See accompanying notes to the unaudited
condensed consolidated financial statements
See accompanying notes to the unaudited
condensed consolidated financial statements
See accompanying notes to the unaudited
condensed consolidated financial statements
See accompanying notes to the unaudited
condensed consolidated financial statements
See accompanying notes to the unaudited
condensed consolidated financial statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
SEPTEMBER 30, 2018
(UNAUDITED
)
NOTE A – BASIS OF PRESENTATION
AND SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting
policies applied in the preparation of the accompanying condensed consolidated financial statements follows.
General
The accompanying unaudited condensed consolidated
financial statements of Telkonet, Inc. (the “Company”, “Telkonet”) have been prepared in accordance with
Rule S-X of the Securities and Exchange Commission (the “SEC”) and with the instructions to Form 10-Q. Accordingly,
they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial
statements.
In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair presentation have been included. However, the results
from operations for the nine months ended September 30, 2018, are not necessarily indicative of the results that may be expected
for the year ending December 31, 2018. The unaudited condensed consolidated financial statements should be read in conjunction
with the consolidated December 31, 2017 financial statements and footnotes thereto included in the Company's Form 10-K filed with
the SEC. Refer to Note C – Revenue for the adoption of a new revenue recognition standard in the first quarter of 2018.
Business and Basis of Presentation
Telkonet, formed in 1999 and incorporated
under the laws of the state of Utah, is the creator of the EcoSmart Platform of intelligent automation solutions designed to optimize
energy efficiency, comfort and analytics in support of the emerging Internet of Things (“IoT”).
In 2007, the Company acquired substantially
all of the assets of Smart Systems International (“SSI”), which was a provider of energy management products and solutions
to customers in the United States and Canada and the precursor to the Company’s EcoSmart platform. The EcoSmart platform
provides comprehensive savings, management reporting, analytics and virtual engineering of a customer’s portfolio and/or
property’s room-by-room energy consumption. Telkonet has deployed more than a half million intelligent devices worldwide
in properties within the hospitality, military, educational, healthcare and other commercial markets. The EcoSmart platform is
rapidly being recognized as a leading solution for reducing energy consumption, operational costs and carbon footprints, and eliminating
the need for new energy generation in these marketplaces – all while improving occupant comfort and convenience.
On March 28, 2017, the Company sold substantially
all of the assets of its wholly-owned subsidiary, EthoStream LLC. Refer to Note M for further details.
The condensed consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiary, Telkonet Communications, Inc. The prior period accounts of
EthoStream LLC have been classified as discontinued operations on the condensed consolidated statement of operations and the condensed
consolidated statement of cash flows. All significant intercompany balances and transactions have been eliminated in consolidation.
Unless otherwise noted, all financial information
in the consolidated financial statement footnotes reflects the Company’s results from continuing operations.
Liquidity and Financial Condition
We have financed our operations since inception
primarily through private and public offerings of our equity securities, the issuance of various debt instruments and asset based
lending, and the sale of EthoStream LLC.
The Company reported a net loss from continuing
operations of $2,671,756 for the nine months ended September 30, 2018, had cash used in operating activities from continuing operations
of $3,674,311, had an accumulated deficit of $122,826,412, and total current assets in excess of current liabilities of $6,511,483
as of September 30, 2018.
Income (Loss) per Common Share
The Company computes earnings per share
under Accounting Standards Codification (“ASC”) 260-10, “Earnings Per Share”. Basic net income (loss) per
common share is computed using the treasury stock method, which assumes that the proceeds to be received on exercise of outstanding
stock options and warrants are used to repurchase shares of the Company at the average market price of the common shares for the
year. Dilutive common stock equivalents consist of shares issuable upon the exercise of the Company's outstanding stock options
and warrants. For the nine months ended September 30, 2018 and 2017, there were 3,557,399 and 5,621,800 shares of common stock
underlying options and warrants excluded due to these instruments being anti-dilutive, respectively.
Use of Estimates
The preparation of financial statements
in conformity with United States of America (U.S.) generally accepted accounting principles (GAAP) requires management to make
certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting
period. Estimates are used when accounting for items and matters such as revenue recognition and allowances for uncollectible accounts
receivable, inventory obsolescence, depreciation and amortization, long-lived assets, taxes and related valuation allowance, income
tax provisions, stock-based compensation, and contingencies. The Company believes that the estimates, judgments and assumptions
are reasonable, based on information available at the time they are made. Actual results may differ from those estimates.
