As filed with the Securities and Exchange Commission on August 28, 2003
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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TELKONET, INC.
(Exact Name of Registrant as Specified in Its Charter)
UTAH 87-0627421
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
902-A COMMERCE ROAD, ANNAPOLIS, MARYLAND 21401
(410) 897-5900
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Principal Executive Offices)
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STEPHEN L. SADLE
CHIEF OPERATING OFFICER
902-A COMMERCE ROAD
ANNAPOLIS, MARYLAND 21401
(Name and Address of Agent for Service)
(410) 897-5900
(Telephone Number, Including Area Code, of Agent for Service)
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copy to:
WILLIAM J. CONTI, ESQ.
BAKER & HOSTETLER LLP
1050 CONNECTICUT AVENUE, NW
SUITE 1100
WASHINGTON, D.C. 20036
202-861-1726
202-861-1783 (FAX)
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: ______________.
If the only securities being registered on this form are being offered pursuant
to dividend or interest reinvestment plans, please check the following box. [ ]
If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [x]
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] ______________________________
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] _____________________________________________________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
========================= ==================== ======================== ======================== ======================
Title of Amount Proposed Proposed
Securities To To Be Maximum Offering Maximum Aggregate Amount of
Be Registered Registered Price Per Share Offering Price Registration Fee
------------------------- -------------------- ------------------------ ------------------------ ----------------------
Common Stock,
$0.001 par value 17,353,367 $ 2.77(1) $ 48,068,826(1) $3,889.00
========================= ==================== ======================== ======================== ======================
(1) Estimated in accordance with Rule 457 solely for the purpose of determining
the registration fee.
The registrant hereby amends this registration statement on such date
or dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933, as amended, or until the registration statement
shall become effective on such date as the Securities and Exchange Commission
(SEC), acting pursuant to said Section 8(a), may determine.
PROSPECTUS
TELKONET, INC.
17,353,367 Shares
Common Stock
This prospectus covers 17,353,367 shares of our common stock that may
be offered and sold from time to time by the selling stockholders. We will not
receive any proceeds from the sale of the shares of our common stock pursuant to
this prospectus. We will bear the costs relating to the registration of the
shares of our common stock, which we estimate to be approximately $________.
The selling stockholders may sell the shares of our common stock
through ordinary brokerage transactions or through any other means described in
this prospectus under "PLAN OF DISTRIBUTION." The price at which the selling
stockholders may sell the shares will be determined by the prevailing market
price for the shares or in negotiated transactions.
Our common stock is traded on the NASDAQ OTC Bulletin Board under the
symbol "TLKO.OB." On August 22, 2003, the last reported sale price of our common
stock was $2.70.
Investing in shares of our common stock involves risks, including the
risk that Telkonet will not be able to continue as a going concern. See "RISK
FACTORS" beginning on page 7 of this prospectus.
Neither the SEC nor any state securities commission has approved or
disapproved of these securities or determined if this prospectus is truthful or
complete. Any representation to the contrary is a criminal offense.
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No dealer, salesperson or other person has been authorized to give any
information or to make any representations other than those contained in or
incorporated by reference into this prospectus in connection with the offer
contained in this prospectus and, if given or made, such information or
representations must not be relied upon as having been authorized by us. Neither
the delivery of this prospectus nor any sale made hereunder shall under any
circumstances create an implication that there has been no change in our affairs
since the date hereof. We are offering to sell, and seeking offers to buy,
shares of our common stock only in jurisdictions where such offers and sales are
permitted. The information contained in, and incorporated by reference into,
this prospectus speaks only as of the date of this prospectus unless the
information specifically indicates that another date applies.
------------------
The date of this prospectus is August 28, 2003.
TABLE OF CONTENTS
Prospectus Summary 3
Risk Factors 7
Forward-Looking Statements 13
The Company 13
Market Price of and Dividends on our Common Stock and Related
Stockholder Matters 17
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 17
Quantitative and Qualitative Disclosures About Market Risk 18
Executive Officers and Directors 18
Security Ownership of Certain Beneficial Owners and Management 23
Certain Relationships and Related Transactions 25
Use of Proceeds 28
Selling Stockholders 28
Selected Financial Data 35
Management's Discussion and Analysis of Financial Condition
and Results of Operations 37
Plan of Distribution 47
Description of Common Stock 48
Experts 48
Legal Matters 49
Where You Can Find More Information 49
Indemnification for Securities Act Liabilities 49
Table of Contents for Financial Statements F-1
2
PROSPECTUS SUMMARY
This summary highlights information described more fully elsewhere in
this prospectus and may not contain all of the information that may be important
to you. You should read this entire prospectus carefully, including the
consolidated financial statements and related notes and other financial data
included in this prospectus, before making an investment decision. You should
also carefully consider the information set forth under "RISK FACTORS" beginning
on p. 7.
As used in this prospectus, the terms "we," "us," "our," "our company,"
and "Telkonet" mean Telkonet, Inc. and our subsidiaries, unless the context
otherwise requires.
THE COMPANY
We were formed in 1999 to develop products for use in the powerline
communications (PLC) industry. PLC products use existing electrical wiring in
commercial buildings and residences to carry high speed data communications
signals, including the Internet. Since our formation, we have worked on the
development and marketing of our patent-pending PLC technology.
Our PLC technology, the "PlugPlusInternet" product suite, consists of
two separate components, the PlugPlusInternet Gateway and the PlugPlusInternet
Modem. The PlugPlusInternet Gateway is a modular, self-contained unit that
accepts data from an existing network on one port and distributes it via a
second port. The Gateway integrates a communications processor that runs a
series of proprietary applications under Linux. The signal generated by the
Gateway can be directly coupled into low voltage wiring via the power cord of
the Gateway. The signal may also be routed to a remote injection point via an
inexpensive coaxial cable. This allows the PlugPlusInternet product suite to
couple into the medium voltage and multi-phase environments found in commercial
buildings. A suite of software applications running on the Gateway can perform
communications functions or system management functions. The Gateway is designed
to network with dozens of PlugPlusInternet Modems. The PlugPlusInternet Modem is
a small, self-contained unit with a standard 110V plug on one side and an
Ethernet RJ-45 connector on the other.
The PlugPlusInternet product suite delivers data at speeds in excess of
7 Mega bits per second (Mbps), with burst speeds of 12.6 Mbps. The
PlugPlusInternet product suite is installed by connecting an incoming broadband
signal (DSL, TL, satellite or cable modem) into the Gateway and connecting the
Gateway to a building's electrical panel. Once installed, the Gateway
distributes the high-speed Internet signal throughout the entire existing
network of electrical wires within the building. The user may access a
high-speed Internet signal by plugging the PlugPlusInternet Modem into any
electrical outlet and plugging a computer Ethernet connection into the Modem.
Multiple personal computers equipped with a PlugPlusInternet Modem can
communicate with one another and can share a single broadband resource via the
PlugPlusInternet Gateway. Moving the location of a personal computer, server, or
printer is accomplished by moving the PlugPlusInternet Modem to another
electrical outlet without additional wiring. Our target markets for sales of the
PlugPlusInternet product suite include office buildings, hotels, schools,
shopping malls, commercial buildings, multi-dwelling units, government
facilities, and any other commercial facilities that have a need for Internet
access and network connectivity.
We have applied for patents that cover the unique technology integrated
into the PlugPlusInternet product suite. We also continue to identify, design
and develop enhancements to our core technologies that will provide additional
functionality, diversification of application and desirability for current and
future users of the PlugPlusInternet product suite.
Telkonet is a Utah corporation with its principal executive offices at
902-A Commerce Road, Annapolis, Maryland 21401. Our telephone number is (410)
897-5900.
THE OFFERING
This prospectus covers up to 17,353,367 shares of our common stock to
be sold by the selling stockholders identified in this prospectus. The selling
stockholders, or their pledgees, donees, transferees or other successors in
interest may, from time to time, sell all or a portion of the shares covered by
this prospectus at fixed prices that may be changed, at market prices prevailing
3
at the time of sale, at prices related to such market prices or at negotiated
prices. The selling stockholders may also sell shares of our common stock
covered by this prospectus directly to purchasers or may use brokers, dealers,
underwriters or agents to sell shares upon terms and conditions that will be
described in the applicable prospectus supplement.
From time to time the selling stockholders may be engaged in short
sales, short sales against the box, puts and calls and other hedging
transactions in our securities to the extent permitted by applicable law and
exchange regulations, and may sell and deliver the shares in connection with
such transactions or in settlement of securities loans. These transactions may
be entered into with broker-dealers or other financial institutions. In
addition, from time to time, a selling stockholder may pledge its shares
pursuant to the margin provisions of its customer agreements with its
broker-dealer. Upon delivery of the shares or a default by a selling
stockholder, the broker-dealer or financial institution may offer and sell the
pledged shares from time to time. For a more complete description of the
offering see "PLAN OF DISTRIBUTION" on p. 47.
USE OF PROCEEDS
All net proceeds from the sale of our common stock by the selling
stockholders will go to the selling stockholders and we will not receive any
proceeds from the sale of the common stock by the selling stockholders. The
proceeds Telkonet receives from the exercise of warrants, the underlying shares
of our common stock of which are included in this prospectus, will be used to
expand sales and marketing efforts, support strategic partnership programs,
build required infrastructure and fund working capital requirements.
4
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
We derived the following historical financial information from the
unaudited consolidated financial statements of Telkonet for the six months ended
June 30, 2003 and 2002 and the consolidated financial statements of Telkonet for
the year ended December 31, 2002, 2001 and 2000 which have been audited by
Russell Bedford Stefanou Mirchandani LLP. Russell Bedford Stefanou Mirchandani
LLP's report on our financial statements contained explanatory paragraphs
expressing substantial doubt about our ability to continue as a going concern.
The unaudited financial data as of and for the six months ended June 30, 2003
and 2002 include adjustments, all of which are normal recurring adjustments,
which our management considers necessary for the fair presentation of our
results for these unaudited periods. The results of operations for the six
months ended June 30, 2003 are not necessarily indicative of the results that
may be expected for the full year. Certain reclassifications have been made to
conform this data to the current presentation.
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE SIX MONTHS ENDED FOR THE YEARS ENDED
(Amounts in thousands, except per share data) JUNE 30, DECEMBER 31,
---------------------------------------------------- ------------------------ ---------------------------------------
2003 2002 (AS 2002 2001 (AS 2000
--------- --------- --------- --------- ---------
RESTATED) RESTATED)
--------- ---------
STATEMENT OF OPERATIONS DATA:
Product revenue .................................... $ -- $ -- $ -- $ -- $ --
Service Revenue .................................... -- -- -- -- --
--------- --------- --------- --------- ---------
Total net revenue .................................. -- -- -- -- --
Cost of products sold .............................. -- -- -- -- --
Cost of services sold .............................. -- -- -- -- --
--------- --------- --------- --------- ---------
Gross profit ....................................... -- -- -- -- --
Selling, general and administrative expenses ....... 2,063 655 2,875 1,417 795
Management fees .................................... -- -- -- -- --
Research and development expenses .................. 598 602 280 121 119
Asset impairment charge ............................ -- -- -- 39 --
Interest income .................................... -- -- -- -- --
Interest expense ................................... 799 218 626 141 16
Interest expense-others ............................ -- -- -- -- --
Other income ....................................... -- -- (3) (1) --
--------- --------- --------- --------- ---------
Provision for income taxes ......................... -- -- -- -- --
--------- --------- --------- --------- ---------
Minority interest share of losses (income) ......... -- -- -- -- --
Net (loss) income .................................. $ (3,460) $ (1,475) $ (3,778) $ (1,717) $ (930)
========= ========= ========= ========= =========
Net (loss) income per common share-basic and diluted $ (0.22) $ (0.09) $ (0.22) $ (0.08) $ (0.04)
========= ========= ========= ========= =========
Weighted average common shares outstanding-basic ... 15,775 17,245 17,120 21,974 20,891
========= ========= ========= ========= =========
Weighted average common shares outstanding-diluted .
========= ========= ========= ========= =========
5
(Amounts in thousands) JUNE 30, DECEMBER 31,
---------------------------------------------------- -------- -------------------------------------------------
2003 2002 2001 (AS 2000
---- ---- --------- ----
RESTATED)
---------
BALANCE SHEET DATA:
Cash and cash equivalents .......................... $ 4,581 $ 19 $ 22 $ 10
Property and equipment, net ........................ 107 38 27 67
Goodwill and other intangibles, net ................ -- -- -- --
Total assets ....................................... 5,430 295 236 82
Long-term debt and notes payable ................... 6,453 863 126 --
Total debt ......................................... 7,752 1,822 650 264
Minority interest .................................. -- -- -- --
Total stockholders' equity ......................... (2,322) (1,527) (414) (182)
FOR THE SIX MONTHS ENDED FOR THE YEARS ENDED
(Amounts in thousands) JUNE 30, DECEMBER 31,
------------------------------------------------------------- ------------------------- ------------------------------------
2003 2002 (AS 2002 2001 (AS 2000
---- --------- ---- --------- ----
RESTATED) RESTATED)
--------- ---------
OTHER FINANCIAL DATA:
Depreciation and amortization ................................ $ 82 $ 71 $ 84 $ 31 $ 22
Net cash provided by (used in) operating activities .......... (2,420) (842) (2,070) (1,349) (660)
Net cash provided by (used in) investing activities .......... (29) (19) (18) (5) (89)
Net cash provided by financing activities .................... 7,011 982 2,086 1,366 759
Capital expenditures ......................................... 29 19 18 5 89
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangible Assets" (SFAS No.
142). SFAS No. 142 requires that goodwill and certain intangibles no
longer be amortized but instead tested for impairment at least
annually.
The following table presents the impact of SFAS No. 142 on our
summary financial data as indicated:
FOR THE YEARS ENDED
(Amounts in thousands, except per share data) DECEMBER 31,
-------------------------------------------------------------------- ------------------------
2001 (AS
--------
RESTATED) 2000
--------- ----
Net (loss) income:
Net (loss) income as reported ............................. $ (1,717) $ (930)
Goodwill amortization ..................................... -- --
Equity method investment amortization ..................... -- --
---------- ----------
Adjusted net (loss) income ......................................... $ (1,717) $ (930)
========== ==========
Basic and diluted (loss) income per share:
Net (loss) income per share, basic and diluted, as reported $ (0.08) $ (0.04)
Goodwill amortization ..................................... -- --
Equity method investment amortization ..................... -- --
---------- ----------
Adjusted (loss) income per share, basic and diluted ................ $ (0.08) $ (0.04)
========== ==========
6
RISK FACTORS
An investment in our common stock involves a high degree of risk. You
should carefully consider the following risk factors and other information
contained in or incorporated by reference into this prospectus and any
accompanying prospectus supplement before deciding to purchase any shares of our
common stock.
TELKONET'S INDEPENDENT ACCOUNTANTS HAVE EXPRESSED SUBSTANTIAL DOUBTS ABOUT
TELKONET'S ABILITY TO CONTINUE AS A GOING CONCERN.
The report of Telkonet's independent accountants contains an
explanatory paragraph expressing substantial doubts about Telkonet's ability to
continue as a going concern due to the fact that Telkonet has incurred losses
since inception. There can be no assurance that Telkonet will ever achieve
significant revenues or profitable operations.
TELKONET IS EMERGING FROM ITS DEVELOPMENT STAGE AND HAS NO OPERATING HISTORY ON
WHICH TO BASE AN EVALUATION OF ITS CURRENT BUSINESS AND FUTURE PROSPECTS.
Telkonet is emerging from its development stage. As a result, it has no
operating history upon which to base an evaluation of its current business and
future prospects. The first PlugPlusInternet product was introduced in July
2001. We have not generated substantial revenues. Moreover, we do not currently
have any contracts in place that will provide any significant revenue. Because
of our lack of an operating history, management has limited insight into trends
that may emerge and could materially adversely affect our business. Prospective
investors should consider the risks and difficulties our company may encounter
in its new and rapidly evolving market, especially given our lack of operating
history. These risks include our ability to:
o market the PlugPlusInternet product suite;
o build a customer base;
o generate revenues;
o compete favorably in a highly competitive market;
o access sufficient capital to support growth;
o recruit and retain qualified employees;
o introduce new products and services; and
o build technology and support systems.
WE HAVE A HISTORY OF OPERATING LOSSES AND AN ACCUMULATED DEFICIT AND WE EXPECT
TO CONTINUE TO INCUR LOSSES FOR THE FORESEEABLE FUTURE.
Since inception through June 30, 2003, we have incurred cumulative
losses of $9,918,391 and have never generated enough funds through our
operations to support our business. As of June 30, 2003, we have had no sales of
the PlugPlusInternet product suite. We expect to continue to incur substantial
operating losses at least through 2003. Our losses to date have resulted
principally from:
o research and development costs relating to the development of
our PlugPlusInternet product suite;
o costs and expenses associated with manufacturing, distribution
and marketing of our products;
o general and administrative costs relating to our operations;
and
7
o interest expense related to our Series A and Series B
Debentures and our Senior Notes.
We are currently unprofitable and may never become profitable. Since
inception, we have funded our research and development activities primarily from
private placements of equity and debt securities, a bank loan and short term
loans from certain of our executive officers. As a result of our substantial
research and development expenditures and limited product revenues, we have
incurred substantial net losses. Our ability to achieve profitability will
depend primarily on our ability to successfully commercialize the
PlugPlusInternet product suite.
THE TERMS OF OUR SENIOR NOTES SUBJECT US TO THE RISK OF FORECLOSURE ON
SUBSTANTIALLY ALL OF OUR ASSETS.
During the second quarter of 2003, we completed an offering of
$5,000,000 of Senior Notes. The Senior Notes each accrue interest at 8.0% per
annum and mature three years from the date of purchase. Accrued but unpaid
interest on the Senior Notes is payable quarterly on January 1, April 1, July 1
and October 1 of each year during the Senior Note term. The Senior Notes are
secured by a first priority security interest in all of the intellectual
property assets of Telkonet. If an event of default occurs under the Senior
Notes, including, but not limited to, the failure by Telkonet to make any
required payment to the noteholders when such payment is due, the noteholders
may exercise their right to foreclose on all or a portion of our assets used as
collateral for the payment of these obligations. Any such default and resulting
foreclosure could have a material adverse effect on our financial condition.
The Senior Notes mature three years from the date of issuance, at which
time the entire outstanding principal balance of each Senior Note becomes due
and payable. We may not have sufficient funds to repay the outstanding balance
on the Senior Notes upon their maturity. Accordingly, we may be required to
obtain the funds necessary to repay the noteholders through the issuance of
additional equity or debt securities or the sale of assets. There can be no
assurance that, if needed, we can issue equity or debt securities or sell assets
under terms that are acceptable to us or at all. If we are unable to obtain
funds to repay this indebtedness, we may be forced to dispose of assets or take
other actions on disadvantageous terms, which could result in losses to Telkonet
and have a material adverse effect on our financial condition.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS COULD HAVE A NEGATIVE EFFECT ON THE
PRICE OF OUR COMMON STOCK.
Our operating results may fluctuate significantly in the future as a
result of a variety of factors, most of which are outside our control,
including:
o the level of use of the Internet;
o the demand for high-tech goods;
o the amount and timing of capital expenditures and other costs
relating to the expansion of our operations;
o price competition or pricing changes in the industry;
o technical difficulties or system downtime;
8
o economic conditions specific to the internet and
communications industry; and
o general economic conditions.
Our quarterly results may also be significantly impacted by the impact of the
accounting treatment of acquisitions, financing transactions or other matters.
Such accounting treatment could have a material impact on the results for any
quarter and have a negative impact on the price of our common stock.
THERE IS PRESENTLY A LIMITED TRADING MARKET FOR SHARES OF OUR COMMON STOCK.
Our common stock is traded on the OTC Bulletin Board. Stocks that trade
on the OTC Bulletin Board tend to be less liquid and trade with larger spreads
between the bid and ask price than stocks on larger exchanges or automated
quotation systems. Information with respect to OTC Bulletin Board quotations
reflects inter-dealer prices without retail markup, markdown or commission and
may not represent actual transactions, and quotations on the OTC Bulletin Board
are sporadic. This means that shares of our common stock are less liquid than
shares of companies traded on larger exchanges or automated quotation systems
and, as a result, holders of our common stock may have some difficulty selling
their shares in the open market.
In addition, our stock is subject to what are known as the "penny
stock" rules. The "penny stock" rules place additional requirements on
broker-dealers who sell or make a market in such securities. Consequently, the
ability or willingness of broker-dealers to sell or make a market in our common
stock could be impacted and your ability to resell your shares, and the price at
which you could sell your shares, could be adversely affected.
OUR DIRECTORS AND EXECUTIVE OFFICERS OWN A SUBSTANTIAL PERCENTAGE OF OUR ISSUED
AND OUTSTANDING COMMON STOCK. THEIR OWNERSHIP COULD ALLOW THEM TO EXERCISE
SIGNIFICANT CONTROL OVER CORPORATE DECISIONS.
As of June 30, 2003, our officers and directors owned 49.2% of our
common stock. This means that our officers and directors, as a group, exercise
significant control over matters upon which our stockholders may vote, including
the selection of the Board of Directors, mergers, acquisitions and other
significant corporate transactions.
FURTHER ISSUANCES OF EQUITY SECURITIES MAY BE DILUTIVE TO CURRENT STOCKHOLDERS.
During the third quarter of 2001, we commenced an offering of up to
$1,689,100 principal amount of Series A Debentures. In connection with the
placement of the Series A Debentures, we also issued non-detachable warrants
granting holders the right to acquire 1,689,100 shares of our common stock at
$1.00 per share. The Series A Debentures are convertible into, and the warrants
are exerciseable for, the shares of our common stock that are included in the
registration statement of which this prospectus forms a part. As of the date of
this prospectus, 3,378,200 shares of our common stock have been issued in
connection with the conversion of the Series A Debentures.
During the fourth quarter of 2002, we commenced an offering of up to
$2,500,000 principal amount of Series B Debentures. In connection with the
placement of the Series B Debentures, we also issued non-detachable warrants
granting holders the right to acquire 2,500,000 shares of our common stock at
$1.00 per share. The Series B Debentures are convertible into, and the warrants
are exerciseable for, the shares of our common stock that are included in the
registration statement of which this prospectus forms a part. As of the date of
this prospectus, 4,545,455 shares of our common stock have been issued in
connection with the conversion of the Series B Debentures.
9
During the second quarter of 2003, we commenced an offering of up to
$5,000,000 principal amount of Senior Notes. The Senior Notes each accrue
interest at 8.0% per annum, mature three years from the date of purchase and are
secured by a first priority security interest in all of the intellectual
property assets of Telkonet. In connection with the placement of the Senior
Notes, we also issued non-detachable warrants granting holders the right to
acquire 6,250,000 shares of our common stock at $1.00 per share. The warrants
issued in connection with the Senior Note offering are exerciseable for the
shares of our common stock that are the subject of the registration statement of
which this prospectus forms a part.
Although the funds raised in the debenture offerings and the note
offering are being used for general working capital purposes, it is likely that
we will be required to seek additional capital in the future. This capital
funding could involve one or more types of equity securities, including
convertible debt, common or convertible preferred stock and warrants to acquire
common or preferred stock. Such equity securities could be issued at or below
the then-prevailing market price for our common stock. Any issuance of
additional shares of our common stock will be dilutive to existing stockholders
and could adversely affect the market price of our common stock.
THE EXERCISE OF OPTIONS AND WARRANTS OUTSTANDING AND AVAILABLE FOR ISSUANCE MAY
ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
As of June 30, 2003, we had outstanding options to purchase a total of
10,336,667 shares of common stock at exercise prices ranging from $1.00 to $3.43
per share, with a weighted average exercise price of $1.08. As of June 30, 2003,
we had warrants outstanding to purchase a total of 12,123,260 shares of common
stock at exercise prices ranging from $0.50 to $2.97 per share, with a weighted
average exercise price of $0.96. In addition, as of June 30, 2003, we had
4,663,333 additional shares of common stock which may be issued in the future
under the Telkonet, Inc. Stock Incentive Plan. The exercise of outstanding
options and warrants and the sale in the public market of the shares purchased
upon such exercise will be dilutive to existing stockholders and could adversely
affect the market price of our common stock.
THE POWERLINE COMMUNICATIONS INDUSTRY IS INTENSELY COMPETITIVE AND RAPIDLY
EVOLVING.
We operate in a highly competitive, quickly changing environment, and
our future success depends on our ability to develop and introduce new products
and product enhancements that achieve broad market acceptance in commercial and
governmental sectors. Our future success will depend, in large part, upon our
ability to identify demand trends in the commercial and governmental sectors and
quickly develop, manufacture and sell products that satisfy these demands in a
cost effective manner. We will also need to respond effectively to new product
announcements by our competitors by quickly introducing competitive products.
Delays in product development and introduction could result in:
o loss of or delay in revenue and loss of market share;
o negative publicity and damage to our reputation and brand; and
o decline in the average selling price of our products.
10
GOVERNMENT REGULATION OF OUR PRODUCTS COULD IMPAIR OUR ABILITY TO SELL SUCH
PRODUCTS IN CERTAIN MARKETS.
FCC rules permit the operation of unlicensed digital devices that
radiate radio frequency emissions if the manufacturer complies with certain
equipment authorization procedures, technical requirements, marketing
restrictions and product labeling requirements. Differing technical requirements
apply to "Class A" devices intended for use in commercial settings, and "Class
B" devices intended for residential use to which more stringent standards apply.
An independent, FCC-certified testing lab has verified that our PlugPlusInternet
Gateways comply with the FCC technical requirements for Class A and Class B
digital devices. No further testing of these devices is required and the devices
may be manufactured and marketed for commercial and residential use. Additional
devices designed by us for commercial and residential use will be subject to the
FCC rules for unlicensed digital devices. Moreover, if in the future, the FCC
changes its technical requirements for unlicensed digital devices, further
testing and/or modifications of devices may be necessary. Failure to comply with
any FCC technical requirements could impair our ability to sell our products in
certain markets and could have a negative impact on our business and results of
operations.
PRODUCTS SOLD BY OUR COMPETITORS COULD BECOME MORE POPULAR THAN OUR PRODUCTS OR
RENDER OUR PRODUCTS OBSOLETE.
The market for powerline communications products is highly competitive.
Although we are presently the only company marketing PLC products to the
commercial segment, Linksys Group, Inc. (recently acquired by Cisco Systems) and
Netgear, Inc. offer similar PLC solutions for the residential market. There can
be no assurance that Linksys Group, Netgear or any other company will not
develop PLC products that compete with our products in the future. These
potential competitors have longer operating histories, greater name recognition
and substantially greater financial, technical, sales, marketing and other
resources. These potential competitors may, among other things, undertake more
extensive marketing campaigns, adopt more aggressive pricing policies, obtain
more favorable pricing from suppliers and manufacturers and exert more influence
on the sales channel than we can. As a result, we may not be able to compete
successfully with these potential competitors and these potential competitors
may develop or market technologies and products that are more widely accepted
than those being developed by us or that would render our products obsolete or
noncompetitive. We anticipate that potential competitors will also intensify
their efforts to penetrate our target markets. These potential competitors may
have more advanced technology, more extensive distribution channels, stronger
brand names, bigger promotional budgets and larger customer bases than we do.
These companies could devote more capital resources to develop, manufacture and
market competing products than we could. If any of these companies are
successful in competing against us, our sales could decline, our margins could
be negatively impacted, and we could lose market share, any of which could
seriously harm our business and results of operations.
THE FAILURE OF THE INTERNET TO CONTINUE AS AN ACCEPTED MEDIUM FOR BUSINESS
COMMERCE COULD HAVE A NEGATIVE IMPACT ON OUR RESULTS OF OPERATIONS.
Our long-term viability is substantially dependent upon the continued
widespread acceptance and use of the Internet as a medium for business commerce.
The Internet has experienced, and is expected to continue to experience,
significant growth in the number of users. There can be no assurance that the
Internet infrastructure will continue to be able to support the demands placed
on it by this continued growth. In addition, delays in the development or
11
adoption of new standards and protocols to handle increased levels of Internet
activity or increased governmental regulation could slow or stop the growth of
the Internet as a viable medium for business commerce. Moreover, critical issues
concerning the commercial use of the Internet (including security, reliability,
accessibility and quality of service) remain unresolved and may adversely affect
the growth of Internet use or the attractiveness of its use for business
commerce. The failure of the necessary infrastructure to further develop in a
timely manner or the failure of the Internet to continue to develop rapidly as a
valid medium for business would have a negative impact on our results of
operations.
FAILURE OF OUR SERVICES AND PRODUCTS TO BE SUCCESSFUL IN THE MARKETPLACE COULD
HAVE A NEGATIVE EFFECT ON OUR RESULTS OF OPERATIONS.
Since we are just emerging from our development stage, we do not know
with any certainty whether our services and/or products will be accepted within
the business marketplace. If our services and/or products prove to be
unsuccessful within the marketplace, or if we fail to attain market acceptance,
it could have a negative effect on our results of operations.
WE MAY NOT BE ABLE TO OBTAIN PATENTS, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT
ON OUR BUSINESS.
Our ability to compete effectively in the powerline technology industry
will depend on our success in acquiring suitable patent protection. We currently
have several patents pending. We intend to file additional patent applications
that we deem to be economically beneficial. If we are not successful in
obtaining patents, we will have limited protection against those who might copy
our technology. As a result, the failure to obtain patents could negatively
impact our business and results of operations.
INFRINGEMENT BY THIRD PARTIES ON OUR PROPRIETARY TECHNOLOGY AND DEVELOPMENT OF
SUBSTANTIALLY EQUIVALENT PROPRIETARY TECHNOLOGY BY OUR COMPETITORS COULD
NEGATIVELY IMPACT OUR BUSINESS.
Our success depends partly on our ability to maintain patent and trade
secret protection, to obtain future patents and licenses, and to operate without
infringing on the proprietary rights of third parties. There can be no assurance
that the measures we have taken to protect our intellectual property, including
those integrated to our PlugPlusInternet product suite, will prevent
misappropriation or circumvention. In addition, there can be no assurance that
any patent application, when filed, will result in an issued patent, or that our
existing patents, or any patents that may be issued in the future, will provide
us with significant protection against competitors. Moreover, there can be no
assurance that any patents issued to, or licensed by, us will not be infringed
upon or circumvented by others. Infringement by third parties on our proprietary
technology could negatively impact our business. Moreover, litigation to
establish the validity of patents, to assert infringement claims against others,
and to defend against patent infringement claims can be expensive and
time-consuming, even if the outcome is in our favor. We also rely to a lesser
extent on unpatented proprietary technology, and no assurance can be given that
others will not independently develop substantially equivalent proprietary
information, techniques or processes or that we can meaningfully protect our
rights to such unpatented proprietary technology. Development of substantially
equivalent technology by our competitors could negatively impact our business.
WE DEPEND ON A SMALL TEAM OF SENIOR MANAGEMENT, AND WE MAY HAVE DIFFICULTY
ATTRACTING AND RETAINING ADDITIONAL PERSONNEL.
Our future success will depend in large part upon the continued
services and performance of senior management and other key personnel. If we
lose the services of any member of our senior management team, our overall
operations could be materially and adversely affected. In addition, our future
success will depend on our ability to identify, attract, hire, train, retain and
motivate other highly skilled technical, managerial, marketing, purchasing and
customer service personnel when they are needed. Competition for these
individuals is intense. We cannot ensure that we will be able to successfully
attract, integrate or retain sufficiently qualified personnel when the need
arises. Any failure to attract and retain the necessary technical, managerial,
marketing, purchasing and customer service personnel could have a negative
effect on our financial condition and results of operations.
12
FORWARD-LOOKING STATEMENTS
This prospectus and any prospectus supplement may contain
"forward-looking statements" which represent our expectations or beliefs,
including, but not limited to, statements concerning industry performance and
our results, operations, performance, financial condition, plans, growth and
strategies, which include, without limitation, statements preceded or followed
by or that include the words "may," "will," "expect," "anticipate," "intend,"
"could," "estimate," or "continue" or the negative or other variations thereof
or comparable terminology. Any statements contained in this prospectus, any
prospectus supplement or the information incorporated by reference that are not
statements of historical fact may be deemed to be forward-looking statements
within the meaning of Section 27(A) of the Securities Act of 1933 and Section
21(F) of the Securities Exchange Act of 1934. For such statements, we claim the
protection of the safe harbor for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995. These statements by their
nature involve substantial risks and uncertainties, some of which are beyond our
control, and actual results may differ materially depending on a variety of
important factors, many of which are also beyond our control. You should not
place undue reliance on these forward-looking statements, which speak only as of
the date of this prospectus. We do not undertake any obligation to update or
release any revisions to these forward-looking statements to reflect events or
circumstances after the date of this prospectus or to reflect the occurrence of
unanticipated events, except to the extent such updates and/or revisions are
required to prevent these forward-looking statements from being materially false
or misleading.
THE COMPANY
We were formed in 1999 to develop products for use in the powerline
communications (PLC) industry. PLC products use existing electrical wiring in
commercial buildings and residences to carry high speed data communications
signals, including the Internet. Since our formation, we have worked on the
development and marketing of our patent-pending PLC technology.
Our PLC technology, the "PlugPlusInternet" product suite, consists of
two separate components, the PlugPlusInternet Gateway and the PlugPlusInternet
Modem. The PlugPlusInternet Gateway is a modular, self-contained unit that
accepts data from an existing network on one port and distributes it via a
second port. The Gateway integrates a communications processor that runs a
series of proprietary applications under Linux. The signal generated by the
Gateway can be directly coupled into low voltage wiring via the power cord of
the Gateway. The signal may also be routed to a remote injection point via an
inexpensive coaxial cable. This allows the PlugPlusInternet product suite to
couple into the medium voltage and multi-phase environments found in commercial
buildings. A suite of software applications running on the Gateway can perform
communications functions or system management functions. The Gateway is designed
to network with dozens of PlugPlusInternet Modems. The PlugPlusInternet Modem is
a small, self-contained unit with a standard 110V plug on one side and an
Ethernet RJ-45 connector on the other.
The PlugPlusInternet product suite delivers data at speeds in excess of
7 Mega bits per second (Mbps), with burst speeds of 12.6 Mbps. The
PlugPlusInternet product suite is installed by connecting an incoming broadband
signal (DSL, TL, satellite or cable modem) into the Gateway and connecting the
Gateway to a building's electrical panel. Once installed, the Gateway
distributes the high-speed Internet signal throughout the entire existing
network of electrical wires within the building. The user may access a
high-speed Internet signal by plugging the PlugPlusInternet Modem into any
electrical outlet and plugging a computer Ethernet connection into the Modem.
Multiple personal computers equipped with a PlugPlusInternet Modem can
communicate with one another and can share a single broadband resource via the
PlugPlusInternet Gateway. Moving the location of a personal computer, server, or
printer is accomplished by moving the PlugPlusInternet Modem to another
electrical outlet without additional wiring. Our target markets for sales of the
PlugPlusInternet product suite include office buildings, hotels, schools,
shopping malls, commercial buildings, multi-dwelling units, government
facilities, and any other commercial facilities that have a need for Internet
access and network connectivity.
13
We have applied for patents that cover the unique technology integrated
into the PlugPlusInternet product suite. We also continue to identify, design
and develop enhancements to our core technologies that will provide additional
functionality, diversification of application and desirability for current and
future users of the PlugPlusInternet product suite.
In July 2001, we announced the completion of our initial product
development phase of the PlugPlusInternet product suite and, in August 2001, we
announced that successful system tests of the PlugPlusInternet product suite had
been performed.
In January 2002, we shifted our management emphasis from research and
development to sales and marketing of the PlugPlusInternet product suite.
In November 2002, we successfully installed a PlugPlusInternet system
at the historic Partridge Inn in Augusta, Georgia. The installation provided
high-speed Internet connectivity to guest rooms, meeting rooms and a lobby
kiosk. In December 2002, we conducted a product field trial at the Marriott
Residence Inn-Landfall in Wilmington, NC. As part of this trial, we implemented
a hotel-wide PlugPlusInternet system that provided connectivity to the hotel's
90 guest rooms, meeting rooms, common areas and a lobby kiosk.
In January 2003, we received Federal Communications Commission (FCC)
approval to market the PlugPlusInternet product suite. FCC rules permit the
operation of unlicensed digital devices that radiate radio frequency emissions,
provided that the manufacturer complies with certain equipment authorization
procedures, technical requirements, marketing restrictions and product labeling
requirements. An independent, FCC-certified testing lab has verified that our
PlugPlusInternet Gateway complies with the FCC technical requirements for Class
A and Class B digital devices. No further testing of this device is required and
the device may be manufactured and marketed for commercial and residential use.
In March 2003, we entered into a Strategic Alliance Agreement with
Choice Hotels International (NYSE: CHH), one of the largest hotel franchise
companies in the world with more than 3,500 hotels, inns, all-suite hotels and
resorts open and under development in 46 countries under the Comfort Inn,
Comfort Suites, Quality, Clarion, Sleep Inn, Rodeway Inn, EconoLodge and
MainStay Suites brand names. The agreement has an initial term of two years,
pursuant to which we will become a Choice Hotels-endorsed vendor offering the
PlugPlusInternet product suite to Choice Hotels' U.S. franchisees. Choice Hotel
franchisees that participate in our "Early Adopter Program" will receive a
discount on installation and maintenance of the PlugPlusInternet product suite.
We are a member of the HomePlug(R) Powerline Alliance, an industry
trade group that engages in marketing and educational initiatives, and sets
standards and specifications for products, in the powerline communications
industry.
Telkonet is a Utah corporation with its principal executive offices at
902-A Commerce Road, Annapolis, Maryland 21401. Our telephone number is (410)
897-5900.
14
COMPETITION
The market for powerline communications is highly competitive. Although
we are presently the only company marketing PLC products to the commercial
segment, Linksys Group, Inc. (recently acquired by Cisco Systems) and Netgear,
Inc. offer similar PLC solutions for the residential market. There can be no
assurance that Linksys Group, Netgear or any other company will not develop PLC
products that compete with our products in the future. These potential
competitors have longer operating histories, greater name recognition and
substantially greater financial, technical, sales, marketing and other
resources. These potential competitors may, among other things, undertake more
extensive marketing campaigns, adopt more aggressive pricing policies, obtain
more favorable pricing from suppliers and manufacturers and exert more influence
on the sales channel than we can. As a result, we may not be able to compete
successfully with these potential competitors and these potential competitors
may develop or market technologies and products that are more widely accepted
than those being developed by us or that would render our products obsolete or
noncompetitive.
We anticipate that potential competitors will also intensify their
efforts to penetrate our target markets. These potential competitors may have
more advanced technologies, more extensive distribution channels, stronger brand
names, bigger promotional budgets and larger customer bases than we do. These
companies could devote more capital resources to develop, manufacture and market
competing products than we could.
RAW MATERIALS
We have not experienced any significant or unusual problems in the
purchase of raw materials or commodities. While we are dependent, in certain
situations, on a limited number of vendors to provide certain raw materials and
components, we have not experienced significant problems or issues procuring any
essential materials, parts or components. We obtain the majority of our raw
materials from the following suppliers: Arrow Electronics, Inc., Avnet
Electronics Marketing, Digi-Key Corporation, Intellon Corporation and Superior
Manufacturing Services.
PATENTS AND TRADEMARKS
We have various patents pending which we consider in the aggregate to
constitute a valuable asset. These pending patents cover various technologies
incorporated to our PlugPlusInternet product suite, including components
enabling the use of electric utility power lines as a telephonic communications
carrier network. We believe several of our pending patents offer us a
significant competitive advantage. We are not presently a party to any license
agreements.
MANUFACTURING AND INSTALLATION METHODS
Telkonet sources its own raw material components and utilizes contract
manufacturers for assembly and testing of its products. Our finished product is
distributed directly from Telkonet to the customer. On July 23, 2003, Telkonet
executed an agreement with CompuCom Systems, Inc. pursuant to which CompuCom has
agreed to provide installation and customer support services for the
PlugPlusInternet product suite. Telkonet is not presently a party to any third
party distribution agreement.
RESEARCH AND DEVELOPMENT
During the six months ended June 30, 2003 and for the year ended
December 31, 2002, we spent $597,550 and $280,450, respectively, on research and
development activities relating to the development of new products or
improvements of existing products. We spent $120,828 in 2001 (as restated) and
$119,000 in 2000 on research and development activities.
15
MAJOR CUSTOMERS
Telkonet has just emerged from its development stage and, as of the
date of this prospectus, has not had significant sales of its products or
services.
ENVIRONMENTAL MATTERS
We do not anticipate any material effect on our capital expenditures,
earnings or competitive position due to compliance with government regulations
involving environmental matters.
SEASONALITY
We do not consider our business to be seasonal.
EMPLOYEES
As of June 30, 2003, we had 17 full time employees. The hiring of
additional key staff is planned in the areas of business development, sales and
marketing, engineering and support. We believe our relations with our employees
are good.
GOVERNMENT REGULATION
We are subject to regulation in the United States by the Federal
Communications Commission (FCC). We are also may be subject to regulation by
government entities in other countries.
UNITED STATES REGULATION
FCC rules permit the operation of unlicensed digital devices that
radiate radio frequency emissions if the manufacturer complies with certain
equipment authorization procedures, technical requirements, marketing
restrictions and product labeling requirements. Differing technical requirements
apply to "Class A" devices intended for use in commercial settings and more
stringent standards apply to "Class B" devices intended for residential use. An
independent, FCC-certified testing lab has verified that our PlugPlusInternet
Gateways comply with the FCC technical requirements for Class A and Class B
digital devices. No further testing of these devices is required and the devices
may be manufactured and marketed for commercial and residential use. Additional
devices designed by us for commercial and residential use will be subject to the
FCC rules for unlicensed digital devices. Moreover, if in the future, the FCC
changes its technical requirements for unlicensed digital devices, further
testing and/or modifications of devices may be necessary.
REGULATION ABROAD
Our products will be subject to compliance with applicable regulatory
requirements in those foreign countries where our products are sold.
PROPERTY
We currently lease approximately 3,000 square feet office space at 902A
Commerce Drive, Annapolis, Maryland 21401, where we maintain our principal
business office.
16
We consider this property to be suitable and adequate for its present
purposes, well maintained and in good operating condition.
LEGAL PROCEEDINGS
In March 2003, Jenson Services, Inc. and James P. Doolin filed an
action against Telkonet in the Third Judicial District Court in and for Salt
Lake County, State of Utah. The action sets forth various counts all based on
allegations that Telkonet, through its agents, promised to undertake a
registration of certain shares of Telkonet common stock owned by plaintiffs. The
action seeks damages from Telkonet in unspecified amounts. Telkonet believes
that plaintiffs' claims are without merit and that Telkonet has meritorious
defenses to such claims. Telkonet intends to vigorously defend itself against
the plaintiffs' claims in their entirety.
MARKET PRICE OF AND DIVIDENDS ON OUR COMMON STOCK AND
RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the OTC Bulletin Board (OTCBB) under the
symbol "TLKO.OB." The following table shows the high and low sales prices for
our common stock as quoted on the OTCBB for the periods indicated. On August 22,
2003, the last reported sale price of our common stock was $2.70. As of August
22, 2003, there were 24,011,065 shares of our common stock issued and
outstanding.
HIGH LOW
---- ---
YEAR ENDED DECEMBER 31, 2003
First Quarter ........................... $ 1.33 $ 1.18
Second Quarter .......................... $ 2.67 $ 2.43
YEAR ENDED DECEMBER 31, 2002
First Quarter ........................... $ 0.87 $ 0.87
Second Quarter .......................... $ 1.53 $ 1.40
Third Quarter ........................... $ 1.08 $ 0.98
Fourth Quarter .......................... $ 0.62 $ 0.56
YEAR ENDED DECEMBER 31, 2001
First Quarter ........................... $ 1.98 $ 1.98
Second Quarter .......................... $ 1.06 $ 1.00
Third Quarter ........................... $ 0.84 $ 0.83
Fourth Quarter .......................... $ 0.95 $ 0.95
YEAR ENDED DECEMBER 31, 2000
Third Quarter ........................... $ 1.74 $ 1.29
Fourth Quarter .......................... $ 4.08 $ 3.54
We have never paid dividends on our common stock and do not anticipate
paying dividends in the foreseeable future.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
During our two most recent fiscal years and the subsequent interim
periods, no independent accountant that was previously engaged as the principal
accountant to audit our financial statements resigned, indicated that it
declined to stand for re-election or was dismissed by us.
17
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are presently engaging in marketing our products in Canada and
contemplate future sales in various regions of the world. In connection with
these foreign marketing and sales activities, we may export to and import from
other countries. Our operations may, therefore, be subject to volatility because
of currency fluctuations, inflation and changes in political and economic
conditions in these countries. Sales and expenses may be denominated in local
currencies and may be affected as currency fluctuations affect our product
prices and operating costs or those of our competitors.
We presently do not use any derivative financial instruments to hedge
our exposure to adverse fluctuations in interest rates, foreign exchange rates,
fluctuations in commodity prices or other market risks, nor do we invest in
speculative financial instruments.
Due to the nature of our borrowings, we have concluded that there is no
material market risk exposure and, therefore, no quantitative tabular
disclosures are required.
EXECUTIVE OFFICERS AND DIRECTORS
GENERAL
The following table furnishes the information concerning Telkonet's
executive officers and directors as of June 30, 2003:
Name Age Title
---- --- -----
Ronald W. Pickett 55 President & Director
Stephen Sadle 56 Chief Operating Officer & Director
E. Barry Smith 52 Chief Financial Officer
James Landry 49 Vice President, Engineering
Robert P. Crabb 55 Secretary
Warren V. Musser 76 Chairman of the Board
A. Hugo DeCesaris 44 Director
David W. Grimes 65 Director
RONALD W. PICKETT, President and Director, fostered the development of
Telkonet since 1999 as Telkonet's principal investor and co-founder. He also was
the founder, and for twenty years served as Chairman of the Board of Directors
and President, of Medical Advisory Systems, Inc., which is now named Digital
Angel Corporation (AMEX: "DOC"). A graduate of Gordon College, Mr. Pickett has
engaged in various entrepreneurial activities for 35 years.
STEPHEN L. SADLE, Director and Chief Operating Officer, is a co-founder
of Telkonet. From 1970 to 1986 Mr. Sadle was president of a successful
infrastructure construction and development company in the Washington, D.C.
metro area. From 1986 to 1999, he was Vice President of Business Development and
Sales for The Driggs Corporation, a major heavy and infrastructure firm
interfacing with both government and the private sectors. From 1999 to 2000, Mr.
Sadle was Vice President and General Sales Manager of Internos, a provider of
web-based vertical intranet applications, and developed operating extranets in
the transportation and construction industries.
18
E. BARRY SMITH, Chief Financial Officer, is a CPA and senior financial
executive with diversified experience in both public and private companies. Mr.
Smith's background includes big-four public accounting experience with the firm
of Deloitte & Touche, Senior Financial Partner with over 15 years executive
management experience with Safeguard Scientifics, Inc. and their partner
companies including: ThinAirApps, Inc. (Wireless Application Provider-sold to
Palm, Inc.) and Tangram Enterprise Solutions (Software/Hardware for PC/LAN
Mainframe Connectivity and Enterprise Software Management). Mr. Smith's
experience also includes, Vice President of Finance & Administration for US Golf
Management (Public/Private Golf Course & Restaurant Management), Vice President
of Finance for International Communications Research (Market Research & Database
Services) and Treasurer for The Chilton Company (Publishing).
JAMES LANDRY, Vice President, Engineering, has over 18 years experience
in developing communications hardware for the enterprise/carrier market with
3Com, US Robotics, Penril Datacomm and Data General. While at 3Com/US Robotics,
he was singularly responsible for the development of the xDSL product line as
well as a number of modems and interface cards. At Penril, he served as the
product development leader for the Series 1544 multiplexer/channel bank and at
Data General he was technical leader of system integration for ISDN WAN. Mr.
Landry brings a wealth of practical design leadership and a solid history of
delivering products to the marketplace. He holds four United States patents.
ROBERT P. CRABB, Secretary, has over 35 years of sales, marketing and
corporate management experience, including a career in sales and management with
the Metropolitan Life Insurance Company. His entrepreneurial expertise also
includes public company administration, financial consulting and
commercial/residential real estate development. Mr. Crabb oversees Telkonet's
public company administration and corporate governance, is a former Director of
Telkonet and has been involved with Telkonet since 1999.
WARREN V. MUSSER, Chairman of the Board of Directors, has had extensive
experience with public companies during his distinguished and successful career
as an entrepreneur. A partial list of his accomplishments includes: Chairman
Emeritus, Safeguard Scientifics, Inc. (formerly Safeguard Industries, Inc.),
Chairman of the Board and Chief Executive Officer, Safeguard Scientifics, Inc.,
Founder, Chairman of the Board and President, Lancaster Corporation (became
Safeguard Industries, Inc.), Founder & President, Musser and Company, Inc.
(Investment Banking Firm). In addition, Mr. Musser is a Director of CompuCom
Systems, Inc. and Internet Capital Group, Inc., Vice Chairman of Nutri/System,
Inc. and Eastern Technology Council and Chairman of Economics, PA. He also
serves as the Vice President/Development, Cradle of Liberty Council of the Boy
Scouts of America.
A. HUGO DECESARIS, Director, has over 25 years experience in the
homebuilding industry with Washington Homes, Inc., where he served as Vice
President and a member of the Board of Directors. In January of 2001, Washington
Homes, Inc. became a wholly-owned subsidiary of K. Hovnanian Enterprises, Inc.
and is now one of the top ten homebuilders in the nation. Mr. DeCesaris is
currently the Regional Vice President for the Maryland Division of Washington
Homes, Inc., President and owner of Southern Maryland's largest Marina and a
member of the Board of Directors of MNCBIA Volume Builders Council.
DAVID W. GRIMES, Director, is a co-founder of Telkonet. From 1963 to
1982, Mr. Grimes was a senior executive with NASA, heading the $200 million per
year Delta Program. He also was founder, and from 1982 to 1989 served as Chief
Executive Officer, of Transpace Carriers Inc., a venture to commercialize the
Delta launch vehicle. From 1989 to 1992, he was the Engineering Division
19
Director at EER Inc., with supervisory responsibility for more than 100
engineers and technicians on electrical mechanical and thermal tasks for Goddard
Space Flight Center. From 1992 to 1999, Mr. Grimes served as Chief Engineer for
Final Analysis, Inc. and led the design and development of the Low Earth Orbit
constellation of 38 satellites for use in global store and forward
communications. Mr. Grimes is a recognized expert in space and ground
communications systems.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth information concerning the annual and
long-term compensation for services in all capacities to Telkonet for the fiscal
year ended December 31, 2002 for each of the three highest paid persons who are
officers or directors of Telkonet.
NAME AND BASE OTHER ANNUAL
PRINCIPAL POSITION YEAR SALARY($) BONUS ($) COMPENSATION($)
------------------ ---- --------- --------- ---------------
2000 $ 76,747 $ 0 $ 0
Peter Larson (1) 2001 $ 160,484 $ 0 $ 0
Chief Executive Officer 2002 $ 4,000 $ 0 $ 0
2000 $ 0 $ 0 $ 0
J. Gregory Fowler (2) 2001 $ 0 $ 0 $ 0
Chief Executive Officer 2002 $ 114,000 $ 0 $ 0
2000 $ 0 $ 0 $ 0
David S. Yaney (3) 2001 $ 0 $ 0 $ 0
Chief Technology Officer 2002 $ 73,000 $ 0 $ 0
2000 $ 0 $ 0 $ 0
James Landry 2001 $ 29,000 $ 0 $ 0
Vice President, Engineering 2002 $ 116,000 $ 0 $ 0
2000 $ 78,270 $ 0 $ 0
Stephen L. Sadle 2001 $ 160,484 $ 0 $ 0
Chief Operating Officer 2002 $ 130,000 $ 0 $ 0
(1) Mr. Larson resigned as Chief Executive Officer of Telkonet on January
12, 2002.
(2) On January 30, 2002, Mr. Fowler was appointed Chief Executive Officer
of Telkonet. Mr. Fowler resigned as Chief Executive Officer of Telkonet
on December 12, 2002.
(3) Dr. Yaney was appointed Chief Technology Officer of Telkonet on
February 15, 2002. Dr. Yaney resigned as Chief Technology Officer of
Telkonet on September 3, 2002.
20
OPTION/SAR GRANTS
The following table sets forth information concerning stock options
granted in the fiscal year ended December 31, 2002, to the persons listed on the
Summary Compensation Table.
PERCENT OF TOTAL
NUMBER OF SECURITIES OPTIONS/SARS GRANTED EXERCISE OF
UNDERLYING TO EMPLOYEE IN BASE PRICE EXPIRATION
NAME OPTIONS/SARS GRANTED FISCAL YEAR ($/SH) DATE
---- -------------------- ----------- ------ ----
Peter Larson 0 0 $ 0 0
J. Gregory Fowler 650,000 (1) 22.9% $ 1.00 1/29/2012
David S. Yaney 400,000 14.1% $ 1.00 2/15/2012
James Landry 100,000 3.5% $ 1.00 2/15/2012
Stephen L. Sadle 1,000,000 35.5% $ 1.00 1/12/2012
-----------------
(1) This includes 450,000 shares of our common stock subject to purchase
pursuant to options that were forfeited by Mr. Fowler upon his resignation on
December 12, 2002.
AGGREGATED OPTION/SAR EXERCISES
The following table summarizes information relating to stock option
exercises during the year ended December 31, 2002 by those persons listed on the
Summary Compensation Table.
AGGREGATE OPTION EXERCISES IN 2002 AND
OPTION VALUES AS OF DECEMBER 31, 2002
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED IN-THE-MONEY
UNEXERCISED OPTIONS AT OPTIONS AT
DECEMBER 31, 2002 DECEMBER 31, 2002 (1)
----------------- ------------------
SHARES
ACQUIRED
ON VALUE
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- -------- -------- ----------- ------------- ----------- -------------
Peter Larson 0 $ 0 0 0 $ 0 $ 0
J. Gregory Fowler 0 $ 0 200,000 0 $ 0 $ 0
David S. Yaney 0 $ 0 50,000 0 $ 0 $ 0
James Landry 0 $ 0 78,845 0 $ 0 $ 0
Stephen L. Sadle 1,000,000(2) $ 8,330 0 0 $ 0 $ 0
21
-----------------------
(1) Based on a stock price of $0.55, which was the average of the high
asked and low bid prices reported on December 31, 2002.
(2) Mr. Sadle sold 166,600 shares in a private sale in 2002 and returned
the remaining 833,400 shares to the Company as part of a
recapitalization. See, "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS"
on page 25 of this prospectus.
DIRECTORS' COMPENSATION
Telkonet reimburses directors for costs and expenses in connection with
their attendance and participation at Board of Directors meetings and for other
travel expenses incurred on Telkonet's behalf. Telkonet has the authority to
compensate each non-management director $250.00 for each meeting of the Board of
Directors. As of the date of this prospectus, no such payments have been made.
In January 2003, options to purchase the following number of shares
were granted to the following non-employee directors of Telkonet under the Stock
Incentive Plan: David Grimes (900,000 shares) and Warren Musser (2,000,000
shares). These options entitle the holder to purchase shares of Telkonet common
stock at $1.00 per share and vest ratably over twelve quarters beginning January
1, 2003. These options are not "incentive stock options" within the meaning of
Section 422 of the Internal Revenue Code of 1986. Approval of the grant of these
options will be submitted to Telkonet's stockholders at the 2003 annual meeting
of stockholders.
EMPLOYMENT AGREEMENTS
Peter Larson, former Chief Executive Officer, was employed pursuant to
an employment agreement for a three-year term that commenced June 19, 2000 and
provided for an annual salary of $130,000 and bonuses and benefits based upon
Telkonet's internal policies. Mr. Larson resigned from his employment on January
12, 2002.
Mr. Sadle, Chief Operating Officer, is employed pursuant to an
employment agreement for a three-year term that commenced June 19, 2000 and
provides for an annual salary of $130,000 and bonuses and benefits based upon
Telkonet's internal policies. On April 24, 2002, Mr. Sadle's employment
agreement was amended to, among other things, extend the term through December
31, 2004. On January 18, 2003, Telkonet and Mr. Sadle executed a new employment
agreement, the terms of which superceded the terms of the April 24, 2002 amended
employment agreement. The January 18, 2003 employment agreement has a term of
three years and provides for an annual salary of $130,000 and bonuses and
benefits based upon Telkonet's internal policies.
Mr. Fowler, former Chief Executive Officer, was employed pursuant to an
employment agreement for a three-year term that commenced January 30, 2002 and
provided for an annual salary of $130,000 and bonuses and benefits based upon
Telkonet's internal policies. Mr. Fowler resigned effective December 12, 2002.
22
David S. Yaney, former Chief Technology Officer, was employed pursuant
to an employment agreement for a three-year term that commenced February 15,
2002 and provided for an annual salary of $130,000 and bonuses and benefits
based upon Telkonet's internal policies. Dr. Yaney resigned effective September
3, 2002.
Mr. Landry, Vice President--Engineering, has been employed since
September 24, 2001 with an annual salary of $160,000 with bonuses and benefits
based upon Telkonet's internal policies.
Mr. Crabb, corporate secretary, is employed pursuant to an employment
agreement for a three year term that commenced January 18, 2003 and provides for
an annual salary of $120,000 and bonuses and benefits based upon Telkonet's
internal policies.
Mr. Pickett, President, is employed pursuant to an employment agreement
for an unspecified term that commenced January 30, 2003 and provides for an
annual salary $100,000, 3,000 shares of our common stock per month for each
month of his employment and bonuses and benefits based upon Telkonet's internal
policies.
Mr. Smith, Chief Financial Officer, is employed pursuant to an
employment agreement for a one-year term that commenced February 17, 2003 and
provides for an annual salary of $130,000 and bonuses and benefits based upon
Telkonet's internal policies.
Mr. Lubert, former Chief Executive Officer, was employed pursuant to an
employment agreement for a two-year term that commenced January 1, 2003 and
provided for an annual salary of $130,000 and bonuses and benefits based upon
Telkonet's internal policies. Mr. Lubert resigned effective June 16, 2003,
however, Telkonet has agreed to pay Mr. Lubert's salary through December 17,
2004.
In addition, under the Stock Incentive Plan, stock options are
periodically granted to employees at the discretion of the Board of Directors.
Executives of Telkonet are eligible to receive stock option grants, based upon
individual performance and the performance of Telkonet as a whole.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Telkonet presently does not have any committees of the Board of
Directors. However, on August 12, 2003 the Board of Directors voted unanimously
to expand our Board of Directors to seven. The Board of Directors is presently
considering candidates for appointment to these vacant board seats. We intend
that these new directors will be "independent" as such term is defined by Rule
4200(a)(14) of the Rules of the National Association of Securities Dealers. Once
appointed, each independent director will serve until the next annual meeting of
our stockholders and his successor is duly elected and qualified.
SECURITY OWNERSHIP OF MANAGEMENT
AND CERTAIN BENEFICIAL OWNERS
The following table sets forth, as of August 22, 2003, the number of
shares of Telkonet's common stock beneficially owned by each director and
executive officer of Telkonet, by all directors and executive officers as a
group, and by each person known by Telkonet to own beneficially more than 5.0%
of the outstanding common stock.
23
SHARES BENEFICIALLY
BENEFICIAL OWNER (1) OWNED PERCENT OF CLASS
---------------- ----- ----------------
Howard Lubert
435 Devon Park Drive
Building 500
Wayne, PA 19087 83,333 (2) 0.3%
E. Barry Smith
435 Devon Park Drive
Building 500
Wayne, PA 19087 87,501 (3) 0.4%
Stephen Sadle,
902-A Commerce Road
Annapolis, MD 21401 3,946,600 (4) 16.3%
James Landry
902-A Commerce Road
Annapolis, MD 21401 176,763 (5) 0.7%
Robert P. Crabb
902-A Commerce Road
Annapolis, MD 21401 641,331 (6) 2.6%
Warren V. Musser
435 Devon Park Drive
Building 500
Wayne, PA 19087 500,001 (7) 2.0%
Ronald W. Pickett
902-A Commerce Road
Annapolis, MD 21401 2,679,964 (8) 11.2%
David Grimes
902-A Commerce Road
Annapolis, MD 21401 1,523,000 (9) 6.3%
L. Peter Larson
902-A Commerce Road
Annapolis, MD 21401 2,505,285 (10) 10.0%
Hugo DeCesaris
902-A Commerce Road
Annapolis, MD 21401 1,375,000 (11) 5.5%
Jenson and Associates,
5525 South 900 East
Suite 110
Salt Lake City, Utah 84117 1,980,000 8.2%
All directors and executive
officers as a group 13,518,778 49.2%
--------------------
(1) Unless otherwise indicated, each person has sole power to vote and
dispose, or direct the disposition of, all shares of common stock
beneficially owned, subject to applicable community property and
similar laws.
(2) Includes immediately exercisable options to purchase 83,333 shares of
Telkonet common stock at $1.00 per share.
24
(3) Includes immediately exercisable options to purchase 58,334 shares of
Telkonet common stock at $1.00 per share.
(4) Includes immediately exercisable options to purchase 225,000 shares of
Telkonet common stock at $1.00 per share.
(5) Includes immediately exercisable options to purchase 176,763 shares of
Telkonet common stock at $1.00 per share.
(6) Includes immediately exercisable options to purchase 125,000 shares of
Telkonet common stock at $1.00 per share. Also includes 279,793 shares
of Telkonet common stock and immediately exercisable options to
purchase 236,538 shares of Telkonet common stock at $1.00 per share
owned by Susquehanna Development Company, LLC of which Mr. Crabb is the
managing member.
(7) Includes immediately exercisable options to purchase 500,001 shares of
Telkonet common stock at $1.00 per share.
(8) Includes 21,000 shares of our common stock subject to issuance pursuant
to Mr. Pickett's employment agreement.
(9) Includes immediately exercisable options to purchase 225,000 shares of
Telkonet common stock at $1.00 per share.
(10) Includes immediately exercisable options to purchase 1,000,000 shares
of Telkonet common stock at $1.00 per share.
(11) Includes an immediately exercisable warrant to purchase 815,000 shares
of Telkonet common stock at $0.50 per share.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
STOCK REPURCHASES
On January 12, 2002, the Board of Directors approved a plan authorizing
the repurchase of certain shares of, and options to purchase, Telkonet common
stock owned by Messrs. Grimes, Larson and Sadle. Each of Messrs. Grimes, Larson
and Sadle, at the time of the stock repurchase, owned in excess of five percent
of the issued and outstanding shares of Telkonet common stock and were directors
and executive officers of Telkonet.
As part of the stock repurchase, Mr. Grimes surrendered 3,721,918
shares of Telkonet common stock and options to purchase 160,000 shares of
Telkonet common stock owned by him. In consideration of the surrender of these
shares and options, Telkonet retained Mr. Grimes as a consultant for a period of
three years and issued to Mr. Grimes fully vested options to purchase 1,000,000
shares of Telkonet common stock at fair market value on the date of exercise,
but not less than $1.00 per share. In addition, Mr. Grimes agreed that certain
shares of Telkonet common stock owned by him would be subject to a 36-month
lock-up agreement under which 50,000 shares would be released on each of
December 1, 2002 and December 1, 2003 and the remaining shares would be released
on January 1, 2005. On April 24, 2002, the terms of Mr. Grimes' lock-up
agreement were amended to permit the immediate release of 139,280 shares of
Telkonet common stock, the release of 50,000 shares of Telkonet common stock on
December 1, 2002, the release of 50,000 shares of Telkonet common stock on
December 1, 2003 and the release of the remaining Telkonet common stock on
January 1, 2005. The revised lock-up agreement also provided for the release of
common stock in proportion to the number of options to purchase Telkonet common
stock exercised by Mr. Grimes from time to time during the term of the lock-up
agreement. As of December 31, 2002, Mr. Grimes had exercised all of the options
issued to Mr. Grimes in the repurchase. Consequently, all of the shares subject
to Mr. Grimes' revised lock-up agreement were released as of December 31, 2002.
Mr. Larson surrendered 705,000 shares of Telkonet common stock and
options to purchase 200,000 shares of Telkonet common stock owned by him. In
consideration of the surrender of these shares and options, Telkonet retained
Mr. Larson as a consultant for a period of three years and issued to Mr. Larson
fully vested options to purchase 1,000,000 shares of Telkonet common stock at
fair market value on the date of exercise, but not less than $1.00 per share. In
addition, Mr. Larson agreed that certain shares of Telkonet common stock owned
25
by him would be subject to a 36-month lock-up agreement under which 50,000
shares would be released on each of December 1, 2002 and December 1, 2003 and
the remaining shares would be released on January 1, 2005. On April 24, 2002,
the terms of Mr. Larson's lock-up agreement were amended to permit the immediate
release of 139,280 shares of Telkonet common stock, the release of 50,000 shares
of Telkonet common stock on December 1, 2002, the release of 50,000 shares of
Telkonet common stock on December 1, 2003 and the release of the remaining
Telkonet common stock on January 1, 2005. The revised lock-up agreement also
provides for the release of common stock in proportion to the number of options
to purchase Telkonet common stock exercised by Mr. Larson from time to time
during the term of the lock-up agreement.
Mr. Sadle surrendered 2,147,694 shares of Telkonet common stock and
options to purchase 200,000 shares of Telkonet common stock owned by him. In
consideration of the surrender of these shares and options, the Board of
Directors granted Mr. Sadle options to purchase 1,000,000 shares of Telkonet
common stock at fair market value on the date of exercise, but not less than
$1.00 per share. In addition, Mr. Sadle agreed that certain shares of Telkonet
common stock owned by him would be subject to a 36-month lock-up agreement under
which 50,000 shares would be released on each of December 1, 2002 and December
1, 2003 and the remaining shares would be released on January 1, 2005. On April
24, 2002, the terms of Mr. Sadle's lock-up agreement were amended to permit the
immediate release of 139,280 shares of Telkonet common stock, the release of
50,000 shares of Telkonet common stock on December 1, 2002, the release of
50,000 shares of Telkonet common stock on December 1, 2003 and the release of
the remaining Telkonet common stock on January 1, 2005. The revised lock-up
agreement also provides for the release of common stock in proportion to the
number of options to purchase Telkonet common stock exercised by Mr. Sadle from
time to time during the term of the lock-up agreement. As of December 31, 2002,
Mr. Sadle had exercised all of the options issued to Mr. Sadle in the
repurchase. Consequently, all of the shares subject to Mr. Sadle's revised
lock-up agreement were released as of December 31, 2002.
Mr. Sadle's employment agreement was also amended to include a
provision by which Mr. Sadle would be required to forfeit shares of Telkonet
common stock owned by him, up to an aggregate of 1,500,000 shares of common
stock, in the event he voluntarily terminated his employment prior to the end of
its 36-month term. Pursuant to the amended employment agreement, Mr. Sadle was
required to forfeit 40,000 shares for each month following the month in which he
resigned until the expiration of the amended employment agreement. The amended
employment agreement also extended the term of Mr. Sadle's employment until
December 31, 2004. On January 30, 2003, the Board of Directors approved an
amendment to Mr. Sadle's employment agreement that permits the release of the
1,500,000 shares of common stock subject to forfeiture upon Mr. Sadle's
resignation in proportion to the number of options to purchase Telkonet common
stock exercised by Mr. Sadle from time to time during the term of the employment
agreement. As of December 31, 2002, Mr. Sadle had exercised all of the options
issued to Mr. Sadle in the repurchase. Consequently, all of the shares subject
to forfeiture pursuant to Mr. Sadle's revised employment agreement were released
from such forfeiture restriction as of January 30, 2003.
PERSONAL GUARANTY BY A DIRECTOR OF TELKONET
On March 9, 2001, we issued A. Hugo DeCesaris, a Telkonet director and
stockholder owning in excess of 5.0% of Telkonet's issued and outstanding common
stock, a warrant to purchase 1,000,000 shares of our common stock at $0.50 per
share as consideration for his personal guaranty of Telkonet's $250,000 line of
credit with First Mariner Bank.
LOANS BY OFFICERS AND SIGNIFICANT STOCKHOLDERS
In 2001 and 2002, Ronald W. Pickett and Stephen Sadle, each of whom is
a director and officer of Telkonet and owns in excess of 5.0% of the issued
outstanding Telkonet common stock, loaned $200,000 and $4,830, respectively, to
Telkonet for working capital purposes. At the time of such loans, no formal
repayment terms or arrangements were agreed to by the parties. On December 30,
2002, the aggregate remaining principal balance owed by Telkonet to Mr. Pickett
was forgiven in exchange for Telkonet Series B Debentures. On January 31, 2003,
the aggregate principal balance owed by Telkonet to Mr. Sadle was repaid in
full, without interest.
26
On June 1, 2001, Hugo DeCesaris, a director of Telkonet and a
stockholder owning in excess of 5.0% of Telkonet's issued and outstanding common
stock, loaned $7,500 to Telkonet for working capital purposes. At the time of
such loan, no formal repayment terms or arrangements were agreed to by the
parties. As of December 31, 2002, the aggregate remaining principal balance owed
by Telkonet to Mr. DeCesaris was $7,500.
PURCHASE OF CONVERTIBLE DEBENTURES
During the third quarter of 2001, Telkonet commenced an offering of up
to $1,689,100 principal amount of Series A Debentures. The Series A Debentures
each accrue interest at 8.0% per annum and mature three years from the date of
purchase. Each Series A Debenture is convertible at any time following the six
month anniversary of the date of issuance of such Series A Debenture into shares
of Telkonet common stock at a conversion price equal to $0.50 per share for each
$10,000 principal amount plus interest of the Series A Debenture converted. In
connection with the placement of the Series A Debentures, Telkonet issued
non-detachable warrants granting holders the right to acquire 1,689,100 share of
our common stock at $1.00 per share.
During the fourth quarter of 2002, Telkonet commenced an offering of up
to $2,500,000 principal amount of Series B Debentures. The Series B Debentures
each accrue interest at 8.0% per annum and mature three years from the date of
purchase. Each Series B Debenture is convertible at any time following the six
month anniversary of the date of issuance of such Series B Debenture into shares
of Telkonet common stock at a conversion price equal to $0.55 per share for each
$10,000 principal amount plus interest of the Series B Debenture converted. In
connection with the placement of the Series B Debentures, Telkonet issued
non-detachable warrants granting holders the right to acquire 2,500,000 shares
of our common stock at $1.00 per share.
As of March 26, 2003, Telkonet sold Series A and Series B Debentures
having an aggregate principal value of $4,189,100, of which $824,000 was
attributable to sales to the following Telkonet directors, officers and 5.0%
shareholders, and members of their immediate family:
NAME PURCHASE PRICE
---- --------------
Stephen L. Sadle $ 65,000
David Grimes $ 65,000
Hugo DeCesaris $ 42,000 (1)
Ronald W. Pickett $ 200,000
E. Barry Smith $ 20,000
Howard E. Lubert $ 100,000
Robert P. Crabb $ 7,000
Warren V. Musser $ 325,000 (2)
-----------------
(1) Includes Series A Debentures having an aggregate principal
value of $20,000 and Series B Debentures having an aggregate
principal value of $22,000 purchased by a members of Mr.
DeCesaris' immediate family.
(2) Includes Series B Debentures having an aggregate principal
value of $25,000 purchased by Mr. Musser's wife, and Series B
Debentures having an aggregate principal value of $200,000
purchased by The Musser Foundation, of which Mr. Musser is
the founder.
27
ARRANGEMENT WITH A DIRECTOR AND EXECUTIVE OFFICER
On January 29, 2002, we granted Susquehanna Development, LLC options to
purchase 300,000 shares of our common stock at $1.00 per share as consideration
for certain business services provided by Susquehanna Development. Robert P.
Crabb, our corporate secretary, is the managing member of Susquehanna
Development.
In January, 2003, we entered into an oral agreement with Warren V.
Musser, Chairman of our Board of Directors, pursuant to which we agreed
to pay Mr. Musser a commission equal to 8.0% of the aggregate value of Series B
Debentures purchased by persons referred to Telkonet by Mr. Musser. Pursuant to
this agreement, Mr. Musser received $8,000.
In January, 2003, we entered into an oral agreement with Howard Lubert,
Telkonet's former Chief Executive Officer, pursuant to which we agreed to pay
Mr. Lubert a commission equal to 8.0% of the aggregate value of Series B
Debentures purchased by persons referred to Telkonet by Mr. Lubert. Pursuant to
this agreement, Mr. Lubert received $12,000.
USE OF PROCEEDS
All net proceeds from the sale of our common stock will go to the
selling stockholders selling common stock under this prospectus. We will not
receive any proceeds from the sale of the common stock sold by the selling
stockholders. The proceeds Telkonet receives from the exercise of warrants, the
underlying shares of our common stock of which are included in this prospectus,
will be used to expand sales and marketing efforts, support strategic
partnership programs, build required infrastructure and fund working capital
requirements.
SELLING STOCKHOLDERS
During the third quarter of 2001, we commenced an offering of up to
$1,689,100 principal amount of Series A Debentures. The Series A Debentures each
accrue interest at 8.0% per annum and mature three years from the date of
purchase. Each Series A Debenture is convertible at any time following the six
month anniversary of the date of issuance of such Series A Debenture into shares
of Telkonet common stock at a conversion price equal to $0.50 per share for each
$10,000 principal amount plus interest of the Series A Debenture converted. In
connection with the placement of the Series A Debentures, Telkonet issued
non-detachable warrants granting holders the right to acquire 1,689,100 share of
our common stock at $1.00 per share. As of May 23, 2002, the Series A Debenture
offering was fully subscribed.
During the fourth quarter of 2002, we commenced an offering of up to
$2,500,000 principal amount of Series B Debentures. The Series B Debentures each
accrue interest at 8.0% per annum and mature three years from the date of
purchase. Each Series B Debenture is convertible at any time following the six
month anniversary of the date of issuance of such Series B Debenture into shares
of our common stock at a conversion price equal to $0.55 per share for each
$10,000 principal amount plus interest of the Series B Debenture converted. In
connection with the placement of the Series B Debentures, we also issued
non-detachable warrants granting holders the right to acquire 2,500,000 shares
of our common stock at $1.00 per share. As of February 14, 2003, the Series B
Debenture offering was fully subscribed.
During the second quarter of 2003, we commenced an offering of up to
$5,000,000 principal amount of Senior Notes. The Senior Notes each accrue
interest at 8.0% per annum, mature three years from the date of purchase and are
secured by a first priority security interest in all of the intellectual
property assets of Telkonet. In connection with the placement of the Senior
Notes, we also issued non-detachable warrants granting holders the right to
acquire 6,250,000 shares of our common stock at $1.00 per share. As of June 26,
2003, the Senior Note offering was fully subscribed.
28
The shares of our common stock covered by this prospectus include
shares of common stock acquired by the selling stockholders pursuant to the
conversion of the Series A and Series B Debentures (including outstanding
principal and accrued interest) and shares of our common stock that have been
issued or will be issued upon the exercise of warrants to purchase shares of our
common stock issued in the Series A and Series B Debenture offerings and the
Senior Note offering. The following table provides certain information regarding
the selling stockholders' beneficial ownership of our common stock prior to and
after the offering. Beneficial ownership is determined under the SEC's rules,
and generally includes voting or investment power with respect to securities.
NUMBER OF
NUMBER OF SHARES SHARES OWNED
OWNED PRIOR TO THE NUMBER OF SHARES BEING AFTER THE PERCENTAGE
SELLING STOCKHOLDER OFFERING OFFERED FOR SALE OFFERING (1) OF CLASS
=================================== ====================== ===================== ================= ===========
Cynthia S. Abshire 37,455 37,455 0 0%
Robert Abshire 16,027 16,027 0 0%
Michael G. and Maria Accattato 90,539 90,539 0 0%
F. Scott and Barbara Addis 57,455 57,455 0 0%
Steven Agnoff 68,013 68,013 0 0%
Burgess M. Allen, Jr. 43,914 43,914 0 0%
Henry Alperin 303,138 303,138 0 0%
Mark D. Anderson 10,055 10,055 0 0%
George Anthony 28,763 28,763 0 0%
Fred C. Applegate Trust 250,000 250,000 0 0%
Ozcan Ardan 16,194 16,194 0 0%
Wendel B. Ardrey 28,735 28,735 0 0%
Kerry Armbruster 144,227 144,227 0 0%
Tonya Armstrong 11,569 11,569 0 0%
Nancy P. Arnold 48,583 48,583 0 0%
Sonan L. Ashley 234,264 234,264 0 0%
Attkisson, Carter, and Akers,
Incorporated 677,788 677,788 0 0%
Augusta Cardiology Clinic 182,958 182,958 0 0%
John W. Baker 125,000 125,000 0 0%
Burton Barmore 12,389 12,389 0 0%
Bryan W. Baughman 22,672 22,672 0 0%
Matthew K. Beckstead 211,476 211,476 0 0%
Rod K. Beckstead 53,105 53,105 0 0%
Berkin Business S.A. 125,000 125,000 0 0%
Valerie Biskey 155,368 155,368 0 0%
Horace Blalock 174,673 174,673 0 0%
A. Boardman Oil Company 28,743 28,743 0 0%
J. Dickey Boardman, Jr. 7,185 7,185 0 0%
29
NUMBER OF
NUMBER OF SHARES SHARES OWNED
OWNED PRIOR TO THE NUMBER OF SHARES BEING AFTER THE PERCENTAGE
SELLING STOCKHOLDER OFFERING OFFERED FOR SALE OFFERING OF CLASS
=================================== ====================== ===================== ================= ===========
Robert L. Bower 63,966 63,966 0 0%
Barbara Sue Bramlett 32,389 32,389 0 0%
Jackie Brooks 222,891 222,891 0 0%
Barry S. Bryant 70,337 70,337 0 0%
Carolyn H. Byrd 125,000 125,000 0 0%
Patsy D. Clayton 14,381 14,381 0 0%
Lynn Claytor 125,000 125,000 0 0%
Robert Clemmens 14,397 14,397 0 0%
Bryan Coats 14,371 14,371 0 0%
Kathy Coleman 70,994 70,994 0 0%
I.R. Collier 19,233 19,233 0 0%
Edward A. Corley 189,778 189,778 0 0%
William D. Corley 128,902 128,902 0 0%
James Cosper 972 972 0 0%
Robert P. and Kriss Crabb 20,109 (2) 20,109 0 0%
John R. Cralle 61,232 61,232 0 0%
Tony and Johanna Currin 37,231 37,231 0 0%
John Daily 15,817 15,817 0 0%
Charles Daniel 178,180 178,180 0 0%
Anthony DeCesaris, Jr. 63,350 (3) 63,350 0 0%
Joseph A. and Donna M. DeCesaris 44,778 (4) 44,778 0 0%
Amy Dickson 10,055 10,055 0 0%
Milton O. Dickson, Sr. 10,055 10,055 0 0%
Tommy Duncan 239,910 239,910 0 0%
Barry Dunn 169,108 169,108 0 0%
William A. Dunn, Jr. 211,887 211,887 0 0%
J. Martin Echols 355,475 355,475 0 0%
Robert Edmond 109,138 109,138 0 0%
Verda C. Elrod 10,077 10,077 0 0%
EPM AG 125,000 125,000 0 0%
EPM Holdings AG 125,000 125,000 0 0%
Paul Facchina, Jr. 15,837 15,837 0 0%
D. Greer Falls 15,885 15,885 0 0%
Dorth G. Falls 28,850 28,850 0 0%
Frank A. Farnesi 31,250 31,250 0 0%
30
NUMBER OF
NUMBER OF SHARES SHARES OWNED
OWNED PRIOR TO THE NUMBER OF SHARES BEING AFTER THE PERCENTAGE
SELLING STOCKHOLDER OFFERING OFFERED FOR SALE OFFERING OF CLASS
=================================== ====================== ===================== ================= ===========
Edward J. Farrell 312,500 312,500 0 0%
Robert J. Ferrara 125,930 125,930 0 0%
First Mirage, Inc. 125,000 125,000 0 0%
First Montauk Securities Corp. 50,000 50,000 0 0%
Patsy A. Fisher 45,029 45,029 0 0%
H.E. and Paula Fowler 64,357 (5) 64,357 0 0%
Joseph A. and Cecelia A. Fowler 64,357 (6) 64,357 0 0%
J. Gregory and Sherry L. Fowler 31,976 (7) 31,976 0 0%
Kurt Friemann 125,000 125,000 0 0%
Donna Michelle Godwin Trust 15,817 15,817 0 0%
David W. and Suzanne Grimes 207,109 (8) 207,109 0 0%
Donnie W. Guy 70,246 70,246 0 0%
Thomas M. Hall 315,298 315,298 0 0%
Richard A. Hansen 312,500 312,500 0 0%
Franklin D. Hart, Jr. 96,521 96,521 0 0%
The Hart Organization Corp. 62,500 62,500 0 0%
James A. Hendrickson 302,410 302,410 0 0%
Robert F. Heishman 60,450 60,450 0 0%
High Capital Funding, LLC 187,500 187,500 0 0%
James H. Hillis, Jr. 57,487 57,487 0 0%
Hitschler Enterprises, LLC 500,000 500,000 0 0%
Kevin J. Hoban 38,959 38,959 0 0%
Judith Hollington 45,817 45,817 0 0%
Larry Hollington 64,444 64,444 0 0%
A. Louis Hook, Jr. 32,389 32,389 0 0%
Kenneth S. Hudson 103,449 103,449 0 0%
Dale L. Hutchins 5,000 5,000 0 0%
Ronald Jacobson 14,491 14,491 0 0%
Faye S. Jennings 28,727 28,727 0 0%
Joseph L. and Karen L. Johnson, III 32,231 32,231 0 0%
David E. Jones 4,329 4,329 0 0%
Glen E. Jones 25,000 25,000 0 0%
J. Pope and Gail W. Jones 18,467 18,467 0 0%
John Pope Jones 7,478 7,478 0 0%
David Jordon 316,093 316,093 0 0%
31
NUMBER OF
NUMBER OF SHARES SHARES OWNED
OWNED PRIOR TO THE NUMBER OF SHARES BEING AFTER THE PERCENTAGE
SELLING STOCKHOLDER OFFERING OFFERED FOR SALE OFFERING OF CLASS
=================================== ====================== ===================== ================= ===========
Richard L. Keller 16,194 16,194 0 0%
James R. Kelley 60,872 60,872 0 0%
Nancy Kines 64,778 64,778 0 0%
Michael Kingoff 5,000 5,000 0 0%
Richard Knight, Sr. 14,405 14,405 0 0%
Richard L. Kunkle 21,572 21,572 0 0%
Langtry Trust Group 125,000 125,000 0 0%
P. David and Jennifer Leinwand 5,000 5,000 0 0%
Joanne Leonard 8,277 8,277 0 0%
Tom Leonard 73,097 73,097 0 0%
James T. Lewis 161,945 161,945 0 0%
Ronald and Brenda Boyette Lindquist 29,154 29,154 0 0%
Dianne H. Lollis 15,800 15,800 0 0%
Hoyt G. Louder 250,000 250,000 0 0%
Howard and Barbara Lubert 287,357 (9) 287,357 0 0%
Earl Marshall 57,671 57,671 0 0%
Phillip R. Mason 229,208 229,208 0 0%
Joseph H. May 22,893 22,893 0 0%
Alice McCoy 34,200 34,200 0 0%
J. Lavern McCullough 48,583 48,583 0 0%
Cynthia L. McDonald 171,319 171,319 0 0%
Daniel McGinnis 62,500 62,500 0 0%
M. Dixon McKay 339,098 339,098 0 0%
Charles McPherson 15,837 15,837 0 0%
Meadow Ventures 103,939 103,939 0 0%
Eugenia Medlock 197,713 197,713 0 0%
Claire Merica 15,817 15,817 0 0%
Jan O. and Janice M. Miller 15,846 15,846 0 0%
Lawrence W. and Crystal D. Moeller 32,178 32,178 0 0%
Robert A and Cathleen Parlett Moeller 38,614 38,614 0 0%
Maria Molinsky 31,250 31,250 0 0%
Louis Mulherin, Jr. 254,436 254,436 0 0%
Julian I. Murphy 28,743 28,743 0 0%
Hilary Musser 71,819 (10) 71,819 0 0%
Peter Musser, Jr. 824,555 (11) 824,555 0 0%
32
NUMBER OF
NUMBER OF SHARES SHARES OWNED
OWNED PRIOR TO THE NUMBER OF SHARES BEING AFTER THE PERCENTAGE
SELLING STOCKHOLDER OFFERING OFFERED FOR SALE OFFERING OF CLASS
=================================== ====================== ===================== ================= ===========
The Musser Foundation 60,004 (12) 60,004 0 0%
Eric Newquist 15,817 15,817 0 0%
Patrick L. O'Donnell 24,479 24,479 0 0%
John G. and Nancy Lee Page 71,105 71,105 0 0%
John Parlett, Jr. 28,727 (13) 28,727 0 0%
W. Timothy Parlett 5,000 (14) 5,000 0 0%
William Parlett 28,731 (15) 28,731 0 0%
Pasquale Patrizio 12,500 12,500 0 0%
Walter M. and Susan R. Patterson, III 28,763 28,763 0 0%
Selena Peregoy 15,817 15,817 0 0%
Brian K. Phelan 287,915 287,915 0 0%
Jana S. Pine 110,085 110,085 0 0%
Ted A. Poore 34,774 34,774 0 0%
Randall Redmond 14,395 14,395 0 0%
Kenneth J. Remington 48,583 48,583 0 0%
Gerry Rhodes 28,791 28,791 0 0%
Caroline T. Richardson 241,164 241,164 0 0%
Furman Terry Richardson 8,621 8,621 0 0%
Pamela K. Richardson 2,866 2,866 0 0%
Michael C. and Pamela Rogers 60,529 60,529 0 0%
Collin and Susan P. Royster 57,514 57,514 0 0%
Stephen L. and Barbara J. Sadle 207,109 (16) 207,109 0 0%
Dawn Saggus 48,583 48,583 0 0%
Clayton Reed Shop 41,938 41,938 0 0%
Kenneth D. Simpson 126,945 126,945 0 0%
Kimberly Sligh 97,076 97,076 0 0%
E. Barry and Donna Smith 1,107 (17) 1,107 0 0%
William A. Smith 64,778 64,778 0 0%
Scott Stolz 15,846 15,846 0 0%
H. Swain 86,947 86,947 0 0%
James J. and Diane J. Swiggard 1,091 1,091 0 0%
Ronald K. Taylor 40,000 40,000 0 0%
Thomas D. Thompson 84,011 84,011 0 0%
John W. Thurmound, III 28,727 28,727 0 0%
John and Robin Tinney 10,000 10,000 0 0%
33
NUMBER OF
NUMBER OF SHARES SHARES OWNED
OWNED PRIOR TO THE NUMBER OF SHARES BEING AFTER THE PERCENTAGE
SELLING STOCKHOLDER OFFERING OFFERED FOR SALE OFFERING OF CLASS
=================================== ====================== ===================== ================= ===========
Phoebe Tuten 14,363 14,363 0 0%
Hilton E. Vaughn, Sr. 64,778 64,778 0 0%
John R. Velky 281,678 281,678 0 0%
David Ventresca 126,770 126,770 0 0%
Gerald Ventresca 15,817 15,817 0 0%
John Ventresca 93,540 93,540 0 0%
Ventresca Enterprises 72,029 72,029 0 0%
Gina Ventresca Trust 15,817 15,817 0 0%
VFinance Investments, Inc. 35,000 35,000 0 0%
Geraldine N. Videtto 58,300 58,300 0 0%
WEC Partners LLC 125,000 125,000 0 0%
Pamela Weinbach 143,977 143,977 0 0%
Jimmy Wilcher 46,325 46,325 0 0%
Regina Wilcher 6,374 6,374 0 0%
Laurie Wiley 64,868 64,868 0 0%
Jack Williams 110,122 110,122 0 0%
David L. and Katherine W. Wilson 37,226 37,226 0 0%
George M. Wilson 8,621 8,621 0 0%
Ken Wilson 28,867 28,867 0 0%
Dr. R. Warner Wood 114,974 114,974 0 0%
I. Camille Woodruff 22,672 22,672 0 0%
Alan and Rose Zimmer 57,527 57,527 0 0%
Monica Zimmerman 28,735 28,735 0 0%
--------------
(1) Assumes full conversion of the Series A and Series B Debentures
(including principal and interest), exercise of all warrants issued in
the Series A Debenture, Series B Debenture and Senior Note offerings
and the sale of these shares pursuant to this prospectus.
(2) Mr. Crabb is the corporate secretary and an employee of Telkonet.
(3) Mr. DeCesaris is an immediate family member of A. Hugo DeCesaris, a
director of Telkonet.
(4) Mr. and Mrs. DeCesaris are immediate family members of A. Hugo
DeCesaris, a director of Telkonet.
(5) Mr. and Mrs. Fowler are immediate family members of J. Gregory Fowler,
the former Chief Executive Officer of Telkonet.
(6) Mr. and Mrs. Fowler are immediate family members of J. Gregory Fowler,
the former Chief Executive Officer of Telkonet.
(7) Mr. Fowler is the former Chief Executive Officer of Telkonet. Mr.
Fowler resigned as Chief Executive Officer effective December 12, 2002.
(8) Mr. Grimes is a director and co-founder of Telkonet.
(9) Mr. Lubert is the former Chief Executive Officer of Telkonet. Mr.
Lubert resigned as Chief Executive Officer effective June 16, 2003.
(10 Ms. Musser is an immediate family member of Warren V. Musser, Chairman
of the Board of Directors of Telkonet.
(11) Mr. Musser is an immediate family member of Warren V. Musser, Chairman
of the Board of Directors of Telkonet.
34
(12) Mr. Musser, chairman of Telkonet's board of directors, is the founder
of the Musser Foundation.
(13) Mr. Parlett is an immediate family member of Ronald W. Pickett,
President, a director and co-founder of Telkonet.
(14) Mr. Parlett is an immediate family member of Ronald W. Pickett,
President, a director and co-founder of Telkonet.
(15) Mr. Parlett is an immediate family member of Ronald W. Pickett,
President, a director and co-founder of Telkonet.
(16) Mr. Sadle is the Chief Operating Officer, a director and co-founder of
Telkonet.
(17) Mr. Smith is the Chief Financial Officer Telkonet.
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction
with our financial statements and related notes included in this prospectus, the
information contained in the section entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and other financial
information appearing elsewhere in this prospectus.
We derived the following historical financial information from the
unaudited consolidated financial statements of Telkonet for the six months ended
June 30, 2003 and 2002 and the consolidated financial statements of Telkonet for
the year ended December 31, 2002, 2001 and 2000 which have been audited by
Russell Bedford Stefanou Mirchandani LLP. Russell Bedford Stefanou Mirchandani
LLP's report on our financial statements contained explanatory paragraphs
expressing substantial doubt about our ability to continue as a going concern.
The unaudited financial data as of and for the six months ended June
30, 2003 and 2002 include adjustments, all of which are normal recurring
adjustments, which our management considers necessary for the fair presentation
of our results for these unaudited periods. The results of operations for the
six months ended June 30, 2003 are not necessarily indicative of the results
that may be expected for the full year. Certain reclassifications have been made
to conform this data to the current presentation.
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE SIX MONTHS ENDED FOR THE YEARS ENDED
(Amounts in thousands, except per share data) JUNE 30, DECEMBER 31,
-------------------------------------------- ------------------------ ---------------------------------------
2003 2002 (AS 2002 2001 (AS 2000
--------- --------- --------- --------- ---------
RESTATED) RESTATED)
--------- ---------
STATEMENT OF OPERATIONS DATA:
Product revenue ............................ $ -- $ -- $ -- $ -- $ --
Service Revenue ............................ -- -- -- -- --
--------- --------- --------- --------- ---------
Total net revenue .......................... -- -- -- -- --
Cost of products sold ...................... -- -- -- -- --
Cost of services sold ...................... -- -- -- -- --
--------- --------- --------- --------- ---------
Gross profit ............................... -- -- -- -- --
Selling, general and administrative expenses 2,063 655 2,875 1,417 795
Management fees ............................ -- -- -- -- --
Research and development expenses .......... 598 602 280 121 119
Asset impairment charge .................... -- -- -- 39 --
Interest income ............................ -- -- -- -- --
Interest expense ........................... 799 218 626 141 16
Interest expense-others .................... -- -- -- -- --
Other income ............................... -- -- (3) (1) --
--------- --------- --------- --------- ---------
Provision for income taxes ................. -- -- -- -- --
--------- --------- --------- --------- ---------
Minority interest share of losses (income) . -- -- -- -- --
Net (loss) income .......................... $ (3,460) $ (1,475) $ (3,778) $ (1,717) $ (930)
========= ========= ========= ========= =========
Net (loss) income per common share-basic
and diluted ................................ $ (0.22) $ (0.09) $ (0.22) $ (0.08) $ (0.04)
========= ========= ========= ========= =========
Weighted average common shares
outstanding-basic .......................... 15,775 17,245 17,120 21,974 20,891
========= ========= ========= ========= =========
Weighted average common shares
outstanding-diluted.........................
========= ========= ========= ========= =========
35
(Amounts in thousands) JUNE 30, DECEMBER 31,
---------------------------------------------------- ----------- ----------------------------------------------------
2003 2002 2001 (AS 2000
---- ---- --------- ----
RESTATED)
---------
BALANCE SHEET DATA:
Cash and cash equivalents .......................... $ 4,581 $ 19 $ 22 $ 10
Property and equipment, net ........................ 107 38 27 67
Goodwill and other intangibles, net ................ -- -- -- --
Total assets ....................................... 5,430 295 236 82
Long-term debt and notes payable ................... 6,453 863 126 --
Total debt ......................................... 7,752 1,822 650 264
Minority interest .................................. -- -- -- --
Total stockholders' equity ......................... (2,322) (1,527) (414) (182)
FOR THE SIX MONTHS ENDED FOR THE YEARS ENDED
(Amounts in thousands) JUNE 30, DECEMBER 31,
-------------------------------------------------------------- --------------------------- ------------------------------------
2003 2002 (AS 2002 2001 (AS 2000
---- --------- ---- --------- ----
RESTATED) RESTATED)
--------- ---------
OTHER FINANCIAL DATA:
Depreciation and amortization ................................ $ 82 $ 71 $ 84 $ 31 $ 22
Net cash provided by (used in) operating activities .......... (2,420) (842) (2,070) (1,349) (660)
Net cash provided by (used in) investing activities .......... (29) (19) (18) (5) (89)
Net cash provided by financing activities .................... 7,011 982 2,086 1,366 759
Capital expenditures ......................................... 29 19 18 5 89
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142). SFAS
No. 142 requires that goodwill and certain intangibles no longer be amortized
but instead tested for impairment at least annually.
The following table presents the impact of SFAS No. 142 on our summary
financial data as indicated:
FOR THE YEARS ENDED
(Amounts in thousands, except per share data) DECEMBER 31,
-------------------------------------------------------------------- ------------------------
2001 (AS
--------
RESTATED) 2000
--------- ----
Net (loss) income:
Net (loss) income as reported ............................. $ (1,717) $ (930)
Goodwill amortization ..................................... -- --
Equity method investment amortization ..................... -- --
---------- ----------
Adjusted net (loss) income ......................................... $ (1,717) $ (930)
========== ==========
Basic and diluted (loss) income per share:
Net (loss) income per share, basic and diluted, as reported $ (0.08) $ (0.04)
Goodwill amortization ..................................... -- --
Equity method investment amortization ..................... -- --
---------- ----------
Adjusted (loss) income per share, basic and diluted ................ $ (0.08) $ (0.04)
========== ==========
36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE ACCOMPANYING
FINANCIAL STATEMENTS AND RELATED NOTES THERETO.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2002
Telkonet is commencing its transition from a development stage company
with its planned PlugPlus product suite launched during the second quarter of
2003. Telkonet may experience fluctuations in operating results in the future
due to a variety of factors including, but not limited to, market acceptance of
the Internet and power line communication technologies as a medium for customers
to purchase Telkonet's products, our ability to acquire and deliver high quality
products at a price lower than currently available to consumers, our ability to
obtain additional financing in a timely manner and on terms favorable to
Telkonet, our ability to successfully attract customers at a steady rate and
maintain customer satisfaction, promotions, branding and sales programs, the
amount and timing of operating costs and capital expenditures relating to the
expansion of Telkonet's business, operations and infrastructure and the
implementation of marketing programs, key agreements and strategic alliances,
the number of products offered the number of returns experienced, and general
economic conditions specific to the Internet, power-line communications, and the
communications industry.
REVENUES
To date, Telkonet has not generated any revenues as it was in the
development stage. Telkonet believes it will begin generating revenues from
operations within the next three to six months with the acceleration of its
sales and marketing efforts.
COSTS AND EXPENSES
From its inception on November 3, 1999 through June 30, 2003, Telkonet
has incurred operating expenses of $8,340,971. These expenses were associated
principally with compensation to employees, product development costs,
professional services and costs associated with non-employee stock options.
Overall expenses increased for the three and six months ended June 30,
2003 over the comparable period in 2002 by $870,086 or 124% and $1,402,843 or
112%, respectively. These increases are principally due to an increase in
payroll and related costs for development, sales and marketing and
administrative functions, and external costs associated with product
development, pre-production costs for the PlugPlus powerline products, ramp-up
of sales and marketing activities and costs associated with non-employee stock
options issued in connection with services rendered.
LIQUIDITY AND CAPITAL RESOURCES
To date Telkonet has not generated revenues to offset any development
and organizational expenses. As a result of Telkonet's operating losses from its
inception through June 30, 2003, Telkonet has generated a cash flow deficit of
$6,520,252 from operating activities. Telkonet's current assets exceeded its
current liabilities by $3,808,222 as of June 30, 2003. For the period from
inception through June 30, 2003, Telkonet has accumulated losses of $9,918,391.
Consequently, its operations are subject to all risks inherent in the
establishment of a new business enterprise. See, RISK FACTORS, "Telkonet is
emerging from its development stage and has no operating history on which to
base an evaluation of its current business and future prospects."
While Telkonet has raised capital to meet its working capital and
financing needs to date, additional financing may be required in order to meet
Telkonet's current and projected cash flow deficits from operations and
development during the next twelve months. Management believes Telkonet has
sufficient capital resources to meet projected cash flow deficits through the
next twelve months. However, if thereafter, we are not successful in generating
sufficient liquidity from operations or in raising sufficient capital resources
on terms acceptable to us, this could have a material adverse effect on our
business, results of operations, liquidity and financial condition.
37
During the second quarter of 2003, Telkonet completed its $5,000,000,
principal amount 8.0% senior note offering, the proceeds of which were used to
provide the necessary working capital. These notes provide for interest payable
quarterly and include non-detachable warrants to purchase 125,000 shares of our
common stock for each $100,000 of units sold. The warrants are exercisable for
three years from issuance at an exercise price of $1.00 per share.
After June 30, 2003, the Series A Debenture holders demanded
registration of shares of common stock sufficient to cover the conversion of
their debentures and exercise of the attached warrants. Accordingly, Telkonet
notified the Series B Debenture holders, Senior Noteholders and Warrant holders
with piggy-back registration rights of the right to participate in the
registration. Telkonet anticipates that additional cash resources will be
generated as the result of exercise of the warrants. However, the amount of such
funding cannot be determined until September 12, 2003, at which time the
exercise price for the warrants is required to be paid to Telkonet.
Telkonet's independent certified public accountants have stated in
their report included in Telkonet's December 31, 2002 Form 10-KSB, that Telkonet
has incurred operating losses in the last two years, and that Telkonet is
dependent upon management's ability to develop profitable operations. These
factors, among others, may raise substantial doubt about Telkonet's ability to
continue as a going concern. SEE, RISK FACTORS, "Telkonet's independent
accountants have expressed substantial doubts about Telkonet's ability to
continue as a going concern."
PRODUCT RESEARCH AND DEVELOPMENT
Company-sponsored research and development costs related to both
present and future products are expensed in the period incurred. Total expenses
for the three and six months ended June 30, 2003 decreased over the comparable
period in 2002 by $48,882 or 15.0% and $4,773 or 1.0%, respectively. During the
second quarter of 2002, non-recurring costs of approximately $49,000 related to
the purchase of prototype units, PCB board testing and UL and FCC testing were
incurred.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased for the three
and six months ended June 30, 2003 over the comparable periods in 2002 by
$937,354 or 397.0% and $1,335,966 or 373.0%, respectively. These increases were
related to one-time costs associated with the Senior Note and Series B Debenture
offerings, including commissions, public relations and employee separation
costs.
ACQUISITION OR DISPOSITION OF PLANT AND EQUIPMENT
During the six months ended June 30, 2003, Telkonet renewed certain
operating equipment leases and added a $1.00 buy-out option at the end of the
new 18 month lease term. Accordingly, the leases and the related debt
obligations for approximately $52,000 were capitalized. Telkonet does not
anticipate the sale of any significant property, plant or equipment or the
acquisition of any significant property, plant or equipment during the next
twelve months, other than leasehold improvements, computer equipment and
peripherals used in Telkonet's day-to-day operations.
NUMBER OF EMPLOYEES
During the period ended June 30, 2003, Telkonet had 17 employees. In
order for Telkonet to attract and retain quality personnel, Telkonet anticipates
it will continue to offer competitive salaries to current and future employees.
We anticipate incurring additional costs for personnel in connection with future
expansion efforts. This anticipated increase in personnel is dependent upon
Telkonet generating revenues and obtaining sources of financing. There can be no
assurance Telkonet will be successful in raising the funds required or
generating revenues sufficient to fund the projected increase in the number of
employees.
38
TRENDS, RISKS AND UNCERTAINTIES
Telkonet is not aware of any trends or uncertainties that have had or
are reasonably expected to have a material favorable or unfavorable impact on
net sales or revenues or income from continuing operations. Telkonet has sought
to identify what it believes to be the most significant risks to its business,
but cannot predict whether or to what extent any of such risks may be realized
nor can there be any assurances that Telkonet has identified all possible risks
that might arise. SEE, RISK FACTORS beginning on p. 7 of this propsectus.
Investors should carefully consider all such risk factors before making an
investment in Telkonet's common stock.
FISCAL YEAR ENDED DECEMBER 31, 2002
PLAN OF OPERATION
We are still in the development stage and have yet to generate revenues
from operations. We may experience fluctuations in operating results in future
periods due to a variety of factors including, but not limited to, market
acceptance of the Internet and power line communication technologies as a medium
for customers requiring high-speed Internet access utilizing our products, our
ability to acquire and deliver high quality products at a price lower than
currently available to consumers, our ability to obtain additional financing in
a timely manner and on terms favorable to us, our ability to successfully
attract customers at a steady rate and maintain customer satisfaction,
promotions, branding and sales programs, the amount and timing of operating
costs and capital expenditures relating to the expansion of our business,
operations and infrastructure and the implementation of marketing programs, key
agreements and strategic alliances, the number of products offered by us, the
number of returns experienced by us, and general economic conditions specific to
the Internet, power-line communications, and the communications industry.
39
REVENUES
Telkonet is transitioning from a development stage company to that of
an active growth and acquisition stage company. Initial hospitality market
revenues are projected to commence in the second quarter 2003 primarily driven
by the recent Strategic Alliance Agreement with Choice Hotels International
pursuant to which Telkonet became a Choice Hotels-endorsed vendor offering the
PlugPlusInternet product suite to Choice Hotels' U.S. franchisees. SEE, RISK
FACTORS, "The powerline communications industry is intensely competitive and
rapidly evolving."
COSTS AND EXPENSES
From our inception on November 3, 1999 through December 31, 2002, we
have not generated any revenues. We have incurred total costs and expenses of
$6,458,676 during this period. These expenses were associated principally with
compensation to employees, product development costs, amortization of debt
discount costs related to our convertible debentures, and issuance of
equity-based compensation to non-employees in exchange for consulting services
and financing.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2002, we had a deficiency in working capital of
$894,403. To date we have no operating revenues, have incurred significant
expenses, and have sustained losses from operating activities. As a result of
our operating losses from our inception through December 31, 2002, we generated
a cash flow deficit of $4,100,225 from operating activities. Cash flows used in
investing activities were $112,502 during the period November 3, 1999 through
December 31, 2002. We met our cash requirements during this period through the
private placement of $1,751,224 of our common stock, loan proceeds (net of
repayments) of $440,330 from banks and shareholders, and $2,040,000 proceeds
(net of financing fess) from issuance of convertible debentures.
While we have raised capital to meet our working capital and financing
needs in the past, additional financing is required in order to meet our current
and projected cash flow deficits from operations and development. Such financing
may be upon terms that are dilutive or potentially dilutive to our shareholders.
We are presently seeking financing in the form of debt or equity in order to
provide the necessary working capital. We currently have no commitments for
financing. There can be no assurances that we will be successful in raising the
funds required.
By adjusting its operations and development to the level of
capitalization, management believes it has sufficient capital resources to meet
projected cash flow deficits through the next twelve months. However, if
thereafter, we are not successful in generating sufficient liquidity from
operations or in raising sufficient capital resources on terms acceptable to us,
this could have a material adverse affect on our business, results of
operations, liquidity and financial condition.
The independent auditors report on our December 31, 2002 financial
statements included in this prospectus states that our recurring losses raise
substantial doubt about our ability to continue as a going concern.
40
PRODUCT RESEARCH AND DEVELOPMENT
Company-sponsored research and development costs related to both
present and future products are expensed in the period incurred. Total
expenditures on research and product development for the period November 3, 1999
(date of inception) through December 31, 2002 were $520,278. We anticipate
continuing to incur approximately $500,000 in research and development
expenditures in connection with the development of Telkonet PlugPlusInternet
product suite the Telkonet PlugPlusInternet Gateway and the Telkonet
PlugPlusInternet Modem.
These projected expenditures are dependent upon our generating revenues
and obtaining sources of financing in excess of our existing capital resources.
There is no guarantee that we will be successful in raising the funds required
or generating revenues sufficient to fund the projected costs of research and
development during the next twelve months.
ACQUISITION OR DISPOSITION OF PLANT AND EQUIPMENT
We do not anticipate the sale of any significant property, plant or
equipment during the next twelve months, other than computer equipment and
peripherals used in the day-to-day operations. We believe we have sufficient
resources available to meet these acquisition needs.
NUMBER OF EMPLOYEES
As of March 26, 2003, we had 14 full time employees. In
order for us to attract and retain quality personnel, we anticipate that we will
continue to offer competitive salaries to current and future employees. We
anticipate increasing our employment base to meet the needs outlined in the
business plan.
As we continue to expand, we will incur additional costs for personnel.
This projected increase in personnel is dependent upon us generating revenues
and obtaining sources of financing in excess of our existing capital resources.
There can be no assurance that we will be successful in raising the funds
required or generating revenues sufficient to fund the projected increase in the
number of employees.
TRENDS, RISKS AND UNCERTAINTIES
Telkonet is not aware of any trends or uncertainties that have had or
are reasonably expected to have a material favorable or unfavorable impact on
net sales or revenues or income from continuing operations. Telkonet has sought
to identify what it believes to be the most significant risks to our business,
but cannot predict whether or to what extent any of such risks may be realized
nor can there be any assurances that Telkonet has identified all possible risks
that might arise. Investors should carefully consider all of such risk factors
before making an investment decision with respect to our stock. SEE, RISK
FACTORS, beginning of p. 7 of this prospectus.
41
FISCAL YEAR ENDED DECEMBER 31, 2001
PLAN OF OPERATION
Telkonet is still in the development stage and is yet to earn revenues
from operations. We may experience fluctuations in operating results in future
periods due to a variety of factors including, but not limited to, market
acceptance of the Internet and power line communication technologies as a medium
for customers to purchase our products, our ability to acquire and deliver high
quality products at a price lower than currently available to consumers, our
ability to obtain additional financing in a timely manner and on terms favorable
to us, our ability to successfully attract customers at a steady rate and
maintain customer satisfaction, our promotions, branding and sales programs, the
amount and timing of operating costs and capital expenditures relating to the
expansion of our business, operations and infrastructure and the implementation
of marketing programs, key agreements and strategic alliances, the number of
products offered by us, the number of returns experienced by us, and general
economic conditions specific to the Internet, power-line communications, and the
communications industry.
REVENUES
We have generated no revenues from operations from our inception. We
believe we will begin earning revenues from operations within the next twelve
months as we transition from a development stage company to that of an active
growth and acquisition stage company.
On October 3, 2000 we entered into a Sales/Marketing Agreement with
Medical Advisory Systems, Inc. (AMEX: DOC) that provides for Medical Advisory
Systems to perform international business development, marketing (including
demographic analysis), and sales/support services for our products and services
through an international network of call centers owned by CORIS Group
International of Paris, France. Through its agreement with CORIS, Medical
Advisory Systems may market our power-line technology in up to 38 countries
located on six continents. This geographic focus would include all the former
Soviet Republics in Eastern Europe where the need for basic telephony exists for
most rural citizens. Also, Medical Advisory Systems, through CORIS, would
provide legal, business, regulatory and technical consulting for countries
targeted by Telkonet where CORIS is positioned. CORIS would make introductions
with other potential partners for Telkonet for the purpose of increasing the
scope and deployment of its power-line technology. Telkonet would reimburse
CORIS for all costs associated with pursuing the agreed upon services plus an
administrative fee for sales contracts that are successfully completed on behalf
of Telkonet.
PRIVATE PLACEMENTS 2001
In June 2001, Telkonet commenced a private placement offering of
investment units consisting of one share of our common stock valued at $0.50,
and one warrant to purchase 0.5 shares of our common stock at any time on or
before the date which occurs three years from the date of issuance of the
warrant at an exercise price of $1.00 per share. The offering was concluded on
June 30, 2001. In August of 2001, Telkonet commenced a private placement
offering of convertible debentures. The debentures each accrue interest at 8%
per annum and mature three years from the date of purchase. The debentures may
be converted to shares of our common stock at any time after the date which
occurs six months following the date of issuance by the holder at a price of
$0.50 per share. In connection with the placement of the debenture, Telkonet
issued non-detachable warrants granting holders the right to acquire 1,689,000
shares of our common stock at $1.00 per share. We paid Attkisson, Carter and
Akers, Incorporated, as our placement agent, a fee consisting of: (a) a retainer
of $25,000 payable from the first funds received, (b) a commission equal to 8.0%
of the selling price for each investment unit, (c) an investment banking fee of
2.0% of the selling price of each investment unit, and (d) warrants for the
purchase of shares of our common stock in a number equal to 20.0% multiplied by
the aggregate selling price for each unit sold, with an exercise price of $0.525
per share.
42
COSTS AND EXPENSES
From its inception on November 3, 1999 through December 31, 2001,
Telkonet has not generated any revenues. We have incurred expenses of $2,680,188
(as restated)during this period. These expenses were associated principally with
compensation to employees, product development costs and professional services.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2001, Telkonet had a deficiency in working capital
of $502,356 (as restated). As a result of our operating losses from our
inception through December 31, 2001, Telkonet generated a cash flow deficit of
$2,069,216 (as restated) from operating activities. Cash flows used in investing
activities was $54,950 during the period November 3, 1999 through December 31,
2001. Telkonet met its cash requirements during this period through the private
placement of $818,000, net of costs of convertible debentures, the sale of our
common stock of $920,551, net of costs and bank loan proceeds of $400,000.
While Telkonet has raised capital to meet its working capital and
financing needs in the past, additional financing is required in order to meet
our current and projected cash flow deficits from operations and development.
Telkonet is seeking financing in the form of equity in order to provide the
necessary working capital. Telkonet currently has no commitments for financing.
There are no assurances Telkonet will be successful in raising the funds
required.
Telkonet's independent certified public accountants have stated in
their report included in this prospectus, that Telkonet has incurred operating
loss losses from its inception, and that Telkonet is dependent upon management's
ability to develop profitable operations. These factors among others, may raise
substantial doubt about Telkonet's ability to continue as a going concern.
PRODUCT RESEARCH AND DEVELOPMENT
Company-sponsored research and development costs related to both
present and future products are expended in the period incurred. Total
expenditures on research and product development for the period November 3, 1999
(date of inception) through December 31, 2001 were approximately $279,115. The
current generation of the Telkonet PlugPlusInternet product suite delivers data
at speeds in excess of 7 Mega bits per second (Mbps), with burst speeds of 12.6
Mbps. The Telkonet PlugPlusInternet Gateway provides the connection to the
broadband connection (DSL, TL, Satellite, Cable Modem) and the Telkonet
PlugPlusInternet Terminal connects to a user device. Many PCs, each equipped
with one Telkonet PlugPlusInternet Terminal, can communicate amongst themselves
and can share a single expensive broadband resource via the single Telkonet
PlugPlusInternet Gateway.
43
NUMBER OF EMPLOYEES
As of March 5, 2002, Telkonet had five full time employees. In order
for Telkonet to attract and retain quality personnel, Telkonet anticipates it
will continue to offer competitive salaries to current and future employees.
Telkonet anticipates increasing its employment base to meet the needs outlined
in the business plan.
As Telkonet continues to expand, Telkonet will incur additional costs
for personnel. This projected increase in personnel is dependent upon Telkonet
generating revenues and obtaining sources of financing in excess of our existing
capital resources. There can be no assurance that Telkonet will be successful in
raising the funds required or generating revenues sufficient to fund the
projected increase in the number of employees.
TRENDS, RISKS AND UNCERTAINTIES
Telkonet is not aware of any trends or uncertainties that have had or
are reasonably expected to have a material favorable or unfavorable impact on
net sales or revenues or income from continuing operations. Telkonet has sought
to identify what it believes to be the most significant risks to its business,
but cannot predict whether or to what extent any of such risks may be realized
nor can there be any assurances that Telkonet has identified all possible risks
that might arise. Investors should carefully consider all of such risk factors
before making an investment decision with respect to Telkonet's stock. SEE, RISK
FACTORS, beginning of p. 7 of this prospectus.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2000, the Financial Accounting Standards Board (FASB) issued
interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving
Stock Compensation, an Interpretation of APB Opinion No. 25". FIN 44 clarifies
the application of APB No. 25 for (a) the definition of employee for purposes of
applying APB No. 25, (b) the criteria for determining whether a plan qualifies
as a noncompensatory plan, (c) the accounting consequences of various
modifications to previously fixed stock option or award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. FIN 44
is effective July 2, 2000 but certain conclusions cover specific events that
occur after either December 15, 1998 or January 12, 2000. The adoption of FIN 44
did not have an affect on Telkonet's financial statements but may impact the
accounting for grants or awards in future periods.
In July 2001, FASB issued Statement of Financial Accounting Standards
No. 141, Business Combinations (FAS 141), and FAS 142, Goodwill and Other
Intangible Assets (FAS 142). FAS 141 addresses the initial recognition and
measurement of goodwill and other intangible assets acquired in a business
combination. FAS 142 addresses the initial recognition and measurement of
intangible assets acquired outside of a business combination, whether acquired
individually or with a group of other assets, and the accounting and reporting
for goodwill and other intangibles subsequent to their acquisition. These
standards require all future business combinations to be accounted for using the
purchase method of accounting. Goodwill will no longer be amortized but instead
will be subject to impairment tests at least annually. Telkonet is required to
adopt FAS 141 and FAS 142 on a prospective basis as of January 1, 2002; however,
certain provisions of these new standards may also apply to any acquisitions
concluded subsequent to June 30, 2001. As a result of implementing these new
standards, Telkonet will discontinue the amortization of goodwill as of December
31, 2001. Telkonet does not believe that the adoption of FAS 141 or 142 will
have a material impact on its consolidated financial statements.
In October 2001, FASB issued FAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (FAS 144). FAS 144 addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. This
statement supersedes FAS 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of" (FAS 121) and related
literature and establishes a single accounting model, based on the framework
established in FAS 121, for long-lived assets to be disposed of by sale.
Telkonet is required to adopt FAS 144 no later than January 1, 2002. Telkonet
does not believe that the adoption of FAS 144 will have a material impact on its
consolidated financial statements.
44
In July 2001, FASB issued Statement of Financial Accounting Standards
No. 141, "Business Combinations" (SFAS No. 141), and Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No.
142). The FASB also issued Statement of Financial Accounting Standards No. 143,
"Accounting for Obligations Associated with the Retirement of Long-Lived Assets"
(SFAS No. 143), and Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144)
in August and October 2001, respectively.
SFAS No. 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interest method. The adoption of SFAS No. 141 had no material impact
on our consolidated financial statements.
Effective January 1, 2002, we adopted SFAS No. 142. Under the new
rules, we will no longer amortize goodwill and other intangible assets with
indefinite lives, but such assets will be subject to periodic testing for
impairment. On an annual basis, and when there is reason to suspect that their
values have been diminished or impaired, these assets must be tested for
impairment, and write-downs to be included in results from operations may be
necessary. SFAS No. 142 also requires us to complete a transitional goodwill
impairment test six months from the date of adoption.
Any goodwill impairment loss recognized as a result of the transitional
goodwill impairment test will be recorded as a cumulative effect of a change in
accounting principle no later than the end of fiscal year 2002. The adoption of
SFAS No. 142 had no material impact on our consolidated financial statements.
SFAS No. 143 establishes accounting standards for the recognition and
measurement of an asset retirement obligation and its associated asset
retirement cost. It also provides accounting guidance for legal obligations
associated with the retirement of tangible long-lived assets. SFAS No. 143 is
effective in fiscal years beginning after June 15, 2002, with early adoption
permitted. We expect that the provisions of SFAS No. 143 will not have a
material impact on our consolidated results of operations and financial position
upon adoption. We plan to adopt SFAS No. 143 effective January 1, 2003.
SFAS No. 144 establishes a single accounting model for the impairment
or disposal of long-lived assets, including discontinued operations. SFAS No.
144 superseded Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" (SFAS No. 121), and APB Opinion No. 30, "Reporting the Results of Operations
- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions". We
adopted SFAS No. 144 effective January 1, 2002. The adoption of SFAS No. 144 had
no material impact on our consolidated financial statements.
In April 2002, FASB issued Statement No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This Statement rescinds FASB Statement No. 4, "Reporting Gains and
Losses from Extinguishment of Debt", and an amendment of that Statement, FASB
Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements" and FASB Statement No. 44, "Accounting for Intangible Assets of
Motor Carriers". This Statement amends FASB Statement No. 13, "Accounting for
Leases", to eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. We do not expect the adoption to have a material impact on our
financial position or results of operations.
In June 2002, FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. We do not
expect the adoption to have a material impact to our financial position or
results of operations.
45
In October 2002, FASB issued Statement No. 147, "Acquisitions of
Certain Financial Institutions-an amendment of FASB Statements No. 72 and 144
and FASB Interpretation No. 9", which removes acquisitions of financial
institutions from the scope of both Statement 72 and Interpretation 9 and
requires that those transactions be accounted for in accordance with Statements
No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible
Assets. In addition, this Statement amends SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets and credit cardholder
intangible assets. The requirements relating to acquisitions of financial
institutions is effective for acquisitions for which the date of acquisition is
on or after October 1, 2002. The provisions related to accounting for the
impairment or disposal of certain long-term customer-relationship intangible
assets are effective on October 1, 2002. The adoption of this Statement did not
have a material impact on our financial position or results of operations as we
have not engaged in either of these activities.
In December 2002, FASB issued Statement No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure", which amends FASB Statement
No. 123, Accounting for Stock-Based Compensation, to provide alternative methods
of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The transition guidance and annual disclosure
provisions of Statement 148 are effective for fiscal years ending after December
15, 2002, with earlier application permitted in certain circumstances. The
interim disclosure provisions are effective for financial reports containing
financial statements for interim periods beginning after December 15, 2002. The
adoption of this statement did not have a material impact on our financial
position or results of operations as we have not elected to change to the fair
value based method of accounting for stock-based employee compensation.
In January 2003, FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation 46 changes the criteria by which one
company includes another entity in its consolidated financial statements.
Previously, the criteria were based on control through voting interest.
Interpretation 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. A company that consolidates a variable
interest entity is called the primary beneficiary of that entity. The
consolidation requirements of Interpretation 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation requirements
apply to older entities in the first fiscal year or interim period beginning
after June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. We do not expect the adoption to have
a material impact on our financial position or results of operations.
46
PLAN OF DISTRIBUTION
The selling stockholders, or their pledgees, donees, transferees or
other successors in interest may, from time to time, sell all or a portion of
the shares at fixed prices that may be changed, at market prices prevailing at
the time of sale, at prices related to such market prices or at negotiated
prices. The selling stockholders may offer their shares at various times in one
or more of the following transactions:
o on any national securities exchange, or other market on which
our common stock may be listed at the time of sale;
o in the over-the-counter market;
o through block trades in which the broker or dealer so engaged
will attempt to sell the shares as agent, but may position and
resell a portion of the block as principal to facilitate the
transaction;
o through purchases by a broker or dealer as principal and
resale by such broker or dealer for its account pursuant to
this prospectus;
o in ordinary brokerage transactions and transactions in which
the broker solicits purchasers;
o through options, swaps or derivatives;
o in privately negotiated transactions;
o in transactions to cover short sales; and
o through a combination of any such methods of sale.
In addition, the selling stockholders may also sell their shares that
qualify for sale pursuant to Rule 144 under the Securities Act of 1933 under the
terms of such rule rather than pursuant to this prospectus.
47
The selling stockholders may sell their shares directly to purchasers
or may use brokers, dealers, underwriters or agents to sell their shares upon
terms and conditions that will be described in the applicable prospectus
supplement. In effecting sales, brokers and dealers engaged by the selling
stockholders may arrange for other brokers or dealers to participate. Brokers or
dealers may receive commissions, discounts or concessions from a selling
stockholder or, if any such broker-dealer acts as agent for the purchaser of
such shares, from such purchaser in amounts to be negotiated. Such compensation
may, but is not expected to, exceed that which is customary for the types of
transactions involved. Broker-dealers may agree with a selling stockholder to
sell a specified number of such shares at a stipulated price per share, and, to
the extent such broker-dealer is unable to do so acting as agent for a selling
stockholder, to purchase as principal any unsold shares at the price required to
fulfill the broker-dealer commitment to the selling stockholders. Broker-dealers
who acquire shares as principal may thereafter resell such shares from time to
time in transactions, which may involve block transactions and sales to and
through other broker-dealers, including transactions of the nature described
above, in the over-the-counter market or otherwise at prices and on terms then
prevailing at the time of sale, at prices then related to the then-current
market price or in negotiated transactions. In connection with such resales,
broker-dealers may pay to or receive from the purchasers of such shares
commissions as described above.
The selling stockholders and any broker-dealers or agents that
participate with the selling stockholders in sales of the shares may be deemed
to be "underwriters" within the meaning of the Securities Act of 1933 in
connection with such sales. In such event, any commissions received by such
broker-dealers or agents and any profit on the resale of the shares purchased by
them may be deemed to be underwriting commissions or discounts under the
Securities Act of 1933.
From time to time the selling stockholders may be engaged in short
sales, short sales against the box, puts and calls and other hedging
transactions in our securities, to the extent permitted by applicable law and
exchange regulations, and may sell and deliver the shares in connection with
such transactions or in settlement of securities loans. These transactions may
be entered into with broker-dealers or other financial institutions. In
addition, from time to time, a selling stockholder may pledge its shares
pursuant to the margin provisions of its customer agreements with its
broker-dealer. Upon delivery of the shares or a default by a selling
stockholder, the broker-dealer or financial institution may offer and sell the
pledged shares from time to time.
We are required to pay all of the fees and expenses incident to the
registration of our common stock hereunder. Additionally, we have agreed to
indemnify certain selling stockholders against certain losses, claims, damages
and liabilities, including liabilities under the Securities Act of 1933.
DESCRIPTION OF OUR COMMON STOCK
Our common stock is quoted on the OTC Bulletin Board under the symbol
"TLKO.OB." The holders of our common stock are entitled to receive dividends
when, as and if declared by the board of directors and paid by us out of funds
legally available therefore and to share ratably in our assets available for
distribution after the payment of all prior claims in the event we liquidate,
dissolve or wind-up our business, and after payment to any holders of any of our
preferred stock. Holders of our common stock are entitled to one vote per share
on all matters requiring a vote of stockholders. Our common stock does not have
cumulative voting rights. The rights of the holders of our common stock will be
subject to any preferential rights of any class or series of our preferred stock
that we might issue. As of the date of this prospectus, we had no shares of
preferred stock issued or outstanding. Holders of our common stock have no
preemptive or other subscription rights, and there are no conversion, redemption
or sinking fund provisions applicable thereto.
EXPERTS
The consolidated financial statements of Telkonet included in this
prospectus from our Form 10-KSB for the years ended December 31, 2002 and 2001
have been audited by Russell Bedford Stefanou Mirchandani LLP, independent
certified public accountants, and have been included herein in reliance upon the
report of such firm given upon their authority as experts in accounting and
auditing.
48
LEGAL MATTERS
An opinion has been rendered by the law firm of Baker & Hostetler LLP
to the effect that the shares of our common stock offered by the selling
stockholders under this prospectus, when paid for and issued in accordance with
the Series A and Series B Debentures and the warrants, are legally issued, fully
paid and non-assessable.
WHERE YOU CAN FIND MORE INFORMATION
We are subject to the informational requirements of the Securities
Exchange Act of 1934 pursuant to which we file reports and other information
with the SEC. These reports and other information may be inspected and copied at
public reference facilities maintained by the SEC at Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549 and at the SEC's Regional Office
at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. Copies may be obtained at prescribed rates from the Public Reference
Section of the SEC at its principal office in Washington, D.C. The SEC also
maintains an internet web site that contains periodic and other reports, proxy
and information statements and other information regarding registrants,
including us, that file electronically with the SEC. The address of the SEC's
web site is http://www.sec.gov.
All information concerning us contained in this prospectus has been
furnished by us. No person is authorized to make any representation with respect
to the matters described in this prospectus other than those contained in this
prospectus and if given or made must not be relied upon as having been
authorized by us or any other person.
We have not authorized anyone to give any information or make any
representation about our company that is different from, or in addition to, that
contained in this prospectus. Therefore, if anyone gives you such information,
you should not rely on it. This prospectus is dated August 28, 2003. You should
not assume that the information contained in this document is accurate as of any
other date unless the information specifically indicates that another date
applies.
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Section 16-10a-902 of the Utah Business Corporation Act enables
Telkonet to indemnify an individual made a party to a proceeding because he is
or was a director of Telkonet if (i) his conduct was in good faith, (ii) he
reasonably believed his conduct was in, or not opposed to, Telkonet's best
interests, and (iii) in the case of a criminal proceeding, he had no reasonable
cause to believe his conduct was unlawful. Notwithstanding the foregoing,
Telkonet may not indemnify a director (i) in connection with a proceeding by or
in the right of the corporation in which the director was adjudged liable to
Telkonet, or (ii) in connection with any other proceeding charging that the
director derived an improper personal benefit, whether or not involving action
in his official capacity, in which proceeding he was adjudged liable on the
basis that he derived an improper personal benefit. The Utah Business
Corporation Act also permits Telkonet to purchase insurance on behalf of any
person that is or was a director, officer, employee, fiduciary or agent of
Telkonet. Telkonet's amended and restated articles of incorporation provide, in
effect, for the elimination of the personal liability of Telkonet's directors
and for the indemnification by Telkonet of each director and officer of
Telkonet, in each case, to the fullest extent permitted by applicable law.
Telkonet purchases and maintains insurance on behalf of any person who is or was
a director, officer, employee, fiduciary or agent of Telkonet against any
liability asserted against him or her and incurred by him or her in any such
capacity, or arising out of his or her status as such, whether or not Telkonet
would have the power or the obligation to indemnify him or her against such
liability under the provisions of Telkonet's amended and restated articles of
incorporation.
49
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, the registrant has been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is
therefore unenforceable.
