The accompanying notes are an integral part of these consolidated financial statements. 

(unaudited)

Description of businessBusiness

Tecogen Inc., or the Company, we, our or us, produces commercial and industrial natural-gas-fueled engine-driven, combined heat and power (CHP) products that reduce energy costs, decrease greenhouse gas emissions and alleviate congestion on the national power grid. The Company’s products supply electric power or mechanical power for cooling, while heat from the engine is recovered and purposefully used at a facility. The Company also installs, owns, operates and maintains complete energy systems and other complementary systems at customer sites and sells electricity, hot water, heat and cooling energy under long-term contracts at prices guaranteed to the customer to be below conventional utility rates.

The majority of the Company’s customers are located in regions with the highest utility rates, typically California, the Midwest and the Northeast. The Company's common stock is listed on NASDAQ under the ticker symbol TGEN.

On May 18, 2017, the Company acquired 100% of the outstanding common stock of American DG Energy Inc., formerly a related entity, in a stock-for-stock merger (see Note 3. "Acquisition of American DG Energy Inc.").merger.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. 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 considered necessary for a fair presentation have been included. Operating results for the ninethree months ended September 30, 2017March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2020.

The condensed consolidated balance sheet at December 31, 20162019 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

For further information, refer to the consolidated financial statements and footnotes thereto included in Tecogen Inc.'s Annual Report on Form 10-K and American DG Energy Inc.'sTecogen's Annual Report on Form 10-K for the year ended December 31, 2016.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and entities in which it has a controlling financial interest. Those entities include the Company's wholly-owned subsidiaries American DG Energy Inc. and Ilios Inc., TTcogen LLC, and a joint venture, American DG New York, LLC, in which American DG Energy Inc. holds a 51.0%51% interest. Investments in partnerships and companies in which the Company does not have a controlling financial interest but where we have significant influence are accounted for under the equity method. Any intercompany transactions have been eliminated in consolidation.

The Company’s operations are comprised of two business segments. Our Products and Services segment designs, manufactures and sells industrial and commercial cogeneration systems as described above. Our Energy Production segment sells energy in the form of electricity, heat, hot water and cooling to our customers under long-term sales agreements.

Reclassification

Certain prior period amounts have been reclassified to conform with current year presentation.

Use of Estimates

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. Actual results could differ from those estimates.

Income Taxes

Revenue is recognized when performance obligations under the terms of a contract with our customer are satisfied; generally this occurs with the transfer of control of our products, services and energy production. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or Updates Not Yet Effective

Shipping and eliminate industry-specific guidance. The underlying principle is to recognize revenue when promised goods or services are transferredhandling fees billed to customers in an amount that reflectsa sales transaction are recorded in revenue and shipping and handling costs incurred are recorded in cost of sales. The Company has elected to exclude from revenue any value add sales and other taxes which it collects concurrent with revenue-producing activities. These accounting policy elections are consistent with the consideration that is expected to be received for those goods or services. This accounting standard update, as amended, will be effective formanner in which the Company beginninghistorically recorded shipping and handling fees and taxes. Incremental costs incurred by us in obtaining a contract with a customer are negligible, if any, and are expensed ratably in proportion to the first quarter of fiscal 2018. The newrelated revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized in retained earnings as of the date of adoption ("modified retrospective basis"). The Company expects to adopt this accounting standard update on a modified retrospective basis in the first quarter of fiscal 2018, and has engaged an outside expert to assist with the evaluation of the impact of this accounting standard update on its consolidated financial statements and its implementation.

In general, the Company's business segmentation is aligned according to the nature and diluted income (loss) per shareeconomic characteristics of its products and customer relationships and provides meaningful disaggregation of each business segment's results of operations.

We have includedrecognize revenue in certain circumstances before delivery to the financial resultscustomer has occurred (commonly referred to as bill and hold transactions). We recognize revenue related to such transactions once, among other things, the customer has made a written fixed commitment to purchase the product(s) under normal billing and credit terms, the customer has requested the product(s) be held for future delivery as scheduled and designated by them, risk of ADGE in our condensed consolidated financial statementsownership has been assumed by the customer, and the product(s) are tagged as sold and segregated for storage awaiting further direction from the datecustomer. Due to the infrequent nature and duration of acquisition. Forbill and hold arrangements, the threevalue associated with custodial storage services is deemed immaterial in the context of the contract and nine months ended September 30, 2017, ADGE contributed $1,556,115in total, and $2,330,307accordingly, none of the transaction price is allocated to our total revenues and $832,917 and $1,276,566 to our gross profit, respectively.such service.