Income Taxes
The Company accounts for income taxes in
accordance with ASC 740-10 “Income Taxes.” Under this method, deferred income taxes (when required) are provided based
on the difference between the financial reporting and income tax bases of assets and liabilities and net operating losses at the
statutory rates enacted for future periods. The Company has a policy of establishing a valuation allowance when it is more likely
than not that the Company will not realize the benefits of its deferred income tax assets in the future.
The Company adopted ASC 740-10-25, which
prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. ASC 740-10-25 also provides guidance on derecognition, classification, treatment
of interest and penalties, and disclosure of such positions.
The U.S. Tax Cuts and Jobs Act (“Tax
Act”) was enacted on December 22, 2017. The Tax Act makes broad complex changes to the U.S. tax code including, but not limited
to, reducing the U.S. federal corporate tax rate from 35% to 21%, requiring companies to pay a one-time transition tax on earnings
of certain foreign subsidiaries that were previously tax deferred, and creating new taxes on certain foreign sourced earnings and
additional limitations on the deductibility of interest.
The SEC issued Staff Accounting Bulletin
No. 118 (SAB 118) in December, 2017, to provide guidance on accounting for the effects of the Tax Act. SAB 118 provides for a measurement
period of up to one year from the Tax Act enactment date for companies to complete their assessment of and accounting for those
effects of the Tax Act. Under SAB 118, a company must first reflect the income tax effects of the Tax Act for which the accounting
is complete in the period of the date of enactment. To the extent the accounting for other income tax effects is incomplete, but
a reasonable estimate can be determined, companies must record a provisional estimate to be included in their financial statements.
For any income tax effect for which a reasonable estimate cannot be determined, an entity must continue to apply ASC 740 based
on the provisions of the tax laws in effect immediately prior to the Tax Act being enacted until such time as a reasonable estimate
can be determined. The Company requires additional time to complete its analysis of the impacts of the Tax Act and therefore its
accounting for the Tax Act is provisional but is a reasonable estimate based on available information. The Company will complete
its analysis and finalize its accounting for this provisional estimate during the one year measurement period as prescribed by
SAB 118.
Revenue from Contracts with Customers
Accounting Standards
Codification Topic 606, Revenue from Contracts with Customers (“ASC 606, the Standard”) supersedes nearly all
legacy revenue recognition guidance. ASC 606, the Standard outlines a comprehensive five-step revenue recognition model based
on the principle that an entity should recognize revenue based on when it satisfies its performance obligations by
transferring control of promised goods or services in an amount that reflects the consideration to which the entity expects
to be entitled in exchange for said goods or services.
Identify the customer contracts
The Company accounts for a customer contract
under ASC 606 when the contract is legally enforceable. A contract is legally enforceable when all of the following criteria are
met: (1) the contract has been approved by the Company 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 post-installation
support services to customers. Support services are considered a separate performance obligation.
Determine the transaction price
The Company generally enters into contracts
containing fixed prices. It is not customary for the Company to include contract terms that would result in variable consideration.
In the rare situation that a contract does include this type of provision, it is not expected to result in a material adjustment
to the transaction price. The Company regularly extends pricing discounts; however, they are negotiated up front and adjust the
fixed transaction price set out in the contract.
Customer contracts will typically contain
upfront deposits that will be applied against future invoices, as well as customer retainage. The intent of any required deposit
or retainage is to ensure that the obligations of either party are honored and follow customary industry practices. In addition,
the Company will typically be paid in advance at the beginning of any support contracts, consistent with industry practices. None
of these payment provisions are intended to represent significant implicit financing. The Company’s standard payment terms
are thirty days from invoice date. Products are fully refundable when returned in their original packaging without damage or defacing
less a restocking fee not to exceed fifty (50%) percent of the product’s price. Historical returns have shown to be immaterial.
The Company offers a standard one-year assurance warranty. However customers can purchase an extended warranty. Under the new standard,
extended warranties are accounted for as a service warranty, requiring the revenue to be recognized over the extended service periods.
Contracts involving an extended warranty are immaterial and will continue to be combined with support revenue and recognized on
a straight-line basis over the support revenue term.
