UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-K
Annual
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
Commission
file number: 000-27305
TELKONET,
INC.
(Exact
name of registrant as specified in its charter)
|
Utah
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87-0627421
|
|
(State
or other jurisdiction of incorporation or
organization)
|
(IRS
Employee Identification
No.)
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20374
Seneca Meadows Parkway
Germantown,
MD 20876
(Address
of principal executive offices)
(240)
912-1800
(Issuer’s
telephone number)
Securities
Registered pursuant to section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-know seasoned issuer, as defined
in
Rule 405 of the Securities Act. o Yes xNo
Indicate
by check mark if the registrant is not required to file reports pursuant
to
Section 13 or Section 15(b) of the Act. o Yes xNo
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. x Yes oNo
Check
if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not
contained in this form, and no disclosure will be contained, to the best
of
Registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment
to this
Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See the definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.
o Large
Accelerated
Filer x
Accelerated Filer o
Non-Accelerated Filer
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act) o Yes xNo
Aggregate
market value of the voting stock held by non-affiliates of the registrant
as of
March 1 2006: $155,184,856
Number
of
outstanding shares of the registrant’s par value $0.001 common stock
as
of
March 1, 2006: 46,316,539.
TELKONET,
INC.
FORM
10-K
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Page
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Part
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11
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Part
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21
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Part
III
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24
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27
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32
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34
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34
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Part
IV
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35
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PART
I
ITEM
1.
DESCRIPTION
OF BUSINESS.
General
Telkonet,
Inc. was formed in 1999 to develop products for use in the powerline
communications (PLC) industry. PLC products use existing electrical wiring
in
commercial and residential buildings to carry high speed data communications
signals, including the Internet. Since the Company’s formation, it has focused
on development and marketing of its PLC technology.
The
Company’s PLC technology, the “Telkonet iWire System(TM)” product
suite (formerly referred to as the PlugPlus™ product suite), consists of four
primary components, the Gateway, the eXtender, the Coupler and the iBridge.
The
Gateway, the hub of the Telkonet iWire SystemTM
product
suite, 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 Coupler, which interfaces directly between the Gateway
and the building’s electrical panel. Multi-panel buildings typically require
multiple Couplers, which are connected to the Gateway via inexpensive coaxial
cable and concentrated using standard radio frequency splitters. A suite
of
software applications running on the Gateway can perform communications
functions or system management functions. The iBridge serves as the user’s
network access device and connects to a user’s personal computer through a
standard Ethernet cable. The iBridge’s AC line cord serves as its power source
as well as its network interface. The eXtender is used to extend the reach
of
the Gateway in larger buildings or campus environments.
The
Telkonet iWire System™ product suite delivers data to the user at speeds in
excess of 7 Mega bits per second (Mbps), with burst speeds of 12.6 Mbps.
The
Telkonet iWire System™ product suite is installed by connecting an incoming
broadband signal (DSL, T-1, satellite or cable modem) into the Gateway and
connecting the Gateway to a building's electrical panel using one or more
Couplers. 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 iBridge
into
any electrical outlet and connecting a personal computer to the iBridge using
the computer's built-in Ethernet port. Multiple personal computers connected
to
the iBridge can communicate with one another and can share a single broadband
resource via the Gateway.
The
Company is a member of the HomePlug(TM)
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.
The
Company’s principal executive offices are located at 20374 Seneca Meadows
Parkway, Germantown, Maryland 20876.
Business
History
In
January 2002, the Company announced that it had shifted its management emphasis
from research and development to product sales and marketing in order to
move
its initial proprietary products into the commercial market. In January 2002,
the Board of Directors, Founders and executive management of the Company
also
reassessed the Company’s capital structure. In order to attract additional
management and marketing expertise, and to raise the necessary capital for
manufacturing, sales, and marketing, the Board of Directors approved a plan
authorizing the repurchase of certain shares of, and options to purchase,
Telkonet common stock held by each of David Grimes, L. Peter Larson and Stephen
Sadle who, at the time of the stock repurchase, each owned in excess of five
percent of the issued and outstanding capital stock and were directors and
executive officers of Telkonet. The net effect of the recapitalization was
to
reduce the number of shares of issued and outstanding common stock from
approximately 22,100,000 shares to 13,900,000 shares.
In
May
2002, the Company concluded an offering of Series A convertible debentures
pursuant to which the Company raised approximately $1.7 million dollars for
working capital purposes. In the fourth quarter of 2002, the Company announced
the successful installation of its PlugPlus™ product suite at a historic inn in
Augusta, Georgia and installation of a product field trial in Wilmington,
North
Carolina.
In
the
first quarter of 2003, the Company concluded an offering of Series B convertible
debentures pursuant to which the Company raised approximately $2.5 million
dollars for working capital purposes. The Company also executed a strategic
alliance agreement with Choice Hotels International (NYSE: CHH), one of the
largest hotel franchise companies in the world, pursuant to which Telkonet
agreed to become a Choice Hotels-endorsed vendor.
In
the
second quarter of 2003, the Company concluded an offering of Senior Notes
pursuant to which the Company raised approximately $5,000,000, exclusive
of
placement costs and fees. The proceeds of the Senior Note offering were
designated for working capital purposes.
In
January 2004, the Board of Directors determined to permit the Senior
Noteholders, for a limited period of time, to convert their Senior Notes
into
the Company's common stock at a conversion price of $2.10 per share. In
connection with this transaction, Senior Noteholders converted Senior Notes
having an aggregate principal value of $2,539,000. As of December 31, 2005,
the
aggregate outstanding balance on the Senior Notes, including principal and
accrued but unpaid interest, was $102,000.
In
February 2004, the Company completed a private offering of its common stock
resulting in net proceeds of $12.8 million. The Company sold 6,387,600 shares
of
its common stock in the private offering. The proceeds of the private placement
were designated for working capital purposes.
In
October 2005, the Company announced that it completed a convertible senior
debt financing of $20 million. The $20 million is for general working
capital needs. The convertible notes bear interest at a fixed rate of 7.25%,
payable in cash or, under certain
conditions, Telkonet common stock, and call for monthly principal
installments beginning March 1, 2006. The convertible senior notes
were purchased by two institutional investors in the face amount of
$10 million each.
In
January 2006, the Company acquired, for $9 million, a 90% interest in Microwave
Satellite Technologies (MST), a communications technology company that offers
complete sales, installation, and service of Very Small Aperture Terminal
(VSAT) and business television networks, and is a full-service national
Internet Service Provider (ISP). This acquisition will allow the
Company to provide a “triple-play” solution to HDTV, VoIP telephony and
Internet subscribers. The $9 million purchase price is payable $1.8 million
in
cash and 1.6 million unregistered shares of the Company’s common stock,
the $900,000 of the cash portion of the purchase price was paid at the
closing and the remaining $900,000 is payable in January 2007. With
respect to the stock portion of the purchase price, 400,000 shares of Telkonet
common stock were paid at the closing and the remaining 1,200,000 shares
are
currently held in escrow and shall be released upon the achievement of
3,300 “triple play” subscribers over a three year period. The Company plans to
expand MST's existing operations, which currently
are concentrated in Manhattan, throughout New York and increase its
presence in other major metropolitan cities using the New York system as
a
template.
Competition
The
HomePlug(TM)
Powerline Alliance has grown over the past year and now includes many well
recognized brands in the networking and communications industries. These
include
Linksys (a Cisco company), Intel, GE, Motorola, Netgear, Sony and Samsung.
While
these companies may choose to move into the commercial market at a future
date,
they do not presently represent a direct competitive threat to Telkonet since
they only market and sell their products in the residential sector.
Notwithstanding
the present absence of direct competitors, there can be no assurance that
the
HomePlug(TM) Powerline Alliance members, or any other company will
not develop PLC products that compete with Telkonet’s products in the
future. Some of these potential competitors have longer operating
histories, greater name recognition and substantially greater financial,
technical, sales, marketing and other resources than Telkonet. 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 Telkonet can. As a result, Telkonet 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 Telkonet or that would render Telkonet’s products obsolete or
noncompetitive.
Management
has focused its sales and marketing efforts primarily on the commercial sector,
which includes 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.
The
Company has also focused on establishing relationships with value added
resellers. Telkonet continues to examine, select and approach entities with
existing distribution channels that will be enhanced by the Company’s offerings.
The Company also intends to focus future sales and marketing efforts in Europe,
South America, Asia and the Pacific Rim.
Raw Materials
The
Company has not experienced any significant or unusual problems in the purchase
of raw materials or commodities. While the Company is dependent, in certain
situations, on a limited number of vendors to provide certain raw materials
and
components, it has not experienced significant problems or issues purchasing
any
essential materials, parts or components. The Company obtains the majority
of
its raw materials from the following suppliers: Avnet Electronics Marketing,
Digi-Key Corporation, Intellon Corporation, and Parkview Metal Products.
In
addition, Superior Manufacturing Services, a U.S. based company, provides
substantially all the manufacturing and assembly requirements for the
Company.
Customers
The
Company is neither limited to, nor reliant upon, a single or narrowly segmented
consumer base from which it derives its revenues. Presently, the Company
is not
dependent on any particular customer under contract. However, in 2005, the
Company sold certain rental contract agreements to Hospitality Leasing
Corporation, which sale represented approximately 18% of total revenues. In
2004, revenues from another customer represented approximately 19% of total
revenues. The Company’s primary focus is in the hospitality, multi-dwelling
units, government and international markets.
Intellectual
Property
The
Company has applied for patents that cover its unique technology, and has
utilized the recently announced advancements in transmission speeds to build
its
next generation of products. The Company continues to identify, design and
develop enhancements to its core technologies that will provide additional
functionality, diversification of application and desirability for current
and
future users. It is the intent of the Company to protect this intellectual
property by filing additional patent applications. The Company also has multiple
registered and common law trademarks that it uses in the conduct of its
business. The Company is presently not a party to any intellectual property
licensing agreements.
In
September 2003, the Company received approval from the U.S. Patent and Trademark
Office for its “Method and Apparatus for Providing Telephonic Communication
Services” patent.
In
December 2005, Telkonet was granted United States Patent 6,975,212 by the
U.S.
Patent and Trademark Office. The patent is titled “Method and Apparatus for
Attaching Power Line Communications to Customer Premises.” This patent covers
the Telkonet Coupler, which is a unique technique used by the Company to
interface and couple its communication devices onto the three-phase electrical
systems that are predominate in commercial buildings and facilities
worldwide. In addition to the foregoing, in 2005, Telkonet filed three new
patent applications related to its PLC technology.
Notwithstanding
the issuance of this patent, there
can be no assurance that any of the Company’s current or future patent
applications will be granted, or, if granted, that such patents will provide
necessary protection for the Company’s technology or its product offerings, or
be of commercial benefit to the Company.
Government
Regulation
We
are
subject to regulation in the United States by the FCC. FCC rules permit the
operation of unlicensed digital devices that radiate radio frequency (RF)
emissions if 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
PLC product line complies with the FCC technical requirements for 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.
In
Europe
and other overseas markets, the Company’s products are subject to safety and RF
emissions regulations adopted by the European Union (EU) for Information
Technology Equipment. In March 2005, the Company received final Conformite
Europeene (CE) certification, which is required for the Company to freely
market
and sell its products within the EU. As a result of the certification, the
Company’s products that will be sold and installed in EU countries will bear the
CE marking, a symbol that demonstrates that the product has met the EU’s
regulatory standards and is approved for sale in the EU.
Future
products designed by the Company will require testing for compliance with
FCC
and EU regulations. Moreover, if in the future, the FCC or EU change their
respective regulatory requirements, further testing and/or modifications
to the
Company's products may be necessary to comply with such
changes.
Research and Development
During
the years ended December 31, 2005, 2004 and 2003, the Company spent $2,096,104,
$1,852,308 and $1,370,785, respectively, on research and development activities.
In 2005, research and development activities included (a)
Quality of Service (QoS) for VoIP service for both commercial and FIPS
140-2 product applications, (b) design of next generation high-speed development
platform, (c) design, prototype and release of a new Integrated
Coupler Breaker product line, (d) design and development of second
generation automated test equipment for manufacturing Telkonet's products,
(e)
automated Software Quality Assurance (SQA) regression testing. In
2004,
research and development activities included (a) development of a reduced
cost (“G3”) iBridge/eXtender, (b) router software development, and (c) advanced
encryption support. In 2003, research and development activities included
(a)
improved network capabilities with the introduction of the Company’s
secondary gateway, (b) the introduction of an encrypted product feature
to enhance security functions, (c) improved ability to remotely monitor
network status, (d) the addition of a Virtual Local Area Network (VLAN) support
function for enhanced integration of subscriber management and billing
systems, and (e) development of the reduced cost iBridge/eXtender
products.
Long
Term Investments
Amperion,
Inc.
On
November 30, 2004, the Company invested $500,000 in Amperion, Inc., a privately
held company, in exchange for 11,013,215 shares of Series A Preferred Stock,
which represents an equity interest in Amperion of approximately 4.7%.
Amperion is engaged in the business of developing networking hardware and
software that enables the delivery of high-speed broadband data over
medium-voltage power lines. The Series A Preferred Stock has a preferential
right to receive dividends and with respect to liquidation. The Series A
Preferred Stock also votes as a single class with the shares of common stock
and
Class C common stock, except with respect to certain extraordinary matters,
including an amendment to Amperion’s certificate of incorporation, an increase
in the number of authorized shares of preferred stock, the issuance of any
class
of stock having parity with or rights superior to those of the Series A
Preferred Stock and certain material transactions, in which case, the Series
A
Preferred Stock must approve such extraordinary action voting as a separate
class. The Company has the right to designate one member of Amperion’s
seven-person board of directors. The Board of Directors has designated Warren
“Pete” Musser, the Chairman of the Board of Directors of Telkonet, to fill this
position. Each share of Series A Preferred Stock is entitled to one vote
per
share. The Company accounted for this investment under the cost method, as
the
Company does not have the ability to exercise significant influence over
Amperion’s operating or financial policies. The
Company determined that its investment in Amperion was impaired based upon
forecasted discounted cash flow and has written-off 80%, or $400,000, of
its
investment based on management assessment. The remaining value of the Company’s
investment in Amperion is $100,000 at December 31, 2005.
BPL
Global, Ltd.
On
February 4, 2005, the board of directors approved an investment
in BPL Global, Ltd. (“BPL Global”), a privately held company. During the
year-end December 31, 2005, the Company funded, in the aggregate, $131,000
of the approved committment. This investment represents an equity
interest of approximately 6.21% at December 31, 2005. BPL Global is engaged
in
the business of developing broadband services via power lines through joint
ventures in the United States, Asia, Eastern Europe and the Middle East.
The
Company accounted for this investment under the cost method, as the Company
does
not have the ability to exercise significant influence over operating and
financial policies of BPL Global. The Company reviewed the assumptions
underlying the operating performance and cash flow forecasts in assessing
the
carrying values of the investment. The fair value of the Company's investment
in
BPL Global remained at $131,000 as of December 31, 2005.
Environmental
Matters
The
Company does not anticipate any material effect on its capital expenditures,
earnings or competitive position due to compliance with government regulations
involving environmental matters.
Employees
As
of
March 1, 2006, the Company had eighty-three (83) full time employees, which
were comprised of sixty-six (66) full-time employees of Telkonet and
seventeen (17) employees of MST. The Company anticipates that it will hire
additional key staff throughout 2006 in the areas of business development,
sales
and marketing, and engineering.
Backlog
As
of
December 31, 2005 and 2004, revenues to be recognized under non-cancelable
leases (backlog) was approximately $2,411,000 and $933,000, respectively.
The
associated remaining weighted average lease term was approximately 31 months
for
both years. In January 2006, the Company consummated a non-recourse sale
of
certain rental contract agreements (backlog) of approximately $918,000. Of
the
remaining $1,493,000 backlog, $498,000 will be recognized as revenue in 2006
while the remaining $995,000 will be recognized in 2007 through
2010.
Financial
Information About Geographic Areas
To
date,
the majority of the Company's revenue has been derived from United
States sources although the Company does recognize revenue from
international sales. International sales represented 25% and 10% of the
Company's total revenue in 2005 and 2004, respectively. Telkonet's
international sales presently are concentrated in Canada, Latin America and
Western Europe, however, Telkonet continues to expand into other markets
worldwide. The table below sets forth the Company's net
revenue in the United States and Worldwide.
|
Year
Ended December 31,
|
||||||||||||||||
|
2005
|
Percentage
Change
|
2004
|
Percentage
Change
|
2003
|
||||||||||||
|
United
States
|
$
|
1,871,241
|
197
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%
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$
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630,957
|
574
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%
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$
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93,660
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||||||
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Worldwide
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617,082
|
812
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%
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67,695
|
-
|
-
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||||||||||
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Total
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$
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2,488,323
|
256
|
%
|
$
|
698,652
|
646
|
%
|
$
|
93,660
|
||||||
ITEM
1A. RISK
FACTORS.
The
risks
and uncertainties described below are those that the Company currently deems
to
be material and that it believes are specific to the Company and the industry
in
which it competes. In addition to these risks, the Company’s business may be
subject to risks currently unknown to the Company.
The
Company has a history of operating losses and an accumulated deficit and
expects
to continue to incur losses for the foreseeable future.
Since
inception through December 31, 2005, the Company has incurred cumulative
losses
of $42,987,553 and has never generated enough funds through operations to
support its business. The Company expects to continue to incur operating
losses
through 2006. The Company’s losses to date have resulted principally
from:
| · |
research
and development costs relating to the development of the Telkonet
iWire
SystemTM
product suite;
|
| · |
costs
and expenses associated with manufacturing, distribution and marketing
of
the Company’s products;
|
| · |
general
and administrative costs relating to the Company’s operations;
and
|
| · |
interest
expense related to the Company’s
indebtedness.
|
The
Company is currently unprofitable and may never become profitable. Since
inception, the Company has funded its research and development activities
primarily from private placements of equity and debt securities, a bank loan
and
short term loans from certain of its executive officers. As a result of its
substantial research and development expenditures and limited product revenues,
the Company has incurred substantial net losses. The Company’s ability to
achieve profitability will depend primarily on its ability to successfully
commercialize the Telkonet iWire SystemTM
product
suite.
Potential
fluctuations in operating results could have a negative effect on the price
of
the Company’s common stock.
The
Company’s operating results may fluctuate significantly in the future as a
result of a variety of factors, most of which are outside the Company’s control,
including:
| · |
the
level of use of the Internet;
|
| · |
the
demand for high-tech goods;
|
| · |
the
amount and timing of capital expenditures and other costs relating
to the
expansion of the Company’s
operations;
|
| · |
price
competition or pricing changes in the
industry;
|
| · |
technical
difficulties or system downtime;
|
| · |
economic
conditions specific to the internet and communications industry;
and
|
| · |
general
economic conditions.
|
The
Company’s quarterly results may also be significantly impacted by certain
accounting treatment of acquisitions, financing transactions or other matters.
Such accounting treatment could have a material impact on the Company’s results
of operations and have a negative impact on the price of the Company’s common
stock.
The
Company’s directors and executive officers own a substantial percentage of the
Company’s issued and outstanding common stock. Their ownership could allow them
to exercise significant control over corporate decisions.
As
of
March 1, 2006, the Company’s officers and directors owned 26.4% of the Company’s
issued and outstanding common stock. This means that the Company’s officers and
directors, as a group, exercise significant control over matters upon which
the
Company’s 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.
Although
the funds raised in the Company’s debenture offerings, the note offerings and
the private placement of common stock are being used for general working
capital
purposes, it is likely that the Company 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 the Company’s
common stock. Any issuance of additional shares of the Company’s common stock
will be dilutive to existing stockholders and could adversely affect the
market
price of the Company’s common stock.
Our
significant indebtedness and interest payment obligations may adversely affect
our ability to obtain additional financings, service other existing debt,
use
our operating cash flow in other areas of our business, or otherwise adversely
affect our operations.
In
October 2005, the Company completed a $20 million convertible senior debt
financing to two institutional investors in exchange for $20
million, in the aggregate pursuant to which the Company issued senior
convertible notes. The convertible senior notes accrue interest at 7.25%
per
annum and call for monthly principal installments beginning March 1, 2006.
The
convertible senior notes, coupled with our other outstanding indebtedness,
could
make it difficult for us to obtain additional financing when, and if, needed.
In
addition, the significant interest payment obligations on the convertible
senior
notes could make it difficult to service our other outstanding indebtedness.
Both the failure to obtain additional financing and the default on existing
indebtedness could have a negative impact on the Company's business and results
of operations.
Our
convertible senior debt financing contains loan covenants relating to revenue
targets and other restrictions which may reduce our operating
cash.
The
documents executed in connection with the $20 million convertible senior
debt
financing, contain certain covenants that require the Company to achieve
minimum
revenue of $3 million for the period October 1, 2005 through March 31, 2006
and $2 million for each fiscal quarter thereafter in 2006. The covenant
requires that the Company pay an accelerated principal payment of up to
$1 million on a pro rata basis calculated based upon the
percentage shortfall between actual revenues and the quarterly
targeted revenues. Failure to meet these revenue targets could reduce our
operating cash and have a negative impact on the Company's business and results
of operations.
If
we
acquire any companies or technologies in the future, they could provide
difficult to integrate, disrupt our business, dilute stockholder value and
adversely affect our operating results.
In
January 2006, the Company acquired a 90% interest in Microwave Satellite
Technologies (MST), a communications technology company that offers complete
sales, installation, and service of VSAT and business television networks,
and
is a full-service national Internet Service Provider (ISP). The failure of
the
Company to successfully integrate MST, or any Company acquired by Telkonet
in
the future, to Telkonet's business, could have a negative impact on the
Company's results of operations.
Recent
accounting pronouncements may impact our future financial position and results
of operations.
There
have been new accounting pronouncements or regulatory rulings that will have
an
impact on our future financial position and results of operations. For instance,
on December 16, 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 123 (revised 2004), "Share-Based Payment", which is a
revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation".
SFAS 123(R) supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and amends FASB Statement No. 95, "Statement of Cash Flows".
Generally, the approach in SFAS 123(R) is similar to the approach described
in
Statement 123. However, SFAS 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in
the
income statement based on their fair values. Pro forma disclosure is no longer
an alternative. We expect to adopt SFAS 123(R) effective January 1, 2006
under
the modified-prospective method. The adoption of SFAS 123(R)'s fair value
method
will have a significant impact on our results of operations, although it
will
have no impact on our overall financial position. With the adoption of SFAS
123(R), we expect to record stock-based compensation of approximately $2
million
in 2006. Our estimate of stock-based compensation expense is affected by
our
stock price, the number of stock-based awards we may grant in 2006, as well
as a
number of complex and subjective valuation assumptions including, but not
limited to, the volatility of our stock price, interest rates and employee
stock
option exercise behaviors.
The
exercise of options and warrants outstanding and available for issuance may
adversely affect the market price of the Company’s common
stock.
As
of
December 31, 2005, the Company had outstanding employee options to purchase
a
total of 10,151,078 shares of common stock at exercise prices ranging from
$1.00
to $5.97 per share, with a weighted average exercise price of $1.85. As of
December 31, 2005, the Company had outstanding non-employee options to purchase
a total of 1,841,774 shares of common stock at an exercise price of $1.00
per
share. As of December 31, 2005, the Company had warrants outstanding to purchase
a total of 1,230,000 shares of common stock at exercise prices ranging from
$1.00 to $5.00 per share, with a weighted average exercise price of $4.31.
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 the Company’s common
stock.
The
powerline communications industry is intensely competitive and rapidly
evolving.
The
Company operates in a highly competitive, quickly changing environment, and
the
Company’s future success will depend on its ability to develop and introduce new
products and product enhancements that achieve broad market acceptance in
commercial and governmental sectors. The Company will also need to respond
effectively to new product announcements by its competitors by quickly
introducing competitive products.