Acquisition related costs included in generalDepending on the product and administrative expenses totaled $37,445terms of the arrangement, we may defer the recognition of a portion of the transaction price received because we have to satisfy a future obligation (e.g., product start-up service). Amounts allocated to product start-up services are recognized as revenue when the start-up service has been completed. We use an observable selling price to determine standalone selling prices where available and $374,042, respectivelyeither a combination of an adjusted market assessment approach, an expected cost plus a margin approach, and/or a residual approach to determine the standalone selling prices for the three and nine months ended September 30, 2017. Stock issuance related costs totaling $367,101 were netted against additional paid in capital during the nine months ended September 30, 2017.

Under complete turnkey installation service contracts revenue is recognized over time using the percentage-of-completion method determined on a cost to cost basis. Our performance obligation under such contracts is satisfied progressively over time as enhancements are made to customer owned and controlled properties. We measure progress towards satisfaction of the merger, each outstanding shareperformance obligation based on an input method based on cost which we believe is the most faithful depiction of ADGE common stock was converted intothe transfer of products and services to the customer under these contracts. When the financial metrics of a contract indicate a loss, our policy is to record the entire expected loss as soon as it is known. Contract costs and profit recognized to date under the percentage-of-completion method in excess of billings are recognized as contract assets and are recorded as unbilled revenue. Billings in excess of contract costs and profit are recognized as contract liabilities and are recorded as deferred revenue. Generally billings under complete turnkey installation contracts are made when contractually determined milestones of progress have been achieved, with payment terms generally being 30 days.

Revenue recognized during the quarter ended March 31, 2020 that was included in unbilled revenue at the effective timebeginning of the merger, assumed the (a) outstanding stock options of ADGE and (b) outstanding warrants to purchase common stock of ADGE, eachperiod was approximately $1.2 million. Approximately $0.8 million was billed in this period that had been recognized as adjusted pursuant to the Exchange Ratio and subject to the terms of the merger agreement.revenue in previous periods.

     One-time acquisition-related expensesRemaining performance obligations related to ASC 606 represent the merger incurred duringaggregate transaction price allocated to performance obligations with an original contract term greater than one year, excluding certain maintenance contracts and all energy production contracts where a direct measurement of the three-monthvalue to the customer is used as a method of measuring progress towards completion of our performance obligation. Exclusion of these remaining performance obligations is due in part to the inability to quantify values based on unknown future levels of delivery and nine-month periods ended September 30, 2017 are not includedin some cases rates used to bill customers. Remaining performance obligations therefore consist of unsatisfied or partially satisfied performance obligations related to fixed price maintenance contracts and installation contracts.

As of March 31, 2020, the aggregate amount of the transaction price allocated to remaining performance obligations was approximately $12.3 million. The Company expects to recognize revenue of approximately 95% of the remaining performance obligations over the next 24 months, 93% recognized in the unaudited pro forma financial information as they are not expected to have a continuing impact onfirst 12 months and 2% recognized over the consolidated results.

The aggregate amortization expense related to intangible assets and liabilities exclusive of contract related intangibles for the ninethree months ended September 30, 2017March 31, 2020 and 20162019 was $74,482$22,816 and $73,511,$24,099, respectively. The net credit to cost of sales related to the amortization of contract related intangible assets and liabilities for the ninethree months ended September 30, 2017March 31, 2020 and 20162019 was $428,264$107,998 and $-0-,$173,292, respectively. During the three months ended March 31, 2020, the Company abandoned certain patent applications amounting to a $179,944 abandonment charge for the period.

Favorable/Unfavorable Contract Assets and Liabilities

The favorable contract asset and unfavorable contract liability in the foregoing table represent the estimated fair value of American DG Energy's customer contracts (both positive for favorable contracts and negative for unfavorable contracts) which were acquired by the Company onin May 18, 2017 (see Note 3. "Acquisition of American DG Energy Inc."). These contracts are long-term and provide customers with an alternative source of electrical power in addition to that provided by the local power utility, at rates that are lower than local utilities. This alternative electrical power is typically produced by ADGE owned, operated and maintained natural gas powered systems installed at the customers' sites, with ADGE bearing all costs of operation and maintenance. In addition to the alternative source of electrical power provided by ADGE’s systems, customers can opt to add and take advantage of the heat generated in the electrical production process in the form of hot water and/or space heating. Pricing to the customer for electrical power produced and supplied by ADGE under the contracts is under a fixed formula which requires the customer to pay for the kilowatts of electrical power provided at a fixed percentage discount to the local utility’s electric rate for that period. As a result, as utility rates for electrical power change, the amount ADGE is able to charge the customer under the contract also changes. There has been a sharp decrease in electric rates over the past several years, subsequent to the vast majority of customer contract dates, causing the billable value of the electrical power generated by ADGE’s systems to decrease, resulting in a deterioration of expected profitability. As of the date of acquisition, utility electric rates were significantly below the level anticipated at the time the fixed percentage discounts contained in the vast majority of ADGE’s customer contracts were contracted for, thus these contract terms, although they produce cash flow, were considered to be off market in the vast majority of ADGE’s customer contracts. Additionally, the demand and volume of kilowatts produced and billed for vary by contract and by period and in certain instances have been significantly below what was originally expected such that had it been known at the time the contract(s) were negotiated, it would have influenced ADGE’s determination of the level of the fixed percentage discount in those contracts.