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.
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.
Recognize Revenue
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.
Revenues from support services are recognized
over time, in even daily increments over the term of the contract.
Deferred revenue includes deferrals for
the monthly support service fees. Long-term deferred revenue represents support service fees that will be recognized as revenue
after September 30, 2019.
Transition
The Company adopted ASC 606 using a modified
retrospective approach to all contracts not completed as of January 1, 2018. Results for reporting periods beginning January 1,
2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the
Company’s historic accounting under Topic 605, Revenue Recognition. The Company recorded a net decrease to beginning retained
earnings of $0.43 million as of January 1, 2018 due to the cumulative impact of adopting ASC 606. The impact to beginning retained
earnings was primarily driven by the deferral of revenue for unfulfilled performance obligations related to the Company’s
turnkey solutions.
Guarantees and Product Warranties
The Company records a liability for potential
warranty claims in cost of sales at the time of sale. The amount of the liability is based on the trend in the historical ratio
of claims to sales, the historical length of time between the sale and resulting warranty claim, new product introductions and
other factors. The products sold are generally covered by a warranty for a period of one year. In the event the Company determines
that its current or future product repair and replacement costs exceed its estimates, an adjustment to these reserves would be
charged to earnings in the period such determination is made. For the nine months ended September 30, 2018 and the year ended December
31, 2017, the Company experienced returns of approximately 1% to 2% of materials included in the cost of sales. As of September
30, 2018 and December 31, 2017, the Company recorded warranty liabilities in the amount of $47,967 and $59,892, respectively, using
this experience factor range.
Product warranties for the nine months
ended September 30, 2018 and the year ended December 31, 2017 are as follows:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
Beginning balance
|
|
$
|
59,892
|
|
|
$
|
95,540
|
|
Warranty claims incurred
|
|
|
(25,082
|
)
|
|
|
(84,087
|
)
|
Provision charged to expense
|
|
|
13,157
|
|
|
|
48,439
|
|
Ending balance
|
|
$
|
47,967
|
|
|
$
|
59,892
|
|
NOTE B – NEW ACCOUNTING PRONOUNCEMENTS
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 June 2016, the FASB issued ASU No. 2016-13,
Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 provides
guidance for estimating credit losses on certain types of financial instruments, including trade receivables, by introducing an
approach based on expected losses. The expected loss approach will require entities to incorporate considerations of historical
information, current information and reasonable and supportable forecasts. ASU 2016-13 also amends the accounting for credit losses
on available-for-sale debt securities and purchased financial assets with credit deterioration. The guidance is effective for fiscal
years beginning after December 15, 2019, including interim periods within those fiscal years. The guidance requires a modified
retrospective transition method and early adoption is permitted. The Company does not expect the adoption of ASU 2016-13 to have
a material impact on its consolidated financial statements.
Management has evaluated other recently
issued accounting pronouncements and does not believe that any of these pronouncements will have a significant impact on our consolidated
financial statements and related disclosures.
Accounting Standards Recently Adopted
Effective January 1, 2018, the Company
has adopted Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606, the Standard”),
which supersedes nearly all legacy revenue recognition guidance. ASC 606 outlines a comprehensive five-step revenue recognition
model based on the principle that an entity should recognize revenue based on when an it satisfies its performance obligations
by transferring control of promised goods or services in an amount that reflects the consideration to which the entity expects
to be entitled in exchange for said goods or services.
Effective January 1, 2018, the Company has adopted ASU No. 2016-18, Statement
of Cash Flows: Restricted Cash, (“Update 2016-18”). Update 2016-18 provides guidance on the classification of
restricted cash in the statement of cash flows. The amendments are effective for interim and annual periods beginning after December
15, 2017. The amendments in Update 2016-18 was adopted on a retrospective basis. Due to the adoption of ASU 2016-18, the cash,
cash equivalents and restricted cash presented in the Condensed Consolidated Statement of Cash Flows for the nine months ended
September 30, 2018 and 2017 increased by $10,000 and $800,000 of restricted cash held as of September 30, 2018 and 2017, respectively
NOTE C– REVENUE
The following table presents the Company’s
product and recurring revenues disaggregated by industry for the three months ended September 30, 2018.
