KonaTel, Inc. - Quarter Report: 2018 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________

FORM 10-Q

________________

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

For the quarterly period ended March 31, 2018

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 No. 001-10171

KonaTel, Inc.

(Exact name of the issuer as specified in its charter)

13601 Preston Road, # E816

Dallas, Texas 75240

(Address of Principal Executive Offices)

214-323-8410

(Registrant Telephone Number)

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 o

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

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x

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

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

The number of shares outstanding of each of the Registrant’s classes of common equity, as of the latest practicable date:

Explanatory Note

On December 18, 2017 (the “Effective Time”), we completed an Agreement and Plan of Merger between our newly formed and wholly-owned acquisition subsidiary, and KonaTel, Inc., a Nevada corporation (respectively, “KonaTel Nevada” and the “KonaTel Nevada Merger Agreement”), whereby at the Effective Time, KonaTel Nevada was the surviving corporation and became our wholly-owned subsidiary (the “KonaTel Nevada Merger”).  Following the KonaTel Nevada Merger, our primary business operations have been those conducted by KonaTel Nevada.  Additional information about the KonaTel Nevada Merger is contained in our 8-KA-1 and our 8-KA-2 Current Reports dated November 15, 2017, and respectively filed with the Securities and Exchange Commission (the “SEC”) on December 20, 2017, and April 17, 2018, and is incorporated herein by reference.  These Current Reports can be viewed by Hyperlink in Part II, Item 6 of this Quarterly Report.  Under the KonaTel Merger Agreement, we changed our fiscal year end from September 30, 2017, to a calendar year end; accordingly, we filed a 10-K Transition Report for the period from October 1, 2017, to the year ended December 31, 2017, with the SEC on June 29, 2018, which can also be accessed by Hyperlink in Part II, Item 6.

Cautionary Statements

We have a limited public float of our outstanding common stock, and there has been no established trading market in our common stock during the past three years.  See the caption “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of Part II, Item 5 of our 10-K Transition Report, filed with the SEC on June 29, 2018.  These factors may result in uncertainty and volatility in the trading price of our common stock that may not have any relation to our current or future prospects.  On or about September 29, 2017, our Application for continued quotation of our common stock on the OTC Markets Group OTCQB Tier (respectively, the “OTC Markets” and the “OTCQB Tier”) was not approved because of our limited public float and the high concentration of the ownership in our common stock in one entity at that time, among other potential reasons. With the December 18, 2017, closing of the KonaTel Nevada Merger, the percentage of a majority of the ownership of our common stock in a limited number of holders has increased, with an aggregate of 26,174,500 shares (includes 574,500 shares underlying vested options that can be exercised within 60 days of the date of this Quarterly Report) being deemed to be beneficially owned by D. Sean McEwen, our Chairman, CEO, President and a director, 13,500,000 shares of direct ownership and 374,500 shares underlying personally owned vested options, and 12,225,000 shares (includes 125,000 shares underlying vested options owned by others) of indirect ownership under a Shareholder Voting Agreement executed and delivered at the Effective Time of the KonaTel Nevada Merger.  Based on the present number of outstanding shares of our common stock of 33,516,786 shares, which includes all 574,500 shares underlying vested options that can be exercised within 60 days of the date of this Quarterly Report, Mr. McEwen is currently the beneficial owner of approximately 77.9% of our outstanding shares.  See the caption “Security Ownership of Certain Beneficial Owners and Management” of Part III, Item 12 of our 10-K Transition Report filed with the SEC on June 29, 2018, for additional information on these computations.  No further Application could have been made by us to the OTC Markets for further consideration of quotations of our common stock on the OCTQB Tier until on or about March 31, 2018, and no determination by management has been made as to whether any such Application will be filed in the near future.  Our common stock is currently quoted on the OTC Markets OTC Pink Tier (the “OTC Pink Tier”) under the trading symbol “KTEL.”

FORWARD LOOKING STATEMENTS

In this Quarterly Report, references to “KonaTel, Inc.,” “KonaTel,” the “Company,” “we,” “our,” “us” and words of similar import, refer to KonaTel, Inc., a Delaware corporation, formerly named Dala Petroleum Corp., which is the Registrant, and our wholly-owned subsidiary, KonaTel Nevada.

2

This Quarterly Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  In some cases, you can identify forward-looking statements by the following words: “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “ongoing,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would,” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Forward-looking statements are not a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time the statements are made and involve known and unknown risks, uncertainties and other factors that may cause our results, levels of activity, performance or achievements to be materially different from the information expressed or implied by the forward-looking statements in this Quarterly Report. We cannot assure you that the forward-looking statements in this Quarterly Report will prove to be accurate, and therefore, prospective investors are encouraged not to place undue reliance on forward-looking statements. You should carefully read this Quarterly Report completely, and it should be read and considered with all other reports filed by us with the SEC. Other than as required by law, we undertake no obligation to update or revise these forward-looking statements, even though our situation may change in the future.

KONATEL, INC.

FORM 10-Q

MARCH 31, 2018

INDEX

PART I - FINANCIAL STATEMENTS

March 31, 2018

Table of Contents

3

Item 1. Financial Statements.

KonaTel, Inc.

Consolidated Balance Sheets

See accompanying notes to unaudited consolidated financial statements.

4

KonaTel, Inc.

Consolidated Statements of Operations

See accompanying notes to unaudited consolidated financial statements.

5

KonaTel, Inc.

Consolidated Statements of Cash Flow

See accompanying notes to unaudited consolidated financial statements.

6

KONATEL, INC.

Notes to Consolidated Financial Statements

(unaudited)

NOTE 1 – ORGANIZATION

KonaTel Inc., formerly known as Dala Petroleum Corp. (the “Company,” “we,” “our,” or “Dala”), also formerly known as “Westcott Products Corporation,” was incorporated as “Light Tech, Inc.” under the laws of the State of Nevada on May 24, 1984. A subsidiary in the name “Westcott Products Corporation” was organized by us under the laws of the State of Delaware on June 24, 1986, for the purpose of changing our name and domicile to the State of Delaware. On June 27, 1986, we merged with the Delaware subsidiary, with the survivor being Westcott Products Corporation, a Delaware corporation (“Westcott”). On December 18, 2017, we acquired KonaTel, Inc, a Nevada sub S-Corporation (“KonaTel Nevada”), in a merger with our acquisition subsidiary under which KonaTel Nevada became our wholly-owned subsidiary.

NOTE 2 – TRANSACTIONS

June 2014 Merger

On June 2, 2014, the Company, its newly formed and wholly-owned subsidiary, Dala Acquisition Corp., a Nevada corporation (“Merger Subsidiary”), and Dala Petroleum Corp., a Nevada corporation (“Dala Nevada”), executed and delivered an Agreement and Plan of Merger (the “Merger Agreement”), whereby Merger Subsidiary merged with and into Dala Nevada, and Dala Nevada was the surviving company under the merger and became a wholly-owned subsidiary of then-named Westcott (the “Merger”) on the closing of the Merger. As a result of the Merger, Westcott issued 10,000,000 shares of its common stock in exchange for all of the outstanding shares of common stock of Dala Nevada, which shares were distributed to Dala Nevada’s sole shareholder, Chisholm Partners II, LLC, a Louisiana limited liability company (“Chisholm II”), and were then distributed on a pro rata basis to its members.