Amortization of intangibles including contract related amounts is calculated using the straight linestraight-line method over the remaining useful life or contract term. Aggregate future amortization over the next five years is estimated to be as follows:

ChangesDuring the first quarter of 2019, the Company recognized two individual sales of energy producing assets, for a total of eight power purchase agreements, including the associated energy production contracts for total consideration of $7 million, which resulted in a combined gain on sale of assets of $1,081,049 included in the carryingaccompanying statement of operations.

The combined gain on sale of these assets was determined after deducting from the gross proceeds the remaining net book value of the assets sold and an estimate of the remaining costs to complete installation of certain of the site assets as well as deducting an estimate of amounts which the Company believes it will be required to pay under the minimum cash flow guarantee described above. In determining the combined gain on the sale of these assets, no amount of goodwill assigned to the energy production segment and excessreporting unit was included as individual sites and related site energy producing assets are not considered businesses. The aggregate of cost overthe assets sold represents a significant portion of the energy production segment and reporting unit’s assets and cash flows which is the basis for determination of the fair value of netthe energy production reporting unit as used for goodwill impairment determinations. Accordingly, the sale of these assets acquiredcaused the Company to assess the impact of the sales on the valuation of remaining goodwill assigned to the energy production reporting unit. That assessment included a determination of whether the remaining carrying value of the energy production reporting unit including goodwill exceeded its fair value. Following a goodwill impairment charge in 2018 which reduced the carrying value of the energy production reporting unit including goodwill to fair value based on discounted cash flows, exclusion of the discounted cash flows related to the assets sold resulted in impairment of the remaining goodwill assigned to the energy production reporting unit in an amount proportionate to the discounted cash flows related to the assets sold to the total discounted cash flows of the energy production reporting unit before the sales. The goodwill impairment as a result of the sales and recognized in the first quarter of 2019 totaled approximately $3.7 million, reducing the remaining carrying value of the energy production reporting unit, including goodwill to the discounted cash flow of the remaining sites or fair value.

Future minimum lease commitments under non-cancellable operating leases as of March 31, 2020 were as follows:

The Company adopted thea 2006 Stock Option and Incentive Plan, or the Plan, under which the Board of Directors may grant incentive or non-qualified stock options and stock grants to key employees, directors, advisors and consultants of the Company. The Plan was amended at various dates by the Board of Directors to increase the reserved shares of common stock issuable under the Amended Plan to 3,838,750 as of September 30, 2017, or the Amended Plan.March 31, 2020.

Stock options vest based upon the terms within the individual option grants, with an acceleration of the unvested portion of such options upon a change in control event, as defined in the Amended Plan. The options are not transferable except by will or domestic relations order. The option price per share under the Amended Plan cannot be less than the fair market value of the underlying shares on the date of the grant. The number of shares remaining available for future issuance under the Amended Plan as of September 30, 2017March 31, 2020 was 2,250,536.

The fair value topic of the FASB Accounting Standards Codification defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The accounting guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:

 

 

 

The following table presents the asset reported in "other assets" in the consolidated balance sheet measured at its fair value on a recurring basis as of September 30, 2017March 31, 2020 by level within the fair value hierarchy.

The Company utilizes a Level 32 category fair value measurement to value its investment in EuroSite Power as an available-for-salea marketable equity security at period end. That measurement is determinedequal to the quoted market closing price at period end. Since this security is not actively traded the Company classifies it as Level 2.

Borrowings under the Credit Agreement bear interest at a rate equal to, at the Borrower's option, either (1) One Month LIBOR, plus 3.00%, or (2) Lender’s Base Rate, plus 1.5%. Lender’s Base Rate is defined as the highest of (a) the Federal Funds rate plus 0.5%, (b) Lender’s Prime Rate as adjusted by managementLender from time to time, and (c) One Month LIBOR, plus 2.75%.

The $145,011 of costs incurred in connection with the issuance of the revolving credit facility were capitalized and are being amortized to interest expense on a straight-line basis over three years based on the lowest closing sales price in a 15 day trading period prior to period end.

The following table summarizes changescost related to the Credit Agreement was $37,861 and is netted against the revolving line of credit balance in level 3 assets which are comprised of available-for-sale securities for the period: