SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act August 30, 2000 Date of Report (Date of Earliest Event Reported) TELKONET, INC. (formerly known as Comstock Coal Company, Inc.) (Exact Name of Registrant as Specified in its Charter) 670 Ritchie Highway, 2nd Floor Severna Park, Maryland 21146 (Address of principal executive offices) 410/544-1044 Registrant's telephone number Utah 87-0627421 (State of Incorporation) (IRS Employer Identification No.) ITEM 1. CHANGES IN CONTROL OF REGISTRANT (a) Pursuant to an Agreement and Plan of Reorganization (the "Agreement") dated as of August 30, 2000 by and among Comstock Coal Company, Inc. (the "Company"), a Utah corporation, Comstock Acquisition Corporation ("CAC"), a Utah corporation and a wholly-owned subsidiary of the Company, and Telkonet Communications, Inc. ("TCI"), a Delaware corporation, CAC merged with and into TCI, with TCI emerging as the surviving corporation. In consideration of such merger transaction, the common stock of TCI's shareholders was converted into and exchanged for 19,795,337 shares of Company common stock and outstanding warrants of various holders for TCI common stock were converted into warrants for an additional 1,397,098 shares of Company common stock. In addition, by operation of law, CAC's common stock was converted into TCI common stock. Furthermore, as of the effective date of the Agreement the Company changed its name to "Telkonet, Inc." As a result of the execution of the transactions set forth in the Agreement, TCI has become a wholly-owned subsidiary of the Company. The Agreement was adopted by the unanimous consent of the Board of Directors of the Company on August 30, 2000. The Agreement was adopted by the unanimous consent of the Board of Directors of CAC and approved by consent of the sole shareholder of CAC on August 30, 2000. The Agreement was adopted by the unanimous consent of the Board of Directors of TCI and by the consent of a majority of the shareholders of TCI on August 30, 2000. Upon effectiveness of the Agreement, the Company had an aggregate of 21,775,337 shares of common stock outstanding. Immediately prior to the effectiveness of the Agreement (I.E, the moment before the effective date of the Agreement) the Company had 1,980,000 shares of common stock outstanding. By virtue of the merger, and their receipt of 19,795,337 shares of the Company common stock, TCI's shareholders acquired 90.90% of the issued and outstanding common stock of the Company. The directors of the Company, prior to the effectiveness of the Agreement, have, as part of and as a result of the reorganization, elected new officers and directors of the Company and immediately thereafter (upon the effectiveness of the Agreement) resigned as directors of the Company. As a result, the pre-merger shareholders of TCI, who acquired 90.90% of the issued and outstanding common stock of Company in the reorganization, control the Company and TCI's officers and directors have become the officers and directors of the Company. See "Management" below. The officers and directors of TCI shall remain and be the officers and directors of TCI after the effective date of the Agreement. A copy of the Agreement is filed as an exhibit to this Form 8-K and is incorporated in its entirety herein, with the exception of the schedules to the Agreement. The foregoing description is modified by such reference. (b) The following table contains information regarding the shareholdings of the 3 (three) current directors and executive officers and those persons or entities who beneficially own more than 5% of its common stock (giving effect to the exercise of the warrants held by each such person or entity): Amount of Percent of Common Stock Common Stock Beneficially Beneficially Name Owned (1) Owned Officers and Directors David W. Grimes 4,971,917 21.5% Chairman and Chief Technology Officer 670 Ritchie Highway, 2nd Floor Severna Park, Maryland 21146 L. Peter Larson 1,505,285 6.5% President and Chief Executive Officer 670 Ritchie Highway, 2nd Floor Severna Park, Maryland 21146 Stephen L. Sadle 5,722,694 24.7% Chief Operating Officer 670 Ritchie Highway, 2nd Floor Severna Park, Maryland 21146 Others Donald Erat 2,861,347 12.3% 670 Ritchie Highway, 2nd Floor Severna Park, Maryland 21146 Ronald Pickett 2,658,964 11.5% 2321 Ocean Point Drive Wilmington, NC 28405 FERST for St. Mary's, Inc. 1,958,549* 8.5% P.O. Box 167 Mechanicsville, MD 20658 * Includes 652,850 immediately exercisable warrants to purchase shares of common stock at $1.00 per share (1) Based upon 21,775,337 outstanding shares of common stock (subsequent to the effectiveness of the reorganization) plus 1,397,098 immediately exercisable warrants to purchase shares of common stock. (c) The holders of restricted "legended" shares of the Company's common stock, prior to the effectiveness of the Agreement, are entitled pursuant to an agreement entered into with the Company (the "Registration Rights Agreement") to piggyback registration rights with other substantially similar securities registered by the Company during a 2 year period following the effectiveness of the Agreement. A copy of the Registration Rights Agreement is filed as an exhibit to this Form 8-K and is incorporated in its entirety herein. The foregoing description is modified by such reference. ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS On August 30, 2000, a 90.90% interest in Company was acquired by the shareholders of TCI by way of a reorganization involving a reverse triangular merger (through CAC) by and with TCI, a Delaware corporation. The Company's Board of Directors approved the reorganization set forth in the Agreement. As a result of this reorganization transaction TCI is a wholly-owned subsidiary of Company. CURRENT OPERATIONS The Company had no independent business operations prior to the effectiveness of the reorganization. Subsequent to the effectiveness of the reorganization, the Company's only business operation was a holding company for its wholly-owned subsidiary, TCI. TCI is actively engaged in the telephone and Internet businesses. TCI has developed working prototypes for two products designed to provide Internet and telephone service through power line transmission. TCI has developed and applied for patents which cover the technology developed and plans to utilize recently announced advancements in transmission speed to build next generation hardware for field test and marketing demonstrations. TCI intends to expand its design team to produce and deliver a variety of telephony products to provide complete solution sets for its customers. TCI BUSINESS TCI was formed to develop applications for emerging power-line carrier technologies. Technology developed will be licensed or sold to companies with vertical markets who could build on TCI's basic expertise to construct power line carrier based systems that enhance their business base and capability. TCI can be characterized as a high technology systems application developer with primary focus on applications in Internet distribution worldwide and telephony systems in developing countries around the globe, where local communications infrastructures are not providing cost-effective service. TCI intends to be a key global supplier of communications products through the development of strategic joint venture and licensing relationships, which will enhance long-term growth and provide a stable platform for market penetration. TCI has developed proprietary products, which are the first of their kind to provide telephony communications solutions. The first involves the use of the power line infrastructure to distribute telephony using a hybrid system. The central office of a public service telephone network may choose to provide the wide band line for interconnectivity to the TCI power line carrier telephony system. This approach greatly reduces the cost and time required to bring telecommunications services to communities that do not have such services. Alternatively, V-sat connectivity can also be used for distribution to an access point of a public service telephone network. TCI's second proprietary product provides Internet service via power lines to end users through interfaces with available high-speed landlines or geosynchronous satellite to a Vsat terminal. Use of power lines substantially improves the cost effectiveness of this Internet delivery system, and when used in conjunction with satellite access may avoid the traditional per minute telecom charges that are incurred by users throughout Europe. Using power lines for distribution could make the Internet economically viable for a large population of potential customers. TCI's system avoids the disruption and high cost of new wiring. PERCEIVED BENEFITS There are certain perceived benefits to being a reporting company with a class of publicly traded securities. These are commonly thought to include the following: * the ability to use registered securities to make acquisitions of assets or businesses; * increased visibility in the financial community; * the facilitation of borrowing from financial institutions; * improved trading efficiency; * shareholder liquidity; * greater ease in subsequently raising capital; * compensation of key employees through stock options; * enhanced corporate image; * a presence in the United States capital markets. PROPERTY AND OFFICES The Company's principal executive office is located at 670 Ritchie Highway, 2nd Floor, Severna Park, Maryland 21146. The Company's registered office in Utah is c/o Richard Lawrence, Suite 1200, Beneficial Life Tower, 36 South State Street, Salt Lake City, Utah 84111. TCI currently has approximately 1000 sq. ft. of office space rented at 670 Ritchie Highway, 2nd Floor, Severna Park, Maryland 21146 and shares