50
FINANCIAL STATEMENTS
TABLE OF CONTENTS
Condensed Consolidated Balance Sheets
June 30, 2003 and December 31, 2002 F-2
Condensed Consolidated Statements of Losses
Three Months Ended June 30, 2003 and 2002
Six Months Ended June 30, 2003 and 2002
November 3, 1999 (Date of Inception) through June 30, 2003 F-3
Consolidated Statement of Deficiency in Stockholders' Equity
November 3, 1999 (Date of Inception) through June 30, 2003 F-4
Condensed Consolidated Statements of Cash Flows:
Six Months Ended June 30, 2003 and 2002
November 3, 1999 (Date of Inception) through June 30, 2003 F-8
Notes to Unaudited Condensed Consolidated Financial Information--
June 30, 2003 F-10
Report of Independent Certified Public Accountants F-21
Consolidated Balance Sheets
December 31, 2002 and 2001 F-22
Consolidated Statements of Losses
Years ended December 31, 2002 and 2001
November 3, 1999 (Date of Inception) Through December 31, 2002 F-23
Consolidated Statements of Deficiency in Stockholders' Equity
November 3, 1999 (Date of Inception) Through December 31, 2002 F-24
Consolidated Statements of Cash Flows
Years ended December 31, 2002 and 2001
November 3, 1999 (Date of Inception) through December 31, 2002 F-29
Notes to Consolidated Financial Statements F-31
Report of Independent Certified Public Accountants F-51
Consolidated Balance Sheet
Years ended December 31, 2001 and 2000 F-52
Consolidated Statement of Losses
Years ended December 31, 2001and 2000
November 3, 1999 (Date of Inception) through December 31, 2001 F-53
Consolidated Statement of Deficiency in Stockholder's Equity
November 3, 1999 (Date of Inception) through December 31, 2001 F-54
Consolidated Statement of Cash Flows
Years ended December 31, 2001 and 2000
November 3, 1999 (Date of Inception) through December 31, 2001 F-56
Notes to Consolidated Financial Statements F-57
F-1
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) (Audited)
June 30, 2003 December 31, 2002
------------- -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,580,779 $ 18,827
Inventory, net 449,487 39,790
Other receivable -- 1,550
Prepaid expenses and deposits 75,785 4,625
------------ ------------
Total current assets 5,106,051 64,792
PROPERTY AND EQUIPMENT:
Furniture and equipment, at cost 161,462 73,215
Less: accumulated depreciation 54,628 35,252
------------ ------------
106,833 37,963
OTHER ASSETS
Financing costs, less accumulated amortization of $164,449 and
$101,692 at June 30, 2003 and December 31, 2002, respectively 217,060 192,600
$ 5,429,945 $ 295,355
============ ============
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 981,038 $ 518,865
Notes payable and capital leases 309,291 310,000
Due to shareholders 7,500 130,330
------------ ------------
Total current liabilities 1,297,829 959,195
Convertible debentures, net of discounts - including related
parties (Note B) 1,453,720 862,682
Senior notes payable (Note C) 5,000,000 --
COMMITMENTS AND CONTINGENCIES -- --
DEFICIENCY IN STOCKHOLDERS' EQUITY
Preferred stock, par value $.001 per share; 15,000,000 shares
authorized; none issued at June 30, 2003 and December 31, 2002
(Note E) -- --
Common stock, par value $.001 per share; 100,000,000 shares
authorized; 15,977,795 and 15,721,131 shares issued and
outstanding at June 30, 2003 and December 31, 2002, respectively
(Note E) 15,978 15,721
Additional paid-in-capital 7,580,809 4,916,433
Accumulated deficit during development stage (9,918,391) (6,458,676)
------------ ------------
Deficiency in stockholders' equity (2,321,604) (1,526,522)
------------ ------------
$ 5,429,945 $ 295,355
============ ============
See accompanying footnotes to the unaudited condensed
consolidated financial information
F-2
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF LOSSES
(UNAUDITED)
For the period from
For The Three Months Ended For The Six Months Ended November 3, 1999
June 30, June 30, (date of inception)
2002 (As 2002 (As through
Restated - Restated - June 30, 2003 (As
---------- ---------- -----------------
2003 Note F) 2003 Note F) Restated - Note F)
---- ------- ---- ------- ------------------
Costs and Expenses:
Research and Development $ 282,821 $ 331,704 $ 597,550 $ 602,283 $ 3,010,021
Selling, General and Administrative 1,173,675 236,321 1,693,797 357,831 4,360,918
Non-Employee Stock Options (Note D) 67,884 113,115 286,904 226,230 750,954
Depreciation and Amortization 48,589 21,743 82,133 71,196 219,077
------------- ------------- ------------- ------------- -------------
Total Operating Expense 1,572,969 702,883 2,660,384 1,257,540 (8,340,971)
Loss from Operations (1,572,969) (702,883) (2,660,384) (1,257,540) (8,340,971)
Other Income (Expense) -- -- -- -- 4,579
Interest Income (Expense) (446,003) (126,148) (799,332) (217,594) (1,582,000)
Provision for Income Tax -- -- -- -- --
------------- ------------- ------------- ------------- -------------
(446,003) (126,148) (799,332) (217,594) (1,577,421)
Net Loss $ (2,018,972) $ (829,031) $ (3,459,715) $ (1,475,134) $ (9,918,391)
============= ============= ============= ============= =============
Loss per common share (basic and
assuming dilution) $ (0.13) $ (0.06) $ (0.22) $ (0.09) $ (0.62)
============= ============= ============= ============= =============
Weighted average common shares
outstanding 15,827,613 14,154,678 15,774,666 17,244,540 15,998,108
See accompanying footnotes to the unaudited condensed
consolidated financial information
F-3
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO JUNE 30, 2003
Deficit
Accumulated
Preferred Common Additional Common During
Preferred Stock Stock Paid in Stock Development
Shares Amount Common Shares Amount Capital Subscription Stage Total
Net Loss -- $ -- -- $ -- $ -- $ -- $ (33,973) $ (33,973)
-------- ------- ----------- --------- --------- ------- ---------- ----------
Balance at December 31, 1999 -- -- -- -- -- -- (33,973) (33,973)
Shares issued to founders
January 2000, in exchange
for services and costs
valued at $ 0.60 per share -- -- 19,300 193 11,387 -- -- 11,580
Shares issued in June 2000,
for cash in connection with
private placement at $375
per share, net of costs -- -- 1,735 17 644,219 -- -- 644,236
Shares issued in July 2000,
for warrants exercised at a
price of $375 per share -- -- 190 -- 71,250 -- -- 71,250
Shares issued in August 2000,
in connection with the merger
of Comstock Coal and Telkonet
Communications, Inc -- -- 21,775,335 21,775 -- -- -- 21,775
August 2000, retirement of
Telkonet Communications, Inc
shares -- -- (21,225) (210) -- -- -- (210)
Shares issued in October 2000,
in exchange for warrants
exercised at a price of $1
per share -- -- 29,145 29 29,115 -- -- 29,144
Shares issued in October 2000,
in exchange for warrants
exercised at a price of $0.40
per share -- -- 10,891 11 4,345 -- -- 4,356
Net loss -- -- -- -- -- -- (929,720) (929,720)
-------- ------- ----------- --------- --------- ------- ---------- ----------
BALANCE AT DECEMBER 31, 2000 -- $ -- 21,815,371 $ 21,815 $760,316 $ -- $(963,693) $(181,562)
======== ======= =========== ========= ========= ======= ========== ==========
See accompanying footnotes to the unaudited condensed
consolidated financial information
F-4
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO JUNE 30, 2003
Deficit
Accumulated
Preferred Common Additional Common During
Preferred Stock Common Stock Paid in Stock Development
Shares Amount Shares Amount Capital Subscription Stage Total
Balance Forward -- $ -- 21,815,371 $21,815 $ 760,316 $ -- $ (963,693) $ (181,562)
Shares issued in June 2001,
for cash in connection with
a private placement, shares
issued at $.50 a share,
net of costs -- -- 260,000 260 129,740 -- -- 130,000
1,839,378 warrants issued in
June 2001, valued at $0.13 per
warrant, in exchange for services -- -- -- -- 237,035 -- -- 237,035
72,668 stock options issued in
June 2001, valued at $ 0.09 per
stock option, in exchange for
services -- -- -- -- 6,375 -- -- 6,375
245,287 warrants issued in July
2001, valued at $0.08 per warrant,
in exchange for services -- -- -- -- 18,568 -- -- 18,568
36,917 stock options issued in
July 2001, valued at $ 0.08 per
warrant, in exchange for services -- -- -- -- 2,795 -- -- 2,795
Shares issued in August 2001, for
cash in connection with a private
placement, shares issued at $.50
a share, net of costs -- -- 40,000 40 19,960 -- -- 20,000
241,000 warrants issued in August
2001, valued at $ 0.39 per warrant
in exchange for financing costs -- -- -- -- 85,818 -- -- 85,818
150,000 warrants issued in August
2001, valued at $ 0.16 per warrant,
in exchange for services -- -- -- -- 23,340 -- -- 23,340
36,917 stock options issued in
August 2001, valued at $ 0.06 per
stock option, in exchange for services -- -- -- -- 2,422 -- -- 2,422
25,000 warrants issued in September
2001, valued at $0.30 per warrant in
exchange for services -- -- -- -- 7,380 -- -- 7,380
95,000 warrants issued in October
2001, valued at $ 0.21 per warrant,
in exchange for services -- -- -- -- 19,558 -- -- 19,558
25,000 warrants issued in November
2001, valued at $ 0.33 per warrant,
in exchange for services -- -- -- -- 8,218 -- -- 8,218
25,000 warrants issued in December
2001, valued at $ 0.30 per warrant,
in exchange for services -- -- -- -- 7,380 -- -- 7,380
Beneficial conversion feature of
convertible debentures (Note E) -- -- -- -- 837,874 -- -- 837,874
Value of warrants attached to
convertible debentures (Note E) -- -- -- -- 77,254 -- -- 77,254
Net loss -- -- -- -- -- -- (1,716,495) (1,716,495)
-------- ------- ----------- -------- ----------- ------- ------------ ------------
BALANCE AT DECEMBER 31, 2001
(AS RESTATED- NOTE L) -- $ -- 22,115,371 $22,115 $2,244,033 $ -- $(2,680,188) $ (414,040)
======== ======= =========== ======== =========== ======= ============ ============
See accompanying footnotes to the unaudited condensed
consolidated financial information
F-5
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO JUNE 30, 2003
Deficit
Accumulated
Preferred Common Additional Common During
Preferred Stock Common Stock Paid in Stock Development
Shares Amount Shares Amount Capital Subscription Stage Total
Balance Forward -- $ -- 22,115,371 $ 22,115 $ 2,244,033 $ -- $(2,680,188) $ (414,040)
Shares issued in February 2002,
in exchange for convertible
debentures interest, at $.50
per share -- -- 43,586 44 21,749 -- -- 21,793
Shares issued in March 2002,
to a founder in exchange for
shares canceled -- -- 5,250,000 5,250 (5,250) -- -- --
Shares canceled in March 2002
in connection with capital
restructure -- -- (13,480,961) (13,481) 13,481 -- -- --
Shares issued in June 2002,
for warrants exercised at $1.00
per share for services rendered -- -- 47,906 48 47,857 -- -- 47,905
Shares issued in June 2002, for
warrants exercised at $.40 per
share for services rendered -- -- 26,443 26 10,551 -- -- 10,577
Shares issued in June 2002 to
founders, for options exercised
at $1.00 per share -- -- 1,000,000 1,000 999,000 -- -- 1,000,000
Shares issued in June 2002, for
warrants exercised at $1.0025
per share, for services rendered -- -- 80,039 80 80,158 -- -- 80,238
Shares issued in June 2002, for
warrants exercised at $.41, in
connection with original private
placement -- -- 189,327 189 77,720 -- -- 77,909
Shares issued in July 2002, for
warrants exercised at $.40, in
connection with original private
placement -- -- 41,970 42 16,830 -- -- 16,872
Shares issued in July 2002 to
founders, for options exercised
at $1.00 per share -- -- 1,000,000 1,000 999,000 -- -- 1,000,000
Shares issued in August 2002,
for warrants exercised at $.43,
in connection with original
private placement -- -- 542,500 543 232,459 -- -- 233,002
Shares issued in August 2002,
for warrants exercised at $.40,
in connection with original
private placement -- -- 193,302 193 77,127 -- -- 77,320
Shares issued in October 2002,
for warrants exercised at $.40,
in connection with original
private placement -- -- 77,048 77 30,896 -- -- 30,973
Shares issued in October 2002,
for warrants exercised at $0.50
per share in connection with
original private placement -- -- 400,000 400 199,600 -- -- 200,000
Common stock subscription -- -- -- -- -- (1,805,400) -- (1,805,400)
Return of founders shares in
connection with stock subscription -- -- (1,805,400) (1,805) (1,803,595) 1,805,400 -- --
Stock based compensation for the
issuance of stock options to
consultants in exchange for
services (Note G) -- -- -- -- 452,459 -- -- 452,459
Stock based compensation for the
issuance of warrants to consultants
in exchange for services (Note G) -- -- -- -- 170,330 -- -- 170,330
Stock based compensation for the
issuance of warrants to consultants
in exchange for financing costs
(Note G) -- -- -- -- 86,474 -- -- 86,474
Beneficial conversion feature of
convertible debentures (Note E) -- -- -- -- 840,877 -- -- 840,877
Value of warrants attached to
convertible debentures (Note E) -- -- -- -- 124,677 -- -- 124,677
Net Loss -- -- -- -- -- -- (3,778,488) (3,778,488)
------- ------- ----------- --------- ------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 2002 -- $ -- 15,721,131 $ 15,721 $ 4,916,433 $ -- $(6,458,676) $(1,526,522)
======= ======= =========== ========= ============ ============ ============ ============
See accompanying footnotes to the unaudited condensed
consolidated financial information
F-6
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO JUNE 30, 2003
Deficit
Accumulated
Preferred Common Additional Common During
Preferred Stock Common Stock Paid in Stock Development
Shares Amount Shares Amount Capital Subscription Stage Total
BALANCE FORWARD -- $ -- 15,721,131 $ 15,721 $ 4,916,433 $ -- $(6,458,676) $(1,526,522)
Shares issued in April 2003,
in exchange for convertible
debentures at $.50 per share
(Note E) -- -- 40,000 40 19,960 -- -- 20,000
Shares issued in April 2003,
in exchange for services @
$1.54 per share (Note E) 49,998 50 76,695 76,745
Shares issued in June 2003,
for employee options exercised
at $1.00 per share (Note E) -- -- 83,333 83 83,250 -- -- 83,333
Shares issued in June 2003,
for non-employee options
exercised at $1.00 per share
(Note E) -- -- 83,333 83 83,250 -- -- 83,333
Stock based compensation for
the issuance of stock options
to consultants in exchange for
services (Note D) -- -- -- -- 286,904 -- -- 286,904
Stock based compensation for the
issuance of warrants in exchange
for financing costs (Note D) -- -- -- -- 87,217 -- -- 87,217
Beneficial conversion feature of
convertible debentures (Note B) -- -- -- -- 1,761,675 -- -- 1,761,675
Value of warrants attached to
convertible debentures (Note B) -- -- -- -- 265,425 -- -- 265,425
Net Loss -- -- -- -- -- -- (3,459,715) (3,459,711)
------------ --------- ------------ ------------ ------------ --------- ------------ ------------
BALANCE AT JUNE 30, 2003 -- $ -- 15,977,795 $ 15,978 $ 7,580,809 $ -- $(9,918,391) $(2,321,604)
============ ========= ============ ============ ============ ========= ============ ============
See accompanying footnotes to the unaudited condensed
consolidated financial information
F-7
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the period
from November
3, 1999 (date
of inception)
through
Six Months Ended June 30, June 30, 2003
----------------------------------- -------------
2003 2002 (As Restated -
---- ---- --------------
(As Re-stated - Note F) Note F)
----------------------- -------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from development stage operations $ (3,459,715) $ (1,475,134) $ (9,918,891)
Adjustments to reconcile net loss from development
stage operations to cash used for operating
activities
Amortization of debt discount - beneficial
conversion feature of convertible debentures 538,425 183,926 1,071,847
Amortization of debt discount - value of warrants
attached to convertible debentures 72,614 16,452 120,556
Stock options and warrants issued in exchange for
services rendered 286,904 -- 1,242,766
Common stock issued in exchange for services
rendered 76,745 138,722 227,047
Common stock issued in exchange for conversion of
interest -- 21,793 21,793
Impairment of property and equipment -- -- 39,287
Depreciation and amortization of financing costs 82,133 71,196 219,077
Increase (decrease) in:
Other receivable 1,550 -- --
Inventory (409,696) -- (449,487)
Prepaid expenses and deposits (71,160) -- (75,785)
Accounts payable and accrued expenses, net 462,173 201,051 981,038
------------- ------------- -------------
NET CASH USED IN OPERATING ACTIVITIES (2,420,027) (841,994) (6,520,252)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net of disposals (28,957) (19,499) (141,459)
------------- ------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (28,957) (19,499) (141,459)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net of costs -- 99,702 1,751,224
Proceeds from (repayments of) stockholder advances (122,830) -- 7,500
Proceeds from issuance of convertible debentures,
net of costs 2,027,100 715,407 4,067,100
Proceeds from issuance of senior notes, net of costs 5,000,000 -- 5,000,000
Proceeds from exercise of stock options 166,666 166,666
Repayments of loans (60,000) 166,500 (150,000)
Proceeds from loans -- -- 400,000
------------- ------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 7,010,935 981,609 11,242,490
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS 4,561,952 120,116 4,580,779
Cash and cash equivalents at the beginning of the
period 18,827 21,885 --
------------- ------------- -------------
Cash and cash equivalents at the end of the period $ 4,580,779 $ 142,001 $ 4,580,779
------------- ------------- -------------
See accompanying footnotes to the unaudited condensed
consolidated financial information
F-8
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the period
from November
3, 1999 (date
of inception)
through
Six Months Ended June 30, June 30, 2003
--------------------------------- -------------
2003 2002 (As Restated -
---- ---- --------------
(As Re-stated - Note F) Note F)
----------------------- -------
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for interest $ 10,423 $ 17,216 $ 35,388
Income taxes paid -- -- --
Non-cash transactions: -- -- --
Issuance of stock options and warrants in exchange for services
rendered 286,904 -- 1,242,766
Issuance of stock warrants in exchange for financing costs 87,217 -- 173,691
Common stock issued for services rendered 76,745 138,722 227,047
Common stock issued in exchange for interest -- 21,793 21,793
Common stock issued in exchange for conversion of convertible
debenture 20,000 -- 20,000
Notes payable issued in connection with capital lease 59,291 -- 59,291
Beneficial conversion feature on convertible debentures 1,761,675 693,018 3,440,426
Value of warrants attached to convertible debentures 265,425 56,082 467,356
Acquisition:
Assets Acquired -- -- 1
Accumulated Deficit -- -- 2,643
Liabilities Assumed -- -- (2,642)
------------ ------------ ------------
$ -- $ -- $ 1
------------ ------------ ------------
See accompanying footnotes to the unaudited condensed
consolidated financial information
F-9
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE A - SUMMARY OF ACCOUNTING POLICIES
---------------------------------------
General
-------
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-QSB. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Accordingly, the results from operations for the six-month period ended June 30,
2003, are not necessarily indicative of the results that may be expected for the
year ended December 31, 2003. The unaudited condensed consolidated financial
statements should be read in conjunction with the consolidated December 31, 2002
financial statements and footnotes thereto included in the Company's SEC Form
10-KSB.
Basis of Presentation
---------------------
Telkonet, Inc. (the "Company"), formerly Comstock Coal Company, Inc., was formed
on November 3, 1999 under the laws of the state of Utah. The Company is a
development stage enterprise, as defined by Statement of Financial Accounting
Standards No. 7 ("SFAS 7") and is seeking to develop, produce and market
proprietary equipment enabling the transmission of voice and data over electric
utility lines. From its inception through the date of these financial
statements, the Company has recognized no revenues and has incurred significant
operating expenses.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Telkonet Communications, Inc. Significant
intercompany transactions have been eliminated in consolidation.
Reclassification
----------------
Certain reclassifications have been made to conform to prior periods' data to
the current presentation. These reclassifications had no effect on reported
losses.
Concentrations of Credit Risk
-----------------------------
Financial instruments and related items, which potentially subject the Company
to concentrations of credit risk, consist primarily of cash, cash equivalents.
The Company places its cash and temporary cash investments with credit quality
institutions. At times, such investments may be in excess of the FDIC insurance
limit.
Stock Based Compensation
------------------------
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS 123." This statement
amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in APB
Opinion No. 25 and related interpretations. Accordingly, compensation expense
for stock options is measured as
F-10
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE A - SUMMARY OF ACCOUNTING POLICIES
---------------------------------------
Stock Based Compensation (Continued)
------------------------------------
the excess, if any, of the fair market value of the Company's stock at the date
of the grant over the exercise price of the related option. The Company has
adopted the annual disclosure provisions of SFAS No. 148 in its financial
reports for the year ended December 31, 2002 and for the quarter ended June 30,
2003.
Had compensation costs for the Company's stock options been determined based on
the fair value at the grant dates for the awards, the Company's net loss and
losses per share would have been as follows (transactions involving stock
options issued to employees and Black-Scholes model assumptions are presented in
Note D):
For the three months ended For the six months ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Net loss - as reported $(2,018,972) $ (829,031) $(3,459,715) $(1,475,134)
Add: Total stock based employee compensation
expense as reported under intrinsic value method
(APB. No. 25) -- -- -- --
Deduct: Total stock based employee compensation
expense as reported under fair value based method
(SFAS No. 123) (1,129,199) (52,708) (1,291,134) (105,416)
------------ ------------ ------------ ------------
Net loss - Pro Forma $(3,148,171) $ (881,739) $(4,750,849) $(1,580,550)
Net loss attributable to common stockholders - Pro
Forma $(3,148,171) $ (881,739) $(4,750,849) $(1,580,550)
Basic (and assuming dilution) loss per share - as
reported $ (0.13) $ (0.06) $ (0.22) $ (0.09)
Basic (and assuming dilution) loss per share - Pro
forma $ (0.20) $ (0.06) $ (0.30) $ (0.09)
New Accounting Pronouncements
-----------------------------
In April 2003, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES. SFAS 149 amends SFAS No. 133 to provide clarification on the
financial accounting and reporting of derivative instruments and hedging
activities and requires that contracts with similar characteristics be accounted
for on a comparable basis. The provisions of SFAS 149 are effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 will not
have a material impact on the Company's results of operations or financial
position.
F-11
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE A - SUMMARY OF ACCOUNTING POLICIES
---------------------------------------
New Accounting Pronouncements (Continued)
-----------------------------------------
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY. SFAS 150
establishes standards on the classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. The provisions
of SFAS 150 are effective for financial instruments entered into or modified
after May 31, 2003 and to all other instruments that exist as of the beginning
of the first interim financial reporting period beginning after June 15, 2003.
The adoption of SFAS 150 will not have a material impact on the Company's
results of operations or financial position.
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE
A summary of convertible promissory notes payable at June 30, 2003 and December
31, 2002 is as follows:
June 30, 2003 December 31, 2002
Convertible notes payable ("Debenture-1"), in quarterly
installments of interest only at 8% per annum, unsecured and
due three years from the date of the note with the latest
maturity May 2005; Noteholder has the option to convert
unpaid note principal together with accrued and unpaid interest
to the Company's common stock at a rate of $.50 per
share six months after issuance $ 1,669,100 $ 1,689,100
Debt Discount - beneficial conversion feature, net
of accumulated amortization of $787,014 and
$531,858 at June 30, 2003 and December 31, 2002,
respectively (743,878) (999,034)
Debt Discount - value attributable to warrants
attached to notes, net of accumulated amortization
of $69,428 and $47,216 at June 30, 2003 and
December 31, 2002, respectively (63,908) (86,120)
------------ ------------
861,314 603,946
Convertible notes payable ("Series B Debenture"), in quarterly
installments of interest only at 8% per annum, unsecured and
due three years from the date of the note with the latest
maturity February 2006; Noteholder has the option to convert
unpaid note principal together with accrued and unpaid interest
to the Company's common stock at a rate of $.55 per share six
months after issuance 2,500,000 472,900
Debt Discount - beneficial conversion feature, net
of accumulated amortization of $284,833 and $1,564
at June 30, 2003 and December 31, 2002, respectively (1,624,702) (146,295)
Debt Discount - value attributable to warrants
attached to notes, net of accumulated amortization
of $51,128 and $726 at June 30, 2003 and December
31, 2002, respectively (282,892) (67,869)
------------ ------------
592,406 258,736
------------ ------------
Total $ 1,453,720 $ 862,682
Less: current portion -- --
------------ ------------
$ 1,453,720 $ 862,682
============ ============
F-12
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE
Convertible Debentures
----------------------
During the year ended December 31, 2001, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $940,000, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of
November 2004. Noteholder has the option to convert any unpaid note principal
together with accrued and unpaid interest to the Company's common stock at a
rate of $.50 per share six months after issuance. In accordance with EMERGING
ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR CONVERTIBLE SECURITIES WITH A
BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY ADJUSTABLE CONVERSION RATIOS
("EITF 98-5"), the Company recognized an imbedded beneficial conversion feature
present in the Debenture-1 note. The Company allocated a portion of the proceeds
equal to the intrinsic value of that feature to additional paid in capital. The
Company recognized and measured an aggregate of $837,874 of the proceeds, which
is equal to the intrinsic value of the imbedded beneficial conversion feature,
to additional paid in capital and a discount against the Debenture-1. The debt
discount attributed to the beneficial conversion feature is amortized over the
Debenture-1's maturity period (three years) as interest expense.
In connection with the placement of the Debenture-1 notes, the Company issued
non-detachable warrants granting the holders the right to acquire 940,000 shares
of the Company's common stock at $1.00 per share. In accordance with EMERGING
ISSUES TASK FORCE ISSUE 00-27, APPLICATION OF ISSUE NO. 98-5 TO CERTAIN
CONVERTIBLE INSTRUMENTS ("EITF - 0027"), the Company recognized the value
attributable to the warrants in the amount of $77,254 to additional paid in
capital and a discount against the Debenture-1. The Company valued the warrants
in accordance with EITF 00-27 using the Black-Scholes pricing model and the
following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.25%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.
During the year ended December 31, 2002, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $749,100, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of May
2005. Noteholders have the option to convert any unpaid note principal together
with accrued and unpaid interest to the Company's common stock at a rate of $.50
per share six months after issuance.
In accordance with EMERGING ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR
CONVERTIBLE SECURITIES WITH A BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY
ADJUSTABLE CONVERSION RATIOS ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Debenture-1 note. The Company
allocated a portion of the proceeds equal to the intrinsic value of that feature
to additional paid in capital. The Company recognized and measured an aggregate
of $693,018 of the proceeds, which is equal to the intrinsic value of the
imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Debenture-1. The debt discount attributed to the beneficial
conversion feature is amortized over the Debenture-1's maturity period (three
years) as interest expense.
F-13
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE
Convertible Debentures (Continued)
----------------------------------
In connection with the placement of the Debenture-1 notes in 2002, the Company
issued non-detachable warrants granting the holders the right to acquire 749,100
shares of the Company's common stock at $1.00 per share. In accordance with
EMERGING ISSUES TASK FORCE ISSUE 00-27, APPLICATION OF ISSUE NO. 98-5 TO CERTAIN
CONVERTIBLE INSTRUMENTS ("EITF -0027"), the Company recognized the value
attributable to the warrants in the amount of $56,082 to additional paid in
capital and a discount against the Debenture-1. The Company valued the warrants
in accordance with EITF 00-27 using the Black-Scholes pricing model and the
following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.67%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.
Series B Debentures
-------------------
In October and December 2002, the Company issued convertible promissory notes
(the "Series B Debenture") to Company officers, shareholders, and sophisticated
investors in exchange for $472,900, exclusive of placement costs and fees. The
Series B Debenture accrues interest at 8% per annum and is payable and due three
years from the date of the note with the latest maturity date of December 2005.
Noteholders have the option to convert any unpaid note principal together with
accrued and unpaid interest to the Company's common stock at a rate of $.55 per
share six months after issuance.
In accordance with EMERGING ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR
CONVERTIBLE SECURITIES WITH A BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY
ADJUSTABLE CONVERSION RATIOS ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Series B Debenture note. The
Company allocated a portion of the proceeds equal to the intrinsic value of that
feature to additional paid in capital. The Company recognized and measured an
aggregate of $147,859 of the proceeds, which is equal to the intrinsic value of
the imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Series B Debenture. The debt discount attributed to the
beneficial conversion feature is amortized over the Series B Debenture's
maturity period (three years) as interest expense.
In connection with the placement of the Series B Debenture notes in 2002, the
Company issued non-detachable warrants granting the holders the right to acquire
472,900 shares of the Company's common stock at $1.00 per share. In accordance
with EMERGING ISSUES TASK FORCE ISSUE 00-27, APPLICATION OF ISSUE NO. 98-5 TO
CERTAIN CONVERTIBLE INSTRUMENTS ("EITF -0027"), the Company recognized the value
attributable to the warrants in the amount of $68,595 to additional paid in
capital and a discount against the Series B Debenture. The Company valued the
warrants in accordance with EITF 00-27 using the Black-Scholes pricing model and
the following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.67%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Series B Debenture's maturity period (three years) as interest expense.
In January and February 2003, the Company issued convertible promissory notes
(the "Series B Debenture") to Company officers, shareholders, and sophisticated
investors in exchange for $2,027,100, exclusive of placement costs and fees. The
Series B Debenture accrues interest at 8% per annum and is payable and due three
years from the date of the note with the latest maturity date of February 2006.
Noteholders have the option to convert any unpaid note principal together with
accrued and unpaid interest to the Company's common stock at a rate of $.55 per
share six months after issuance.
F-14
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE
Series B Debentures (Continued)
-------------------------------
In accordance with EMERGING ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR
CONVERTIBLE SECURITIES WITH A BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY
ADJUSTABLE CONVERSION RATIOS ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Series B Debenture note. The
Company allocated a portion of the proceeds equal to the intrinsic value of that
feature to additional paid in capital. The Company recognized and measured an
aggregate of $1,761,675 of the proceeds, which is equal to the intrinsic value
of the imbedded beneficial conversion feature, to additional paid in capital and
a discount against the Series B Debenture. The debt discount attributed to the
beneficial conversion feature is amortized over the Series B Debenture's
maturity period (three years) as interest expense.
In connection with the placement of the Series B Debenture notes in January and
February 2003, the Company issued non-detachable warrants granting the holders
the right to acquire 2,027,100 shares of the Company's common stock at $1.00 per
share. In accordance with EMERGING ISSUES TASK FORCE ISSUE 00-27, APPLICATION OF
ISSUE NO. 98-5 TO CERTAIN CONVERTIBLE INSTRUMENTS ("EITF -0027"), the Company
recognized the value attributable to the warrants in the amount of $265,425 to
additional paid in capital and a discount against the Series B Debenture. The
Company valued the warrants in accordance with EITF 00-27 using the
Black-Scholes pricing model and the following assumptions: contractual terms of
3 years, an average risk free interest rate of 1.25%, a dividend yield of 0%,
and volatility of 26%. The debt discount attributed to the value of the warrants
issued is amortized over the Series B Debenture's maturity period (three years)
as interest expense.
The Company amortized the Debenture 1 and the Series B Debenture debt discount
attributed to the beneficial conversion feature and the value of the attached
warrants and recorded non-cash interest expense of $611,039 and $200,377 for the
six month ended June 30, 2003 and 2002, respectively.
NOTE C - SENIOR NOTES PAYABLE
In April, May and June 2003, the Company issued Senior Note to Company officers,
shareholders, and sophisticated investors in exchange for $5,000,000, exclusive
of placement costs and fees. The Senior Note is in units of $100,000, in
quarterly installments of interest at 8% per annum and is due three years from
the date of the note with the latest maturity date of June 2006. Attached to
each unit of the Senior Note are 125,000 warrants to purchase the common stock
of the Company. The warrants have a three-year contractual life and are
exercisable immediately after the issuance of the note at exercise price of
$1.00 per share. The Senior Notes are secured by a first lien priority security
interest in all intellectual property assets of the Company. The Company plans
to use the proceeds from Senior Note for expansion of sales, marketing and
strategic partnership programs, build of required infrastructure and as working
capital.
F-15
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE D - STOCK OPTIONS AND WARRANTS
Employee Stock Options
----------------------
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to employees
of the Company under a non-qualified employee stock option plan.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighted
Number Remaining Contractual Weighted Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$ 1.00 6,775,000 9.19 $ 1.00 1,769,935 $ 1.00
$ 1.51 200,000 9.75 $ 1.51 16,667 $ 1.51
$ 2.35 465,000 9.75 $ 2.35 38,751 $ 2.35
$ 3.43 25,000 9.75 $ 3.43 2,083 $ 3.43
---------------- -------- ----------- --------- -------
7,465,000 9.27 $ 1.11 1,827,436 $ 1.04
================ ======== =========== ========= =======
Transactions involving stock options issued to employees are summarized as
follows:
Weighted Average
Number of Shares Price Per Share
---------------- ---------------
Outstanding at January 1, 2001 840,000 --
Granted 215,000 $ 1.00
Exercised -- --
Canceled or expired -- --
----------- ---------
Outstanding at December 31, 2001 1,055,000 1.00
----------- ---------
Granted 2,835,000 1.00
Exercised (1,000,000) 1.00
Canceled or expired (1,440,000) 1.00
----------- ---------
Outstanding at December 31, 2002 1,450,000 $ 1.00
----------- ---------
Granted 6,098,333 1.11
Exercised (83,333) 1.00
Canceled or expired -- --
----------- ---------
Outstanding at June 30, 2003 7,465,000 $ 1.11
=========== =========
The weighted-average fair value of stock options granted to employees during the
period ended June 30, 2003 and 2002 and the weighted-average significant
assumptions used to determine those fair values, using a Black-Scholes option
pricing model are as follows:
2003 2002
---- ----
Significant assumptions (weighted-average):
Risk-free interest rate at grant date 1.25% 1.67 %
Expected stock price volatility 26% 26 %
Expected dividend payout - -
Expected option life-years (a) 10 10
(a) The expected option life is based on contractual expiration dates.
F-16
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE D - STOCK OPTIONS AND WARRANTS
Employee Stock Options (Continued
---------------------------------
If the Company recognized compensation cost for the non-qualified employee stock
option plan in accordance with SFAS No. 123, the Company's pro forma net loss
and net loss per share would have been $(4,750,849) and $(0.30) for the period
ended June 30, 2003 and $(1,580,550) and $(0.09) for the period ended June 30,
2002, respectively.
Non-Employee Stock Options
--------------------------
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to the
Company consultants. These options were granted in lieu of cash compensation for
services performed.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighted
Number Remaining Contractual Weighed Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$ 1.00 2,871,667 9.18 $ 1.00 1,598,750 $ 1.00
Transactions involving options issued to non-employees are summarized as
follows:
Weighted Average
Number of Shares Price Per Share
---------------- ---------------
Outstanding at January 1, 2001 246,502 $ 0.70
Granted -- --
Exercised -- --
Canceled or expired -- --
----------- ---------
Outstanding at December 31, 2001 246,502 0.70
----------- ---------
Granted 2,455,000 1.00
Exercised (1,146,502) 0.96
Canceled or expired -- --
----------- ---------
Outstanding at December 31, 2002 1,555,000 $ 1.00
----------- ---------
Granted 1,400,000 1.00
Exercised (83,333) 1.00
Canceled or expired -- --
----------- ---------
Outstanding at June 30, 2003 2,871,667 $ 1.00
=========== =========
The estimated value of the options granted to consultants during the period
ended June 30, 2003 was determined using the Black-Scholes option pricing model
and the following assumptions: contractual term of 10 years, a risk free
interest rate of 1.25%, a dividend yield of 0% and volatility of 26%. The amount
of the expense charged to operations in connection with granting the options was
$286,904 and $226,230 during the period June 30, 2003 and 2002, respectively.
F-17
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE D - STOCK OPTIONS AND WARRANTS
Warrants
--------
The following table summarizes the changes in warrants outstanding and the
related prices for the shares of the Company's common stock issued to
non-employees of the Company. These warrants were granted in lieu of cash
compensation for services performed or financing expenses and in connection with
placement of convertible debentures.
Warrants Outstanding Warrants Exercisable
-------------------- --------------------
Weighted Average Weighed Weighted
Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$ .50 815,000 8.00 $ .50 815,000 $ .50
$ .53 354,460 3.00 $ .53 354,460 $ .53
$ .66 229,700 3.00 $ .66 229,700 $ .66
$ 1.00 10,639,100 3.00 $ 1.00 10,639,100 $ 1.00
$ 2.54 50,000 3.00 $ 2.54 50,000 $ 2.54
$ 2.97 35,000 3.00 $ 2.97 35,000 $ 2.97
------ ---- --------- ------------ ---------
12,123,260 3.34 $ 0.96 12,123,260 $ 0.96
========== ==== ========= ============ =========
Transactions involving warrants are summarized as follows:
Weighted Average
Number of Shares Price Per Share
---------------- ---------------
Outstanding at January 1, 2001 1,210,572 $ 1.00
Granted 3,528,665 0.67
Exercised -- --
Canceled or expired (1,210,572) 1.00
------------ ---------
Outstanding at December 31, 2001 3,528,665 $ 0.67
------------ ---------
Granted 1,667,460 0.87
Exercised (1,650,675) 0.51
Canceled or expired (13,990) 1.00
------------ ---------
Outstanding at December 31, 2002 3,531,460 $ 0.84
------------ ---------
Granted 8,591,800 1.01
Exercised -- --
Canceled or expired -- --
------------ ---------
Outstanding at June 30, 2003 12,123,260 $ 0.96
============ =========
The estimated value of the compensatory warrants granted to non-employees in
exchange for services and financing expenses during the period ended June 30,
2003 was determined using the Black-Scholes pricing model and the following
assumptions: contractual term of 3 to 8 years, a risk free interest rate of
1.25%, a dividend yield of 0% and volatility of 26%. The amount of the expense
charged to operations for compensatory warrants granted in exchange for
financing expenses was $0 and $85,620 during the period ended June 30, 2003 and
2002, respectively. The Company also capitalized financing costs of $87,732 and
$39,346 for compensatory warrants granted in connection with placement of
convertible debentures for the period ended June 30, 2003 and 2002,
respectively. The financing cost was amortized over the life (three years) of
the convertible debenture.
F-18
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE E - CAPITAL STOCK
The Company has authorized 15,000,000 shares of preferred stock, with a par
value of $.001 per share. As of June 30, 2003 and December 31, 2002, the Company
has no preferred stock issued and outstanding. The company has authorized
100,000,000 shares of common stock, with a par value of $.001 per share. As of
June 30, 2003 and December 31, 2002, the Company has 15,977,795 and 15,721,131
shares of common stock issued and outstanding, respectively.
In April 2003, the Company issued 40,000 shares of common stock at $0.50 per
share to one of its Debenture-1 noteholder in exchange for $20,000 of conversion
of debts.
In April 2003, the Company issued 49,998 shares of common stock at approximately
$1.54 per share to consultants in exchange for services rendered, which
approximated the fair value of the shares issued during the period the services
were completed and rendered. Compensation costs of $76,745 were charged to
income during the period ended June 30, 2003.
In June 2003, the Company issued 83,333 shares of common stock to an employee in
exchange for exercised employee stock options at $1.00 per share, totaling
$83,333. Additionally, the Company issued 83,333 shares of common stock to a
consultant in exchange for exercised non-employee stock options at $1.00 per
share, totaling $83,333.
Share amounts presented in the consolidated balance sheets and consolidated
statements of stockholders' equity reflect the actual share amounts outstanding
for each period presented.
NOTE F - RESTATEMENT OF FINANCIAL STATEMENTS
The Company has restated its financial statements for the year ended December
31, 2001 and for the period ended June 30, 2002 to correct the following errors
in the financial statements previously filed:
o For the year ended December 31, 2001, the Company erroneously
recorded the Black-Scholes value of the 940,000 warrants
attached to its convertible debentures as an asset (financing
cost), and amortized over the maturity period (three year) of
the note.
o For the year ended December 31, 2001, the Company erroneously
recorded the beneficial conversion feature of its convertible
debentures as an asset (financing cost) and the beneficial
conversion feature was erroneously amortized over six-months
(from the issuance of the note to the earliest conversion
date).
o For the year ended December 31, 2001, the Company erroneously
recorded impairment of property and equipment as research and
development expense.
o For the period ended June 30, 2002, the Company erroneously
did not record and amortize the beneficial conversion feature
of its convertible debentures and value of warrants attached
to the convertible debentures.
F-19
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE F - RESTATEMENT OF FINANCIAL STATEMENTS
The net effect of the correction of these errors was to:
o Decrease the Company's reported net loss for the year ended
December 31, 2001 by $289,645 from $(2,006,140) to
$(1,716,495). Increase the Company's reported net loss for the
period June 30, 2002 by $231,830 from $(1,243,304) to
$(1,475,134).
o Decrease the loss per share for the year ended December 31,
2001 by $.01 from $(.09) to $(.08) per share. Increase the
loss per share for the period ended June 30, 2002 by $.02 from
$(.07) to $(.09) per share.
o Decrease the deficiency accumulated during the development
stage from November 3, 1999 to June 30, 2002, by $57,815 from
$(4,213,137) to $(4,155,322).
o Decrease other assets (financing costs) as of June 30, 2002,
by $507,728 from $628,525 to $120,797.
o Increase debt discount as of June 30, 2002, by $1,362,523 from
$0 to $1,362,523.
o Increase additional paid in capital as of June 30, 2002, by
$771,979 from $3,466,421 to $4,238,400.
NOTE G - SUBSEQUENT EVENTS
Subsequent to the date of the financial statements, the Debenture-1 Noteholders
(see Note B) put forth to the Company its demand registration request for the
registration of common shares of the Company sufficient to cover the conversion
of their debentures and exercise of the attached warrants. Accordingly, the
Company notified the Series B Debenture Noteholder (Note B), Senior Noteholders
(Note C) and Warrant holders with piggy-back registration rights requesting
their exercise of the warrants; however, the amount of funding cannot be
determined until September 12, 2003 at which time the exercise price is required
to be paid to the Company. In August 2003, the Company issued an aggregate of
7,514,541 shares of common stock in connection with the conversion of
Debenture-1 of $1,517,100 and Series B Debentures of $2,180,000 and the issuance
of common stock related accrued interest of $187,039 and $85,586, respectively.