As a condition precedent to the Merger, Westcott raised $2,025,000 from persons who were “accredited investors” in consideration of the sale of 2,025 shares of its Series A 6% Convertible Preferred Stock and 2,893,725 warrants at an offering price of $1,000 per unit.  Each $1,000 unit consisted of (i) one share of Series A 6% Convertible Preferred Stock that was convertible at any time at the option of the holder into common stock at the conversion price of $0.70 per common share based on the total dollar amount invested; and (ii) 1,429 warrants (issued for each share of Series A 6% Convertible Preferred Stock sold in each unit) to purchase common shares of the Company at an exercise price of $1.35 with a life of three years as of the “Effective Date” defined as the earliest date of the following to occur: (a) the initial registration statement required by the offering documents had been declared effective by the United States Securities and Exchange Commission (the “SEC”); (b) all of the underlying shares had been sold pursuant to SEC Rule 144 or may be sold pursuant to SEC Rule 144 without the requirement for the Company to be in compliance with the “current public information” required under SEC Rule 144 and without volume or manner-of-sale restrictions included therein; or (c) following the one year anniversary of June 3, 2014.

The Merger was accounted for as a reverse-merger and recapitalization of Dala.

Dala Nevada possessed rights to engage in oil and natural gas exploration and development in north central Kansas, with total acreage of approximately 80,000 acres (the “Property”).  Since the time of the Merger, we have been operating as an early-stage oil exploration company focused on the Property, which has oil potential at depths of less than 6,000 feet. Since May 2015, the Company had previously temporarily suspended its exploration program due to the decline in the price of oil and difficult market conditions; however, the Company is presently evaluating potential options for the extension of terms of the expired leases comprising the Property and funding the development of the Property, either singly or as a joint venture or with a working interest, carried or fully funded; or an outright sale of its remaining leases and geologic and seismic data on the area.

May 2016 Transaction

The Company entered into a Partial Cancellation Agreement (the “PCA”) by and among its subsidiary, Dala Nevada, Chisholm II and certain members of Chisholm II (the “Chisholm Members”), through which Chisholm II (after receiving shares from these Chisholm Members) returned a total of 8,567,800 shares of the Company’s common stock to the Company for cancellation.  In exchange for the return of these shares for cancellation, the Company assigned 55,000 acres of the Company’s Property rights (approximately 68.75% of its total holdings) to Chisholm II.

7

Pursuant to terms of the PCA, on May 26, 2016, the 8,567,800 shares of common stock delivered by Chisholm Members were cancelled on the books and records of the Company. Prior to that, the Company assigned 55,000 acres of its leased Property to Chisholm II.

On May 16, 2016, as approved by the Board of Directors of the Company as part of a settlement with the Preferred shareholders, the Company filed an Amended and Restated Certificate of Designation of the Company’s Series A 6% Convertible Preferred Stock (the “COD”), which (i) changed the conversion price of the preferred stock from $0.70 per share to $0.05 per share; and (ii) eliminated Section 7 “Certain Adjustments” of the COD.

Pursuant to terms of the PCA, on July 28, 2016, the 1,030,000 shares of common stock delivered after the initial closing by Baldo Sanso (360,000 shares of common stock), Robert Sali (610,000 shares of common stock) and Chris Dabbs (60,000 shares of common stock) were cancelled on the books and records of the Company. The reduction was offset to additional paid-in capital.

July 2017 Transaction

On July 19, 2017, the Company entered into a Common Stock Purchase Agreement with M2 Equity Partners LLC, a Minnesota limited liability company (“M2”), whereby M2 has purchased 12,100,000 newly issued shares of the Company’s common stock (the “Common Stock”) for an aggregate purchase price of $347,500 (the “Purchase Price”), pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”), and/or Rule 506(b) promulgated thereunder.  Prior to the closing (the “Closing”) of the Common Stock Purchase Agreement, the Company had the following outstanding securities: (i) 2,926,486 shares of Common Stock; (ii) 2,008 shares of Series A 6% Convertible Preferred Stock (the “Preferred Stock”); and (iii) 1,928,571 warrants (the “Warrants”) to acquire 1,928,571 shares of Common Stock that were issued in connection with the issuance of its Preferred Stock. In connection with this purchase of Common Stock, certain of the Company’s shareholders agreed to cancel an aggregate 1,584,200 shares of the Company’s Common Stock for an aggregate amount of $15,842; and 2,008 shares of the Company’s Preferred Stock and all outstanding Warrants for an aggregate amount of $53,841, with an additional sum of approximately $4,700 due to those shareholders who had agreed to cancel their respective shares of Preferred Stock and Warrants being reserved for the payment of miscellaneous expenses or other liabilities of the Company not provided for in the schedules and exhibits to the Common Stock Purchase Agreement, and any remainder of this sum was to be paid to these shareholders, pro rata, based upon the respective percentage that the aggregate amount being paid for the cancellation of the Preferred Stock and Warrants bore, if any, to these additional funds, following payment of any such miscellaneous expenses or other liabilities of the Company. $10,750 of the Purchase Price was held in the Trust Account of the Company’s legal counsel to be expended on behalf of the Company or deposited into a new bank account to be opened by the Company, and these funds have been disbursed in payment of expenses or paid to the Company or those persons entitled to them.

As a result of the cancellation of the 1,584,200 shares of Common Stock, Preferred Stock and Warrants, immediately prior to or simultaneous with the Closing, the Company had 1,342,286 shares of Common Stock issued and outstanding (the “Existing Shares”) and no shares of Preferred Stock or Warrants issued and outstanding; and taking into account the share cancellation and the 12,100,000 share Common Stock purchase and issuance, the Company then had issued and outstanding (i) 13,442,286 shares of its Common Stock, consisting of (a) the 1,342,286 Existing Shares, and (b) the 12,100,000 shares purchased by M2; and (ii) no other securities (as defined in the Securities Act) issued or outstanding.

The Company used the remainder of the $347,500 to, among other items set forth in the schedules and exhibits to the Common Stock Purchase Agreement, pay or compromise all outstanding indebtedness and other liabilities of the Company, amounting to approximately $262,367, which included a payment of an aggregate of $10,000 ($5,000 to each) to our then two directors and executive officers, with the understanding that our then current assets would consist of approximately $10,750, our Property, consisting of our oil and gas lease assets that we then owned, along with other intangible assets, and following the payment of the indebtedness and other liabilities and financial obligations of the Company, there would be no liabilities of the Company at Closing.

M2 agreed to pay M2 Capital Advisors, Inc., a Minnesota corporation (“M2 Capital”), which is wholly-owned by Mark Savage, a founding member of M2, an Introduction Fee of $25,000 for introducing the Company to M2. These funds were divided between M2 Capital and Elev8 Marketing, a firm owned by Matthew Atkinson, who is also a founding member of M2 and M2’s sole Manager, and were utilized to repay these entities for legal costs and miscellaneous expenses incurred by them in connection with the formation and funding of M2.  Mr. Savage was appointed the President and Chief Financial Officer and a director at the Closing, and is presently a director of the Company; and Mr. Atkinson was elected as the Secretary at the Closing, and presently serves in that capacity with the Company.

The Closing of the Common Stock Purchase Agreement resulted in a change in control of the Company.