laboratory facilities with Space-port access at Windermere Information Technology Systems in Annapolis. The Company is in negotiation for a leased facility that would allow for planned increases in operating activities. LITIGATION There is no known litigation pending against either the Company or TCI. MARKET FOR THE COMPANY SECURITIES The Company has been a reporting public company. The Company's common stock is listed on the OTC Bulletin Board operated by Nasdaq under the symbol CKCC.OB, but has never been publicly traded. Due to this lack of public trading, there is no established market price for the Company's common stock. Following the effectiveness of the Agreement, the Company's common stock will be listed on the OTC Bulletin Board operated by Nasdaq under the symbol TLKO. MANAGEMENT Name Age Title - --- --- ----- David W. Grimes 63 Chairman & Chief Technology Officer L. Peter Larson 50 President & Chief Executive Officer Kevin L. Miller 47 Chief Financial Officer Stephen L. Sadle 54 Chief Operating Officer Robert P. Crabb 53 Secretary DAVID W. GRIMES is the co-founder of TCI. He is also the founder and CEO of Transpace Carriers, Inc., a venture to commercialize the Delta Launch Vehicle. Grimes was the former Senior Executive for the Delta Program at NASA, heading the $200M per annum program. He was most recently Chief Engineer of 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. Grimes is a recognized expert in space and ground communications systems and brings this expertise to bear on the implementation of the hybrid telephony technology described herein. L. PETER LARSON has an extensive background in engineering and finance. After completing his BSEE and MS in Operations Research at Rensselaer Polytechnic, he began his career with General Dynamics Corporation. During his 20+ year career at General Dynamics, he served in various executive positions including Vice President and Controller of their International Services Company and Senior Vice President Finance and CFO for the Cessna Aircraft Company. Mr. Larson was a consultant and has recently served as CFO or COO in several start-up and turn-around assignments in electronics manufacturing, software, Internet application development and telecommunications. KEVIN L. MILLER has over twenty-six years of experience in finance and business development of which twenty-three years were spent at General Electric Company ("GE"). At GE, he held executive-level positions in such diverse businesses as GE Capital, Information Services, Power Systems, Engineered Materials, Healthcare, Corporate Finance and GE Investments. Mr. Miller began his career at GE on its prestigious three-year Financial Management Program which he completed with honors. Mr. Miller left GE to become a founding partner of the Strategic Ventures Group (SVG), a success-fee based consulting firm to both early-stage technology companies and established global companies. Prior to joining Telkonet, he was the Chief Financial Officer of Internos Corporation, a Dulles, Virginia based Internet company providing electronic commerce services to companies focused in industries such as construction, property management, railroad contracting, and toy manufacturing. STEPHEN L. SADLE is a co-founder of the company. Mr. Sadle was previously employed as Senior Vice President and General Sales Manager of Internos, a provider of Web based vertical extranet applications and has developed operating extranets in the construction and transportation industries. For 15 years prior, Sadle was Vice President of Business Development and Sales for The Driggs Corporation, a major heavy and infrastructure contracting firm interfacing with government and the private sectors. Also, he was president and founder of a successful construction company and was awarded Small Businessman of the Year Award for the Washington Metropolitan Area. Mr. Sadle brings significant management, contracting and entrepreneurial skills to the company. ROBERT P. CRABB has over 30 years of sales, marketing and public and private corporate management experience, including 15 years with the Metropolitan Life Insurance Company where he assisted in the development of marketing and training programs. His entrepreneurial expertise includes marketing and financial consulting and commercial and residential real estate development. Mr. Crabb is the President of Susquehanna Development L.L.C., a marketing and business development consulting company. Mr. Crabb serves on the Board of Directors of Medical Advisory Systems, Inc. (AMEX:"DOC"). As a consultant, Mr. Crabb will provide marketing and public company administration services to Telkonet. EXECUTIVE COMPENSATION L. PETER LARSON is employed as the TCI's President and Chief Executive Officer and has assumed such positions with the Company. Pursuant to a three (3) year employment agreement by and between Mr. Larsen and