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
For the fiscal year ended December 31, 2007
Commission
file number: 001-31972
TELKONET,
INC.
(Exact
name of registrant as specified in its charter)
Utah
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87-0627421
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(State
or other jurisdiction of
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(IRS
Employee Identification No.)
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incorporation
or organization)
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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. __Yes
X No
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(b) of the Act. __Yes
X No
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 __ No
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.
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.
___
Large Accelerated Filer
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X
Accelerated Filer
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___
Non-Accelerated Filer
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act) ___ Yes
X No
Aggregate
market value of the voting stock held by non-affiliates of the registrant as of
March 1, 2008: $51,800,422.
Number of
outstanding shares of the registrant’s par value $0.001 common stock as of March
1, 2008: 72,039,455.
TELKONET,
INC.
FORM
10-K
INDEX
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Page
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Part
I |
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Item
1.
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Description
of Business
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1
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Item
1A.
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Risk
Factors
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11
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Item
1B.
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Unresolved
Staff Comments
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18
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Item
2.
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Description
of Property
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18
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Item
3.
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Legal
Proceedings
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19
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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19
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Part
II
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Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters and
Registrant’s Purchases of Securities
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19
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Item
6.
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Selected
Financial Data
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20
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Item
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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21
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Item
7A.
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Quantitative
and Qualitative Disclosures About Market Risk.
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33
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Item
8.
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Financial
Statements
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34
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Item
9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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34
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Item
9A.
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Controls
and Procedures
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34
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Item
9B.
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Other
Information
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37
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Part
III
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Item
10.
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Directors
and Executive Officers of the Registrant
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37
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Item
11.
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Executive
Compensation
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40
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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49
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Item
13.
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Certain
Relationships and Related Transactions
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51
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Item
14.
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Principal
Accounting Fees and Services
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51
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Part
IV
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Item
15.
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Exhibits
and Financial Statement Schedules
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52
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PART
I
ITEM
1. DESCRIPTION OF
BUSINESS.
GENERAL
Business
Telkonet,
Inc., formed in 1999 and incorporated under the laws of the State of Utah, is a
leading provider of innovative, centrally managed solutions for integrated
energy management, networking, building automation and proactive support
services.
Through
the revolutionary Telkonet iWire System™ and newly released Series 5 platform,
Telkonet utilizes proven PLC technology to deliver commercial high-speed
Broadband access from an IP “platform” that is easy to deploy, reliable and
cost-effective by leveraging a building’s existing electrical infrastructure.
The building’s existing electrical wiring becomes the backbone of a local area
network (LAN), which converts virtually every electrical outlet into a
high-speed data port without the costly installation of additional wiring or
major disruption of business activity.
Through
the Company’s majority-owned subsidiary MSTI Holdings, Inc. (MSTI), the Company
is able to offer quadruple play (“Quad-Play”) services to multi-tenant unit
(“MTU”) and multi-dwelling unit (“MDU”) residential, hospitality and commercial
properties. These Quad- Play services include video, voice, high-speed internet
and wireless fidelity (“Wi-Fi”) access.
The
Company’s acquisition of EthoStream, LLC, a leading high-speed wireless
internet technology and services provider for the
hospitality industry (as described in greater detail below under
“Segment Reporting”), has enabled Telkonet to provide installation and support
for PLC and HSIA products and third party applications to customers across North
America. The Company’s new operating division represented by the assets
acquired from Smart Systems International, a leading provider of energy
management products and solutions (as described in greater detail below
under “Segment Reporting”), permits the Company to offer new energy management
products and solutions to its customers in the United States and
Canada.
As a
result of Telkonet's acquisition of Smart Systems International and
EthoStream, the Company can now provide hospitality owners with a
greater return on investment on technology investments. Hotel owners
can leverage the Telkonet platform to support wired and wireless Internet
access, digital video surveillance, digital displays and the
forthcoming networked energy management system. With the synergy of
EthoStream’s centralized remote monitoring and management platform extending
over HSIA, digital video surveillance and energy management, hospitality owners
will have a complete technology offering based on Telkonet’s core PLC system as
the infrastructure backbone, demonstrating true technology
convergence.
The
Company’s headquarters are located at 20374 Seneca Meadows Parkway, Germantown,
Maryland 20876. The reports that the Company files pursuant to the Securities
Exchange Act of 1934 can be found at the Company’s web site at www.telkonet.com.
The
highlights and business developments for the twelve months ended December 31,
2007 include the following:
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·
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Consolidated
revenue growth of 173% driven by acquisitions, as well as an increase
in sales of the Telkonet iWire System™
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·
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The
acquisition of 1,800 hotel customers through the addition of EthoStream to
the Telkonet segment in March 2007. As of March 1, 2008, the Company has
over 2,300 hotels under management.
|
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·
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The
acquisition of exclusive and patented technology from Smart Systems
International
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·
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The
raising of $10 million through a private placement of 4 million shares of
common stock
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·
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Completion
of a merger by 90%-owned Microwave Satellite Technologies, Inc. (MST) with
a wholly-owned subsidiary of a public shell corporation and a
subsequent raise by the public shell corporation of $9.1 million
through sales of convertible debentures and a private placement of common
stock of the newly formed corporation.
|
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·
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The
acquisition of approximately 1,900 internet and telephone subscribers from
Newport Telecommunications Co. by the MST segment in July
2007.
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·
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A
strategic investment in Geeks on Call America, Inc., the nation's premier
provider of on-site computer services
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·
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The
sale of the Company’s investment in BPL Global for $2,000,000,
yielding a gross profit of $1,868,956
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·
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The
award of a $3.8M Contract with InTown Suites for the installation of the
Telkonet SmartEnergy™ (TSE) energy management system in 125 properties
across the U.S.
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Segment
Reporting
We
classify our operations in two reportable segments: the Telkonet Segment and the
MST Segment.
Telkonet
Segment (“Telkonet”)
The
Telkonet Segment consists of the Telkonet iWire System™ and Series 5 platform,
energy management products, and centrally managed high-speed internet network
platforms integrated to form a complete SAAS technology platform. This segment
employs both direct and indirect sales models to distribute and support its
products on a worldwide basis and serves five major markets: hospitality,
commercial, industrial, government (including defense and education) and
retail.
The
Telkonet iWire System™ and Series 5 platform offer a viable and cost-effective
alternative to the challenges of hardwiring and wireless local area networks
(LANs). Telkonet’s products are designed for use in residential, commercial and
industrial applications, including multi-dwelling hospitality,
government and utility markets. Applications supported by the
Telkonet “platform” include, but are not limited to, VoIP telephones, internet
connectivity, local area networking, video conferencing, closed circuit security
surveillance, point of sale, digital signage and a host of other information
services.
Telkonet
has been shipping PLC products since 2003, initially targeting the hospitality
market followed by the multi-dwelling unit (MDU) market as well as the
government and other commercial markets.
The
Company released its Series 5 product on March 1, 2008. The Series 5
product provides enhancements to the Telkonet iWire System™ which include, but
are not limited to, the following:
·
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more
than 14 times faster than the legacy
product,
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·
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more
robust security and data
encryption,
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·
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enhanced
quality of service, or QOS,
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·
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uses
both alternating current and direct current which makes it highly
compatible within utility and industrial
space,
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·
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increased
survivability in harsh environments,
and
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·
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additional
physical interfaces.
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On March
9, 2007, the Company acquired substantially all of the assets of Smart Systems
International (SSI), a leading provider of energy management products and
solutions to customers in the United States and Canada for cash and Company
common stock having an aggregate value of $7,000,000. The purchase price was
comprised of $875,000 in cash and 2,227,273 shares of the Company’s common
stock. 1,090,909 of these shares were held in an escrow account for a period of
one year following the closing from which certain potential indemnification
obligations under the purchase agreement could be satisfied. The aggregate
number of shares held in escrow was subject to adjustment upward or downward
depending upon the trading price of the Company’s common stock during the one
year period following the closing date. On March 12, 2008, the
Company released these shares from escrow and plans to issue an additional
1,909,091 shares pursuant to the adjustment provision in the SSI asset purchase
agreement.
Many of
the largest initiatives within Telkonet center on the sale of energy management
products and services. The Telkonet SmartEnergy system uses a combination of
occupancy sensors along with intelligent programmable thermostats or controllers
to adjust and maintain room temperature according to occupancy, time of day, and
environmental factors, for a preset configuration eliminating wasteful heating
and cooling of unoccupied rooms, and limiting the damaging impact of improper
temperature fluctuations. On average, the installation of these
devices can save 30% or more per year on heating and cooling energy
consumption.
Thus far
the hospitality, MDU, educational, and government industries have been highly
interested in energy management devices and Telkonet has increased sales in
these markets consistently during the past three quarters. In
addition, Telkonet continues to recognize increased interest and significant
wins internationally with its SmartEnergy offering. Telkonet intends
to expand these efforts to facilitate growth acceleration in the installation of
our Telkonet SmartEnergy product line. This effort is supported by
the enforcement of new energy conservation legislation such as the Energy
Independence and Security Act signed into law by President Bush on December 19,
2007 which contains provisions to improve energy efficiency in appliances and
commercial products and reduce federal government energy
usage. Telkonet continues to support these initiatives and will
remain at the forefront of green technology solutions throughout 2008 with
upcoming introductions such as our networked Telkonet SmartEnergy product
line.
Additionally,
the integration of the Series Five product line with the energy management
products will allow Telkonet to use the electrical grid of commercial buildings
as a backbone for the networked Telkonet SmartEnergy solution making it easier,
quicker, less intrusive, and less expensive to install and operate the system
within a commercial environment. The benefits of this are
twofold. First, reduced costs provide the possibility of increased
margins on Telkonet’s sales. Second, Telkonet has increased price
flexibility in order to respond to competitive market pressures.
On March
15, 2007, the Company acquired 100% of the outstanding membership units of
EthoStream, LLC, a network solutions integration company that offers
installation, sales and service to the hospitality industry. The EthoStream, LLC
acquisition enables Telkonet to provide installation and support for PLC
products and third party applications to customers across North America. The
purchase price of $11,756,097 was comprised of $2.0 million in cash and
3,459,609 shares of the Company’s common stock. The entire stock portion of the
purchase price is being held in escrow to satisfy certain potential
indemnification obligations of the sellers under the purchase agreement. The
shares held in escrow are distributable over the three years following the
closing.
One of
Telkonet’s largest recurring revenue streams is the Milwaukee-based technical
support center that was acquired in the EthoStream acquisition. This
support center is one of the only internally-operated hospitality HSIA support
centers and the key driver in the quality and customer satisfaction that
EthoStream is credited with. Telkonet’s support center is
a fully operating 24/7, 365 day full-service customer support center
that provides e-mail, phone, and technical support not only to hospitality
internet access customers but to the third party vendors as well.
This has
been a growth market for the past several years due to business travel demand
for high quality internet access in a hotel room. Additionally, over
the past year, the demands for high speed wireless internet access have extended
beyond the traditional business traveler with a significant number of leisure
travelers also demanding that the service be available. Over the past
few quarters, we partnered with several large hotel chains allowing us to
service more than 2,300 total properties and providing connectivity to more than
a million travelers monthly. We continue these efforts and Telkonet’s
hospitality market expansion through working with additional franchisors through
approved or preferred affiliations and franchise upgrades or
rollouts.
Competition
Telkonet
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
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. With
the exception of Motorola, which recently introduced a commercial product, these
companies do not presently represent a direct competitive threat to Telkonet
since they only market and sell their products in the residential
sector.
There can
be no assurance that other companies will not develop PLC products that compete
with Telkonet’s products in the future. Many 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 and
industrial sector, which includes office buildings, hotels, schools, shopping
malls, commercial buildings, multi-dwelling units, government facilities,
utilities, substations, and any other commercial facilities that have a need for
Internet access and network connectivity. Telkonet 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 Telkonet’s offerings.
Raw
Materials
Telkonet
has not experienced any significant or unusual problems in the purchase of raw
materials or commodities. While Telkonet 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. Telkonet obtains the majority of its raw
materials from the following suppliers: Arrow Electronics, Avnet Electronics
Marketing, Digi-Key Corporation, Intellon Corporation, and Versa Technology. In
addition, Superior Manufacturing Services, a U.S. based company, provides
substantially all the manufacturing and assembly requirements for Telkonet iWire
System™ and ATR Manufacturing, a Chinese based company, provides substantially
all the manufacturing requirements for the Telkonet SmartEnergy
products.
Customers
Telkonet
is neither limited to, nor reliant upon, a single or narrowly segmented consumer
base from which it derives its revenues. Presently, Telkonet is not dependent on
any particular customer under contract. Telkonet’s primary focus is
in the hospitality, commercial, industrial and government markets.
Revenue
from one (1) major customer approximated $1,436,838 or 10% of total revenues for
the year ending December 31, 2007. Total sales of rental contract agreements
(Note F) and the related capitalized equipment to Hospitality Leasing
Corporation approximated $705,000 and $252,000 in the year ending December 31,
2006, and $439,000 and $0 in the year ending 2005, which constituted
approximately 18% and approximately 18% of total revenue, respectively, and
represented the only major customer for years then ended.
Intellectual
Property
Telkonet
has applied for patents that cover the unique technology integrated into the
Telkonet iWire SystemTM and
Series 5 product suite. Telkonet also 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 of the Telkonet iWire SystemTM and
Series 5 product suite.
In
December 2005, the United States Patent and Trademark Office issued Patent
No: 6,975,212 titled “Method and Apparatus for Attaching Power Line
Communications to Customer Premises”. The patent covers the method and apparatus
for modifying a three-phase power distribution network in a building in order to
provide data communications by using a PLC signal to an electrical central
location point of the power distribution system. Telkonet’s Coupler technology
enables the conversion of electrical outlets into high-speed data ports without
costly installation, additional wiring, or significant disruption of business
activity. The Coupler is an integral component of the Telkonet iWire SystemTM and Series
5 product suites.
In August
2006, the United States Patent and Trademark Office issued Patent No: 7,091,831,
titled "Method and Apparatus for Attaching Power Line Communications to Customer
Premises". The patented technology incorporates a safety disconnect circuit
breaker into the Telkonet Coupler, creating a single streamlined unit. In doing
so, installation of the Telkonet iWire System(TM) is faster, more efficient, and
more economical than with separate disconnect switches, delivering optimal
signal quality. The Telkonet Integrated Coupler Breaker patent covers the unique
technique used for interfacing and coupling its communication devices onto the
three-phase electrical systems that are predominant in commercial
buildings.
In
January 2007, the United States Patent and Trademark Office issued Patent No:
7,170,395 titled “Methods and Apparatus for Attaching Power Line Communications
to Customer Premises” for Delta phase power distribution system applications,
which are prevalent in the maritime industry, shipboard systems, along with that
of heavy industrial plants and facilities.