|
|
|
Hospitality
|
|
|
Education
|
|
|
Multiple
Dwelling Units
|
|
|
Government
|
|
|
Total
|
|
|
Recurring
|
|
|
$
|
103,157
|
|
|
$
|
40,344
|
|
|
$
|
1,469
|
|
|
$
|
–
|
|
|
$
|
144,970
|
|
|
Product
|
|
|
|
1,222,543
|
|
|
|
(4,159
|
)
|
|
|
100,604
|
|
|
|
58
|
|
|
|
1,319,046
|
|
|
|
|
|
$
|
1,325,700
|
|
|
$
|
36,185
|
|
|
$
|
102,073
|
|
|
$
|
58
|
|
|
$
|
1,464,016
|
|
The following table presents the Company’s
product and recurring revenues disaggregated by industry for the nine months ended September 30, 2018.
|
|
|
Hospitality
|
|
|
Education
|
|
|
Multiple Dwelling Units
|
|
|
Government
|
|
|
Total
|
|
|
Recurring
|
|
|
$
|
330,652
|
|
|
$
|
58,449
|
|
|
$
|
10,764
|
|
|
$
|
–
|
|
|
$
|
399,865
|
|
|
Product
|
|
|
|
4,755,219
|
|
|
|
647,079
|
|
|
|
166,454
|
|
|
|
74,757
|
|
|
|
5,643,509
|
|
|
|
|
|
$
|
5,085,871
|
|
|
$
|
705,528
|
|
|
$
|
177,218
|
|
|
$
|
74,757
|
|
|
$
|
6,043,374
|
|
Sales taxes and other usage-based taxes
are excluded from revenues.
Contract assets
Contracts are billed in accordance with
the terms and conditions, either at periodic intervals or upon substantial completion. This can result in billing occurring subsequent
to revenue recognition, resulting in contract assets. Contract assets are presented as current assets in the Condensed Consolidated
Balance Sheet. The balance of contract assets as of September 30, 2018 and at the date of adoption of ASC 606 was $0.36 million
and $0.35 million, respectively. There were approximately $0.1 million of costs incurred to fulfill a contract in the closing balance
of contract assets.
Contract liabilities
Contracts are billed in accordance with
the terms and conditions, either at periodic intervals or upon substantial completion. Often, the Company will require customers
to pay a deposit upon contract signing that will be applied against work performed or products shipped. In addition, the Company
will often invoice the full term of support at the start of the support period. Billings that occur prior to revenue recognition
result in contract liabilities. As of September 30, 2018 and at the date of adoption of ASC 606, contract liabilities were $1.05
million and $0.78 million, respectively. The change in the contract liability balance during the nine-month period ended September
30, 2018 is the result of cash payments received and billing in advance of satisfying performance obligations, less an immaterial
amount of revenue recognized during the period that was included in the contract liability balance at the date of adoption.
Contract costs
Costs to fulfill a turnkey contract primarily
relate to the materials cost and direct labor and are recognized proportionately as the performance obligation is satisfied. The
Company will defer cost to fulfill a contract when materials have shipped (and control over the materials has transferred to the
customer), but an insignificant amount of rooms have been installed. The Company will recognize any deferred costs in proportion
to revenues recognized from the related turnkey contract. The Company does not expect deferred contract costs to be long-lived
since a typical turnkey project takes sixty days to complete. Deferred contract costs are generally presented as other current
assets in the condensed consolidated balance sheets.
The Company incurs incremental costs to
obtain a contract in the form of sales commissions. These costs, whether related to performance obligations that extend beyond
twelve months or not, are immaterial and will continue to be recognized in the period incurred within selling, general and administrative
expenses.
The tables below present the impacts of
our adoption of the new revenue standard on our income statement and balance sheet.