Delays
in
product development and introduction could result in:
| · |
loss
of or delay in revenue and loss of market
share;
|
| · |
negative
publicity and damage to the Company’s reputation and brand;
and
|
| · |
decline
in the average selling price of the Company’s
products.
|
Government
regulation of the Company’s products could impair the Company’s 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 Telkonet’s iWire
SystemTM
product
suite complies 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. In
addition, the Company's products are subject to safety and RF emissions
regulations adopted by the European Union (EU) for Information Technology
Equipment. In March 2005, the Company received final Conformite Europeane
(CE)
certification, which is required for the Company to freely market and sell
its
products in the EU. Additional devices designed by the Company for commercial
and residential use may be subject to FCC and EU rules. Moreover, if
in the future, the FCC, EU or any other regulatory body changes its
technical requirements for our products, further testing and/or
modifications of the Company's products may be necessary to comply
with such changes. Failure to comply with any existing or future
applicable technical requirements could impair the Company’s ability to
sell its products in certain markets and could have a negative impact on
its
business and results of operations.
Products
sold by the Company’s competitors could become more popular than the Company’s
products or render the Company’s products obsolete.
The
market for powerline communications products is highly competitive. The Company
believes it has the only commercial integrated three phase solution for
“in-building” distribution of broadband utilizing the electrical wiring
infrastructure. Certain HomePlug(TM)
Powerline Alliance members offer similar PLC solutions for the residential
market. Although the HomePlug(TM)
Powerline Alliance members do not presently compete with the Company in the
commercial market, there can be no assurance that the HomePlug(TM)
Powerline Alliance members or any other company will not develop PLC products
that compete with the Company’s products in the future. Some of 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, may
obtain more favorable pricing from suppliers and manufacturers and exert
more
influence on the sales channel than the Company can. As a result, the Company
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 the Company or that
would
render the Company’s products obsolete or noncompetitive. The Company
anticipates that potential competitors will also intensify their efforts
to
penetrate the Company’s 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 the Company
does. These companies could devote more capital resources to develop,
manufacture and market competing products than the Company could. If any
of
these companies are successful in competing against the Company, its sales
could
decline, its margins could be negatively impacted, and the Company could
lose
market share, any of which could seriously harm the Company’s 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 the Company’s results of
operations.
The
Company’s 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
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 the Company’s results
of operations.
The
Company may not be able to obtain patents, which could have a material adverse
effect on its business.
The
Company’s ability to compete effectively in the powerline technology industry
will depend on its success in acquiring suitable patent protection. The Company
currently has several patents pending. The Company also intends to file
additional patent applications that it deems to be economically beneficial.
If
the Company is not successful in obtaining patents, it will have limited
protection against those who might copy its technology. As a result, the
failure
to obtain patents could negatively impact the Company’s business and results of
operations.
Infringement
by third parties on the Company’s proprietary technology and development of
substantially equivalent proprietary technology by the Company’s competitors
could negatively impact the Company’s business.
The
Company’s success depends partly on its 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 the Company has taken to protect its intellectual property,
including those integrated to its Telkonet iWire SystemTM
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 the Company’s existing patents, or any patents that may be
issued in the future, will provide the Company with significant protection
against competitors. Moreover, there can be no assurance that any patents
issued
to, or licensed by, the Company will not be infringed upon or circumvented
by
others. Infringement by third parties on the Company’s proprietary technology
could negatively impact its 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 the Company’s favor. The Company also relies 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 the Company can meaningfully
protect its rights to such unpatented proprietary technology. Development
of
substantially equivalent technology by the Company’s competitors could
negatively impact its business.
The
Company depends on a small team of senior management, and it may have difficulty
attracting and retaining additional personnel.
The
Company’s future success will depend in large part upon the continued services
and performance of senior management and other key personnel. If the Company
loses the services of any member of its senior management team, its overall
operations could be materially and adversely affected. In addition, the
Company’s future success will depend on its 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. The Company cannot ensure that
it
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 the Company’s financial condition and results of
operations.
ITEM
1B.
UNRESOLVED
STAFF COMMENTS.
None.
ITEM
2.
PROPERTIES.
The
Company presently leases 11,600 square feet of commercial office space in
Germantown, Maryland for its corporate headquarters. The Germantown lease
expires in November 2010. The Company also leases 1,800 square feet of office
space in White Marsh, Maryland, where it operates a portion of its sales
and
marketing activities. The White Marsh lease expires in May 2007. The Company
also leases a corporate apartment in Germantown, Maryland on a month-to-month
basis for an executive officer.
In
March
2005, the Company entered into a lease agreement for 6,742 square feet of
commercial office space in Crystal City, Virginia. The majority of the Company’s
sales organization is located at the Crystal City facility. The Crystal City
lease expires in March 2008.
MST,
an
entity controlled by the Company as a result of a January 2006 stock
purchase, presently leases 12,600 square feet of commercial office space in
Hawthorne, New Jersey for its office and warehouse spaces. This lease expires
in
April 2010.
ITEM
3.
LEGAL
PROCEEDINGS.
None.
ITEM
4.
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On
December 9, 2005, the Company held its annual meeting of stockholders at
which
the Company’s stockholders were asked to elect seven (7) directors to serve on
the Company’s Board of Directors and ratify the appointment of the Company’s
independent accountants for 2005. The following directors were elected at
the
annual meeting based on the number of votes indicated below. Each director
was
elected to serve until the next annual meeting of stockholders or until his
successor is elected and qualified.
|
Director
Name
|
For
|
Against
|
Abstain
|
Broker
Non-votes
|
|
Warren
V. Musser
|
33,192,391
|
0
|
518,356
|
0
|
|
Ronald
W. Pickett
|
33,264,857
|
0
|
445,890
|
0
|
|
Stephen
L. Sadle
|
33,257,667
|
0
|
453,080
|
0
|
|
Thomas
C. Lynch
|
33,523,803
|
0
|
186,944
|
0
|
|
James
L. Peeler
|
33,534,573
|
0
|
176,174
|
0
|
|
Thomas
M. Hall
|
33,536,073
|
0
|
174,674
|
0
|
|
Seth
D. Blumenfeld
|
33,262,997
|
0
|
447,750
|
0
|
The
other
matters presented at the meeting were approved by the Company’s stockholders as
follows:
|
Matter
Voted Upon
|
For
|
Against
|
Abstain
|
Broker
Non-votes
|
|
Ratification
of Independent Accountants
|
33,604,555
|
78,030
|
28,162
|
0
|
PART
II
ITEM
5.
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES.
On
January 24, 2004, the Company’s common stock was listed for trading on the
American Stock Exchange (AMEX) under the ticker symbol “TKO.” Prior to January
24, 2004, the Company’s common stock was quoted on the OTC Bulletin Board under
the symbol “TLKO.OB.” As of March 1, 2006, the Company had 253 stockholders of
record and 46,316,539 shares of its common stock issued and outstanding.
The
following table documents the high and low sales prices for the Company’s common
stock on the AMEX for the period beginning January 24, 2004 through December
31,
2005. The information provided for the period prior to January 24, 2004
was
obtained from the Yahoo! Finance web site.
|
High
|
Low
|
|
|
Year
Ended December 31, 2005
|
||
|
First
Quarter
|
$6.85
|
$3.66
|
|
Second
Quarter
|
$5.34
|
$2.61
|
|
Third
Quarter
|
$5.60
|
$3.11
|
|
Fourth
Quarter
|
$5.23
|
$3.51
|
|
Year
Ended December 31, 2004
|
||
|
First
Quarter
|
$5.48
|
$2.54
|
|
Second
Quarter
|
$5.32
|
$3.00
|
|
Third
Quarter
|
$3.50
|
$2.20
|
|
Fourth
Quarter
|
$5.98
|
$2.61
|
The
Company has never paid dividends on its common stock and does not anticipate
paying dividends in the foreseeable future.
During
the three months ended December 31, 2005, the Company agreed to issue 9,000
shares of common stock to Ronald W. Pickett, the Company’s President and Chief
Executive Officer, pursuant to his employment agreement dated January 20,
2004.
During
the three months ended December 2005, the Company also issued an aggregate
of
363,636 shares of common stock to Ronald W. Pickett, the Company's President
and
Chief Executive Officer, in connection with Mr. Pickett's conversion of
Series B
Debentures. The Company also issued an aggregate of 48,858 shares of common
stock in payment of accrued interest on the Series B
Debentures. In addition, the Company issued an aggregate of 200,000 shares
of
common stock upon the exercise of warrants at $1.00 per share upon conversion
of
the notes.
During
the three months ended December 31, 2005, the Company issued 30,000 shares
of
common stock to Seth Blumenfeld, a member of the board of directors, pursuant
to
the terms of the Professional Services Agreement dated July 1, 2005.
This
issuance of foregoing shares was made 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.
|
SELECTED
FINANCIAL DATA
|
The
following table sets forth selected financial data for the last 5 years.
This
selected financial data should be read in conjunction with the consolidated
financial statements and related notes included in Item 15 of this Form
10-K.
|
Year
Ended December 31,
|
||||||||||||||||
| (in thousands, except per share amounts) |
2005
|
2004
|
2003
|
2002
|
2001
(Restated)
|
|||||||||||
|
Total
revenues
|
$
|
2,488
|
$
|
698
|
$
|
94
|
$
|
—
|
$
|
—
|
||||||
|
Operating
loss
|
(15,307
|
)
|
(13,112
|
)
|
(6,564
|
)
|
(3,155
|
)
|
(1,577
|
)
|
||||||
|
Net
loss
|
(15,778
|
)
|
(13,093
|
)
|
(7,657
|
)
|
(3,778
|
)
|
(,1,716
|
)
|
||||||
|
Loss
per share - basic
|
(0.35
|
)
|
(0.32
|
)
|
(0.37
|
)
|
(.22
|
)
|
(0.08
|
)
|
||||||
|
Loss
per share - diluted
|
(0.35
|
)
|
(0.32
|
)
|
(0.37
|
)
|
(.22
|
)
|
(0.08
|
)
|
||||||
|
Basic
weighted average common shares outstanding
|
44,743
|
41,384
|
20,702
|
17,120
|
21,974
|
|||||||||||
|
Diluted
weighted average common shares outstanding
|
44,743
|
41,384
|
20,702
|
17,120
|
21,974
|
|||||||||||
|
Working
capital
|
12,061
|
12,672
|
5,296
|
(894
|
)
|
(502
|
)
|
|||||||||
|
Total
assets
|
23,291
|
15,493
|
6,176
|
295
|
236
|
|||||||||||
|
Short-term
borrowings and current portion of long-term debt
|
6,350
|
—
|
15
|
310
|
400
|
|||||||||||
|
Long-term
debt, net of current portion
|
9,617
|
588
|
3,132
|
863
|
126
|
|||||||||||
|
Stockholders’
equity (deficiency)
|
5,315
|
13,646
|
2,388
|
(1,527
|
)
|
(414
|
)
|
|||||||||
ITEM
7.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
The
following discussion and analysis of the Company’s financial condition and
results of operations should be read in conjunction with the accompanying
financial statements and related notes thereto.
Critical
Accounting Policies and Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make
estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. On an ongoing basis, we evaluate significant
estimates used in preparing our financial statements including those related
to
revenue recognition, guarantees and product warranties and stock based
compensation. We base our estimates on historical experience, underlying
run
rates and various other assumptions that we believe to be reasonable, the
results of which form the basis for making judgments about the carrying
values
of assets and liabilities. Actual results could differ from these estimates.
The
following are critical judgments, assumptions, and estimates used in the
preparation of the consolidated financial statements.
Revenue
Recognition
For
revenue from product sales, the Company recognizes revenue in accordance
with
Staff Accounting Bulletin No. 104, Revenue
Recognition
(“SAB104”), which superceded Staff Accounting Bulletin No. 101,
Revenue
Recognition in Financial Statements
(“SAB101”). SAB 101 requires that four basic criteria must be met before revenue
can be recognized: (1) persuasive evidence of an arrangement exists; (2)
delivery has occurred; (3) the selling price is fixed and determinable;
and (4)
collectibility is reasonably assured. Determination of criteria (3) and
(4) are
based on management’s judgments regarding the fixed nature of the selling prices
of the products delivered and the collectibility of those amounts. Provisions
for discounts and rebates to customers, estimated returns and allowances,
and
other adjustments are provided for in the same period the related sales
are
recorded. The Company defers any revenue for which the product has not
been
delivered or is subject to refund until such time that the Company and
the
customer jointly determine that the product has been delivered or no refund
will
be required. SAB 104 incorporates Emerging Issues Task Force 00-21 (“EITF
00-21”), Multiple-Deliverable
Revenue Arrangements. EITF
00-21 addresses accounting for arrangements that may involve the delivery
or
performance of multiple products, services and/or rights to use assets.
For
equipment under lease, revenue is recognized over the lease term for operating
lease and rental contracts. All of the Company’s leases are accounted for as
operating leases. At the inception of the lease, no lease revenue is recognized
and the leased equipment and installation costs are capitalized and appear
on
the balance sheet as “Equipment Under Operating Leases.” The capitalized cost of
this equipment is depreciated from two to three years, on a straight-line
basis
down to the Company’s original estimate of the projected value of the equipment
at the end of the scheduled lease term. Monthly lease payments are recognized
as
rental income.
Guarantees
and Product Warranties
FASB
Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”),
requires that upon issuance of a guarantee, the guarantor must disclose
and
recognize a liability for the fair value of the obligation it assumes under
that
guarantee.
The
Company’s guarantees issued subject to the recognition and disclosure
requirements of FIN 45 as of December 31, 2005 and 2004 were not material.
The
Company records a liability for potential warranty claims. The amount of
the
liability is based on the trend in the historical ratio of claims to sales,
the
historical length of time between the sale and resulting warranty claim,
new
product introductions and other factors. The products sold are generally
covered
by a warranty for a period of one year. In the event the Company determines
that
its current or future product repair and replacement costs exceed its estimates,
an adjustment to these reserves would be charged to earnings in the period
such
determination is made. During the year ended December 31, 2005, the Company
experienced approximately three percent of units returned. Using this experience
factor a reserve of $24,000 was accrued. Prior to the fiscal year of 2005,
the
Company had not established historical ratio of claims, and the cost of
replacing defective products and product returns were immaterial and within
management's expectations, accordingly there were no warranties provided
with
the purchase of the Company's products during the year ended December 31,
2004.
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 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 years ended December 31, 2005,
2004 and
2003 and will adopt the interim disclosure provisions for its financial
reports
for the subsequent periods.
On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued
FASB
Statement No. 123R (revised 2004), "Share-Based Payment" which is a revision
of
FASB Statement No. 123, "Accounting for Stock-Based Compensation". Statement
123R supersedes APB opinion No. 25, "Accounting for Stock Issued to Employees",
and amends FASB Statement No. 95, "Statement of Cash Flows". Generally,
the
approach in Statement 123R is similar to the approach described in Statement
123. However, Statement 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro-forma disclosure is no longer
an
alternative. On April 14, 2005, the SEC amended the effective date of the
provisions of this statement. The effect of this amendment by the SEC is
that
the Company will have to comply with Statement 123R and use the Fair Value
based
method of accounting no later than the first quarter of 2006. The Company
has
previously issued employee stock options for which no expense has been
recognized, and which will not be fully vested as of the effective date
of SFAS
No. 123R. The Company has assessed the impact SFAS 123R and believes the
impact of adopting SFAS No. 123R, based on our unvested options outstanding
at December 31, 2005, will be to increase our pre-tax stock-based compensation
expense in 2006 by approximately $2 million.
Year
Ended December 31, 2005 Compared to Year Ended December 31,
2004
Revenues
The
Company’s revenue consists of direct product sales and a rental (lease) model in
the commercial, government and international markets. The table below outlines
product versus rental (lease) revenues for comparable periods:
|
Year
ended December 31,
|
|||||||||||||||||||
|
Revenue:
|
2005
|
2004
|
Variance
|
||||||||||||||||
|
Product
|
$
|
1,769,727
|
71
|
%
|
$
|
477,555
|
68
|
%
|
$
|
1,292,172
|
271
|
%
|
|||||||
|
Rental
(lease)
|
718,596
|
29
|
%
|
221,097
|
32
|
%
|
497,499
|
225
|
%
|
||||||||||
|
Total
|
$
|
2,488,323
|
100
|
%
|
$
|
698,652
|
100
|
%
|
$
|
1,789,671
|
256
|
%
|
|||||||
Product
revenue
Product
revenue principally arises from the sale of iBridges and other Telkonet
iWire
SystemTM
components directly to customers. Revenues to date have been principally
derived
from the Commercial (Hospitality and Multi-Dwelling) and International
business
units. The Company anticipates continued growth in Commercial and International
product revenue in the Value Added Reseller purchase programs. The Company
expanded its international sales and marketing efforts upon receiving its
European certification (CE) in March 2005. The Company expanded its sales
and
marketing efforts in the government sector in connection with the receipt
of the
FIPS 140-2 certification received in July 2005.
In
December 2005, the Company consummated a non-recourse sale of certain rental
contract agreements and the related capitalized equipment which were accounted
for as operating leases with Hospitality Leasing Corporation. The remaining
rental income payments of the contracts were valued at approximately $732,000,
including the customer support component of approximately $205,000 which
the
Company will retain and continue to receive monthly customer support payments
over the remaining average unexpired lease term of 26 months. In December
2005,
the Company recognized revenue of approximately $439,000 for the sale,
calculated based on the present value of total unpaid rental payments,
and
expensed the associated capitalized equipment cost, net of depreciation,
of
approximately $267,000 and expensed associated taxes of approximately $40,000.
Rental
(lease) revenue
The
increase in rental (lease) revenue was primarily due to the increase in
non-cancelable leases. Accordingly, revenues associated with these leases
are
recognized ratably over a three to five year lease term. Revenues to be
recognized under these non-cancelable leases (backlog) was approximately
$2,411,000 including a non-recourse sale of $918,000 certain rental
contract agreements
in January 2006. The weighted average remaining lease term was approximately
31
months as of December 31, 2005. The associated unamortized capitalized
costs in
connection with these leases was approximately $664,000 or 26% of revenue
backlog.
Cost
of Sales
|
Year
ended December 31,
|
|||||||||||||||||||
|
Cost
of Sales:
|
2005
|
2004
|
Variance
|
||||||||||||||||
|
Product
|
$
|
1,183,574
|
67
|
%
|
$
|
459,225
|
96
|
%
|
$
|
724,349
|
158
|
%
|
|||||||
|
Rental
(lease)
|
533,605
|
74
|
%
|
83,634
|
38
|
%
|
449,971
|
538
|
%
|
||||||||||
|
Total
|
$
|
1,717,179
|
69
|
%
|
$
|
542,859
|
78
|
%
|
$
|
1,174,320
|
216
|
%
|
|||||||
Product
Costs
Product
cost primarily includes Telkonet iWire SystemTM
product
suite equipment cost and installation labor. The related product cost
in
connection with the non-recourse sale of approximately $766,000 of rental
contract agreements amounted to approximately $267,000 of previously
capitalized
equipment cost and other related cost.
Rental
(lease) Costs
Lease
Cost primarily represents the amortization of the capitalized costs which
are
amortized over the lease term and include Telkonet equipment, installation
labor
and customer support. This increase compared to the prior year quarter
is
commensurate with the increase in leases.
Gross
Profit
|
Year
ended December 31,
|
|||||||||||||||||||
|
Gross
Profit:
|
2005
|
2004
|
Variance
|
||||||||||||||||
|
Product
|
$
|
586,153
|
33
|
%
|
$
|
18,330
|
4
|
%
|
$
|
567,823
|
3,098
|
%
|
|||||||
|
Rental
(lease)
|
184,991
|
26
|
%
|
137,463
|
62
|
%
|
47,528
|
-35
|
%
|
||||||||||
|
Total
|
$
|
771,144
|
31
|
%
|
$
|
155,793
|
22
|
%
|
$
|
615,351
|
395
|
%
|
|||||||
Product
Costs
Gross
profit associated with the product revenues for the year ended December
31, 2005
improved over the prior year primarily as a result of reduction of equipment
costs and of improved installation processes, including upfront site
surveys and
standardized training.
Rental
(lease) Costs
Gross
profit associated with the rental (lease) revenue decreased as a result
of the
build-out of the customer support services.
Operating
Expenses
|
Year
ended December 31,
|
|||||||||||||
|
2005
|
2004
|
Variance
|
|||||||||||
|
Total
|
$
|
16,077,912
|
$
|
13,268,067
|
$
|
2,809,845
|
21
|
%
|
|||||
Overall
expenses increased for the year ended December 31, 2005 over the comparable
period in 2004 by $2,809,845 or 21%. Excluding the fee paid pursuant
to certain
agreements with consultants of $2,500,000 expensed in the year end December
31,
2004, the increase for the year ended December 31, 2005 over the prior
year
amounted to $5,309,845 or 49%. This increase was principally due to salary
and
travel costs related to increased sales and marketing functions and office
rent
related to the Germantown, MD and Crystal City, VA leases. The number
of
employees increased from 48 at December 31, 2004 to 66 at December 31,
2005. In
addition, the Company wrote-off $400,000 of the carrying value of its
investment
in Amperion through a charge to operations during the year end December
31,
2005.
Product
Research and Development
|
Year
ended December 31,
|
|||||||||||||
|
2005
|
2004
|
Variance
|
|||||||||||
|
Total
|
$
|
2,096,104
|
$
|
1,852,309
|
$
|
243,795
|
13
|
%
|
|||||
Research
and development costs related to both present and future products are
expensed
in the period incurred. Total expenses for the year ended December 31,
2005
increased over the comparable prior year by $243,795 or 13%. This increase
was
primarily related to an increase in salaries and related costs associated
with
the addition of employees and costs related to CE, FIPS 140-2 and other
required
certifications of the Company’s product.
Selling,
General and Administrative
|
Year
ended December 31,
|
|||||||||||||
|
2005
|
2004
|
Variance
|
|||||||||||
|
Total
|
$
|
12,041,661
|
$
|
7,663,369
|
$
|
4,378,292
|
57
|
%
|
|||||
Selling,
general and administrative expenses increased for the year ended December
31,
2005 over the comparable prior year by $4,378,292 or 57%. This increase
is
related to an increase in payroll and associated costs for sales and
marketing
resources, advertising, trade shows, and office rent and related facility
costs.
Year
Ended December 31, 2004 Compared to Year Ended December 31,
2003
Revenues
|
Year
ended December 31,
|
|||||||||||||||||||
|
Revenue:
|
2004
|
2003
|
Variance
|
||||||||||||||||
|
Product
|
$
|
477,555
|
68
|
%
|
$
|
88,403
|
94
|
%
|
$
|
389,152
|
440
|
%
|
|||||||
|
Rental
(lease)
|
221,097
|
32
|
%
|
5,257
|
6
|
%
|
215,840
|
4,106
|
%
|
||||||||||
|
Total
|
$
|
698,652
|
100
|
%
|
$
|
93,660
|
100
|
%
|
$
|
604,992
|
646
|
%
|
|||||||
Product
revenue
Product
revenue principally arises from the sale of iBridges and other Telkonet
iWire
SystemTM components directly to customers. Revenues have primarily been
derived
from the Hospitality and Multi-Dwelling business units. The Company has
expanded
its marketing efforts in the International and Government markets and
anticipates full deployment of its product upon successful product certification
in each of these respective markets.
Rental
(lease) revenue
As
of
December 31, 2004, revenues to be recognized under non-cancelable contracts
(backlog) was approximately $933,000 with a weighted average remaining
term of
approximately 31 months. The remaining costs to be amortized in connection
with
these contracts is approximately $451,000.
Cost
of Sales
|
Year
ended December 31,
|
|||||||||||||||||||
|
Cost
of Sales:
|
2004
|
2003
|
Variance
|
||||||||||||||||
|
Product
|
$
|
459,225
|
96
|
%
|
$
|
101,171
|
114
|
%
|
$
|
358,054
|
354
|
%
|
|||||||
|
Rental
(lease)
|
83,634
|
38
|
%
|
3,485
|
66
|
%
|
80,149
|
2,300
|
%
|
||||||||||
|
Total
|
$
|
542,859
|
78
|
%
|
$
|
104,656
|
112
|
%
|
$
|
438,203
|
419
|
%
|
|||||||
Product
Costs
The
Company emerged from its development stage as of December 31, 2003. Therefore,
there were no comparable costs of sales in the prior year. Product cost
primarily includes Telkonet iWire SystemTM product suite equipment cost
and
installation labor.
Rental
(lease) Costs
During
the year, revenue from the Company’s rental (lease) sales model was derived
principally in the Hospitality and Multi-Dwelling markets.