8

December 2017 Transaction

On November 15, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement” and the “Merger”) with Mark Savage, our then President, a director (currently serving as a director) and a beneficial shareholder, Matthew Atkinson, our Secretary, a beneficial shareholder and the Manager of our then principal shareholder, M2, and M2 and our wholly-owned Nevada acquisition subsidiary, Dala Subsidiary Corp., on the one hand; and KonaTel Nevada and D. Sean McEwen, KonaTel Nevada’s President and sole shareholder, on the other hand. The Merger was closed on December 18, 2017, and Articles of Merger were filed on that date with the Secretary of State of the State of Nevada whereby KonaTel Nevada was the surviving corporation and became our wholly-owned subsidiary. The Company issued 13,500,000 shares of our one mill ($0.001) par value common stock comprised of “restricted securities” as defined in SEC Rule 144 promulgated under the Securities Act, in exchange for all of the outstanding shares of common stock of KonaTel Nevada. Post-Merger, and except as discussed below about conditions to the closing of the Merger, there were approximately 27,192,286 outstanding shares of our common stock, 13,500,000 shares of which are owned by Mr. McEwen; 12,100,000 shares of which were then owned by M2 (Messrs. Savage and Atkinson are members of M2 and collectively owned approximately 65.2% of M2, which equated to an indirect beneficial ownership of approximately 3,950,000 shares of our common stock each, and with Mr. Atkinson being the sole Manager of M2, he was then also the beneficial owner of all of M2’s shares of our common stock; and 1,692,286 shares, which were owned by public shareholders.  On April 24, 2018, the 12,100,000 shares of our common stock that were acquired by M2 under the Common Stock Purchase Agreement referenced above were distributed to its members, pro rata, in accordance with their respective membership interests.

The Company entered into Shareholder Voting Agreement between the Company, Mr. Savage, Mr. Atkinson, M2 and Mr. McEwen whereby Mr. McEwen was granted an irrevocable proxy coupled with an interest from each of the foregoing, together with the following rights, including a right of veto, for a period of two (2) years, on the following matters: (i) an increase in the compensation of any employee of the Company by more than $20,000 in any one calendar year and for these purposes, the term compensation includes any form of remuneration or monetary benefit; (ii) the issuance of stock, the creation of a new class of stock, the grant of options or warrants, modification of any shareholder, option holder or warrant holder’s rights, grants, conversion rights or the taking of any other action that directly or indirectly dilutes the outstanding securities of the Company, excepting the current private placement of common stock of the Company for an equity funding of $1,300,000 through the offer and sale of 6,500,000 shares of the Company’s common stock solely to “accredited investors” (iii) the issuance of debt in excess of $100,000 in the aggregate in any one calendar year; (iv) the approval of a plan of merger, reorganization or conversion; (v) the sale, transfer or other conveyance of assets of the Company having an aggregate value in excess of $100,000 in any one calendar year, other than in the ordinary course of the business; and (vi) the entry into a contract or other transaction having a total aggregate contractual liability for the Company in excess of $100,000 in any one calendar year.

The Company entered into a Lock-Up/Leak-Out Agreement with Mr. Savage, Mr. Atkinson, M2 and Mr. McEwen respecting the resale of their respective shares of common stock beneficially owned or subsequently acquired in the Company covering an 18 month period commencing at the closing of the Merger.

At the Effective Time of the Merger, the Company changed its fiscal year from September 30 to a calendar year end of December 31 to coincide with the calendar fiscal year end of KonaTel Nevada; and the “S Corporation Election” of KonaTel Nevada was terminated. The parties agreed to make all necessary tax elections to achieve a direct tax accounting cut-off as of the date of the S Corporation Election termination for purposes of reporting the applicable short period S and C corporation tax returns, as applicable.

The Merger was accounted for as a reverse-merger and recapitalization of the Company. Accordingly, the 2016 legal capital of KonaTel Nevada was adjusted retroactively to reflect the December 31, 2016 legal capital of Dala.

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying financial statements have been prepared using the accrual basis of accounting.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates 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. Significant estimates in these financial statements include the allowance for doubtful receivables, allowance for inventory obsolescence, the estimated useful lives of property and equipment, and customer lists. Actual results could differ from those estimates.

9

Cash and Cash Equivalents

Cash and Cash Equivalents include cash on hand and all short-term investments with maturities of three months or less.

Trade Accounts Receivable

The Company accounts for trade receivables based on amounts billed to customers. Past due receivables are determined based on contractual terms. The Company does not accrue interest and does not require collateral on any of its trade receivables.

Allowance for Doubtful Receivables

The allowance for doubtful receivables is determined by management based on customer credit history, specific customer circumstances and general economic conditions. Periodically, management reviews accounts receivable and adjusts the allowance based on current circumstances and charges off uncollectible receivables against the allowance when all attempts to collect the receivable have failed. As of March 31, 2018, and December 31, 2017, management has determined that no allowance for doubtful receivables is necessary.

Inventory

Inventory consists primarily of the cost of cellular phones and cellular accessories. Inventory is reported at the lower of cost and net realizable value. Cost is determined by the first-in, first-out (“FIFO”) method.

Due to the rapidly changing technology within the industry, inventory is evaluated on a regular basis to determine if any obsolescence exists.  As of March 31, 2018, and December 31, 2017, the allowance for inventory obsolescence amounted to $12,755 and $19,243, respectively.

Property and Equipment

Property and equipment are recorded at cost, and are depreciated on the straight-line method over their estimated useful lives. Leasehold improvements are amortized over the lesser of the lease term or estimated useful life, furniture and fixtures, equipment, and vehicles are depreciated over periods ranging from five to seven (5-7) years, and billing software is depreciated over three (3) years which represents the estimated useful life of the assets. Maintenance and repairs are charged to expense as incurred while major replacements and improvements are capitalized. When property and equipment are retired or sold, the cost and applicable accumulated depreciation are removed from the respective accounts and the related gain or loss is recognized.

The Company recognizes impairment losses for long-lived assets whenever changes in circumstances result in the carrying amount of the assets exceeding the sum of the expected future cash flows associated with such assets. Management has concluded that no impairment reserves are required as of March 31, 2018 and December 31, 2017.

Goodwill and Intangible Assets

Goodwill represents the excess of cost over the fair value of net assets acquired in connection with business acquisitions. Goodwill is tested at the reporting unit level, which is defined as an operating segment or a component of an operating segment that constitutes a business for which financial information is available and is regularly reviewed by management. The Company assesses goodwill for impairment at least annually in the absence of an indicator of possible impairment and immediately upon an indicator of possible impairment. The annual impairment review is completed at the end of the year.

If the carrying amount of a reporting unit exceeds its fair value, the Company measures the possible goodwill impairment based upon an allocation of the estimate of fair value  to the underlying assets and liabilities of the reporting unit, including any previously unrecognized intangible assets, based upon known facts and circumstances as if the acquisition occurred currently. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized to the extent the carrying value of goodwill exceeds the implied fair value of the goodwill. It was determined that Goodwill of $80,867 created through the reverse merger was fully impaired as of December 31, 2017.

Impairment losses of $80,867 are reflected in the Consolidated Statements of Operations.

Intangible assets consist of customer lists arising from acquisitions which are amortized on a straight line basis over three years, their estimated useful lives.

10

Customer Deposits

Before entering into a contract with a sub-reseller customer, the Company will require the customer to either secure a formal letter of credit with a bank, or require a certain level of cash collateral deposits from the customer. These collateral requirements are determined by management and may be adjusted upward or downward depending on the volume of business with the sub-reseller customer, or if management’s assessment of credit risk for a sub-reseller customer would change.

The Company held $28,854 in collateral deposits from various sub-reseller customers at March 31, 2018 and December 31, 2017. Such amounts represent collateral received from the sub-resellers in order to contract with the Company. The related contracts have an option to terminate the contract within a period of less than one year, and accordingly, these collateral deposits are classified as current liabilities in the accompanying balance sheet.

Impairment of Long-Lived Assets

The Company accounts for long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards ASC 360-10, “Accounting for the Impairment or Disposal of Long-Lived Assets”. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. 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 fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

The Company measures its financial assets and liabilities in accordance with generally accepted accounting principles. For certain of our financial instruments, including cash, accounts payable, accrued expenses, deposits received from customers for receivables and short-term loans the carrying amounts approximate fair value due to their short maturities.