|
|
For the Three Months Ended
September 30, 2018
|
|
|
|
As Reported
|
|
|
Balance Without Adoption of
ASC 606
|
|
|
Effect of
Change Higher/(Lower)
|
|
Income Statement:
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
1,464,016
|
|
|
$
|
1,673,809
|
|
|
$
|
(209,793
|
)
|
Cost of Goods Sold
|
|
|
949,911
|
|
|
|
1,017,131
|
|
|
|
(67,220
|
)
|
Net loss
|
|
$
|
(1,281,008
|
)
|
|
$
|
(1,138,435
|
)
|
|
$
|
142,573
|
|
|
|
For the Nine Months Ended
September 30, 2018
|
|
|
|
As Reported
|
|
|
Balance Without Adoption of
ASC 606
|
|
|
Effect of
Change Higher/(Lower)
|
|
Income Statement:
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
6,043,374
|
|
|
$
|
6,436,657
|
|
|
$
|
(393,193
|
)
|
Cost of Goods Sold
|
|
|
3,427,357
|
|
|
|
3,571, 876
|
|
|
|
(124,520
|
)
|
Net loss
|
|
$
|
(2,671,756
|
)
|
|
$
|
(2,403,083
|
)
|
|
$
|
268,673
|
|
|
|
As of September 30, 2018
|
|
|
|
As Reported
|
|
|
Balance Without Adoption of
ASC 606
|
|
|
Effect of
Change Higher/(Lower)
|
|
Balance Sheet:
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract Assets
|
|
$
|
356,292
|
|
|
$
|
–
|
|
|
$
|
356,292
|
|
Accounts Receivable, net
|
|
|
1,223,039
|
|
|
|
1,432,832
|
|
|
|
(209,793
|
)
|
Inventories
|
|
|
1,889,985
|
|
|
|
1,526,465
|
|
|
|
363,520
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract Liabilities
|
|
|
1,045,237
|
|
|
|
–
|
|
|
|
1,045,237
|
|
Customer Deposits
|
|
|
–
|
|
|
|
201,143
|
|
|
|
(201,143
|
)
|
Deferred Revenue - Current
|
|
|
–
|
|
|
|
486,136
|
|
|
|
(486,136
|
)
|
Deferred Revenue – Long Term
|
|
|
–
|
|
|
|
179,304
|
|
|
|
(179,304
|
)
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated Deficit
|
|
$
|
122,826,412
|
|
|
$
|
122,137,739
|
|
|
$
|
(688,673
|
)
|
The table below presents the cumulative
effect of the changes made to our consolidated balance sheet as of January 1, 2018 after the adoption of ASU 2014-09, Revenue from Contracts with Customers (Topic 606).
|
|
December 31, 2017
|
|
|
Transition Adjustments
|
|
|
January 1,
2018
|
|
Balance Sheet:
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract Assets
|
|
$
|
–
|
|
|
$
|
110,000
|
|
|
$
|
110,000
|
|
Inventories
|
|
|
1,259,536
|
|
|
|
239,000
|
|
|
|
1,498,536
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract Liabilities
|
|
|
–
|
|
|
|
779,000
|
|
|
|
779,000
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated Deficit
|
|
$
|
(119,724,656
|
)
|
|
$
|
(430,000
|
)
|
|
$
|
(120,154,656
|
)
|
Remaining performance obligations
As of September 30, 2018, the aggregate
amount of the transaction price allocated to remaining performance obligations was approximately $0.59 million. Except for support
services, the Company expects to recognize 100% of the remaining performance obligations over the next six months.
NOTE D – ACCOUNTS RECEIVABLE
Components of accounts receivable as of September 30, 2018 and
December 31, 2017 are as follows:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
Accounts receivable
|
|
$
|
1,335,581
|
|
|
$
|
1,632,459
|
|
Allowance for doubtful accounts
|
|
|
(112,542
|
)
|
|
|
(22,173
|
)
|
Accounts receivable, net
|
|
$
|
1,223,039
|
|
|
$
|
1,610,286
|
|
NOTE E – ACCRUED LIABILITIES AND EXPENSES
Accrued liabilities and expenses at September 30, 2018 and December
31, 2017 are as follows
:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
Accrued liabilities and expenses
|
|
$
|
590,336
|
|
|
$
|
294,709
|
|
Accrued payroll and payroll taxes
|
|
|
291,143
|
|
|
|
230,931
|
|
Accrued sales taxes, penalties, and interest
|
|
|
37,171
|
|
|
|
83,282
|
|
Product warranties
|
|
|
47,967
|
|
|
|
59,892
|
|
Total accrued liabilities and expenses
|
|
$
|
966,617
|
|
|
$
|
668,814
|
|
NOTE F – DEBT
Revolving Credit Facility
The Heritage Bank Loan Agreement (the “Credit
Facility”) contains representations and warranties, covenants, and other provisions customary to transactions of this nature.
