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ARKADOS GROUP, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[October 11, 2013]

ARKADOS GROUP, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand the Company's financial condition and results of operations. The MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes thereto.

We remain engaged in the process of seeking settlements with certain of our unsecured creditors.

We have executed several agreements that will enable us to provide the services contemplated in the home automation industry.


While we have begun to generate revenue from operations during quarter ending August 31, 2013, such revenue is not sufficient to meet our monthly operating expenses and we remain dependent on outside sources of financing to fund our operations.

Corporate Background We conduct our business activities principally through Arkados, Inc., which is a wholly owned subsidiary. In September 2006, we changed our corporate name from CDKnet.com, Inc., to its current form to align our corporate identity with the "Arkados" brand developed by our subsidiary.

We were an early adopter in the powerline communication space, and experienced in home automation. Our Arkados, Inc. subsidiary was a member of the HomePlug Powerline Alliance, an independent trade organization which has developed global specifications for high-speed powerline communications, the world's leading professional association for the advancement of technology.

The Company underwent a significant restructuring between December 23, 2010 and continuing beyond May 31, 2013 (the period ending for this report) during which substantially all of its assets were acquired by STMicroelectronics (sometimes referred to hereinafter as the "Asset Sale"), as disclosed in the 8-K filed December 29, 2010 and further described (as to the closing) in the 8-K filed July 12, 2011.

Following the sale of its assets associated with the manufacture of microchips, the Company, still a development stage company, shifted its focus towards development of software and hardware solutions that enable machine to machine communication for the Internet of Things (IoT), primarily in the areas of energy management and home automation. During the period, the Company has been in continuous negotiations with partners and industry contacts to establish joint ventures and other commercial relationships that would enable us to sell such solutions to service providers that would include these applications in product or service offerings to their customers.

Market Opportunities We expect to develop our sales force to include a network of direct sales regions. As we develop our international relationships with Tatung and STMicroelectronics, we expect to establish international sales offices and develop relationships with organizations related to our business that will be located worldwide. We anticipate supplementing our direct sales force with sales representative organizations and distributors. The scope and development of our sales and marketing organization will depend, among other things, on the amount of capital available to us and when products are ready for testing.

Industry Background While endeavoring to restructure the Company following the Asset Sale and settle obligations as a result of the Asset Sale, we retained the ability to pursue key elements of our software and platform solutions.

The smart grid and smart home markets can be characterized by the paradigm shift created by the advances in information technology and telecommunications meeting the energy industry. At the grid level, electric meters with enhanced communication capabilities-an essential component of the smart grid-are becoming more prevalent. In 2011, more than 23% of all U.S. electrical customers had smart meters. These meters use two-way communication to connect utilities and their customers. They support demand response and distributed generation, can improve reliability, and also provide information that consumers can use to save money by managing their use of electricity.

Within the home, advanced mobile and wireless technologies have contributed to a smarter, more connected home that can deliver much in the way of energy savings, convenience, comfort and security. Networked sensors, devices and appliances create an internet of things that can be managed within the home and from afar.

2 Electric meters with enhanced communication capabilities-an essential component of the smart grid-are becoming more prevalent. In 2011, more than 23% of all U.S. electrical customers had smart meters. These meters use two-way communication to connect utilities and their customers. They support demand response and distributed generation, can improve reliability, and also provide information that consumers can use to save money by managing their use of electricity.

According to research firm Zpryme, the smart grid core and enabled technology market will reach $220 billion in size by 2020. The explosive growth in this market is driven primarily by the first wave of smart grid implementation: advanced metering infrastructure (the "AMI"). Utilities throughout the world have aggressively implemented smart meters to residential and industrial customers mainly because it is the required first step to achieve a true smart grid and, secondarily, in response to significant government incentives to do so. AMI lays the foundation as a hub for networking and communication and it the gateway to the HAN. From the perspective of the end user (residential or industrial), in-home (or in-building) devices are not only capable to communicating with the other devices within the local network, but are also capable of communicating outward to the WAN and implementing demand response protocols.

Strategic Relationships We continue to foster our relationships with STMicroelectronics and Tatung. Each of these relationships will allow Arkados to engage in our devised strategy of developing software and platform solutions for home automation services.

Research and Development While we may engage in certain activities in pursuit of home automation services plans, no such activity exists through the end of the period covered by this report.

Patents, Licenses and Trademarks The Company did not acquire any patents, licenses or trademarks during the period of this report. We continue to maintain our license with STMicroelectronics for patents relating to home automation services. In addition, we maintain the federal registration of our "Arkados" mark.

Competition We face competition both from established players that are beginning to focus on powerline networking technology, as well as recent entrants in the field. Some of these competitors create solutions that are compliant with existing standards and specifications, while other competitors' products are based on proprietary technologies. Key competitors include companies such as Tendril, Greenbox Technology and Echelon.

Results of Operations While we remain a development stage company as of the end of the reporting period, we have been diligently undertaking negotiations with partners and industry contacts to establish joint ventures and other commercial relationships that would enable us to sell solutions in the energy management and home automation industries to service providers that would include these applications in product or service offerings to their customers.