We follow accounting guidance for financial and non-financial assets and liabilities. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. This guidance does not apply to measurements related to share-based payments. This guidance discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2: Inputs other than quoted prices, which are observable, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3: Unobservable inputs in which little or no market data exists, therefore developed using estimates and assumptions developed by us, which reflect those that a market participant would use.

Unproved oil and natural gas properties are accounted for and measured under Regulation S-X, Rule 4-10.

We currently measure and report at fair value other intangible assets (due to our impairment analysis) and derivative liabilities using ASC 820-10, Fair Value Measurement.  The fair value of intangible assets has been determined using the present value of estimated future cash flows method. The fair value of derivative liabilities is measured using the Black-Scholes option pricing method. The following table summarizes our non-financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2017:

11

Oil and Natural Gas Properties

The Company follows the full cost method of accounting for oil and natural gas operations whereby all costs related to the exploration and development of oil and natural gas properties are initially capitalized into a single cost center (“full cost pool”). Such costs include land acquisition costs, a portion of employee salaries related to Property development, geological and geophysical expenses, carrying charges on non-producing properties, costs of drilling directly related to acquisition, and exploration activities. Internal salaries are capitalized based on employee time allocated to the acquisition of leaseholds and development of oil and natural gas properties. The Company did not capitalize interest for the period ended March 31, 2018, as it was not required.

Proceeds from Property sales will generally be credited to the full cost pool, with no gain or loss recognized, unless such a sale would significantly alter the relationship between capitalized costs and the proved reserves attributable to these costs.

The Company assesses all items classified as unproved Property on a quarterly basis for possible impairment or reduction in value. The assessment includes consideration of the following factors, among others: intent to drill, remaining lease term, geological and geophysical evaluations, drilling results and activity, the assignment of proved reserves, and the economic viability of development if proved reserves are assigned. During any period in which these factors indicate an impairment, the cumulative drilling costs incurred to date for such Property and all or a portion of the associated leasehold costs are transferred to the full cost pool and are then subject to depletion and amortization.  The costs of drilling exploratory dry holes are included in the amortization base immediately upon determination that the well is dry.

Capitalized costs associated with impaired properties and properties having proven reserves, estimated future development costs, and asset retirement costs under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 410-20-25 are depleted and amortized on the unit-of-production method based on the estimated gross proved reserves.  The costs of unproved properties are withheld from the depletion base until such time as they are developed, impaired, or abandoned.

Under the full cost method of accounting, capitalized oil and natural gas Property costs less accumulated depletion, net of deferred income taxes, may not exceed a ceiling amount equal to the present value, discounted at 10%, of estimated future net revenues from proved oil and natural gas reserves plus the cost of unproved properties not subject to amortization (without regard to estimates of fair value), or estimated fair value, if lower, of unproved properties that are subject to amortization. Should capitalized costs exceed this ceiling, which is tested on a quarterly basis, an impairment is recognized. The present value of estimated future net revenues is computed by applying prices based on a 12-month unweighted average of the oil and natural gas prices in effect on the first day of each month, less estimated future expenditures to be incurred in developing and producing the proved reserves (assuming the continuation of existing economic conditions), less any applicable future taxes.  If such capitalized costs exceed the ceiling, the Company will record a write-down to the extent of such excess as a non-cash charge to earnings. Any such write-down will reduce earnings in the period of occurrence and result in a lower depreciation, depletion and amortization rate in future periods.  A write-down may not be reversed in future periods even though higher oil and natural gas prices may subsequently increase the ceiling.

During the period ended March 31, 2018, and December 31, 2017, the Company incurred a total of $0 in oil and natural gas expenditures.

During the three months ended March 31, 2018, we reduced the ceiling under the full cost method through amortization expense of $25,437.

No impairment was realized for the period ending March 31, 2018, or the year ended December 31, 2017.

On May 10, 2016, the Company entered into a Partial Cancellation Agreement (the “PCA”) by and among its subsidiary, Dala Nevada, Chisholm II, and certain Chisholm Members through which Chisholm II (after receiving shares from these Chisholm Members) returned a total of 8,567,800 shares of the Company’s common stock to the Company’s treasury for cancellation.  In exchange for the return of these shares for cancellation, the Company returned 55,000 acres of the Company’s Property rights, held in the form of oil and gas leases acquired from Chisholm II (approximately 68.75% of its total holdings), to Chisholm II.

Revenue Recognition

Services revenues are generated from cellular and telecommunication services.  The revenue is derived from wholesale and retail services.

12

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This update provides a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. We have adopted this update. We do not believe this guidance will impact the recognition of our primary source of revenue from our wholesale and retail customers. The adoption of this guidance did not have a material impact on our consolidated financial statements.

Cost of Revenue

Cost of Revenue includes the cost of communication services, equipment and accessories, shipping costs, and commissions of sub-agents.

Stock-based Compensation

The Company records stock based compensation in accordance with the guidance in ASC 718 which requires the Company to recognize expenses related to the fair value of its employee stock option awards. This requires that such transactions be accounted for using a fair-value-based method. The Company recognizes the cost of all share-based awards on a graded vesting basis over the vesting period of the award.

The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with ASC 718-10 and the conclusions reached by the ASC 505-50. Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration other than employee services is determined on the earliest of a performance commitment or completion of performance by the provider of goods or services as defined by ASC 505-50.

Income Taxes

Beginning on December 18, 2018, the Effective Date of the KonaTel Nevada Merger, KonaTel Nevada terminated its S Corporation status.  For the short-tax year, there was no tax provision of federal or state taxes in the financial statements.  As of March 31, 2018, because of a net loss, there was no tax provision of federal or state taxes in the financial statements.

Prior to the closing of Merger, with the consent of its shareholders, KonaTel Nevada had elected under the Internal Revenue Code and for Pennsylvania tax purposes to be an S Corporation. In lieu of corporation income taxes, the shareholders of a S Corporation are taxed on their proportionate share of the Company’s taxable income. Therefore, no provision for federal or state income tax is included in the financial statements. The Company evaluates tax positions taken and determines whether it is more-likely-than-not that the tax position will be sustained upon examination based on the technical merits of the position. Management has reviewed its tax positions regarding state nexus as well as its status as a pass-through entity and has determined there are no such positions that fail to meet the more-likely-than-not criterion.

Net Loss Per Share

The Company follows ASC Topic 260 to account for the loss per share. Basic loss per common share calculations are determined by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted loss per common share calculations are determined by dividing net loss by the weighted average number of common shares and dilutive common share equivalents outstanding.

During periods when common stock equivalents, if any, are anti-dilutive they are not considered in the computation.  As of March 31, 2018, the Company had vested stock options and awards outstanding totaling 3,925,000, which are not included in the calculation because they are anti-dilutive.  For March 31, 2018, the weighted average common shares equivalent was 28,406,175.  For March 31, 2017, the weighted average common share equivalents were 13,692,286.

The following table presents the potentially dilutive shares that were excluded from the computation of diluted net income (loss) per share of common stock attributable to common stockholders, because their effect was anti-dilutive:

13

Concentrations of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of receivables, cash, and cash equivalents.

All cash and cash equivalents and restricted cash and cash equivalents are held at high credit financial institutions. These deposits are generally insured under the FDIC’s deposit insurance coverage; however, from time to time, the deposit levels may exceed FDIC coverage levels.