The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 8.3% at September
30, 2018 and 7.50% at December 31, 2017. The outstanding balance on the Credit Facility was $255,730 and $682,211 at September
30, 2018 and December 31, 2017, respectively. The remaining available borrowing capacity was approximately $453,739 and $202,000
at September 30, 2018 and December 31, 2017, respectively.
Covenants and events of default
The Credit Facility contains customary
events of default (including the failure to meet certain financial covenants), the occurrence which could allow Heritage Bank
of Commerce (“HBOC”) to exercise any one or more of the following rights: declare all obligations immediately due
and payable, cease advancing money or extending credit, set off and apply any and all indebtedness at any time owing to or for
the credit or the account of a Borrower held by Bank, among other remedies available to HBOC under the Credit Facility. The covenants
in the Credit Facility include: a minimum asset coverage ratio (monthly) and maximum quarterly YTD EBITDA Loss values. On November
7, 2018, an amendment to the revolving credit facility with HBOC, effective September 30, 2018 was executed to amend certain terms
of the Credit Facility. Among the terms of the amendment, even if the Company fails to comply with required EBITDA covenants as
of any particular quarterly measurement date, the Company will be deemed to be in compliance as of the measurement date if the
Company’s unrestricted cash maintained at HBOC is in excess of $3 million.
As of September 30, 2018, the Company did
not meet the EBITDA covenant for YTD EBITDA loss; however the Company maintained unrestricted cash in excess of $3 million at the
bank as of September 30, 2018.
The Company has assessed both historical
quarterly trends and average cash burn during the past fiscal year. Per the Company’s assessment, there is uncertainty looking
forward to meet both the EBITDA and unrestricted cash covenants during fiscal year 2019.
The Credit Facility matures on September 30, 2019. The Company is exploring alternatives regarding the
Credit Agreement with HBOC. There can be no assurance that the Company will be successful in obtaining a modification of the Agreement
or financing through another lender, on acceptable terms, if at all.
NOTE G – PREFERRED STOCK
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, 2018,
the liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $429,832,
which includes cumulative accrued unpaid dividends of $169,832, and second, Series A with a preference value of $1,581,508, which
includes cumulative accrued unpaid dividends of $656,508. As of December 31, 2017, the liquidation preference of the preferred
stock is based on the following order: first, Series B with a preference value of $414,258, which includes cumulative accrued unpaid
dividends of $154,258, and second, Series A with a preference value of $1,526,141, which includes cumulative accrued unpaid dividends
of $601,141.
NOTE H – CAPITAL STOCK
The Company has authorized 190,000,000
shares of common stock with a par value of $.001 per share. As of September 30, 2018 and December 31, 2017 the Company had 134,536,907
and 133,695,111 common shares issued and outstanding.
NOTE I – STOCK OPTIONS
AND WARRANTS
Employee Stock Options
The Company maintains an equity incentive
plan, (the “Plan”). The Plan was established in 2010 as an incentive plan for officers, employees, non-employee directors,
prospective employees and other key persons. It is anticipated that providing such persons with a direct stake in the Company’s
welfare will assure a better alignment of their interests with those of the Company and its stockholders.
The following table summarizes the changes
in options outstanding and the related prices for the shares of the Company’s common stock issued to employees of the Company
under the Plan as of September 30, 2018.