Gross
Profit
|
Year
ended December 31
|
|||||||||||||||||||
|
Gross
Profit:
|
2004
|
2003
|
Variance
|
||||||||||||||||
|
Product
|
$
|
18,330
|
4
|
%
|
$
|
(12,768
|
)
|
(14
|
%)
|
$
|
31,098
|
244
|
%
|
||||||
|
Rental
(lease)
|
137,463
|
62
|
%
|
1,772
|
34
|
%
|
135,691
|
7,658
|
%
|
||||||||||
|
Total
|
$
|
155,793
|
22
|
%
|
$
|
(10,996
|
)
|
(12
|
%)
|
$
|
166,789
|
1,517
|
%
|
||||||
The
Company improved installation processes and began operational improvements
which
resulted in increased gross margins.
Operating
Expenses
|
Year
ended December 31
|
|||||||||||||
|
2004
|
2003
|
Variance
|
|||||||||||
|
Total
|
$
|
13,268,067
|
$
|
6,553,335
|
$
|
6,714,732
|
102
|
%
|
|||||
Overall
expenses increased for the year ended December 31, 2004 over the prior
year by
$6,714,732 or 102%. Excluding the fee paid pursuant to certain agreements
with
consultants of $2,500,000 which was expensed during the second quarter,
the
increase for the year was $4,214,732 or 64%. This increase is principally
due to
payroll and related costs for administrative sales and marketing, non-employee
compensation for services, advertising and trade show attendance, and
rent and
related relocation costs for our corporate and sales offices.
Product
Research and Development
|
Year
ended December 31
|
|||||||||||||
|
2004
|
2003
|
Variance
|
|||||||||||
|
Total
|
$
|
1,852,309
|
$
|
1,370,785
|
$
|
481,524
|
35
|
%
|
|||||
Company-sponsored
research and development costs related to both present and future products
are
expended in the period incurred. Total expenses for the year ended December
31,
2004 increased over the comparable prior year by $481,524, or 35%. This
increase
was primarily related to an increase in salaries and related costs associated
with the addition of two full-time employees and costs related to independent
lab testing and certification of the Company's product.
Selling,
General and Administrative
|
Year
ended December 31
|
|||||||||||||
|
2004
|
2003
|
Variance
|
|||||||||||
|
Total
|
$
|
7,663,369
|
$
|
4,089,172
|
$
|
3,574,197
|
87
|
%
|
|||||
Selling,
general and administrative expenses increased for the year ended December
31,
2004 over the comparable prior year by $3,574,197 or 87%. The increase
is
related to an increase in payroll and associated costs for management,
sales and
marketing resources, advertising and trade show attendance and related
relocation costs for corporate and new sales offices.
Liquidity
and Capital
Resources
As
of
December 31, 2005, the Company's current assets exceeded its current
liabilities
by $12,060,807, with cash and cash equivalents representing $8,422,079
and
Restricted Certificate of Deposit representing $10,000,000 of the current
assets
as of December 31, 2005.
While
the
Company believes it has sufficient capital to meet its working capital
requirements for the next twelve months, additional financing may be
required in
order to meet growth opportunities in financing and/or investing activities.
If
additional capital is required and the Company is not successful in generating
sufficient liquidity from operations or in raising sufficient capital
resources
on terms acceptable to the Company, this could have a material adverse
effect on
the Company’s business, results of operations, liquidity and financial
condition.
The
recent acquisition of Microwave Technologies, Inc. (MST) and its related
planned
roll-out requires capital equipment, which if financing is not available
may
limit the rate upon which roll-out occurs. The Company is exploring several
of
its options such as lease financing or strategic partnerships to provide
the
necessary funding which may or may not occur.
In
January 2004, the Board of Directors determined to permit the Senior
Noteholders, for a limited period of time, to convert their Senior Notes
into
the Company's common stock at a conversion price of $2.10 per share.
In
connection with this transaction, Senior Noteholders converted Senior
Notes
having an aggregate principal value of $2,539,000.
In
February 2004, Telkonet completed a private placement of its common stock
resulting in net proceeds to the Company of approximately $12.8 million.
The
Company sold 6,387,600 shares of its common stock at a discount of 18%
to the
average market price of the Company’s common stock for the preceding 30 days.
In
March
2004, the Company received $3.9 million upon the exercise of 4,235,007
warrants
to purchase the Company’s common stock. Additionally, $200,000 of debentures
were converted into 324,000 shares of the Company’s common stock.
In
October 2005, the Company completed a convertible senior debt financing of
$20 million, exclusive of placement cost and fees. The Company intends to
use the $20 million for general working capital needs. The convertible
notes bear interest at a fixed rate of 7.25%, payable in cash, plus equal
monthly principal installments beginning March 1, 2006. The maturity date
is 3 years from the issuance of the notes. At any time or times, the
noteholders
are entitled to convert any portion of the outstanding and unpaid note
amount
into fully paid and nonassessable common shares at a conversion price
of $5 per
share. At any time at the option of the Company, the principal payments
due
under the notes may be paid either in cash or in common stock at the lower
of $5 or 92.5% of the average recent market price of the Company's common
stock. At any time after six months should the stock trade at or above
$8.75 for
20 of 30 consecutive trading days, the Company can cause a mandatory
redemption
and conversion to shares at $5 per share. At any time, the Company can
pre-pay
the notes with cash or common stock. Should the Company pre-pay the notes
other
than by mandatory conversion, warrant coverage to the noteholders increases
from
25% to 65% for the amount pre-paid at a strike price of $5 per
share.
In
addition to standard financial covenants, the Company has agreed to maintain
a
letter of credit in favor of the noteholders equal to $10 million which
is
renewed annually. Once each of the notes decline below $15 million, the
balance on the letter of credit is reduced by $.50 for every $1 amortized.
Also,
the Company is required to achieve minimum revenue of $3 million for
the period
October 1, 2005 through March 31, 2006 and $2 million for each fiscal
quarter
thereafter in 2006. The covenant requires that the Company pay an
accelerated principal payment up to $1 million on a pro rata basis
calculated based upon the percentage shortfall between actual
revenues and the quarterly targeted revenues. The Company may, at its
option, repay all or any part of the outstanding debt represented by
the Senior
Convertible Notes in Company common stock. Once the Senior Convertible
Notes are
repaid, the funds underlying a Certificate of Deposit in the amount of
$10
million, which has been posted as collateral for the Letter of Credit,
will be
available for operating purposes.
The
Company filed a registration statement to cover the future issuance of
shares
which may be issued upon conversion of the notes and/or warrants. The
registration statement was declared effective by the Securities and Exchange
Commission on December 13, 2005.
During
the year the Company received $852,638 proceeds from the exercise of
employee
and non-employee stock options and $321,900 from exercise of warrants.
Inflation
We
do not
believe that inflation has had a material effect on our business, financial
condition or results of operations. If our costs were to become subject
to
significant inflationary pressures, we may not be able to fully offset
such
higher costs through price increases. Our inability or failure to do
so could
adversely affect our business, financial condition and results of
operations.
Off
Balance Sheet Arrangements
In
October 2005, the Company entered into an irrevocable letter of credit
with a
bank for $10 million as collateral for the $20 million Senior Convertible
Notes.
A $10 million Certificate of Deposit is pledged as collateral for the
irrevocable letter of credit agreement. The letter of credit is automatically
renewable annually as required in the loan covenant. As of December 31,
2005,
the $10 million Restricted Certificate of Deposit is recorded in the
accompanying consolidated balance sheet as a current asset.
Acquisition
or Disposition of Plant and Equipment
During
the year ended December 31, 2005, fixed assets increased $336,448 or
48% which
is primarily related to furniture and fixtures in the Crystal City, Virginia
office, sales support software and computer equipment related to new
employees.
The Company does not anticipate the sale or purchase of any significant
property, plant or equipment during the next twelve months, other than
computer
equipment and peripherals to be used in the Company’s day-to-day operations.
In
April
2005, the Company entered into a three-year lease agreement for 6,742
square
feet of commercial office space in Crystal City, Virginia. Pursuant to
this
lease, the Company agreed to assume a portion of the build-out cost for
this
facility
MST
presently leases 12,600 square feet of commercial office space in Hawthorne,
New
Jersey for its office and warehouse spaces. This lease will expire in
April
2010.
New
Accounting Pronouncements
In
March
2005, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
(FIN) No. 47, “Accounting for Conditional Asset Retirement Obligations, an
interpretation of FASB Statement No. 143,” which requires an entity to recognize
a liability for the fair value of a conditional asset retirement obligation
when
incurred if the liability’s fair value can be reasonably estimated. The Company
is required to adopt the provisions of FIN 47 no later than the first
quarter of
fiscal 2006. The Company does not expect the adoption of this Interpretation
to
have a material impact on its consolidated financial position, results
of
operations or cash flows.
In
May
2005 the FASB issued Statement of Financial Accounting Standards (SFAS)
No. 154,
“Accounting Changes and Error Corrections, a replacement of APB Opinion
No. 20
and FASB Statement No. 3.” SFAS 154 requires retrospective application to prior
periods’ financial statements for changes in accounting principle, unless it is
impracticable to determine either the period-specific effects or the
cumulative
effect of the change. SFAS 154 also requires that retrospective application
of a
change in accounting principle be limited to the direct effects of the
change.
Indirect effects of a change in accounting principle, such as a change
in
non-discretionary profit-sharing payments resulting from an accounting
change,
should be recognized in the period of the accounting change. SFAS 154
also
requires that a change in depreciation, amortization, or depletion method
for
long-lived, non-financial assets be accounted for as a change in accounting
estimate effected by a change in accounting principle. SFAS 154 is effective
for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. Early adoption is permitted for accounting changes
and
corrections of errors made in fiscal years beginning after the date this
Statement is issued. The Company does not expect the adoption of this
SFAS to
have a material impact on its consolidated financial position, results
of
operations or cash flows.
On
February 16, 2006 the Financial Accounting Standards Board (FASB) issued
SFAS 155, “Accounting for Certain Hybrid Instruments,” which amends SFAS 133,
“Accounting for Derivative Instruments and Hedging Activities,” and SFAS 140,
“Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities.” SFAS 155 allows financial instruments that have embedded
derivatives to be accounted for as a whole (eliminating the need to bifurcate
the derivative from its host) if the holder elects to account for the
whole
instrument on a fair value basis. SFAS 155 also clarifies and amends
certain
other provisions of SFAS 133 and SFAS 140. This statement is effective
for all
financial instruments acquired or issued in fiscal years beginning after
September 15, 2006. The Company does not expect its adoption of this new
standard to have a material impact on its financial position, results
of
operations or cash flows.
Disclosure
of Contractual Obligations
|
Payment
Due by Period
|
|||||
|
Contractual
obligations
|
Total
|
Less
than 1 year
|
1-3
years
|
3-5
years
|
More
than 5 years
|
|
Long-Term
Debt Obligations
|
$20,100,000
|
$6,350,000
|
$13,750,000
|
-
|
-
|
|
Capital
Lease Obligations
|
-
|
-
|
-
|
-
|
-
|
|
Operating
Lease Obligations
|
$1,715,000
(1)
|
$514,000
|
$785,000
|
$416,000
|
-
|
|
Purchase
Obligations
|
-
|
-
|
-
|
-
|
-
|
|
Other
Long-Term Liabilities Reflected on the Registrant’s Balance Sheet Under
GAAP
|
-
|
-
|
-
|
-
|
-
|
|
Total
|
$21,815,000
|
$6,864,000
|
$14,535,000
|
$416,000
|
-
|
(1)
Operating lease obligations includes approximately $352,000 of future lease
obligations, primarily related to office and warehouse space, in conjunction
with the January 2006 acquisition of Microwave Satellite Technologies,
Inc.
ITEM
7A.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Short
Term Investments
We
held
no marketable securities as of December 31, 2005. Our excess cash is held
in
money market accounts in a bank and brokerage firms both of which are nationally
ranked top tier firms with an average return of approximately 300 basis
points.
The certificate of deposit, which is restricted and currently held as collateral
for the Letter of Credit in connection with the $20 million senior convertible
notes, accrues interest with an average return of approximately 400 basis
points. Due to the conservative nature of our investment portfolio, an
increase
or decrease of 100 basis points in interest rates would not have a material
effect on our results of operations or the fair value of our portfolio.
Investments
in Privately Held Companies
We
have
invested in privately held companies, which are in the startup or development
stages. These investments are inherently risky because the markets for
the
technologies or products these companies are developing are typically in
the
early stages and may never materialize. As a result, we could lose our
entire
initial investment in these companies. In addition, we could also be required
to
hold our investment indefinitely, since there is presently no public market
in
the securities of these companies and none is expected to develop. These
investments are carried at cost, which as of March 1, 2006 was $131,000
and
$100,000 in BPL Global and Amperion, respectively, and at December 31,
2005, are
recorded in other assets in the Consolidated Balance Sheets. The
Company determined that its investment in Amperion was impaired based upon
forecasted discounted cash flow. Accordingly, the Company wrote-off 80%,
or
$400,000, of the carrying value of its investment through a charge to operations
during the year ended December 31, 2005.
The fair
value of the Company’s investment in BPL Global, remained at $131,000 as of
December 31, 2005.
ITEM
8.
FINANCIAL
STATEMENTS.
See
the
Financial Statements and Notes thereto commencing on Page F-1.
ITEM
9.
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
ITEM
9A.
CONTROLS
AND PROCEDURES.
As
of
December 31, 2005, the Company performed an evaluation, under the supervision
and with the participation of management, including its Chief Executive
Officer
and Chief Financial Officer, of the effectiveness of the design and operation
of
its disclosure controls and procedures as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended. Based
upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company’s disclosure controls and procedures are effective in timely
alerting them to material information required to be included in the Company’s
periodic filings with the U.S. Securities and Exchange Commission. There
were no
significant changes in the Company’s internal controls or in other factors that
could materially affected or are reasonable likely to materially affect,
the
Company’s internal controls subsequent to the date of the most recent
evaluation.
RUSSELL
BEDFORD STEFANOU MIRCHANDANI LLP
CERTIFIED
PUBLIC ACCOUNTANTS
REPORT
OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board
of
Directors
Telkonet,
Inc.
Germantown,
MD
We
have
audited management's assessment, included in the accompanying Management's
Report on Internal Control over Financial Reporting, that Telkonet, Inc.
and its
wholly-owned subsidiary (the Company) maintained effective internal control
over
financial reporting as of December 31, 2005, based on criteria established
in
Internal Control-Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
The Company's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness
of
internal control over financial reporting. Our responsibility is to express
an
opinion on management's assessment and an opinion on the effectiveness
of the
Company's internal control over financial reporting based on our
audit.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing
such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company's internal control over financial reporting is a process designed
to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control
over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(2)
provide reasonable assurance that transactions are recorded as necessary
to
permit preparation of financial statements in accordance with generally
accepted
accounting principles, and that receipts and expenditures of the company
are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention
or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting
may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our
opinion, management's assessment that Telkonet, Inc. and its wholly-owned
subsidiary maintained effective internal control over financial reporting
as of
December 31, 2005, is fairly stated, in all material respects, based on
criteria
established in Internal
Control Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
Also, in our opinion, Telkonet, Inc. and its wholly-owned subsidiary,
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 20005, based on criteria
established in
Internal Control-Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Telkonet,
Inc. and its wholly-owned subsidiary as of December 31, 2005 and 2004,
and the
related consolidated statements of losses, stockholders' equity, and cash
flows
for the three-years ended December 31, 2005, and our report dated February
2,
2006 expressed an unqualified opinion on those consolidated financial
statements,
/s/RUSSELL
BEDFORD STEFANOU MIRCHANDANI LLP
Russell
Bedford Stefanou Mirchandani LLP
Certified
Public Accountants
McLean,
Virginia
February
2, 2006
ITEM
9B.
OTHER
INFORMATION.
None.
PART
III
ITEM
10.
DIRECTORS
AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The
following table furnishes the information concerning the Company’s directors and
officers during the fiscal year ended December 31, 2005. The directors
of the
Company are elected every year and serve until their successors are duly
elected
and qualified.
|
Name
|
Age
|
Title
|
|
Ronald
W. Pickett
|
58
|
President,
Director & Chief Executive Officer
|
|
Frank
T. Matarazzo
|
44
|
President
& Chief Executive Officer, Microwave Satellite Technologies,
Inc.
|
|
John
Cramp
|
50
|
Chief
Operating Officer
|
|
E.
Barry Smith
|
55
|
Chief
Financial Officer
|
|
Stephen
Sadle
|
60
|
Senior
Vice President & Director
|
|
James
Landry
|
50
|
Chief
Technology Officer
|
|
Warren
V. Musser
|
79
|
Chairman
of the Board (3)
|
|
David
Grimes
|
67
|
Director
(1)
|
|
Thomas
C. Lynch
|
63
|
Director
(2), (3)
|
|
Dr.
Thomas M. Hall
|
54
|
Director
(2), (3)
|
|
James
L. “Lou” Peeler
|
72
|
Director
(2)
|
|
Seth
Blumenfeld
|
65
|
Director
(1)
|
| (1) |
Mr.
Grimes died on September 27, 2005. Mr. Blumenfeld was elected
to Mr.
Grimes’ vacant board seat on December 9, 2005.
|
| (2) |
Member
of the Audit Committee
|
| (3) |
Member
of the Compensation Committee
|
Ronald
W. Pickett—President, Chief Executive Officer &
Director
Mr.
Pickett has served as the Company’s Chief Executive Officer since January 2003.
In addition, he has fostered the development of Telkonet since 1999 as
the
Company’s principle investor and co-Founder. He was the Founder, and for twenty
years served as the Chairman of the Board and President of Medical Advisory
Systems, Inc. (a company providing international medical services and
pharmaceutical distribution) until its merger with Digital Angel Corporation
(AMEX: DOC) in March 2002. A graduate of Gordon College, Mr. Pickett
has engaged
in various entrepreneurial activities for 35 years. Mr. Pickett has been
a
director of the Company since January 2003.
Frank
T. Matarazzo—President & Chief Executive Officer, Microwave Satellite
Technologies, Inc. (MST)
Mr.
Matarazzo has been the President and Chief Executive Officer of Microwave
Satellite Technologies, Inc. since its inception in 1982. Mr. Matarazzo
has
directed the growth and development of the Microwave Satellite Technologies,
Inc. (MST) and designed and constructed the first private cable television
systems operated by MST and continues to be involved in all technology
deployed
at MST. Mr. Matarazzo’s experience includes employment for Conrac Avionics, as a
prototype design engineer, working on the development of the guidance/navigation
systems for military fighter planes as well as the development and construction
of the FM communication systems and engine interface units for the Space
Shuttle
Columbia. He is known in the private cable television industry, having
both
written articles for trade publications and served as a technical consultant
to
municipalities on the subject of satellite delivered information
systems.
John
Cramp—Chief Operating Officer
Mr.
Cramp
has served as the Company’s Chief Operating Officer since December 2005.
Prior to this appointment, Mr. Cramp served as the Company’s Executive Vice
President of Government Sales. Before joining Telkonet in May, 2005,
Mr. Cramp
served as President and CEO and Director of Seneca Corporation, a
privately-held information technology company, from October 2004 to April
2005.
Mr. Cramp served as Chief Executive Officer and Director of CardSystems
Solutions, Inc., an Electronic Payment Company, from 1998 to 2004 and
was
Executive Vice President and COO from 1997 to 1998. Prior to joining
CardSystems, Mr. Cramp was Vice President of Information Management Consultants
Inc., a systems integration and software development company. From 1990
to 1995,
Mr. Cramp was President and CEO (in 1995) of Simpact Inc., a privately
held data
communication products and services company. Prior to 1990, Mr. Cramp
spent over 10 years in the computer industry in management roles with
Encore Computer, Wang Laboratories and Data General. Mr. Cramp earned
a BA from
Franklin and Marshall College in 1977.
E.
Barry Smith—Chief Financial Officer
Mr.
Smith
has served as the Company’s Chief Financial Officer since February 2003. Mr.
Smith is a CPA and senior financial executive with diverse experience
in both
public and private companies. From September 1987 to February 2003, Mr.
Smith
was employed as a financial partner to, or retained as a consultant with,
Safeguard Scientifics or its subsidiary companies. Mr Smith’s background also
includes big-four public accounting experience with the accounting firm
of
Deloitte & Touche. Mr. Smith’s experience also includes serving as Vice
President of Finance & Administration for US Golf Management (a
public/private golf course and restaurant management company), Vice President
of
Finance for International Communications Research (a market research
and
database services company), and Treasurer for The Chilton Company (a
publishing
company).
Stephen
L. Sadle—Senior Vice President, Co-Founder & Director
From
1999
until he joined Telkonet in 2000, Mr. Sadle served as Senior Vice President
and
General Sales Manager of Internos (a provider of web-based vertical extranet
applications). From 1986 until 1999, Mr. 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. From 1970 until 1986, Mr. Sadle was President of a successful
infrastructure construction and development company in the Washington,
D.C.
metropolitan area. Mr. Sadle has been a director of the Company since
November
1999.
James
F. Landry—Chief Technology Officer
Mr.
Landry has served as the Company’s Chief Technology Officer since December 2004
and Vice President of Engineering from September 2001 to May 2004. Before
joining Telkonet, Mr. Landry was a Senior Member of 3Com Technical Staff
since
1994. Mr. Landry has over 20 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 responsible
for the
development of the entire 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.
Mr. Landry holds four US patents.
David
W. Grimes—Co-Founder & Former Director
From
1992
until he joined Telkonet in 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. From 1989 to 1992 he was the Engineering Division Director
at
EER Inc. and supervised over 100 engineers and technicians on electrical
mechanical and thermal tasks for Goddard Space Flight Center. From 1982
to 1989
Mr. Grimes served as Chief Executive Officer of Transpace Carriers Inc.,
a
venture to commercialize the Delta launch vehicle. From 1963 to 1982,
Mr. Grimes
was a Senior Executive with NASA, heading the $200 million per year Delta
Program. Mr. Grimes is a recognized expert in space and ground communications
systems and brings this expertise to bear on the implementation of the
hybrid
telephony and high speed Internet technology. Mr. Grimes has been a director
of
the Company since November 1999. Mr. Grimes died September 27,
2005.
Warren
V. Musser—Chairman of the Board of Directors
Mr. Musser, has taken over 50 companies public during his distinguished
and
successful career as an entrepreneur, and Mr. Musser is the founder and
Chairman
Emeritus of Safeguard Scientifics, Inc. (a high-tech venture capital
company,
formerly Safeguard Industries, Inc.). Mr. Musser is currently the Managing
Director, The Musser Group (a business consulting firm) and Founder &
President, Musser and Company, Inc. (an investment banking firm). In
addition,
Mr. Musser is a Director of Internet Capital Group, Inc. (a business-to-business
venture capital company), and Mr. Musser is a Director and Vice Chairman
of
Nutri/System, Inc (Nasdaq:NRTI). (a weight management company) and Co-Chairman
of Eastern Technology Council (a business advisory firm). Mr. Musser
serves on a
variety of civic, educational and charitable boards of directors, and
serves as
vice president of development, Cradle of Liberty Council, Boy Scouts
of America;
vice chairman of The Eastern Technology Council; and chairman of the
Pennsylvania Partnership on Economic Education. Mr. Musser has been a
director
of the Company since January 2003.
Thomas
C. Lynch—Director
Mr.
Lynch
is Senior Vice President and Director of The Staubach Company’s Federal Sector
(a real estate management and advisory services firm) in the Washington,
D.C.
area. Mr. Lynch joined The Staubach Company in November 2002 after 6
years as
Senior Vice President at Safeguard Scientifics, Inc. (NYSE: SFE) (a high-tech
venture capital company). While at Safeguard, he served nearly two years
as
President and Chief Operating Officer at CompuCom Systems, a Safeguard
subsidiary. After a 31-year career of naval service, Mr. Lynch retired
in the
rank of Rear Admiral. Mr. Lynch’s Naval service included chief, Navy Legislative
Affairs, command of the Eisenhower Battle Group during Operation Desert
Shield,
Superintendent of the United States Naval Academy from 1991 to 1994 and
Director
of the Navy Staff in the Pentagon from 1994 to 1995. Mr. Lynch presently
serves
as a Director of Pennsylvania Eastern Technology Council, Armed Forces
Benefit
Association, Catholic Leadership Institute, National Center for the American
Revolution at Valley Forge and Mikros Systems. Mr. Lynch has been a director
of
the Company since October 2003.
Dr.