The Company also has a concentration of risk with respect to trade receivables from sub-resellers. As of March 31, 2018, and December 31, 2017, the Company had a significant concentration of receivables due from three and two major customers, respectively (defined as customers whose receivable balances are greater than 10% of total accounts receivable). These customers represented approximately 63% of the total accounts receivable as of March 31, 2018, and approximately 78% of total accounts receivable as of December 31, 2017.

Concentration of Major Customer

A significant amount of the revenue is derived from contracts with major sub-reseller customers.  For the period ended March 31, 2018, and 2017, the Company had two major sub-reseller customers which amounted to approximately 21% and 47%, respectively, of total revenues.  For the year ended December 31, 2017, the Company had two major sub-reseller customers which amounted to approximately 43% of total revenues.

Effect of Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (“ASU No. 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. The new standard is effective for annual reporting periods beginning after December 15, 2017.  Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company has determined that this pronouncement has very little impact on the financial statements.  The Company has determined that the cumulative effect transition method would be applied.

In November 2014, the FASB issued ASU No. 2014-16, Derivatives and Hedging (Topic 815) Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or Equity.  This update amends existing guidance with the objective to eliminate the use of different methods in practice with respect to the consideration of redemption features in relation to other features when determining whether the nature of a host contract is more akin to debt or equity and thereby reduce existing diversity under GAAP in accounting for hybrid financial instruments issued in the form of a share.  The amendments clarify how current GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share.

The Company has evaluated all other recent accounting pronouncements and believes that none will have a significant effect on the Company’s financial statement.

Emerging Growth Company

The Company is an emerging growth company and has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

NOTE 4 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following major classifications as of March 31, 2018, and December 31, 2017:

14

Depreciation expense amounted to $12,243 and 36,337 for the periods ended March 31, 2018, and 2017, respectively. Depreciation and amortization expense are included as a component of operating expenses in the accompanying statements of operations.

NOTE 5 – INTANGIBLE ASSETS

Intangible Assets consist of customer lists that were acquired through acquisitions:

Amortization expense amounted to $50,351 and $18,933 for the periods ended March 31, 2018, and 2017, respectively. Amortization expense is included as a component of operating expenses in the accompanying statements of operations. Future amortization over the next year will be $134,276, which fully amortizes intangible assets.

NOTE 6 – LINES OF CREDIT

The Company has three lines of credit with a bank which provide aggregate maximum borrowing availability of $1,050,000 as of March 31, 2018, and December 31, 2017. The lines of credit are payable on demand and bear interest at a variable rate with a floor set at 5.25%. Outstanding advances under these line of credit arrangements amounted to $153,141 as of March 31, 2018, and December 31, 2017.  The lines of credit matured in April 2018. The maturity date has been verbally extended by the bank on a month-to-month basis.

The lines are secured by the general assets of the Company and aggregate amounts drawn under the line of credit may be limited to a borrowing base, as defined. The revolving lines of credit are guaranteed by an officer of the Company.

NOTE 7 – OPERATING LEASES

The Company leases property under non-cancelable operating leases with terms in excess of one year. The current property lease in excess of one year expires April 30, 2019. Future minimum lease payments over the next three years under the terms of these operating leases are as follows:

The Company also leases an office space on a month-to-month basis. Total lease expense for the three months ended March 31, 2018, and 2017 amounted to $39,683 and $37,401, respectively.

NOTE 8 – AMOUNT DUE TO SHAREHOLDER

During 2018, Gary Stevens advanced the Company $100,000. The amount was used for working capital purposes.  The note consisted of a $5,000 loan fee, plus an annual interest rate of 8.00%.  As of March 31, 2018, the amount outstanding was $100,000.

During 2017, certain of the Company’s principal shareholders, D. Sean McEwen, Matthew Atkinson, and Mark Savage, advanced the Company $191,500, $17,063 and $14,764, respectively. The amounts advanced were used for working capital purposes and bear no interest and do not have a maturity date.  Interest expense is imputed based on the applicable federal rate of 1.52%.  As of March 31, 2018, D. Sean McEwen is owed $150,000.

NOTE 9 – RELATED PARTY TRANSACTIONS

Transactions with Shareholders

As of March 31, 2018, amounts due from advances to shareholders were $250,000. The details of the advances are set forth in NOTE 8.

15

NOTE 10 – RETIREMENT PLAN

The Company sponsors a 401(k) profit sharing plan for its employees, whereby participants may contribute through salary deductions as defined, not to exceed certain IRS limits. The plan also provides for an employer matching contribution and also discretionary employer contributions. As of November 3, 2017, the Company no longer provided an employer match. The Company contributed $14,298 for the period ended March 31, 2017.

NOTE 11 – CONTINGENCIES AND COMMITMENTS

Litigation

From time to time, the Company may be subject to legal proceedings and claims which arise in the ordinary course of business. The Company tentatively reached a settlement agreement on litigation, which arose from an issue with a lawsuit with a business purchased by KonaTel Nevada.

Contract Contingency

The Company has the normal obligation for the completion of its cellular provider contracts in accordance with the appropriate standards of the industry and that may be provided in the contractual agreements.

Escrowed Contract

Effective February 7, 2018, the Company entered into an Agreement for the Purchase and Sale of Membership Interest dated as of February 5, 2018 (the “PSMI”), with the transaction documents being deposited in escrow on February 7, 2018, respecting the acquisition of 100% of the membership interest in IM Telecom, LLC, an Oklahoma limited liability company (“IM Telecom”), from its sole owner, Trevan Morrow (“Mr. Morrow”).  The principal asset of IM Telecom is a “Lifeline Program” license (a Federal Communications Commission [the “FCC”] approved Compliance Plan), the transfer of ownership of which requires prior approval of the FCC.  If the transfer of the beneficial ownership of the Lifeline Program license to us is not approved by the FCC prior to April 30, 2018, or a later date agreed upon by the parties, either party may terminate the PSMI.  The parties continue to seek FCC approval of the transfer of the Lifeline Program License, and neither party has exercised its right to terminate the PSMI.  No assurance can be given that the transfer of this license will be approved.  The FCC approval has not been granted as of yet.

Letters of Credit

The Company maintains irrevocable standby letter of credit arrangements with certain cellular carriers in the aggregate amount of $593,000. The letters of credit serve as collateral and security for various resale contracts the Company has with their suppliers. The letters of credit are unused as of March 31, 2018, and December 31, 2017.

Going Concern

As the Company did not generate net income during the three month periods ending March 31, 2018 and 2017, we have been dependent upon equity financing to support our operations.  In addition to losses of $528,027 and $423,198 for the periods ending March 31, 2018, and 2017, respectively, we have experienced negative cash flow from operations of $707,906 and $92,170 in 2018, and 2017. The accumulated deficit as of March 31, 2018, is $3,718,900.

We believe we have ameliorated any “going concern” issues by generating additional cash flow since the completion of our merger with KonaTel Nevada on December 18, 2017; receiving cash investments through the private placement of shares of our common stock; and the increase of revenues from the growth of our Virtual ETC program, all of which has contributed to an improvement in our working capital, resulting in a working capital surplus, without the use of additional lines of credit or borrowings.  Additionally, we also have two options to finance our mobile phone equipment purchases whereby multiple equipment suppliers provide us short term credit terms of up to 60 days on mobile phone purchases and a bank line of credit for purchases of select mobile phones.

NOTE 12 – SEGMENT REPORTING

The Company operates within three reportable segments. The Company’s management evaluates performance and allocates resources based on the profit or loss from operations.  The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.  Because the Company is a service business with very few physical assets, Management does not use total assets by segment to make decisions regarding operations, and therefore the total assets disclosure by segment has not been included.