Options Outstanding
|
|
Options Exercisable
|
|
Exercise Prices
|
|
Number
Outstanding
|
|
|
Weighted Average
Remaining
Contractual Life
(Years)
|
|
|
Weighted Average
Exercise Price
|
|
|
Number
Exercisable
|
|
|
Weighted Average
Exercise Price
|
|
$
0.01 - $0.15
|
|
|
|
2,000,000
|
|
|
|
8.26
|
|
|
|
0.14
|
|
|
|
2,000,000
|
|
|
|
0.14
|
|
$
0.16 - $0.99
|
|
|
|
1,282,399
|
|
|
|
4.83
|
|
|
|
0.18
|
|
|
|
1,117,564
|
|
|
|
0.18
|
|
|
|
|
|
3,282,399
|
|
|
|
6.92
|
|
|
|
0.16
|
|
|
|
3,117,564
|
|
|
|
0.16
|
|
Transactions involving stock options issued
to employees are summarized as follows:
|
|
Number of
Shares
|
|
|
Weighted Average
Price Per Share
|
|
Outstanding at January 1, 2017
|
|
|
2,832,725
|
|
|
$
|
0.18
|
|
Granted
|
|
|
3,000,000
|
|
|
|
0.14
|
|
Exercised
|
|
|
–
|
|
|
|
–
|
|
Cancelled or expired
|
|
|
(1,456,251
|
)
|
|
|
0.17
|
|
Outstanding at December 31, 2017
|
|
|
4,376,474
|
|
|
$
|
0.16
|
|
Granted
|
|
|
–
|
|
|
|
–
|
|
Exercised
|
|
|
–
|
|
|
|
–
|
|
Cancelled or expired
|
|
|
(1,094,075
|
)
|
|
|
0.14
|
|
Outstanding at September 30, 2018
|
|
|
3,282,399
|
|
|
$
|
0.16
|
|
There were zero and 3,000,000 options
granted, 1,094,075 and 280,925 options cancelled or expired and zero options exercised during the nine months ended September
30, 2018 and 2017, respectively. Total stock-based compensation expense in connection with options granted to employees recognized
in the condensed consolidated statements of operations for the three and nine months ended September 30, 2018 and 2017 was $1,530
and $2,343, respectively, and $4,590 and $320,545, respectively.
Warrants
The following table summarizes the changes
in warrants outstanding and the related prices for the shares of the Company’s common stock issued to non-employees of the
Company.
|
|
|
|
Warrants Outstanding
|
|
|
|
|
|
|
Warrants Exercisable
|
|
|
Exercise Prices
|
|
|
Number
Outstanding
|
|
|
Weighted Average
Remaining
Contractual Life
(Years)
|
|
|
|
Weighted Average
Exercise Price
|
|
|
Number
Exercisable
|
|
|
Weighted Average
Exercise Price
|
|
$
|
0.20
|
|
|
250,000
|
|
|
3.02
|
|
|
|
0.20
|
|
|
250,000
|
|
|
0.20
|
|
Transactions involving warrants are summarized as follows:
|
|
Number of
Shares
|
|
|
Weighted Average
Price Per Share
|
|
Outstanding at January 1, 2017
|
|
|
300,000
|
|
|
$
|
0.20
|
|
Issued
|
|
|
–
|
|
|
|
–
|
|
Exercised
|
|
|
–
|
|
|
|
–
|
|
Cancelled or expired
|
|
|
(50,000
|
)
|
|
|
0.18
|
|
Outstanding at December 31, 2017
|
|
|
250,000
|
|
|
|
0.20
|
|
Issued
|
|
|
–
|
|
|
|
–
|
|
Exercised
|
|
|
–
|
|
|
|
–
|
|
Cancelled or expired
|
|
|
–
|
|
|
|
–
|
|
Outstanding at September 30, 2018
|
|
|
250,000
|
|
|
$
|
0.20
|
|
There were no warrants granted, exercised,
cancelled or forfeited during the nine months ended September 30, 2018 and 2017.
NOTE J – RELATED PARTY
TRANSACTIONS
During the nine months ended September
30, 2018 and during the year ended December 31, 2017, the Company agreed to issue common stock in the amount of $108,000 and $144,000,
respectively, to the Company’s non-employee directors as compensation for their attendance and participation in the Company’s
Board of Director and committee meetings.
Upon execution of their employment agreements
during the nine months ended September 30, 2017, the CEO, CTO and former COO, were each granted 1,000,000 stock options at their
fair market value and were scheduled to vest over a three year period. However, pursuant to their employment agreements, the stock
options vested immediately upon the sale of the Company’s subsidiary, EthoStream, in March 2017. Effective with the sale
of the assets of EthoStream, the former COO was hired by DCI. In compliance with the terms of the former COO’s stock option
grant letter, the former COO’s stock options were canceled during the nine months ended September 30, 2018.
During the nine months ended September
30, 2017, the CEO, CTO, and former COO, each earned a bonus of $29,250 that was contingent on the sale and sale price amount of
EthoStream.