Thomas M. Hall—Director
Dr.
Hall is the Managing Member of Marrell Enterprises, LLC (a company that
specializes in international business development). Dr. Hall serves on
the board
of directors of Coris International SA (a Paris-based insurance services
company
with subsidiaries in 36 countries). For 12 years (until 2002), Dr. Hall
was the
chief executive officer of Medical Advisory Systems, Inc. (a company
providing
international medical services and pharmaceutical distribution). Dr.
Hall holds
a bachelor of science and a medical degree from the George Washington
University
and a master of international management degree from the University of
Maryland.
Dr. Hall has been a director of the Company since April 2004.
James
L. “Lou” Peeler—Director
Mr. Peeler was a founder and member of the board of Digital Communications
Corporation (DCC), which evolved into Hughes Network Systems (HNS), a
provider
of global broadband, satellite, and wireless communications products
for home
and business, such as DirecTV and DIRECWAY. Mr. Peeler retired as executive
vice
president of operations in 1999 after 27 years of service and is presently
a
member of the Advisory Council to Hughes Network Systems. Mr. Peeler
also served
on the Board of Directors of Hughes Software Systems (HSS). Prior to
the
founding of DCC, he was vice president of Engineering for Washington
Technological Associates (WTA) (a satellite communications development
company),
where he was instrumental in the development of rocket and satellite
communications and instrumentation equipment. Mr. Peeler received a bachelor
of
science degree in electrical engineering from Auburn University. Mr.
Peeler has
been a director of the Company since April 2004.
Seth
D. Blumenfeld—Director
Mr. Blumenfeld served as President of International Services for MCI
International (a provider of telecommunication services) from 1998 until
his
retirement in January of 2005. Mr. Blumenfeld was President and Chief
Operating
Officer of several of MCI's international subsidiaries from 1984 to 1998.
Mr.
Blumenfeld earned his Doctorate Jurisprudence from Fordham University
Law School
in 1965. He practiced law on Wall Street prior to serving as infantry
captain
for the U.S. Army in Vietnam. From 1976 through 1978, Mr. Blumenfeld
lived in
Japan. Mr. Blumenfeld's involvement on professional boards and community
associations have included Executive Committee member of the United States
Council for International Business, Member of the Board of Directors
of the
United States Telecommunications Training Institute, Member of the State
Department Advisory Council on International Communications and Information
Policy, Member of the University of Colorado Institute for International
Business Board of Advisors, Member of the American Graduate School of
International Management (Thunderbird) Board of Advisors, Member of the
Advisory
Board of Visitors to Fordham University School of Law, and honorary Chairman
of
the Connecticut Association of Children with Learning Disabilities.
Audit
Committee
The
Company maintains an Audit Committee of the Board of Directors. For the
year
ended December 31, 2005, Messrs. Hall, Lynch and Peeler served on the
Audit
Committee. The Company’s Board of Directors has determined that each of Messrs.
Hall and Lynch is a “financial expert” as defined by Item 401 of Regulation S-K
promulgated under the Securities Act of 1933 and the Securities Exchange
Act of
1934. The Company’s Board of Directors also has determined that each of Messrs.
Hall, Lynch and Peeler are “independent” as such term is defined in Item
7(d)(3)(iv) of Schedule 14A promulgated under the Securities Exchange
Act of
1934. The Board of Directors has adopted an audit committee charter,
which was
ratified by the Company’s stockholders.
Compensation
Committee
The
Company maintains a Compensation Committee of the Board of Directors.
For the
year ended December 31, 2005, Messrs. Hall, Lynch and Musser served on
the
Compensation Committee. The committee held two meetings during
2005.
Section
16(a) Beneficial Ownership Reporting Compliance
David
Grimes, a former director of the Company, failed to file on a timely
basis
certain reports required by Section 16(a) of the Exchange Act. Mr. Grimes
failed
to file 43 reports resulting in 43 transactions not being reported on
a timely
basis. Mr. Grimes’ estate filed a Form 5 on February 10, 2006 to make corrective
disclosure with respect to these transactions.
Code
of Ethics
The
Company has also adopted a Code of Ethics that applies to the Company’s
principal executive officer, principal financial officer and those persons
performing similar functions, including those employees of the Company
with
senior financial roles. A copy of the Company’s Code of Ethics was filed as
Exhibit 14 to the Company’s Annual Report on Form 10-KSB for the year ended
December 31, 2003 (filed with the Securities and Exchange Commission
on March
30, 2004). In addition, the Company will provide a copy of its Code of
Ethics
free of charge upon request to any person submitting a written request
to the
Company’s Chief Executive Officer.
ITEM
11. EXECUTIVE
COMPENSATION.
The
following table sets forth all compensation actually paid or accrued
by the
Company for services rendered to the Company for the years ended December
31,
2005, 2004 and 2003 to the Company’s Chief Executive Officer, the Company’s four
most highly compensated executive officers other than the Chief Executive
Officer who were serving as executive officers of the Company as of December
31,
2005, and those persons for whom disclosure would have been required
but for the
fact that they were not serving as an executive officer of the Company
as of
December 31, 2005.
Summary
Compensation Table
|
Annual
Compensation
|
Long
Term Compensation
|
|||||||
|
Awards
|
Payouts
|
|
||||||
|
(a)
|
(b)
|
(c)
|
(d)
|
(e)
|
(f)
|
(g)
|
(h)
|
(i)
|
|
Name
and Principal Position
|
Year
|
Salary
($)
|
Bonus
($)
|
Other
Annual Compensation
|
Restricted
Stock
($)
|
Securities
Underlying/
Options
SARs
(#)
|
LTIP
Payouts
|
All
Other Compensation
|
|
Ronald
W. Pickett
President
& Chief
Executive
Officer
|
2003
|
91,538
|
-
|
-
|
64,460
(1)
|
-
|
-
|
-
|
|
2004
|
100,089
|
-
|
-
|
107,779
(1)
|
-
|
-
|
-
|
|
|
2005
|
102,340
|
200,000
|
-
|
163,319(1)
|
-
|
-
|
-
|
|
|
Frank
T. Matarazzo
President
& Chief Executive
Officer,
MST (2)
|
2003
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
2004
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
|
2005
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
|
John
S. Cramp
Chief
Operating Officer
|
2003
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
2004
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
|
2005
|
135,288
|
6,731
|
||||||
|
Howard
Lubert
Former
Chief Executive
Officer
|
2003
|
162,083(3)
|
-
|
-
|
-
|
-
|
-
|
-
|
|
2004
|
130,000(3)
|
|||||||
|
Stephen
L. Sadle
Sr.
Vice President
|
2003
|
130,000
|
-
|
-
|
-
|
900,000
|
-
|
-
|
|
2004
|
171,983
|
6,538
|
-
|
-
|
-
|
-
|
||
|
2005
|
171,872
|
10,000
|
-
|
-
|
-
|
-
|
-
|
|
|
Jim
Landry
Chief
Technology Officer
|
2003
|
160,000
|
10,000
|
-
|
100,000
|
-
|
-
|
|
|
2004
|
172,514
|
15,000
|
|
250,000
|
-
|
|
||
|
2005
|
176,508
|
15,000
|
|
-
|
-
|
-
|
|
|
|
E.
Barry Smith
Chief
Financial Officer
|
2003
|
115,539
|
-
|
-
|
500,000
|
-
|
-
|
|
|
2004
|
171,983
|
15,000
|
|
-
|
-
|
-
|
||
|
2005
|
171,872
|
15,000
|
|
-
|
-
|
-
|
-
|
|
(1)
In
each year ending December 31, 2005, 2004 and 2003, Mr. Pickett earned
36,000
shares issued under the Company’s Employee Stock Incentive Plan as additional
compensation pursuant to his employment agreement. The fair market
value of
these shares upon issuance was $163,319, $107,779 and $64,460, respectively.
Mr.
Pickett has deferred the receipt of his 2004 and 2005 shares although
the value
of such shares is reflected in this table. The number of restricted
shares held
by Mr. Pickett at December 31, 2005, was 108,000, and the aggregate
value of
these restricted shares of common stock as of December 31, 2005, was
$448,200.
(2)
In
January 2006, the Company acquired a 90% interest in MST, a corporation
wholly
owned by Frank T. Matarazzo, prior to the acquisition. No compensation
was paid
by Telkonet to Mr. Matarazzo for the years ended December 31, 2005,
2004 and
2003.
(3)
Mr.
Lubert’s compensation includes $177,083 of the Company’s common stock acquired
by Mr. Lubert upon the exercise of options exercised in conjunction
his
resignation in June 2003. The Company paid Mr. Lubert’s salary through December
14, 2004 which was accrued in 2003 at an annual rate of $130,000.
Option/SAR
Grants In Last Fiscal Year
The
following table sets forth information concerning stock options granted
in the
fiscal year ended December 31, 2005, to the persons listed on the
Summary
Compensation Table.
|
Name
(a)
|
Number
of Securities
Underlying
Options/SARs
Granted
(#)
(b)
|
Percent
of Total Options/SARs
Granted
to
Employees
In
Fiscal
Year
(c)
|
Exercise
Or
Base
Price
($/sh)
(d)
|
Expiration
Date
(e)
|
|
Ronald
W. Pickett
|
0
|
0%
|
n/a
|
n/a
|
|
Frank
T. Matarazzo
|
0
|
0%
|
n/a
|
n/a
|
|
John
S. Cramp
|
500,000
|
37%
|
$3.04
|
5/1/2015
|
|
Stephen
L. Sadle
|
0
|
0%
|
n/a
|
n/a
|
|
James
Landry
|
0
|
0%
|
n/a
|
n/a
|
|
E.
Barry Smith
|
0
|
0%
|
n/a
|
n/a
|
Aggregated
Option/SAR Exercises In Last Fiscal Year And Fiscal Year End Option/SAR
Values
The
following table summarizes information relating to stock option exercises
during
the year ended December 31, 2005 by those persons listed on the Summary
Compensation Table.
|
Name
(a)
|
Shares
Acquired
on
Exercise
(#)
(b)
|
Value
Realized
($)
(c)
|
Number
of Unexercised Securities Underlying Options/SARs at
FY-End
(#)
Exerciseable/
Unexerciseable
(d)
|
Value
of Unexercised
In-The-Money
Options/SARs
at
FY-End ($)
Exerciseable/
Unexerciseable
(e)
|
|
Ronald
W. Pickett
|
-0-
|
-0-
|
-0-
-0-
|
-0-
-0-
|
|
Frank
T. Matarazzo (1)
|
-0-
|
-0-
|
-0-
-0-
|
-0-
-0-
|
|
John
S. Cramp
|
-0-
|
-0-
|
50,000/
450,000
|
55,500/
499,500
|
|
Stephen
L. Sadle
|
-0-
|
-0-
|
900,000/
-0-
|
2,835,000/
-0-
|
|
James
Landry
|
-0-
|
-0-
|
350,000/
150,000
|
857,500/
105,000
|
|
E.
Barry Smith
|
31,000
|
110,050
|
441,000/
-0-
|
1,389,150/
-0-
|
Director
Compensation
Telkonet
reimburses non-management 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 compensates each
non-management director (excluding Mr. Musser): $4,000 per month,
10,000 vested
stock options per quarter and $1,000 for each committee meeting of
the Board of
Directors such director attends, except that Mr. Musser, as Chairman
of the
Board of Directors, is compensated $8,333 per month (consisting of
monthly
payments in the amount of $4,000, which payments are consistent with
the monthly
payments made to the other non-management directors, and $4,333.33
per month,
which payments are in lieu of the 10,000 vested stock options per
quarter and
$1,000 for each committee meeting that the other non-management directors
receive). Payments to Mr. Musser for Board services were made to
The Musser
Group pursuant to a consulting agreement described below under the
heading
“Certain Relationships and Related Transactions.”
Employment
Agreements
Stephen
L. Sadle, Senior Vice President, is employed pursuant to an employment
agreement
for a three-year term that commenced January 18, 2003 and renewed
for a one-year
term through January 17, 2007 and provides for an annual salary of
$130,000 and
bonuses and benefits based upon Telkonet’s internal policies. Mr. Sadle’s annual
salary was increased to $171,872 in 2004.
James
Landry, Chief Technology Officer, 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. Landry’s annual salary was increased to
$176,508 in 2004.
Ronald
W.
Pickett, President and Chief Executive Officer, 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 the Company’s common
stock per month for each month of his employment and bonuses and
benefits based
upon Telkonet’s internal policies. Mr. Pickett’s annual salary was increased to
$102,340 on August 1, 2004 and he received a bonus of $200,000 for
the year
ended December 31, 2005. In January 2006, Mr. Pickett’s salary was increased to
$250,000 with an incentive bonus up to $150,000. The incentive portion
of the
salary will be awarded based on the successful achievement of $15
million in
revenues in 2006 and a cash flow break even run rate by the fourth
quarter,
2006.
Frank
T.
Matarazzo, President and Chief Executive Officer, MST, is employed
pursuant to
an employment agreement for a three-year term that commenced February
1, 2006
and provides for an annual salary of $250,000 and bonuses and benefits
based
upon MST’s internal policies.
E.
Barry
Smith, Chief Financial Officer, is employed pursuant to an employment
agreement
for a one-year term that commenced February 17, 2003 and renewed
for a one-year
term through February 16, 2007 and provides for an annual salary
of $130,000 and
bonuses and benefits based upon Telkonet’s internal policies. Mr. Smith’s annual
salary was increased to $171,872 in 2004.
Howard
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,
in
connection with Mr. Lubert’s separation from the Company, Telkonet agreed to pay
Mr. Lubert’s salary through December 14, 2004.
In
addition, under the Stock Incentive Plan, stock options are periodically
granted
to employees at the discretion of the Compensation Committee 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
In
September 2005, the Board of Directors nominated and approved a Compensation
Committee which consisted of Messrs. Musser and Lynch and Dr. Hall.
Prior to
September 2005, Telkonet did not have a Compensation Committee. However,
Messrs. Lynch and Peeler and Dr. Hall, all of the independent members
of the
Company's Board of Directors, fulfilled the functions of a Compensation
Committee. None of these individuals was, or has been, an officer
or employee of
Telkonet or any of its subsidiaries, nor does any of these individuals
have a
relationship that would constitute an interlocking relationship with
executive
officers or directors of Telkonet or another entity.
Board
Compensation Committee Report on Executive
Compensation
Report
of the Compensation Committee
Notwithstanding anything to the contrary set forth in any of Telkonet's
previous
filings under the Securities Act of 1933 or the Exchange Act that
might
incorporate future filings or this proxy statement, the following
report shall
not be deemed to be incorporated by reference into any such filings.
In
addition, the following report shall not be deemed to be "soliciting
material"
or "filed" with the SEC.
The base salary, bonus, benefits and other compensation payable
to Telkonet's
executive officers for the year ended December 31, 2004 were fixed
under written
employment agreements (except for Mr. Landry, who does not have
an employment
agreement) described above under the heading Employment Contracts
and
Termination of Employment Arrangements.
Prior to establishing Mr. Pickett's compensation pursuant to his
employment
agreement (as well as the compensation of the other executive officers),
the
Board of Directors reviewed compensation recommendations prepared
by Telkonet's
human resources director, which recommendations provide information
regarding
compensation at the tenth to fiftieth percentiles in peer companies.
The Board
of Directors believes that Mr. Pickett's executive compensation
is commensurate
with his peers in comparable companies. In 2004, the Telkonet Board
of Directors
determined to increase Mr. Pickett's compensation from approximately
$92,000 to
$101,000 to give effect to a one-time adjustment for company-paid
medical
benefits in accordance with Mr. Pickett's employment agreement.
Thereafter, all
employees, including Mr. Pickett, are required to pay 25% of their
respective
medical premiums as part of a cost containment initiative.
Messrs. Lynch and Peeler and Dr. Hall have the power to administer
the Amended
and Restated Stock Incentive Plan, which stock options may be granted
to
officers, directors, employees, advisors and consultants who render
services to
Telkonet. For the fiscal year ended December 31, 2004, no awards
were made to
the executive officers pursuant to the Amended and Restated Stock
Incentive
Plan, except that Mr. Pickett, pursuant to the terms of his employment
agreement, was awarded 3,000 restricted shares of Telkonet's common
stock per
month which vest immediately, and Mr. Landry received an stock
option award to
purchase 250,000 shares of Telkonet's common stock, based on his
years of
contribution to the development of Telkonet's technology and his
promotion to
the position of Telkonet's Chief Technology Officer.
By,
Thomas
M.
Hall
Thomas
C.
Lynch
James
L.
Peeler
Performance
Graph
Set
forth
below is a line graph comparing the cumulative total return on Telkonet’s Common
Stock against the cumulative total return of the Market Index for
the American
Stock Exchange (U.S.) (“AMEX”) and for the peer group “Communications Services,
within the Standard Industrial Classification Code category, (SIC)
Code 4899”,
for the period beginning August 15, 2002 and each fiscal year ending
December 31
thereafter through the fiscal year ended December 31, 2005. Because
Telkonet’s
common stock was not widely traded prior to August 15, 2002, the
graph does not
show the total return on Telkonet’s common stock prior to August 15, 2002. The
total returns assume $100 invested on August 15, 2002 with reinvestment
of
dividends.
ITEM
12.
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.
The
following table provides information concerning securities authorized
for
issuance pursuant to equity compensation plans approved by the
Company’s
stockholders and equity compensation plans not approved by the
Company’s
stockholders as of December 31, 2005.
|
Number
of securities to be
issued
upon exercise of
outstanding
options,
warrants
and rights
|
Weighted
-average
exercise
price of
outstanding
options,
warrants
and rights
|
Number
of securities remaining
available
for future issuance
under
equity compensation plans
(excluding
securities reflected in
column
(a))
|
|
|
(a)
|
(b)
|
(c)
|
|
|
Equity
compensation plans approved by
security
holders
|
15,000,000
|
$1.56
|
-
|
|
Equity
compensation plans not approved
by
security holders
|
933,327
|
$3.64
|
-
|
|
Total
|
15,933,327
|
$1.72
|
-
|
The
following table sets forth, as of March 1, 2006, the number of
shares of the
Company’s common stock beneficially owned by each director and executive
officer
of the Company, by all directors and executive officers as a group,
and by each
person known by the Company to own beneficially more than 5.0%
of the Company’s
outstanding common stock. As of March 1, 2006, there were no issued
and
outstanding shares of any other class of the Company’s equity securities.
|
Name
and Address of Beneficial Owner
|
Shares
Beneficially Owned
|
Percentage
of Class
|
|
Officers
and Directors
|
||
|
Ronald
W. Pickett, President and CEO
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
2,699,699
|
5.8%
|
|
Frank
T. Matarazzo, President and CEO, MST
259-263
Goffle Road
Hawthorne,
NJ 07506
|
400,000(1)
|
0.9%
|
|
John
S. Cramp, Chief Operating Officer
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
75,000(2)
|
0.2%
|
|
E.
Barry Smith, Chief Financial Officer
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
441,000(3)
|
0.9%
|
|
Stephen
L. Sadle, Senior Vice President
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
4,389,514(4)
|
9.3%
|
|
James
Landry, Chief Technology Officer
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
434,200(5)
|
0.9%
|
|
Warren
V. Musser, Chairman
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
2,237,027(7)
|
4.6%
|
|
David
Grimes, Former Director
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
1,575,405(8)
|
3.3%
|
|
Thomas
C. Lynch, Director
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
100,000(9)
|
0.2%
|
|
Dr.
Thomas M. Hall, Director
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
667,790(10)
|
1.4%
|
|
James
“Lou” L. Peeler, Director
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
84,400(11)
|
0.2%
|
|
Seth
D. Blumenfeld
20374
Seneca Meadows Parkway
Germantown,
MD 20876
|
40,000
(12)
|
0.1%
|
|
All
Directors and Executive Officers as a Group
|
13,642,035
|
26.4%
|
|
(1)
|
Includes
400,000 shares of the Company’s common stock issued to Mr. Matarazzo in
conjunction with the Company’s January 2006 acquisition of a 90% interest
in Microwave Satellite Technologies, Inc. As part of
the purchase price,
an additional 1,200,000 shares of the Company’s common stock are held in
escrow,issuable upon the achievement of certain performance
targets and
excluded from this table.
|
|
(2)
|
Includes
options exerciseable within 60 days to purchase 75,000
shares of the
Company’s common stock at $3.04 per
share.
|
|
(3)
|
Includes
options exerciseable within 60 days to purchase 441,000
shares of the
Company’s common stock at $1.00 per
share.
|
|
(4)
|
Includes
options exerciseable within 60 days to purchase 900,000
shares of the
Company’s common stock at $1.00 per
share.
|
|
(5)
|
Includes
options exerciseable within 60 days to purchase 250,000
and 100,000 shares
of the Company’s common stock at $1.00 and $3.45 per share,
respectively.
|
|
(6)
|
Includes
options exerciseable within 60 days to purchase 500,000
shares of the
Company’s common stock at $1.00 per
share.
|
|
(7)
|
Includes
options exerciseable within 60 days to purchase 2,000,000
shares of the
Company’s common stock at $1.00 per
share.
|
|
(8)
|
Includes
options exerciseable within 60 days to purchase 825,000
shares of the
Company’s common stock at $1.00 per share. The remaining 75,000
unvested
options were cancelled.
|
|
(9)
|
Includes
options exerciseable within 60 days to purchase 20,000
and 80,000 shares
of the Company’s common stock at $2.00 and $3.45 per share,
respectively.
|
|
(10)
|
Includes
options exerciseable within 60 days to purchase 80,000
shares of the
Company’s common stock at $3.45 per
share.
|
|
(11)
|
Includes
options exerciseable within 60 days to purchase 80,000
shares of the
Company’s common stock at $3.45 per
share.
|
|
(12)
|
Includes
10,000 shares of the Company’s common stock to be issued within 60 days
pursuant to a Professional Services
Agreement.
|
ITEM
13.
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS.
In
September 2003, the Company entered into a consulting agreement
(renewable
annually) with The Musser Group to compensate Mr. Musser in the
amount of
$100,000 per year for his services to the Company as a director.
Mr. Musser,
Chairman of the Board of Directors, is the sole principal of The
Musser Group,
which is owned by Mr. Musser’s wife. For the years ended December 31, 2005, 2004
and 2003, the Company paid and expensed $100,000, $100,000 and
$33,333,
respectively.
On
July
1, 2005, Mr. Blumenfeld was retained as a consultant to Telkonet
pursuant to a
Professional Services Agreement between the Company and Mr. Blumenfeld.
Pursuant
to the terms of the agreement, Mr. Blumenfeld received 10,000 shares
of Company
stock upon execution of the agreement, 10,000 shares of Company
stock per
quarter for the first year (for a total 50,000 shares in the first
year) and
5,000 shares of Company stock per quarter thereafter plus a five
percent (5%)
commission (payable in cash or Company stock) on international
sales generated
by him with gross margins of 50% or greater. The stock awarded
to Mr. Blumenfeld
pursuant to the agreement is restricted stock. The agreement has
a one year
term, which is renewable annually upon both parties' agreement.
In
December 2005, the Company issued an aggregate of 363,636 shares
of common stock
to Ronald W. Pickett, President and Chief Executive Officer of
the Company, a
convertible debenture holder in exchange for $200,000 of Series
B Debentures.
The Company also issued an aggregate of 48,858 shares of common
stock in
exchange for accrued interest of $26,872 for Series B Debentures.
In addition,
the Company issued an aggregate of 200,000 shares of common stock
upon the
exercise of warrants at $1.00 per share upon conversion of the
notes.
ITEM
14.
PRINCIPAL
ACCOUNTANT FEES AND SERVICES.
The
following table sets forth fees billed to the Company by our auditors
during the
fiscal years ended December 31, 2005 and 2004 Additionally, the
Company incurred
approximately $200,000 associated with its Sarbanes-Oxley compliance
review.
|
December
31, 2005
|
December
31, 2004
|
||||||
|
1.
Audit Fees
|
$
|
119,090
|
$
|
63,875
|
|||
|
2.
Audit Related Fees
|
62,825
|
23,900
|
|||||
|
3.
Tax Fees
|
1,175
|
5,000
|
|||||
|
4.