The
Company acquired certain intellectual property in the SSI acquisition, including
Patent No: 5,395,042, titled “Apparatus and Method for automatic climate
control,” which was issued by the United States Patent Trademark Office in March
1995. This invention calculates and records the amount of time needed
for the thermostat to return the room temperature to the occupant’s set point
once a person re-enters the room
In
addition to the foregoing, Telkonet currently has multiple patent applications
under examination, and intends to file additional patent applications covering a
wide range of technologies including that of improved network topologies and
techniques for imposing LANs over existing wired infrastructure.
Telkonet
has also filed multiple Patent Cooperation Treaty (PCT) patent applications,
which have been used to file national patent applications in foreign countries
including the European Union, Japan, China, Russia, India and
others.
Notwithstanding
the issuance of these patents, there can be no assurance that any of Telkonet’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.
In
January 2003, Telkonet received Federal Communications Commission
(FCC) approval to market the Telkonet iWire SystemTM product
suite. 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. An independent, FCC-certified testing lab has
verified the Company’s Gateway complies with the FCC technical requirements for
Class A digital devices. No further testing of this device is required and
the device may be manufactured and marketed for commercial use.
In
December 2003, Telkonet received approval from the U.S. Patent and Trademark
Office for its “Method and Apparatus for Providing Telephonic Communication
Services” Patent No.: 6,668,058. This invention covers the utilization of an
electrical power grid, for a concentration of electrical power consumers, and
use of existing consumer power lines to provide for a worldwide voice and data
telephony exchange
In
March 2005, Telkonet received final certification of its Telkonet iWire
SystemTM product
suite from European Union (EU) authorities, which certification was
required before Telkonet could sell and permanently install the Telkonet iWire
SystemTM in
EU countries. As a result of the certification, the Telkonet iWire SystemTM
that will be sold and installed in EU countries will bear the Conformite
Europeene (CE) mark, a symbol that demonstrates that the product has met the
EU’s regulatory standards and is approved for sale within the EU. Telkonet now
has satisfied the governmental requirements for product safety and certification
in the EU and is free to sell and install the Telkonet iWire SystemTM product
suite in the EU.
In
June 2005, Telkonet received the National Institute of Standards and
Technology (NIST) Federal Information Processing Standard (FIPS) 140-2
validation for the Gateway. In July 2005, Telkonet received FIPS 140-2
validation for the eXtender and iBridge. The U.S. federal government requires,
as a condition to purchasing certain information processing applications, that
such applications receive FIPS 140-2 validation. U.S. federal agencies use FIPS
140-2 compliant products for the protection of sensitive information. As a
result of the foregoing validations, as of July 2005, all of Telkonet’s
powerline carrier products have satisfied all governmental requirements for
security certification and are eligible for purchase by the U.S. federal
government. In addition to the foregoing, Canadian provincial authorities use
FIPS 140-2 compliant products for the protection of sensitive designate
information. The Communications-Electronics Security Group (CESG) also has
stated that FIPS 140-2 compliant products meet its security criteria for use in
data traffic categorized as “Private.” CESG is part of the United Kingdom’s
National Technical Authority for Information Assurance, which is a government
agency responsible for validating the security of information processing
applications for the government of the United Kingdom, financial institutions,
healthcare organizations, and international governments, among
others.
In
November 2005, Telkonet received the Norma Official Mexicana
(NOM) certification, enabling Telkonet to sell the iWire SystemTM product
suite in Mexico. NOM certification is required for Telkonet’s products to be
sold in Mexico, and no further certifications are required to sell the Telkonet
iWire SystemTM product
suite in Mexico.
Future
products designed by the Company will require testing for compliance with FCC
and CE regulations. Moreover, if in the future, the FCC or EU changes its
technical requirements, further testing and/or modifications may be
necessary.
Research
and Development
During the years ended December 31,
2007, 2006 and 2005, Telkonet spent $2,349,690, $1,925,746 and $2,096,104,
respectively, on research and development activities. In 2007 and 2006, research
and development activities were focused on the development of Telkonet’s next
generation product. In 2005, research and development activities included (a)
QoS for VoIP service for both commercial and FIPS 140-2 product applications,
(b) design of the next generation high-speed development platform, (c) design,
prototype & release of the Integrated Coupler Breaker product line, (d)
design & development of the second generation automated test equipment for
manufacturing, (e) automated SQA regression testing.
Long
Term Investments
Amperion,
Inc.
On
November 30, 2004, Telkonet 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%. Telkonet 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 Telkonet to regularly review the assumptions underlying the operating
performance and cash flow forecasts in assessing the carrying values of the
investment. Telkonet 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. Telkonet determined that its
investment in Amperion was impaired based upon forecasted discounted cash flow.
Accordingly, Telkonet wrote-off $92,000 and $400,000 of the carrying value of
its investment through a charge to operations during the year-ended December 31,
2006 and 2005, respectively. The remaining value of Telkonet’s investment in
Amperion is $8,000 at December 31, 2007 and 2006 and the amount at December 31,
2007, represents the current fair value.
BPL Global,
Ltd.
On
February 4, 2005, the Company’s Board of Directors approved an investment in BPL
Global, Ltd. (“BPL Global”), a privately held company. The Company funded an
aggregate of $131,000 as of December 31, 2005 and additional $44 during the year
of 2006.. 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 did 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. amounted $131,044 as of December
31, 2006. On November 7, 2007, the Company completed the sale of its
investment in BPL Global, Ltd for $2,000,000 in cash to certain existing
stockholders of BPL Global.
Geeks on Call America,
Inc.
On
October 19, 2007, the Company completed the acquisition of approximately 30.0%
of the issued and outstanding shares of common stock of Geeks on Call America,
Inc. (“GOCA”), the nation's premier provider of on-site computer services.
Under the terms of the stock purchase agreement, the Company acquired
approximately 1,160,043 shares of GOCA common stock from several GOCA
stockholders in exchange for 2,940,200 shares of the Company’s common stock for
total consideration valued at approximately $4.5 million. The number of shares
issued in connection with this transaction was determined using a per share
price equal to the average closing price of the Company’s common stock on the
American Stock Exchange (AMEX) during the ten trading days immediately preceding
the closing date. The number of shares is subject to adjustment on the date the
Company files a registration statement for the shares issued in this
transaction, which must occur no later than the 180th day
following the closing date. The increase or decrease to the number of shares
issued will be determined using a per share price equal to the average closing
price of the Company’s common stock on the AMEX during the ten trading days
immediately preceding the date the registration statement is
filed. 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.
On
February 8 2008, Geeks on Call Acquisition Corp., a newly formed, wholly-owned
subsidiary of Geeks On Call Holdings, Inc., (formerly Lightview, Inc.) merged
with Geeks on Call America, Inc (“GOCA”). As a result of the merger, the
Company’s common stock in GOCA was exchanged for shares of common stock of Geeks
on Call Holdings Inc. Immediately following the merger, Geeks on Call
Holdings Inc. completed a private placement of its common stock for aggregate
gross proceeds of $3,000,000. As a result of this transaction, the Company’s 30%
interest in GOCA became an 18% interest in Geeks on Call Holdings
Inc.
Multiband
Corporation
In
connection with a payment of $75,000 of accounts receivable, the company
received 30,000 shares of common stock of Multiband Corporation, a
Minnesota-based communication services provider to multiple dwelling
units. 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, and the shares
are not eligible for sale by the Company under Rule 144 of the Securities Act of
1933. The value of this investment amounted to $75,000 as of December
31, 2007.
Backlog
The
Telkonet Segment maintains contracts and monthly services for more than 2,300
hotels which are expected to generate approximately $3,600,000 annual recurring
support and internet advertising revenue.
The
Telkonet Segment has maintained certain purchase orders relating to a major
utilities energy management initiative provided through the two selected
providers. The current order backlog amounts to approximately $1,100,000 and the
estimated remaining program value amounts to $4,500,000 for products and
services to be provided through March 2010. In addition, the Company recently
contracted a similar energy efficiency program in Wisconsin estimated to achieve
5,000 rooms and establish offerings within utility programs
nationally.
The
Company has contracted with a national hotel operator to install energy
management devices in approximately 16,000 rooms for an approximate value of
$3,800,000. The implementation is anticipated to be completed by the third
quarter of 2008.
MST
Segment (“MSTI”)
MSTI is a
communications service provider offering quadruple play (“Quad-Play”) services
to multi-tenant unit (“MTU”) and multi-dwelling unit (“MDU”) residential,
hospitality and commercial properties. These Quad-Play services include video,
voice, high-speed internet and wireless fidelity (“Wi-Fi”) access. In addition,
MSTI currently offers or plans to offer a variety of next-generation
telecommunications solutions and services including satellite installation,
video conferencing, surveillance/security and energy management, and other
complementary professional services.
NuVisions™
MSTI
currently offers digital television service through DISH Network, a national
satellite television provider, under its private label NuVisions™ brand of
services. The NuVisions TV offering currently includes over 500 channels of
video and audio programming, with a large high definition (more than 40
channels) and ethnic offering (over 100 channels from 17 countries) available in
the market today. MSTI also offers its NuVisions Broadband high speed internet
service and NuVisions Digital Voice telephone service to multi-family residences
and commercial properties. MSTI delivers its broadband based services using
terrestrial fiber optic links and in February 2005, began deployment in New York
City of a proprietary wireless gigabit network that connects properties served
in a redundant gigabit ring - a virtual fiber optic network in the
air.
Wi-Fi
Network
MSTI has
constructed a large NuVisions Wi-Fi footprint in New York City intended to
create a ubiquitous citywide Wi-Fi network. NuVisions Wi-Fi offers Internet
access in the southern-half of Central Park, Riverside Park from 60th to 79th
Streets, Dag Hammarskjold Plaza, and the United Nations Plaza. In addition, MSTI
provides NuVisions Wi-Fi service in and around Trump Tower on Fifth Avenue,
Trump World Tower on First Avenue, the Trump Place properties located on
Riverside Boulevard, Trump Palace, Trump Parc, Trump Parc East as well as
portions of Roosevelt Island surrounding the Octagon residential community. MSTI
currently has plans to deploy additional Wi-Fi “Hot Zones” throughout New York
City and continue to enlarge its Wi-Fi footprint as new properties are
served.
Internet
Protocol Television (“IPTV”)
In fourth
quarter of 2006, MSTI invested in an IPTV platform to deploy in 2008. IPTV is a
method of distributing television content over IP that enables a more
user-defined, on-demand and interactive experience than traditional cable or
satellite television. The IPTV service delivers traditional cable TV programming
and enables subscribers to surf the Internet, receive on-demand content, and
perform a host of Internet-based functions via their TV sets.
Competition
The home
entertainment and video programming industry is competitive, and MSTI expects
competition to intensify in the future. MSTI faces its most significant
competition from the franchised cable operators. In addition, MSTI’s competition
includes other satellite providers, telecom providers and off-air
broadcasters.
Hardwired
Franchised Cable System
Cable
companies currently dominate the market in terms of subscriber penetration, the
number of programming services available, audience ratings and expenditures on
programming. However, satellite services are gaining market share which MSTI
believes will provide it with the opportunity to acquire and consolidate a
subscriber base by providing a high quality signal at a comparable or reduced
price to many cable operators' current service.
Other
Operators
MSTI’s
next largest competitors are other operators who build and operate
communications systems such as satellite master antenna television systems,
commonly known as SMATV, or private cable headend systems, which generally serve
condominiums, apartment and office complexes and residential developments. MSTI
also competes with other national DBS operators such as EchoStar.
Off-Air
Broadcasters
A
majority of U.S. households that are not serviced by cable operators are
serviced only by broadcast networks and local television stations (“off-air
broadcasters”). Off-air broadcasters send signals through the air, which are
received by traditional television antennas. Signals are accessible to anyone
with an antenna and programming is funded by advertisers. Audio and video
quality is limited and service can be adversely affected by weather or by
buildings blocking a signal.
Traditional
Telephone Companies
Traditional
telephone companies such as Verizon and AT&T have recently diversified their
service offerings to compete with traditional franchised cable companies in a
triple-play market. Although their subscriber growth is currently smaller than
franchise cable companies, these traditional phone companies are developing
video offerings such as Verizon's FIOS product. These phone companies have in
the past also been resellers of DIRECTV and EchoStar video programming, however,
rarely in the multi-dwelling unit market. In the future, video offerings from
traditional phone companies may become a significant competitor in the MDU
market.
Customers/Strategy
MSTI’s
customer base and strategy is to target and cultivate a subscriber base that
will demand high margin products, including, video, IPTV, VoIP, high-speed
Internet and Wi-Fi services.
MSTI
currently maintains service agreements with approximately 22 MDU and MTU
properties. Generally, under the terms of a service agreement, MSTI provides
either (i) “bulk services,” which may include one or all of a bundle of products
and services, at a fixed price per month to the owner of the MDU or MTU
property, and contract with individual residents for enhanced services, such as
premium cable channels, for a monthly fee or (ii) contract with individual
residents of the MDU property for one or more basic or enhanced services for a
monthly fee. These agreements typically include a revenue sharing arrangement
with property owners, whereby the property owner is entitled to a share of the
revenues derived from subscribers who reside at the MDU/MTU property. These revenue sharing
arrangements are either based upon a fix amount per subscriber or based on a
percentage, typically between 7-10%, of the monthly fees MSTI charges residents
for its services. MSTI believes that its complementary products and services
allows for future growth and as such are designed and integrated with
scalability in mind.
Governmental
Regulation
Federal
Regulation
MSTI’s
systems do not use or traverse public rights-of-way and thus are exempt
from the comprehensive regulation of cable systems under the Federal
Communications Act of 1934, as amended (the “Communications Act”). Because its
systems are subject to minimal federal regulation, MSTI has greater pricing
freedom and is not required to serve any customer whom it does not choose to
serve, and management believes that MSTI has significantly more competitive
flexibility than do the franchised cable systems. Management believes that these
regulatory advantages help to make MSTIs’ private systems competitive with
larger franchised cable systems.
On
October 5, 1992, Congress enacted the Cable Consumer Protection and Competition
Act of 1992 (the “1992 Cable Act”), which imposed additional regulation on
traditional franchised cable operators and permits regulation of rates in
markets in which there is no “effective competition”, as defined in the 1992
Cable Act, and directed the FCC to adopt comprehensive new federal standards for
local regulation of certain rates charged by traditional franchised cable
operators. Conversely, the legislation also provides for deregulation of
traditional hardwire cable in a given market where effective competition is
shown to exist. Rates charged by private cable operators, typically already
lower than traditional franchise cable rates, are not subject to regulation
under the 1992 Cable Act.
