U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q/A
(Amendment No. 1)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

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 Issuer as specified in its charter)

Utah
87-0627421
 (State or Other Jurisdiction of Incorporation or Organization)
 (I.R.S. Employer Identification No.)
   
10200 Innovation Drive, Suite 300, Milwaukee, WI
53226
(Address of Principal Executive Offices)
(Zip Code)

(414) 223-0473
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer o
Accelerated filer o
   
Non-accelerated filer o
Smaller reporting company x
(Do not check if a smaller reporting company)
  

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act.  Yes o  No x

Indicate the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 104,349,507 shares of Common Stock ($.001 par value) as of April 11, 2012.
 
 
 
 
  
TELKONET, INC.
FORM 10-Q/A for the Quarter Ended September 30, 2011

Index
   
 
Page
   
EXPLANATORY NOTE
 2
   
PART I. FINANCIAL INFORMATION
3
   
Item 1. Financial Statements
3
   
Condensed Consolidated Balance Sheets:
September 30, 2011 (Unaudited) and December 31, 2010
3
   
Condensed Consolidated Statements of Operations (Unaudited):
Three And Nine Months Ended September 30, 2011 and 2010
 4
   
Condensed Consolidated Statement of Stockholders’ Equity (Unaudited):
Year ended December 31, 2010
 5
   
Condensed Consolidated Statement of Stockholders’ Equity (Unaudited):
January 1, 2011 through September 30, 2011
 6
   
Condensed Consolidated Statements of Cash Flows (Unaudited):
Nine Months Ended September 30, 2011 and 2010
7
   
Notes to Condensed Consolidated Financial Statements (Unaudited)
9
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
29
   
Item 4. Controls and Procedures
 35
   
PART II. OTHER INFORMATION
36
   
Item 1. Legal Proceedings
 36
   
Item 1A. Risk Factors
 37
   
Item 6. Exhibits
 37
   
 
 
 
  
EXPLANATORY NOTE
 
This Quarterly Report on Form 10-Q/A for the nine months ended September 30, 2011, amends and restates the unaudited condensed consolidated balance sheet of Telkonet, Inc. (the “Company”) as of September 30, 2011, the unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2011 and 2010, the unaudited condensed  consolidated statement of stockholders’ equity for the year ended December 31, 2010, the unaudited condensed consolidated statement of stockholders’ equity for the period from January 1, 2011 through September 30, 2011 and the unaudited condensed consolidated statement of cash flows for the nine months ended September 30, 2011 and 2010.  The comparative condensed consolidated balance sheet as of December 31, 2010 has also been restated.
 
The Company’s management has recommended, and its Audit Committee has concluded, that the Company’s audited consolidated financial statements for the year ended December 31, 2010 as well as the unaudited interim condensed consolidated financial statements for 2011 and 2010 included in its Quarterly Reports on Form 10-Q for the quarters ended March 31, 2011, June 30, 2011 and September 30, 2011 needed to be restated as a result of certain adjustments and therefore could no longer be relied upon.
 
As is detailed in Note B of the notes to condensed consolidated financial statements in this Quarterly Report, the above referenced restatements are the result of corrections that management has determined are necessary as of December 31, 2010 and 2009 and for all periods previously reported for each of the three and nine month periods ended September 30, 2011 for the following items:
 
·
The Company had understated accrued sales tax, penalties, interest and related expenses.
 
·
Incorrect application of Accounting Standards Codification (ASC) 450, Accounting for Contingencies, resulted in an understatement of accrued warranty and related expenses.
 
·
Incorrect application of ASC 840, Accounting for Leases, resulted in an understatement of deferred lease liability and related rent expense.
 
·
Errors related to improper recording of depreciation expense and related understatement of accumulated depreciation.
 
·
Errors related to improper recording of various accrued liabilities and expenses, as well as other current liabilities resulting in a net understatement of such liabilities and related expenses.
 
·
Additionally, certain reclassifications have been made to previously reported unaudited condensed consolidated financial statements.
     
This Form 10-Q/A should be read in conjunction with our Form 10Q/As for the periods ending March 31, 2011 and June 30, 2011 and our filings made with the SEC subsequent to the filing of the original Form 10-Q. The following items have been amended (and conforming changes have been made where indicated as restated) as a result of the restatement:
 
Part I – Item 1 – Financial Statements
 
Part I – Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
  
The restated consolidated financial statements as of December 31, 2010 and for the year ended December 31, 2010 will be included in our 2011 Form 10-K for the year ended December 31, 2011.  The restatements of the other quarterly and year-to-date periods for 2010 and 2011 have been included in our Form 10-Q/A’s for the quarters ended March 31, 2011 and June 30, 2011.
   