TCI, in compensation for the performance of his executive duties, Mr. Larsen shall be compensated in the amount of One Hundred Thirty Thousand Dollars ($130,000) per annum. Such annual compensation may be increased at TCI's discretion and Mr. Larsen is eligible for yearly bonuses also at TCI's discretion. The base term of Mr. Larsen's employment contract expires on June 18, 2003. STEPHEN L. SADLE is employed as the TCI's Executive Vice-President, Secretary, Treasurer and Chief Operating Officer and has assumed such positions with the Company. Pursuant to a three (3) year employment agreement by and between Mr. Sadle and TCI, in compensation for the performance of his executive duties, Mr. Sadle shall be compensated in the amount of One Hundred Thirty Thousand Dollars ($130,000) per annum. Such annual compensation may be increased at TCI's discretion and Mr. Sadle is eligible for yearly bonuses also at TCI's discretion. The base term of Mr. Sadle's employment contract expires on June 18, 2003. DAVID W. GRIMES is employed as TCI's Chairman and has assumed such position with the Company. He has no employment contract with TCI, being an employee at-will, and he is compensated for the performance of his executive duties in the amount of Forty-Eight Thousand Dollars ($48,000) per annum KEVIN L. MILLER is employed as TCI's Chief Financial Officer and has assumed such position with the Company. He has no employment contract with TCI, being an employee at-will, and he is compensated for the performance of his executive duties in the amount of Ninety-Six Thousand Dollars ($96,000) per annum RELATED TRANSACTIONS NOT APPLICABLE RISK FACTORS The Company, its business plan and any offering of its securities are subject to numerous risk factors which prospective investors should carefully consider, including the following: TAXATION. The business combination described herein has been structured so as to minimize the federal and state tax consequences to the Company, TCI and their respective shareholders. No rulings have been requested from the Internal Revenue Service regarding this reorganization and, therefore, there can be no absolute assurance that such business combination have met the statutory requirements of a tax-free reorganization or that the parties will obtain the intended tax-free treatment. A non-qualifying reorganization could result in the imposition of both federal and state taxes, which might have an adverse effect on the parties to the transaction. POSSIBLE PRICE VOLATILITY. Although it is impossible to predict the nature of any secondary trading market for the Company's common stock in the future, the market prices for securities of emerging companies historically have been highly volatile. Future announcements concerning the Company or its competitors, including the results of testing, technological innovations or new commercial products, government regulations and developments concerning proprietary rights or litigation may have a significant impact on the price of the Company's securities in any such secondary trading. NO DIVIDENDS ANTICIPATED. The Company has never paid any dividends on its securities and does not anticipate the payment of dividends in the foreseeable future. CURRENT TRADING MARKET FOR THE COMPANY'S SECURITIES. The Company's common stock is listed on the OTC Bulletin Board operated by Nasdaq under the symbol CKCC.OB. There has been no previous open market trading of the Company's Common Stock. PENNY STOCK REGULATION. Upon commencement of trading in the Company's stock, if such continues (of which there can be no assurance) the Company's common stock may be deemed a penny stock. Penny stocks generally are equity securities with a price of less than $5.00 per share other than securities registered on certain national securities exchanges or quoted on the Nasdaq Stock Market, provided that current price and volume information with respect to transactions in such securities is provided by the exchange or system. The Company's securities may be subject to "penny stock rules" that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally those with assets in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with their spouse). For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of such securities and have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the "penny stock rules" require the delivery, prior to the transaction, of a disclosure schedule prescribed by the Commission relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements must be sent disclosing recent price information on the limited market in penny stocks. Consequently, the "penny stock rules" may restrict the ability of broker-dealers to sell the Company's securities. The foregoing required penny stock restrictions will not apply to the Company's securities if such securities maintain a market price of $5.00 or greater. There can