In
February 1996, Congress passed the Telecommunications Act of 1996 (the “1996
Act”), which substantially amended the Communications Act. The 1996 Act contains
provisions intended to increase competition in the telephone, radio, broadcast
television, and hardwire and wireless cable television businesses. This
legislation has altered, and management believes will continue to alter,
federal, state, and local laws and regulations affecting the communications
industry, including certain of the services MSTI provides.
Under the
federal copyright laws, permission from the copyright holder generally must be
secured before a video program may be retransmitted. Section 111 of the
Copyright Act establishes the cable compulsory license pursuant to which certain
“cable systems” are entitled to engage in the secondary transmission of
broadcast programming without the prior permission of the holders of copyrights
in the programming. In order to do so, a cable system must secure a compulsory
copyright license. Such a license may be obtained upon the filing of certain
reports with and the payment of certain licensing fees to the U.S. Copyright
Office. Private cable operators, such as MSTI, may rely on the cable compulsory
license with respect to the secondary transmission of broadcast programming.
Management does not expect the licensing fees to have a material adverse effect
on MSTI’s business.
Under the
retransmission consent provisions of the 1992 Cable Act, multichannel video
programming distributors, including, but not limited to, franchised and private
cable operators, seeking to retransmit certain commercial television broadcast
signals, notwithstanding the cable compulsory license, must first obtain the
permission of the broadcast station in order to retransmit the station’s signal.
However, private cable systems, unlike franchised cable systems, are not
required under the FCC’s “must carry” rules to retransmit local television
signals. Although there can be no assurances that MSTI will be able to obtain
requisite broadcaster consents, management believes, in most cases, MSTI will be
able to do so for little or no additional cost.
On
November 29, 1999, Congress enacted the Satellite Home Viewer Improvement Act of
1999 (“SHVIA”), which amended the Satellite Home Viewer Act. SHVIA permits DBS
operators to transmit local television signals into local markets. SHVIA
generally seeks to place satellite operators on an equal footing with cable
television operators in regards to the availability of television broadcast
programming. SHVIA amends the Copyright Act and other applicable laws and
regulations in order to clarify the terms and conditions under which a DBS
operator may retransmit local and distant broadcast television stations to
subscribers. The law was intended to promote the ability of satellite services
to compete with cable television systems and to resolve disputes that had arisen
between broadcasters and satellite carriers regarding the delivery of broadcast
television station programming to satellite service subscribers. As a result of
SHVIA, television stations are generally entitled to seek carriage on any DBS
operator's system providing local service in their respective markets. SHVIA
creates a statutory copyright license applicable to the retransmission of
broadcast television stations to DBS subscribers located in their markets.
Although there is no royalty payment obligation associated with this license,
eligibility for the license is conditioned on the satellite carrier's compliance
with applicable laws, regulations and FCC rules governing the retransmission of
such “local” broadcast television stations to satellite service subscribers.
Noncompliance with such laws, regulations and/or FCC requirements could subject
a satellite carrier to liability for copyright infringement. SHVIA was extended
and re-enacted by the Satellite Home Viewer Extension and Reauthorization Act
(“SHVERA”) in December of 2004.
MSTI is
not directly subject to rate regulation or certification requirements by the FCC
or state public utility commissions because its equipment installation and sales
agent activities do not constitute the provision of common carrier or cable
television services. As a private cable operator, MSTI is not subject to
regulation as a DBS provider, but primarily relies upon its third-party
programming aggregators to procure all necessary re-transmission consents and
other programming rights under the Communications Act and the Copyright
Act.
State
and Local Cable System Regulation
MSTI does
not anticipate that its deployment of video programming services will be subject
to state or local franchise laws primarily due to the fact that its facilities
do not use or traverse public rights-of-way. Although MSTI may be required to
comply with state and local property tax, environmental laws and local zoning
laws, management does not anticipate that compliance with these laws will have
any material adverse impact on MSTI’s business.
State
Mandatory Access Laws
A number
of states have enacted mandatory access laws that generally require, in exchange
for just compensation, the owners of rental apartments (and, in some instances,
the owners of condominiums) to allow the local franchise cable television
operator to have access to the property to install its equipment and provide
cable service to residents of the MDU. Such state mandatory access laws
effectively eliminate the ability of the property owner to enter into an
exclusive right of entry with a provider of cable or other broadcast services.
In addition, some states have anti-compensation statutes forbidding an owner of
an MDU from accepting compensation from whomever the owner permits to provide
cable or other broadcast services to the property. These statutes have been and
are being challenged on constitutional grounds in various
states. These state access laws may provide both benefits and
detriments to our business plan should we expand significantly in any of these
states.
Preferential
Access Right
MSTI
generally negotiates exclusive rights to provide satellite services singularly
or in competition with competing cable providers, and also negotiates, where
possible, “rights-of-first-refusal” to match price and terms of third-party
offers to provide other communication services in buildings where it has
negotiated broadcast access rights. Management believes that these preferential
rights of entry are generally enforceable under applicable law. However, current
trends at the state and federal level suggest that the future enforceability of
these provisions may be uncertain. In 2001, the FCC issued an order prohibiting
telecommunications service providers from negotiating exclusive contracts with
owners of commercial MDU properties. The FCC recently extended this prior action
to prohibit carriers from entering into contracts with residential MDU owners
that grant carriers exclusive access for the provision of telecommunications
services to residents in those MDUs. The ban applies retrospectively to
existing contracts as well as to any future agreements. The FCC has also
banned agreements that provide exclusive access for video services to
MDUs. The ban applies retrospectively to existing contracts as well as to
any future agreements. The ban on exclusive video agreements does not
currently apply to non-franchised entities such as MSTI however the FCC is
currently considering extending the ban to such entities. While
limitations on exclusivity may undermine the exclusivity provisions of MSTI’s
rights of entry on the one hand, they may also open up many other properties to
which MSTI may provide a competing service. There can be no assurance that
future state or federal laws or regulations will not restrict MSTI’s ability to
offer access payments, limit MDU owners' ability to receive access payments or e
enter into exclusive agreements, any of which could have a material adverse
effect on MSTI’s business.
Regulation
of the High-Speed lnternet and Wi-Fi Business
ISPs,
including Internet access providers, are largely unregulated by the FCC or state
public utility commissions at this time (apart from federal, state and local
laws and regulations applicable to business in general). However, there can be
no assurance that this business will not become subject to regulatory
restraints. Also, although the FCC has rejected proposals to impose additional
costs and regulations on ISPs to the extent they use local exchange telephone
network facilities, such change may affect demand for Internet related services.
No assurance can be given that changes in current or future regulations adopted
by the FCC or state regulators or other legislative or judicial initiatives
relating to Internet services would not have a material adverse effect on MSTI’s
business.
Regulation
of the VoIP Business
IP-based
voice services are currently exempt from the reporting and pricing restrictions
placed on common carriers by the FCC. However, there are several state and
federal regulatory proceedings further defining what specific service offerings
qualify for this exemption. Due to the growing acceptance and deployment of VoIP
services, the FCC and a number of state public service commissions are
conducting regulatory proceedings that could affect the regulatory duties and
rights of entities that provide IP-based voice applications. There is regulatory
uncertainty as to the imposition of traditional retail, common carrier
regulation on VoIP products and services.
Long
Term Investments
MSTI
maintains an investment in Interactivewifi.com, LLC a privately held company.
This investment represents an equity interest of approximately 50% at December
31, 2007. Interactivewifi.com is engaged in providing internet and related
services to customers throughout metropolitan New York, including the Nuvision's
internet services. MSTI accounted for this investment under the cost method, as
MSTI does not have the ability to exercise significant influence over operating
and financial policies of the investee. Telkonet reviewed the assumptions
underlying the operating performance and cash flow forecasts in assessing the
carrying values of the investment. The fair value of MSTI’s investment in
Interactivewifi.com amounted to approximately $55,000 as of December 31,
2007.
Backlog
The MSTI
subscriber portfolio includes approximately 22 MDU properties with bulk service
agreements and/or access licenses to service the individual subscribers in
metropolitan New York. The remaining terms of the access agreements provide MSTI
access rights from 7 to 15 years with the final agreement expiring in 2016 and
the revenues to be recognized under non-cancelable bulk agreements provide a
minimum of $2,100,000 in revenue through 2013.
Other
information
Employees
As of
March 1, 2008, the Company had 172 full time employees comprised of 141 full
time employees of Telkonet and 31 employees of MSTI. The Company intends to hire
additional personnel to meet future operating requirements. The
Company anticipates that it may need to hire additional staff in the areas of
customer support, engineering, sales and marketing, and
administration.
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.
Financial
Information About Geographic Areas
To date,
the majority of the Company’s revenue has been derived in the United States,
although the Company continues to derive a growing portion of our revenue from
international sales. International sales as a percentage of total revenue
represented 2%, 19% and 25% in 2007, 2006 and 2005, respectively. Our
international sales are concentrated in Canada, Latin America and Western Europe
and we continue to expand into other markets worldwide. The table below sets
forth our net revenue by major geographic region.
|
|
Year
Ended December 31,
|
|
|
|
2007
|
|
Percentage
Change
|
|
2006
|
|
Percentage
Change
|
|
2005
|
|
United
States
|
|
$
|
13,851,021
|
|
207%
|
|
$
|
4,508,478
|
|
141%
|
|
$
|
1,871,241
|
|
Worldwide
|
|
|
301,712
|
|
-55%
|
|
|
672,850
|
|
9%
|
|
|
617,082
|
|
Total
|
|
$
|
14,152,733
|
|
173%
|
|
$
|
5,181,328
|
|
108%
|
|
$
|
2,488,323
|
|
ITEM
1A. RISK
FACTORS.
The
Company’s results of operations, financial condition and cash flows can be
adversely affected by various risks. These risks include, but are not limited
to, the principal factors listed below and the other matters set forth in this
annual report on Form 10-K. You should carefully consider all of these
risks.
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, 2007, the Company has incurred cumulative losses
of $90,815,779 and has never generated enough funds through operations to
support its business. Additional capital may be required in order to provide
working capital requirements for the next twelve months. 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. If 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.
Our
independent auditors have added an explanatory paragraph to their report of our
financial statements for the year ended December 31, 2007 stating that our net
losses, lack of revenues and dependence on our ability to raise additional
capital to continue our existence, raise substantial doubt about our ability to
continue as a going concern. If we are not successful in raising sufficient
additional capital, we may we may not be able to continue as a going concern,
our stockholders may lose their entire investment in us.
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, 2008, the Company’s officers and directors owned 11.2% 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 that were 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.
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, 2007, the Company had outstanding employee options to purchase a
total of 8,105,429 shares of common stock at exercise prices ranging from $1.00
to $5.97 per share, with a weighted average exercise price of $1.98. As of
December 31, 2007, the Company had outstanding non-employee options to purchase
a total of 1,815,937 shares of common stock at an exercise price of $1.00 per
share. As of December 31, 2007, the Company had warrants outstanding to purchase
a total of 7,673,627 shares of common stock at exercise prices ranging from
$2.59 to $4.70 per share, with a weighted average exercise price of $4.15. 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.
|
The
communication industry is intensely competitive and rapidly
evolving.
The
Company operates in a highly competitive, quickly changing environment, and our
future success will depend on our ability to develop and introduce new services
and service enhancements that achieve broad market acceptance in MDU and
commercial sectors. The Company will also need to respond effectively to new
product announcements by our competitors by quickly introducing competitive
products.
Delays in
product development and introduction could result in:
·
|
loss
of or delay in revenue and loss of market
share;
|
·
|
negative
publicity and damage to our reputation and brand;
and
|
·
|
decline
in the selling price of our products and
services.
|
Additionally,
new companies are constantly entering the market, thus increasing the
competition. This could also have a negative impact on our ability to obtain
additional capital from investors. Larger companies who have been engaged in our
business for substantially longer periods of time may have access to greater
resources. These companies may have greater success in the recruitment and
retention of qualified employees, as well as in conducting their operations,
which may give them a competitive advantage. In addition, actual or potential
competitors may be strengthened through the acquisition of additional assets and
interests. If the Company is unable to compete effectively or adequately respond
to competitive pressures, this may materially adversely affect our results of
operation and financial condition. Large companies including Direct TV,
EchoStar, Time Warner, Cablevision and Verizon are active in our markets in the
provision and distribution of communications services and we will have to
compete with such companies.
The
Company is not large enough to negotiate cable television programming contracts
as favorable as some of our larger competitors.
Programming
costs are generally directly related to the number of subscribers to which the
programming is provided, with discounts available to large traditional cable
operators and direct broadcast satellite (DBS) providers based on their high
subscriber levels. As a result, larger cable and DBS systems generally pay lower
per subscriber programming costs. The Company has attempted to obtain volume
discounts from our suppliers. Despite these efforts, we believe that our per
subscriber programming costs are significantly higher than large cable operators
and DBS providers with which we compete in some of our markets. This may put us
at a competitive disadvantage in terms of maintaining our operating results
while remaining competitive with prices offered by these providers. In addition,
as programming agreements come up for renewal, the Company cannot assure you
that we will be able to renew these agreements on comparable or favorable terms.
To the extent that we are unable to reach agreement with a programmer on terms
that we believe are reasonable, we may be forced to remove programming from our
line-up, which could result in a loss of customers.
Programming
costs have risen in past years and are expected to continue to rise, which may
adversely affect our financial results.
The cost
of acquiring programming is a significant portion of the operating costs for our
cable television business. These costs have increased each year and we expect
them to continue to increase, especially the costs associated with sports
programming. Many of our programming contracts cover multiple years and provide
for future increases in the fees we must pay. Historically, we have absorbed
increased programming costs in large part through increased prices to our
customers. However, competitive and other marketplace factors may not permit us
to continue to pass these costs through to customers. In order to minimize the
negative impact that increased programming costs may have on our margins, we may
pursue a variety of strategies, including offering some programming at premium
prices or moving some programming from our analog service to our premium digital
services. Despite our efforts to manage programming expenses and pricing, the
rising cost of programming may adversely affect our results of
operations.
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 the Company’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. Additional
devices designed by the Company for commercial and residential use will be
subject to the FCC rules for unlicensed digital devices. Moreover, if in the
future, the FCC changes its technical requirements for unlicensed digital
devices, further testing and/or modifications of devices may be necessary.
Failure to comply with any FCC technical requirements could impair 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
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. With the exception of Motorola, who recently introduced a commercial
product, these companies do not presently represent a direct competitive threat
to the Company since they only market and sell their products in the residential
sector. There can be no assurance that other companies 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, 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.
Any
acquisitions we make could result in difficulties in successfully managing our
business and consequently harm our financial condition.