All Other Fees
|
--
|
--
|
|||||
|
Total
Fees
|
$
|
183,090
|
$
|
92,775
|
|||
Audit
fees consist of fees billed for professional services rendered
for the audit of
the Company’s consolidated financial statements and review of the interim
consolidated financial statements included in quarterly reports
and services
that are normally provided by Russell Bedford Stefanou Mirchandani
LLP in
connection with statutory and regulatory filings or engagements.
Audit-related
fees consists of fees billed for assurance and related services
that are
reasonably related to the performance of the audit or review
of the Company’s
consolidated financial statements, which are not reported under
“Audit Fees.”
Tax
fees
consists of fees billed for professional services for tax compliance,
tax advice
and tax planning. The tax fees relate to federal and state income
tax reporting
requirements.
All
other
fees consist of fees for products and services other than the
services reported
above.
Prior
to
the Company’s engagement of its independent auditor, such engagement is approved
by the Company’s audit committee. The services provided under this engagement
may include audit services, audit-related services, tax services
and other
services. Pre-approval is generally provided for up to one year
and any
pre-approval is detailed as to the particular service or category
of services
and is generally subject to a specific budget. Pursuant to the
Company’s Audit
Committee Charter, the independent auditors and management are
required to
report to the Company’s audit committee at least quarterly regarding the extent
of services provided by the independent auditors in accordance
with this
pre-approval, and the fees for the services performed to date.
The audit
committee may also pre-approve particular services on a case-by-case
basis. All
audit fees, audit-related fees, tax fees and other fees incurred
by the Company
for the year ended December 31, 2005, were approved by the Company’s audit
committee.
PART
IV
ITEM
15.
EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES.
The
following table sets forth selected unaudited quarterly information
for the
Company’s year-ended December 31, 2005 and 2004.
|
QUARTERLY
FINANCIAL DATA
|
|
(unaudited)
|
|
March
31, 2005
|
June
30, 2005
|
September
30, 2005
|
December
31, 2005
|
||||||||||
|
Net
Revenue
|
$
|
246,188
|
$
|
472,947
|
$
|
621,923
|
$
|
1,147,265
|
|||||
|
Gross
Profit
|
$
|
88,798
|
$
|
120,791
|
$
|
212,749
|
$
|
348,806
|
|||||
|
Provision
for income taxes
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
-
|
|||||
|
Net
loss per share -- basic
|
$
|
(0.07
|
)
|
$
|
(0.08
|
)
|
$
|
(0.08
|
)
|
$
|
(0.12
|
)
|
|
|
Net
loss per share -- diluted
|
$
|
(0.07
|
)
|
$
|
(0.08
|
)
|
$
|
(0.08
|
)
|
$
|
(0.12
|
)
|
|
|
|
March
31, 2004
|
June
30, 2004
|
September
30, 2004
|
December
31, 2004
|
|||||||||
|
Net
Revenue
|
$
|
140,099
|
$
|
271,903
|
$
|
79,335
|
$
|
207,315
|
|||||
|
Gross
Profit
|
$
|
5,695
|
$
|
12,774
|
$
|
10,462
|
$
|
126,862
|
|||||
|
Provision
for income taxes
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
-
|
|||||
|
Net
loss per share -- basic
|
$
|
(0.09
|
)
|
$
|
(0.11
|
)
|
$
|
(0.06
|
)
|
$
|
(0.06
|
)
|
|
|
Net
loss per share -- diluted
|
$
|
(0.09
|
)
|
$
|
(0.11
|
)
|
$
|
(0.06
|
)
|
$
|
(0.06
|
)
|
|
The
following table sets forth selected unaudited valuation and
qualifying account
information for the Company’s year-ended December 31, 2005, 2004 and
2003.
|
SCHEDULE
II- VALUATION AND QUALIFYING ACCOUNTS
|
|||||||||||||||
|
(unaudited)
|
|||||||||||||||
|
Balance
|
CHARGED
TO
|
||||||||||||||
|
BEGINNING
OF
|
COSTS
AND
|
BALANCE,
END
|
|||||||||||||
|
DESCRIPTION
|
YEAR
|
EXPENSES
|
DEDUCTIONS
|
OF
YEAR
|
|||||||||||
|
Allowance
for doubtful accounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended December 31,
|
|||||||||||||||
|
2005
|
$
|
13,000
|
|
|
$
|
39,710
|
|
|
$
|
(22,710)
|
|
|
$
|
30,000
|
|
|
2004
|
7,000
|
30,637
|
(24,637)
|
13,000
|
|||||||||||
|
2003
|
|
0
|
|
|
|
7,000
|
|
|
|
0
|
|
|
|
7,000
|
|
|
Reserve
for product returns:
|
|||||||||||||||
|
Year
ended December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
$
|
0
|
$
|
24,000
|
$
|
0
|
$
|
24,000
|
|||||||
|
2004
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
2003
|
—
|
—
|
—
|
—
|
|||||||||||
The
following exhibits are included herein or incorporated by
reference:
| Exhibit Number |
Description
Of Document
|
| 3.1 |
Articles
of Incorporation of the Registrant (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
of the Registrant (incorporated by reference to
our Registration Statement
on Form S-1 (No. 333-108307), filed on August 28,
2003)
|
| 4.1 |
Form
of Series A Convertible Debenture (incorporated
by reference to our Form
10-KSB (No. 000-27305), filed on March 31, 2003)
|
| 4.2 |
Form
of Series A Non-Detachable Warrant (incorporated
by reference to our Form
10- KSB (No. 000-27305), filed on March 31, 2003)
|
| 4.3 |
Form
of Series B Convertible Debenture (incorporated
by reference to our Form
10-KSB (No. 000-27305), filed on March 31, 2003)
|
| 4.4 |
Form
of Series B Non-Detachable Warrant (incorporated
by reference to our Form
10- KSB (No. 000-27305), filed on March 31, 2003)
|
| 4.5 |
Form
of Senior Note (incorporated by reference to our
Registration Statement on
Form S-1 (No. 333-108307), filed on August 28,
2003)
|
| 4.6 |
Form
of Non-Detachable Senior Note Warrant (incorporated
by reference to our
Registration Statement on Form S-1 (No. 333-108307),
filed on August 28,
2003)
|
| 10.1 |
Amended
and Restated Telkonet, Inc. Incentive Stock Option
Plan (incorporated by
reference to our Registration Statement on Form
S-8 (No. 333-412), filed
on April 17, 2002)
|
| 10.2 |
Employment
Agreement by and between Telkonet, Inc. and Stephen
L. Sadle, dated as of
January 18, 2003 (incorporated by reference to
our Registration Statement
on Form S-1 (No. 333-108307), filed on August 28,
2003
|
| 10.3 |
Employment
Agreement by and between Telkonet, Inc. and Robert
P. Crabb, dated as of
January 18, 2003 (incorporated by reference to
our Registration Statement
on Form S-1 (No. 333-108307), filed on August 28,
2003)
|
| 10.4 |
Employment
Agreement by and between Telkonet, Inc. and Ronald
W. Pickett, dated as of
January 30, 2003 (incorporated by reference to
our Registration Statement
on Form S-1 (No. 333-108307), filed on August 28,
2003)
|
| 10.5 |
Employment
Agreement by and between Telkonet, Inc. and E.
Barry Smith, dated as of
February 17, 2003 (incorporated by reference to
our Registration Statement
on Form S-1 (No. 333-108307), filed on August 28,
2003)
|
| 10.6 |
Employment
Agreement by and between Telkonet, Inc. and Frank
T Matarazzo, dated as of
February 1, 2006
|
| 10.7 |
Professional
Services Agreement by and between Telkonet, Inc.
and Seth D. Blumethel,
dated July 1, 2005 (incorporated by reference to
our Form 10-Q (No.
000-27305), filed on November 9,
2005.
|
| 10.8 |
MST
Stock Purchase Agreement and Amendment (incorporated
by reference to our
8-K filed on February 2, 2006) (No.
001-31972)
|
| 14 |
Code
of Ethics (incorporated by reference to our Form
10-KSB (No. 001-31972),
filed on March 30, 2004).
|
| 21 |
Telkonet,
Inc. Subsidiaries
|
|
23
|
Consent
of Registered Independent Certified Public
Accountants
|
| 24 |
Power
of Attorney (incorporated by reference to our Registration
Statement on
Form S-1 (No. 333-108307), filed on August 28,
2003)
|
| 31.1 |
Certification
Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 of Ronald W.
Pickett
|
| 31.2 |
Certification
Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 of E. Barry
Smith
|
| 32.1 |
Certification
of Ronald W. Pickett pursuant to 18 U.S.C. Section
1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
|
| 32.2 |
Certification
of E. Barry Smith pursuant to 18 U.S.C. Section
1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of
2002
|
In
accordance with Section 13 or 15(d) of the Exchange Act,
the registrant has duly
caused this report to be signed on its behalf by the undersigned,
thereunto duly
authorized.
TELKONET,
INC.
/s/
Ronald W. Pickett
Ronald
W.
Pickett
Chief
Executive Officer
Pursuant
to the requirements of the Securities Exchange Act of 1934,
this report has been
signed below by the following persons on behalf of the registrant
and in the
capacities and on the dates indicated.
|
Name
|
Position
|
Date
|
|
/s/
Warren V. Musser
Warren
V. Musser
|
Chairman
of the Board
|
March
16, 2006
|
|
/s/
Ronald W. Pickett
Ronald
W. Pickett
|
Chief
Executive Officer &
Director
|
March
16, 2006
|
|
/s/
E. Barry Smith
E.
Barry Smith
|
Chief
Financial Officer
|
March
16, 2006
|
|
/s/
James Landry
James
Landry
|
Chief
Technology Officer
|
March
16, 2006
|
|
/s/
Stephen L. Sadle
Stephen
L. Sadle
|
Senior
Vice President &
Director
|
March
16, 2006
|
|
/s/
Dr. Thomas M. Hall
Dr.
Thomas M. Hall
|
Director
|
March
16, 2006
|
|
/s/
James L. Peeler
James
L. Peeler
|
Director
|
March
16, 2006
|
|
/s/
Seth D. Blumenfeld
Seth
D. Blumenfeld
|
Director
|
March
16, 2006
|
|
/s/
Thomas C. Lynch
Thomas
C. Lynch
|
Director
|
March
16, 2006
|
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FINANCIAL
STATEMENTS AND SCHEDULES
DECEMBER
31, 2005 AND 2004
FORMING
A PART OF ANNUAL REPORT
PURSUANT
TO THE SECURITIES EXCHANGE ACT OF 1934
TELKONET,
INC.
TELKONET,
INC.
Index
to Financial Statements
|
Report
of Independent Registered Certified Public
Accounting Firm
|
F-3
|
|
Consolidated
Balance Sheets at December 31, 2005 and 2004
|
F-4
|
|
Consolidated
Statements of Losses for the Years ended December
31, 2005, 2004 and
2003
|
F-5
|
|
Consolidated
Statements of Stockholders’ Equity for the Years ended December 31, 2005,
2004 and 2003
|
F-6
- F-8
|
|
Consolidated
Statements of Cash Flows for the Years ended
December 31, 2005, 2004 and
2003
|
F-9
- F-10
|
|
Notes
to Consolidated Financial Statements
|
F-11
- F-32
|
RUSSELL
BEDFORD STEFANOU
MIRCHANDANI LLP
Certified
Public Accountants
REPORT
OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING
FIRM
Board
of
Directors
Telkonet,
Inc.
Germantown,
MD
We
have
audited the accompanying consolidated balance sheets
of Telkonet, Inc. and its
wholly-owned subsidiary (the "Company") as of December
31, 2005 and 2004 and the
related consolidated statements of losses, stockholders'
equity, and cash flows
for each of the three years in the period ended December 31, 2005. 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 standards of
the Public Company
Accounting Oversight Board (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 consolidated 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, 2005 and 2004,
and the results of its
operations and its cash flows for each of the three years
in the period ended
December 31, 2005, in conformity with accounting principles generally
accepted in the United States of America.
We have also audited, in accordance with the standards
of the Public Company
Accounting Oversight Board (United States), the effectiveness
of the Company’s
internal control over financial reporting as of December 31, 2005, based on
the criteria established in
Internal Control—Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway
Commission and our
report dated February 2, 2006 expressed an unqualified
opinion on management’s
assessment of the effectiveness of the Company’s internal control over financial
reporting and an unqualified opinion on the effectiveness
of the Company’s
internal control over financial reporting.
/s/RUSSELL
BEDFORD STEFANOU MIRCHANDANI LLP
Russell
Bedford Stefanou Mirchandani LLP
McLean,
Virginia
February
2, 2006
TELKONET,
INC.
CONSOLIDATED
BALANCE SHEETS
DECEMBER
31, 2005 AND 2004
|
ASSETS
|
2005
|
2004
|
|||||
|
Current
Assets:
|
|||||||
|
Cash
and cash equivalents
|
$
|
8,422,079
|
$
|
11,838,702
|
|||
|
Restricted
Certificate of Deposit
|
10,000,000
|
--
|
|||||
|
Accounts
receivable, net of allowance for doubtful
accounts of $30,000 and $13,000
at
December
31, 2005 and 2004, respectively
|
119,191
|
63,147
|
|||||
|
Inventories
(Note B)
|
1,475,806
|
1,873,718
|
|||||
|
Prepaid
expenses and deposits
|
360,880
|
124,852
|
|||||
|
Total
current assets
|
20,377,956
|
13,900,419
|
|||||
|
Property
and equipment, at cost
(Note C):
|
|||||||
|
Furniture
and equipment
|
1,041,137
|
704,689
|
|||||
|
Less:
accumulated depreciation
|
323,667
|
137,739
|
|||||
|
Total
property and equipment, net
|
717,470
|
566,950
|
|||||
|
Equipment
under operating leases, at cost
(Note D):
|
|||||||
|
Telecommunications
and related equipment, at cost
|
789,099
|
525,664
|
|||||
|
Less:
accumulated depreciation
|
124,669
|
75,329
|
|||||
|
Total
equipment under operating leases, net
|
664,430
|
450,335
|
|||||
|
Other
assets:
|
|||||||
|
Long-term
investments (Note E)
|
231,000
|
500,000
|
|||||
|
Financing
Costs, net of accumulated amortization of
$73,499 and $0 at December 31,
2005
and
2004, respectively (Note F)
|
1,145,911
|
--
|
|||||
|
Deposits
|
154,216
|
76,288
|
|||||
|
Total
other assets
|
1,531,127
|
576,288
|
|||||
|
Total
Assets
|
$
|
23,290,983
|
$
|
15,493,992
|
|||
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|||||||
|
Current
liabilities:
|
|||||||
|
Accounts
payable and accrued liabilities (Note M)
|
$
|
1,821,872
|
$
|
1,195,924
|
|||
|
Customer
deposits held
|
86,257
|
32,975
|
|||||
|
Senior
notes payable, current portion (Note G)
|
100,000
|
--
|
|||||
|
Convertible
debentures, current portion (Note F)
|
6,250,000
|
--
|
|||||
|
Deferred
revenue
|
59,020
|
--
|
|||||
|
Total
current liabilities
|
8,317,149
|
1,228,899
|
|||||
|
Long-term
liabilities:
|
|||||||
|
Convertible
debentures, net of discounts (Note F)
|
9,616,521
|
137,910
|
|||||
|
Senior
notes payable (Note G)
|
--
|
450,000
|
|||||
|
Deferred
lease liability
|
42,317
|
30,911
|
|||||
|
Total
long-term liabilities
|
9,658,838
|
618,821
|
|||||
|
Commitments
and contingencies
(Note N)
|
--
|
--
|
|||||
|
Stockholders’
equity
(Note H)
|
|||||||
|
Preferred
stock, par value $.001 per share; 15,000,000
shares authorized; none
issued
and
outstanding at December 31, 2005 and 2004
|
--
|
--
|
|||||
|
Common
stock, par value $.001 per share; 100,000,000
shares authorized;
45,765,171
and
44,335,989 shares issued and outstanding
at December 31, 2005 and 2004,
respectively
|
45,765
|
44,336
|
|||||
|
Additional
paid-in-capital
|
48,256,784
|
40,811,208
|
|||||
|
Accumulated
deficit
|
(42,987,553
|
)
|
(27,209,272
|
)
|
|||
|
Stockholders’
equity
|
5,314,996
|
13,646,272
|
|||||
|
Total
Liabilities and Stockholders’ Equity
|
$
|
23,290,983
|
$
|
15,493,992
|
|||
See
accompanying notes to consolidated financial statements
TELKONET,
INC.
CONSOLIDATED
STATEMENTS OF LOSSES
FOR
THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
|
2005
|
2004
|
2003
|
||||||||
|
Product
Revenues, net
|
$
|
1,769,727
|
$
|
477,555
|
$
|
88,403
|
||||
|
Rental
Revenue, net
|
718,596
|
221,097
|
5,257
|
|||||||
|
Total
Revenue
|
2,488,323
|
698,652
|
93,660
|
|||||||
|
Product
|
1,183,574
|
459,225
|
101,171
|
|||||||
|
Rental
|
533,605
|
83,634
|
3,485
|
|||||||
|
Total
Cost of Sales
|
1,717,179
|
542,859
|
104,656
|
|||||||
|
Gross
Profit (Loss)
|
771,144
|
155,793
|
(10,996
|
)
|
||||||
|
Operating
Expenses:
|
||||||||||
|
Research
and Development (Note A)
|
2,096,104
|
1,852,309
|
1,370,785
|
|||||||
|
Selling,
General and Administrative
|
12,041,661
|
7,663,369
|
4,089,172
|
|||||||
|
Consulting
Fees (Note H)
|
-
|
2,500,000
|
-
|
|||||||
|
Impairment
write-down in investment in affiliate (Note
E)
|
400,000
|
-
|
-
|
|||||||
|
Non-Employee
Stock Options and Warrants (Note I)
|
1,354,219
|
1,180,875
|
982,390
|
|||||||
|
Depreciation
and Amortization
|
185,928
|
71,514
|
110,988
|
|||||||
|
Total
Operating Expense
|
16,077,912
|
13,268,067
|
6,553,335
|
|||||||
|
Loss
from Operations
|
(15,306,768
|
)
|
(13,112,274
|
)
|
(6,564,331
|
)
|
||||
|
Other
Income (Expense):
|
||||||||||
|
Other
Income (Note F)
|
8,600
|
--
|
--
|
|||||||
|
Interest
Income
|
166,070
|
128,938
|
20,297
|
|||||||
|
Interest
Expense
|
(
646,183
|
)
|
(109,324
|
)
|
(1,113,902
|
)
|
||||
|
Total
Other Income (Expenses)
|
(471,513
|
)
|
19,614
|
(1,093,605
|
)
|
|||||
|
Loss
Before Provision for Income Taxes
|
(15,778,281
|
)
|
(13,092,660
|
)
|
(7,657,936
|
)
|
||||
|
Provision
for Income Tax (Note K)
|
--
|
--
|
--
|
|||||||
|
Net
Loss
|
$
|
(15,778,281
|
)
|
$
|
(13,092,660
|
)
|
$
|
(
7,657,936
|
)
|
|
|
Loss
per common share (basic and assuming dilution)
(Note L)
|
$
|
(0.35
|
)
|
$
|
(0.32
|
)
|
$
|
(0.37
|
)
|
|
|
Weighted
average common shares outstanding
|
44,743,223
|
41,384,074
|
20,702,482
|
|||||||
See
accompanying notes to consolidated financial statements
TELKONET,
INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR
THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
|
Preferred
Shares
|
Preferred
Stock
Amount
|
Common
Shares
|
Common
Stock Amount
|
Additional
Paid in Capital
|
Accumulated
Deficit
|
Total
|
||||||||||||||||
|
Balance
at January 1, 2003
|
-
|
$
|
-
|
15,721,131
|
$
|
15,721
|
$
|
4,916,433
|
$
|
(6,458,676
|
)
|
$
|
(1,526,522
|
)
|
||||||||
|
Shares
issued for cash at $2.00 per share, net of
costs
and
fees
|
-
|
-
|
333
|
-
|
666
|
-
|
666
|
|||||||||||||||
|
Shares
issued for employee stock options exercised
at
approximately
$1.01 per share
|
-
|
-
|
109,333
|
109
|
110,724
|
-
|
110,833
|
|||||||||||||||
|
Shares
issued to a director for employee stock options
exercised
at $.50 per share
|
315,000
|
315
|
157,185
|
157,500
|
||||||||||||||||||
|
Shares
issued in exchange for non-employee options
exercised
at $1.00 per share
|
-
|
-
|
187,499
|
189
|
187,311
|
-
|
187,500
|
|||||||||||||||
|
Shares
issued to consultants in exchange for services
at
approximately $2.13 per share
|
-
|
-
|
149,498
|
150
|
318,955
|
-
|
319,105
|
|||||||||||||||
|
Shares
issued to noteholders for warrants exercised
at
$1.00 per share
|
-
|
-
|
3,599,250
|
3,599
|
3,595,651
|
-
|
3,599,250
|
|||||||||||||||
|
Shares
issued to noteholders for warrants exercised
at
$.50 per share
|
-
|
-
|
500,000
|
500
|
249,500
|
-
|
250,000
|
|||||||||||||||
|
Shares
issued to noteholders for cashless warrants
exercised
|
-
|
-
|
317,239
|
317
|
(317
|
)
|
-
|
-
|
||||||||||||||
|
Shares
issued in exchange for convertible debentures
(Note
F)
|
-
|
-
|
7,217,836
|
7,218
|
3,799,882
|
-
|
3,807,100
|
|||||||||||||||
|
Shares
issued in exchange for accrued interest on
convertible
debentures (Note F)
|
-
|
-
|
525,403
|
525
|
280,209
|
-
|
280,734
|
|||||||||||||||
|
Shares
issued for warrants exercised at $1.00, in
exchange
for Senior Notes (Note G)
|
-
|
-
|
2,011,000
|
2,011
|
2,008,989
|
-
|
2,011,000
|
|||||||||||||||
|
Write-off
of beneficial conversion features and warrants
attached
to convertible debentures in connection with
conversion
of Debenture-1 and Series B debentures (Note
F)
|
-
|
-
|
-
|
-
|
(2,342,949
|
)
|
-
|
(2,342,949
|
)
|
|||||||||||||
|
Shares
issued to an employee in exchange for services
at
approximately $1.79 per share
|
-
|
-
|
36,000
|
36
|
64,433
|
-
|
64,469
|
|||||||||||||||
|
Stock
options and warrants granted to consultants
in
exchange
for services rendered (Note I)
|
-
|
-
|
-
|
-
|
1,013,262
|
-
|
1,013,262
|
|||||||||||||||
|
Stock
based compensation for the issuance of warrants
in
exchange for financing costs (Note I)
|
-
|
-
|
-
|
-
|
87,217
|
-
|
87,217
|
|||||||||||||||
|
Beneficial
conversion feature of convertible debentures
(Note
F)
|
-
|
-
|
-
|
-
|
1,761,675
|
-
|
1,761,675
|
|||||||||||||||
|
Value
of warrants attached to convertible debentures
(Note
F)
|
-
|
-
|
-
|
-
|
265,425
|
-
|
265,425
|
|||||||||||||||
|
Net
loss
|
-
|
-
|
-
|
-
|
-
|
(7,657,936
|
)
|
(7,657,936
|
)
|
|||||||||||||
|
Balance
at December 31, 2003
|
-
|
$
|
-
|
30,689,522
|
$
|
30,690
|
$
|
16,474,251
|
$
|
(14,116,612
|
)
|
$
|
2,388,329
|
|||||||||
TELKONET,
INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR
THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
|
Preferred
Shares
|
Preferred
Stock
Amount
|
Common
Shares
|
Common
Stock Amount
|
Additional
Paid in Capital
|
Accumulated
Deficit
|
Total
|
||||||||||||||||
|
Balance
at January 1, 2004
|
-
|
$
|
-
|
30,689,522
|
$
|
30,690
|
$
|
16,474,251
|
$
|
(14,116,612
|
)
|
$
|
2,388,329
|
|||||||||
|
Shares
issued for employee stock options exercised
at
approximately $1.08 per share
|
-
|
-
|
540,399
|
540
|
582,358
|
-
|
582,898
|
|||||||||||||||
|
Shares
issued in exchange for non-employee options
exercised
at $1.00 per share
|
-
|
-
|
328,333
|
328
|
328,005
|
-
|
328,333
|
|||||||||||||||
|
Shares
issued to consultants in exchange for services
rendered
at approximately $3.07 per share
|
-
|
-
|
63,566
|
63
|
196,252
|
-
|
196,315
|
|||||||||||||||
|
Shares
issued for senior note conversion at $2.10
per
share
(Note G)
|
-
|
-
|
1,209,038
|
1,209
|
2,537,791
|
-
|
2,539,000
|
|||||||||||||||
|
Shares
issued in connection with private placement
at
$2.00
per share, net of costs
|
-
|
-
|
6,387,600
|
6,388
|
12,720,455
|
-
|
12,726,843
|
|||||||||||||||
|
Shares
issued to consultants for warrants exercised
at
$2.54
per share
|
-
|
-
|
50,000
|
50
|
126,950
|
-
|
127,000
|
|||||||||||||||
|
Shares
issued to noteholders for warrants exercised
at
$1.00
per share
|
-
|
-
|
4,000,950
|
4,001
|
3,996,949
|
-
|
4,000,950
|
|||||||||||||||
|
Shares
issued to noteholders for cashless warrants
exercised
|
-
|
-
|
203,751
|
204
|
(204
|
)
|
-
|
-
|
||||||||||||||
|
Shares
issued for cashless exercise of underwriter
warrants
|
-
|
-
|
165,116
|
165
|
(165
|
)
|
-
|
-
|
||||||||||||||
|
Shares
issued in exchange for convertible debentures
at
$0.50
per share (Note F)
|
-
|
-
|
124,000
|
124
|
61,876
|
-
|
62,000
|
|||||||||||||||
|
Shares
issued in exchange for convertible debentures
at
$0.55
per share (Note F)
|
-
|
-
|
200,000
|
200
|
109,800
|
-
|
110,000
|
|||||||||||||||
|
Shares
issued in exchange for accrued interest on
convertible
debentures
(Note F)
|
-
|
-
|
42,999
|
43
|
23,233
|
-
|
23,276
|
|||||||||||||||
|
Shares