16

The Company’s reportable segments consist of a Wholesale unit, a Retail unit, and Gas & Oil Operations.  The Wholesale unit purchases bulk rate services at a discounted cost.  The Wholesale unit then sells to providers that provide services to the end-user.  The Retail unit provides these same services to the end-user.

The Wholesale unit had 19 and 24 customers for the periods ended March 31, 2018, and 2017, respectively. The Retail Unit had an average lines/customers of 19,518 and 12,366 for the periods ended March 31, 2018, and 2017, respectively. The Gross Profit per line for Wholesale was $2.41 and $1.72 for the periods ended March 31, 2018, and 2017, respectively. The Gross Profit per line for Retail was $5.41 and $10.38 for the three month periods ended March 31, 2018, and 2017, respectively.

The following table reflects the result of operations of the Company’s reportable segments:

NOTE 13 – PREFERRED CONVERTIBLE STOCK AND WARRANTS

As discussed above in NOTE 2, in fiscal year 2014, the Company sold 2,025 units consisting of a total of 2,025 shares of Series A 6% Convertible Preferred Stock and 2,893,725 warrants at the price of $1,000 per unit.  Proceeds received totaled $2,025,000 (with a net of offering costs of $1,990,000).  The warrants were valued at $711,044 and this amount was separated from the value of the preferred stock.  Each $1,000 unit consisted of (i) one share of Series A 6% Convertible Preferred Stock that was convertible at any time at the option of the holder into common stock at the conversion price of $0.70 per common share based on the total dollar amount invested (subject to adjustment); and (ii) 1,429 warrants (issued for each share of Series A 6% Convertible Preferred Stock sold in each unit) to purchase common shares of the Company at an exercise price of $1.35 for three years of the “Effective Date,” defined as the earliest date of the following to occur: (a) the initial registration statement required by the offering documents had been declared effective by the SEC; (b) all of the underlying shares have been sold pursuant to SEC Rule 144 or may be sold pursuant to SEC Rule 144 without the requirement for the Company to be in compliance with the current public information required under SEC Rule 144 and without volume or manner-of-sale restrictions thereof; or (c) following the one year anniversary of June 3, 2014.  A total of 2,008 shares of Series A 6% Convertible Preferred Stock, exercisable into 2,868,571 shares of common stock, were issued and outstanding as of June 30, 2017. The 6% per annum dividends are cumulative and payable quarterly in cash or, at the Company’s option, in shares of the Company’s common stock. The Company discontinued paying the quarterly dividend as of July 1, 2015, and the amount owed thereunder had been accruing since that time until May 10, 2016, at which time all accrued dividends on 675 of the 2,025 shares were waived and cancelled by certain preferred shareholders.  The cancelled dividends were accounted for by offsetting to additional paid-in capital.

As the Series A 6% Convertible Preferred Stock was contingently redeemable at a fixed price and such redemption would not be solely within the control of the Company, the preferred stock is classified outside of stockholders’ equity, as “temporary equity” between liabilities and stockholders’ equity on the Company’s consolidated balance sheet.

The Series A 6% Convertible Preferred Stock has no voting rights.

17

On February 17, 2016, a supermajority of more than 67% of the shareholders of the Series A 6% Convertible Preferred Stock approved certain corporate transactions in an effort to settle certain violations of the Series A 6% Convertible Preferred Stock Certificate of Designation and other documents related to the sale of Series A 6% Convertible Preferred Stock in 2014. The transactions approved by a supermajority of the Series A 6% Convertible Preferred Shareholders were to be implemented by the Board of Directors at the Board’s discretion. The approved transactions included the following: (i) the approval of a potential settlement agreement with Chisholm Partners II, LLC and certain Chisholm Members; (ii) the approval of the amendment of the Certificate of Designation for the Series A 6% Convertible Preferred Stock modifying the Conversion Price to $0.05; (iii) the Removal of Section 7, “Certain Adjustments” in the Series A 6% Convertible Preferred Stock Certificate of Designation; (iv) the modification of the permitted indebtedness allowable under the Series A 6% Convertible Preferred Stock COD to $200,000; (v) the approval of promissory notes with related parties in an amount up to $60,000; (vi) the waiver of the right of redemption upon triggering events for the Company’s violations of Section 10 of the COD; (vii) the waiver of the accrual of the late fee for unpaid dividends as of January 1, 2016; (viii) the waiver of the first right of refusal to purchase shares from other Series A 6% Convertible Preferred Shareholders; and (ix) waiver of the “Most Favored Nation” provision in the SPA for the Series A 6% Convertible Preferred Stock, among other things. None of the items approved by the shareholders have yet been effected by the Board.

Upon the occurrence of a triggering event, each holder shall have the right to require the Company to redeem all of the Series A 6% Convertible Preferred Stock in cash at the redemption amount which is the sum of (a) the greater of (i) 130% of the stated value, and (ii) the product of (y) the VWAP on the trading day immediately preceding the date of the triggering event and (z) the stated value divided by the then conversion price, (b) all accrued but unpaid dividends thereon, if any, and (c) all liquidated damages and other costs, expenses or amounts due in respect of the Series A 6% Convertible Preferred Stock.

On November 17, 2014, one of the Company’s shareholders of Series A 6% Convertible Preferred Stock, Chienn Consulting Company, converted 17 shares of its Series A 6% Convertible Preferred Stock into 24,286 shares of the Company’s common stock. As of September 30, 2017, there were no Series A 6% Convertible Preferred Stock shares outstanding.

Effective December 31, 2015, the valuation of the derivative from the warrants using the Black Sholes model was no longer a liability given the decrease in the Company’s stock and the exercise price of the warrants.

Effective July 19, 2017, the remaining 2008 outstanding shares of Series A 6% Convertible Preferred Stock, along with all Warrants issued in connection with their sale in 2014, were cancelled.  See the “July 2017 Transaction” in NOTE 2 above.

NOTE 14 – SHAREHOLDERS’ EQUITY

Common Stock

On June 2, 2014, the Company issued 10,000,000 shares of its common stock to Chisholm II in exchange for oil and natural gas assets recorded at $1,898,947.

As discussed above, the Company completed a reverse-merger with Dala Nevada, with Dala Nevada being the acquirer for financial reporting purposes.  At the date of that Merger, the Company had 2,500,000 shares of common stock outstanding. The total amount of shares issued and outstanding post-Merger, as of December 31, 2014, was 12,500,000 shares of common stock.

On November 17, 2014, one of the Company’s shareholders of Series A 6% Convertible Preferred Stock, Chienn Consulting Company, converted 17 shares of its Series A 6% Convertible Preferred Stock into 24,286 shares of the Company’s common stock.

As part of the PCA executed in May 2016 (see NOTE 2), 9,597,800 shares of common stock were returned to the Company and recorded in treasury and were returned to the authorized but unissued shares of the Company.

On July 19, 2017, the Company issued 12,100,000 shares of common stock to M2.

On July 25, 2017, the Company issued 250,000 shares of our common stock as compensation and for a general release.  We issued 50,000 shares to Daniel Ryweck for his service on our board of directors, and 200,000 to our attorney, Leonard W. Burningham, Esq., for certain of his legal services in the change of control involving M2 and pursuant to his Engagement Letter.