The pro forma balance sheet below represents the effect of the conversion of the
debentures as if it had occurred as of June 30, 2003.
UNAUDITED PROFORMA ADJUSTMENTS PROFORMA
JUNE 30, 2003 DR. CR. JUNE 30, 2003
ASSETS:
Cash 4,580,779 3,000,000 7,580,779
Other current assets 525,272 525,272
---------------- ------------------------- ------------------
Total current assets 5,106,051 3,000,000 8,106,051
Other assets 323,893 323,893
---------------- ------------------------- ------------------
Total Assets 5,429,945 3,000,000 8,429,945
================ ========================= ==================
LIABILITIES & SHAREHOLDERS EQUITY:
Current liabilities 1,297,829 272,625 - 1,025,204
Convertible debentures - net of
discounts 1,453,720 1,453,720 -
Senior notes 5,000,000 5,000,000
Shareholders' (deficiency) equity (2,321,604) 4,726,345 2,404,741
---------------- ------------------------- ------------------
Total liabilities & shareholders'
equity 5,429,945 1,726,345 4,726,345 8,429,945
================ ========================= ==================
NOTES TO PROFORMA BALANCE SHEET:
(1) Conversion of convertible debentures.
(2) Assumes 30% exercise warrants.
(3) Stock issuance for debenture interest.
F-20
RUSSELL BEDFORD STEFANOU MIRCHANDANI LLP
CERTIFIED PUBLIC ACCOUNTANTS
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------
Board of Directors
Telkonet, Inc.
Annapolis, MD
We have audited the accompanying consolidated balance sheets of
Telkonet, Inc. and its wholly-owned subsidiary (the "Company"), a development
stage company, as of December 31, 2002 and 2001 and the related consolidated
statements of losses, deficiency in stockholders' equity, and cash flows for the
years ended December 31, 2002 and 2001 and for the period November 3, 1999 (date
of inception) to December 31, 2002. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based upon our audit.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatements. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Telkonet, Inc. and
its wholly-owned subsidiary as of December 31, 2002 and 2001, and the results of
its operations and its cash flows for the two years then ended, and from
November 3, 1999 (date of inception), to December 31, 2002, in conformity with
accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As shown in the financial
statements, the Company has incurred net losses since its inception. This raises
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to this matter are described in Note K. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
As discussed in Note L, the Company restated its Consolidated Balance
Sheet as of December 31, 2001, and the related Statements of Losses, Deficiency
in Stockholders' Equity and Cash Flows for the year ended December 31, 2001 and
the period November 3, 1999 (date of Inception) to December 31, 2001.
/s/ RUSSELL BEDFORD STEFANOU MIRCHANDANI LLP
--------------------------------------------
Russell Bedford Stefanou Mirchandani LLP
Certified Public Accountants
McLean, Virginia
February 27, 2003
F-21
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
2002 (As Restated -
Note L)
2001
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 18,827 $ 21,885
Inventory, net (Note A) 39,790 --
Other receivable 1,550 --
Prepaid expenses and deposits 4,625 --
Total current assets 64,792 21,885
PROPERTY AND EQUIPMENT (Note B):
Furniture and equipment, at cost 73,215 54,950
Less: accumulated depreciation 35,252 28,108
37,963 26,842
OTHER ASSETS:
Financing costs, less accumulated amortization of $76,923 and
$24,769 at December 31, 2002 and 2001, respectively 192,600 183,049
Prepaid expenses and deposits -- 4,625
192,600 187,674
$ 295,355 $ 236,401
============ ============
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 518,865 $ 116,741
Notes payable (Note D) 310,000 400,000
Due to shareholders (Note C) 130,330 7,500
Total current liabilities 959,195 524,241
Convertible debentures, net of discounts - including related
parties (Note E) 862,682 126,200
COMMITMENTS AND CONTINGENCIES (Note I) -- --
DEFICIENCY IN STOCKHOLDERS' EQUITY (Note F)
Preferred stock, par value $.001 per share; 15,000,000 shares authorized;
none issued and outstanding at December 31, 2002
and 2001 -- --
Common stock, par value $.001 per share; 100,000,000 shares
authorized; 15,721,131 and 22,115,371 shares issued and
outstanding at December 31, 2002 and 2001, respectively 15,721 22,115
Additional paid-in-capital 4,916,433 2,244,033
Accumulated deficit during development stage (6,458,676) (2,680,188)
Deficiency in stockholders' equity (1,526,522) (414,040)
$ 295,355 $ 236,401
============ ============
See accompanying notes to consolidated financial statements
F-22
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF LOSSES
For the period from
For the Year For the Year November 3, 1999
Ended Ended (date of
December 31, December 31, inception) through
2002 2001 December 31, 2002
(As restated - (As restated -
Note L) Note L)
------------- ------------- -------------
Cost and expenses:
Research and development $ 280,450 $ 120,828 $ 520,278
Selling, general and administrative 2,790,819 1,386,222 4,984,078
Impairment of property and equipment
(Note B) -- 39,287 39,287
Depreciation and amortization 84,067 30,797 136,944
Total operating expense 3,155,336 1,577,134 5,680,587
Loss from operations (3,155,336) (1,577,134) (5,680,587)
Other income 3,322 1,257 4,579
Interest income (expense) (626,474) (140,618) (782,668)
Provision for income tax -- -- --
(623,152) (139,361) (778,089)
Net loss $ (3,778,488) $ (1,716,495) $ (6,458,676)
============= ============= =============
Loss per common share (basic and assuming
dilution) (Note J) $ (0.22) $ (0.08) $ (0.40)
============= ============= =============
Weighted average common shares outstanding 17,119,639 21,974,439 16,050,030
See accompanying notes to consolidated financial statements
F-23
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2002
Deficit
Accumulated
Preferred Common Additional Common During
Preferred Stock Stock Paid in Stock Development
Shares Amount Common Shares Amount Capital Subscription Stage Total
Net Loss -- $ -- -- $ -- $ -- $ -- $ (33,973) $ (33,973)
-------- ------- ----------- --------- --------- ------- ---------- ----------
Balance at December 31, 1999 -- -- -- -- -- -- (33,973) (33,973)
Shares issued to founders
January 2000, in exchange
for services and costs
valued at $ 0.60 per share -- -- 19,300 193 11,387 -- -- 11,580
Shares issued in June 2000,
for cash in connection with
private placement at $375
per share, net of costs -- -- 1,735 17 644,219 -- -- 644,236
Shares issued in July 2000,
for warrants exercised at a
price of $375 per share -- -- 190 -- 71,250 -- -- 71,250
Shares issued in August 2000,
in connection with the merger
of Comstock Coal and Telkonet
Communications, Inc -- -- 21,775,335 21,775 -- -- -- 21,775
August 2000, retirement of
Telkonet Communications, Inc
shares -- -- (21,225) (210) -- -- -- (210)
Shares issued in October 2000,
in exchange for warrants
exercised at a price of $1
per share -- -- 29,145 29 29,115 -- -- 29,144
Shares issued in October 2000,
in exchange for warrants
exercised at a price of $0.40
per share -- -- 10,891 11 4,345 -- -- 4,356
Net loss -- -- -- -- -- -- (929,720) (929,720)
BALANCE AT DECEMBER 31, 2000 -- $ -- 21,815,371 $ 21,815 $760,316 $ -- $(963,693) $(181,562)
-------- ------- ----------- --------- --------- ------- ---------- ----------
Shares issued in June 2001, for
cash in connection with a private
placement, shares issued at $.50 a
share, net of costs -- -- 260,000 260 129,740 -- -- 130,000
F-24
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2002
1,839,378 warrants issued in
June 2001, valued at $0.13 per
warrant, in exchange for services -- -- -- -- 237,035 -- -- 237,035
72,668 stock options issued in
June 2001, valued at $ 0.09 per
stock option, in exchange for
services -- -- -- -- 6,375 -- -- 6,375
245,287 warrants issued in July
2001, valued at $0.08 per warrant,
in exchange for services -- -- -- -- 18,568 -- -- 18,568
36,917 stock options issued in
July 2001, valued at $ 0.08 per
warrant, in exchange for services -- -- -- -- 2,795 -- -- 2,795
Shares issued in August 2001, for
cash in connection with a private
placement, shares issued at $.50
a share, net of costs -- -- 40,000 40 19,960 -- -- 20,000
241,000 warrants issued in August
2001, valued at $ 0.39 per warrant
in exchange for financing costs -- -- -- -- 85,818 -- -- 85,818
150,000 warrants issued in August
2001, valued at $ 0.16 per warrant,
in exchange for services -- -- -- -- 23,340 -- -- 23,340
36,917 stock options issued in
August 2001, valued at $ 0.06 per
stock option, in exchange for services -- -- -- -- 2,422 -- -- 2,422
25,000 warrants issued in September
2001, valued at $0.30 per warrant in
exchange for services -- -- -- -- 7,380 -- -- 7,380
95,000 warrants issued in October
2001, valued at $ 0.21 per warrant,
in exchange for services -- -- -- -- 19,558 -- -- 19,558
25,000 warrants issued in November
2001, valued at $ 0.33 per warrant,
in exchange for services -- -- -- -- 8,218 -- -- 8,218
F-25
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2002
25,000 warrants issued in December
2001, valued at $ 0.30 per warrant,
in exchange for services -- -- -- -- 7,380 -- -- 7,380
Beneficial conversion feature of
convertible debentures (Note E) -- -- -- -- 837,874 -- -- 837,874
Value of warrants attached to
convertible debentures (Note E) -- -- -- -- 77,254 -- -- 77,254
Net loss -- -- -- -- -- -- (1,716,495) (1,716,495)
-------- ------- ----------- -------- ----------- ------- ------------ ------------
BALANCE AT DECEMBER 31, 2001
(AS RESTATED- NOTE L) -- $ -- 22,115,371 $22,115 $2,244,033 $ -- $(2,680,188) $ (414,040)
======== ======= =========== ======== =========== ======= ============ ============
Balance Forward -- $ -- 22,115,371 $ 22,115 $ 2,244,033 $ -- $(2,680,188) $ (414,040)
Shares issued in February 2002,
in exchange for convertible
debentures interest, at $.50
per share -- -- 43,586 44 21,749 -- -- 21,793
Shares issued in March 2002,
to a founder in exchange for
shares canceled -- -- 5,250,000 5,250 (5,250) -- -- --
Shares canceled in March 2002
in connection with capital
restructure -- -- (13,480,961) (13,481) 13,481 -- -- --
Shares issued in June 2002,
for warrants exercised at $1.00
per share for services rendered -- -- 47,906 48 47,857 -- -- 47,906
Shares issued in June 2002, for
warrants exercised at $.40 per
share for services rendered -- -- 26,443 26 10,551 -- -- 10,577
Shares issued in June 2002 to
founders, for options exercised
at $1.00 per share -- -- 1,000,000 1,000 999,000 -- -- 1,000,000
Shares issued in June 2002, for
warrants exercised at $1.0025
per share, for services rendered -- -- 80,039 80 80,158 -- -- 80,238
Shares issued in June 2002, for
warrants exercised at $.41, in
connection with original private
placement -- -- 189,327 189 77,720 -- -- 77,910
Shares issued in July 2002, for
warrants exercised at $.40, in
connection with original private
placement -- -- 41,970 42 16,830 -- -- 16,872
F-26
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2002
Shares issued in July 2002 to
founders, for options exercised
at $1.00 per share -- -- 1,000,000 1,000 999,000 -- -- 1,000,000
Shares issued in August 2002,
for warrants exercised at $.43,
in connection with original
private placement -- -- 542,500 543 232,459 -- -- 233,001
Shares issued in August 2002,
for warrants exercised at $.40,
in connection with original
private placement -- -- 193,302 193 77,127 -- -- 77,320
Shares issued in October 2002,
for warrants exercised at $.40,
in connection with original
private placement -- -- 77,048 77 30,896 -- -- 30,973
Shares issued in October 2002,
for warrants exercised at $0.50
per share in connection with
original private placement -- -- 400,000 400 199,600 -- -- 200,000
Common stock subscription -- -- -- -- -- (1,805,400) -- (1,805,400)
Return of founders shares in
connection with stock subscription -- -- (1,805,400) (1,805) (1,803,595) 1,805,400 -- --
Stock based compensation for the
issuance of stock options to
consultants in exchange for
services (Note G) -- -- -- -- 452,459 -- -- 452,459
Stock based compensation for the
issuance of warrants to consultants
in exchange for services (Note G) -- -- -- -- 170,330 -- -- 170,330
Stock based compensation for the
issuance of warrants to consultants
in exchange for financing costs
(Note G) -- -- -- -- 86,474 -- -- 86,474
Beneficial conversion feature of
convertible debentures (Note E) -- -- -- -- 840,877 -- -- 840,877
Value of warrants attached to
convertible debentures (Note E) -- -- -- -- 124,677 -- -- 124,677
F-27
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2002
Net Loss -- -- -- -- -- -- (3,778,488) (3,778,488)
---------- ----------- ----------- ----------- ----------- ----------- ------------ ------------
BALANCE AT DECEMBER 31, 2002 -- $ -- 15,721,131 $ 15,721 $ 4,916,433 $ -- $(6,458,676) $(1,526,522)
========== =========== =========== =========== =========== =========== ============ ============
See accompanying notes to consolidated financial statements
F-28
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year For the Period
Ended November 3, 1999
For the Year December 31, (Date of Inception)
Ended 2001 to
December 31, (As Restated December 31, 2002
2002 - Note L) (As Restated - Note L)
------------ ------------- ----------------------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from development stage operations $(3,778,488) $(1,716,495) $(6,458,676)
Adjustments to reconcile net loss from development stage
operations to cash used for operating activities -- -- --
Amortization of debt discount - beneficial conversion
feature of convertible debentures (Note E) 440,646 92,776 533,422
Amortization of debt discount - value of warrants
attached to convertible debentures (Note E) 39,390 8,552 47,942
Stock options and warrants issued in exchange for
services (Note G) 622,790 333,072 955,862
Common stock issued in exchange for services rendered
(Note F) 138,722 -- 150,302
Common stock issued in exchange for debenture interest
(Note F) 21,793 -- 21,793
Impairment of property and equipment, net (Note B) -- 39,287 39,287
Depreciation and amortization 84,067 30,797 136,944
Increase (decrease) in:
Other receivable (1,550) -- (1,550)
Inventory (39,790) -- (39,790)
Deposits -- -- (4,625)
Accounts payable and accrued expenses, net 402,124 (136,846) 518,864
NET CASH USED BY OPERATING ACTIVITIES (2,070,296) (1,348,857) (4,100,225)
CASH FLOWS USED IN INVESTING ACTIVITIES:
Capital expenditures, net (18,265) (5,208) (112,502)
NET CASH USED IN INVESTING ACTIVITIES (18,265) (5,208) (112,502)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net of costs 830,673 150,000 1,751,224
Proceeds from (repayments to) stockholder advances 122,830 (2,500) 130,330
Proceeds from issuance of convertible debentures, net of costs 1,222,000 818,000 2,040,000
Repayment of loans (90,000) -- (90,000)
Proceeds from loans -- 400,000 400,000
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,085,503 1,365,500 4,231,554
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS (3,058) 11,435 18,827
Cash and cash equivalents at the beginning of the period 21,885 10,450 --
Cash and cash equivalents at the end of the period $ 18,827 $ 21,885 $ 18,827
=========== =========== ===========
See accompanying notes to consolidated financial statements
F-29
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Year For the Period
Ended November 3, 1999
For the Year December 31, (Date of Inception)
Ended 2001 to
December 31, (As Restated December 31, 2002
2002 - Note L) (As Restated - Note L)
---------------- ----------------- ---------------------
Supplemental Disclosures of Cash Flow Information:
Cash transaction:
Cash paid during the period for interest $ 30,885 $ 24,965 $ 55,850
Income taxes paid -- -- --
Non-cash transactions:
Issuance of warrants and options for services rendered 622,790 333,072 955,862
Common stock issued in exchange for services rendered 138,722 -- 150,302
Common stock issued in exchange for debenture interest 21,793 -- 21,793
Beneficial conversion feature on convertible debentures 840,877 837,874 1,678,751
Value of warrants attached to convertible debentures 124,677 77,254 201,931
Acquisition:
Assets acquired -- -- 1
Accumulated deficit -- -- 2,643
Liabilities assumed -- -- (2,642)
$ -- $ -- $ 1
See accompanying notes to consolidated financial statements
F-30
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
NOTE A - SUMMARY OF ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation of
the accompanying consolidated financial statements follows.
Business and Basis of Presentation
----------------------------------
Telkonet, Inc. (the "Company"), formerly Comstock Coal Company, Inc., was formed
on November 3, 1999 under the laws of the state of Utah. The Company is a
development stage enterprise, as defined by Statement of Financial Accounting
Standards No. 7 ("SFAS 7") and is seeking to develop, produce and market
proprietary equipment enabling the transmission of voice and data over electric
utility lines. From its inception through the date of these financial statements
the Company has recognized no revenues and has incurred significant operating
expenses.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Telkonet Communications, Inc. Significant
intercompany transactions have been eliminated in consolidation.
Cash and Cash Equivalents
-------------------------
For purposes of the Statements of Cash Flows, the Company considers all highly
liquid debt instruments purchased with a maturity date of three months or less
to be cash equivalents.
Property and Equipment
----------------------
Property and equipment is stated at cost. Depreciation is calculated using the
straight-line method over the estimated useful lives of the assets.
Long-Lived Assets
-----------------
The Company has adopted Statement of Financial Accounting Standards No. 144
("SFAS 144"). The Statement requires that long-lived assets and certain
identifiable intangibles held and used by the Company be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Events relating to recoverability may include
significant unfavorable changes in business conditions, recurring losses, or a
forecasted inability to achieve break-even operating results over an extended
period. The Company evaluates the recoverability of long-lived assets based upon
forecasted undercounted cash flows. Should an impairment in value be indicated,
the carrying value of intangible assets will be adjusted, based on estimates of
future discounted cash flows resulting from the use and ultimate disposition of
the asset. SFAS No. 144 also requires assets to be disposed of be reported at
the lower of the carrying amount or the fair value less costs to sell.
F-31
NOTE A - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Inventories
-----------
Inventories are stated at the lower of cost or market determined by the
first-in, first-out (FIFO) method. Inventories consist of Internet applications,
routers and related products available for sale to distributors and retailers.
Components of inventories as of December 31, 2002 and 2001 are as follows:
2002 2001
---- ----
Finished Goods $ 39,790 $ --
Income Taxes
------------
The Company has implemented the provisions on Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires
that income tax accounts be computed using the liability method. Deferred taxes
are determined based upon the future effects of differences between the
financial reporting and tax reporting bases of assets and liabilities given the
provisions of currently enacted tax laws.
Net Loss Per Common Share
-------------------------
The Company computes earnings per share under Financial Accounting Standard No.
128, "Earnings Per Share" (SFAS 128). Net loss per common share is computed by
dividing net loss by the weighted average number of shares of common stock and
dilutive common stock equivalents outstanding during the year. Dilutive common
stock equivalents consist of shares issuable upon conversion of convertible
preferred shares and the exercise of the Company's stock options and warrants
(calculated using the treasury stock method). During 2002 and 2001, common stock
equivalents are not considered in the calculation of the weighted average number
of common shares outstanding because they would be anti-dilutive, thereby
decreasing the net loss per common share.
Use of Estimates
----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. Accordingly actual results
could differ from those estimates.
Revenue Recognition
-------------------
The Company follows a policy of recognizing revenues as services are rendered or
at the time the product is shipped to or picked up by customers.
Advertising
-----------
The Company follows the policy of charging the costs of advertising to expenses
incurred. The Company incurred no advertising costs during the years ended
December 31, 2002 and 2001, and for the period from November 3, 1999 (date of
inception) to December 31, 2002.
Research and Development
------------------------
The Company accounts for research and development costs in accordance with the
Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 2 ("SFAS 2"), "Accounting for Research and Development Costs.
Under SFAS 2, all research and development costs must be charged to expense as
incurred. Accordingly, internal research and development costs are expenses as
F-32
incurred. Third-party research and developments costs are expenses when the
contracted work has been performed or as milestone results have been achieved.
Company-sponsored research and development costs related to both present and
future products are expenses in the period incurred. Total expenditures on
research and product development for 2002, 2001, and the period from November 3,
1999 (date of inception) to December 31, 2002 were $280,450, $120,828, and
$520,278, respectively.
Liquidity
---------
As shown in the accompanying financial statements, the Company has incurred a
net loss of $6,458,676 from its inception through December 31, 2002. The
Company's current liabilities exceeded its current assets by $894,403 as of
December 31, 2002.
Concentrations of Credit Risk
-----------------------------
Financial instruments and related items, which potentially subject the Company
to concentrations of credit risk, consist primarily of cash, cash equivalents
and related party receivables. The Company places its cash and temporary cash
investments with credit quality institutions. At times, such investments may be
in excess of the FDIC insurance limit. The Company periodically reviews its
trade receivables in determining its allowance for doubtful accounts. The
allowance for doubtful accounts was $0 at December 31, 2002 and 2001.
Comprehensive Income
--------------------
Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "reporting
Comprehensive Income," establishes standards for reporting and displaying of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. Among other disclosures, SFAS
130 requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. The Company does not have any items of comprehensive
income in any of the periods presented.
Stock Based Compensation
------------------------
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS 123." This statement
amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary charge to the fair value based
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in APB
Opinion No. 25 and related interpretations. Accordingly, compensation expense
for stock options is measures as the excess, if any, of the fair market value of
the Company's stock at the date of the grant over the exercise price of the
related option. The Company has adopted the annual disclosure provisions of SFAS
No. 148 in its financial reports for the year ended December 31, 2002 and will
adopt the interim disclosure provisions for its financial reports for the
quarter ended March 31, 2003.
F-33
NOTE A - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Stock Based Compensation (Continued)
------------------------------------
Had compensation costs for the Company's stock options been determined based on
the fair value at the grant dates for the awards, the Company's net loss and
losses per share would have been as follows (transactions involving stock
options issued to employees and Black-Scholes model assumptions are presented in
Note G):
2002 2001
---- ----
Net loss - as reported $ (3,778,488) $ (1,716,495)
Add: Total stock based employee compensation expense as
reported under intrinsic value method (APB. No. 25) -- --
Deduct: Total stock based employee compensation expense as
reported under fair value based method (SFAS No. 123) (210,833) (81,852)
Net loss - Pro forma $ (3,989,321) $ (1,798,347)
Net loss attributable to common stockholders - Pro forma $ (3,989,321) $ (1,798,347)
Basic (and assuming dilution) loss per share - as reported $ (0.22) $ (0.08)
Basic (and assuming dilution) loss per share - Pro forma $ (0.23) $ (0.08)
Segment Information
-------------------
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131") establishes standards for
reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS 131 also establishes
standards for related disclosures about products and services and geographic
areas. Operating segments are identified as components of an enterprise about
which separate discrete financial information is available for evaluation by the
chief operating decision maker, or decision-making group, in making decisions
how to allocate resources and assess performance. The information disclosed
herein materially represents all of the financial information related to the
Company's principal operating segment.
Reclassification
----------------
Certain reclassifications have been made in prior year's financial statements to
conform to classifications used in the current year (see Note L).
New Accounting Pronouncements
-----------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" (SFAS No.
141), and Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets: (SFAS No. 142). The FASB also issued Statement of
Financial Accounting Standards No. 143, "Accounting for Obligations Associated
with the Retirement of Long-Lived Assets" (SFAS No. 143), and Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144) in August and October 2001,
respectively.
SFAS No. 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interest method. The adoption of SFAS No. 141 had no material impact
on the Company's consolidated financial statements.
F-34
NOTE A - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
New Accounting Pronouncements (Continued)
-----------------------------------------
Effective January 1, 2002, the Company adopted SFAS No. 142. Under the new
rules, the Company will no longer amortize goodwill and other intangible assets
with indefinite lives, but such assets will be subject to periodic testing for
impairment. On an annual basis, and when there is reason to suspect that their
values have been diminished or impaired, these assets must be tested for
impairment, the write-downs to be included in results from operations may be
necessary. SFAS No. 142 also requires the Company to complete a transitional
goodwill impairment test six month from the date of adoption. Any goodwill
impairment loss recognized as a result of the transitional goodwill impairment
test will be recorded as a cumulative effect of a change in accounting principle
no later than the end of fiscal year 2002. The adoption of SFAS No. 142 had no
material impact on the Company's consolidated financial statements
SFAS No. 143 establishes accounting standards for the recognition and
measurement of an asset retirement obligation and its associated asset
retirement cost. It also provides accounting guidance for legal obligations
associated with the retirement of tangible long-lived assets. SFAS No. 143 is
effective in fiscal years beginning after June 15, 2002, with early adoption
permitted. The Company expects that the provisions of SFAS No. 143 will not have
a material impact on its consolidated results of operations and financial
position upon adoption. The Company plans to adopt SFAS No. 143 effective
January 1, 2003.
SFAS No. 144 establishes a single accounting model for the impairment or
disposal of long-lived assets, including discontinued operations. SFAS No. 144
superseded Statement of Financial Accounting Standards No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
(SFAS No. 121), and APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." The Company adopted
SFAS No. 144 effective January 1, 2002. The adoption of SFAS No. 144 had no
material impact on Company's consolidated financial statements.
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This
Statement rescinds FASB Statement No. 4, "Reporting Gains and Losses from
Extinguishment of Debt", and an amendment of that Statement, FASB Statement No.
64, "Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements" and FASB
Statement No. 44, "Accounting for Intangible Assets of Motor Carriers." This
Statement amends FASB Statement No. 13, "Accounting for Leases," to eliminate an
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. The Company does not
expect the adoption to have a material impact to the Company's financial
position or results of operations. In June 2002, the FASB issued Statement No.
146, "Accounting for Costs Associated with Exit or Disposal Activities." This
Statement addresses financial accounting and reporting for costs associated with
exit or disposal activities and nullifies Emerging Issues Task Force (EITF Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The provisions of this Statement are effective for exit or
disposal activities that are initiated after December 31, 2002, with early
application encouraged. The Company does not expect the adoption to have a
material impact to the Company's financial position or results of operations.
F-35
NOTE A - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
New Accounting Pronouncements (Continued)
-----------------------------------------
In October 2002, the FASB issued Statement No. 147, "Acquisitions of Certain
Financial Institutions-an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9," which removes acquisitions of financial institutions from
the scope of both Statement 72 and Interpretation 9 and requires that those
transactions be accounted for in accordance with Statements No. 141, Business
Combinations, and No. 142, Goodwill and Other Intangible Assets. In addition,
this Statement amends SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, to include in its scope long-term customer-relationship
intangible assets of financial institutions such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
The requirements relating to acquisitions of financial institutions is effective
for acquisitions for which the date of acquisition is on or after October 1,
2002. The provisions related to accounting for the impairment or disposal of
certain long-term customer-relationship intangible assets are effective on
October 1, 2002. The adoption of this Statement did not have a material impact
to the Company's financial position or results of operations as the Company has
not engaged in either of these activities.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure," which amends FASB Statement No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The transition guidance and annual disclosure provisions of Statement
148 are effective for fiscal years ending after December 15, 2002, with earlier
application permitted in certain circumstances. The interim disclosure
provisions are effective for financial reports containing financial statements
for interim periods beginning after December 15, 2002. The adoption of this
statement did not have a material impact on the Company's financial position or
results of operations as the Company has not elected to change to the fair value
based method of accounting for stock-based employee compensation.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation 46 changes the criteria by which one
company includes another entity in its consolidated financial statements.
Previously, the criteria were based on control through voting interest.
Interpretation 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. A company that consolidates a variable
interest entity is called the primary beneficiary of that entity. The
consolidation requirements of Interpretation 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation requirements
apply to older entities in the first fiscal year or interim period beginning
after June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company does not expect the
adoption to have a material impact to the Company's financial position or
results of operations.
F-36
NOTE B - PROPERTY, PLANT AND EQUIPMENT
The Company's property and equipment at December 31, 2002 and 2001 consists of
the following:
2002 2001
---- ----
Office Equipment $ 58,514 $ 42,005
Office Fixtures and Furniture $ 14,701 $ 12,945
Total 73,215 54,950
Accumulated Depreciation (35,252) (28,108)
$ 37,963 $ 26,842
================= ================
Depreciation expense included as a charge to income amounted to $7,144, $,6,028,
and $35,252 for the year ended December 31, 2002, 2001, and from inception to
December 31, 2002, respectively.
Impairment of Property and Equipment
------------------------------------
During the year ended December 31, 2001, the Company recorded a charge for the
impairment of certain property and equipment held and used by the Company
because the estimated fair value of the assets was less than the carrying value.
Considerable management judgment is necessary to estimate fair value.
Accordingly, actual results could very significantly from managements'
estimates. Based upon the evaluation, the Company recognized as asset impairment
loss of $39,287 or $ (.00) per share during the year ended December 31, 2001.
NOTE C - RELATED PARTY TRANSACTIONS
A company officer has advanced funds to the Company for working capital
purposes. No formal repayment terms or arrangements exist. The net amount of
advances due the officer at December 31, 2002 was $4,830.
Significant shareholders of the Company have advanced funds to the Company for
working capital purposes. The amount of the advances at December 31, 2002 and
2001 is $125,500 and $7,500, respectively. Nor formal repayment terms or
arrangements exist.
F-37
NOTE D - NOTES PAYABLE
Notes payable at December 31, 2002 and 2001 consists of the following:
2002 2001
---- ----
Note payable in monthly installments of interest only at
7.5% per annum, unsecured and guaranteed by a Company shareholder.
Maturity date is in September 2002; the Company paid the debt in
fully in February 2003 $ 60,000 $ 150,000
Note payable in monthly installments of interest only at the
prime lending rate plus 1%, unsecured and guaranteed by a
Company shareholder. The original maturity sate of the
loan was extended from March 2002 to March 2003 250,000 250,000
310,000 400,000
Less: current portion (310,000) (400,000)
$ -- $ --
=============== ===============
NOTE E - CONVERTIBLE PROMISSORY NOTES PAYABLE
A summary of convertible promissory notes payable at December 31, 2002 and 2001
is as follows:
2002 2001
---- ----
Convertible notes payable ("Debenture-1"), in quarterly installments
of interest only at 8% per annum, unsecured and due three years from
the date of the note with the latest maturity May 2005; Noteholder has
the option to convert unpaid note principal together with accrued and
unpaid interest to the Company's common stock at a rate of $.50 per
share six months after issuance $ 1,689,100 $ 940,000
Debt Discount - beneficial conversion feature, net of amortization of
$439,082 in 2002 and $92,776 in 2001 (999,034) (745,098)
Debt Discount - value attributable to warrants attached to notes, net
of amortization of $38,664 in 2002 and $8,552 in 2001 (86,120) (68,702)
603,946 126,200
Convertible notes payable ("Series B Debenture"), in quarterly installments
of interest only 8% per annum, unsecured and due three years from the date
of the note with the latest maturity December 2005; Noteholder has the option
to convert unpaid note principal together with accrued and unpaid interest
to the Company's common stock at a rate of $.55 per share six months after
issuance 472,900 --
Debt Discount - beneficial conversion feature, net of amortization of
$1,564 in 2002 (146,295) --
Debt Discount - value attributable to warrants attached to notes, net
of amortization of $726 (67,869) --
258,736 --
Total $ 862,682 $ 126,200
------------------- ------------------
Less: current portion -- --
$ 862,682 $ 126,200
=================== ==================
F-38
NOTE E - CONVERTIBLE PROMISSORY NOTES PAYABLE (CONTINUED)
Convertible Debentures
----------------------
During the year ended December 31, 2001, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $940,000, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of
November 2004. Noteholder has the option to convert any unpaid note principal
together with accrued and unpaid interest to the Company's common stock at a
rate of $.50 per share six months after issuance. In accordance with Emerging
Issues Task Force Issue 98-5, Accounting for Convertible Securities with a
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios
("EITF 98-5"), the Company recognized an imbedded beneficial conversion feature
present in the Debenture-1 note. The Company allocated a portion of the proceeds
equal to the intrinsic value of that feature to additional paid in capital. The
Company recognized and measured an aggregate of $837,874 of the proceeds, which
is equal to the intrinsic value of the imbedded beneficial conversion feature,
to additional paid in capital and a discount against the Debenture-1. The debt
discount attributed to the beneficial conversion feature is amortized over the
Debenture-1's maturity period (three years) as interest expense.
In connection with the placement of the Debenture-1 notes, the Company issued
non-detachable warrants granting the holders the right to acquire 940,000 shares
of the Company's common stock at $1.00 per share. In accordance with Emerging
Issues Task Force Issue 00-27, Application of Issue No. 98-5 to Certain
Convertible Instruments ("EITF - 0027"), the Company recognized the value
attributable to the warrants in the amount of $77,254 to additional paid in
capital and a discount against the Debenture-1. The Company valued the warrants
in accordance with EITF 00-27 using the Black-Scholes pricing model and the
following assumptions: contractual terms of 3 years, an average risk free
interest rate of 4.25%, a dividend yield of 0%, and volatility of 21%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.
During the year ended December 31, 2002, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $749,100, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of May
2005. Noteholders have the option to convert any unpaid note principal together
with accrued and unpaid interest to the Company's common stock at a rate of $.50
per share six months after issuance.
In accordance with Emerging Issues Task Force Issue 98-5, Accounting for
Convertible Securities with a Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Debenture-1 note. The Company
allocated a portion of the proceeds equal to the intrinsic value of that feature
to additional paid in capital. The Company recognized and measured an aggregate
of $693,018 of the proceeds, which is equal to the intrinsic value of the
imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Debenture-1. The debt discount attributed to the beneficial
conversion feature is amortized over the Debenture-1;s maturity period (three
years) as interest expense.