 
2
 

PART I. FINANCIAL INFORMATION
  
Item 1.  Financial Statements

TELKONET, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
  
    (Unaudited)
September 30, 2011
(As Restated)
    
December 31, 2010
(As Restated)
  
ASSETS
                
Current assets:
                
Cash and cash equivalents
  
$
1,172,010
    
$
136,030
  
Restricted cash on deposit
    
91,000
      
-
  
Accounts receivable, net
    
804,546
      
799,185
  
Inventories
    
719,821
      
599,402
  
Prepaid expenses
    
137,997
      
163,327
  
Total current assets
    
2,925,374
      
1,697,944
  
                 
Property and equipment, net
    
17,300
      
43,329
  
                 
Other assets:
                
Deferred financing costs, net
    
-
      
56,732
  
Goodwill
    
11,670,446
      
11,670,446
  
Intangible assets, net
    
1,802,397
      
1,983,657
  
Deposits
    
34,238
      
34,238
  
Total other assets
    
13,507,081
      
13,745,073
  
                 
Total Assets
  
$
16,449,755
    
$
15,486,346
  
         
LIABILITIES AND STOCKHOLDERS’ EQUITY
        
Current liabilities:
                
Accounts payable
  
$
1,605,889
    
$
2,402,950
  
Accrued liabilities and expenses
    
2,095,692
      
1,890,951
  
Notes payable – current
    
73,592
      
47,536
  
Notes payable– related party
    
-
      
25,114
  
Convertible debentures, net of debt discounts of $134,625
    
-
      
1,471,398
  
Derivative liability – current
    
-
      
619,698
  
Other current liabilities
    
59,865
      
151,035
  
Total current liabilities
    
3,835,038
      
6,608,682
  
                 
Long-term liabilities:
                
Derivative liability – long term
    
-
      
1,282,077
  
Deferred lease liability
    
108,862
      
82,802
  
Notes payable – long term
    
916,165
      
252,464
  
Total long-term liabilities
    
1,025,027
      
 1,617,343
  
                 
Redeemable preferred stock:
                
Redeemable preferred stock, 15,000,000 shares authorized; par value $.001 per share;                
    Series A, 215 shares issued, 185 and 215 shares outstanding at September 30, 2011 and December 31, 2010, respectively
    
           856,434
      
890,475
  
    Series B, 538 shares issued, 493 outstanding at September 30, 2011, 267 shares issued and outstanding at December 31, 2010
    
1,319,813
      
653,371
  
Total redeemable preferred stock
    
2,176,247
      
1,543,846
  
                 
Commitments and contingencies
    
-
      
-
  
                 
Stockholders’ Equity
                
Common stock, par value $.001 per share; 190,000,000 shares authorized; 104,164,253 and 101,258,725  shares issued and
     outstanding at September 30, 2011 and December 31, 2010, respectively
    
104,166
      
101,261
  
Additional paid-in-capital
    
124,638,806
      
122,057,171
  
Accumulated deficit
    
(115,329,529)
      
(116,441,957)
  
Total stockholders’ equity
    
      9,413,443
      
5,716,475
  
                 
Total Liabilities and Stockholders’ Equity
  
$
16,449,755
 
 
$
15,486,346
  

 
See accompanying notes to the condensed consolidated financial statements
 
 
3
 
  
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 
   
   
For The Three Months Ended
September 30,
    
For The Nine Months Ended
September 30,
  
    2011
(As Restated)
     2010
(As Restated)
     2011
(As Restated)
     2010
(As Restated)
  
Revenues, net:
                        
Product
   $ 1,632,160     $ 1,817,391     $ 4,760,120     $ 5,354,128  
Recurring
     1,162,559       1,194,856       3,445,234       3,267,885  
Total Revenue
     2,794,719       3,012,247       8,205,354       8,622,013  
                                 
Cost of Sales:
                                
Product
     1,002,816       1,129,017       2,728,980       2,918,499  
Recurring
     294,846       340,369       849,962       960,670  
Total Cost of Sales
     1,297,662       1,469,386       3,578,942       3,879,169  
                                 
Gross Profit
     1,497,057       1,542,861       4,626,412       4,742,844  
                                 
Operating Expenses:
                                
Research and development
     197,674       280,848       588,908       869,044  
Selling, general and administrative
     1,194,156       1,324,028       3,488,802       4,432,702  
Depreciation and amortization
     72,463       72,491       202,809       265,525  
Total Operating Expenses
     1,464,293       1,677,367       4,280,519       5,567,271  
                                 
Income (Loss) from Operations
     32,764       (134,506 )     345,893       (824,427 )
                                 
Other Income (Expenses):
                                
