

 

 

 29 

 

 

RECONCILIATION OF NET LOSS FROM

CONTINUING OPERATIONS TO ADJUSTED EBITDA

(Unaudited)

  

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
  2017  2016  2017  2016 
             
Net loss from continuing operations $(871,340) $(1,192,083) $(3,034,984) $(2,995,699)
Interest (income) expense, net  (8,722)  15,482   (2,797)  45,308 
Provision (benefit) for income taxes  (3,600)  2,575   4,301   3,200 
Depreciation and amortization  14,616   8,382   34,405   24,366 
EBITDA – continuing operations  (869,046)  (1,165,644)  (2,999,075)  (2,922,825)
Adjustments:                
Stock-based compensation  2,343   2,703   320,545   10,204 
Bonuses paid to executives upon sale of discontinued operations        87,750    
Adjusted EBITDA $(866,703) $(1,162,941) $(2,590,780) $(2,912,621)

Liquidity and Capital ResourcesThe Company’s Board also continues to consider 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. However, these actions are not solely within the control of the Company. At May 15, 2020, no definitive alternatives had been identified.

 

The Company has financed its operations since inception primarily through privateAccordingly, and public offeringsin light of the Company’s equity securities,historic 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.

 

Working Capital

 

Working capital (current assets in excess of current liabilities) from continuing operations increaseddecreased by $9,840,658$626,181 during the ninethree months ended September 30, 2017March 31, 2020 from working capital deficit of $26,859$4,187,449 at December 31, 20162019 to a working capital of $9,813,799$3,561,268 at September 30, 2017.

Kross Promissory Note

On August 4, 2016, the Board of Directors authorized the Company to reimburse Peter T. Kross (“Mr. Kross”) $161,075 for expenses incurred related to his successful contested proxy. Effective June 27, 2016, Mr. Kross becameMarch 31, 2020. The changes in Accounts Receivable and Inventory were primarily a directorresult of the Company and is considereddecline in revenues. The change in Accounts Payable was primarily 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 balanceresult of the Kross Note as of September 30, 2017decline in revenues and December 31, 2016 was zero and $97,127, respectively.cost containment actions.

 

Revolving Credit Facility

 

On September 30, 2014, the Company and its wholly-owned subsidiary, EthoStream, as co-borrowers (collectively, the “Borrowers”), entered into a loan and security agreement (the “Heritage Bank Loan Agreement”), with Heritage Bank of Commerce, a California state chartered bank (“Heritage Bank”), governing a new revolving credit facility in a principal amount not to exceed $2,000,000 (the “Credit Facility”). Availability of borrowings under the Credit Facility from time to time is subject to a borrowing base calculation based on the Company’s eligible accounts receivable and eligible inventory each multiplied by an applicable advance rate, with an overall limitation tied to the Company’s eligible accounts receivable. The Heritage Bank Loan Agreement is available for working 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%6.25% at September 30, 2017March 31, 2020 and 6.75% at7.75% December 31, 2016.2019. 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, anNovember 6, 2019, the eleventh amendment to the Credit Facility was executed extendingto extend the maturity date to September 30, 2018,2021, unless earlier accelerated under the terms of the Heritage Bank Loan Agreement.Agreement, and eliminate the maximum EBITDA loss covenant.  The eleventh amendment was effective as of September 30, 2019.

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. As discussed above, the EBITDA loss covenant was eliminated in the eleventh amendment to the Credit Facility. The sole financial covenants that require the Borrowers to maintain a minimum EBITDA level, measured quarterly, andare a minimum asset coverage ratio and a minimum unrestricted cash balance of $2 million, both of which are measured monthly.at the end of each month. A violation of anyeither 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 30, 2017$518,463 and $624,347 at March 31, 2020 and December 31, 2019 and the remaining available borrowing capacity was approximately $1,304,000.$153,000 and $424,000, respectively. As of September 30, 2017,March 31, 2020, 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.

30

 

Cash Flow Analysis

 

Cash used in continuing operations was $2,459,746$109,888 and $2,768,301$1,716,357 during the ninethree months ended September 30, 2017March 31, 2020 and 2016,2019, respectively. As of September 30, 2017,March 31, 2020, our primary capital needs included costs incurred to increase energy management sales, inventory procurement and managing current liabilities. The working capital changes during the ninethree months ended September 30, 2017March 31, 2020 were primarily related to ana result of approximate $380,500 increase$961,000 decrease in accounts receivable, a $305,000 increase$423,000 decrease in inventory,inventories, a $305,000 increase$115,000 decrease in contract assets, partially offset by a $582,000 decrease in accounts payable, a $330,000$157,000 decrease in contract liabilities, a $85,000 decrease in other accrued expenses, a $89,000 increase in deferred revenueprepaid expenses and other current assets, and a $168,000 increase$91,000 decrease in accrued liabilities and expenses.the reserve for inventory obsolescence. The working capital changes during the ninethree months ended September 30, 2016March 31, 2019 were primarily related toa result of increased working capital needs based on revenue growth, with an approximately $469,000 decreaseapproximate $1,439,000 increase in accounts receivable, a $410,000$463,000 increase in inventory, a $535,000 decrease in accounts payable, and a $300,000$187,000 increase in accrued expenses, a $172,000 increase in the reserve for inventory obsolescence, a $169,000 decrease in contract liabilities, and expenses.a $132,000 increase in contract assets. Accounts receivable fluctuatesbalances fluctuate 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 fluctuatesbalances fluctuate with changes in inventory levels, volume of inventory purchases, and negotiated supplier and vendor terms.