18

As discussed above, the Company completed a reverse-merger with KonaTel Nevada, with KonaTel Nevada being the acquirer for financial reporting purposes.  At the date of the Merger, the Company issued 13,500,000 shares of common stock to D. Sean McEwen, who was then the sole shareholder of KonaTel Nevada.  At the date of the Merger, 12,100,000 shares were owned by M2 (Messrs. Mark Savage and Matthew Atkinson are members of M2 and collectively owned approximately 65.2% of M2, which equated to an indirect beneficial ownership of approximately 3,950,000 shares of our common stock each), and with Mr. Atkinson being the sole Manager of M2, he was also the then beneficial owner of all of M2’s shares of our common stock; and 1,692,286 shares, which were owned by public shareholders.  On April 24, 2018, the 12,100,000 shares of our common stock that were acquired by M2 under the Common Stock Purchase Agreement referenced above were distributed to its members, pro rata, in accordance with their respective membership interests.

On March 8, 2018, we issued 4,750,000 shares of our common stock in a private placement to “accredited investors” at $0.20 per share for an aggregate amount of $950,000.

During the three months period ended March 31, 2018, the Company recorded vested options expense of $134,978.

Also, see NOTE 2 above.

Stock Compensation

The Company offered stock option outstanding equity awards to directors and key employees. Options vested in tranches and do not expire for five years. During the three months period ended March 31, 2018, the Company recorded vested options expense of $134,978.

The following table represents stock option activity as of and for the three months ended March 31, 2018:

NOTE 15 – INCOME TAX

For the periods ending March 31, 2018, and 2017, there was no provision for income taxes and deferred tax assets have been entirely offset by valuation allowances.

Prior to the Merger with KonaTel Nevada, and, with the consent of its sole shareholder, KonaTel Nevada had elected under the Internal Revenue Code and for Pennsylvania tax purposes to be an S Corporation. In lieu of corporation income taxes, the shareholders of an S Corporation are taxed on their proportionate share of the Company’s taxable income. Therefore, no provision for federal or state income tax is included in the financial statements. The Company evaluates tax positions taken and determines whether it is more-likely-than-not that the tax position will be sustained upon examination based on the technical merits of the position. Management has reviewed its tax positions regarding state nexus as well as its status as a pass-through entity and has determined there are no such positions that fail to meet the more-likely-than-not criterion.

On November 30, 2017, the Company adopted ASU 2015-17, “Income Taxes (Topic 740) Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17”). ASU 2015-17 requires deferred tax assets and liabilities to be classified as noncurrent in the consolidated balance sheet.  A reporting entity should apply the amendment prospectively or retrospectively.  The adoption of ASU 2015-17 did not have a significant impact on its consolidated financial statements as the Company continues to provide a full valuation allowance against its net deferred tax assets.

The Company’s tax expense differs from the “expected” tax expense for Federal income tax purposes (computed by applying the United States Federal tax rate of 21% to loss before taxes).

19

The tax effects of the temporary differences between reportable financial statement income and taxable income are recognized as deferred tax assets and liabilities.

The tax effect of significant components of the Company’s deferred tax assets and liabilities at March 31, 2018 and 2017, respectively, are as follows:

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

Because of the historical earnings history of the Company, the net deferred tax assets for 2017 were fully offset by a 100% valuation allowance. The valuation allowance for the remaining net deferred tax assets was $373,130 and $408,391 as of March 31, 2018 and 2017, respectively.

On December 22, 2017, the United States Government passed new tax legislation that, among other provisions, will lower the corporate tax rate from 35% to 21%.  In addition to applying the new lower corporate tax rate in 2018 and thereafter to any taxable income we may have, the legislation affects the way we can use and carry forward net operating losses previously accumulated and results in a revaluation of deferred tax assets recorded on our balance sheet.  Given that the deferred tax assets are offset by a full valuation allowance, these changes will have no net impact on the Company’s financial position and net loss. However, if and when we become profitable, we will receive a reduced benefit from such deferred tax assets. Had this legislation passed prior to our September 30, 2017, fiscal year-end, the effect of the legislation would have been a reduction in deferred tax assets and the corresponding valuation allowance.

NOTE 16 – SUBSEQUENT EVENTS

On April 13, 2018, we issued 1,000,000 shares of our common stock through an additional private placement at $0.20 per share for an aggregate of $200,000, $100,000 in cash and $100,000 in payment of our short term note to this subscriber, Gary Stevens.  See NOTE 8.

On April 24, 2018, the 12,100,000 shares of our common stock that were acquired by M2 under the Common Stock Purchase Agreement referenced above were distributed to its members, pro rata, in accordance with their respective membership interests.  This action was approved by the requisite members of M2 on April 9, 2018.

The Company has evaluated subsequent events through July 26, 2018, the date the financial statements were available to be issued.

20

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

When used in this Quarterly Report, the words “may,” “will,” “expect,” “anticipate,” “continue,” “estimate,” “project,” “intend,” and similar expressions are intended to identify forward-looking statements within the meaning of Section 27a of the Securities Act and Section 21e of the Exchange Act regarding events, conditions, and financial trends that may affect our future plans of operations, business strategy, operating results, and financial position.  Persons reviewing this Quarterly Report are cautioned that any forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties and actual results may differ materially from those included within the forward-looking statements as a result of various factors.  Such factors are discussed further below under “Trends and Uncertainties,” and also include general economic factors and conditions that may directly or indirectly impact our financial condition or results of operations.

Overview of Current and Planned Business Operations

We are a cellular reseller of wholesale priced minutes, text and data, including traditional post-paid cellular services, primarily operating on mobile networks of major communications companies like Verizon and AT&T; and we are a Sprint authorized agent of cellular services and products that principally include business to business and business to customer products and services, mostly B2B Mobile Service and Internet of Things or wireless data.  During the coming year, we plan to devote additional sales resources to IoT, and we have direct wholesale data agreements with Verizon and AT&T to provide us with our required wireless services.  We also presently provide Lifeline Program service through a virtual eligible telecommunications carrier with a Lifeline Program license; and we have entered into an agreement with IM Telecom of Oklahoma, whose principal asset is a “Lifeline Program” license issued by the FCC, to acquire 100% of the membership interest in IM Telecom, subject to approval of the transfer of this license to us as a 100% member owner of IM Telecom by the FCC, if there is an FCC approved transfer and subsequent closing of this agreement.  The parties continue to seek approval of the transfer of this license, and no assurance can be given that any such transfer will be approved by the FCC.  Lifeline was created under President Ronald Reagan as part of the 1984 Telecommunications Act.  Lifeline is an FCC program that provides subsidized, fixed or mobile telecommunications services to low-income consumers.  We primarily distribute all of our products and services through independent field agents.

Comparison of the Quarter Ended March 31, 2018, to the quarter ended March 31, 2017

Results of Operations

For the quarter ended March 31, 2018, we had $2,393,355 in revenues from operations compared to the quarter ended March 31, 2017, where we had $3,349,268 in revenue from operations.  The cost of revenue for the quarter ended March 31, 2018, was $1,934,690, compared to $2,720,776 for the quarter ended March 31, 2017.  We had a gross profit of $458,665 for the quarter ended March 31, 2018, and $628,492 for the quarter ended March 31, 2017.

For the quarter ended March 31, 2018, and the quarter ended March 31, 2017, total operating expenses were $973,869 and $1,039,115, respectively, for a decrease of $65,246.

For the quarter ended March 31, 2018, non-operating expenses were other income of $4,281 and interest expense of $17,104 compared to no other income and interest expense of $12,574 for the quarter ended March 31, 2017.

For the quarter ended March 31, 2018, and the quarter ended March 31, 2017, we had a net loss from operations of $528,027 and $423,197, respectively.