We may
seek to expand by acquiring competing businesses in our current or other
geographic markets, including as a means to acquire spectrum. We cannot
accurately predict the timing, size and success of our acquisition efforts and
the associated capital commitments that might be required. We expect to face
competition for acquisition candidates, which may limit the number of
acquisition opportunities available to us and may lead to higher acquisition
prices. There can be no assurance that we will be able to identify, acquire or
profitably manage additional businesses or successfully integrate acquired
businesses, if any, without substantial costs, delays or other operational or
financial difficulties. In addition, acquisitions involve a number of other
risks, including:
|
·
|
failure
of the acquired businesses to achieve expected
results;
|
|
·
|
diversion
of management’s attention and resources to
acquisitions;
|
|
·
|
failure
to retain key customers or personnel of the acquired
businesses;
|
|
·
|
disappointing
quality or functionality of acquired equipment and people:
and
|
|
·
|
risks
associated with unanticipated events, liabilities or
contingencies.
|
Client
dissatisfaction or performance problems at a single acquired business could
negatively affect our reputation. The inability to acquire businesses on
reasonable terms or successfully integrate and manage acquired companies, or the
occurrence of performance problems at acquired companies, could result in
dilution, unfavorable accounting treatment or one-time charges and difficulties
in successfully managing our business.
Our
inability to obtain capital, use internally generated cash or debt, or use
shares of our common stock to finance future acquisitions could impair the
growth and expansion of our business.
Reliance
on internally generated cash or debt to finance our operations or complete
acquisitions could substantially limit our operational and financial
flexibility. The extent to which we will be able or willing to use shares of our
common stock to consummate acquisitions will depend on our market value which
will vary, and liquidity. Using shares of our common stock for this purpose also
may result in significant dilution to our then existing stockholders. To the
extent that we are unable to use our common stock to make future acquisitions,
our ability to grow through acquisitions may be limited by the extent to which
we are able to raise capital through debt or additional equity financings. No
assurance can be given that we will be able to obtain the necessary capital to
finance any acquisitions or our other cash needs. If we are unable to obtain
additional capital on acceptable terms, we may be required to reduce the scope
of any expansion or redirect resources committed to internal purposes. In
addition to requiring funding for acquisitions, we may need additional funds to
implement our internal growth and operating strategies or to finance other
aspects of our operations. Our failure to: (i) obtain additional capital on
acceptable terms; (ii) use internally generated cash or debt to complete
acquisitions because it significantly limits our operational or financial
flexibility; or (iii) use shares of our common stock to make future
acquisitions, may hinder our ability to actively pursue our acquisition
program.
We
rely on a limited number of third party suppliers. If these companies fail to
perform or experience delays, shortages, or increased demand for their products
or services, we may face shortages, increased costs, and may be required to
suspend deployment of our products and services.
We depend
on a limited number of third party suppliers to provide the components and the
equipment required to deliver our solutions. If these providers fail to perform
their obligations under our agreements with them or we are unable to renew these
agreements, we may be forced to suspend the sale and deployment of our products
and services and enrollment of new customers, which would have an adverse effect
on our business, prospects, financial condition and operating
results.
Our
management and operational systems might be inadequate to handle our potential
growth.
We may
experience growth that could place a significant strain upon our management and
operational systems and resources. Failure to manage our growth effectively
could have a material adverse effect upon our business, results of operations
and financial condition. Our ability to compete effectively as a provider of PLC
technology and a provider of digital satellite television and high-speed
Internet products and services and to manage future growth will require us to
continue to improve our operational systems, organization and financial and
management controls, reporting systems and procedures. We may fail to make these
improvements effectively. Additionally, our efforts to make these improvements
may divert the focus of our personnel. We must integrate our key executives into
a cohesive management team to expand our business. If new hires perform poorly,
or if we are unsuccessful in hiring, training and integrating these new
employees, or if we are not successful in retaining our existing employees, our
business may be harmed. To manage the growth we will need to increase our
operational and financial systems, procedures and controls. Our current and
planned personnel, systems, procedures and controls may not be adequate to
support our future operations. We may not be able to effectively manage such
growth, and failure to do so could have a material adverse effect on our
business, financial condition and results of operations.
We
may be affected if the United States participates in wars or military or other
action or by international terrorism.
Involvement
in a war or other military action or acts of terrorism may cause significant
disruption to commerce throughout the world. To the extent that such disruptions
result in (i) delays or cancellations of customer orders, (ii) a general
decrease in consumer spending on information technology, (iii) our inability to
effectively market and distribute our services or products or (iv) our inability
to access capital markets, our business and results of operations could be
materially and adversely affected. We are unable to predict whether the
involvement in a war or other military action will result in any long-term
commercial disruptions or if such involvement or responses will have any
long-term material adverse effect on our business, results of operations, or
financial condition.
A
significant portion of our total assets consists of goodwill, which is subject
to a periodic impairment analysis and a significant impairment determination in
any future period could have an adverse effect on our results of operations even
without a significant loss of revenue or increase in cash expenses attributable
to such period.
We have
goodwill totaling approximately $14.7 million at December 31, 2007 resulting
from recent and past acquisitions. We evaluate this goodwill for impairment
based on the fair value of the operating business units to which this goodwill
relates at least once a year. This estimated fair value could change if we are
unable to achieve operating results at the levels that have been forecasted, the
market valuation of those business units decreases based on transactions
involving similar companies, or there is a permanent, negative change in the
market demand for the services offered by the business units. These changes
could result in an impairment of the existing goodwill balance that could
require a material non-cash charge to our results of operations.
At
December 31, 2007, the Company performed an impairment test on the goodwill and
intangibles acquired, it was determined that there were no changes in the
carrying value of the intangibles acquired. However, based upon
managements assessment of operating results and forecasted discounted cash flow
the carrying value of MSTI goodwill was determined to be impaired and therefore
the entire value of $1,977,768 was written off during the year ended December
31, 2007.
MSTI
may be unable to register for resale all of the common stock included within the
units sold in its Private Placement, which would cause a default under the
Registration Rights Agreement executed in connection with such Private
Placement.
MSTI is
obligated to file a “resale” registration statement with the SEC that covers all
of the common stock included within the units sold in the private placement and
issuable upon conversion of its debentures and the exercise of the warrants
thereto and to use its best efforts to have such “resale” registration statement
declared effective by the SEC as set forth therein. Nevertheless, it is possible
that the SEC may not permit MSTI to register all of such shares of common stock
for resale. In certain circumstances, the SEC may take the view that the private
placement requires MSTI to register the issuance of the securities as a primary
offering. Without sufficient disclosure of this risk, rescission of the private
placement could be sought by investors or an offer of rescission may be mandated
by the SEC, which would result in a material adverse affect to MSTI and us since
we consolidate the financial statements of MSTI.
MSTI has
agreed to file a registration statement with the SEC within 60 days of the final
closing of the Private Placement and the issuance of the Debentures and to use
its best efforts to have the registration statement declared effective by the
SEC within 120 days after the final closing of the private placement and the
original issuance of the debentures. There are many reasons, including those
over which MSTI has no control, which could delay the filing or effectiveness of
the registration statement, including delays resulting from the SEC review
process and comments raised by the SEC during that process. Failure to file or
cause a registration statement to become effective in a timely manner or
maintain its effectiveness could materially adversely affect MSTI and require
MSTI to pay substantial penalties to the holders of those securities pursuant to
the terms of the registration rights agreement. Since we consolidate
the financial statements of MSTI, the incurrence of a significant penalty by
MSTI under the Registration Rights Agreement could materially adversely affect
our results of operations.
Obligations
to the holders of MSTI’s debentures are secured by all of MSTI’s assets, so if
we default on those obligations, the debenture holders could foreclose on MSTI’s
assets.
The
holders of MSTI’s debentures have a security interest in all of MSTI’s assets
and those of its subsidiary. As a result, if we default under our obligations to
the debenture holders, the debenture holders could foreclose their security
interests and liquidate some or all of these assets, which may cause MSTI to
cease operations.
MSTI’s indebtedness
and restrictive debt covenants could limit MSTI’s financing options
and liquidity position, which would limit MSTI’s ability to grow our
business.
The terms
of MSTI’s outstanding debentures could have negative consequences, such
as:
·
|
MSTI
may be unable to obtain additional financing to fund working capital,
operating losses, capital expenditures or acquisitions on terms acceptable
to MSTI, or at all;
|
·
|
MSTI
may be unable to refinance its indebtedness on terms acceptable to MSTI,
or at all; and
|
·
|
MSTI
may be more vulnerable to economic downturns and limit MSTI’s ability to
withstand competitive
pressures.
|
Additionally,
covenants in the securities purchase agreement governing the debentures impose
operating and financial restrictions on MSTI. These restrictions prohibit or
limit MSTI’s ability, and the ability of our subsidiaries, to, among other
things:
·
|
pay
cash dividends to our stockholders;
|
·
|
incur
additional indebtedness;
|
·
|
permit
liens on assets or conduct sales of assets;
and
|
·
|
engage
in transactions with affiliates.
|
These
restrictions may limit MSTI’s ability to obtain additional financing, withstand
downturns in MSTI’s business or take advantage of business opportunities.
Moreover, additional debt financing MSTI may seek may contain terms that include
more restrictive covenants, may require repayment on an accelerated schedule or
may impose other obligations that limit the ability to grow MSTI’s business,
acquire needed assets, or take other actions MSTI might otherwise consider
appropriate or desirable.
MSTI's
restrictive debt covenant requires Frank Matarazzo, Chief Executive Officer of
MSTI, to be in his current position through term of the Debenture
agreement.
On
January 31, 2008, the Company amended the Convertible Debenture agreement
requiring indicating that if Frank T. Matarazzo shall cease to serve as Chief
Executive Officer of the MSTI it may constitute an event of
default.
Our
independent auditors have expressed substantial doubt about our ability to
continue as a going concern, which may hinder our ability to obtain future
financing.
In their
report dated March 31, 2008, our independent auditors stated that our financial
statements for the year ended December 31, 2007 were prepared assuming that we
would continue as a going concern, and that they have substantial doubt about
our ability to continue as a going concern. Our auditors’ doubts are
based on our incurring net losses and deficits in cash flows from
operations. We continue to experience net operating
losses. Our ability to continue as a going concern is subject to our
ability to generate a profit and/or obtain necessary funding from outside
sources, including by the sale of our securities, or obtaining loans from
financial institutions, where possible. Our continued net operating
losses and our auditors’ doubts increase the difficulty of our meeting such
goals and our efforts to continue as a going concern may not prove
successful.
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 spent approximately $61,000 in buildout
costs to increase the office space of its Germantown headquarters by
approximately 6,000 square feet in April 2007. The lease on the
additional office space expires in December 2015.
In March
2005, the Company entered into a lease agreement for 6,742 square feet of
commercial office space in Crystal City, Virginia. The Crystal City lease
expires in March 2008. In February 2007, the Company executed a sublease for
this space commencing in April 2007 through the expiration of the lease in March
2008.
The
Company 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 with an option to extend the lease an additional five
years.
Following
the acquisitions of SSI and Ethostream the Company assumed leases on 9,000
square feet of office space in Las Vegas, NV for the SSI office and warehouse
space on a month to month basis and 8,200 square feet of office space in
Milwaukee, WI for Ethostream. The Milwaukee lease expires in May
2011. The Las Vegas, NV office lease will terminate effective April
30, 2008.
ITEM
3. LEGAL
PROCEEDINGS.
None.
ITEM
4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS.
On
December 21, 2007, the Company held its annual meeting of stockholders at which
the Company’s stockholders elected seven (7) directors to serve on the Company’s
Board of Directors and ratified the appointment of the Company’s independent
accountants for 2006. 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
|
48,456,921
|
0
|
5,154,563
|
0
|
Ronald
W. Pickett
|
44,644,974
|
0
|
8,966,510
|
0
|
Thomas
C. Lynch
|
50,274,675
|
0
|
3,336,809
|
0
|
James
L. Peeler
|
50,114,855
|
0
|
3,496,629
|
0
|
Thomas
M. Hall
|
50,188,670
|
0
|
3,422,814
|
0
|
Anthony
J. Paoni
|
50,253,005
|
0
|
3,358,479
|
0
|
Seth
D. Blumenfeld
|
49,285,144
|
0
|
4,326,340
|
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
|
51,337,882
|
1,111,186
|
1,162,414
|
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, 2008, the Company had 241 stockholders of
record and 72,039,455 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 1, 2006 through December 31,
2007. The information provided for the periods listed below was obtained from
the Yahoo! Finance web site.
|
|
High
|
|
|
Low
|
|
Year
Ended December 31, 2007
|
|
|
|
|
|
|
First
Quarter
|
|
$ |
4.00 |
|
|
$ |
2.50 |
|
Second
Quarter
|
|
$ |
2.77 |
|
|
$ |
1.60 |
|
Third
Quarter
|
|
$ |
2.01 |
|
|
$ |
1.20 |
|
Fourth
Quarter
|
|
$ |
1.84 |
|
|
$ |
0.75 |
|
Year
Ended December 31, 2006
|
|
|
|
|
|
|
|
|
First
Quarter
|
|
$ |
4.51 |
|
|
$ |
3.35 |
|
Second
Quarter
|
|
$ |
4.49 |
|
|
$ |
2.46 |
|
Third
Quarter
|
|
$ |
3.50 |
|
|
$ |
1.65 |
|
Fourth
Quarter
|
|
$ |
3.27 |
|
|
$ |
2.32 |
|
The
Company has never paid dividends on its common stock and does not anticipate
paying dividends in the foreseeable future.
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 December 31, 2002 and each fiscal year ending December
31 thereafter through the fiscal year ended December 31, 2007. The total returns
assume $100 invested on December 31, 2002 with reinvestment of
dividends.
ITEM
6. 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)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
Total
revenues
|
|
$ |
14,153 |
|
|
$ |
5,181 |
|
|
$ |
2,488 |
|
|
$ |
698 |
|
|
$ |
94 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
loss
|
|
|
(23,458
|
) |
|
|
(17,563
|
) |
|
|
(15,307
|
) |
|
|
(13,112
|
) |
|
|
(6,564
|
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
(20,391
|
) |
|
|
(27,437
|
) |
|
|
(15,778
|
) |
|
|
(13,093
|
) |
|
|
(7,657
|
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
per share - basic
|
|
|
(0.31
|
) |
|
|
(0.54
|
) |
|
|
(0.35
|
) |
|
|
(0.32
|
) |
|
|
(0.37
|
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
per share - diluted
|
|
|
(0.31
|
) |
|
|
(0.54
|
) |
|
|
(0.35
|
) |
|
|
(0.32
|
) |
|
|
(0.37
|
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted weighted average common shares outstanding
|
|
|
65,415 |
|
|
|
50,824 |
|
|
|
44,743 |
|
|
|
41,384 |
|
|
|
20,702 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Working
capital
|
|
|
(2,991
|
) |
|
|
(531
|
) |
|
|
12,061 |
|
|
|
12,672 |
|
|
|
5,296 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
|
38,741 |
|
|
|
12,517 |
|
|
|
23,291 |
|
|
|
15,493 |
|
|
|
6,176 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
borrowings and current portion of long-term debt
|
|
|
1,471 |
|
|
|
— |
|
|
|
6,350 |
|
|
|
— |
|
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt, net of current portion
|
|
|
4,432 |
|
|
|
— |
|
|
|
9,617 |
|
|
|
588 |
|
|
|
3,132 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity (deficiency)
|
|
|
21,268 |
|
|
|
8,135 |
|
|
|
5,315 |
|
|
|
13,646 |
|
|
|
2,388 |
|
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.
