TELKONET, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying financial statements and related notes thereto.
23 Recent Developments
VDA Transaction and Change of Control
As previously reported in our Current Reports on Form 8-K dated
Following the issuance of 162,900,947 shares of Common Stock to VDA upon the Closing, VDA owns 53% of the issued and outstanding Common Stock on a fully diluted as exercised/converted basis, resulting in a change of control of the Company. VDA could eventually own as much as 65% of the issued and outstanding Common Stock on a fully diluted as exercised/converted basis if it fully exercises the Warrant.
In connection with the VDA Transaction and pursuant to the Purchase Agreement,
Impact of COVID-19 Pandemic
As discussed above, the Company's operations and financial results have also been impacted by the COVID-19 pandemic. Both the health and economic aspects of the COVID-19 pandemic are highly fluid and the future course of each is uncertain. We cannot predict whether the outbreak of COVID-19 will be effectively contained on a sustained basis. Depending on the length and severity of the COVID-19 pandemic, 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 the Company's financial condition, liquidity, operations, suppliers, industry, and workforce. While we expect this disruption to continue to have a material adverse impact on our results of operations, financial condition, cash flows, and liquidity, the Company is unable to reasonably determine the full extent of the impact at this time.
Due to travel restrictions, social distancing edicts and overall fear, the hospitality industry, our largest market that generally accounts for a majority of our revenue, has suffered as much as any since the onset of the pandemic. While the industry is trending toward recovery, the situation remains fragile. The effects of supply-chain issues, inflation and labor shortages, and subsequent rising wages, all present some level of pandemic uncertainty for the foreseeable future. STR and Tourism Economics expect leisure travel to pace the recovery while commercial demand, the dominant segment, will remain significantly below pre-pandemic levels until there is a significant increase in the quantity of large group events, as well as the return of business travel 7 When adjusted for inflation, revenue per available room (RevPAR) will likely remain below 2019 levels until at least 2025. 8
_________________
7 O'Conner, Stefani C. "Industry's recovery heats up-slowly." Hotelbusiness.com January 2022:8A
8 O'Conner, Stefani C. "Industry's recovery heats up-slowly." Hotelbusiness.com January 2022:14A.
24 Sipco License Agreement
In addition, on
See Part I, Item 1. "Business" of this Annual Report on Form 10-K and the Liquidity and Capital Resources" section below for a discussion of the steps the Company has and is continuing to take to focus on preserving liquidity, managing expenses, and targeted sales and new product growth.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in
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.
25
Identify the performance obligations
The Company will enter into product only contracts that contain a single performance obligation related to the transfer of 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. 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 revenue 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. 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"), unless terminated by either party. 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.
26 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.
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 Statements 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 Consolidated Balance Sheet.
Contract liabilities include monthly support service fees, customer deposits,
and billings in advance of revenue recognition. The long term portion of these
liability balances represent the amount of revenues that will be recognized
after
Contract Fulfillment 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 Sheet.
Accounts Receivable
Accounts receivable are uncollateralized customer obligations due under normal trade terms. The Company records allowances for doubtful accounts based on customer-specific analysis and general matters such as current assessment of past due balances and economic conditions. The Company writes off accounts receivable when they become uncollectible. Management identifies a delinquent customer based upon the delinquent payment status of an outstanding invoice, generally greater than 30 days past due date. The delinquent account designation does not trigger an accounting transaction until such time the account is deemed uncollectible. The allowance for doubtful accounts is determined by examining the reserve history and any outstanding invoices that are over 30 days past due as of the end of the reporting period. Accounts are deemed uncollectible on a case-by-case basis, at management's discretion based upon an examination of the communication with the delinquent customer and payment history. Typically, accounts are only escalated to "uncollectible" status after multiple attempts at collection have proven unsuccessful.
Inventory Obsolescence
Inventories consist of thermostats, sensors and controllers for
27
Guarantees and Product Warranties
The Company records a liability for potential warranty claims. The amount of the
liability is based on the trend in the historical ratio of claims to sales. 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. During the years
ended
Income Taxes
The Company accounts for income taxes in accordance with ASC 740-10. 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.
Stock Based Compensation
We account for our stock based awards in accordance with ASC 718, which requires a fair value measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including employee stock options and restricted stock awards.
We estimate the fair value of stock options granted using the Black-Scholes valuation model. This model requires us to make estimates and assumptions including, among other things, estimates regarding the length of time an employee will retain vested stock options before exercising them and the estimated volatility of our common stock price. 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 our consolidated statements of operations.
Recovery of Long -Lived Assets
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with ASC 360-10. Recoverability is measured by comparison of the carrying amount to the future net undiscounted cash flows which the assets are expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds its fair value.
Sales Tax
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.
28 Results of Operations
Year Ended
The Company's operations and financial results have been impacted by the COVID-19 pandemic. Further, significant uncertainty remains regarding the full impact of the COVID-19 pandemic - both in terms of the health and economic aspects - and the timing of any recovery in markets such as hospitality, our largest market that generally accounts for a majority of our revenue.
Revenues
The table below outlines our product versus recurring revenues from operations for comparable periods:
Year Ended December 31,
2021 2020 Variance
Product $ 5,542,404 88% $ 5,742,251 88% $ (199,847 ) (3%)
Recurring 731,995 12% 751,619 12% (19,624 ) (3%)
Total $ 6,274,399 100% $ 6,493,870 100% $ (219,471 ) (3%)
Product Revenue
Product revenue principally arises from the sale and installation of energy management platforms. The suite of products consists of thermostats, sensors, controllers, wireless networking products, switches, outlets and a control platform.