NOTE K – COMMITMENTS AND CONTINGENCIES
Office Lease Obligations
Commitments for minimum rentals under non-cancelable leases
as of September 30, 2018 are as follows:
|
2018 (remainder of)
|
|
|
$
|
52,272
|
|
|
2019
|
|
|
|
211,448
|
|
|
2020
|
|
|
|
223,417
|
|
|
2021
|
|
|
|
242,785
|
|
|
2022
|
|
|
|
195,176
|
|
|
2023 and thereafter
|
|
|
|
573,883
|
|
|
Total
|
|
|
$
|
1,498,980
|
|
Rental expenses charged to continuing operations
for the three and nine months ended September 30, 2018 and 2017 was $84,620 and $86,649 and $255,568 and $200,816, 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
The following table sets forth the change in the sales tax accrual
as of September 30, 2018 and December 31, 2017:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
Balance, beginning of year
|
|
$
|
83,282
|
|
|
$
|
274,869
|
|
Sales tax collected
|
|
|
70,758
|
|
|
|
297,673
|
|
Provisions
|
|
|
22,665
|
|
|
|
(33,000
|
)
|
Interest and penalties
|
|
|
–
|
|
|
|
(5,890
|
)
|
Payments
|
|
|
(139,534
|
)
|
|
|
(450,370
|
)
|
Balance, end of period
|
|
$
|
37,171
|
|
|
$
|
83,282
|
|
NOTE L – BUSINESS CONCENTRATION
For the nine months ended September 30,
2018 and 2017, no single customer represented 10% or more of total net revenues. As of September 30, 2018, three customers each
accounted for over 10% of the Company’s net accounts receivable, for a total of 43% of net accounts receivables. As of December
31, 2017, three customers accounted for approximately 54% of the Company’s net accounts receivable.
Purchases from one supplier approximated
$3,261,000, or 90%, of purchases for the nine months ended September 30, 2018 and $2,122,000, or 86%, of purchases for the nine
months ended September 30, 2017. Total due to this supplier, net of deposits, was approximately $226,126 as of September 30, 2018,
and $33,000 as of December 31, 2017.
NOTE M – DISCONTINUED OPERATIONS
During the year ended December 31, 2017,
the Company, and EthoStream, entered into an Asset Purchase Agreement (the “Purchase Agreement”) with DCI-Design Communications
LLC (“DCI”), a Delaware limited liability company, whereby DCI acquired substantially all of the assets and certain
liabilities of EthoStream for a base purchase price of $12,750,000. The Purchase Agreement provided that $900,000 of the $12,750,000
base purchase price was placed into an escrow account to support potential indemnification obligations of up to $800,000 and net
working capital adjustments of up to $100,000. On April 06, 2018, the Company received the $800,000 disbursement from the funds
held in escrow. The Company reclassified the balance from restricted cash to cash at March 31, 2018.
On March 29, 2017, pursuant to the terms
and the conditions of the Purchase Agreement, the Company closed on the sale.
As of September 30, 2018 and December 31,
2017 there were no assets or liabilities of discontinued operations.
The following table summarizes the statements
of operations information for discontinued operations.
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Revenues, net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
653,839
|
|
Recurring
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
925,837
|
|
Total Net Revenue
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
1,579,676
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
|
–
|
|
|
|
(11,600
|
)
|
|
|
–
|
|
|
|
403,004
|
|
Recurring
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
209,868
|
|
Total Cost of Sales
|
|
|
–
|
|
|
|
(11,600
|
)
|
|
|
–
|
|
|
|
612,872
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
|
–
|
|
|
|
11,600
|
|
|
|
–
|
|
|
|
966,804
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
–
|
|
|
|
197
|
|
|
|
–
|
|
|
|
252,307
|
|
Depreciation and amortization
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
60,420
|
|
Total Operating Expenses
|
|
|
–
|
|
|
|
197
|
|
|
|
–
|
|
|
|
312,727
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from Discontinued Operations before Provision for Income Taxes
|
|
|
–
|
|
|
|
11,403
|
|
|
|
–
|
|
|
|
654,077
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Income Taxes
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
52,017
|
|
Income from Discontinued Operations (net of tax)
|
|
$
|
–
|
|
|
$
|
11,403
|
|
|
$
|
–
|
|
|
$
|
602,060
|
|
The consolidated statements of cash flows
do not present the cash flows from discontinued operations for investing activities or financing activities because there was no
investing or financing activities associated with the discontinued operations in three and nine months ended September 30, 2018
and 2017.