The
Company reports financial results for the following operating business
segments:
Telkonet
Segment
Through
the revolutionary Telkonet iWire System™ , Telkonet utilizes proven PLC
technology to deliver commercial high-speed Broadband access from an IP
“platform” that is easy to deploy, reliable and cost-effective by leveraging a
building’s existing electrical infrastructure. The building’s existing
electrical wiring becomes the backbone of the local area network, which converts
virtually every electrical outlet into a high-speed data port, without the
costly installation of additional wiring or major disruption of business
activity. The segment’s net sales in 2007 were $11,476,983, representing 81% of
the Company’s consolidated net sales.
MST
Segment
MSTI is a
communications service provider offering Quad-Play services to MTU and MDU
residential, hospitality and commercial properties. These Quad-Play services
include video, voice, high-speed internet and Wi-Fi access. In addition, MST
currently offers or plans to offer a variety of next-generation
telecommunications solutions and services, including satellite installation,
video conferencing, surveillance/security and energy management, and other
complementary professional services. The segments’ net sales in 2007 were
$2,675,750, representing 19% of the Company’s consolidated net
sales.
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 superseded 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.
MSTI
accounts for the revenue, costs and expense related to residential cable
services as the related services are performed in accordance with SFAS
No. 51, Financial Reporting by Cable Television Companies. Installation
revenue for residential cable services is recognized to the extent of direct
selling costs incurred. Direct selling costs have exceeded installation revenue
in all reported periods. Generally, credit risk is managed by disconnecting
services to customers who are delinquent.
Management
identifies a delinquent customer based upon the delinquent payment status of an
outstanding invoice, generally greater than 30 days past due
date. The delinquent account designation does not trigger an
accounting transaction until such time the account is deemed uncollectible.
Accounts are deemed uncollectible on a case-by-case basis, at management’s
discretion based upon an examination of the communication with the delinquent
customer and payment history. Typically, accounts are only escalated
to “uncollectible” status after multiple attempts have been made to communicate
with the customer.
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, 2007 and 2006 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, 2007, the Company
experienced approximately 3% percent of units returned. Using this experience
factor a reserve of $102,534 was accrued.
Stock
Based Compensation
On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors including employee
stock options based on estimated fair values. SFAS 123(R) supersedes the
Company’s previous accounting under Accounting Principles Board Opinion
No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods
beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS
123(R). The Company has applied the provisions of SAB 107 in its adoption of
SFAS 123(R).
The
Company adopted SFAS 123(R) using the modified prospective transition method,
which requires the application of the accounting standard as of January 1, 2006,
the first day of the Company’s fiscal year 2006. The Company’s Consolidated
Financial Statements as of and for the year ended December 31, 2007 and 2006
reflect the impact of SFAS 123(R). In accordance with the modified prospective
transition method, the Company’s Consolidated Financial Statements for prior
periods have not been restated to reflect, and do not include, the impact of
SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for
the year ended December 31, 2007 and 2006, was $1,534,260 and $1,080,895,
respectively, net of tax effect.
SFAS
123(R) requires companies to estimate the fair value of share-based payment
awards on the date of grant using an option-pricing model. The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in the Company’s Consolidated
Statement of Operations. Prior to the adoption of SFAS 123(R), the Company
accounted for stock-based awards to employees and directors using the intrinsic
value method in accordance with APB 25 as allowed under Statement of Financial
Accounting Standards No. 123, “Accounting for Stock-Based Compensation”
(“SFAS 123”). Under the intrinsic value method, no stock-based compensation
expense had been recognized in the Company’s Consolidated Statement of
Operations because the exercise price of the Company’s stock options granted to
employees and directors approximated or exceeded the fair market value of the
underlying stock at the date of grant.
Stock-based
compensation expense recognized during the period is based on the value of the
portion of share-based payment awards that is ultimately expected to vest during
the period. Stock-based compensation expense recognized in the Company’s
Consolidated Statement of Operations for the year ended December 31, 2006
included compensation expense for share-based payment awards granted prior to,
but not yet vested as of prior to January 1, 2006 based on the grant date fair
value estimated in accordance with the pro forma provisions of SFAS 123 and
compensation expense for the share-based payment awards granted subsequent to
December 31, 2005 based on the grant date fair value estimated in accordance
with the provisions of SFAS 123(R). SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates. In the Company’s pro forma
information required under SFAS 123 for the periods prior to fiscal 2006, the
Company accounted for forfeitures as they occurred.
Upon
adoption of SFAS 123(R), the Company is using the Black-Scholes option-pricing
model as its method of valuation for share-based awards granted beginning in
fiscal 2006, which was also previously used for the Company’s pro forma
information required under SFAS 123. The Company’s determination of fair value
of share-based payment awards on the date of grant using an option-pricing model
is affected by the Company’s stock price as well as assumptions regarding a
number of highly complex and subjective variables. These variables include, but
are not limited to the Company’s expected stock price volatility over the term
of the awards, and certain other market variables such as the risk free interest
rate.
Goodwill and Other
Intangibles
Goodwill
represents the excess of the cost of businesses acquired over fair value or net
identifiable assets at the date of acquisition. Goodwill is subject to a
periodic impairment assessment by applying a fair value test based upon a
two-step method. The first step of the process compares the fair value of the
reporting unit with the carrying value of the reporting unit, including any
goodwill. The Company utilizes a discounted cash flow valuation methodology to
determine the fair value of the reporting unit. If the fair value of the
reporting unit exceeds the carrying amount of the reporting unit, goodwill is
deemed not to be impaired in which case the second step in the process is
unnecessary. If the carrying amount exceeds fair value, the Company performs the
second step to measure the amount of impairment loss. Any impairment loss is
measured by comparing the implied fair value of goodwill, calculated per SFAS
No. 142, with the carrying amount of goodwill at the reporting unit, with
the excess of the carrying amount over the fair value recognized as an
impairment loss.
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 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.
Year
Ended December 31, 2007 Compared to Year Ended December 31,
2006
The
Company’s revenue consists of product sales and a recurring (lease) model in the
commercial, government and international markets of the Telkonet Segment
including activity for SSI and Ethostream from the date of acquisition through
December 31, 2007. The MST Segment revenue consists of Quad-Play services
provided to a subscriber portfolio of MDU properties with bulk service
agreements and/or access licenses to service the individual subscribers in
metropolitan New York. The MST Segment is included in revenue since the
acquisition of MST on January 31, 2006.
The table
below outlines product versus recurring (lease) revenues for comparable
periods:
|
|
Year
ended December 31,
|
Revenue:
|
|
2007
|
|
2006
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
9,168,077
|
|
65%
|
|
$
|
3,092,967
|
|
60%
|
|
$
|
6,075,110
|
|
196%
|
Rental
(lease)
|
|
|
4,984,656
|
|
35%
|
|
|
2,088,361
|
|
40%
|
|
|
2,896,295
|
|
139%
|
Total
|
|
|
14,152,733
|
|
100%
|
|
$
|
5,181,328
|
|
100%
|
|
|
8,971,405
|
|
173%
|
Product
revenue
The
Telkonet Segment product revenue principally arises from the sale and
installation of broadband networking and energy management equipment, including
the Telkonet iWire System™ to commercial resellers, and directly to customers in
the hospitality, government and international markets. The Telkonet iWire
SystemTM
consists of the Telkonet Gateway, the Telkonet Extender, the patented Telkonet
Coupler, and the Telkonet iBridge, which “bridges” the connection from a
computer to the data port. The Telkonet SmartEnergy energy management solution
consists of thermostats, sensors and controllers. Product revenue in
the Telkonet Segment increased by approximately $5,961,000 for the year ended
December 31, 2007, including approximately $3,316,000 attributed to the sale of
energy management products since the acquisition of SSI in March 2007 , and
approximately $1,905,000 of additional products and services to the hospitality
market from the acquisition of Ethostream in March
2007. Additionally, revenues generated in the government market were
approximately $1,540,000 for the year ended December 31, 2007, and were related
to site evaluations and deployments of certain government installations. We
anticipate a continued upward trend of quarterly growth in the hospitality,
energy management utility and government markets of the Telkonet
segment.
The MST
Segment product revenue consists of equipment, installations and ancillary
services provided to customers independent of the subscriber model. Product
revenue in this segment for the year ended December 31, 2007 was approximately
$279,000.
Recurring
(lease) Revenue
The
increase in recurring revenue in the Telkonet Segment for the year ended
December 31, 2007, reflects the addition of Ethostream’s hospitality portfolio
in March 2007. During the year ended December 31, 2007, we added approximately
2,100 hotels to our broadband network portfolio, and currently support over
190,000 HSIA rooms, resulting in additional recurring revenue of $2,090,000 for
the year ended December 31, 2007. The Telkonet Segment monthly recurring revenue
is approximately $300,000 and we anticipate growth to our subscriber base as we
deploy additional sites upon installation of Telkonet products.
The
recurring revenue for the MST Segment subscriber base increased by approximately
$806,000 for the year ended December 31, 2007. The MST Segment subscriber
portfolio includes approximately 22 MDU properties with bulk service agreements
and/or access licenses to service the individual subscribers in metropolitan New
York. Additionally, the MST Segment added approximately 1,900 internet and
telephone subscribers through the acquisition of Newport Telecommunications Co.
in July 2007.
Cost
of Sales
|
|
Year
ended December 31,
|
Cost
of Sales:
|
|
2007
|
|
2006
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
7,165,120
|
|
78%
|
|
$
|
2,062,399
|
|
67%
|
|
$
|
5,102,721
|
|
247%
|
Rental
(lease)
|
|
|
4,505,476
|
|
90%
|
|
|
2,418,260
|
|
116%
|
|
|
2,087,216
|
|
86%
|
Total
|
|
|
11,670,596
|
|
82%
|
|
$
|
4,480,659
|
|
86%
|
|
|
7,189,937
|
|
160%
|
Product
Costs
The
Telkonet Segment product costs include equipment and installation labor related
to the Telkonet iWire SystemTM product
suite, as well as wireless networking and energy management
products. During the year ended December 31, 2007, product costs
increased by approximately $5,103,000 in conjunction with the increased sales to
the hospitality, energy management and government markets.
The MST
Segment product costs primarily consist of equipment and installation labor for
installation and ancillary services provided to customers. For the year ended
December 31, 2007, product costs amounted to approximately
$299,000.
Recurring
(lease) Costs
The
Telkonet Segment recurring costs increased by approximately $822,000 for the
year ended December 31, 2007, when compared to the prior year. This
increase is primarily due to the addition of Ethostream’s customer service and
support infrastructure, including an internal call center, to support the
Telkonet Segment recurring revenue from its customer portfolio.
The MST
Segment’s recurring costs increased by $1,265,000 for the year ended December
31, 2007. These costs consist of customer support, programming and
amortization of the capitalized costs to support the subscriber revenue.
Although MSTI's programming fees are a significant portion of the cost,
MSTI continues to pursue competitive agreements and volume discounts in
conjunction with the anticipated growth of the subscriber base. The customer
support costs include build-out of the support services necessary to develop and
support the build-out of the Quad-Play subscriber base in metropolitan New York.
The capitalized costs are amortized over the lease term and include equipment
and installation labor. Additionally, MSTI’s recurring costs
increased due to the addition of the Newport subscribers in July
2007.
Gross
Profit
|
|
Year
ended December 31,
|
Gross
Profit:
|
|
2007
|
|
2006
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
2,002,957
|
|
22%
|
|
$
|
1,030,568
|
|
33%
|
|
$
|
972,389
|
|
94%
|
Rental
(lease)
|
|
|
479,180
|
|
10%
|
|
|
(329,899
|
)
|
-16%
|
|
|
809,079
|
|
-245%
|
Total
|
|
|
2,482,137
|
|
18%
|
|
|
700,669
|
|
14%
|
|
|
1,781,468
|
|
254%
|
Product
Gross Profit
The gross
profit percentage for the year ended December 31, 2007 decreased compared to the
prior year. The primary result of the decrease is attributable to increased
costs in shipping and travel in the fourth quarter of 2007. Additionally, the
Company committed significant resources to achieve a year end commitment with
InTown Suites which resulted in the $3.8 million commitment for
2008. We anticipate an increase in our gross profit trend for
product sales as energy management and hospitality opportunities expand as well
as the focus on opportunities in the government and utility
markets. Additionally, the integration of acquired companies has
resulted in opportunities to increase operating efficiency by eliminating
redundant processes.
Recurring
(lease) Gross Profit
The
Telkonet Segment’s gross profit associated with recurring (lease) revenue
increased for the year ended December 31, 2007 by approximately
$1,268,000. Gross profit represented approximately 48% of recurring
(lease) revenue for the year ended December 31, 2007. Ethostream’s
centralized remote monitoring and management platform and customer support
center has provided the platform to increase the gross profit on the Telkonet
Segment recurring revenue.
The MST
Segment’s gross profit decreased by approximately $458,000 for the year ended
December 31, 2007, compared to the prior year, primarily due to increased
programming costs and expenses related to the addition of the IPTV platform to
the existing infrastructure. MSTI anticipates that it will increase
its gross profit through expanding its subscriber base and reduce programming
costs through the IPTV platform. Gross profit represented
approximately -36% of recurring (lease) revenue for the year ended December 31,
2007.
Operating
Expenses
|
|
Year
ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
25,939,690 |
|
|
$ |
18,263,255 |
|
|
$ |
7,676,435 |
|
|
|
42% |
|
Overall expenses increased for the year
ended December 31, 2007, when compared to the prior year, by approximately
$7,676,435, or 42%. The principal reasons for this increase were the additional
operating costs assumed through the acquisitions of SSI and Ethostream, which
accounted for approximately $3,275,000 of the total increase. There
was a one time, non-cash charge to operations for the impairment write down of
MSTI’s goodwill and fixed assets in the amount of approximately $2,471,000 for
the year ended December 31, 2007. Additionally, we increased research
and development costs (see discussion below), as well as our non-cash stock
compensation by $984,000, which is related to stock options and shares earned by
employees and consultants of Telkonet and MSTI, and additional non-cash
depreciation expense of $342,000, for the year ended December 31,
2007. Also, there was an increase in selling and administrative
expenses for the Telkonet Segment and MST Segment during the year ended December
31, 2007. We expect our operating expenses to decrease in 2008, when
compared to year ended December 31, 2007, as we continue the consolidation of
the operations within the Telkonet Segment including the closure of the Las
Vegas operations and increase in our overall operating
efficiency.