be no assurance that the price of the Company's securities will reach or maintain such a level. DEVELOPMENT STAGE COMPANY. Subsequent to the reorganization the Company has become a development stage company, the business of which is subject to all of the risks and uncertainties normally associated with business ventures in the development stage, which historically have a high failure rate. Although members of the management team of the Company have substantial experience in technology development, there can be no assurance that the Company effectively market such developments and that the Company will be profitable in the future. UNPROVED MARKET ACCEPTANCE. Although the Company believes there is a substantial need for the technologies and products proposed to be offered by the Company, its management is unable to guarantee the level of market acceptance for these products or their performance compared to other existing or future technologies. Furthermore the Company cannot guarantee the level of revenues that will ultimately be generated by these products. UNCERTAIN MARKETING PARTNERSHIPS. Subsequent to the reorganization, the Company has not yet finalized a contract with any partner to guarantee a minimum level of revenue generation. As such, the Company is unable to gauge the level of acceptance of its technologies. Failure of the Company to establish or retain customer acceptance would have a material adverse effect on the operations of the Company and profits of the Company. TECHNOLOGICAL FEASIBILITY UNDETERMINED. While the Company is in the process of evaluating its technologies, important specific applications have not yet been designed nor tested for their final intended use. Thus, there is no assurance that the technologies will function as predicted. Failure of the technologies to function as predicted or any delay in the development of the technologies will have a material adverse effect on the Company. DEPENDENCE ON MANAGEMENT AND LIMITED STAFF. The Company's ability to achieve its objectives is largely dependent upon the services of its key employees. The loss of services of any of those could have a material adverse impact on the Company. The Company has no business interruption insurance or keyman life insurance on any of its employees. The death or disability of any key employees or key independent contractors or the occurrence of any other uninsured event would likely have a material adverse impact on the Company. The Company's future success also depends on its continuing ability to attract and retain highly qualified technical, sales and marketing, customer support, financial and accounting, and managerial personnel. Competition for such personnel in the technology industry is intense, and there can be no assurance that the Company will be able to retain its key personnel or that it can attract, assimilate or retain other highly qualified personnel in the future. PATENT AND TRADE SECRET PROTECTION. Subsequent to the reorganization, no patent has been issued on the technology to be utilized by the Company, nor has any trademark for the use of the name "Telkonet" been issued to the Company. No assurance can be given that the Company will be able to successfully utilize the name Telkonet nor can any assurance be made that the Company will procure trademark rights to same. Additionally, if the Company proceeds with its product and services under the Telkonet name, the Company may be exposed to liability for the use of the names. As a result of the above, use and/or protection of the Company's products and services from competitors may be limited. There is no assurance that the Company can prevent others from offering similar products or that the Company has or will have sufficient resources to prosecute and defend litigation involving such intellectual property. Although the Company plans to register the appropriate trademarks, there is no assurance that the Company will obtain these trademarks, nor prevent others from using said names. NEED FOR ADDITIONAL FUNDS - FUTURE DILUTION. The Company will not be able to adequately fund the development, implementation and marketing of its technology without the infusion of additional funds. Acquisition of such funding may occur through the issuance of additional shares of the Company, the effect of which may be the dilution of the ownership interests of its shareholders subsequent to the reorganization. There is no assurance that the Company will be able to continue development and fully implement its marketing plan as currently contemplated without such future issuances. COMPETITION IN THE INDUSTRY. Competition is intense in the technology field. Moreover, other companies, who may be substantially larger than the Company and with other competitive advantages such as name recognition, an established market presence, legal services, and/or sales organizations, could develop