F-39
NOTE E - CONVERTIBLE PROMISSORY NOTES PAYABLE (CONTINUED)
Convertible Debentures (Continued)
----------------------------------
In connection with the placement of the Debenture-1 notes in 2002, the Company
issued non-detachable warrants granting the holders the right to acquire 749,100
shares of the Company's common stock at $1.00 per share. In accordance with
Emerging Issues Task Force Issue 00-27, Application of Issue No. 98-5 to Certain
Convertible Instruments ("EITF 00-27"), the Company recognized the value
attributable to the warrants in the amount of $56,082 to additional paid in
capital and a discount against the Debenture-1. The Company valued the warrants
in accordance with EITF 00-27 using the Black-Scholes pricing model and the
following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.67%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.
Series B Debentures
-------------------
In October and December 2002, the Company issued convertible promissory notes
(the "Series B Debenture") to Company officers, shareholders, and sophisticated
investors in exchange for $472,900, exclusive of placement costs and fees. The
Series B Debenture accrues interest at 8% per annum and is payable and due three
years from the date of the note with the latest maturity date of December 2005.
Noteholders have the option to convert any unpaid note principal together with
accrued and unpaid interest to the Company's common stock at a rate of $.55 per
share six months after issuance.
In accordance with Emerging Issues Task Force Issue 98-5, Accounting for
Convertible Securities with a Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Series B Debenture note. The
Company allocated a portion of the proceeds equal to the intrinsic value of that
feature to additional paid in capital. The Company recognized and measured an
aggregate of $147,859 of the proceeds, which is equal to the intrinsic value of
the imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Series B Debenture. The debt discount attributed to the
beneficial conversion feature is amortized over the Series B Debenture's
maturity period (three years) as interest expense.
In connection with the placement of the Series B Debenture notes in 2002, the
Company issued non-detachable warrants granting the holders the right to acquire
472,900 shares of the Company's common stock at $1.00 per share. In accordance
with Emerging Issues Task Force Issue 00-27, Application of Issue no. 98-5 to
Certain Convertible Instruments ("EITF -0027"), the Company recognized the value
attributable to the warrants in the amount of $68,595 to additional paid in
capital and a discount against the Series B Debenture. The Company valued the
warrants in accordance with EITF 00-27 using the Black-Scholes pricing model and
the following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.67%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Series B Debenture's maturity period (three years) as interest expense.
The Company amortized the Debenture-1 and the Series B Debenture debt discount
attributed to the beneficial conversion feature and the value of the attached
warrants and recorded non-cash interest expense of $480,036 and $101,328 for the
years ended December 31, 2002 and 2001, respectively.
F-40
NOTE F - CAPITAL STOCK
The Company has authorized 15,000,000 shares of preferred stock, with a par
value of $.001 per share. As of December 31, 2002, the Company has no preferred
stock issued and outstanding. The Company has authorized 100,000,000 shares of
common stock, with a par value of $.001 per share. As of December 31, 2002, the
Company has 15,721,131 shares of common stock issued and outstanding.
In January 2000, the Company issued 19,300 shares to its founders, in exchange
for costs and services, valued at $11,580.
In June 2000, the Company issued a total of 1,735 shares of common stock in a
private placement to sophisticated investors, primarily in the United States in
exchange for $644,236 net of costs and fees. In July 2000 the Predecessor issued
190 shares of common stock in exchange for exercised warrants at $375 per share,
totaling $71,250
In August 2000, the Company issued 21,775,345 shares of common stock in
conjunction with the merger of Comstock Coal Company, Inc. In connection with
the transaction, the Company retired 21,225 shares of previously issued Telkonet
Communications, Inc. common stock.
In October 2000, the Company issued 29,145 and 10,881 shares of common stock in
exchange for exercised warrants with exercise prices of $1.00 and $0.40 per
share, respectively.
In June 2001 and August 2001, the Company issued 260,000 and 40,000 shares of
its common stock, respectively, in a private placement to sophisticated
investors in exchange for $150,000, net of costs and fees.
In January 2002, the Company re-organized its capital structure, whereby the
Company agreed to purchase 8,936,244 shares of the Company's common stock held
by the Founders and cancel certain vested options held by the Founders to
purchase the Company's common stock, in exchange for the issuance of newly
issued options to purchase 3,500,000 shares of the Company's common stock. The
new stock options expire in January 2012, and have an exercise price of $1.00
per share ,which is in excess of the weighted average fair value of the
Company's common stock at the grant dates. The canceled options had no intrinsic
value at the award date and as a result, the Company did not incur a
compensation cost in connection with the cancellation of the options. In
connection with this transaction, the Company issued 5,250,000 shares of common
stock to founders and cancelled 13,480,961 shares of previously issued common
stock.
In June and July 2002, two of the Founders exercised the stock options to
purchase 2,000,000 shares of the Company's common stock. The Company entered
into four promissory notes with principal amounts of $250,000 each and two
promissory notes with principal amounts of $500,000 each with the two Founders
to ensure payments for issued stock. The notes are due one year from the date of
issuance. Interest will begin to accrue from and after the maturity dates on any
unpaid principal balance at an interest rate of 6.0% per annum. During the year
2002, the Company received $194,600 proceeds from the stock subscription. In
December 2002, the Founders returned a total of 1,805,400 shares of common stock
to the Company and the unpaid principal amount of the promissory notes was
canceled accordingly.
F-41
NOTE F - CAPITAL STOCK (CONTINUED)
In February 2002, the Company issued 43, 586 shares of common stock to its
convertible debenture holders in exchange for interest of $21,793.
In June 2002, the Company issued 154,388 shares of common stock to consultants
for warrants exercised at prices ranging from $.40 to $1.00 per share in
exchange for services, totaling $138,722, which approximated the fair value of
the shares issued during the period the services were completed and rendered.
Compensation costs of $138,722 were charged to income during the year ended
December 31, 2002. In 2002, the Company issued 1,444,147 shares of common stock,
or $636,076 to sophisticated investors for warrants exercised at prices ranging
from $.40 to $.50 per share.
Share amounts presented in the consolidated balance sheets and consolidated
statements of stockholders' equity reflect the actual share amounts outstanding
for each period presented.
NOTE G - STOCK OPTIONS AND WARRANTS
Employee Stock Options
----------------------
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to employees
of the Company under a non-qualified employee stock option plan.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighted Weighted
Number Remaining Contractual Average Number Average
Outstanding Life (Years) Exercise Price Exercisable Exercise Price
----------- ------------ -------------- ----------- --------------
Exercise Prices:
$ 1.00 1,450,000 9.08 $ 1.00 649,935 $ 1.00
Transactions involving options issued to employees are summarized as follows:
Weighted Average
Number of Shares Price Per Share
------------------------ ------------------------
Outstanding at January 1, 2001 840,000 --
Granted 215,000 $ 1.00
Exercised -- --
Canceled or expired -- --
Outstanding at December 31, 2001 1,055,000 1.00
Granted 2,835,000 1.00
Exercised (1,000,000) 1.00
Canceled or expired (1,440,000) 1.00
Outstanding at December 31, 2002 1,450,000 $ 1.00
======================== ========================
F-42
NOTE G - STOCK OPTIONS AND WARRANTS (CONTINUED)
Employee Stock Options (Continued)
----------------------------------
The weighted-average fair value of stock options granted to employees during the
years ended December 31, 2002 and 2001 and the weighted-average significant
assumptions used to determine those fair values, using a Black-Scholes option
pricing model are as follows:
2001 2000
---- ----
Significant assumptions (weighted-average):
Risk-free interest rate at grant date 1.67% 4.25%
Expected stock price volatility 26% 21%
Expected dividend payout -- --
Expected option life-years (a) 10 10
(a) The expected option life is based on contractual
expiration dates.
If the Company recognized compensation cost for the non-qualified employee stock
option plan in accordance with SFAS No. 123, the Company's pro forma net loss
and net loss per share would have been $(3,989,321) and $(0.23) in 2002 and
$(1,798,347) and $(0.08) in 2001, respectively.
Non-Employee Stock Options
--------------------------
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to the
Company consultants. These options were granted in lieu of cash compensation for
services performed.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighted Weighted
Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$1.00 1,555,000 8.93 $1.00 1,298,829 $1.00
Transactions involving options issued to non-employees are summarized as
follows:
Weighted Average
Number of Shares Price Per Share
------------------ ---------------------
Outstanding at January 1, 2001
Granted 246,502 $ 0.70
Exercised -- --
Canceled or expired -- --
Outstanding at December 31, 2001 246,502 0.70
Granted 2,455,000 1.00
Exercised (1,146,502) 0.96
Canceled or expired -- --
Outstanding at December 31, 2002 1,555,000 $ 1.00
F-43
NOTE F - STOCK OPTIONS AND WARRANTS (CONTINUED)
Non-Employee Stock Options (Continued)
--------------------------------------
The estimated value of the options granted to consultants was determined using
the Black-Scholes option pricing model and the following assumptions:
contractual term of 10 years, a risk free interest rate of 1.67%, a dividend
yield of 0% and volatility of 26%. The amount of the expense charged to
operations in connection with granting the options was $452,459 and $11,592
during 2002 and 2001, respectively.
Warrants
--------
The following table summarized the changes in warrants outstanding and the
related prices for the shares of the Company's common stock issued to
non-employees of the Company. These warrants were granted in lieu of cash
compensation for services performed or financing expenses and in connection with
placement of convertible debentures.
Warrants Outstanding Warrants Exercisable
-------------------- --------------------
Weighted Average Weighted Weighted
Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$ .50 815,000 8.00 $ .50 815,000 $ .50
$ .53 354,460 3.00 $ .53 354,460 $ .53
$ 1.00 2,362,000 3.00 $ 1.00 2,362,000 $ 1.00
-------------- ------------------
3,531,460 3,531,460
============== ==================
Transactions involving warrants are summarized as follows:
Weighted Average
Number of Shares Price Per Share
------------------------ ------------------------
Outstanding at January 1, 2001 1,210,572 $ 1.00
Granted 3,528,665 0.67
Exercised -- --
Canceled or expired (1,210,572) 1.00
Outstanding at December 31, 2001 3,528,665 $ 0.67
Granted 1,667,460 0.87
Exercised (1,650,675) 0.51
Canceled or expired (13,990) 1.00
Outstanding at December 31, 2002 3,531,460 $ 0.84
F-44
NOTE F - STOCK OPTIONS AND WARRANTS (CONTINUED)
Warrants (Continued)
--------------------
The estimated value of the compensatory warrants granted to non-employees in
exchange for services and financing expenses was determined using the
Black-Scholes pricing model and he following assumptions: contractual term of 3
to 8 years, a risk free interest rate of 1.67%, a dividend yield of 0% and
volatility of 26%. The amount of the expense charged to operations for
compensatory warrants granted in exchange for services and services was $170,330
and $321,479 during 2002 and 2001, respectively. The Company also capitalized
financing costs of $86,474 and $85,818 for compensatory warrants granted in
connection with placement of convertible debentures for the year ended December
31, 2002 and 2001, respectively. The financing cost was amortized over the life
(three years) of the convertible debenture.
NOTE H - INCOME TAXES
The Company has adopted Financial Accounting Standard No. 109 which requires the
recognition of deferred tax liabilities and assets for the expected future tax
consequences of events that have been included in the financial statement or tax
returns. Under this method, deferred tax liabilities and assets are determined
based on the difference between financial statements and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Temporary differences between taxable
income reported for financial reporting purposes and income tax purposes are
insignificant.
For income tax reporting purposes, the Company's aggregate unused net operating
losses approximate $6,450,000 which expire through 2022, subject to limitations
of Section 382 of the Internal Revenue Code, as amended. The deferred tax asset
related to the carryforward is approximately $2,193,000. The Company has
provided a valuation reserve against the full amount of the net operating loss
benefit, because in the opinion of management based upon the earning history of
the Company, it is more likely than not that the benefits will not be realized.
Components of deferred tax assets as of December 31, 2002 are as follows:
Non Current:
Net operating loss carryforward $ 2,193,000
Valuation allowance (2,193,000)
-----------------
Net deferred tax asset $ --
=================
F-45
NOTE I - COMMITMENTS AND CONTINGENCIES
Lease Commitments
-----------------
The Company leases office space on a year to year basis in Annapolis, Maryland
for its corporate offices. Commitments for minimum rentals under non-cancelable
leases at December 31, 2002 are as follows:
2003 44,746
-------------------
$ 44,746
===================
Employment and Consulting Agreements
------------------------------------
The Company has an employment agreements with the Company's employees. In
addition to salary and benefit provisions, the agreements include defined
commitments should the employer terminate the employment with or without cause.
The Company has consulting agreements with outside contractors to provide
marketing and financial advisory services. The Agreements are generally for a
term of 12 months from inception and renewable automatically from year to year
unless either the Company or Consultant terminates such engagement by written
notice.
Litigation
----------
The Company is subject to other legal proceedings and claims which arise in the
ordinary course of its business. Although occasional adverse decisions or
settlements may occur, the Company believes that the final disposition of such
matters should not have a material adverse effect on its financial position,
results of operations or liquidity.
NOTE J - LOSSES PER COMMON SHARE
The following table presents the computations of basic and dilutive loss per
share:
For the period from
November 3, 1999
(date of inception)
through December 31,
2002 2001 2002
---- ---- ----
Net loss available to common shareholders $ (3,778,488) $ (1,716,495) $ (6,458,676)
Basic and fully diluted loss per share $ (0.22) $ (0.08) $ (0.40)
Weighted average common shares outstanding $ 17,119,639 21,974,439 16,050,030
F-46
NOTE K - GOING CONCERN MATTERS
The accompanying statements have been prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. As shown in the financial statements from
November 3, 1999 (date of inception of Company), the Company incurred loses from
operations of $6,458,676. This factor among others may indicate that the Company
will be unable to continue as a going concern for a reasonable period of time.
The Company's existence is dependent upon management's ability to develop
profitable operations and resolve it's liquidity problems. Management
anticipates the Company will attain profitable status and improve it liquidity
through the continued developing of its products, establishing a profitable
market for the Company's products and additional equity investment in the
Company. The accompanying consolidated financial statements do not include any
adjustments that might result should the Company be unable to continue as a
going concern.
In order to improve the Company's liquidity, the Company is actively pursuing
additional equity financing through discussions with investment bankers and
private investors. There can be no assurance the Company will be successful in
its effort to secure additional equity financing.
If operations and cash flows continue to improve through these efforts,
management believes that the Company can continue to operate. However, no
assurance can be given that management's actions will result in profitable
operations or the resolution of its liquidity problems.
F-47
NOTE L - RESTATEMENT OF FINANCIAL STATEMENTS
The Company has restated its financial statements for the year ended December
31, 2001 to correct the following errors in the financial statements previously
filed:
o The Company erroneously recorded the Black-Scholes value of
the 940,000 warrants attached to its convertible debentures as
an asset (financing cost), and amortized over the maturity
period (three year) of the note.
o The Company erroneously recorded the beneficial conversion
feature of its convertible debentures as an asset (financing
cost) and the beneficial conversion feature was erroneously
amortized over six-months (from the issuance of the note to
the earliest conversion date).
o The Company erroneously recorded impairment of property and
equipment as research and development expense.
The net effect of the correction of these errors was to:
o Decrease the Company's reported net loss for the year ended
December 31, 2001 by $289,645 from $(2,006,140) to
$(1,716,495).
o Decrease the loss per share by $.01 from $(.09) to $(.08) per
share.
o Decrease the deficiency accumulated during the development
stage by $289,645 from $(2,969,833) to $(2,680,188).
o Decrease other assets by $501,276 from $688,950 to $187,674.
o Increase debt discount by $813,800 from $0 to $813,800 (Note
E).
o Increase additional paid in capital by $22,879 from $2,221,154
to $2,244,033.
Following are reconciliations of the Company's restatement of the Consolidated
Balance Sheet as of December 31, 2001 and Consolidated Statement of Losses for
the year ended 2001.
F-48
NOTE L - RESTATEMENT OF FINANCIAL STATEMENTS (CONTINUED)
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2001
As Reported Adjustment Restated
-------------- -------------- ---------------
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 21,885 $ 21,885
Total Current Assets 21,885 21,885
PROPERTY AND EQUIPMENT:
Furniture and equipment, at cost 54,950 54,950
Less: accumulated depreciation 28,108 28,108
26,842 26,842
OTHER ASSETS:
Financing Costs, net amortization 684,325 $ (501,276) 183,049
Prepaid expenses and deposits 4,625 4,625
688,950 187,674
$ 737,677 $ (501,276) $ 236,401
-------------- -------------- ---------------
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 116,741 $ 116,741
Notes payable 400,000 400,000
Due to shareholders 7,500 7,500
Total current liabilities 524,241 524,241
Convertible Debentures, net of discounts - including
Related parties 940,000 $ (813,800) 126,200
COMMITMENTS AND CONTINGENCIES -- --
DEFICIENCY IN STOCKHOLDERS' EQUITY
Common stock, par value $.001 per share;
100,000,000 shares authorized; 21,115,371 shares
issued and outstanding at December 31, 2001 22,115 22,115
Additional paid-in-capital 2,221,154 22,879 2,244,033
Accumulated deficit during development stage (2,969,833) 289,645 (2,680,188)
Deficiency in stockholders' equity (726,564) 312,524 (414,040)
$ 737,677 $ (501,276) $ 236,401
-------------- -------------- ---------------
F-49
NOTE L - RESTATEMENT OF FINANCIAL STATEMENTS (CONTINUED)
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF LOSSES
FOR THE YEAR ENDED DECEMBER 31, 2001
As Reported Adjustments Restated
----------------- ----------------- -----------------
Costs and expenses:
Research & Development $ 160,115 $ (39,287) $ 120,828
Selling, General and Administrative 1,386,222 1,386,222
Impairment of Property and Equipment -- 39,287 39,287
Depreciation and Amortization 43,557 (12,760) 30,797
Total Operating Expense 1,589,894 1,577,134
Loss from Operations (1,589,894) (1,577,134)
Other Income 1,257 1,257
Interest Income (Expense) (417,503) 276,885 (140,618)
Provision for Income Tax -- --
(416,246) (139,361)
Net Loss $ (2,006,410) $ 289,645 $ (1,716,495)
================= ================= =================
Loss per common share (basic and assuming
dilution) $ (0.09) $ 0.01 $ (0.08)
================= ================= =================
Weighted average Common shares outstanding 21,974,439 21,974,439 21,947,439
F-50
STEFANOU & COMPANY, LLP
CERTIFIED PUBLIC ACCOUNTANTS
1360 Beverly Road
Suite 305
McLean, VA 22101-3621
703-448-9200
703-448-3515 (fax)
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
-------------------------------------------------
Board of Directors
Telkonet, Inc.
Annapolis, MD
We have audited the accompanying consolidated balance sheets of
Telkonet, Inc. (a development stage company) as of December 31, 2001 and 2000
and the related consolidated statements of losses, deficiency in stockholders'
equity, and cash flows for the years ended December 31 ,2001 and 2000 and for
the period November 3, 1999 (date of inception) to December 31, 2001. These
financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based upon
our audit.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatements. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Telkonet, Inc. as of
December 31, 2001 and 2000, and the results of its operations and its cash flows
for the two years then ended, and from November 3, 1999 (date of inception), to
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As shown in the financial
statements, the Company has incurred net losses since its inception. This raises
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to this matter are described in Note K. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ STEFANOU & COMPANY, LLP
---------------------------
Stefanou & Company, LLP
Certified Public Accountants
McLean, Virginia
February 14, 2002
F-51
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
---- ----
ASSET
CURRENT ASSETS:
Cash and equivalents $ 21,885 $ 10,450
------------ ------------
Total Current Assets 21,885 10,450
PROPERTY AND EQUIPMENT AT COST:
Furniture, equipment and leasehold improvements 54,950 89,029
Less accumulated depreciation 28,108 22,080
------------ ------------
26,842 66,949
Financing Costs, less amortization costs of $415,742 and $0 in 2001 and
2000, respectively 684,325 --
Deposits 4,625 4,625
------------ ------------
$ 737,677 $ 82,024
============ ============
LIABILITIES AND DEFICIENCY IN STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 116,741 $ 253,586
Notes payable (Note D) 400,000 --
Due to shareholder (Note C) 7,500 10,000
------------ ------------
Total current liabilities 524,241 263,586
Convertible Debentures ( Notes D & E) 940,000
COMMITMENTS AND CONTINGENCIES (Note H) -- --
DEFICIENCY IN STOCKHOLDER'S EQUITY (Note E)
Common stock, par value $ 0.001 per share; 100,000,000 shares authorized;
22,115,371 and 21,815,371 issued at December 31, 2001 and 2000 22,115 21,815
Additional Paid in Capital 2,221,154 760,316
Deficit accumulated during development stage (2,969,833) (963,693)
------------ ------------
Deficiency in stockholder's equity (726,564) (181,562)
$ 737,677 $ 82,024
============ ============
See accompanying notes to consolidated financial statements
F-52
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF LOSSES
For the Period
November 3, 1999 (Date
For the Year Ended For the Year Ended of Inception) to
December 31, 2001 December 31, 2000 December 31, 2001
Cost and expenses:
Research and development $ 160,115 $ 119,000 $ 279,115
General and administrative 1,386,222 773,336 2,193,259
Interest 417,503 15,576 433,079
Depreciation and amortization 43,557 21,808 65,637
------------- ------------- -------------
Loss from Operations (2,007,397) (929,720) (2,971,090)
Other Income 1,257 -- 1,257
------------- ------------- -------------
Net Loss $ (2,006,140) $ (929,720) $ (2,969,833)
============= ============= =============
Loss per common share (basic and assuming
dilution) $ (0.09) $ (0.04) $ (0.14)
============= ============= =============
Weighted average Common shares outstanding
(Note I) 21,974,439 20,891,349 21,435,998
See accompanying notes to consolidated financial statements
F-53
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2001
Deficit
Accumulated
Stock Additional Paid During
Common Shares Amount in Capital Development Stage Total
Net Loss - $ - $ - $ (33,973) $ (33,973)
------------ --------- ----------- ------------ -----------
Balance at December 31, 1999 - - - (33,973) (33,973)
Shares issued to founders January
2000, in exchange for services and
costs valued at $ 0.60 per share 19,300 193 11,387 - 11,580
Shares issued in June 2000, for
cash in connection with private
placement at $375 per share, net
of costs 1,735 17 644,219 - 644,236
Shares issued in July 2000, for
warrants exercised at a price of
$375 per share 190 - 71,250 - 71,250
Shares issued in August 2000, in
connection with the merger of
Comstock Coal and Telkonet
Communications, Inc 21,775,345 21,775 - - 21,775
August 2000, retirement of
Telkonet Communications, Inc shares (21,225) (210) - - (210)
Shares issued in October 2000, in
exchange for warrants exercised at
a price of $1 per share 29,145 29 29,115 - 29,144
Shares issued in October 2000, in
exchange for warrants exercised at
a price of $ 0.40 per share 10,881 11 4,345 - 4,356
Net loss - - - (929,720) (929,720)
------------ --------- ----------- ------------ -----------
Balance at December 31, 2000 21,815,371 21,815 760,316 (963,693) (181,562)
Shares issued in June 2001, for
cash in connection with a private
placement , shares issued at $.50
a share, net of costs 260,000 260 129,740 - 130,000
1,839,378 Warrants issued in June
2001, valued at $ .13 per
warrant, in exchange for services - - 237,036 - 237,036
72,668 Stock options issued in
June 2001, valued at $ .09 per
option, in exchange for services - - 6,375 - 6,375
245,287 Warrants issued in July
2001, valued at $ .08 per
warrant, in exchange for services - - 18,568 - 18,568
36,917 Stock options issued in
July 2001, valued at $ .08 per
option, in exchange for services - - 2,795 - 2,795
Shares issued in August 2001, for
cash in connection with a private
placement , shares issued at $.50
a share, net of costs 40,000 40 19,960 - 20,000
See accompanying notes to consolidated financial statements
F-54
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2001
Deficit
Accumulated
Stock Additional Paid During
Common Shares Amount in Capital Development Stage Total
241,000 Warrants issued in August
2001, valued at $ .39 per warrant,
in exchange for financing costs - - 94,687 - 94,687
114,000 Warrants issued in August
2001, valued at $ .43 per
warrant, in exchange for interest - - 49,020 - 49,020
150,000 Warrants issued in August
2001, valued at $ .16 per
warrant, in exchange for services - - 23,340 - 23,340
36,917 Stock options issued in
August 2001, valued at $ .06 per
option, in exchange for services - - 2,422 - 2,422
818,000 Warrants issued in
September 2001, valued at $ .14
per warrant, in exchange for
financing costs - - 112,230 - 112,230
1,636,000 Warrants issued in
September 2001, valued at $ .40
per warrant, in exchange for
interest - - 654,400 - 654,400
25,000 Warrants issued in
September 2001, valued at $ .30
per warrant, in exchange for
services - - 7,380 - 7,380
60,000 Warrants issued in October
2001, valued at $ .16 per
warrant, in exchange for
financing costs - - 9,720 - 9,720
120,000 Warrants issued in October
2001, valued at $ .44 per
warrant, in exchange for interest - - 52,800 - 52,800
95,000 Warrants issued in October
2001, valued at $ .21 per
warrant, in exchange for services - - 19,558 - 19,558
5,000 Warrants issued in November
2001, valued at $.16 per warrant,
in exchange for financing costs - - 810 - 810
10,000 Warrants issued in November
2001, valued at $.44 per warrant,
in exchange for interest - - 4,400 - 4,400
25,000 Warrants issued in November
2001, valued at $ .33 per
warrant, in exchange for services - - 8,218 - 8,218
25,000 Warrants issued in December
2001, valued at $.30 per
warrant, in exchange for services - - 7,380 - 7,380
Net loss - - - (2,006,140) (2,006,140)
------------ --------- ----------- ------------ -----------
Balance at December 31, 2001 22,115,371 22,115 2,221,155 (2,969,833) (726,563)
See accompanying notes to consolidated financial statements
F-55
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDING DECEMBER 31, 2001 AND 2000 AND
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2001
For the Period
For the year For the year November 3, 1999
ended ended (Date of
December 31, December 31, Inception) to
2001 2000 December 31, 2001
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from development stage operations $(2,006,140) $ (929,720) $(2,969,833)
Adjustments to reconcile net loss from development stage
operations to cash used for operating activities
Warrants issued in exchange for financing and interest 378,213 -- 378,213
Warrants issued in exchange for services rendered 333,072 -- 333,072
Common stock issued in exchange for services rendered -- 11,580 11,580
Depreciation and amortization 43,557 22,080 65,637
Increase (decrease) in:
Deposits -- (4,625) (4,625)
Accounts payable and accrued expenses, net (136,845) 241,388 138,516
------------ ------------ ------------
NET CASH USED BY OPERATING ACTIVITIES (1,388,143) (659,297) (2,047,440)
CASH FLOWS USED IN INVESTING ACTIVITIES :
Capital expenditures, net of disposals 34,079 (89,029) (54,950)
------------ ------------ ------------
NET CASH USED IN INVESTING ACTIVITIES 34,079 (89,029) (54,950)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net of costs 150,000 748,776 898,776
Proceeds from (repayments to) stockholder advances (2,500) 10,000 7,500
Proceeds from issuance of convertible debentures,
net of costs 818,000 -- 818,000
Proceeds from bank loans 400,000 -- 400,000
Proceeds from shareholder loans -- 235,000 235,000
Repayment of shareholder loans -- (235,000) (235,000)
----------- ----------- -----------
NET CASH PROVIDED (USED) IN FINANCING ACTIVITIES 1,365,500 758,776 2,124,276
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS 11,435 10,450 21,885
Cash and equivalents at beginning of period 10,450 -- --
------------ ------------ ------------
CASH AND EQUIVALENTS AT END OF PERIOD $ 21,885 $ 10,450 $ 21,885
============ ============ ============
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest $ 24,965 $ -- $ 24,965
Income taxes paid -- -- --
Issuance of warrants for financing and interest 1,278,983 -- 1,278,983
Issuance of warrants and options for services 333,072 -- 333,072
Common stock issued for services -- 11,580 11,580
Acquisition:
Assets Acquired -- 1 1
Accumulated deficit -- 2,643 2,643
Liabilities Assumed -- (2,642) (2,642)
------------ ------------ ------------
$ -- $ 1 $ 1
See accompanying notes to consolidated financial statements
F-56
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
NOTE A - SUMMARY OF ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation of
the accompanying consolidated financial statements follows.
Business and Basis of Presentation
----------------------------------
Telkonet, Inc. ("Company"), formerly Comstock Coal Company, Inc, was formed on
November 3, 1999 under the laws of the state of Utah. The Company is a
development stage enterprise, as defined by Statement of Financial Accounting
Standards No. 7 ("SFAS 7") and is seeking to develop, produce and market
proprietary equipment enabling the transmission of voice and data over electric
utility lines. From its inception through the date of these financial statements
the Company has recognized no revenues and has incurred significant operating
expenses.
The consolidated financial statements include the accounts of the Company, and
its wholly-owned subsidiary, Telkonet Communications, Inc. Significant
intercompany transactions have been eliminated in consolidation.
Advertising
-----------
The Company follows the policy of charging the costs of advertising to expenses
incurred. The Company incurred no advertising costs during the year ended
December 31, 2001 and for the period November 3, 1999 (date of inception)
through December 31, 2001.
Property and Equipment
----------------------
For financial statement purposes, property and equipment are depreciated using
the straight-line method over their estimated useful lives (three to five years
for furniture, fixtures and equipment). The straight-line method of depreciation
is also used for tax purposes.
Marketable Securities
---------------------
Marketable securities consist primarily of corporate equity securities. The
Company's marketable securities are considered to be "available for sale" and
accordingly, are carried on the balance sheet at fair market value, which
approximates cost. Gains and losses from securities have not been material.
Income Taxes
------------
Income taxes are provided based on the liability method for financial reporting
purposes in accordance with the provisions of Statements of Financial Standards
No. 109, "Accounting for Income Taxes." Under this method deferred tax assets
and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be removed or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the consolidated statements of operations
in the period that includes the enactment date.
F-57
NOTE A - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Cash Equivalents
----------------
For purposes of the Statements of Cash Flows, the Company considers all highly
liquid debt instruments purchased with a maturity date of three months or less
to be cash equivalents.
Impairment of Long-Lived Assets
-------------------------------
The Company has adopted Statement of Financial Accounting Standards No. 121
(SFAS 121). The Statement requires that long-lived assets and certain
identifiable intangibles held and used by the Company be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. SFAS 121 also requires assets to be disposed of
be reported at the lower of the carrying amount or the fair value less costs to
sell.
Use of Estimates
----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. Accordingly actual results
could differ from those estimates.
Research and Development
------------------------
Company-sponsored research and development costs related to both present and
future products are expended in the period incurred. Total expenditures on
research and product development for 2001 and 2000 were $160,115 and $119,000,
respectively.
Concentrations of Credit Risk
-----------------------------
Financial instruments and related items which potentially subject the Company to
concentrations of credit risk consist primarily of cash, cash equivalents and
trade receivables. The Company places its cash and temporary cash investments
with credit quality institutions. At times, such investments may be in excess of
the FDIC insurance limit. The Company currently has no customers.
Stock Based Compensation
------------------------
The Company accounts for stock transactions in accordance with APB Opinion 25,
"Accounting for Stock Issued to Employees." In accordance with statement of
Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation," the Company has adopted the proforma disclosure requirements.
From time to time, the Company grants options or warrants to non employees in
return for services rendered. The Company recognizes a charge or the fair value
ascribed to such options and warrants over the service or vesting period.
Liquidity
---------
As shown in the accompanying financial statements, the Company has incurred
losses of $2,969,833 from its inception through December 31, 2001. The Company's
current liabilities exceed its current assets by $502,356 at December 31, 2001.
F-58
NOTE A - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Reclassifications
-----------------
Certain reclassifications have been made in prior year's financial statements to
conform to classifications used in the current year.
Comprehensive Income
--------------------
The Company does not have any items of comprehensive income in any of the
periods presented.
Segment Information
-------------------
The Company adopted Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information ("SFAS 131")
in the year ended December 31, 1998. SFAS establishes standards for reporting
information regarding operating segments in annual financial statements and
requires selected information for those segments to be presented in interim
financial reports issued to stockholders. SFAS 131 also establishes standards
for related disclosures about products and services and geographic areas.
Operating segments are identified as components of an enterprise about which
separate discrete financial information is available for evaluation by the chief
operating decision maker, or decision making group, in making decisions how to
allocate resources and assess performance. The information disclosed herein,
materially represents all of the financial information related to the Company's
principal operating segment.
New Accounting Pronouncements
In March 2000, the FASB issued interpretation No. 44 ("FIN 44"), "Accounting for
Certain Transactions Involving Stock Compensation, an Interpretation of APB
Opinion No. 25." FIN 44 clarifies the application of APB No. 25 for (a) the
definition of employee for purposes of applying APB No. 25, (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan, (c) the
accounting consequences of various modifications to previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. FIN 44 is effective July 2, 2000 but certain
conclusions cover specific events that occur after either December 15, 1998 or
January 12, 2000. The adoption of FIN 44 did not have an affect on the Company's
financial statements but may impact the accounting for grants or awards in
future periods.
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, Business Combinations (FAS 141), and FAS
142, Goodwill and Other Intangible Assets (FAS 142). FAS 141 addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. FAS 142 addresses the initial recognition
and measurement of intangible assets acquired outside of a business combination,
whether acquired individually or with a group of other assets, and the
accounting and reporting for goodwill and other intangibles subsequent to their
acquisition. These standards require all future business combinations to be
accounted for using the purchase method of accounting. Goodwill will no longer
be amortized but instead will be subject to impairment tests at least annually.
The Company is required to adopt FAS 141 and FAS 142 on a prospective basis as
of January 1, 2002; however, certain provisions of these new standards may also
apply to any acquisitions concluded subsequent to June 30, 2001. As a result of
implementing these new standards, the Company will discontinue the amortization
of goodwill as of December 31, 2001. The
F-59
NOTE A - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Company does not believe that the adoption of FAS 141 or 142 will have a
material impact on its consolidated financial statements.
In October 2001, the Financial Accounting Standards Board issued FAS 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144). FAS
144 addresses financial accounting and reporting for the impairment or disposal
of long-lived assets. This statement supersedes FAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
(FAS 121) and related literature and establishes a single accounting model,
based on the framework established in FAS 121, for long-lived assets to be
disposed of by sale. The Company is required to adopt FAS 144 no later than
January 1, 2002. The Company does not believe that the adoption of FAS 144 will
have a material impact on its consolidated financial statements.