Interest expense, net
     (23,428 )     (156,624 )     (237,402 )     (498,545 )
Gain (loss) on derivative liability
     -       (2,001,698 )     172,476       (1,304,905 )
Gain on sale of product line
     -       -       829,296       -  
Gain (loss) on disposal of property and equipment
     -       (3,524 )     2,165       (104,268 )
Total Other Income (Expense)
     (23,428 )     (2,161,846 )     766,535       (1,907,718 )
                                 
Income (Loss) Before Provision for Income Taxes
     9,336       (2,296,352 )     1,112,428       (2,732,145 )
                                 
Provision for Income Taxes
     -       -       -       -  
                                 
Net Income (Loss)
     9,336       (2,296,352 )     1,112,428       (2,732,145 )
                                 
Accretion of preferred dividends and discount
     (194,324 )     (80,285 )     (508,191 )     (158,745 )
Net income (loss) attributable to common stockholders
   $ (184,988 )   $ (2,376,637 )   $ 604,237     $ (2,890,890 )
                                 
Net income (loss) per common share:
                                
Income (loss) per common share – basic
   $ 0.00     $ (0.02 )   $ 0.01     $ (0.03 )
Income (loss) per common share – diluted
   $ 0.00     $ (0.02 )   $ 0.01     $ (0.03 )
                                 
Weighted Average Common Shares Outstanding - basic
     102,970,585       98,947,412       102,033,143       97,387,490  
Weighted Average Common Shares Outstanding - diluted
     104,399,613       98,947,412       103,462,171       97,387,490  

  
See accompanying notes to the condensed consolidated financial statements
   
 
4
 
 
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
FOR THE YEAR ENDED DECEMBER 31, 2010
 
   
   
Common
Shares
    
Common
Stock
Amount
    
Additional
Paid in
Capital
    
Accumulated
Deficit
    
Total
Stockholders’
Equity
  
                               
Balance at January 1, 2010, as restated
     96,563,771     $ 96,564     $ 120,194,142     $ (114,262,940 )   $ 6,027,766  
                                         
Shares issued to directors and management at approximately $0.19 per share
     3,919,821       3,920       1,093,746       -       1,097,666  
                                         
Shares issued to directors and management at approximately $0.165 per share
     224,410       225       36,775       -       37,000  
                                         
Shares issued in exchange for services rendered at approximately $0.19 per share
     550,723       552       77,143       -       77,695  
                                         
Stock-based compensation expense related to employee stock options
     -       -       132,386       -       132,386  
                                         
Warrants issued with redeemable convertible preferred stock
     -       -       394,350       -       394,350  
                                         
Beneficial conversion feature of redeemable convertible preferred stock
     -       -       394,350       -       394,350  
                                         
Warrant repurchase and cancellation
     -       -       (1,000 )     -       (1,000 )
                                         
Accretion of redeemable preferred stock discount
     -       -       (135,638 )     -       (135,638 )
                                         
Accretion of redeemable preferred stock dividend
     -       -       (129,083 )     -       (129,083 )
                                         
Net loss, as restated
                             (2,179,017 )     (2,179,017 )
                                         
Balance at December 31, 2010, as restated
     101,258,725     $ 101,261     $ 122,057,171     $ (116,441,957 )   $ 5,716,475  


See accompanying notes to the condensed consolidated financial statements
   
 
5
 
  
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
FOR THE NINE MONTHS FROM JANUARY 1, 2011 THROUGH SEPTEMBER 30, 2011
 
   
   
Common
Shares
    
Common
Stock
Amount
    
Additional
Paid in
Capital
    
Accumulated
Deficit
    
Total
Stockholders’
Equity
  
                               
Balance at January 1, 2011, as restated
     101,258,725     $ 101,261     $ 122,057,171     $ (116,441,957 )   $ 5,716,475  
                                         
Shares issued to directors and management at approximately $0.145 per share
         584,455           584           85,415           -           85,999  
                                         
Shares issued to directors for consulting fees at approximately $0.15 per share (1)
         177,083           177           24,823           -           25,000  
                                         
Shares issued on conversion of preferred stock at approximately $0.17 per share
         2,143,990           2,144           372,856           -           375,000  
                                         
Stock-based compensation expense related to employee stock options
       -         -         21,643         -         21,643  
                                         
Warrants issued with redeemable convertible preferred stock
       -         -         427,895         -         427,895  
                                         
Beneficial conversion feature of redeemable convertible preferred stock
       -         -         427,895         -         427,895  
                                         
Retirement of derivative liability related to warrant obligation
     -       -       1,729,299       -       1,729,299  
                                         
Accretion of redeemable preferred stock discount
     -       -       (316,908 )     -       (316,908 )
                                         
Accretion of redeemable preferred stock dividend
     -       -       (191,283 )     -       (191,283 )
                                         