For the year ended
Backlogs were approximately
29 Recurring Revenue
Recurring revenue is attributed to our call center support services. The Company
recognizes revenue ratably over the service period for monthly support revenues
and defers revenue for annual support services over the term of the service
period. Recurring revenue consists of
For the year ended
Cost of Sales
The tables below outline product versus recurring cost of sales, along with
respective amounts of those costs as a percentage of revenue for the comparable
periods:
Year ended December 31,
2021 2020 Variance
Product $ 2,978,886 54% $ 3,527,977 61% $ (549,091 ) (16%)
Recurring 52,774 7% 80,580 11% (27,806 ) (35%)
Total $ 3,031,660 48% $ 3,608,557 56% $ (576,897 ) (16%)
Costs of Product Revenue
Costs of product revenue include materials and installation labor related to
Costs of Recurring Revenue
Recurring revenue costs are comprised primarily of call center support labor.
For the year ended
Gross Profit
The tables below outline product versus recurring gross profit, along with respective actual gross profit percentages for the comparable periods:
Year ended December 31,
2021 2020 Variance
Product $ 2,563,518 46% $ 2,214,274 39% $ 349,244 16%
Recurring 679,221 93% 671,039 89% 8,182 1%
Total $ 3,242,739 52% $ 2,885,313 44% $ 357,426 12%
30
Gross Profit on Product Revenue
Gross profit for the year ended
Gross Profit on Recurring Revenue
Gross profit for the year ended
Operating Expenses
The tables below outline operating expenses for the comparable periods, along with percentage change:
Year ended December 31,
2021 2020 Variance
Total $ 5,463,348 $ 5,990,918 $ (527,570 ) (9%)
The Company's operating expenses are comprised of research and development,
selling, general and administrative expenses and depreciation and amortization
expense. During the year ended
Research and Development
Year ended December 31,
2021 2020 Variance
Total $ 1,129,957 $ 1,177,282 $ (47,325 ) (4%)
Research and development costs are related to both present and future products
and are expensed in the period incurred. Current research and development costs
are associated with product development and integration. For the year ended
31
Selling, General and Administrative Expenses
Year ended December 31,
2021 2020 Variance
Total $ 4,289,920 $ 4,754,783 $ (464,863 ) (10%)
For the year ended
The variance is primarily attributable to decreases in royalty fees of
Operating Loss
Operating loss for the year ended
Net Loss
For the year ended
Non-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 stock-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 stock-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), or any other measure
for determining operating performance or liquidity, as determined under
accounting principles generally accepted in
· 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 year.
32
RECONCILIATION OF NET LOSS
TO ADJUSTED EBITDA
FOR THE YEARS ENDED DECEMBER 31,
2021 2020
Net loss $ (412,785 ) $ (3,149,852 )
Gain on debt extinguishment (1,836,780 ) -
Interest expense, net 21,067 21,645
Income tax provision 7,889 22,602
Depreciation and amortization 43,471 58,853
EBITDA (2,177,138 ) (3,046,752 )
Adjustments:
Stock-based compensation 7,262 7,262
Adjusted EBITDA $ (2,169,876 ) $ (3,039,490 ) Liquidity and Capital Resources
As previously reported in our Current Reports on Form 8-K dated
For the year ended
Since inception through
As discussed above, the Company's operations and financial results have also been impacted by the COVID-19 pandemic. Both the health and economic aspects of the COVID-19 pandemic are highly fluid and the future course of each is uncertain. We cannot predict whether the outbreak of COVID-19 will be effectively contained on a sustained basis. Depending on the length and severity of the COVID-19 pandemic, 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 the Company's financial condition, liquidity, operations, suppliers, industry, and workforce. While we expect this disruption to continue to have a material adverse impact on our results of operations, financial condition cash flows, and liquidity, the Company is unable to reasonably determine the full extent of the impact at this time.
33
The Company's sales and gross profits have decreased significantly resulting from a contraction in commercial demand for our products, a lower revenue conversion rate in our existing pipeline and significant one-off transactions from customers in 2020 were not repeated in 2021. Due to travel restrictions, social distancing and shelter at home edicts, the hospitality industry, our largest market that generally accounts for a majority of our revenue, has suffered as much as any. For a more detailed discussion of the impact of COVID-19 on the hospitality industry, see Item 1 - Recent Developments - Impact of COVID-19 Pandemic.
The more recent actions described above 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 reduce 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 to the actions noted above, on
On
Revolving Credit Facility
On
The outstanding principal balance of the Credit Facility bears interest at the
Prime Rate plus 3.00%, which was 6.25% at
On
On
34
On
The Heritage Bank Loan Agreement contains 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 remaining financial covenants are a
minimum asset coverage ratio and a minimum unrestricted cash balance of
The outstanding balance on the Credit Facility was
See the "Liquidity and Capital Resources" section above for a discussion of a potential default under the Credit Facility.
Paycheck Protection Program
The Company has received two loans under the Paycheck Protection Program (the
"PPP") administered by the
On
On
See Note G - Debt in the Notes to the Consolidated Financial Statements under Item 15 of Part IV of this Annual Report on Form 10-K for a summary of the terms of the PPP Loans.
Cash Flow from Operations Analysis
Cash used in operating activities of operations was
35
There was no cash used in investing activities during the years ended
Cash provided by financing activities was
See the "Liquidity and Capital Resources" section above for a discussion of a potential default under the Credit Facility.
Inflation
We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could adversely affect our business, financial condition and results of operations.
Off-Balance Sheet Arrangements
The Company has no material off-balance sheet arrangements.
New Accounting Pronouncements
See Note B - New Accounting Pronouncements in the Notes to the Consolidated Financial Statements under Item 15 of Part IV of this Annual Report on Form 10-K for a description of new accounting pronouncements.
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