issued to an employee in exchange for services
at
approximately
$2.99 per share
|
-
|
-
|
36,000
|
36
|
107,743
|
-
|
107,779
|
|||||||||||||||
|
Shares
issued to consultants in exchange for consulting
fees
at $2.50 per share
|
-
|
-
|
1,000,000
|
1,000
|
2,499,000
|
-
|
2,500,000
|
|||||||||||||||
|
Founders
shares returned and canceled in connection
with
January 2002 capital restructure
|
-
|
-
|
(705,285
|
)
|
(705
|
)
|
705
|
-
|
-
|
|||||||||||||
|
Write-off
of beneficial conversion features and warrants
attached
to convertible debentures in connection with
conversion
of Debenture-1 and Series B debentures (Note
F)
|
-
|
-
|
-
|
-
|
(134,666
|
)
|
-
|
(134,666
|
)
|
|||||||||||||
|
Stock
options and warrants granted to consultants
in
exchange
for services rendered (Note I)
|
-
|
-
|
-
|
-
|
1,180,875
|
-
|
1,180,875
|
|||||||||||||||
|
Net
loss
|
-
|
-
|
-
|
-
|
-
|
(13,092,660
|
)
|
(13,092,660
|
)
|
|||||||||||||
|
Balance
at December 31, 2004
|
-
|
$
|
-
|
44,335,989
|
$
|
44,336
|
$
|
40,811,208
|
$
|
(27,209,272
|
)
|
$
|
13,646,272
|
|||||||||
See
accompanying footnotes to consolidated financial statements
TELKONET,
INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY (Continued)
FOR
THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
|
Preferred
Shares
|
Preferred
Stock
Amount
|
Common
Shares
|
Common
Stock Amount
|
Additional
Paid in Capital
|
Accumulated
Deficit
|
Total
|
||||||||||||||||
|
Balance
at January 1, 2005
|
-
|
$
|
-
|
44,335,989
|
$
|
44,336
|
$
|
40,811,208
|
$
|
(27,209,272
|
)
|
$
|
13,646,272
|
|||||||||
|
Shares
issued for employee stock options exercised
at
approximately
$1.19 per share
|
-
|
-
|
415,989
|
416
|
496,077
|
-
|
496,493
|
|||||||||||||||
|
Shares
issued in exchange for non-employee options
exercised
at
approximately $2.07 per share
|
-
|
-
|
172,395
|
172
|
355,973
|
-
|
356,145
|
|||||||||||||||
|
Shares
issued to noteholders for warrants exercised
at
$1.00
per share
|
-
|
-
|
321,900
|
322
|
321,578
|
-
|
321,900
|
|||||||||||||||
|
Shares
issued to noteholders for cashless warrants
exercised
|
-
|
-
|
36,150
|
36
|
(36
|
)
|
-
|
-
|
||||||||||||||
|
Shares
issued to an employee in exchange for services
at
approximately
$4.65 per share
|
-
|
-
|
36,000
|
36
|
163,283
|
-
|
163,319
|
|||||||||||||||
|
Shares
issued to director in exchange for services
rendered
at
approximately $4.26 per share
|
-
|
-
|
30,000
|
30
|
127,766
|
-
|
127,796
|
|||||||||||||||
|
Shares
issued to consultants in exchange for services
rendered
at
approximately $4.28 per share
|
-
|
-
|
1,968
|
2
|
9,000
|
-
|
9,002
|
|||||||||||||||
|
Shares
issued in exchange for convertible debentures
at $0.55
per
share (Note F)
|
-
|
-
|
363,636
|
364
|
199,636
|
-
|
200,000
|
|||||||||||||||
|
Shares
issued in exchange for interest expense on
convertible
debentures
(Note F)
|
-
|
-
|
51,144
|
51
|
28,080
|
-
|
28,131
|
|||||||||||||||
|
Beneficial
conversion feature of convertible debentures
(Note F)
|
-
|
-
|
-
|
-
|
1,479,300
|
-
|
1,479,300
|
|||||||||||||||
|
Value
of warrants attached to convertible debentures
(Note F)
|
-
|
-
|
-
|
-
|
2,910,700
|
-
|
2,910,700
|
|||||||||||||||
|
Stock
options and warrants granted to consultants
in exchange
for
services rendered (Note I)
|
-
|
-
|
-
|
-
|
1,354,219
|
-
|
1,354,219
|
|||||||||||||||
|
Net
loss
|
-
|
-
|
-
|
-
|
-
|
(15,778,281
|
)
|
(15,778,281
|
)
|
|||||||||||||
|
Balance
at December 31, 2005
|
-
|
$
|
-
|
45,765,171
|
$
|
45,765
|
$
|
48,256,784
|
$
|
(42,987,553
|
)
|
$
|
5,314,996
|
|||||||||
See
accompanying footnotes to consolidated financial statements
TELKONET,
INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
FOR
THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
|
2005
|
2004
|
2003
|
||||||||
|
Increase
(Decrease) In Cash and Equivalents
|
||||||||||
|
Cash
Flows from Operating Activities:
|
||||||||||
|
Net
loss from operating activities
|
$
|
(15,778,281
|
)
|
$
|
(13,092,660
|
)
|
$
|
(7,657,936
|
)
|
|
|
Adjustments
to reconcile net loss from operations to cash
used in operating
activities:
|
||||||||||
|
Amortization
of debt discount - beneficial conversion feature
of convertible
debentures
(Note F)
|
138,406
|
21,888
|
655,261
|
|||||||
|
Amortization
of debt discount - value of warrants attached
to convertible
debentures
(Note F)
|
198,805
|
10,152
|
89,434
|
|||||||
|
Amortization
of financing costs
|
73,499
|
-
|
-
|
|||||||
|
Other
income in connection with derivative warrant
liabilities (Note
F)
|
(8,600
|
)
|
-
|
-
|
||||||
|
Stock
options and warrants issued in exchange for
services (Note
I)
|
1,354,219
|
1,180,875
|
1,013,262
|
|||||||
|
Common
stock issued in exchange for services rendered
(Note H)
|
300,117
|
304,094
|
383,574
|
|||||||
|
Common
stock issued in exchange for conversion of
interest (Note
F)
|
28,131
|
23,276
|
280,735
|
|||||||
|
Common
stock issued in exchange for consulting fees
(Note H)
|
-
|
2,500,000
|
-
|
|||||||
|
Write-off
of financing costs in connection with conversion
of convertible
debentures
(Note F)
|
-
|
-
|
204,749
|
|||||||
|
Depreciation,
including equipment under operating leases
|
430,104
|
143,358
|
110,988
|
|||||||
|
Impairment
write-down in investment in Amperion (Note
E)
|
400,000
|
-
|
-
|
|||||||
|
Increase
/ decrease in:
|
||||||||||
|
Accounts
receivable, trade and other
|
(56,044
|
)
|
(4,950
|
)
|
(56,646
|
)
|
||||
|
Inventory
|
397,912
|
(1,265,202
|
)
|
(568,726
|
)
|
|||||
|
Prepaid
expenses and deposits
|
(313,956
|
)
|
(23,150
|
)
|
(173,366
|
)
|
||||
|
Deferred
lease liability
|
11,406
|
30,911
|
-
|
|||||||
|
Deferred
revenue
|
59,020
|
-
|
-
|
|||||||
|
Accounts
payable, accrued expenses and customer deposits,
net
|
679,230
|
587,848
|
122,186
|
|||||||
|
Net
Cash Used In Operating Activities
|
(12,086,032
|
)
|
(9,583,560
|
)
|
(5,596,485
|
)
|
||||
|
Cash
Flows From Investing Activities:
|
||||||||||
|
Costs
of equipment under operating leases
|
(458,271
|
)
|
(491,776
|
)
|
(33,888
|
)
|
||||
|
Purchase
of property and equipment, net
|
(336,448
|
)
|
(514,903
|
)
|
(103,033
|
)
|
||||
|
Investment
in Restricted Certificate of Deposit
|
(10,000,000
|
)
|
-
|
-
|
||||||
|
Investment
in Amperion and BPL Global (Note E)
|
(131,000
|
)
|
(500,000
|
)
|
-
|
|||||
|
Net
Cash Used In Investing Activities
|
(10,925,719
|
)
|
(1,506,679
|
)
|
(136,921
|
)
|
||||
|
|
||||||||||
|
Cash
Flows From Financing Activities:
|
||||||||||
|
Proceeds
from sale of common stock, net of costs and
fees
|
-
|
12,726,843
|
666
|
|||||||
|
Repayments
of stockholder advances
|
-
|
-
|
(122,830
|
)
|
||||||
|
Proceeds
from issuance of convertible debentures, net
of costs and fees (Note
F)
|
18,780,590
|
-
|
2,027,100
|
|||||||
|
Repayment
of convertible debenture
|
(10,000
|
)
|
-
|
-
|
||||||
|
Proceeds
from issuance of senior notes, net of costs
and fees (Note
G)
|
-
|
-
|
5,000,000
|
|||||||
|
Repayment
of senior notes
|
(350,000
|
)
|
-
|
-
|
||||||
|
Proceeds
from exercise of warrants (Note H)
|
321,900
|
4,127,950
|
3,999,250
|
|||||||
|
Proceeds
from exercise of employee and non-employee
stock options and
warrants
(Note
H)
|
852,638
|
911,230
|
298,311
|
|||||||
|
Repayments
of loans
|
-
|
-
|
(310,000
|
)
|
||||||
|
Repayments
of capital leases
|
-
|
(15,000
|
)
|
-
|
||||||
|
Net
Cash Provided By Financing Activities
|
19,595,128
|
17,751,023
|
10,892,497
|
|||||||
|
Net
Increase (Decrease) In Cash and Equivalents
|
(3,416,623
|
)
|
6,660,784
|
5,159,091
|
||||||
|
Cash
and cash equivalents at the beginning of the
year
|
11,838,702
|
5,177,918
|
18,827
|
|||||||
|
Cash
and cash equivalents at the end of the year
|
$
|
8,422,079
|
$
|
11,838,702
|
$
|
5,177,918
|
||||
See
accompanying footnotes to consolidated financial statements
TELKONET,
INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS (Continued)
FOR
THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
|
2005
|
2004
|
2003
|
||||||||
|
Supplemental
Disclosures of Cash Flow Information:
|
||||||||||
|
Cash
transactions:
|
||||||||||
|
Cash
paid during the period for interest
|
$
|
40,645
|
$
|
100,608
|
$
|
135,879
|
||||
|
Income
taxes paid
|
-
|
-
|
-
|
|||||||
|
Non-cash
transactions:
|
||||||||||
|
Issuance
of stock options and warrants in exchange
for services rendered (Note
H)
|
1,354,219
|
1,180,875
|
1,013,262
|
|||||||
|
Issuance
of stock warrants in exchange for financing
costs (Note I)
|
-
|
-
|
87,217
|
|||||||
|
Common
stock issued for services rendered (Note
H)
|
300,117
|
304,094
|
383,574
|
|||||||
|
Common
stock issued in exchange for interest (Note
F and H)
|
28,131
|
23,276
|
280,735
|
|||||||
|
Common
stock issued in exchange for consulting services
(Note H)
|
-
|
2,500,000
|
-
|
|||||||
|
Common
stock issued in exchange for Senior Note
(Note G and H)
|
-
|
2,539,000
|
2,011,000
|
|||||||
|
Common
stock issued in exchange for conversion of
convertible debenture (Note F
and H)
|
200,000
|
172,000
|
3,807,100
|
|||||||
|
Common
stock issued in exchange for notes payable
(Note H)
|
-
|
-
|
7,500
|
|||||||
|
Write-off
of beneficial conversion feature for conversion
of debenture (Note
F)
|
-
|
134,135
|
2,046,479
|
|||||||
|
Write-off
of value of warrants attached to debenture
in connection with conversion
(Note F)
|
-
|
531
|
296,470
|
|||||||
|
Notes
payable issued in connection with capital
lease, net of repayments (Note
N)
|
-
|
-
|
15,000
|
|||||||
|
Impairment
write-down in investment in affiliate (Note
E)
|
400,000
|
-
|
-
|
|||||||
|
Beneficial
conversion feature on convertible debentures
(Note F)
|
1,479,300
|
-
|
1,761,675
|
|||||||
|
Value
of warrants attached to convertible debentures
(Note F)
|
2,910,700
|
-
|
265,425
|
|||||||
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
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 was a
“development stage enterprise” (as defined by Statement of Financial Accounting
Standards No. 7) until December 31, 2003. The Company is
engaged in the business
of developing, producing and marketing proprietary equipment
enabling the
transmission of voice and data over electric utility lines.
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.
Concentrations
of Credit Risk
Financial
instruments and related items, which potentially subject
the Company to
concentrations of credit risk, consist primarily of cash
and 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. The allowance for doubtful accounts was $30,000
and $13,000 at December
31, 2005 and December 31, 2004, respectively.
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.
Restricted
Certificate of Deposit
Restricted
Certificate of Deposit at December 31, 2005 consists of a $10,000,000
certificate of deposit pledged as collateral for an irrevocable
letter of credit
agreement. This letter of credit agreement is automatically renewable
annually as required in the $20,000,000 Convertible Senior
Notes loan
covenant. (Note F). The certificate of deposit provides for
approximately 4% interest payable at maturity.
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. The
estimated useful life ranges from 3 to 5 years.
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 discounted 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. At
December 31, 2005, the company has determined that its
investment in Amperion
Inc. has been impaired based upon forecasted discounted
cash flow and has
written off 80%, or $400,000, of its investment based on
management assessment
(Note E).
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
A-SUMMARY OF ACCOUNTING POLICIES (Continued)
Inventories
Inventories
consist primarily of Gateways, Extenders, iBridges and
Couplers which are the
significant components of the Telkonet solution. Cost is
determined by the
first-in, first-out method. (Note B).
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 estimated future tax 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
notes and the exercise of the Company's stock options and
warrants (calculated
using the treasury stock method). During 2005, 2004 and
2003, 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
For
revenue from product sales, the Company recognizes revenue
in accordance with
Staff Accounting Bulletin No. 104, Revenue
Recognition
(“SAB104”), which superceded Staff Accounting Bulletin No. 101,
Revenue
Recognition in Financial Statements
(“SAB101”). SAB 101 requires that four basic criteria must be met
before revenue
can be recognized: (1) persuasive evidence of an arrangement
exists; (2)
delivery has occurred; (3) the selling price is fixed and
determinable; and (4)
collectibility is reasonably assured. Determination of
criteria (3) and (4) are
based on management’s judgments regarding the fixed nature of the selling prices
of the products delivered and the collectibility of those
amounts. Provisions
for discounts and rebates to customers, estimated returns
and allowances, and
other adjustments are provided for in the same period the
related sales are
recorded. The Company defers any revenue for which the
product has not been
delivered or is subject to refund until such time that
the Company and the
customer jointly determine that the product has been delivered
or no refund will
be required. SAB 104 incorporates Emerging Issues Task
Force 00-21 (“EITF
00-21”), Multiple-Deliverable
Revenue Arrangements. EITF
00-21 addresses accounting for arrangements that may involve
the delivery or
performance of multiple products, services and/or rights
to use assets.
For
equipment under lease, revenue is recognized over the lease
term for operating
lease and rental contracts. All of the Company’s leases are accounted for as
operating leases. At the inception of the lease, no lease
revenue is recognized
and the leased equipment and installation costs are capitalized
and appear on
the balance sheet as “Equipment Under Operating Leases.” The capitalized cost of
this equipment is depreciated from two to three years,
on a straight-line basis
down to the Company’s original estimate of the projected value of the equipment
at the end of the scheduled lease term. Monthly lease payments
are recognized as
rental income. The Company has sold a portion of its lease
portfolio in December
2005 and substantially all the remaining portfolio during
the first quarter
2006. The related equipment was charged to cost of sales
commensurate with the
associated revenue recognition (Note D and P).
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
A-SUMMARY OF ACCOUNTING POLICIES (Continued)
Guarantees
and Product Warranties
FASB
Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness
of Others” (“FIN 45”),
requires that upon issuance of a guarantee, the guarantor
must disclose and
recognize a liability for the fair value of the obligation
it assumes under that
guarantee.
The
Company’s guarantees issued subject to the recognition and disclosure
requirements of FIN 45 as of December 31, 2005 and 2004
were not material. The
Company records a liability for potential warranty claims.
The amount of the
liability is based on the trend in the historical ratio
of claims to sales, the
historical length of time between the sale and resulting
warranty claim, new
product introductions and other factors. The products
sold are generally covered
by a warranty for a period of one year. In the event
the Company determines that
its current or future product repair and replacement
costs exceed its estimates,
an adjustment to these reserves would be charged to earnings
in the period such
determination is made. During the year ended December
31, 2005, the Company
experienced approximately three percent of units returned.
Using this experience
factor a reserve of $24,000 was accrued. Prior to the
fiscal year of 2005, the
Company had not established historical ratio of claims,
and the cost of
replacing defective products and product returns were
immaterial and within
management's expectations, accordingly there were no
warranties provided with
the purchase of the Company's products during the year
ended December 31,
2004.
Advertising
The
Company follows the policy of charging the costs of advertising
to expenses
incurred. The Company incurred $657,794, $499,874 and
$136,758 in advertising
costs during the years ended December 31, 2005, 2004
and 2003,
respectively.
Liquidity
As
shown
in the accompanying consolidated financial statements,
the Company has incurred
a net loss of $15,778,281, $13,092,660 and $7,657,936
for the year ended
December 31, 2005, 2004 and 2003, respectively. The Company's
current assets
exceeded its current liabilities by $12,060,807, with
cash and cash equivalents
representing $8,422,079 and Restricted Certificate of
Deposit representing
$10,000,000 of the current assets as of December 31,
2005.
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 expensed as
incurred. Third-party research and developments costs
are expensed 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 expensed in the period incurred.
Total expenditures on
research and product development for 2005, 2004 and 2004
were $2,096,104,
$1,852,308 and $1,370,785, respectively.
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.
Reclassifications
Certain
reclassifications have been made in prior year's financial
statements to conform
to classifications used in the current year.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
A-SUMMARY OF ACCOUNTING POLICIES (Continued)
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 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 years ended December
31, 2005, 2004 and
2003 and will adopt the interim disclosure provisions for
its financial reports
for the subsequent periods.
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
I):
|
2005
|
2004
|
2003
|
||||||||
|
Net
loss - as reported
|
$
|
(15,778,281
|
)
|
$
|
(13,092,660
|
)
|
$
|
(7,657,936
|
)
|
|
|
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)
|
(2,440,097
|
)
|
(7,830,385
|
)
|
(5,211,112
|
)
|
||||
|
Net
loss - Pro Forma
|
$
|
(18,218,378
|
$
|
(20,923,045
|
)
|
$
|
(12,869,048
|
)
|
||
|
Net
loss attributable to common stockholders -
Pro forma
|
$
|
(18,218,378
|
)
|
$
|
(20,923,045
|
)
|
$
|
(12,869,048
|
)
|
|
|
Basic
(and assuming dilution) loss per share - as
reported
|
$
|
(0.35
|
)
|
$
|
(0.32
|
)
|
$
|
(0.37
|
)
|
|
|
Basic
(and assuming dilution) loss per share - Pro
forma
|
$
|
(0.41
|
)
|
$
|
(0.51
|
)
|
$
|
(0.62
|
)
|
|
On
December 16, 2004, the Financial Accounting Standards
Board (FASB) issued FASB
Statement No. 123R (revised 2004), "Share-Based Payment"
which is a revision of
FASB Statement No. 123, "Accounting for Stock-Based Compensation".
Statement
123R supersedes APB opinion No. 25, "Accounting for Stock
Issued to Employees",
and amends FASB Statement No. 95, "Statement of Cash
Flows". Generally, the
approach in Statement 123R is similar to the approach
described in Statement
123. However, Statement 123R requires all share-based
payments to employees,
including grants of employee stock options, to be recognized
in the income
statement based on their fair values. Pro-forma disclosure
is no longer an
alternative. On April 14, 2005, the SEC amended the effective
date of the
provisions of this statement. The effect of this amendment
by the SEC is that
the Company will have to comply with Statement 123R and
use the Fair Value based
method of accounting no later than the first quarter
of 2006. The Company has
previously issued employee stock options for which no
expense has been
recognized, and which will not be fully vested as of
the effective date of SFAS
No. 123R. The Company has assessed the impact SFAS 123R and
believes the
impact of adopting SFAS No. 123R, based on our unvested options outstanding
at December 31, 2005, will be to increase our pre-tax
stock-based compensation
expense in 2006 by approximately $2 million.
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.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
A-SUMMARY OF ACCOUNTING POLICIES (Continued)
New
Accounting Pronouncements
In
March
2005, the FASB issued FASB Interpretation (FIN) No. 47,
“Accounting for
Conditional Asset Retirement Obligations, an interpretation
of FASB Statement
No. 143,” which requires an entity to recognize a liability for the
fair value
of a conditional asset retirement obligation when incurred
if the liability’s
fair value can be reasonably estimated. The Company is
required to adopt the
provisions of FIN 47 no later than the first quarter of
fiscal 2006. The Company
does not expect the adoption of this Interpretation to
have a material impact on
its consolidated financial position, results of operations
or cash flows.
In
May
2005 the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 154,
“Accounting Changes and Error Corrections, a replacement
of APB Opinion No. 20
and FASB Statement No. 3.” SFAS 154 requires retrospective application to prior
periods’ financial statements for changes in accounting principle,
unless it is
impracticable to determine either the period-specific effects
or the cumulative
effect of the change. SFAS 154 also requires that retrospective
application of a
change in accounting principle be limited to the direct
effects of the change.
Indirect effects of a change in accounting principle, such
as a change in
non-discretionary profit-sharing payments resulting from
an accounting change,
should be recognized in the period of the accounting change.
SFAS 154 also
requires that a change in depreciation, amortization, or
depletion method for
long-lived, non-financial assets be accounted for as a
change in accounting
estimate effected by a change in accounting principle.
SFAS 154 is effective for
accounting changes and corrections of errors made in fiscal
years beginning
after December 15, 2005. Early adoption is permitted for
accounting changes and
corrections of errors made in fiscal years beginning after
the date this
Statement is issued. The Company does not expect the adoption
of this SFAS to
have a material impact on its consolidated financial position,
results of
operations or cash flows.