In comparing our Statements of Operations between the three month periods ended March 31, 2018, and 2017, the Company was just beginning the process of diversifying the service mix.  Gross Revenue generated from the lower profit margin wholesale service was 67.6% of the total revenue for the three month period ending March 31, 2017.  Comparatively, the wholesale service only accounted for 28.1% of the total gross revenue for the three months ended March 31, 2018.  During the same comparative periods, gross retail revenue increased by 58.5%. Gross profit per line slightly increased to $2.41 from $1.72 on the wholesale service as lower margin, high volume customers were being eliminated.  Retail gross profit per line decreased from $10.38 to $5.41 as the diversification plan created several up-front costs for equipment for re-sale.

Liquidity and Capital Resources

As of March 31, 2018, we have $362,916 in cash and cash equivalents on hand.

21

In comparing liquidity between the three month periods ending March 31, 2018, and December 31, 2017, cash and short-term assets increased by 49.8%.  The increase was generated through sale of common stock and increased receivables and prepaid assets.  Liabilities and total overall debt showed an 8.5% decrease in the three month period ending March 31, 2018, when compared to December 31, 2017.  Going forward, equity investment and growth of new services is expected to provide the liquidity for our business.

Overall, the current ratio (current assets divided by our current liabilities) improved to .95 as of March 31, 2018, compared to .54 as of December 31, 2017.  Working capital increased by 89.9%.

As indicated in NOTE 12 of the Notes to the Consolidated Financial Statements and the Results of Operations, gross revenue has decreased by 28.5% when comparing the three months ended March 31, 2018 and 2017. Similarly, gross profit decreased by 27.0%. This occurred as the Company began the diversification process. The revenue generated in the three month period ended March 31, 2017 was becoming more difficult to maintain as the industry became more regulated, competitive, and volatile. Profit margin percentage increased by 2.1% as the services provided began to be diversified into a more profitable areas.

Cash Flow from Operations

During the quarter ended March 31, 2018, and the quarter ended March 31, 2017, cash flow used in operating activities was $707,906 and $92,170, respectively.  Cash flows used in operating activities were primarily attributable to the Company’s net loss of $528,027 and $423,197 for the quarters ended March 31, 2018, and 2017, respectively.

Cash Flows from Investing Activities

During the quarter ended March 31, 2018, and the quarter ended March 31, 2017, cash flow (used) provided in investing activities was $0 and ($5,845), respectively.

Cash Flows from Financing Activities

During the quarter ended March 31, 2018, and the quarter ended March 31, 2017, cash flow provided by financing activities was $976,673 and cash flow used by financing activities was $4,466, respectively.  The funds provided by financing were comprised of proceeds from issuance of common stock, $950,000 for 2018, and $0 for 2017; repayments of revolving lines of credit was $0 for 2018, and ($4,466) for 2017; advances made by shareholder of $100,000 in 2018, and $0 in 2017; and repayments to shareholder of $73,327 for 2018, and $0 for 2017.

Going Concern

As the Company did not generate net income during the three month periods ending March 31, 2018, and 2017, we have been dependent upon equity financing to support our operations.  In addition to losses of $528,027 and $423,198 for the periods ending March 31, 2018, and 2017, respectively, we have experienced negative cash flow from operations of $707,906 and $92,170 in 2018, and 2017. The accumulated deficit as of March 31, 2018, is $3,718,900.

We believe we have ameliorated any “going concern” issues by generating additional cash flow since the completion of our merger with KonaTel Nevada on December 18, 2017; receiving cash investments through the private placement of shares of our common stock; and the increase of revenues from the growth of our Virtual ETC program, all of which has contributed to an improvement in our working capital, resulting in a working capital surplus, without the use of additional lines of credit or borrowings.  Additionally, we also have two options to finance our mobile phone equipment purchases whereby multiple equipment suppliers provide us short term credit terms of up to 60 days on mobile phone purchases and a bank line of credit for purchases of select mobile phones.

Off-Balance Sheet Arrangements

We had no Off-Balance Sheet arrangements during the year ended March 31, 2018.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk.

Not required.

22

Item 4.  Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The SEC defines the term “disclosure controls and procedures” to mean a company’s controls and other procedures of an issuer that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its chief executive and chief financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. The Company maintains such a system of controls and procedures in an effort to ensure that all information which it is required to disclose in the reports it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified under the SEC’s rules and forms and that information required to be disclosed is accumulated and communicated to the chief executive and interim chief financial officer to allow timely decisions regarding disclosure.

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are not effective as of such date. The Chief Executive Officer and Chief Financial Officer have determined that the Company continues to have the following deficiencies which represent a material weakness:

·

Lack of in-house personnel with the technical knowledge to identify and address some of the reporting issues surrounding certain complex or non-routine transactions.  With material, complex and non-routine transactions, management has and will continue to seek guidance from third-party experts and/or consultants to gain a thorough understanding of these transactions;

·

Insufficient personnel resources within the accounting function to segregate the duties over financial transaction processing and reporting; and

·

Insufficient written policies and procedures over accounting transaction processing and period end financial disclosure and reporting processes.

To remediate our internal control weaknesses, management intends to implement the following measures:

·

As funding permits, the Company will add sufficient accounting personnel to properly segregate duties and to effect a timely, accurate preparation of the financial statements.

·

The Company will hire staff technically proficient at applying U.S. GAAP to financial transactions and reporting.

·

Upon the hiring of additional accounting personnel, the Company will develop and maintain adequate written accounting policies and procedures.

The additional hiring is contingent upon The Company’s efforts to obtain additional funding through equity or debt and the results of its operations. Management hopes to secure funds in the coming fiscal year but provides no assurances that it will be able to do so.

Limitations on the Effectiveness of Controls

The Company’s sole officer does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of the control system must reflect that there are resource constraints and that the benefits must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

Changes in Internal Control Over Financial Reporting

During the fiscal quarter covered by this Quarterly Report, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

23

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

Not required; however, see Item 1A. Risk Factors, Part I, commencing on page 13, of the Company’s 10-K Transition Report filed with the SEC on June 29, 2018, for a list of “risk factors” which can be accessed by Hyperlink in Part II, Item 6 hereof.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On February 12, 2018, we issued 300,000 Incentive Stock Option grants to three newly appointed directors, 100,000 options to each.

On March 8, 2018, we issued 4,750,000 shares in a private placement at $0.20 per share for an aggregate amount of $950,000.

On April 13, 2018, we issued 1,000,000 shares of our common stock through an additional private placement at $0.20 per share for an aggregate of $200,000, $100,000 in cash and $100,000 in payment of our note to this subscriber.

These securities were offered and sold pursuant to an exemption from registration under the Securities Act provided in Section 4(a)(2) thereof, and/or pursuant to Rule 506(b) of Regulation D promulgated by the SEC under the Securities Act.

Item 3. Defaults upon Senior Securities

None, not applicable.

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

Effective February 7, 2018, we entered into an Agreement for the Purchase and Sale of Membership Interest dated as of February 5, 2018 (the “PSMI”), with the transaction documents being deposited in escrow on February 7, 2018, respecting the acquisition of 100% of the membership interest in IM Telecom, LLC, an Oklahoma limited liability company (“IM Telecom”), from its sole owner, Trevan Morrow (“Mr. Morrow”).  The principal asset of IM Telecom is a “Lifeline Program” license (a Federal Communications Commission [the “FCC”] approved Compliance Plan), the transfer of ownership of which requires prior approval of the FCC.  If the transfer of the beneficial ownership of the Lifeline Program license to us is not approved by the FCC prior to April 30, 2018, or a later date agreed upon by the parties, either party may terminate the PSMI.  The parties continue to seek FCC approval of the transfer of the Lifeline Program License, and neither party has exercised its right to terminate the PSMI.  No assurance can be given that the transfer of this license will be approved.

24

Item 6. Exhibits

Exhibits incorporated by reference:

26

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

KonaTel, Inc.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

27