Research
and Development
|
|
Year
ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
2,349,690 |
|
|
$ |
1,925,746 |
|
|
$ |
423,944 |
|
|
|
22% |
|
The
Telkonet Segment research and development costs related to both existing and
development-stage products are expensed in the period that they are incurred.
Total expenses for the year ended December 31, 2007 increased by $423,944, or
22%, when compared to the prior year. This increase was primarily related to the
development of the next generation (Series Five) product suite and the
integration of new applications to the Telkonet iWire System, as well as
additional development of energy management products pursuant to the acquisition
of SSI.
Selling,
General and Administrative Expenses
|
|
Year
ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
17,897,974 |
|
|
$ |
14,346,364 |
|
|
$ |
3,551,610 |
|
|
|
25% |
|
Selling,
general and administrative expenses increased for the year ended December 31,
2007 over the comparable prior year by $3,551,610 or 25%. This increase is
primarily attributed to the administrative expenses of the acquired businesses
of approximately $2,755,000. Additionally, sales and marketing costs
increased following the launch of our new integrated product offerings, and
professional fees increased due to the equity financing in February 2007, the
acquisitions of SSI and Ethostream, and the investment in Geeks on Call America,
Inc. Prior year expenses related to the amortization and write-off of
financing fees $535,000 partially offset the overall increase. We expect
selling, general and administrative expenses to decrease in 2008, when compared
to the year ended December 31, 2007 as we continue the consolidation of the
operations within the Telkonet Segment including the closure of the Las Vegas
facility and increase in overall operating efficiency.
MSTI
selling, general, and administrative expenses which consist of commissions,
salaries, advertising, professional service fees, investor relations services
and overhead expenses, totaled approximately $4,100,000 during 2007 as compared
to $2,900,000 for 2006. This increase is primarily attributable to an
overall increase in administrative and investors relations services costs
compared to the prior period in conjunction with the acquisition of Newport
Telecommunications and the merger of MST with a public shell
corporation.
Year
Ended December 31, 2006 Compared to Year Ended December 31,
2005
Revenues
The
Company’s revenue consists of direct product sales and a recurring (lease) model
in the commercial, government and international markets of the Telkonet Segment.
Additionally, the MST Segment consists of eleven months of revenue from date of
acquisition through December 31, 2006 providing certain Quad-Play services. The
table below outlines product versus recurring (lease) revenues for comparable
periods:
|
|
Year
ended December 31,
|
Revenue:
|
|
2006
|
|
2005
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
3,092,967
|
|
60%
|
|
$
|
1,769,727
|
|
71%
|
|
$
|
1,323,240
|
|
75%
|
Rental
(lease)
|
|
|
2,088,361
|
|
40%
|
|
|
718,596
|
|
29%
|
|
|
1,369,765
|
|
191%
|
Total
|
|
|
5,181,328
|
|
100%
|
|
$
|
2,488,323
|
|
100%
|
|
|
2,693,005
|
|
108%
|
Product
Revenue
Product
revenue in the Telkonet Segment increased approximately $800,000, excluding the
sale of certain rental contract agreements to Hospitality Leasing Corporation,
for the year ended December 31, 2006, and the MST Segment revenue amounted to
approximately $280,000 in installation and ancillary services provided to
customers for the eleven months ended December 31, 2006. The Telkonet
Segment product revenue principally arises from the sale of the Telkonet iWire
SystemTM to
commercial resellers as well as directly to customers. The Telkonet
iWire System™ utilizes a building’s electrical wires as the backbone for a local
area network, converting electrical outlets into data ports. The
Telkonet iWire SystemTM
consists of the Telkonet Gateway, the Telkonet Extender, the patented Telkonet
Coupler, and the Telkonet iBridge, which “bridges” the connection from a
computer to the data port. Customers can purchase Telkonet iBridges
on an as-needed basis, allowing vendors to supply equipment to meet their
occupancy demands. Telkonet’s customers to date have been principally
located in the Commercial (Hospitality and Multi-Dwelling) and International
markets. Revenues to date have been principally derived from the Commercial
(Hospitality and Multi-Dwelling) and International business units. The Telkonet
Segment anticipates continued growth in Commercial and International product
revenue in the Value Added Reseller (VAR) purchase programs. The Telkonet
Segment expanded its international sales and marketing efforts upon receiving
its European certification (CE). The Company has received the FIPS 140-2
certification and continues to pursue opportunities within the government
sector. The Company has extended its iWire SystemTM to
included energy information, management and control solutions for residential
and commercial buildings.
In the
year ended December 31, 2006 and 2005, Telkonet 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 $1,209,000 and $732,000 including the customer support
component of approximately $370,000 and $205,000 which Telkonet will retain and
continue to receive monthly customer support payments over the remaining average
unexpired lease term of 36 and 26 months, respectively. In the years ending
December 31, 2006 and 2005, the Company recognized revenue of approximately
$683,000 and $439,000, respectively, 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 $340,000 and
$267,000, respectively, and expensed associated taxes of approximately $64,000
and $40,000, respectively.
Rental
(lease) Revenue
A
significant increase in the overall recurring revenue was attributable to the
addition of the MST Segment subscriber base in February 2006 and amounted to
approximately $1,476,000 for the eleven months ended December 31, 2006. The MST
Segment subscriber portfolio includes approximately 22 MDU properties with
service bulk service agreements and/or access licenses to service the individual
subscribers in metropolitan New York. The Telkonet Segment rental (lease)
revenue decreased by $95,000 in the year ended December 31, 2006 compared to the
prior year primarily due to the sale of rental contracts to Hospitality Leasing
Corporation and the VAR purchase program sales effort.
Cost
of Sales
|
|
Year
ended December 31,
|
Cost
of Sales:
|
|
2006
|
|
2005
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
2,062,399
|
|
67%
|
|
$
|
1,183,574
|
|
67%
|
|
$
|
878,825
|
|
74%
|
Rental
(lease)
|
|
|
2,418,260
|
|
116%
|
|
|
533,605
|
|
74%
|
|
|
1,884,655
|
|
353%
|
Total
|
|
|
4,480,659
|
|
86%
|
|
$
|
1,717,179
|
|
69%
|
|
|
2,763,480
|
|
161%
|
Product
Costs
The
Telkonet Segment product cost for the Telkonet iWire SystemTM product
suite primarily includes equipment costs and installation labor. The related
product cost in connection with the non-recourse sale of approximately
$1,209,000 of rental contract agreements amounted to approximately $347,000 of
previously capitalized equipment cost and other related cost.
The MST
product costs primarily consist of equipment and installation labor for
installation and ancillary services provided to customers.
Rental
(lease) Costs
MST
Segment recurring costs primarily represent customer support, programming and
amortization of the capitalized costs to support the subscriber revenue.
Although MST’s programming fees are a significant portion of the cost, MST
continues to pursue competitive agreements and volume discounts in conjunction
with the growth of the subscriber base. The customer support costs for the year
ended December 31, 2006 include build-out of the support services necessary for
the anticipated increase in subscribers in metropolitan New York. The
capitalized costs are amortized over the lease term and include equipment and
installation labor. The Telkonet Segment recurring costs increased for the year
ended December 31, 2006 compared to the prior year due to an increase in the
number of iBridges supported and through the utilization of an out-sourced Tier
I call center which was initiated in July 2005.
Gross
Profit
|
|
Year
ended December 31,
|
Gross
Profit:
|
|
2006
|
|
2005
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
1,030,568
|
|
33%
|
|
$
|
586,153
|
|
33%
|
|
$
|
444,415
|
|
76%
|
Rental
(lease)
|
|
|
(329,899
|
)
|
-16%
|
|
|
184,991
|
|
26%
|
|
|
(514,890
|
)
|
-278%
|
Total
|
|
|
700,669
|
|
14%
|
|
|
771,144
|
|
31%
|
|
|
(70,475
|
)
|
-9%
|
Product
Gross Profit
The
increase of Telkonet gross profit for the year 2006 associated with product
revenues over the prior year offsets by ancillary services provided by
MST.
Rental
(lease) Gross Profit
Telkonet
gross profit associated with recurring (lease) revenue decreased as a result of
the sale of rental contracts to Hospitality Leasing Corporation resulting in a
decrease in recurring (lease) revenue which was more than offset by increased
customer support services related to the increased number of iBridges supported.
As MST developed the infrastructure and continued to build-out the subscriber
base, the gross margins were $417,664 or -28% for the 11 months end December 31,
2006, primarily due to programming costs and the support infrastructure. MST
anticipates increased margins in 2008 as the projected new subscriber base
absorbs the current infrastructure.
Operating
Expenses
|
Year
ended December 31,
|
|
|
2006
|
|
2005
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
Total
|
18,263,255
|
|
$
|
16,077,912
|
|
2,185,343
|
|
|
14%
|
|
Overall
expenses increased for the year ended December 31, 2006 over the comparable
period in 2005 by $2,185,343 or 14%. Of this increase, operating expenses
related to the acquisition of MST represented $2,632,449 and were principally
due to salary and other operating costs related to the build-out of the “Quad
Play” subscriber infrastructure, including managerial and back-office support
personnel, professional fees and the amortization of MST’s intangible
assets. Additionally, the Telkonet operating expenses decreased for the
year ended December 31, 2006 due to a reduction in research and development
costs as well as a cost incurred in 2005 for the impairment of Telkonet’s
investment in Amperion.
Product
Research and Development
|
|
Year
ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,925,746 |
|
|
$ |
2,096,104 |
|
|
$ |
(170,358 |
) |
|
|
-8% |
|
Telkonet’s
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,
2006 decreased over the comparable prior year by $170,358 or -8%. This decrease
was primarily related to costs associated to CE, FIPS 140-2 and other required
certifications of the Company’s product that were incurred in 2005.
Selling,
General and Administrative
|
|
Year
ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
14,346,364 |
|
|
$ |
12,041,661 |
|
|
$ |
2,304,703 |
|
|
|
19% |
|
Selling,
general and administrative expenses increased for the year ended December 31,
2006 over the comparable prior year by $2,304,703 or 19%. This increase is
attributed to the administrative expenses associated with the acquisition of MST
such as payroll costs, advertising, trade shows, facility costs and professional
fees. Also, the selling, general and administrative expenses for Telkonet have
remained approximately the same as the prior year.
Liquidity
and Capital Resources
Our
working capital decreased by $2,460,030 during the twelve months ended December
31, 2007 from a working capital deficit of $(530,634) at December 31, 2006 to a
working capital deficit of $(2,990,664) at December 31, 2007. The decrease in
working capital for the twelve months ended December 31, 2007, is due to a
combination of factors, of which the significant factors are set out
below:
|
·
|
Cash
had a net decrease from working capital by $14,454 for the twelve months
ended December 31, 2007. The most significant uses and proceeds of cash
are as follows:
|
|
o
|
Approximately
$13,989,000 of cash consumed directly in operating
activities
|
|
o
|
A
cash payment of $900,000 representing the second installment of the cash
portion of the purchase price for the acquisition of
MST
|
|
o
|
The
cash payment in the acquisition of Ethostream amounted to approximately
$2,000,000, and as part of the acquisition the debt payoff amounted to
approximately $200,000—see discussion of acquisition
below;
|
|
|
|
|
o
|
The
cash payments in the acquisition of SSI amounted to approximately
$875,000—see discussion of acquisition
below;
|
|
o
|
A
private placement from the sale of 4,000,000 shares of common stock at
$2.50 per share provided proceeds of $9,610,000.
|
|
|
|
|
o
|
A
private placement and sale of debentures by MSTI Holdings Inc. for
proceeds, net of placement fees, of $2,694,000 and $5,303,000,
respectively.
|
|
|
|
|
o
|
A
bridge loan in the amount of $1,500,000 issued as a Senior Note payable to
GRQ Consultants, Inc.
|
|
|
|
|
o
|
A
sale of Telkonet’s investment in BPL Global for gross proceeds of
$2,000,000
|
|
|
|
|
o |
A
cash payment of $1,118,000 for the acquisition of the assets of Newport
Telecommunications Co. by MSTI Holdings,
Inc. |
Of the
total $7,004,168 current assets as of December 31, 2007, cash represented
$1,629,584. Of the total $3,766,079 current assets as of December 31, 2006, cash
represented $1,644,037.
Senior
Notes
In 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 remaining outstanding senior note of $100,000 matured and was
repaid in June 2006.
Convertible
Senior Notes
In
October 2005, the Company completed an offering of convertible senior notes (the
“Notes”) in the aggregate principal amount of $20 million. The capital raised in
the Note offering was used for general working capital purposes. The Notes bore
interest at a rate of 7.25%, payable in cash, and called for monthly principal
installments beginning March 1, 2006. The maturity date was 3 years from the
date of issuance of the Notes. The Noteholders were entitled, at any time, to
convert any portion of the outstanding and unpaid Conversion Amount into shares
of Company common stock. At the option of the Company, the principal payments
could be paid either in cash or in common stock. Upon conversion into common
stock, the value of the stock was determined by the lower of $5 or 92.5% of the
average recent market price. The Company also issued one million warrants to the
Noteholders exercisable for five years at $5 per share. At any time after six
months, should the stock trade at or above $8.75 for 20 of 30 consecutive
trading days, the Company could cause a mandatory redemption and conversion to
shares at $5 per share. At any time, the Company was entitled to pre-pay the
notes with cash or common stock. If the Company elected to use common stock to
pre-pay the Notes, the price of the common stock would be deemed to be the lower
of $5 or 92.5% of the average recent market price. If the Company prepaid the
Notes other than by mandatory conversion, the Company was obligated to 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 agreed to maintain a letter of credit in favor of the Noteholders equal
to $10 million. Once the principal amount outstanding on the notes declined
below $15 million, the balance on the letter of credit was reduced by $.50 for
every $1 amortized.
These
notes were repaid on August 14, 2006 as discussed in greater detail below under
“Early Extinguishment of Debt.”
Principal Payments of
Debt
For the
period of January 1, 2006 through August 14, 2006, the Company paid down
principal of $1,250,000 in cash and issued an aggregate of 4,226,246 shares of
common stock in connection with the conversion of $10,821,686 aggregate
principal amount of the Senior Convertible Notes. Pursuant to the note
agreement, the Company issued an additional 1,081,820 warrants to the
Noteholders covering 65% of the $8,321,686 accelerated principal at a strike
price of $5 per share.