On
February 16, 2006 the FASB issued SFAS 155, “Accounting for Certain Hybrid
Instruments,” which amends SFAS 133, “Accounting for Derivative Instruments and
Hedging Activities,” and SFAS 140, “Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities.” SFAS 155 allows financial
instruments that have embedded derivatives to be accounted
for as a whole
(eliminating the need to bifurcate the derivative from
its host) if the holder
elects to account for the whole instrument on a fair value
basis. SFAS 155 also
clarifies and amends certain other provisions of SFAS 133
and SFAS 140. This
statement is effective for all financial instruments acquired
or issued in
fiscal years beginning after September 15, 2006. The Company does not
expect its adoption of this new standard to have a material
impact on its
financial position, results of operations or cash flows.
NOTE
B - INVENTORIES
Inventories
are stated at the lower of cost or market determined by
the first-in, first-out
(FIFO) method. Inventories primarily consist of Gateways,
Extenders, iBridges
and Couplers which are the significant components of the
Telkonet solution.
Components of inventories as of December 31, 2005 and 2004
are as follows:
|
2005
|
2004
|
||||||
|
Raw
Materials
|
$
|
598,335
|
$
|
748,110
|
|||
|
Finished
Goods
|
877,471
|
1,125,608
|
|||||
|
$
|
1,475,806
|
$
|
1,873,718
|
||||
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
C - PROPERTY, PLANT AND EQUIPMENT
The
Company’s property and equipment at December 31, 2005 and 2004
consists of the
following:
|
2005
|
2004
|
||||||
|
Development
Test Equipment
|
$
|
96,967
|
$
|
74,920
|
|||
|
Computer
Software
|
142,894
|
62,919
|
|||||
|
Leasehold
Improvements
|
209,911
|
203,948
|
|||||
|
Office
Equipment
|
360,527
|
235,114
|
|||||
|
Office
Fixtures and Furniture
|
230,838
|
127,788
|
|||||
|
Total
|
1,041,137
|
704,689
|
|||||
|
Accumulated
Depreciation
|
(323,667
|
)
|
(137,739
|
)
|
|||
|
$
|
717,470
|
$
|
566,950
|
||||
Depreciation
expense included as a charge to income was $185,928,
$71,514 and $35,920 for the
years ended December 31, 2005, 2004 and 2003, respectively.
NOTE
D - EQUIPMENT UNDER OPERATING LEASES
Equipment
leased to customers under operating leases is recorded
at cost and is
depreciated on the straight line basis to its estimated
residual value.
Estimated useful lives are two to three years. Equipment
under operating leases
at December 31, 2005 and 2004 consist of the following:
|
2005
|
2004
|
||||||
|
Telecommunications
and related equipment
|
$
|
789,099
|
$
|
525,664
|
|||
|
Less:
accumulated depreciation
|
(124,669
|
)
|
(75,329
|
)
|
|||
|
Capitalized
equipment, net of accumulated depreciation
|
664,430
|
450,335
|
|||||
|
Less:
estimated reserve for residual values
|
--
|
--
|
|||||
|
Capitalized
equipment under operating leases, net
|
$
|
664,430
|
$
|
450,335
|
|||
In
December 2005, the Company consummated a non-recourse
sale of certain rental
contract agreements and the related capitalized equipment
which were accounted
for as operating leases with Hospitality Leasing Corporation.
The remaining
rental income payments of the contracts were valued at
approximately $732,000,
including the customer support component of approximately
$205,000 which the
Company will retain and continue to receive monthly customer
support payments
over the remaining average unexpired lease term of 26
months. In December 2005,
the Company recognized revenue of approximately $439,000
for the sale,
calculated based on the present value of total unpaid
rental payments, and
expensed the associated capitalized equipment cost, net
of accumulated
depreciation, of approximately $267,000 and expensed
associated taxes of
approximately $40,000.
The
following is a schedule by years of minimum future
rentals on non-cancellable
operating leases as of December 31, 2005, including
certain rental contract
agreements sold to Hospitality Leasing Corporation
in January 2006 (Note P):
|
2006
|
$
|
1,416,000
|
||
|
2007
|
442,000
|
|||
|
2008
|
315,000
|
|||
|
2009
|
165,000
|
|||
|
2010
|
73,000
|
|||
|
$
|
2,411,000
|
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
E - LONG-TERM INVESTMENTS
Amperion,
Inc.
On
November 30, 2004, the Company entered into a Stock Purchase
Agreement
(“Agreement”) with Amperion, Inc. ("Amperion"), a privately held
company.
Amperion is engaged in the business of developing networking
hardware and
software that enables the delivery of high-speed broadband
data over
medium-voltage power lines. Pursuant to the Agreement,
the Company invested
$500,000 in Amperion in exchange for 11,013,215 shares
of Series A Preferred
Stock for an equity interest of approximately 4.7%. The
Company has the right to
appoint one person to Amperion’s seven-person board of directors. The Company
accounted for this investment under the cost method,
as the Company does not
have the ability to exercise significant influence over
operating and financial
policies of the investee.
It
is the
policy of the Company to regularly review the assumptions
underlying the
operating performance and cash flow forecasts in assessing
the carrying values
of the investment. The Company identifies and records
impairment losses on
investments when events and circumstances indicate that
such decline in fair
value is other than temporary. Such indicators include,
but are not limited to,
limited capital resources, limited prospects of receiving
additional financing,
and limited prospects for liquidity of the related securities.
The Company
determined that its investment in Amperion was impaired
based upon forecasted
discounted cash flow. Accordingly, the Company wrote-off
$400,000 of the
carrying value of its investment through a charge to
operations during the year
ended December 31, 2005. The remaining value of the Company’s investment in
Amperion is $100,000 at December 31, 2005.
BPL
Global, Ltd.
On
February 4, 2005, the Company approved its investment
in BPL Global, Ltd. (“BPL
Global”), a privately held company. During the year-end December
31, 2005, the
Company has funded an aggregate of $131,000 of this commitment.
This investment
represents an equity interest of approximately 6.21%
at December 31, 2005. BPL
Global is engaged in the business of developing broadband
services via power
lines through joint ventures in the United States, Asia,
Eastern Europe and the
Middle East. The Company accounted for this investment
under the cost method, as
the Company does not have the ability to exercise significant
influence over
operating and financial policies of the investee. The
Company reviewed the
assumptions underlying the operating performance and
cash flow forecasts in
assessing the carrying values of the investment. The
fair value of the Company's
investment in BPL Global, Ltd. remained at $131,000 as
of December 31,
2005.
NOTE
F - CONVERTIBLE PROMISSORY NOTES PAYABLE
A
summary
of convertible promissory notes payable at December 31,
2005 and 2004 is as
follows:
|
2005
|
2004
|
||||||
|
Convertible
Senior Notes payable (“Convertible Senior Notes”), accrue interest at
7.25% per annum and provide for equal monthly
principal installments
beginning March 1, 2006. Maturity date is in
October 2008. 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 $5.0 per share
at any time.
|
$
|
20,000,000
|
$
|
-
|
|||
|
Debt
Discount - beneficial conversion feature, net
of accumulated amortization
of $89,163 and $0 at December 31, 2005 and
2004,
respectively.
|
(1,390,137
|
)
|
-
|
||||
|
Debt
Discount - value attributable to warrants attached
to notes, net of
accumulated amortization of $175,958 and $0
at December 31, 2005 and 2004,
respectively.
|
(2,743,342
|
)
|
-
|
||||
|
$
|
15,866,521
|
$
|
-
|
||||
|
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. All of the Series B
Debenture were repaid or
converted to the Company’s common stock as of December 31, 2005.
|
-
|
210,000
|
|||||
|
Debt
Discount - beneficial conversion feature, net
of accumulated amortization
of $49,243 and $49,249 at December 31, 2005
and 2004,
respectively.
|
-
|
(49,243
|
)
|
||||
|
Debt
Discount - value attributable to warrants attached
to notes, net of
accumulated amortization of $22,847 and $22,841
at December 31, 2005 and
2004, respectively.
|
-
|
(22,847
|
)
|
||||
|
137,910
|
|||||||
|
Total
|
$
|
15,866,521
|
$
|
137,910
|
|||
|
Less:
current portion
|
(6,250,000
|
)
|
-
|
||||
|
$
|
9,616,521
|
$
|
137,910
|
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
F - CONVERTIBLE PROMISSORY NOTES PAYABLE (Continued)
Aggregate
maturities of long-term debt as of December 31,
2005 are as
follows:
|
Fiscal
Year
|
Amount
|
|||
|
2006
|
$
|
6,250,000
|
||
|
2007
|
7,500,000
|
|||
|
2008
|
6,250,000
|
|||
|
$
|
20,000,000
|
|||
Convertible
Senior Notes
During
the year ended December 31, 2005, the Company issued
a convertible senior debt
financing of $20 million (“Convertible Senior Notes”) to sophisticated investors
in exchange for $20,000,000. The Company received
proceeds of $18,780,590, net
of costs and fees in the amount of $1,219,410. The
Convertible Senior Notes
accrue interest at 7.25% per annum and call for monthly
principal installments
beginning March 1, 2006. The maturity date is 3 years
from the issuance of the
notes. At any time or times, the Noteholders shall
be entitled to convert any
portion of the outstanding and unpaid note amount
into fully paid and
nonassessable Common Shares at $5 per share. At any
time at the option of the
Company, the principal payments may be paid either
in cash or in common stock at
the lower of $5 or 92.5% of the average recent market
price. At any time after
six months should the stock trade at or above $8.75
for 20 of 30 consecutive
trading days, the Company can cause a mandatory redemption
and conversion to
shares at $5 per share. At any time, the Company
can pre-pay the notes with cash
or common stock. Should the Company pre-pay the Notes
other than by mandatory
conversion, the Company must issue additional warrants
to the Noteholders
covering 65% of the amount pre-paid at a strike price
of $5 per share. In
addition to standard financial covenants, the Company
has agreed to maintain a
letter of credit in favor of the Noteholders equal
to $10 million (Note A). Once
the Note declines below $15 million, the balance
is reduced by $.50 for every $1
amortized. The Company also has covenants requiring
a minimum revenue test of $9
million through 2006, measured quarterly. 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 notes.
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 $1,479,300 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 Notes issued during the year
ended December 31, 2005. The
debt discount attributed to the beneficial conversion
feature is amortized over
the Notes maturity period (three years) as interest
expense.
In
connection with the placement of the Notes in October
2005, the Company has also
agreed to issue one million warrants to the Noteholders
exercisable for five
years at $5 per share. The
Company recognized
the value attributable to the warrants in the amount
of $2,919,300 to
a
derivative liability due to the possibility of the
Company having to make a cash
settlement, including penalties, in the event the
Company failed to register the
shares underlying the warrants under the Securities
Act of 1933, as amended,
within 90 days after the closing of the transaction. The Company
accounted
for this warrant derivative in accordance with EITF
00-19 Accounting
for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a
Company's Own Stock.
The
warrants were included as a liability and valued
at fair market value until the
Company met the criteria under EITF 00-19 for permanent
equity. A registration
statement covering the convertible notes issued,
along with the shares
underlying the warrants, was filed with the Securities
and Exchange Commission
on Form S-3 on November 23, 2005 and was declared effective
on December 13,
2005. The warrant derivative liability was valued
at the issuance date of the
Notes in the amount of $2,919,300 and then revalued
at $2,910,700 on
December 13, 2005 upon the effective of the Form S-3. The
Company charged
to Other Income in the amount of $8,600 and the derivative
warrant liability was
reclassified to additional paid in capital at December
13, 2005.
The
Company valued the warrants in accordance with EITF
00-27 using the
Black-Scholes pricing model and the following assumptions:
contractual terms of
5 years, an average risk free interest rate of 4.00%,
a dividend yield of 0%,
and volatility of 76%. The $2,919,300 of debt discount
attributed to the value
of the warrants issued is amortized over the Notes
maturity period (three years)
as interest expense.
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.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
F - CONVERTIBLE PROMISSORY NOTES PAYABLE (Continued)
Convertible
Debentures (Continued)
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 issued during
the year ended December 31, 2001.
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
in 2001, the Company issued
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 issued during the year ended December
31, 2001. 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
additional 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 issued
during the year ended December 31, 2002. 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 in 2002, the Company
issued 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 issued during the year ended December
31, 2002. 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.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
F - CONVERTIBLE PROMISSORY NOTES PAYABLE (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 $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
issued during the year ended December 31, 2002.
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 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 issued during the year ended
December 31, 2002. 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 Series B Debentures to
Company officers, shareholders, and sophisticated
investors in exchange for
$2,027,100, exclusive of placement costs and
fees. The Series B Debentures
accrue interest at 8% per annum and are 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.
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
Debentures issued during the year ended December
31, 2003. The debt discount
attributed to the beneficial conversion feature
is amortized over the Series B
Debentures 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 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 Debentures issued during the year ended
December 31, 2003. 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 Debentures maturity
period (three years) as interest
expense.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
F - CONVERTIBLE PROMISSORY NOTES PAYABLE (Continued)
During
the year ended December 31, 2003, the Debenture-1 noteholders
demanded
registration of that number 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
noteholders, Senior
noteholders (Note G) and warrant holders with piggy-back
registration rights of
their right to participate in the registration. During
the year ended December
31, 2003, the Company issued an aggregate of 7,217,836
shares of common stock in
connection with the conversion of $1,627,100 aggregate
principal amount of the
Debenture-1 and $2,180,000 aggregate principal amount of
the Series B
Debentures. The Company also issued an aggregate of 525,403
shares of common
stock in exchange for accrued interest of $195,148 and
$85,586 for Debenture-1
and Series B debenture, respectively. (Note H).
During
the year ended December 31, 2004, the Company issued additional
324,000 shares
of its common stock in connection with the conversion of
$62,000 aggregate
principal amount of the Debenture-1 and $110,000 aggregate
principal amount of
the Series B Debentures. The Company also issued an aggregate
of 42,999 shares
of common stock in exchange for accrued interest of $23,276
for Debenture 1 and
Series B Debentures. (Note H). All of the Debenture-1 were
converted to the
Company’s common stock as of December 31, 2004. During the year
ended December
31, 2005, the Company issued an aggregate of 363,636 shares
of common stock and
$10,000 of cash to its Series B Debenture holders in exchange
for $200,000 and
$10,000 of debt, respectively. The Company also issued
an aggregate of 51,114
shares of common stock in exchange for accrued interest
of $28,131 for the
Series B Debentures. All of the Series B Debentures were
repaid or converted to
the Company’s common stock as of December 31, 2005.
In
connection with the conversion of Debenture-1 and Series
B Debentures, the
Company wrote off the unamortized debt discount attributed
to the beneficial
conversion feature and the value of the attached warrants
in the amount of
$134,135 and $531, respectively, during the year ended
December 31, 2004 and an
additional $2,046,479 and $296,470, respectively, during
the year ended December
31, 2003.
The
Company amortized the Convertible Senior Notes, 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 in the
amount of $337,211, $32,040 and $744,695 for the years
ended December 31, 2005,
2004 and 2003, respectively.
NOTE
G - SENIOR NOTES PAYABLE
In
the
second quarter of 2003, the Company issued Senior Notes
to Company officers,
shareholders, and sophisticated investors in exchange for
$5,000,000, exclusive
of placement costs and fees. The Senior Notes are denominated
in units of
$100,000, accrue interest at 8% per annum and are due three
years from the date
of issuance with the latest maturity date of June 2006.
Attached to each Senior
Note are warrants to purchase 125,000 shares of common
stock. The warrants have
a three-year contractual life and are exercisable immediately
after the issuance
of the Senior Note at exercise price of $1.00 per share.
The Senior Notes are
secured by a first priority security interest in all intellectual
property
assets of the Company. The Company plans to use the Senior
Note proceeds for
expansion of sales, marketing and strategic partnership
programs, building
required infrastructure and for working capital.
In
September 2003, certain Senior noteholders elected to surrender
their Senior
Notes as consideration for the exercise of warrants to
purchase shares of common
stock of the Company. The Company issued an aggregate of
2,011,000 restricted
shares of common stock for warrants exercised at $1.00
per share, in exchange
for $2,011,000 of Senior Notes. In January 2004, certain
senior note holders
elected to convert $2,539,000 of their senior notes into
1,209,038 shares of
common stock of the Company, at a conversion price of $2.10
per share (Note H).
During the year ended December 31, 2005, the Company repaid
$350,000 of Senior
Notes in cash. The remaining outstanding balance of senior
notes as of December
31, 2005 and 2004 was $100,000 and $450,000, respectively.
NOTE
H - 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, 2005, 2004 and 2003,
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,
2005, 2004 and 2003, the Company has 45,765,171, 44,335,989
and 30,689,522
shares, respectively, of common stock issued and outstanding.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
H - CAPITAL STOCK (Continued)
During
the year ended December 31, 2003, the Company issued 109,333
shares of common
stock for an aggregate purchase price of $110,833 to certain
employees upon
exercise of employee stock options at approximately $1.01
per share.
Additionally, the Company issued 187,499 shares of common
stock for an aggregate
purchase price of $187,500 to consultants upon exercise
of non-employee stock
options at approximately $1.00 per share. The Company also
issued 333 shares of
common stock for $666 of cash, net of costs and fees.
During
the year ended December 31, 2003, the Company issued 315,000
shares of common
stock for an aggregate purchase price of $157,500 to one
of the Company's
directors upon exercise of employee stock options exercised
at $0.50 per
share
During
the year ended December 31, 2003, the Company issued an
aggregate of 149,498
shares of common stock, having an aggregate fair market
value of $319,105, to
consultants in exchange for services rendered, which approximated
the fair value
of the shares issued during the period services were completed
and rendered.
During
the year ended December 31, 2003, the Company issued an
aggregate of 7,217,836
shares of common stock to its convertible debenture holders
in exchange for
$3,807,100 of debt (Note F). The Company also issued an
aggregate of 525,403
shares of common stock in exchange for accrued interest
of $280,734 for
Debenture 1 and Series B Debentures (Note F).
During
the year ended December 31, 2003, the Company issued an
aggregate of 3,599,250
and 500,000 shares of common stock for warrants exercised
at $1.00 and $0.50 per
share, respectively.
During
the year ended December 31, 2003, the Company issued an
aggregate of 2,011,000
restricted shares of common stock for warrants exercised
at $1.00 per share, in
exchange for $2,011,000 of Senior Notes (see Note G).
During
the year ended December 31, 2003, the Company issued an
aggregate of 36,000
shares of common stock to an employee in exchange for $64,469
of services
rendered, which approximated the fair value of the shares
issued during the
period services were completed and rendered. Compensation
costs of $64,469 were
charged to operations.
During
the year ended December 31, 2004, the Company issued 540,399
shares of common
stock for an aggregate purchase price of $582,898 to certain
employees upon
exercise of employee stock options at approximately $1.08
per share.
Additionally, the Company issued 328,333 shares of common
stock for an aggregate
purchase price of $328,333 to consultants upon exercise
of non-employee stock
options at approximately $1.00 per share.
During
the year ended December 31, 2004, the Company issued an
aggregate of 63,566
shares of common stock, having an aggregate fair market
value of $196,315, to
consultants in exchange for services rendered, which approximated
the fair value
of the shares issued during the period services were completed
and rendered.
During
the year ended December 31, 2004, the Company issued an
aggregate of 1,209,038
of restricted shares of common stock upon the election
of certain senior note
holders to convert their senior notes into equity at a
conversion price of $2.10
per share (Note G).
During
the year ended December 31, 2004, the Company issued 6,387,600
shares of its
common stock for an aggregate purchase price of $12,726,843,
net of costs and
fees.
During
the year ended December 31, 2004, the Company issued an
aggregate of 4,000,950
shares of common stock upon the exercise of warrants at
approximately $1.00 per
share and an aggregate of 368,867 shares of common stock
in exchange for 448,407
outstanding warrants.
During
the year ended December 31, 2004, the Company issued an
aggregate of 50,000
shares of common stock to consultants pursuant to warrants
exercised at $2.54
per share.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
H - CAPITAL STOCK (Continued)
During
the year ended December 31, 2004, the Company issued
an aggregate of 324,000
shares of common stock in connection with the conversion
of $62,000 aggregate
principal amount of the Debenture-1 and $110,000 aggregate
principal amount of
the Series B Debentures. The Company also issued an aggregate
of 42,999 shares
of common stock in exchange for accrued interest of $23,276
for Debenture 1 and
Series B Debentures (Note F).
During
the year ended December 31, 2004, the Company issued
an aggregate of 36,000
shares of common stock to an employee in exchange for
$107,779 of services
rendered, which approximated the fair value of the shares
issued during the
period services were completed and rendered. Compensation
costs of $107,779 were
charged to operations.
In
March
2004, the Company entered into consulting agreements
(the “Agreements”) with
Aware Capital Consultants, Inc. and Scarborough, Ltd.
(“Consultants”). Pursuant
to the Agreements, the Company issued an aggregate of
1,000,000 shares of its
restricted common stock to Consultants in exchange for
professional services
rendered and to be rendered. In
accordance with Emerging
Issues Task Force Issue 96-18, Accounting for Equity
Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction
with Selling, Goods or
Services (“EITF 96-18”),
the
measurement date to determine fair value was the date
at which a commitment for
performance by the counter party to earn the equity instrument
was reached. The
Company valued the shares issued for consulting services
at the rate which
represents the fair value of the services received which
did not differ
materially from the value of the stock issued.
Compensation cost of $2,500,000 was charged to operations
during the year ended
December 31, 2004.
The
Company reorganized its capital structure in January
2002 whereby the Company
agreed to repurchase common stock held by the founders
of the Company. All
founders shares were returned and canceled in March 2002,
except for 705,285
shares which remained outstanding, but were subject to
repurchase by the Company
pending receipt of the share certificate evidencing those
shares. During the
year ended December 31, 2004, the remaining 705,285 shares
of founder’s stock
were returned to and canceled by the Company.
During
the year ended December 31, 2005, the Company issued
an aggregate of 415,989
shares of common stock for an aggregate purchase price
of $496,493 to certain
employees upon exercise of employee stock options at
approximately $1.19 per
share. Additionally, the Company issued an aggregate
of 172,395 shares of common
stock for an aggregate purchase price of $356,145 to
consultants upon exercise
of non-employee stock options at $2.07 per share (Note
I).
During
the year ended December 31, 2005, the Company issued
an aggregate of 1,968
shares of common stock, having an aggregate fair market
value of $9,002, to
consultants in exchange for services rendered, which
approximated the fair value
of the shares issued during the period services were
completed and rendered.
Compensation costs of $9,002 were charged to operations
during the year ended
December 31, 2005.
The
Company issued an aggregate of 321,900 shares of common
stock to its convertible
noteholders upon the exercise of warrants at $1.00 per
share. The Company also
issued 36,150 shares of common stock in exchange for
50,000 cashless warrants
exercised (Note I).
The
Company issued an aggregate of 36,000 shares of common
stock to an employee in
exchange for $163,319 of services rendered, which approximated
the fair value of
the shares issued during the period services were completed
and rendered.
Compensation costs of $163,319 were charged to operations
during the year ended
December 31, 2005.
The
Company issued an aggregate of 30,000 shares of common
stock to a member of the
board of directors in exchange for $127,796 of consulting
services rendered,
which approximated the fair value of shares issued during
the period services
were completed and rendered. Compensation costs of $127,796
were charged to
operations during the year ended December 31, 2005.
During
the year ended December 31, 2005, the Company issued
an aggregate of 363,636
shares of common stock to its convertible debenture holders
in exchange for
$200,000 of Series B Debentures. The Company also issued
an aggregate of 51,114
shares of common stock in exchange for accrued interest
of $28,131 for Series B
Debentures (Note F and J).