NOTE B - MERGER
On August 25, 2000, Telkonet Communications, Inc ("TCI") completed an Agreement
and Plan of Reorganization ("Agreement") with Comstock Coal Company, Inc.
("Comstock") in a transaction accounted for using the purchase method of
accounting. The total purchase price and carrying value of net assets acquired
of Comstock was $1. From Comstock's inception, until the date of the merger,
Comstock was an inactive corporation with no assets and liabilities. As a result
of the acquisition, there was a change in control of the public entity.
Subsequent to the date of the merger, Comstock Coal Company, Inc. changed its
name to Telkonet, Inc. ("Company"), with Telkonet Communications, Inc becoming a
wholly owned subsidiary of the Company.
Effective with the Agreement, all previously outstanding common stock, preferred
stock, options and warrants owned by former Comstock stockholders were exchanged
for an aggregate of 1,980,000 shares of Telkonet Communications, Inc.'s common
stock. The value of the stock that was issued was the historical cost of
Comstock's net tangible assets, which did not differ materially from their fair
value. The results of operations subsequent to the date of acquisition are
included in the Company's consolidated statement of losses. In accordance with
Accounting Principles Opinion No. 16, Telkonet Communications, Inc. is the
acquiring entity.
The total purchase price and carrying value of net assets acquired of Comstock
was $1. The net assets acquired were as follows:
Net Assets $ 1
Accumulated Deficit 2,643
Net Liabilities (2,642)
-----------
$ 1
===========
NOTE C - DUE TO SHAREHOLDER
Significant shareholders of the Company have advanced funds to the Company for
working capital purposes. The amount of the advances at December 31, 2001 and
2000 are $7,500 and $10,000, respectively. No formal repayment terms exist.
F-60
NOTE D - NOTES PAYABLE
Notes payable at December 31, 2001 and 2000 consists of the following:
2001 2000
----------- ------------
Note payable in monthly installments of interest only at 7.5% per annum,
unsecured and guaranteed by a Company shareholder. $ 150,000 $ --
Note payable in monthly installments of interest only at the prime lending
rate plus 1% unsecured and guaranteed by a Company shareholder. 250,000 --
Convertible notes payable, in quarterly installments of interest only at 8% per
annum, unsecured and due three years from the date of the note with the latest
maturity November, 2004; Noteholder has the option to convert unpaid note
principal together with accrued and unpaid interest to the Company's common
stock at a rate of $.50 per share six months after
issuance. 940,000 --
----------- ------------
1,340,000 --
Less: current portion (400,000) --
----------- ------------
$ 940,000 $ --
=========== ============
Aggregate maturities of long-term debt as of December 31, 2001 are as follows:
Year Amount
---- ------
2002 $ 400,000
2003 --
2004 940,000
2005 --
2006 and after --
--------------
$ 1,340,000
--------------
The Company incurred an aggregate of $339,447 of financing costs associated with
the placement of the convertible debentures. The costs have been capitalized and
are being amortized over a term of the convertible debentures. Financing costs
amortized in 2001 were $37,529 and have been charged to operations.
In addition, the Company recognized the imbedded beneficial conversion feature
in the convertible debenture by allocating a portion of the proceeds equal to
the intrinsic value of that feature to additional paid in capital. The Company
recognized an aggregate of $760,620 of imbedded beneficial conversion feature
and has amortized that cost over six months after the issuance of the
debentures. Costs associated with this beneficial conversion features amortized
in 2001 were $278,213 and have been charged to interest expense in the current
year.
NOTE E - CAPITAL STOCK
The Company was incorporated under the laws of the State of Utah on November 3,
1999 under the name of Telkonet Communications, Inc. The Company is a successor
to Telkonet Communications, Inc., a company formed under the laws of the State
of Maryland ("Predecessor"). The Predecessor was an inactive corporation entity
with no significant assets or operations.
F-61
NOTE E - CAPITAL STOCK (CONTINUED)
The Company has authorized 100,000,000 shares of common stock , with a par value
of $.001 per share.
In January 2000, the Company issued 19,300 shares to its founders, in exchange
for costs and services, valued at $11,387.
In June 2000, the Company issued a total of 1,735 shares of common stock in a
private placement to sophisticated investors, primarily in the United States in
exchange for $644,219 net of costs and fees. In July, 2000 addition, the
Predecessor issued 190 shares of common stock in exchange for exercised warrants
at $375 per share, totaling $71,250.
In August 2000, the Company issued 21,775,345 shares of common stock in
conjunction with the merger of Comstock Coal Company, Inc (Note B). In
connection with the transaction, the Company retired 21,225 shares of previously
issued Telkonet Communications, Inc common stock.
In October 2000, the Company issued 29,145 and 10,891 shares of common stock in
exchange for exercised warrants, with an exercise price of $1.00 and $0.40 per
share, respectively.
In June 2001 and August 2001, the Company issued 260,000 and 40,000 shares of
its common stock, respectively, in a private placement to sophisticated
investors in exchange for $150,000, net of costs and fees.
In 2001, the Company issued $940,000 of 8% Convertible Debentures (see Note D).
The debentures are due three years from date of issuance, and can be converted
to the Company's common stock at the rate of $.50 per share six months after
issuance.
Share amounts presented in the consolidated balance sheets and consolidated
statements of stockholders' equity reflect the actual share amounts outstanding
for each period presented.
NOTE F - STOCK OPTIONS AND WARRANTS
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to employees
of the Company under a non-qualified employee stock option plan.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighted Weighted
Number Contractual Average Number Average
Outstanding Life (Years) Exercise Price Exercisable Exercise Price
----------- ------------ -------------- ----------- --------------
Exercise Prices:
1.00 1,055,000 10 1.00 23,334 1.00
F-62
NOTE F - STOCK OPTIONS AND WARRANTS (CONTINUED)
Transactions involving options issued to employees are summarized as follows:
Weighted Average
Number of Shares Price Per Share
---------------- ----------------
Outstanding at January 1, 2000 -- --
Granted 840,000 $ 1.00
Exercised -- 1.00
Canceled or expired -- 1.00
---------------- ----------------
---------------- ----------------
Outstanding at December 31, 2000 840,000 1.00
Granted 215,000 1.00
Exercised -- 1.00
Canceled or expired -- 1.00
---------------- ----------------
---------------- ----------------
Outstanding at December 31, 2001 1,055,000 $ 1.00
================ ================
The weighted-average fair value of stock options granted to employees during the
years ended December 31, 2001 and 2000 and the weighted-average significant
assumptions used to determine those fair values, using a Black-Scholes option
pricing model are as follows:
2001 2000
---------- ---------
Weighted average grant date fair value per share: $ 1.15 $ 1.00
Significant assumptions (weighted-average):
Risk-free interest rate at grant date 1.67% 4.25%
Expected stock price volatility 26% 21%
Expected dividend payout -- --
Expected option life-years (a) 10 10
(a) The expected option life is based on contractual expiration dates.
If the Company recognized compensation cost for the non-qualified employee stock
option plan in accordance with SFAS No. 123, the Company's pro forma net loss
and net loss per share would have been $(2,015,040) and $(0.09) in 2001 and
$(929,720) and $(0.04) in 2000, respectively.
The Company incurred costs and expenses in connection with granting certain
stock warrants and options to non-employees. These warrants and options were
granted in lieu of cash compensation for services performed and in connection
with placement of convertible debentures (see Note D).
F-63
NOTE F - STOCK OPTIONS AND WARRANTS (CONTINUED)
The following table summarizes the changes in warrants outstanding and the
related prices for the shares of the Company's common stock issued to
non-employees of the Company.
Warrants Outstanding Warrants Exercisable
-------------------- --------------------
Weighted Average Weighted Weighted
Number Contractual Average Number Average
Outstanding Life (Years) Exercise Price Exercisable Exercise Price
----------- ------------ -------------- ----------- --------------
Exercise Prices:
$ .50 1,100,000 8 $ .50 1,100,000 $ .50
.53 184,000 3 .53 184,000 .53
1.00 4,124,665 2 1.00 4,124,665 1.00
--------------- -------------------
5,408,665 5,408,665
=============== ===================
Transactions involving warrants issued to non-employees are summarized as
follows:
Weighted Average
Number of Shares Price Per Share
---------------- ----------------
Outstanding at January 1, 2000
Granted 1,210,572 $ 1.00
Exercised -- 1.00
Canceled or expired -- 1.00
---------------- --------------
Outstanding at December 31, 2000 1,210,572 1.00
Granted 5,408,665 .67
Exercised -- .67
Canceled or expired (1,210,572) 1.00
---------------- --------------
Outstanding at December 31, 2001 5,408,665 $ 0.78
================ ==============
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to
non-employees of the Company.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighted Weighted
Number Contractual Average Number Average
Outstanding Life (Years) Exercise Price Exercisable Exercise Price
----------- ------------ -------------- ----------- --------------
Exercise Prices:
$ 1.00 210,751 3 $ 1.00 210,751 $ 1.00
.40 35,751 1 .40 35,751 .40
--------------- -------------------
246,502 246,502
=============== ===================
F-64
NOTE F - STOCK OPTIONS AND WARRANTS (CONTINUED)
Transactions involving stock options issued to non-employees are summarized as
follows:
Weighted Average
Number of Shares Price Per Share
---------------- ----------------
Outstanding at January 1, 2000 -- --
Granted 286,528 $ 0.70
Exercised (40,026) .70
Canceled or expired -- .70
---------------- ---------------
Outstanding at December 31, 2000 246,502 .70
Granted -- --
Exercised -- --
Canceled or expired -- --
---------------- ---------------
Outstanding at December 31, 2001 246,502 $ 0.70
================ ===============
The amount of the expense charged to operations in connection with granting the
warrants and options to non-employees was $550,518 and $0 during 2001 and 2000,
respectively. The amount incurred in connection with placement of the
convertible debentures was $217,447 in 2001 and is included in the costs of
financing and amortized over the term of the debentures.
NOTE G - INCOME TAXES
The Company has adopted Financial Accounting Standard number 109 which requires
the recognition of deferred tax liabilities and assets for the expected future
tax consequences of events that have been included in the financial statement or
tax returns. Under this method, deferred tax liabilities and assets are
determined based on the difference between financial statements and tax bases of
assets and liabilities using enacted tax rates in effect for the year in which
the differences are expected to reverse. Temporary differences between taxable
income reported for financial reporting purposes and income tax purposes are
insignificant.
For income tax reporting purposes, the Company's aggregate unused net operating
losses approximate $2,900,000 which expire through 2021, subject to limitations
of Section 382 of the Internal Revenue Code, as amended. The deferred tax asset
related to the carryforward is approximately $986,000. The Company has provided
a valuation reserve against the full amount of the net operating loss benefit,
since in the opinion of management based upon the earning history of the
Company, it is more likely than not that the benefits will be realized.
Components of deferred tax assets as of December 31, 2001 are as follows:
Non Current:
Net operating loss carryforward $ 986,000
Valuation allowance (986,000)
-------------
Net deferred tax asset $ --
=============
F-65
NOTE H - COMMITMENTS AND CONTINGENCIES
Lease Commitments
-----------------
The Company leases office space on a year to year basis in Annapolis, Maryland
for its corporate offices. Rental expense charged to operations in 2001 and 2000
was $56,911 and $37,000, respectively.
Commitments for minimum rentals under non cancelable leases at the end of 2001
are as follows:
2002 $ 58,000
2003 44,746
------------
$ 102,746
============
Employment and Consulting Agreements
------------------------------------
The Company has an employment agreement with the Company's Chief Executive
Officer and Chief Operating Officer. In addition to salary and benefit
provisions, the agreement includes defined commitments should the employee
terminate the employment with or without cause.
The Company has consulting agreements with outside contractors to provide
marketing and financial advisory services. The Agreements are generally for a
term of 12 months from inception and renewable automatically from year to year
unless either the Company or Consultant terminates such engagement by written
notice.
NOTE I - LOSSES PER COMMON SHARE
The following table presents the computations of basic and dilutive loss per
share:
2001 2000
---- ----
Net loss available to common shareholders $ (2,006,140) $ (929,720)
============= =============
Basic and fully diluted loss per share $ (0.09) $ (0.04)
============= =============
Weighted average common shares outstanding $ 21,974,439 $ 20,891,349
============= =============
NOTE J - SUBSEQUENT EVENTS
Subsequent to the date of the financial statements, the Company re-organized its
capital structure, whereby the Company agreed to purchase 8,936,244 shares of
the Company's common stock held by the Founders and cancel certain vested
options held by the Founders to purchase the Company's common stock, in exchange
for the issuance of newly issued options to purchase 3,500,000 of the Company's
common stock. The new stock options expire in January 2012, and have an exercise
price of $1.00 per share.
Subsequent to the date of the financial statements, the Company has received an
additional $92,000 in convertible debentures (see Note D).
F-66
NOTE K - GOING CONCERN MATTERS
The accompanying statements have been prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. As shown in the financial statements from
November 3, 1999 (date of inception of Company), the Company incurred loses from
operations of $2,969,833. This factor among others may indicate that the Company
will be unable to continue as a going concern for a reasonable period of time.
The Company's existence is dependent upon management's ability to develop
profitable operations and resolve it's liquidity problems. Management
anticipates the Company will attain profitable status and improve it liquidity
through the continued developing of its products, establishing a profitable
market for the Company's products and additional equity investment in the
Company. The accompanying financial statements do not include any adjustments
that might result should the Company be unable to continue as a going concern.
In order to improve the Company's liquidity, the Company is actively pursing
additional equity financing through discussions with investment bankers and
private investors. There can be no assurance the Company will be successful in
its effort to secure additional equity financing.
If operations and cash flows continue to improve through these efforts,
management believes that the Company can continue to operate. However, no
assurance can be given that management's actions will result in profitable
operations or the resolution of its liquidity problems.
F-67
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the estimated expenses in connection
with the issuance and distribution of the securities being registered, all of
which are being borne by the registrant.
Securities and Exchange Commission Registration Fee............. $ _________
Accounting Fees and Expenses.................................... $ _________
Legal Fees and Expenses......................................... $ _________
Printing Fees and Expenses...................................... $ _________
Miscellaneous................................................... $ _________
TOTAL........................................................... $ _________
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Reference is made to Section 16-10a-902 of the Utah Business
Corporation Act, which enables Telkonet to indemnify an individual made a party
to a proceeding because he is or was a director of Telkonet if (i) his conduct
was in good faith, (ii) he reasonably believed his conduct was in, or not
opposed to, Telkonet's best interests, and (iii) in the case of a criminal
proceeding, he had no reasonable cause to believe his conduct was unlawful.
Notwithstanding the foregoing, Telkonet may not indemnify a director (i) in
connection with a proceeding by or in the right of the corporation in which the
director was adjudged liable to the corporation, or (ii) in connection with any
other proceeding charging that the director derived an improper personal
benefit, whether or not involving action in his official capacity, in which
proceeding he was adjudged liable on the basis that he derived an improper
personal benefit. The Utah Business Corporation Act also permits Telkonet to
purchase insurance on behalf of any person that is or was a director, officer,
employee, fiduciary or agent of Telkonet. Telkonet's amended and restated
articles of incorporation provide in effect for the elimination of the personal
liability of Telkonet's directors and for the indemnification by Telkonet of
each director and officer of Telkonet, in each case, to the fullest extent
permitted by applicable law. Telkonet purchases and maintains insurance on
behalf of any person who is or was a director, officer, employee, fiduciary or
agent of Telkonet against any liability asserted against him or her and incurred
by him or her in any such capacity, or arising out of his or her status as such,
whether or not Telkonet would have the power or the obligation to indemnify him
or her against such liability under the provisions of Telkonet's amended and
restated articles of incorporation.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, the registrant has been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is
therefore unenforceable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
On June 6, 2000, we issued warrants to purchase 93,264 shares of our
common stock to Jorel, Inc. as consideration for certain general business
services provided by Jorel, Inc. These warrants expired on June 5, 2003.
On July 1, 2000, we issued warrants to purchase 46,632 shares of our
common stock to Hayden Communications, Inc. as consideration for certain general
business services provided by Hayden Communications, Inc. These warrants expired
on June 30, 2001.
On July 1, 2000, we issued warrants to purchase 186,528 shares of our
common stock to Attkisson, Carter & Akers, Inc. as consideration for the
preparation of a research report by Attkisson, Carter & Akers, Inc.
II-1
On August 1, 2000, we issued warrants to purchase 46,632 shares of our
common stock to Howard Bronson as consideration for certain general business
services provided by Mr. Bronson. These warrants expired on July 31, 2001.
On October 15, 2000, we granted options to purchase 100,000 shares of
our common stock to Susquehanna Development, LLC as consideration for certain
management services provided by Susquehanna Development, LLC. Susquehanna
Development, LLC is an affiliate of Telkonet.
On March 9, 2001, we issued A. Hugo DeCesaris a warrant to purchase
1,000,000 shares of our common stock as consideration for his personal guaranty
of Telkonet's line of credit with a third party financial institution in the
aggregate amount of $250,000. Mr. DeCesaris is an affiliate of Telkonet.
In June 2001, we commenced an offering of up to $1,500,000 of
investment units consisting of 1 share of our common stock valued at $0.50 and 1
warrant to purchase 0.5 shares of our common stock at any time during the three
years following the date of puchase for an exercise price of $1.00 per share.
This offering was concluded on June 30, 2001.
During the third quarter of 2001, we commenced an offering of up to
$1,689,100 principal amount of Series A Debentures. The Series A Debentures each
accrue interest at 8.0% per annum and mature three years from the date of
purchase. Each Series A Debenture is convertible at any time following the six
month anniversary of the date of issuance of such Series A Debenture into shares
of Telkonet common stock at a conversion price equal to $0.50 per share for each
$10,000 principal amount plus interest of the Series A Debenture converted. In
connection with the placement of the Series A Debentures, Telkonet issued
non-detachable warrants granting holders the right to acquire 1,689,100 share of
our common stock at $1.00 per share. On August 24, 2001, in connection with the
Series A Debenture offering, we entered into a placement agent agreement with
Attkisson, Carter & Akers, Incorporated pursuant to which we agreed to pay
Attkisson, Carter & Akers, Incorporated a commission equal to 10.0% of the
aggregate value of Series A Debentures placed by Attkisson, Carter & Akers,
Incorporated in the offering and issue to Attkisson, Carter & Akers,
Incorporated warrants to purchase shares of our common stock. Pursuant to the
placement agent agreement, Attkisson, Carter & Akers, Incorporated received
$130,780 and warrants to purchase an aggregate of 261,560 shares of our common
stock at a price of $0.525 per share. As of May 23, 2002, the Series A Debenture
offering was fully subscribed.
On January 29, 2002, we granted options to purchase 300,000 shares of
our common stock to Susquehanna Development, LLC as consideration for certain
management services provided by Susquehanna Development, LLC. Susquehanna
Development, LLC is an affiliate of Telkonet.
On April 1, 2002, we granted options to purchase 25,000 shares of our
common stock to John Quade as consideration for certain management services
provided by Mr. Quade.
On August 5, 2002, we granted options to purchase 18,000 shares of our
common stock and issued warrants to purchase 50,000 shares of our common stock
to Success International, Inc. as consideration for certain product positioning
advice provided by Success International, Inc.
During the fourth quarter of 2002, we commenced an offering of up to
$2,500,000 principal amount of Series B Debentures. The Series B Debentures each
accrue interest at 8.0% per annum and mature three years from the date of
purchase. Each Series B Debenture is convertible at any time following the six
month anniversary of
II-2
the date of issuance of such Series B Debenture into shares of our common stock
at a conversion price equal to $0.55 per share for each $10,000 principal amount
plus interest of the Series B Debenture converted. In connection with the
placement of the Series B Debentures, we also issued non-detachable warrants
granting holders the right to acquire 2,500,000 shares of our common stock at
$1.00 per share. On October 14, 2002, in connection with the Series B Debenture
offering, we entered into a placement agent agreement with Attkisson, Carter &
Akers, Incorporated pursuant to which we agreed to pay Attkisson, Carter &
Akers, Incorporated a commission equal to 10.0% of the aggregate value of Series
B Debentures placed by Attkisson, Carter & Akers, Incorporated in the offering
and issue to Attkisson, Carter & Akers, Incorporated warrants to purchase shares
of our common stock. Pursuant to the placement agent agreement, Attkisson,
Carter & Akers, Incorporated received $114,850 in cash and warrants to purchase
an aggregate of 229,700 shares of our common stock at a price of $0.66 per
share. In January 2003, we entered into an oral agreement with Warren V. Musser,
Chairman of Telkonet's Board of Directors, pursuant to which we agreed to pay
Mr. Musser a commission equal to 8.0% of the aggregate value of Series B
Debentures purchased by persons referred to Telkonet by Mr. Musser. Pursuant to
this agreement, Mr. Musser received $8,000. Mr. Musser is an affiliate of
Telkonet. In January 2003, we entered into an oral agreement with Howard Lubert,
Telkonet's former Chief Executive Officer, pursuant to which we agreed to pay
Mr. Lubert a commission equal to 8.0% of the aggregate value of Series B
Debentures purchased by persons referred to Telkonet by Mr. Lubert. Pursuant to
this agreement, Mr. Lubert received $12,000. At the time of this payment, Mr.
Lubert was an affiliate of Telkonet. As of February 14, 2003, the Series B
Debenture offering was fully subscribed.
On January 1, 2003, we granted options to purchase 200,000 shares of
our common stock to John Vasilj as consideration for certain general business
services provided by Mr. Vasilj.
On January 1, 2003, we granted options to purchase 200,000 shares of
our common stock to John Cosper as consideration for certain general business
services provided by Mr. Cosper.
On January 30, 2003, we entered into an employment agreement with
Ronald W. Pickett, our President, pursuant to which we agreed to issue 3,000
shares of our common stock per month for each month during the term of the
employment agreement. As of the date of this registration statement, Mr. Pickett
is entitled to receive 21,000 shares of our common stock. These shares will be
issued to Mr. Pickett upon his request. Mr. Pickett is an affiliate of Telkonet.
On February 1, 2003, we granted options to purchase 375,000 shares of
our common stock to David L. Jordan as consideration for certain general
business services provided by Mr. Jordan.
On February 1, 2003, we granted options to purchase 375,000 shares of
our common stock to Barry W. Zelin as consideration for certain general business
services provided by Mr. Zelin.
On February 1, 2003, we granted options to purchase 250,000 shares of
our common stock to Axiom Capital Management, Inc. as consideration for certain
general business services provided by Axiom Capital Management, Inc.
On February 3, 2003, we issued 49,998 shares of our common stock to
Investor Stock Daily, Inc. as consideration for certain public relations
services provided by Investor Stock Daily, Inc.
During the second quarter of 2003, we commenced an offering of up to
$5,000,000 principal amount of Senior Notes. The Senior Notes each accrue
interest at 8.0% per annum, mature three years from the date of purchase and are
secured by a first priority security interest in all of the intellectual
property assets of Telkonet. In connection with the placement of the Senior
Notes, we also issued non-detachable warrants granting holders the right to
acquire 6,250,000 shares of our common stock at $1.00 per share. On May 21,
2003, in connection with the
II-3
Senior Note offering, we entered into an agreement with First Montauk Securities
Corp. pursuant to which we agreed to pay First Montauk Securities Corp. a
commission equal to 4.0% of the aggregate value of Senior Notes purchased by
persons referred to Telkonet by First Montauk Securities Corp. Pursuant to this
agreement, First Montauk Securities Corp. received $16,000. On June 12, 2003, we
entered into a placement agent agreement with vFinance Investments, Inc.
pursuant to which we agreed to pay vFinance Investments, Inc. a commission equal
to 4.0% of the aggregate value of Senior Notes placed by vFinance Investments,
Inc. in the offering. Pursuant to the placement agent agreement, vFinance
Investments, Inc. received $13,000. On June 16, 2003, we entered into an
agreement with Richard Hansen pursuant to which we agreed to pay Mr. Hansen a
commission equal to 4.0% of the aggregate value of Senior Notes purchased by
persons referred to Telkonet by Mr. Hansen. Pursuant to this agreement, Mr.
Hansen received $52,600. As of June 26, the Senior Note offering was fully
subscribed.
On May 21, 2003, we issued 35,000 shares of our common stock to
vFinance Investments, Inc. as consideration for certain investment banking and
investment advisory services provided by vFinance Investments, Inc.
On May 21, 2003, we issued warrants to purchase 50,000 shares of our
common stock to First Montauk Securities Corp. as consideration for certain
financial services provided by First Montauk Securities Corp.
On July 3, 2003, we agreed to issue 5,000 shares of our common stock to
The Research Works, Inc. as consideration for the preparation of a research
report by The Research Works, Inc.
On July 7, 2003, we agreed to issue 5,000 shares of our common stock to
Market-Pulse Inc. as consideration for certain public relations services
provided by Market Pulse.
On July 21, 2003, we agreed to issue 17,000 shares of our common stock
to CEOcast, Inc. as consideration for certain investor relations and consulting
services provided by CEOcast, Inc.
On August 26, 2003, we sold 333 shares of our common stock to H.E. and
Paula J. Fowler at a price of $2.00 per share.
Each of the transactions described in this Item 15 were effected in
reliance on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933 and/or Rule 506 of Regulation D promulgated thereunder.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
Exhibit
Number Description of Exhibits
------ -----------------------
1.1 Placement Agent Agreement by and between Telkonet, Inc. and
Attkisson, Carter & Akers, Incorporated, dated as of August
24, 2001
1.2 Placement Agent Agreement by and between Telkonet, Inc. and
Attkisson, Carter & Akers, Incorporated, dated as of October
14, 2002
1.3 Placement Agent Agreement by and between Telkonet, Inc. and
vFinance Investments, Inc., dated as of June 12, 2003
II-4
3.1 Amended and Restated Articles of Incorporation (incorporated
by reference to our Form 8-K (No. 000-27305), filed on August
30, 2000 and our Form S-8 (No. 333-47986), filed on October
16, 2000)
3.2 Bylaws
4.1 Telkonet, Inc. Series A Convertible Debenture and Common Stock
Purchase Warrant (incorporated by reference to our Form 10-KSB
(No. 000-27305), filed on March 31, 2003)
4.2 Telkonet, Inc. Series B Convertible Debenture and Common Stock
Purchase Warrant (incorporated by reference to our Form 10-KSB
(No. 000-27305), filed on March 31, 2003)
4.3 Telkonet, Inc. Senior Note and Common Stock Purchase Warrant
5 Opinion of Baker & Hostetler LLP as to the validity of the
issuance of the common stock of Telkonet, Inc. being
registered
10.1 Amended and Restated Telkonet, Inc. Incentive Stock Option
Plan (incorporated by reference to our Form S-8 (No. 333-412),
filed on April 17, 2002)
10.2 Employment Agreement by and between Telkonet, Inc. and Peter
Larson, dated as of June 19, 2000 (incorporated by reference
to our Form 8-K (No. 000-27305), filed on August 30, 2000)
10.3 Employment Agreement by and between Telkonet, Inc. and Stephen
L. Sadle, dated as of June 19, 2000 (incorporated by reference
to our Form 8-K (No. 000-27305), filed on August 30, 2000)
10.4 Amendment to Employment Agreement by and between Telkonet,
Inc. and Stephen L. Sadle, dated as of April 24, 2002
10.5 Employment Agreement by and between Telkonet, Inc. and Stephen
L. Sadle, dated as of January 18, 2003
10.6 Employment Agreement by and between Telkonet, Inc. and J.
Gregory Fowler, dated as of January 30, 2002
10.7 Employment Agreement by and between Telkonet, Inc. and David
S. Yaney, dated as of February 15, 2002
10.8 Employment Agreement by and between Telkonet, Inc. and Howard
Lubert, dated as of January 1, 2003
10.9 Separation Agreement by and between Telkonet, Inc. and Howard
Lubert, dated as of June 16, 2003
II-5
10.10 Employment Agreement by and between Telkonet, Inc. and Robert
P. Crabb, dated as of January 18, 2003
10.11 Employment Agreement by and between Telkonet, Inc. and Ronald
W. Pickett, dated as of January 30, 2003
10.12 Employment Agreement by and between Telkonet, Inc. and E.
Barry Smith, dated as of February 17, 2003
21 Telkonet, Inc. Subsidiaries
23.1 Consent of Russell Bedford Stefanou Mirchandani LLP relating
to the financial statements of Telkonet, Inc.
23.2 Consent of Baker & Hostetler LLP (included in Exhibit 5)
24 Power of Attorney (included on signature page)
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(a) To include any prospectus required by Section
10(a)(3) of the Securities Act of 1933;
(b) To reflect in the prospectus any facts or events
arising after the effective date of the registration
statement (or the most recent post-effective
amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the
information set forth in the registration statement.
Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the
total dollar value of securities offered would not
exceed that which was registered) and any deviation
from the low or high end of the estimated maximum
offering range may be reflected in the form of
prospectus filed with the Securities and Exchange
Commission pursuant to Rule 424(b) if, in the
aggregate, the changes in volume and price represent
no more than a 20 percent change in the maximum
aggregate offering price set forth in the
"Calculation of Registration Fee" table in the
effective registration statement; and
(c) To include any material information with respect to
the plan of distribution not previously disclosed in
the registration statement or any material change to
such information in the registration statement;
provided, however, that paragraphs (1)(a) and (1)(b) shall not apply if the
information required to be included in a post-effective amendment by those
paragraphs is contained in periodic reports filed with or furnished to the
Securities and Exchange Commission by the registrant pursuant to Section 13 or
Section 15(d) of the Securities Exchange Act of 1934 that are incorporated by
reference in the registration statement.
II-6
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial BONA
FIDE offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the termination of
the offering.
The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or Section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial BONA FIDE offering thereof.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
II-7
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, Telkonet,
Inc. has duly caused this registration statement to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of Annapolis, State of
Maryland, on the 28th day of August, 2003.
TELKONET, INC.
By: /s/ Stephen L. Sadle
-----------------------
Stephen L. Sadle
Chief Operating Officer
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Stephen L. Sadle, E. Barry Smith and Robert P. Crabb,
or any of them, his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all post-effective amendments
to this registration statement, and to file the same with all exhibits hereto,
and other documents in connection herewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or any of them, or their
or his substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed on August 28, 2003 by the following
persons in the capacities indicated below.
Signature Title
--------- -----
/s/ Stephen L. Sadle Chief Operating Officer and Director
---------------------
Stephen L. Sadle
/s/ Ronald W. Pickett President and Director
---------------------
Ronald W. Pickett
/s/ E. Barry Smith Chief Financial Officer
---------------------
E. Barry Smith
/s/ Warren V. Musser Chairman of the Board of Directors
---------------------
Warren V. Musser
/s/ A. Hugo DeCesaris Director
---------------------
A. Hugo DeCesaris
/s/ David W. Grimes Director
---------------------
David W. Grimes
/s/ Robert P. Crabb Secretary
---------------------
Robert P. Crabb
II-8
EXHIBIT INDEX
Exhibit
Number Description of Exhibits
------ -----------------------
1.1 Placement Agent Agreement by and between Telkonet, Inc. and
Attkisson, Carter & Akers, Incorporated, dated as of August
24, 2001
1.2 Placement Agent Agreement by and between Telkonet, Inc. and
Attkisson, Carter & Akers, Incorporated, dated as of October
14, 2002
1.3 Placement Agent Agreement by and between Telkonet, Inc. and
vFinance Investments, Inc., dated as of June 12, 2003
3.1 Amended and Restated Articles of Incorporation (incorporated
by reference to our Form 8-K (No. 000-27305), filed on August
30, 2000 and our Form S-8 (No. 333-47986), filed on October
16, 2000)
3.2 Bylaws
4.1 Telkonet, Inc. Series A Convertible Debenture and Common Stock
Purchase Warrant (incorporated by reference to our Form 10-KSB
(No. 000-27305), filed on March 31, 2003)
4.2 Telkonet, Inc. Series B Convertible Debenture and Common Stock
Purchase Warrant (incorporated by reference to our Form 10-KSB
(No. 000-27305), filed on March 31, 2003)
4.3 Telkonet, Inc. Senior Note and Common Stock Purchase Warrant
5 Opinion of Baker & Hostetler LLP as to the validity of the
issuance of the common stock of Telkonet, Inc. being
registered
10.1 Amended and Restated Telkonet, Inc. Incentive Stock Option
Plan (incorporated by reference to our Form S-8 (No. 333-412),
filed on April 17, 2002)
10.2 Employment Agreement by and between Telkonet, Inc. and Peter
Larson, dated as of June 19, 2000 (incorporated by reference
to our Form 8-K (No. 000-27305), filed on August 30, 2000)
10.3 Employment Agreement by and between Telkonet, Inc. and Stephen
L. Sadle, dated as of June 19, 2000 (incorporated by reference
to our Form 8-K (No. 000-27305), filed on August 30, 2000)
10.4 Amendment to Employment Agreement by and between Telkonet,
Inc. and Stephen L. Sadle, dated as of April 24, 2002
10.5 Employment Agreement by and between Telkonet, Inc. and Stephen
L. Sadle, dated as of January 18, 2003
10.6 Employment Agreement by and between Telkonet, Inc. and J.
Gregory Fowler, dated as of January 30, 2002
10.7 Employment Agreement by and between Telkonet, Inc. and David
S. Yaney, dated as of February 15, 2002
10.8 Employment Agreement by and between Telkonet, Inc. and Howard
Lubert, dated as of January 1, 2003
10.9 Separation Agreement by and between Telkonet, Inc. and Howard
Lubert, dated as of June 16, 2003
10.10 Employment Agreement by and between Telkonet, Inc. and Robert
P. Crabb, dated as of January 18, 2003
10.11 Employment Agreement by and between Telkonet, Inc. and Ronald
W. Pickett, dated as of January 30, 2003
10.12 Employment Agreement by and between Telkonet, Inc. and E.
Barry Smith, dated as of February 17, 2003
21 Telkonet, Inc. Subsidiaries
23.1 Consent of Russell Bedford Stefanou Mirchandani LLP relating
to the financial statements of Telkonet, Inc.
23.2 Consent of Baker & Hostetler LLP (included in Exhibit 5)
24 Power of Attorney (included on signature page)