For the
period of January 1, 2006 through August 14, 2006, the Company amortized the
debt discount to the beneficial conversion feature and value of the attached
warrants, and recorded non-cash interest expense in the amount of $251,759 and
$500,353, respectively. The Company also wrote-off the unamortized debt discount
attributed to the beneficial conversion feature and the value of the attached
warrants in the amount of $708,338 and $1,397,857, respectively, in connection
with paydown and conversion of the note.
Early
Extinguishment of Debt
On August
14, 2006, the Company executed separate settlement agreements with the lenders
of its Convertible Senior Notes. Pursuant to the settlement agreements the
Company paid to the lenders in the aggregate $9,910,392 plus accrued but unpaid
interest of $23,951 and certain premiums specified in the Notes in satisfaction
of the amounts then outstanding under the Notes. Of the amount paid to the
lenders under the Notes, $6,500,000 was paid in cash through a drawdown on a
letter of credit previously pledged as collateral for the Company’s obligations
under the Notes. The remaining note balance of $1,428,314 and a Redemption
Premium of $1,982,078, calculated as 25% of remaining principal, was paid to the
lenders in shares of Company’s common stock valued at the lower of $5.00 per
share and 92.5% of the arithmetic average of the weighted average price of the
Company’s common stock on the American Stock Exchange for the twenty trading
days beginning on August 16, 2006. The Company also issued 862,452 warrants to
purchase shares of the Company’s common stock at the exercise price of the lower
of $2.58 per share and 92.5% of the average trading price as described above.
The Company accounted for the Redemption Premium and the warrants as non-cash
early extinguishment of debt expense during the year ended December 31, 2006.
As a
result of the execution of the settlement agreements and the payments required
thereby, the Company fully repaid and believes it satisfied all of its
obligations under the Notes. The Company also agreed to pay the expenses of the
lenders incurred in connection with the negotiation and execution of the
settlement agreements. The settlement agreements were negotiated following the
allegation by one of the lenders that the Company’s failure to meet the minimum
revenue test for the period ending June 30, 2006 as specified on the Notes may
have constituted an event of default under the Notes, which allegation the
Company disputed.
In
conjunction with the settlement agreement, the Company recorded $4,626,679 of
loss from early extinguishment of debt, which consists of $1,982,078 redemption
premium paid with the Company’s common stock, $1,014,934 of additional warrants
issued to the lenders, write-off of the remaining unamortized debt discount
attributed to the beneficial conversion feature and the value of the attached
warrants in the amount of $430,040 and $845,143, respectively, and write-off of
the remaining unamortized financing costs of $354,484.
The
settlement agreements provide that the number of shares issued to the
noteholders shall be adjusted based upon the arithmetic average of the weighted
average price of the Company’s common stock on the American Stock Exchange for
the twenty trading days immediately following the settlement date. The
Company has concluded that, based upon the weighted average of the Company's
common stock between August 16, 2006 and September 13, 2006, the Company is
entitled to a refund from the two noteholders. One of the noteholders has
informed the Company that it does not believe such a refund is required.
As a result, the Company has declined to deliver to the noteholders certain
stock purchase warrants issued to them pursuant to the settlement agreements
pending resolution of this disagreement. One of the noteholders has alleged that
the Company has failed to satisfy its obligations under the settlement agreement
by failing to deliver the warrants. In addition, the noteholder maintains that
the Company has breached certain provisions of the registration rights agreement
and, as a result of such breach, such noteholder claims that it is entitled to
receive liquidated damages from the Company. As of March 28, 2008, no legal
claim has been filed by the noteholder.
MSTI
Holdings, Inc. Convertible Debentures
In May
2007, MSTI Holdings Inc., a majority owned subsidiary of the Company, issued
senior convertible debentures having a principal value of $6,576,350 to
investors, including an original issue discount of $526,350, in exchange for
$6,050,000 from investors, exclusive of placement fees. The original issue
discount to the Debentures is amortized over 12 months. The Debentures
accrue interest at 8% per annum commencing on the first anniversary of the
original issue date of the Debentures, payable quarterly in cash or common
stock, at MSTI Holdings Inc.'s option, and mature on April 30, 2010. The
Debentures are not callable and are convertible at a conversion price of $0.65
per share into 10,117,462 shares of MSTI Holdings Inc. common
stock.
Acquisition
of Microwave Satellite Technologies, Inc.
On
January 31, 2006, the Company acquired a 90% interest in MST from Frank
Matarazzo, the sole stockholder of MST in exchange for $1.8 million in cash and
1.6 million unregistered shares of the Company’s common stock for an aggregate
purchase price of $9,000,000. The cash portion of the purchase price was paid in
two installments, $900,000 at closing and $900,000 in February 2007. The stock
portion is payable from shares held in escrow, 400,000 shares of which were paid
at closing and the remaining 1,200,000 shares of which shall be issued based on
the achievement of 3,300 “Triple Play” subscribers over a three year period.
During the year ended December 31, 2006, the Company issued 200,000 shares of
the purchase price contingency valued at $900,000 as an adjustment to goodwill.
In the event the Company’s common stock price is below $4.50 per share upon
issuance of the shares from escrow, a pro rata adjustment in the number of
shares will be required to support the aggregate consideration of $5.4 million.
As of December 31, 2006, the Company’s common stock price was below $4.50. To
the extent that the market price of Company’s common stock is below $4.50 per
share upon issuance of the shares from escrow, the number of shares issuable on
conversion is ratably increased, which could result in further dilution of the
Company’s stockholders.
Acquisition
of Smart Systems International (SSI)
On March
9, 2007, the Company acquired substantially all of the assets of Smart Systems
International (SSI), a leading provider of energy management products and
solutions to customers in the United States and Canada for cash and Company
common stock having an aggregate value of $7,000,000. The purchase price was
comprised of $875,000 in cash and 2,227,273 shares of the Company’s common
stock. 1,090,909 shares were held in escrow for a period of one year
following the closing for the purpose of satisfying certain potential
indemnification obligations under the purchase agreement could be satisfied. The
aggregate number of shares held in escrow was subject to adjustment upward or
downward depending upon the trading price of the Company’s common stock during
the one year period following the closing date. On March 12, 2008,
the Company released these shares from escrow and plans to issue an additional
1,909,091 shares pursuant to the adjustment provisions of the SSI asset purchase
agreement.
Acquisition
of Ethostream, LLC
On March
15, 2007, the Company acquired 100% of the outstanding membership units of
Ethostream, LLC, a network solutions integration company that offers
installation, sales and service to the hospitality industry. The Ethostream
acquisition enables Telkonet to provide installation and support for PLC
products and third party applications to customers across North America. The
purchase price of $11,756,097 was comprised of $2.0 million in cash and
3,459,609 shares of the Company’s common stock. The entire stock portion of the
purchase price is being held in escrow to satisfy certain potential
indemnification obligations of the sellers under the purchase agreement. The
shares held in escrow are distributable over the three years following the
closing.
Proceeds
from the issuance of common stock
During
the twelve months ended December 31, 2007, the Company received $124,460 from
the exercise of employee stock options. No non-employee options
or warrants were exercised during the year ended December 31, 2007.
In
February 2007, the Company issued 4,000,000 shares of common stock valued at
$2.50 per share for an aggregate purchase price of $10,000,000. The Company also
issued to this investor warrants to purchase 2.6 million shares of its common
stock at an exercise price of $4.17 per share.
Additionally,
during the twelve months ended December 31, 2007, MSTI Holdings Inc. completed a
private placement resulting in proceeds of approximately
$2,694,000.
Cash
flow analysis
Cash
utilized in operating activities was $13,989,434 during the year ended December
31, 2007 compared to $13,971,529 and during the year ended December 31, 2006,
respectively. The primary use of cash during the twelve months ended December
31, 2007 was net operating expenses of the Company.
The
Company utilized and was provided cash for investing activities $5,048,217 and
$6,717,442 during the twelve months ended December 31, 2007 and 2006,
respectively. These expenditures were primarily the result of the payment of the
cash portion of the MST purchase price of $900,000 in February 2007, and cash
payments of $875,000 and $2,000,000, for the acquisition of SSI and Ethostream,
respectively, in March 2007 and $1,020,000 for the acquisition of Newport
Telecommunications in July 2007. The proceeds of the sale of the investment
in BPL Global provided $2,000,000 in November 2007. Additionally, cost of
equipment under operating leases, and cable and related equipment, amounted to
$1,568,651 and $1,939,759 for the twelve months ended December 31, 2007 and
2006. Equipment costs were net of $350,571 in proceeds from the sale of certain
equipment under operating leases during the twelve months ended December 31,
2006. Purchases of property and equipment amounted to $310,715 and
$734,888 for the twelve months ended December 31, 2007 and 2006,
respectively. During the period ended December 31, 2006, the proceeds
from the release of funds from the Restricted Certificate of Deposit provided
$10,000,000 in conjunction with the conversion and settlement agreement with the
lenders under the Company’s Convertible Senior Notes. The expenditures were
primarily the result of the acquisition of MST in January 2006 of $958,438, net
of acquired cash. Additionally, cost of equipment under operating leases
amounted to $1,589,188, net of proceeds from the sale of certain equipment under
operating leases of $350,571, and $458,271 for the December 31, 2006 and 2005,
respectively. Furthermore, purchases of property and equipment amounted to
$734,888 and $336,448 for the year ended December 31, 2006 and 2005,
respectively.
The
Company was provided cash from financing activities of $19,023,197 and $476,045
during the twelve months ended December 31, 2007 and 2006, respectively. The
financing activities involved the sale of 4.0 million shares of common stock at
$2.50 per share for a total of $9,610,000, net of placement fees, in February
2007. Additionally, proceeds from the exercise of stock options and warrants
were $124,460 and $2,684,663 during the twelve months ended December 31, 2007
and 2006, respectively. In July 2007, the Company issued a senior note payable
in the principal amount of $1,500,000. Through its majority-owned
subsidiary MSTI Holdings, Inc., the Company raised $5,303,238 through the sale
of debentures, and $2,694,020 through the sale of common stock, during the
twelve months ended December 31, 2007. In 2006, the proceeds of the financing
activities were offset by repayment of debt principal of $8,162,119, including
$7,750,000 of principal payments in conjunction with the conversion and
settlement agreement with the lenders of its Convertible Senior Notes and
approximately $410,000 in conjunction with the acquisition of MST.
We are
reducing cash required for operations by reducing operating costs and reducing
staff levels. In addition, we are working to manage our current liabilities
while we continue to make changes in operations to improve our cash flow and
liquidity position.
Our
registered independent certified public accountants have stated in their report
dated March 31, 2008, that we have incurred operating losses in the past years,
and that we are dependent upon management's ability to develop profitable
operations. These factors among others may raise substantial doubt about our
ability to continue as a going concern.
While we
have raised capital in the First Quarter of 2008 to meet our working capital and
financing needs, additional financing is required in order to meet our current
and projected cashflow requirements from operations and development . Additional
investments are being sought, but we cannot guarantee that we will be able to
obtain such investments. Financing transactions may include the issuance of
equity or debt securities, obtaining credit facilities, or other financing
mechanisms. However, the trading price of our common stock and the downturn in
the U.S. stock and debt markets could make it more difficult to obtain financing
through the issuance of equity or debt securities. Even if we are able to raise
the funds required, it is possible that we could incur unexpected costs and
expenses, fail to collect significant amounts owed to us, or experience
unexpected cash requirements that would force us to seek alternative financing.
Further, if we issue additional equity or debt securities, stockholders may
experience additional dilution or the new equity securities may have rights,
preferences or privileges senior to those of existing holders of our common
stock. If additional financing is not available or is not available on
acceptable terms, we will have to curtail our operations.
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
We do not
maintain off-balance sheet arrangements nor do we participate in any
non-exchange traded contracts requiring fair value accounting
treatment.
Acquisition
or Disposition of Plant and Equipment
During
the year ended December 31, 2007, fixed assets increased approximately
$2,341,000, including $2,323,000 for the MST Segment primarily from the addition
of the Newport assets acquired in July 2007 and equipment purchased for the MST
build-out. The remainder is related to computer equipment and peripherals used
in day-to-day operations. The Company anticipates significant expenditures in
the MST Segment to continue the build-out the head-end equipment, IPTV and other
related projects. The Telkonet Segment 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. This lease terminates in March 2008.
MSTI
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.
Following
the acquisitions of SSI and Ethostream, the Company assumed leases on 9,000
square feet of office space in Las Vegas, NV for the SSI office and warehouse
space on a month to month basis and 4,100 square feet of office space in
Milwaukee, WI for Ethostream. The Milwaukee lease expires in May
2011. The Las Vegas, NV office lease will terminate effective
April 30, 2008.
New
Accounting Pronouncements
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose
to measure many financial instruments, and certain other items, at fair value.
SFAS 159 applies to reporting periods beginning after November 15, 2007. The
adoption of SFAS 159 is not expected to have a material impact on the Company’s
financial condition or results of operations.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141(R), “Business Combinations” (“Statement 141(R)”) and Financial Accounting
Standards No. 160, “Noncontrolling Interests in Consolidated Financial
Statements” (“Statement 160”). Statements 141(R) and 160 require most
identifiable assets, liabilities, noncontrolling interests and goodwill acquired
in a business combination to be recorded at “full fair value” and require
noncontrolling interests (previously referred to as minority interests) to be
reported as a component of equity. Both statements are effective for
fiscal years beginning after December 15, 2008. Statement 141(R) will
be applied to business combinations occurring after the effective
date. Statement 160 will be applied prospectively to all
noncontrolling interests, including any that arose before the effective
date. The Company has not determined the effect, if any, the adoption
of Statements 141(R) and 160 will have on the Company’s financial position or
results of operations.
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
|
|
$
|
6,576,350
|
|
|
|
-
|
|
|
|
6,576,350
|
|
|
|
-
|
|
|
|
-
|
|
Current
Debt Obligations
|
|
$
|
1,500,000
|
|
|
|
1,500,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Capital
Lease Obligations
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Operating
Lease Obligations
|
|
$
|
2,082,799
|
|
|
|
539,681
|
|
|
|
852,142
|
|
|
|
348,232
|
|
|
|
342,744
|
|
Purchase
Obligations (1)(2)
|
|
$
|
2,386,564
|
|
|
|
2,576,442
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Other
Long-Term Liabilities Reflected on the
Registrant’s Balance Sheet Under GAAP
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
12,545,713
|
|
|
|
4,616,123
|
|
|
|
7,428,492
|
|
|
|
348,232
|
|
|
|
342,744
|
|
(1)
|
Purchase
commitment for the IPTV build-out of MSTI subscriber base in the second
half of 2007 in the amount of
$476,776.
|
(2)
|
Purchase
commitment of $1,909,788 for inventory orders of energy management
products through April 2008. The Company has prepaid
approximately $380,000 as of December 31,
2007.
|
ITEM
7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Short
Term Investments
We held
no marketable securities as of December 31, 2007. 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 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, 2008 was $8,000 in
Amperion and at December 31, 2007 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 92%, or $92,000, of the carrying value of its investment
through a charge to operations during the year ended December 31,
2006. The Company sold its investment in BPL Global for $2,000,000
during the year ended December 31, 2007. The fair value of the
Company’s investment in BPL Global was $131,044 at the time of the
sale.