Net income, as restated
                             1,112,428       1,112,428  
                                         
Balance at September 30, 2011, as restated
     104,164,253     $ 104,166     $ 124,638,806     $ (115,329,529 )   $ 9,413,443  


See accompanying notes to the condensed consolidated financial statements

(1) Represents consulting fees earned by Mr. Davis in 2009, but the shares were not issued until after the election to Board of Directors
   
 
6
 
 
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
   
    For the Nine Months
Ended September 30,
  
   
2011
(As Restated)
    
2010
(As Restated)
  
Cash Flows from Operating Activities:
                
Net income (loss)
  
$
1,112,428
    
$
(2,732,145
) 
                 
Adjustments to reconcile net income (loss) from operations to cash used in operating activities:
                
Amortization of debt discounts and financing costs
    
191,357
      
374,675
  
Gain on sale of product line
    
(829,296
)
    
-
  
(Gain) loss on derivative liability
    
(172,476
) 
    
1,304,905
  
(Gain) loss on disposal of property and equipment
    
(2,165
) 
    
104,268
  
Provision for lease loss
    
59,937
      
-
  
Stock based compensation expense
    
132,642
      
154,591
  
Depreciation
    
21,549
      
84,265
  
Amortization
    
181,260
      
181,260
  
Provision for doubtful accounts
    
     (68,321
) 
    
      41,290
  
                 
Increase / decrease in:
                
Accounts receivable, trade and other
    
62,960
      
(1,097,533
) 
Inventories
    
(241,123
) 
    
404,462
  
Prepaid expenses
    
25,330
      
(141,294
) 
Other assets
    
-
      
(140,232
)
Other current liabilities
    
(91,170
) 
    
-
  
Accounts payable, accrued liabilities & expenses, net
    
(652,257
)
    
279,412
  
Deferred lease liability
    
26,060
      
23,991
  
Net Cash Used In Operating Activities
    
(243,285
)
    
(1,158,085
)
                 
Cash Flows From Investing Activities:
                
Purchase of property and equipment
    
-
      
(4,800
)
Proceeds from disposal of property and equipment
    
6,645
      
-
  
Proceeds from sale of product line
    
 1,000,000
      
-
  
Deposit of restricted cash
    
(91,000
)
    
-
  
Net Cash Provided By (Used In) Investing Activities
    
915,645
      
(4,800
) 
                 
Cash Flows From Financing Activities:
                
Repayment on line of credit
    
-
      
(387,000
) 
Proceeds from issuance of note payable
    
700,000
      
-
  
Payments on note payable
    
(60,243
)
    
-
  
Payments on note payable – related party
    
(25,114
)
    
-
  
Proceeds from issuance of redeemable preferred stock
    
1,355,000
      
1,335,000
  
Repayment of convertible debentures
    
(1,606,023
)
    
-
  
Net Cash Provided By Financing Activities
    
363,620
      
948,000
  
                 
Net increase (decrease) in cash and cash equivalents
    
1,035,980
      
(214,885
)
Cash and cash equivalents at the beginning of the period
    
136,030
  
    
503,870
  
Cash and cash equivalents at the end of the period
  
$
1,172,010
    
$
288,985
  

  
See accompanying notes to the condensed consolidated financial statements
  
 
7
 
 
TELKONET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(UNAUDITED)
 
  
   
For the Nine Months Ended
September 30,
  
    2011
(As Restated)
     2010
(As Restated)
  
Supplemental Disclosures of Cash Flow Information:
                
                 
Cash transactions:
                
Cash paid during the period for interest expense
  
$
180,162
    
$
257,176
  
Non-cash transactions:
                
Issuance of common stock as consideration for accounts payable
  
$
-
    
$
77,695
  
Issuance of note payable in conjunction with warrant cancellation
    
50,000
      
-
  
Beneficial conversion feature of redeemable convertible preferred stock
    
427,895
      
394,350
  
Value of warrants issued with redeemable convertible preferred stock
    
427,895
      
394,350
  
Accretion of discount on redeemable preferred stock
    
316,908
    
 
78,299
  
Accretion of dividends on redeemable preferred stock
    
191,283
    
 
80,446
  
Retirement of derivative liability related to warrant obligation
    
1,729,299
      
-
  
Conversion of preferred stock to common stock
    
375,000
      
-
  
 
 
See accompanying notes to the condensed consolidated financial statements
   
 
8
 
 
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(UNAUDITED)

   
NOTE A – SUMMARY OF ACCOUNTING POLICIES

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

General

The restated condensed consolidated balance sheet as of December 31, 2010 and the restated condensed consolidated statement of stockholders’ equity for the year ended December 31, 2010 have been derived from the restated  financial statements. The accompanying unaudited condensed consolidated financial statements of Telkonet, Inc. (the “Company”) 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 restated results from operations for the three and nine month periods ended September 30, 2011 and 2010, are not necessarily indicative of the results that may be expected for the year ending December 31.  The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company's Form 2011 10-K to be filed here after with the SEC.