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
I - 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
|
|||||||||
|
Exercise
Prices
|
Number
Outstanding
|
Weighted
Average
Remaining
Contractual
Life
(Years)
|
Weighted
Average Exercise
Price
|
Number
Exercisable
|
Weighted
Average Exercise
Price
|
|||||
|
$
1.00 - $1.99
|
5,813,578
|
6.96
|
$
1.00
|
5,751,078
|
$
1.00
|
|||||
|
$
2.00 - $2.99
|
2,136,000
|
7.76
|
$
2.28
|
1,044,250
|
$
2.25
|
|||||
|
$
3.00 - $3.99
|
1,716,500
|
8.76
|
$
3.31
|
502,083
|
$
3.44
|
|||||
|
$
4.00 - $4.99
|
185,000
|
9.20
|
$
4.45
|
14,250
|
$
4.51
|
|||||
|
$
5.00 - $5.99
|
300,000
|
9.07
|
$
5.22
|
35,750
|
$
5.14
|
|||||
|
10,151,078
|
7.54
|
$
1.85
|
7,347,411
|
$
1.37
|
||||||
Transactions
involving stock options issued to employees are summarized
as
follows:
|
Number
of Shares
|
Weighted
Average
Price
Per Share
|
||||||
|
Outstanding
at January 1, 2003
|
1,950,000
|
$
|
1.00
|
||||
|
Granted
|
7,202,333
|
1.22
|
|||||
|
Exercised
(Note H)
|
(109,333
|
)
|
1.01
|
||||
|
Cancelled
or expired
|
(750,000
|
)
|
1.00
|
||||
|
Outstanding
at December 31, 2003
|
8,293,000
|
$
|
1.19
|
||||
|
Granted
|
2,108,000
|
3.06
|
|||||
|
Exercised
(Note H)
|
(540,399
|
)
|
1.08
|
||||
|
Cancelled
or expired
|
(245,834
|
)
|
1.74
|
||||
|
Outstanding
at December 31, 2004
|
9,614,767
|
$
|
1.61
|
||||
|
Granted
|
1,325,000
|
3.97
|
|||||
|
Exercised
(Note H)
|
(415,989
|
)
|
1.18
|
||||
|
Cancelled
or expired
|
(372,700
|
)
|
3.74
|
||||
|
Outstanding
at December 31, 2005
|
10,151,078
|
$
|
1.85
|
||||
The
weighted-average fair value of stock options granted
to employees during the
years ended December 31, 2005, 2004 and 2003 and the
weighted-average
significant assumptions used to determine those fair
values, using a
Black-Scholes option pricing model are as follows:
|
2005
|
2004
|
2003
|
||||||||
|
Significant
assumptions (weighted-average):
|
||||||||||
|
Risk-free
interest rate at grant date
|
4.50%
|
|
1.35%
|
|
1.13%
|
|
||||
|
Expected
stock price volatility
|
71%
|
|
76%
|
|
118%
|
|
||||
|
Expected
dividend payout
|
-
|
-
|
-
|
|||||||
|
Expected
option life (in years)
|
5.0
|
5.0
|
10.0
|
|||||||
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 $(18,218,378) and $(0.41),
respectively, for the
year ended December 31, 2005; and $(20,923,045) and
$(0.51), respectively, for
the year ended December 31, 2004 and $(12,869,048)
and $(0.62), respectively,
for the year ended December 31, 2003.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
I - STOCK OPTIONS AND WARRANTS (Continued)
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
|
|||||||||
|
Exercise
Price
|
Number
Outstanding
|
Weighted
Average Remaining Contractual Life
(Years)
|
Weighed
Average Exercise
Price
|
Number
Exercisable
|
Weighted
Average Exercise
Price
|
|||||
|
$
1.00
|
1,841,774
|
6.34
|
$
1.00
|
1,758,441
|
$
1.00
|
|||||
Transactions
involving options issued to non-employees are summarized
as
follows:
|
Number
of Shares
|
Weighted
Average
Price
Per Share
|
||||||
|
Outstanding
at January 1, 2003
|
1,555,000
|
$
|
1.00
|
||||
|
Granted
|
1,900,000
|
1.00
|
|||||
|
Exercised
(Note H)
|
(187,500
|
)
|
0.96
|
||||
|
Canceled
or expired
|
-
|
-
|
|||||
|
Outstanding
at December 31, 2003
|
3,267,500
|
$
|
1.00
|
||||
|
Granted
|
60,000
|
3.45
|
|||||
|
Exercised
(Note H)
|
(328,331
|
)
|
1.00
|
||||
|
Canceled
or expired
|
(1,000,000
|
)
|
1.00
|
||||
|
Outstanding
at December 31, 2004
|
1,999,169
|
$
|
1.07
|
||||
|
Granted
|
15,000
|
3.45
|
|||||
|
Exercised
(Note H)
|
(172,395
|
)
|
2.07
|
||||
|
Canceled
or expired
|
-
|
-
|
|||||
|
Outstanding
at December 31, 2005
|
1,841,774
|
$
|
1.00
|
||||
The
estimated value of the non-employee stock options
vested during the year ended
December 31, 2005 was determined using the Black-Scholes
option pricing model
and the following assumptions: expected option
life of 4 years, a risk free
interest rate of 4.35%, a dividend yield of 0%
and volatility of 71%. The amount
of the expense charged to operations in connection
with granting the options was
$1,191,767, $1,130,780 and $982,390 during the
year ended December 31, 2005,
2004 and 2003, respectively.
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
|
|||||||||
|
Exercise
Prices
|
Number
Outstanding
|
Weighted
Average
Remaining
Contractual
Life
(Years)
|
Weighed
Average
Exercise
Price
|
Number
Exercisable
|
Weighted
Average Exercise
Price
|
|||||
|
$
1.00
|
195,000
|
0.35
|
$
1.00
|
195,000
|
$
1.00
|
|||||
|
$
2.97
|
35,000
|
0.38
|
$
2.97
|
35,000
|
$
2.97
|
|||||
|
$
5.00
|
1,000,000
|
2.82
|
$
5.00
|
1,000,000
|
$
5.00
|
|||||
|
1,230,000
|
2.36
|
$
4.31
|
1,230,000
|
$
4.31
|
||||||
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
I - STOCK OPTIONS AND WARRANTS (Continued)
Warrants
(Continued)
Transactions
involving warrants are summarized as follows:
|
Number
of Shares
|
Weighted
Average
Price
Per Share
|
||||||
|
Outstanding
at January 1, 2003
|
3,531,460
|
$
0.84
|
|||||
|
Granted
|
8,591,800
|
1.01
|
|||||
|
Exercised
(Note H)
|
(6,963,770
|
)
|
0.92
|
||||
|
Canceled
or expired
|
-
|
-
|
|||||
|
Outstanding
at December 31, 2003
|
5,159,490
|
$
|
1.01
|
||||
|
Granted
|
-
|
-
|
|||||
|
Exercised
(Note H)
|
(4,468,590
|
)
|
0.99
|
||||
|
Canceled
or expired
|
(115,000
|
)
|
1.00
|
||||
|
Outstanding
at December 31, 2004
|
575,900
|
$
|
1.12
|
||||
|
Granted
|
1,040,000
|
4.85
|
|||||
|
Exercised
(Note H)
|
(371,900
|
)
|
1.00
|
||||
|
Canceled
or expired
|
(14,000
|
)
|
1.00
|
||||
|
Outstanding
at December 31, 2005
|
1,230,000
|
$
|
4.31
|
||||
The
Company capitalized financing costs of $87,217 for
compensatory warrants granted
in connection with placement of convertible debentures
during the year ended
December 31, 2003. The financing cost was amortized
over the life of the
convertible debentures and all unamortized financing
cost was expensed upon the
conversion of the convertible debentures during the
year ended December 31,
2003. The Company did not granted any warrants during
the year ended December
31, 2004. The Company granted 1,000,000 warrants to
Convertible Senior Notes
holders (Note F) and 40,000 compensatory warrants to
non-employees during the
year ended December 31, 2005. The estimated value of
compensatory warrants
granted and previously granted warrants vested during
the period ended December
31, 2005 was determined using the Black-Scholes option
pricing model and the
following assumptions: contractual term of 3 years,
a risk free interest rate of
approximately 4.50%, a dividend yield of 0% and volatility
of 71%. Compensation
expense of $162,453, $50,096 and $30,872 was charged
to operations for the year
ended December 31, 2005, 2004 and 2003, respectively.
NOTE
J - RELATED PARTY TRANSACTIONS
In
January 2003, the Company entered into an informal
agreement with Warren V.
Musser, Chairman of the Board of Directors, pursuant
to which the Company 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,
Inc. by Mr. Musser.
Pursuant to this agreement, Mr. Musser received $8,000
during the year ended
December 31, 2003.
In
January 2003, the Company entered into an informal
agreement with Howard Lubert,
Telkonet's formed Chief Executive Officer, pursuant
to which the Company agreed
to pay Mr. Lubert a commission equal to 8.0% of the
aggregate value of the
Series B Debentures purchased by persons referred to
Telkonet, Inc. by Mr.
Lubert. Pursuant to this agreement, Mr. Lubert received
$12,000 during the year
ended December 31, 2003.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
J - RELATED PARTY TRANSACTIONS (Continued)
In
January 2003, the Company entered into an employment
agreement with Ronald W.
Pickett, President and Chief Executive Officer of
the Company, to provide for an
annual compensation of $100,000 and 3,000 shares
of restricted stock from the
Employee Stock Option Plan for each month that he
serves as President. As of
December 31, 2005, 2004 and 2003, the Company has
provided for the issuance of
36,000 shares of its common stock to Mr. Pickett
each year (Note H).
In
September 2003, the Company entered into a consulting
agreement that provides
for annual compensation of $100,000, payable monthly,
with The Musser Group, an
entity controlled by the Company's Chairman of the
Board of Directors, for
certain services. As of December 31, 2005, 2004 and
2003, an aggregate of
$100,000, $100,000 and $33,333 of consulting fees
was charged to income pursuant
to the agreement, respectively.
In
July
2005, the Company entered into a Professional Services
Agreement for
international consulting with Seth Blumenfeld, a
member of the board of
directors. Pursuant to the terms of the agreement,
Mr. Blumenfeld received
10,000 shares of Company stock upon execution of
the agreement, 10,000 shares of
Company stock per quarter for the first year and
5,000 shares of Company stock
per quarter thereafter plus a five percent (5%) commission.
The stock awarded to
Mr. Blumenfeld pursuant to the agreement is restricted
stock. The agreement has
a one year term, which is renewable annually upon
both parties' agreement. As of
December 31, 2005, the Company issued 30,000 common
shares and an aggregate of
$127,766 was charged to operations.
In
December 2005, the Company issued an aggregate of
363,636 shares of common stock
to Ronald W. Pickett, President and Chief Executive
Officer of the Company, a
convertible debenture holder in exchange for $200,000
of Series B Debentures.
The Company also issued an aggregate of 48,858 shares
of common stock in
exchange for accrued interest of $26,872 for Series
B Debentures. In addition,
the Company issued an aggregate of 200,000 shares
of common stock upon the
exercise of warrants at $1.00 per share upon conversion
of the notes. (Note F
and H).
NOTE
K - 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.
A
reconciliation of tax expense computed at the statutory
federal tax rate on loss
from operations before income taxes to the actual
income tax expense is as
follows:
|
|
2005
|
2004
|
2003
|
|||||||
|
Tax
provision computed at the statutory rate
|
$
|
(5,522,000
|
)
|
$
|
(4,583,000
|
)
|
$
|
(2,680,000
|
)
|
|
|
Deferred
state income taxes, net of federal income
tax benefit
|
(525,000
|
)
|
-
|
-
|
||||||
|
Book
expenses not deductible for tax purposes
|
19,000
|
15,000
|
5,000
|
|||||||
|
U.S.
NOL created from stock option exercise
|
(463,000
|
)
|
(404,000
|
)
|
-
|
|||||
|
U.S.
deferred tax liability for beneficial
conversion feature
|
518,000
|
-
|
617,000
|
|||||||
|
Change
in valuation allowance for deferred tax
assets
|
5,973,000
|
4,972,000
|
2,058,000
|
|||||||
|
Income
tax expense
|
$
|
--
|
$
|
--
|
$
|
--
|
||||
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
K - INCOME TAXES (Continued)
The
Company has provided a valuation reserve against the full
amount of the net
deferred tax assets, because in the opinion of management,
it is more likely
than not that these tax assets will not be realized. Approximately
$877,000 of
the valuation allowance relates to stock option expense
for which subsequently
recognized tax benefits will be allocated to Additional
Paid in
Capital.
Deferred
income taxes include the net tax effects of net operating
loss (NOL)
carryforwards and the temporary differences between the
carrying amounts of
assets and liabilities for financial reporting purposes
and the amounts used for
income tax purposes. Significant components of the Company's
deferred tax assets
are as follows:
|
|
2005
|
2004
|
|||||
|
Deferred
Tax Assets:
|
|||||||
|
Net
operating loss carryforwards
|
$
|
15,015,000
|
$
|
8,983,000
|
|||
|
Warrants
and non-employee stock options
|
684,000
|
379,000
|
|||||
|
Investment
in Amperion
|
152,000
|
-
|
|||||
|
Other
|
487,000
|
459,000
|
|||||
|
Total
deferred tax assets
|
16,338,000
|
9,821,000
|
|||||
|
Deferred
Tax Liabilities:
|
|||||||
|
Beneficial
Conversion Feature of Convertible Debentures
|
(527,000
|
)
|
(17,000
|
)
|
|||
|
Property
and equipment, principally due to differences
in
depreciation
|
(66,000
|
)
|
(32,000
|
)
|
|||
|
Total
deferred tax liabilities
|
(593,000
|
)
|
(49,000
|
)
|
|||
|
Valuation
allowance
|
(15,745,000
|
)
|
(9,772,000
|
)
|
|||
|
Net
deferred tax assets
|
$
|
--
|
$
|
--
|
|||
At
December 31, 2005, the Company has net operating loss
carryforwards of
approximately $39,100,000 for federal income tax purposes
which will expire at
various dates from 2020 through 2025.
The
Company’s NOL and tax credit carryovers may be significantly
limited under
Section 382 of the Internal Revenue Code (IRC). NOL and
tax credit carryovers
are limited under Section 382 when there is a significant
“ownership change” as
defined in the IRC. During 2005 and in prior years, the
Company may have
experienced such ownership changes.
The
limitation imposed by Section 382 would place an annual
limitation on the amount
of NOL and tax credit carryovers that can be utilized.
When the Company
completes the necessary studies, the amount of NOL carryovers
available may be
reduced significantly. However, since the valuation allowance
fully reserves for
all available carryovers, the effect of the reduction
would be offset by a
reduction in the valuation allowance. Thus, the resolution
of this matter would
have no effect on the reported assets, liabilities, revenues
and expenses for
the periods presented.
F-28
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
L - LOSSES PER COMMON SHARE
The
following table presents the computations of basic
and dilutive loss per
share:
|
2005
|
2004
|
2003
|
||||||||
|
Net
loss available to common shareholders
|
$
|
(15,778,281
|
)
|
$
|
(13,092,660
|
)
|
$
|
(
7,657,936
|
)
|
|
|
Basic
and fully diluted loss per share
|
$
|
(0.35
|
)
|
$
|
(0.32
|
)
|
$
|
(0.37
|
)
|
|
|
Weighted
average common shares outstanding
|
44,743,223
|
41,384,074
|
20,702,482
|
|||||||
For
the
years ended December 31, 2005, 2004 and 2003, 7,577,208, 9,198,646
and 10,984,201 potential shares, respectively were excluded
from shares
used to calculate diluted losses per share as their
inclusion would reduce net
losses per share.
NOTE
M - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts
payable and accrued liabilities at December 31,
2005 and 2004 are as
follows:
|
2005
|
2004
|
||||||
|
Accounts
payable
|
$
|
880,802
|
$
|
812,602
|
|||
|
Accrued
interest
|
263,806
|
21,611
|
|||||
|
Accrued
payroll and payroll taxes
|
594,401
|
348,471
|
|||||
|
Warranty
|
24,000
|
-
|
|||||
|
Other
|
58,863
|
13,240
|
|||||
|
Total
|
$
|
1,821,872
|
$
|
1,195,924
|
|||
NOTE
N - COMMITMENTS AND CONTINGENCIES
Office
Leases
The
Company leases office space under a sub-lease
agreement through November 2010
for office space which occupies approximately
11,600 square feet in Germantown,
MD. In April 2005, the Company entered into
a three-year lease agreement for
6,742 square feet of commercial office space
in Crystal City, Virginia. Pursuant
to this lease, the Company agreed to assume
a portion of the build-out cost for
this facility. The Company also leases office
space of approximately 1,800
square feet in White Marsh, MD. Additionally,
the Company leases two corporate
apartments through May 2006 in Germantown,
MD and Crystal City, VA. Commitments
for minimum rentals under non cancelable leases
at December 31, 2005 are as
follows:
|
2006
|
$
|
428,907
|
||
|
2007
|
404,667
|
|||
|
2008
|
217,479
|
|||
|
2009
|
161,195
|
|||
|
2010
and thereafter
|
150,918
|
|||
|
$
|
1,363,166
|
Rental
expenses charged to operations for the
year ended December 31, 2005, 2004 and
2003 are $389,935, $165,249 and $74,777,
respectively.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
N - COMMITMENTS AND CONTINGENCIES (Continued)
Capital
Lease Obligations
Development
test equipment (Note C) includes the following amounts
for capitalized leases at
December 31, 2005 and 2004:
|
2005
|
2004
|
||||||
|
Computer
equipment and software
|
$
|
52,000
|
$
|
52,000
|
|||
|
Less:
accumulated depreciation and amortization
|
(26,000
|
)
|
(15,600
|
)
|
|||
|
$
|
26,000
|
$
|
36,400
|
||||
The
Company has computer equipment and software purchased
under non-cancelable
leases with an original cost of $52,000. As of December
31, 2005, the Company
has paid in full the lease obligation. Depreciation
expense of $10,400, $10,400
and $5,200 in connection with the capital leased equipment
was charged to
operations during the year ended December 31, 2005,
2004 and 2003,
respectively.
Employment
and Consulting Agreements
The
Company has employment agreements with certain of its
key employees which
include non-disclosure and confidentiality provisions
for protection of the
Company’s proprietary information.
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 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
O - BUSINESS CONCENTRATION
The
sale
of certain rental contract agreements and the related capitalized equipment
to Hospitality Leasing Corporation in December 2005
represented $439,074 or
approximately 18% of the 2005 revenues (Note D). Revenue from one major
customer represented $136,166 or approximately 19% of 2004
revenues. In 2003, two customers represented $32,762 or approximately
35% of total 2003 revenues. There were no other customers
which represented more
than 10% of total revenues in the three years ended
December 31, 2005. There
were no outstanding accounts receivable from these
major customers as of the
December 31, 2005 and 2004.
Purchases
from three (3) major suppliers approximated $598,000
or 48% of purchases,
$885,568 or 40% of purchases and $354,149 or 47% of
purchases for the years
ended December 31, 2005, 2004 and 2003, respectively.
Total accounts payable of
approximately $3,000 or 0.4% of total accounts payable
was due to these three
suppliers as of December 31, 2005 and approximately
$105,000 or 13% of total
accounts payable was due to these three suppliers as
of December 31,
2004.
NOTE
P - SUBSEQUENT EVENTS
Sale
of Rental Contracts
In
January 2006, the Company consummated a non-recourse
sale of certain rental
contract agreements which were previously accounted
for as operating leases and
the related capitalized equipment with Hospitality
Leasing Corporation. The
remaining rental income payments of the contracts were
valued at approximately
$918,000, excluding the customer support component
of approximately $250,000
which the Company will retain and continue to receive
monthly customer support
payments over the remaining average unexpired lease
term of 25 months. The
Company recognized revenue of approximately $464,000
for the sale, calculated
based on the present value of total unpaid rental payments,
and expensed the
associated capitalized equipment cost, net of accumulated
depreciation, of
approximately $210,000 and expensed associated taxes
of approximately
$45,000.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
P - SUBSEQUENT EVENTS (Continued)
Acquisition
of Microwave Satellite Technologies, Inc.
In
January 2006, the Company acquired a 90% interest in Microwave
Satellite
Technologies (MST), a
communications technology company that
offers complete sales, installation, and service of VSAT
and business television
networks, and is a full-service national Internet Service
Provider (ISP). The $9
million cash and stock acquisition will provide the Company
a “triple-play”
solution to subscribers of HDTV, VoIP telephony and Internet
access. The
purchase price is payable $1.8 million in cash and 1.6
million unregistered
shares of the Company’s common stock. The cash portion of the purchase price
is
payable $900,000 at closing and $900,000 payable in January
2007. The stock
portion is payable from shares held in escrow 400,000 shares
at closing and the
remaining 1,200,000 shares issued based on the achievement
of 3,300 “Triple
Play” subscribers over a three year period.
The
Company plans to expand the existing operations concentrated
in Manhattan
throughout New York and to increase its presence in other
major metropolitan
cities using the New York system as a template. This acquisition
will enable the
Company to establish a subscriber base with recurring revenues.
A substantial
portion of the purchase price will be allocated to intangible
assets and
amortized over the estimated useful life. Intangible assets
consist primarily of
subscriber rights, property access rights and network infrastructure.
The
acquisition was accounted for using the purchase method
of accounting under SFAS
No. 141.
The
value
of the Company’s common stock issued as a part of the acquisition was
determined
based on the average price of the Company's common stock
for several days before
the acquisition of MST. The components of the purchase
price were as
follows:
|
Cash
|
$ | 1,800,000 | ||
|
Common
stock
|
7,200,000
|
|||
|
Direct
acquisition costs
|
62,000
|
|||
|
Total
purchase price
|
$
|
9,062,000
|
The
following table presents the purchase price allocation,
including professional
fees and other related acquisition costs, to the assets
acquired and liabilities
assumed, based on their fair values at the date of acquisition:
|
Current
assets
|
$
|
400,548
|
||
|
Fixed
and other assets
|
1,396,190
|
|||
|
Intangible
assets
|
2,737,697
|
|||
|
Goodwill
|
5,334,249
|
|||
|
Total
liabilities assumed
|
(868,684
|
)
|
||
|
Acquisition
costs
|
62,000
|
|||
|
Total
purchase price
|
$
|
9,062,000
|
Due
to
its recent date of acquisition, the purchase price
allocation to Intangibles and
Goodwill is based upon preliminary data that is subject
to adjustment and could
change significantly pending the completion of an independent
appraisal to
accurately evaluate this allocation. The Company recognizes
goodwill in
connection with this acquisition as a result of MST’s historical development of
its subscriber base, high profile customer acquisition,
its unique “Triple Play”
solution and strategic industry position. All of the
intangible assets, which
consist of subscriber
rights, property access rights and network infrastructure,
are
subject to amortization and have a weighted-average
useful life of 10 years. The
results of the acquisition will be included within
the consolidated financial
statements from its date of acquisition as of January
31, 2006.
TELKONET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2005, 2004 AND 2003
NOTE
P - SUBSEQUENT EVENTS (Continued)
The
following data presents unaudited pro forma revenues, net
loss and basic and
diluted net loss per share of common stock for the Company
as if the
acquisitions discussed above, had occurred on January 1,
2004. The Company has
prepared these pro forma financial results for comparative
purposes only. These
pro forma financial results may not be indicative of the
results that would have
occurred if the Company had completed these acquisitions
at the beginning of the
periods shown below or the results that will be attained
in the future.
Additionally, the Pro forma results for MST does not include
the results
associated with the analog subscriber base sold to Cablevision
in
2004:
|
|
|
Year
Ended December 31, 2005
|
|
|||||||
|
|
|
As
Reported
|
|
Pro
Forma Adjustments
|
|
Pro
Forma
|
|
|||
|
Revenues
|
$
|
2,488,323
|
$
|
1,795,658
|
4,283,981
|
|||||
|
Net
loss
|
|
$
|
(15,919,778)
|
|
$
|
(1,132,722)
|
(17,052,500)
|
|||
|
Net
loss per common share outstanding - basic & diluted
|
$
|
(.36)
|
$
|
(.01)
|
(.37)
|
|||||
|
Weighted
average common shares outstanding - basic & diluted
|
|
|
44,743,223
|
|
|
|
46,343,223
|
|||
Acquisition
of Microwave Satellite Technologies, Inc. (Continued)
|
|
|
Year
Ended December 31, 2004
|
|
|||||||
|
|
|
As
Reported
|
|
Pro
Forma Adjustments
|
|
Pro
Forma
|
|
|||
|
Revenues
|
$
|
698,652
|
$
|
2,766,372
|
$
|
3,465,024
|
||||
|
Net
loss
|
|
$
|
(13,092,660)
|
|
$
|
(558,299)
|
$
|
(13,650,959)
|
|
|
|
Net
loss per common share outstanding - basic & diluted
|
$
|
(.32)
|
$
|
.00
|
$
|
(.32)
|
||||
|
Weighted
average common shares outstanding - basic & diluted
|
|
|
41,384,074
|
|
|
|
42,984,074
|
|
||
F-32