technologies that would provide identical features to the Company's proposed technologies, or products that are broader in scope or more technologically advanced than those of the Company. PARTICIPATION OF OTHER CORPORATIONS. A key to success of the Telkonet technologies is the participation of other corporations and sponsors. Subsequent to the reorganization, the Company has not yet signed any participation or sponsor agreements which would generate revenue for the Company. Failure of the Company to establish and retain these sources of revenue would have a material adverse effect on the Company. CONTROL OF THE COMPANY. Current executive officers and directors of the Company hold stock representing 53.9% of the Common Stock of the Company. These shareholders will continue to determine the outcome of corporate actions requiring shareholder approval, including the election of directors until such time as their shares are diluted through subsequent offerings. RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE. The market in which the Company competes is characterized by rapidly changing technology, evolving industry standards, frequent new product announcements, introductions and enhancements, and changing customer demands. Accordingly, the Company's future success will depend on its ability to rapidly adapt to new ideas or scientific findings, its ability to rapidly adapt its solutions to meet evolving industry standards and its ability to continually improve the performance, features and reliability of its product to both changing customer demands and competitive product offerings. The failure of the Company to successfully adapt to such changes in a timely manner could have material adverse effect on the Company's business, results of operations and financial condition. Furthermore, there can be no assurance that the Company will not experience difficulties that could delay or prevent the successful design, development, testing, introduction or marketing of new technologies, or that any new solutions or enhancements to existing technologies will adequately meet the requirements of its prospective customers and achieve any degree of significant market acceptance. LITIGATION AND LIABILITY INSURANCE. The Company intends to secure general professional liability insurance. However, there can be no guarantee that clients of the Company will not enter into litigation against the Company as a result of information received from the Company. In the event that the Company is in fact sued, the Company may not be adequately insured. BROAD DISCRETION OF MANAGEMENT. Management will have broad discretion with respect to the expenditure of the Company's funds and the overall operation of the Company. Though each of the members of the senior management team has had broad experience in the technology field their exposure to start-up companies and start-up telephony companies in particular has been limited. UNCERTAIN VALUE OF STOCK OF COMPANY. There have been no professional opinions concerning the value of the stock of the Company or the net worth of the Company. GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES. Due to concerns arising in connection with the increasing popularity and use of the Internet, laws and regulations, in the United States and abroad, may be adopted covering issues such as user privacy, acceptable content, or taxation for services. Such legislation could affect the growth in use of the Internet generally or the Company, either of which could have a material adverse effect on the Company's business, results of operations and financial condition. NO OPERATING History or Revenue and Minimal Assets. Prior to the effectiveness of the Agreement the Company had no operating history nor revenues or earnings from operations nor significant assets or financial resources. TCI also had insignificant operation and minimal revenues prior to the effectiveness of the Agreement and had only minor amounts of assets. LACK OF DIVERSIFICATION. The Company's proposed operations, even if successful, will in all likelihood result in the Company engaging in a single line of business. The Company's inability to diversify its activities into a number of areas may subject the Company to economic fluctuations within a particular business or industry and therefore increase the risks associated with the Company's operations. ITEM 3. BANKRUPTCY OR RECEIVERSHIP Not applicable. ITEM 4. CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT On August 29, 2000, the Company dismissed its certifying public accountants, H J & Associates, LLC (formerly Jones, Jensen & Company) ("HJ"). HJ's report on the financial statements for the period as of December 31, 1999 and the related statements of operations, stockholders' equity (deficit) and cash flows for the years ended December 31, 1999 and 1998 and from the beginning of the development stage on