Business and Basis of Presentation

Telkonet, Inc., formed in 1999 and incorporated under the laws of the state of Utah, has evolved into a Clean Technology company that develops, manufactures and sells proprietary energy efficiency and SmartGrid networking technology. Prior to January 1, 2007, the Company was primarily engaged in the business of developing, producing and marketing proprietary equipment enabling the transmission of voice and data communications over a building’s internal electrical wiring.

In March 2007, the Company acquired substantially all of the assets of Smart Systems International (“SSI”), a leading provider of energy management products and solutions to customers in the United States and Canada.

In March 2007, the Company acquired 100% of the outstanding membership units of EthoStream, LLC, a network solutions integration company that offers installation, sales and service to the hospitality industry. The EthoStream acquisition enabled Telkonet to provide installation and support for PLC products and third party applications to customers across North America.

In March 2011, the Company sold all its Series 5 PLC product line assets to Wisconsin-based Dynamic Ratings, Inc. under an Asset Purchase Agreement.

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Telkonet Communications, Inc., and EthoStream, LLC. All significant intercompany balances and transactions have been eliminated in consolidation.

Going Concern

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. The Company has reported net income of $1,112,428 for the nine month period ended September 30, 2011, accumulated deficit of $115,329,529 and total current liabilities in excess of current assets of $909,664 as of September 30, 2011.  The accompanying financial statements do not include any adjustments that might result from the outcome of these uncertainties.

We continue to experience net operating losses and deficits in cash flows from operations.  Our ability to continue as a going concern is subject to our ability to generate a profit and/or obtain necessary funding from outside sources, including by the sale of our securities or assets, or obtaining loans from financial institutions, where possible.  Our continued net operating losses and the uncertainty regarding contingent liabilities cast doubt on our ability to meet such goals and the Company cannot make any representations for fiscal 2012 and beyond.
   
 
9
 
 
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(UNAUDITED)

  
The Company believes that anticipated revenues from operations will be insufficient to satisfy its ongoing capital requirements for at least the next 12 months.  If the Company’s financial resources from operations are insufficient, the Company will require financing in addition to the funds received from the sale of the Series 5 product line in order to execute its operating plan and continue as a going concern. The Company cannot predict whether this additional financing will be in the form of equity or debt, or be in another form. The Company may not be able to obtain the necessary additional capital on a timely basis, on acceptable terms, or at all.  In any of these events, the Company may be unable to implement its current plans for expansion, repay its debt obligations as they become due, or respond to competitive pressures, any of which circumstances would have a material adverse effect on its business, prospects, financial condition and results of operations.

Management intends to review the options for raising capital including, but not limited to, through asset-based financing, private placements, and/or disposition.  Management believes that with this financing, the Company will be able to generate additional revenues that will allow the Company to continue as a going concern. There can be no assurance that the Company will be successful in obtaining additional funding.
   
Fair Value of Financial Instruments

The Company accounts for the fair value of financial instruments in accordance with Accounting Standard Codification (ASC) 820, which defines fair value for accounting purposes, established a framework for measuring fair value and expanded disclosure requirements regarding fair value measurements.  Fair value is defined as an exit price, which is the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date.  The degree of judgment utilized in measuring the fair value of assets and liabilities generally correlates to the level of pricing observability.  Financial assets and liabilities with readily available, actively quoted prices or for which fair value can be measured from actively quoted prices in active markets generally have more pricing observability and require less judgment in measuring fair value.  Conversely, financial assets and liabilities that are rarely traded or not quoted have less price observability and are generally measured at fair value using valuation models that require more judgment.  These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency of the asset, liability or market and the nature of the asset or liability.  We have categorized our financial assets and liabilities that are recurring, at fair value into a three-level hierarchy in accordance with these provisions.

Restricted Cash on Deposit

During the third quarter, the Company was awarded a contract that contained a bonding requirement.  The Company satisfied this requirement with cash collateral supported by an irrevocable standby letter of credit in the amount of $91,000 which expires September 30, 2012.  The amount is presented as restricted cash on deposit on the condensed consolidated balance sheets.

Goodwill and Other Intangibles

Goodwill represents the excess of the cost of businesses acquired over fair value or net identifiable assets at the date of acquisition.  Goodwill is subject to a periodic impairment assessment by applying a fair value test based upon a two-step method.  The first step of the process compares the fair value of the reporting unit with the carrying value of the reporting unit, including any goodwill.  We utilize a discounted cash flow valuation methodology to determine the fair value of the reporting unit.  If the fair value of the reporting unit exceeds the carrying amount of the reporting unit, goodwill is deemed not to be impaired in which case the second step in the process is unnecessary.  If the carrying amount exceeds fair value, we perform the second step to measure the amount of impairment loss.  Any impairment loss is measured by comparing the implied fair value of goodwill with the carrying amount of goodwill at the reporting unit, with the excess of the carrying amount over the fair value recognized as an impairment loss.