During the period, we entered into an agreement with a multinational corporation that designs and manufactures an array of digital consumer products, including personal computers, liquid crystal display televisions, plasma displays, network-connected devices, storage-based media players, videophones and home appliances. This agreement is our sole source of cash flow at this time.

Since inception, we have incurred accumulated operating losses of approximately $34,000,000. We have financed operating losses since September 2004 with the proceeds primarily from related party lending from our major stockholders and affiliated lenders, as well as other stockholders and lenders.

If we are unable to raise funds to finance our working capital needs, we will not have the capital necessary for ongoing operations and for making our chip ready for mass production, we could lose professional staff necessary to develop our products and the value of our technology could be impaired. In addition, the lack of adequate funding could jeopardize our development and delivery schedule of our planned products. Such delays could in turn jeopardize relationships with our current customers, strategic partners and prospective suppliers.

3 For The Three Months Ended August 31, 2013 and August 31, 2012 During the three month period ended August 31, 2013, we invoiced a customer for software development costs in the amount of $30,000. In accordance with accounting rules for recognition of revenue, however, this did not result in sales being recorded during the period, but was recorded as a reduction of our research and development expense and therefore our revenue was $0 for the three months ended August 31, 2013 and August 31, 2012. Total operating expenses for the three month period ended August 31, 2013 was $225,936, consisting mainly of salaries of our management, as well as consulting expenses and professional fees. During this period we also incurred net research and development expenses (after the offset described above) of $3,781 relating to development of new technology. This is compared to total operating expenses for the three month period ended August 31, 2012 of $39,574, consisting mainly of consulting expenses and professional fees.

Interest expense on our existing debt for the three month periods ended August 31, 2013 and August 31, 2012 was $99,454 and $13,886, respectively.

Liquidity and Capital Resources Our principal source of operating capital has been provided in the form of the private placement of convertible debt securities. We do not have any significant sources of revenue from our operations. No assurance can be given that we can engage in any public or private sales of our equity or debt securities to raise working capital. We have depended, in part, upon loans from investors and there can be no assurances that investors will make any additional loans to us.

Our present material commitments are the compensation of our employees, including our executive officers, and professional and administrative fees and expenses associated with the preparation of our filings with the Securities and Exchange Commission and other regulatory requirements.

As of August 31, 2013, we had cash of $126,373 and negative working capital of ($9,395,023) compared to cash of $345,126 and negative working capital of ($9,146,637) at May 31, 2013. The decrease in working capital since May 31, 2013 has resulted from additional accrued expenses and decreased cash used to pay such expenses. There has not been any new financing during the quarter, however, the decreasing cash from prior financing is offset by $30,000 received in connection with development of a software product for a customer.

Commitments We do not have any commitments which are required to be disclosed in tabular form as of August 31, 2013.

Critical Accounting Policies The discussion and analysis of the Company's financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure on contingent assets and liabilities at the date of the financial statements.

Actual results may differ from these estimates under different assumptions and conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and may potentially result in materially different results under different assumptions and conditions. As of August 31, 2013, management believes the critical accounting policies applicable to the Company that are reflective of significant judgments and or uncertainties are limited to equity based transactions or convertible debt instruments.

Accounting for Stock Based Compensation The computation of the expense associated with stock-based compensation requires the use of a valuation model. ASC 718 is a complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility, expected option lives, and expected option forfeiture rates, to value equity-based compensation. We currently use a Black-Scholes option pricing model to calculate the fair value of stock options. We primarily use historical data to determine the assumptions to be used in the Black-Scholes model and have no reason to believe that future data is likely to differ materially from historical data. However, changes in the assumptions to reflect future stock price volatility and future stock award exercise experience could result in a change in the assumptions used to value awards in the future and may result in a material change to the fair value calculation of stock-based awards. ASC 718 requires the recognition of the fair value of stock compensation in net income.

Although every effort is made to ensure the accuracy of our estimates and assumptions, significant unanticipated changes in those estimates, interpretations and assumptions may result in recording stock option expense that may materially impact our financial statements for each respective reporting period.

4 Impact of Debt with Conversion Features The Company at times enters into financing transactions whereby such debt instruments contain conversion features into common stock and or may contain detachable equity rights. These debt inducement features may be considered freestanding and or beneficial conversion features in our financial statements pursuant to the accounting guidance under ASC 470-20. These features would be fair valued and recorded as a discount to the debt instrument and amortized over the life of the instrument. Additional valuation features of warrants, conversion features in debt, and similar terms that include "full-ratchet" or reset provisions, which mean that the exercise or conversion price adjusts to pricing in subsequent sales or issuances, no longer meet the definition of indexed to a company's own stock and are not exempt from equity classification provided in ASC Topic 815-15. This means that instruments that were previously classified in equity are reclassified to liabilities and ongoing measurement under ASC Topic 815. The amount of quarterly non-cash gains or losses we will record in future periods will be based upon the fair market value of our common stock on the measurement date.

Off Balance Sheet Arrangements We do not have any off balance sheet arrangements.

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