July 28, 1997 through December 31, 1999 did not contain an adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles, except that their report for the year ended December 31, 1999 contained an explanatory paragraph regarding the substantial doubt about the Company's ability to continue as a going concern. The decision to dismiss HJ was approved by the Company's Board of Directors. During the period of July 28, 1997 (beginning of the development stage) through December 31, 1999 and subsequent interim period through August 29, 2000, the Company has not had any disagreements with HJ on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. The Company has engaged Stefanou & Company, LLP ("Stefanou") as its certifying accountant as of August 29, 2000 for the Company's fiscal year ending December 31, 2000. The Company has not consulted Stefanou previously. HJ's letter, which is required pursuant to Item 304(a)(3) of Regulation S-B, is attached. The Company has not consulted Stefanou previously. Jones, Jensen's letter, which is required pursuant to Item 304(a)(3) of Regulation S-B, is attached. ITEM 5. OTHER EVENTS Not applicable. ITEM 6. RESIGNATIONS OF DIRECTORS AND EXECUTIVE OFFICERS The directors and executive officers of the Company serving prior to the effectiveness of the Agreement, have, as part of and as a result of the reorganization, resigned as officers and directors of Company. New directors and executive officers of the Company were elected or selected immediately prior to the effectiveness of the Agreement. These newly elected or selected directors and executive officers are the prior directors and executive officers of TCI. Item 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS (a) Financial statements of business acquired. The required financial statements of the business acquired are set forth below TELKONET, INC. Index to Financial Statements Page Audit Report of Independent Certified Public Accountants F-3 Financial Statements Balance Sheet F-4 Statements of Losses F-5 Statements of Deficiency in Stockholders' Equity F-6 Statements of Cash Flows F-7 Notes to Financial Statements F-8 to F-13 Interim Financial Statements (Unaudited) Balance Sheet as of December 31, 1999 F-13 Statement of Losses for the six months ended December 31, 1999 F-14 Notes to Financial Statements at December 31, 1999 F-15 STEFANOU & COMPANY, LLP CERTIFIED PUBLIC ACCOUNTANTS 1360 Beverly Road Suite 305 McLean, VA 22101-3621 703-448-9200 703-448-3515 (fax) Philadelphia, PA REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors Telkonet Communications, Inc. Severna Park, Maryland We have audited the accompanying balance sheet of Telkonet Communications, Inc. (a development stage company) as of June 30, 2000 and the related statements of losses, stockholders' equity, and cash flows for the period November 3, 1999 (date of inception) to June 30, 2000. 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 audit in accordance with generally accepted auditing standards. 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 audit provides 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 Communications, Inc. as of June 30, 2000, and the results of its operations and its cash flows from November 3, 1999 (date of inception), to June 30, 2000, in conformity with generally accepted accounting principles. 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 H. 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 August 16, 2000 F-3 TELKONET COMMUNICATIONS, INC. (A DEVELOPMENT STAGE COMPANY) BALANCE SHEET JUNE 30, 2000 ASSETS ------ CURRENT ASSETS: Cash and equivalent $ 8,232 Marketable securities, at cost which approximates market 525,000 ---------- Total current assets 533,232 PROPERTY AND EQUIPMENT-AT COST: Furniture, equipment and leasehold improvements 74,646 Less accumulated depreciation 10,505 ---------- 64,141 ---------- $ 597,373 ========== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable and accrued expenses $ 70,070 Note payable (Note B) 235,000 ---------- Total current liabilities 305,070 COMMITMENTS AND CONTINGENCIES (Note E) STOCKHOLDERS' EQUITY (Note C) Common stock, par value $.01 per share; 25,000 shares authorized; 21,035 issued at June 30, 2000 210 Additional paid in capital 656,985 Deficit accumulated during development stage (364,892) ---------- Total stockholders' equity 292,303 ---------- $ 597,373 ========== F-4 TELKONET COMMUNICATIONS, INC. (A DEVELOPMENT STAGE COMPANY ) STATEMENT OF LOSSES FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) THROUGH JUNE 30, 2000 For the Period November 3, 1999, (Date of Inception) to June 30, 2000 ------------- Cost and expenses: Research and development $ 51,138 General and administrative 295,958 Interest 7,564 Depreciation and amortization 10,232 ---------- 364,892 Loss before income taxes (364,892) Income (taxes) benefit - ---------- Net loss $(364,892) ========== F-5