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 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 the projected discounted future cash flows arising from the asset using a discount rate determined by management to be commensurate with the risk inherent to our current business model.

Income (Loss) per Common Share
 
The Company computes earnings per share under ASC 260-10, Earnings Per Share.  Basic net income per common share is computed by dividing net income (loss) by the weighted average number of shares of outstanding common stock.  Diluted earnings per share is computed using the weighted average number of common and common stock equivalent shares outstanding during the period. There is no effect on diluted income (loss) per share since the common stock equivalents are anti-dilutive. Dilutive common stock equivalents consist of shares issuable upon the exercise of the Company's outstanding stock options and warrants.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures.  Accordingly, actual results could differ from those estimates.
   
 
10
 
 
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(UNAUDITED)
 
   
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 has adopted the Financial Accounting Standards Board (“FASB”) issued ASC 740-10-25, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740-10-25 also provides guidance on derecognition, classification, treatment of interest and penalties, and disclosure of such positions.

Revenue Recognition

For revenue from product sales, we recognize revenue in accordance with ASC 605-10, and ASC Topic 13 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.  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.  We defer any revenue for which the product has not been delivered or is subject to refund until such time that we and the customer jointly determine that the product has been delivered or no refund will be required.  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.

We provide call center support services to properties installed by us and also to properties installed by other providers. In addition, we provide the property with the portal to access the Internet. We receive monthly service fees from such properties for our services and Internet access. We recognize 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 contracts and standalone sales.  We report such revenues as recurring revenues.

Stock-Based Compensation

We account for our stock based awards in accordance with ASC 718-10, Compensation, 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, the estimated volatility of our 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 our 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 2011 and prior years, expected stock price volatility is based on the historical volatility of the Company’s stock for the related vesting periods.
 
Stock-based compensation expense in connection with options granted to employees for the three and nine months ended September 30, 2011 and 2010 was $5,655 and $21,643 and $44,720 and $111,258, respectively.

Deferred Lease Liability

Rent expense is recorded on a straight-line basis over the term of the lease. Rent escalations and rent abatement periods during the term of the lease create a deferred lease liability which represents the excess of cumulative rent expense recorded to date over the actual rent paid to date.
     
 
11
 
 
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(UNAUDITED)
  
 
Lease Abandonment

On July 15, 2011, the Company executed a sublease agreement for approximately 12,000 sq ft of commercial office space in Germantown, MD. The subtenant has the option to extend the sublease from January 31, 2013 to December 31, 2015. Because we no longer have access to subleased space, we have recorded a charge of $56,659 during the period ended September 30, 2011 which is included in accrued liabilities and expenses related to this abandonment.

Reclassifications

Certain reclassifications have been made in prior years financial statements to conform to classifications used in the current year.
   
NOTE B – RESTATEMENT OF FINANCIAL STATEMENTS

The Company accounts for the correction of  errors in previously issued financial statements in accordance with the provisions of ASC Topic 250, Accounting Changes and Error Corrections. In accordance with the disclosure provisions of ASC 250, when financial statements are restated to correct an error, an entity is required to disclose that its previously issued financial statements have been restated along with a description of the nature of the error, the effect of the correction on each financial statement line item and any per share amount affected for each prior period presented, and the cumulative effect on the accumulated deficit in the respective balance sheets, as of the beginning of the earliest period presented.

Of the details to follow, the most significant adjustment was related to the Company’s failure to assess, collect and remit sales tax in accordance with state and local sales and use tax regulations.
 
Throughout this Form 10-Q/A, all amounts presented from prior periods and prior period comparisons that have been corrected are labeled “As Restated” and reflect the balances and amounts on a restated basis. The specific line-item effect of the restatement on the Company’s previously issued condensed consolidated financial statements as of September 30, 2011 and 2010 and the Company’s previously issued consolidated financial statements as of December 31, 2010 and for the three and nine months ended September 30, 2011 and 2010 as filed on Form 10-Q on November 4, 2011 are as follows:

The following is a summary of the restatements for the periods ended September 30:
 
   
2011
  
   
For the
Three Months Ended
(Unaudited)
    
For the
Nine Months Ended
(Unaudited)
  
             
Increase in sales tax, penalties and interest
   $ (41,156 )   $ (120,836 )
                 
Incorrect application of ASC 840, Accounting for Leases, resulted in an understatement of deferred lease liability
     -       82,802  
                 