 

Cash provided by investing activitiesThere was $11,092,051 during the nine months ended September 30, 2017 andno cash used in investing activities was $2,352 during the ninethree months ended September 30, 2016, respectively.March 31, 2020. Cash used in investing activities was $2,302 during the three months ended March 31, 2019. During the ninethree months ended September 30, 2017, the cash provided by investing activities reflects the proceeds less adjustments associated with the sale of the assets and certain liabilities assumed of the Company’s wholly-owned subsidiary, EthoStream and a decrease of $142,572 associated with the purchase of computer equipment and furniture, fixtures and equipment. Due to the sale of EthoStream, the Company extended the Waukesha lease, as discussed in Note J, and refurbished the corporate office to accommodate employee’s previously working at the Milwaukee operations office. During the nine months ended September 30, 2016,March 31, 2019, the Company purchased $33,629approximately $2,302 of computer equipment and had $31,277 of restricted cash related to a bonding requirement released.equipment.

31

 

Cash used in financing activities was $982,176 and cash$105,884 during the three months ended March 31, 2020. Cash provided by financing activities was $707,637 during the nine months ended September 30, 2017 and 2016, respectively. The Heritage Bank Loan Agreement for the Company’s line of credit includedthe Company and EthoStream as co borrowers. Upon closing the EthoStream sale transaction on March 29, 2017, the entire balance outstanding on the Credit Facility, $1,062,129, was repaid and a net balance of $79,953 was subsequently borrowed$785,766 during the three months ended September 30, 2017. DuringMarch 31, 2019. Proceeds borrowed from the nine months ended September 30, 2016, 5,211,542 warrantsline of credit were exercised$2,820,000 and cash 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 $2,925,884 during the ninethree months ended September 30, 2016.March 31, 2020. Proceeds borrowed from the line of credit were $2,339,000 and cash used for payments on the line of credit were $1,553,234 during the three months ended March 31, 2019.

 

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 impacts and uncertainties of the COVID-19 outbreak and the decreasing price of energy, along with competition will continue to present a challenging operating environment through 2017;2020; therefore working capital management will continue to be a high priority for 2017.2020. The Company’s estimated cash requirements for our operations forover the next 12 months is notare anticipated to differ significantlybenefit from the cost elimination and liquidity management actions that the Company has initiated. However, due to the speed with which the COVID-19 pandemic is developing and the uncertainty of its duration and the timing of recovery, we are unable to predict at this time the extent to which the COVID-19 pandemic may impact our present cash requirements for our operations.financial results, including liquidity.

 

Off-Balance Sheet Arrangements

 

The Company has no material off-balance sheet arrangements.

 

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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.

 

AsEvaluation of September 30, 2017, the Company performed an evaluation,Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that material information required to be disclosed in our periodic reports filed under the supervisionSecurities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized, and withreported within the participationtime periods specified in the SEC’s rules and forms and to ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure. The Company’s Chief Executive Officer and Chief Financial Officer each evaluated the effectiveness of management, includingour disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2020. Based on these evaluations, the Chief Executive Officer and the Chief Financial Officer of the effectiveness of the design and operation of itsconcluded that our disclosure controls and procedures. Management has identified control deficiencies regarding the lackprocedures required by paragraph (b) of segregationRule 13a-15 and 15d-15 were not effective as of duties due to the limited sizeMarch 31, 2020 as a result of the Company’s accounting department, a failure to implementmaterial weaknesses discussed below.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining 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, 2019 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, 2019 based on the COSO framework criteria.

As previously disclosed in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2019, our 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.

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·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.

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 conclude that our consolidated financial statements as of and for the small sizeyears ended December 31, 2019 and 2018 included in the Annual Report on Form 10-K and as of March 31, 2020 and 2019 included in this Form 10-Q were fairly stated in accordance with U.S. GAAP. Notwithstanding the identified material weaknesses, our management has concluded that the audited financial statements included in the Annual Report on Form 10K for the year ended December 31, 2019 and the unaudited condensed consolidated financial statements included in this quarterly filing fairly represent, in all material respects, our financial position, results of operations, cash flows, and changes in stockholders’ equity as of and for the periods presented in accordance with U.S. GAAP.

Under applicable Securities Law, the Company 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 the Annual Report on Form 10-K for the year ended December 31, 2019.

Attestation Report of the Company’s accounting staff. The small size of the Company’s accounting staff may prevent adequate controls in the future, such as segregation of duties, due to the cost/benefit of such remediation. The Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were ineffective as of the end of the period covered by this report.Registered Public Accounting Firm

 

DuringNot applicable.

Changes in Internal Controls

Other than the nine monthsmaterial weaknesses discussed above, during the quarter ended September 30, 2017,March 31, 2020, 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.2019.

 

Item 6. Exhibits.

  

Exhibit Number Description Of Document
10.1Paycheck Protection Program Promissory Note, dated April 17, 2020, between Telkonet, Inc. and Heritage Bank of Commerce (incorporated by reference to our Form 8-K (File No. 000-31972) filed April 27, 2020)
10.2Amendment to the Telkonet, Inc. 2010 Stock Option and Incentive Plan
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

 

 

 

 

 

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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, 2017May 15, 2020By:/s/ Jason L. Tienor
 

Jason L. Tienor

Chief Executive Officer

(principal executive officer)

 

Date: November 14, 2017May 15, 2020By:/s/ Richard E. Mushrush
 

Richard E. Mushrush

Chief Financial Officer

(principal financial officer)

 

 

 

 

 

 

 

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