Decrease in depreciation expense related to recording depreciation expense in improper periods
     17,417       52,251  
                 
Increase in expense related to improper recording of various accrued liabilities
     -       (30,531 )
                 
Total decrease in net income for the stated period
   $ (23,739 )   $ (16,314 )

   
   
2010
  
   
For the
Three Months Ended
(Unaudited)
    
For the
Nine Months Ended
(Unaudited)
  
             
Increase in sales tax, penalties and interest
   $ (46,082 )   $ (131,903 )
                 
Incorrect application of ASC 840, Accounting for Leases, resulted in an understatement of deferred lease liability
     (2,497 )     (23,991 )
                 
Increase in depreciation expense related to recording depreciation expense in improper periods
     (17,417 )     (52,251 )
                 
Increase in expense related to improper recording of various accrued liabilities
     (48,000 )     (153,343 )
                 
Total increase in net loss for the stated period
   $ (113,996 )   $ (361,488 )
      
The net income (loss) per common share effect of each individual correction has not been reported individually due to the fact that there was no effect on the per share amounts.
  
 
12
 

TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(UNAUDITED)
 
   
   
Effect on Condensed Consolidated Balance Sheets as of
  
   
September 30, 2011 (Unaudited)
    
December 31, 2010
  
   
As Previously
Reported
    
As
Restated
    
Effect of
Correction
    
As Previously
Reported
    
As
Restated
    
Effect of
Correction
  
Assets:                                    
Current assets:                                    
Prepaid expenses   $ 172,235     $ 137,997     $ (34,238 )   $ 197,565     $ 163,327     $ (34,238 )
Total current assets     2,959,612       2,925,374       (34,238 )     1,732,182       1,697,944       (34,238 )
                                                 
Property and equipment, net     34,717       17,300       (17,417 )     112,997       43,329       (69,668 )
                                                 
Other assets:                                                
Deposits     -       34,238       34,238       -       34,238       34,238  
Total other assets     13,472,843       13,507,081       34,238       13,710,835       13,745,073       34,238  
Total assets     16,467,172       16,449,755       (17,417 )     15,556,014       15,486,346       (69,668 )
                                                 
Current liabilities:                                                
Accrued liabilities and expenses     1,211,248       2,095,692       884,444       1,157,873       1,890,951       733,078  
Other current liabilities     78,863       59,865       (18,998 )     170,033       151,035       (18,998 )
Total current liabilities     2,969,592       3,835,038       865,446       5,894,602       6,608,682       714,080  
                                                 
Long-term liabilities:                                                
Deferred lease liability     108,862       108,862       -       -       82,802       82,802  
Total long-term liabilities     1,025,027       1,025,027       -       1,534,541       1,617,343       82,802  
                                                 
Stockholders' equity:                                                
Additional paid-in-capital     124,576,751       124,638,806       62,055       121,995,117       122,057,171       62,054  
Accumulated deficit     (114,384,611 )     (115,329,529 )     (944,918 )     (115,513,353 )     (116,441,957 )     (928,604 )
Total stockholders’ equity   $ 10,296,306     $ 9,413,443     $ (882,863 )   $ 6,583,025     $ 5,716,475     $ (866,550 )
    
 
13
 
 
TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(UNAUDITED)
 
     
   
Effect on Condensed Consolidated Statements of Operations
  
   
Three Months ended September 30, 2011
(Unaudited)
    
Three Months ended September 30, 2010
(Unaudited)
  
   
As Previously
Reported
    
As
Restated
    
Effect of
Correction
    
As Previously
Reported
    
As
Restated
    
Effect of
Correction
  
                                     
Revenues, net
                                    
Recurring
   $ 1,162,559     $ 1,162,559     $ -     $ 1,287,275     $ 1,194,856     $ (92,419 )
Total Revenue
     2,794,719       2,794,719       -       3,104,666       3,012,247       (92,419 )
                                                 
Cost of Sales
                                                
Product
     1,002,816       1,002,816       -       1,195,448       1,129,017       (66,431 )
Recurring
     294,846       294,846       -       349,203       340,369       (8,834 )
Total Cost of Sales
     1,297,662       1,297,662       -       1,544,651       1,469,386       (75,265 )
                                                 
Gross Profit
     1,497,057       1,497,057       -       1,560,015       1,542,861       (17,154 )
                                                 
Operating Expenses
                                                
Research and development
     197,674       197,674       -       251,259       280,848       29,589  
Selling, general and administrative
     1,165,174       1,194,156       28,982       1,283,657       1,324,028       40,371  
Depreciation and amortization
     89,880       72,463       (17,417 )     55,074       72,491       17,417  
Total Operating Expenses
     1,452,728       1,464,293       11,565       1,589,990       1,677,367       87,377  
                                                 
Income (Loss) from Operations
     44,329       32,764       (11,565 )     (29,975 )     (134,506 )     (104,531 )
                                                 
Other Income (Expenses)
                                                
Interest expense, net
     (11,254 )     (23,428 )     (12,174 )     (147,159 )     (156,624 )     (9,465 )
Total Other Income (Expenses)
     (11,254 )     (23,428 )     (12,174 )     (2,152,381 )     (2,161,846 )     (9,465 )
                                                 
Income (Loss) Before Provision for Income Taxes
     33,075       9,336       (23,739 )     (2,182,356 )     (2,296,352 )     (113,996 )
                                                 
Net Income (Loss)
     33,075       9,336       (23,739 )     (2,182,356 )     (2,296,352 )     (113,996 )
Net income (loss) attributable to common stockholders
   $ (161,249 )   $ (184,988 )   $ (23,739 )   $ (2,262,641 )   $ (2,376,637 )   $ (113,996 )
Net income (loss) per common share:
                                                
Net income (loss) per common share – basic
   $ 0.00     $ 0.00     $ 0.00     $ (0.02 )   $ (0.02 )   $ 0.00  
Net income (loss) per common share – diluted
   $ 0.00     $ 0.00     $ 0.00     $ (0.02 )   $ (0.02 )   $ 0.00  
Weighted Average Common Shares Outstanding – basic
     102,970,585       102,970,585       -       98,947,412       98,947,412       -  
Weighted Average Common Shares Outstanding – diluted
     104,399,613       104,399,613       -       98,947,412       98,947,412       -  
  
The net income (loss) per common share effect of each individual correction has not been reported individually due to the fact that there was no effect on the per share amounts
   
 
14
 

TELKONET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(UNAUDITED)
 
  
   
Effect on Condensed Consolidated Statements of Operations
  
   
Nine Months ended September 30, 2011
(Unaudited)
    
Nine Months ended September 30, 2010
(Unaudited)
  
   
As Previously
Reported
    
As
Restated
    
Effect of
Correction
    
As Previously
Reported
    
As
Restated
    
Effect of
Correction
  
                                     
Revenues net
                                    
Recurring
   $ 3,445,234     $ 3,445,234     $ -     $ 3,517,979     $ 3,267,885     $ (250,094 )
Total Revenue
     8,205,354       8,205,354       -       8,872,107       8,622,013       (250,094 )
                                                 
Cost of Sales
                                                
Product
     2,728,980       2,728,980       -       3,107,355       2,918,499       (188,856 )
Recurring
     849,962       849,962       -       981,110       960,670       (20,440 )
Total Cost of Sales
     3,578,942       3,578,942       -       4,088,465       3,879,169       (209,296 )
                                                 
Gross Profit
     4,626,412       4,626,412       -       4,783,642       4,742,844       (40,798 )
                                                 
Operating Expenses
                                                
Research and development
     568,992       588,908       19,916       781,159       869,044       87,885  
Selling, general and administrative
     3,475,896       3,488,802       (12,906 )     4,279,241       4,432,702       153,461  
Depreciation and amortization
     255,060       202,809       (52,251 )     213,274       265,525       52,251  
Total Operating Expense
     4,299,948       4,280,519       (19,429 )     5,273,674       5,567,271       293,597  
                                                 
Income (Loss) from Operations
     326,464       345,893       19,429       (490,032 )     (824,427 )     (334,395 )
                                                 
Other Income (Expense)
                                                
Interest expense, net
     (201,660 )     (237,402 )     (35,742 )     (471,452 )     (498,545 )     (27,093 )
Total Other Income (Expense)
     802,278       766,535       (35,743 )     (1,880,625 )     (1,907,718 )     (27,093 )
                                                 
Income (Loss) Before Provision for Income Taxes
     1,128,742       1,112,428       (16,314 )     (2,370,657 )     (2,732,145 )     (361,488 )
                                                 
Net Income (Loss)
     1,128,742       1,112,428       (16,314 )     (2,370,657 )     (2,732,145 )     (361,488 )
Net income (loss) attributable to common stockholders
   $ 620,551     $ 604,237     $ (16,314 )   $ (2,529,402 )   $ (2,890,890 )   $ (361,488 )
                                                 
Net income (loss) per common share:
                                                
Net income (loss) per common share – basic
   $ 0.01     $ 0.01     $ -     $ (0.02 )   $ (0.03 )   $ (0.01 )
Net income (loss) per common share – diluted
   $ 0.01     $ 0.01     $ -     $ (0.02 )   $ (0.03 )   $ (0.01 )
Weighted Average Common Shares Outstanding – basic
     101,914,800       102,033,143       118,343       97,387,490       97,387,490       -