On
October 19, 2007, the Company completed the acquisition of approximately 30.0%
of the issued and outstanding shares of common stock of Geeks on Call America,
Inc. (“GOCA”), the nation's premier provider of on-site computer services.
Under the terms of the stock purchase agreement, the Company acquired
approximately 1,160,043 shares of GOCA common stock from several GOCA
stockholders in exchange for 2,940,202 shares of the Company’s common stock for
total consideration valued at approximately $4.5 million.
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.
Evaluation of
Disclosure Controls and Procedures. Under the supervision and
with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, the Company evaluated the effectiveness of the
design and operation of its disclosure controls and procedures (as such term is
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the
“Exchange Act”)).
The
Company's conclusion on the effectiveness of internal control over financial
reporting did not include the internal controls of the acquisitions in 2006 of
Smart Systems International, Ethostream, LLC, and Newport Telecommunications Co.
(the "acquisitions") which are included in the 2007 consolidated financial
statements of the Company.
Disclosure
controls and procedures are the controls and other procedures that the Company
designed to ensure that it records, processes, summarizes and reports in a
timely manner the information it must disclose in reports that it files with or
submits to the Securities and Exchange Commission under the Exchange Act. Based
on this evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company’s disclosure controls and procedures were effective
as of the end of the period covered by this report.
Changes in
Internal Control over Financial Reporting. During the fourth quarter of
2007, there was no change in the Company’s internal control over financial
reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act)
that has materially affected, or is reasonably likely to materially affect, the
Company’s internal control over financial reporting.
Management Report
On Internal Control over Financial Reporting. The Company’s management is
responsible for establishing and maintaining adequate internal control over
financial reporting. Internal control over financial reporting is defined in
Rule 13a-15(f) under the Exchange Act as a process designed by, or under the
supervision of, the Company’s principal executive and principal financial
officers and effected by the Company’s board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in the
United States of America and includes those policies and procedures
that:
|
·
|
pertain
to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the Company’s
assets;
|
|
·
|
provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America, and that
the Company’s receipts and expenditures are being made only in accordance
with authorization of management and directors;
and
|
|
·
|
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.
|
We have
excluded from this assessment the operations of Smart Systems International,
Ethostream, LLC, and Newport Telecommunications Co. These businesses were
acquired during 2007 and constituted $22.4 million total assets,
respectively, as of December 31, 2007 and $7.9 million of net sales for the year
then ended.
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.
Under the
supervision and with the participation of the Company’s management, including
its principal executive and principal financial officers, the Company assessed,
as of December 31, 2007, the effectiveness of its internal control over
financial reporting. This assessment was based on criteria established in the
framework in Internal
Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on the Company’s assessment,
management concluded that the Company’s internal control over financial
reporting was effective as of December 31, 2007.
The
Company’s assessment of the effectiveness of its internal control over financial
reporting as of December 31, 2007 has been audited by RBSM LLP, an independent
registered public accounting firm, as stated in their report which is included
in this Annual Report on Form 10-K.
RBSM
LLP
CERTIFIED PUBLIC ACCOUNTANTS
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors
Telkonet,
Inc.
Germantown,
MD
We have
audited Telkonet, Inc. and its subsidiaries (the "Company") internal
control over financial
reporting as of December 31, 2007, based on criteria established inInternal
Control -- Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). 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, included in the accompanying
Management's Report on Internal Control over Financial Reporting. Our
responsibility is to express an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We
conducted our audit 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, assessing the risk that a material weakness exists,
testing and evaluating the design and operating effectiveness of internal
control based on assessed risk. Our audit also included 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.
As
indicated in the accompanying Management's Report on Internal Control Over
Financial Reporting, management's assessment of and conclusion on the
effectiveness of internal control over financial reporting did not include the
internal
controls of Smart Systems International, Ethostream, LLC and Newport
Telecommunications Co. (the "acquisitions")
which are included in the 2007 consolidated financial statements of Telkonet,
Inc. and its subsidiaries and constituted $22.4 million total assets,
as of December 31, 2007 and $7.9 million
of net sales for the year then ended. Our audit of internal control over
financial reporting of Telkonet, Inc. and its subsidiaries also did not include
an evaluation of the internal controls over financial reporting of the
acquisitions.
In our
opinion, Telkonet, Inc. and its subsidiaries maintained, in all material
respects, effective internal control over financial reporting as of
December 31, 2007, based on the COSO criteria.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balances sheets of Telkonet,
Inc. and its subsidiaries as of December 31, 2007 and 2006, and the related
consolidated statements of losses, stockholders’ equity and cash flows for each
of the three years in the period ended December 31, 2007 and our report dated
March 31, 2008 expressed an unqualified opinion thereon and included an
explanatory paragraph related to the Company's ability to continue as a going
concern.
|
/s/ RBSM
LLP
Certified
Public Accountants
|
McLean,
Virginia
March 31,
2008
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 for the fiscal year ended December 31, 2007. The directors of the
Company are elected every year and serve until their successors are duly elected
and qualified.
Name
|
Age
|
Title
|
|
|
|
Jason
Tienor
|
33
|
President
& Chief Executive Officer
|
|
|
|
Dorothy
E. Cleal
|
58
|
Chief
Operating Officer
|
|
|
|
Richard
J. Leimbach
|
39
|
Chief
Financial Officer of Telkonet, Vice President Finance, MSTI
Holdings, Inc.
|
|
|
|
Jeffrey
Sobieski
|
31
|
Executive
Vice President, Energy Management
|
|
|
|
James
Landry
|
52
|
Chief
Technology Officer
|
|
|
|
Warren
V. Musser
|
81
|
Chairman
of the Board
|
|
|
|
Ronald
W. Pickett
|
60
|
Vice
Chairman of the Board, President, MSTI Holdings, Inc
|
|
|
|
Thomas
C. Lynch
|
65
|
Director
(1), (2)
|
|
|
|
Dr.
Thomas M. Hall
|
56
|
Director
(1), (2)
|
|
|
|
James
L. “Lou” Peeler
|
74
|
Director
(1)
|
|
|
|
Seth
Blumenfeld
|
67
|
Director
|
|
|
|
Anthony
J. Paoni
|
63
|
Director
(2)
|
_________________________
|
(1)
|
Member
of the Audit Committee
|
|
(2)
|
Member
of the Compensation Committee
|
Jason
Tienor—President and Chief Executive Officer
Mr.
Tienor has served as the Company’s President and Chief Executive Officer since
December 2007 and, from August 2007 until December 2007, he served as the
Company’s Chief Operating Officer. Mr. Tienor has also served as
Chief Executive Officer of EthoStream, LLC, a wholly-owned subsidiary of the
Company, since March 2007. From 2002 until his employment with the
Company, Mr. Tienor served as Chief Executive Officer of Ethostream, LLC, the
company that he co-founded. Mr. Tienor received a bachelor of business
administration in management information systems and marketing from the
University of Wisconsin – Oshkosh and a masters of business
administration from Marquette University.
Dorothy
E. Cleal—Chief Operating Officer
Ms. Cleal
has served as the Company’s Chief Operating Officer since December 2007 and,
from August 2007 until December 2007, she served as the Company’s Executive Vice
President. Prior to joining Telkonet, Ms. Cleal served, since 2005, as the
Company’s Vice President and Director, Navy and Marine Corps Business Program of
SRA International, a billion dollar leading provider of consulting services to
clients in the national security, civil government, health care and public
health industries. From 2000 through 2005 she served as the Navy
account manager as well as the Navy and Marine Corps account manager with
SRA. Prior to joining SRA, Ms. Cleal was the acting Chief Information
Officer and Associate Director for Information Systems and Technology at the
White House.
Richard
J. Leimbach—Chief Financial Officer
Mr.
Leimbach has served as the Company’s Chief Financial Officer since December 2007
and, from June 2006 until December 2007, he served as the Vice President of
Finance. He also served as the Company’s Controller from January 2004 until June
2006. Mr. Leimbach is a certified public accountant with over fifteen
years of public accounting and private industry experience. Prior to joining
Telkonet, Mr. Leimbach was the Controller with Ultrabridge, Inc., an
applications solution provider. Mr. Leimbach also served as Corporate Accounting
Manager for Snyder Communications, Inc., a global provider of integrated
marketing solutions.
Jeffrey
Sobieski—Executive Vice President, Energy Management
Mr.
Sobieski has served as the Company’s Executive Vice President, Energy Management
since December 2007 and from March 2007 until December 2007, he served as Chief
Information Officer of Ethostream, LLC, wholly-owned subsidiary of the
Company. From 2002 until his employment with the Company, Mr.
Sobieski served as Chief Information Officer of Ethostream, LLC, the company he
co-founded. Mr. Sobieski is also the co-founder of Interactive
Solutions, a consulting firm providing support to the Insurance and
Telecommunications Industries.
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.
Warren
V. Musser—Chairman of the Board of Directors
Warren V.
“Pete” Musser joined the Board of
Telkonet in January, 2003. Mr. Musser is the President and Chief
Executive Officer of The Musser Group LLC, a strategy consulting firm based in
Wayne, Pennsylvania which he started in 2001. Mr. Musser is the
founder and former Chief Executive Officer and Chairman and current
Chairman Emeritus of Safeguard Scientifics, Inc., a company that builds
value in high-growth, revenue-stage information technology and life sciences
businesses. He was a founding investor of QVC, Novell, Compucom
Systems and Cambridge Technology Partners, among other companies. Mr.
Musser currently serves as Chairman of InfoLogix, Inc. and Epitome Systems,
Inc. and is on the Board of Directors of NutriSystem, Inc., Internet
Capital Group, Inc., Health Benefits Direct Corporation and Health
Advocate. Mr. Musser serves on a variety of civic and charitable boards,
including as Co-Chairman of the Eastern Technology Council, Chairman of
Economics PA and Vice Chairman of the National Center for the American
Revolution.
Ronald
W. Pickett—Vice Chairman of the Board of Directors
Mr.
Pickett was appointed as Vice Chairman of the Board of Directors subsequent to
his resignation as the Company’s Chief Executive Officer in December 2007, a
position which he held since January 2003. In addition, he has fostered the
development of Telkonet since 1999 as the Company’s principal 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.
Thomas
C. Lynch—Director
Mr. Lynch
is Senior Vice President 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 Chairman of Sprinturf, a synthetic turf company, and also as
a Director of Epitome Systems, Infologix Systems, Mikros Systems Corp.,
Economics Pennsylvania, Armed Forces Benefit Association, Catholic Leadership
Institute, National Center for the American Revolution at Valley Forge, USO
Board of Governors and is currently a trustee of the US Naval Academy
Foundation. Mr. Lynch has served as the President of Valley Forge
Historical Society, and Chairman of the Cradle of Liberty Council, Boy Scouts of
America. Mr. Lynch graduated from the US Naval Academy with his
Bachelor of Science degree in 1964 and received his Master of Science degree
from the George Washington University. Mr. Lynch has been a director
of the Company since October 2003.
Dr.
Thomas M. Hall—Director
Dr. Hall
is the Managing Director of Marrell Enterprises, LLC (a company that specializes
in international business development). 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 was 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.
Anthony
J. Paoni - Director
Professor
Paoni has been a faculty member at Northwestern University’s Kellogg School of
Management since 1996. Previously, he spent 28 years in the information
technology industry with market leading organizations that provided computer
hardware, software and consulting services. For the first 15 years of
his career Professor Paoni managed sales and marketing organizations and in the
later stages of his career he moved into general management positions starting
with PANSOPHIC Systems Incorporated. This Lisle, Illinois based firm was the
world’s fifth largest international software company prior to its acquisition by
Computer Associates, Incorporated. Subsequently, he became chief operating
officer of Cross Access, a venture capital funded software firm that provided
industry-leading solutions to the heterogeneous database connectivity market
segment. In addition, he has been president of two wholly-owned U.S.
subsidiaries of Ricardo Consulting, a U.K.-based international engineering
consulting firm focused on computer based automotive powertrain design. Prior to
joining the Kellogg faculty, Professor Paoni was chief executive officer of
Eolas, an Internet software company with patent pending Web technology - one of
the key technology drivers responsible for the rapid adoption of the Internet
platform.
Audit
Committee
The
Company maintains an Audit Committee of the Board of Directors. For the year
ended December 31, 2007, Messrs. Hall, Lynch and Peeler served on the Audit
Committee. The Company’s Board of Directors has determined that each of Messrs.
Hall, Lynch and Peeler 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 Section 121(A) of the AMEX Rules and Rule 10A-3 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 at the 2004
Annual Meeting of Stockholders.
Compensation
Committee
The
Company maintains a Compensation Committee of the Board of Directors. For the
year ended December 31, 2007, Dr. Hall and Messrs. Lynch and Paoni served on the
Compensation Committee. The committee held 2 meetings during
2007. During the year ended December 31, 2007, Mr. Musser served on
the Compensation Committee until November 21, 2007, at which time Mr. Paoni was
elected to replace him.
Code of
Ethics
The Board
has approved, and Telkonet has adopted, a Code of Ethics that applies to all
directors, officers and employees of Telkonet. 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.
SECTION
16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section
16(a) of the Securities Exchange Act of 1934 requires our directors and certain
of our officers to file reports of holdings and transactions in shares of
Telkonet common stock with the Securities and Exchange Commission. Based on our
records and other information, we believe that in 2007 our directors and our
officers who are subject to Section 16 met all applicable filing
requirements.
ITEM
11. EXECUTIVE
COMPENSATION.
COMPENSATION
COMMITTEE REPORT
The
Compensation Committee of the Board of Directors has reviewed and discussed the
section of this Form 10-K entitled “Compensation Discussion and Analysis” with
management. Based on this review and discussion, the Committee has recommended
to the Board that the section entitled “Compensation Discussion and Analysis,”
be included in this Form 10-K for the fiscal year ended December 31,
2007.
Thomas M.
Hall
Thomas C.
Lynch
Anthony
J. Paoni
COMPENSATION
DISCUSSION AND ANALYSIS
Oversight
of Executive Compensation Program
The
Compensation Committee of the Board of Directors oversees the Company’s
compensation programs, which are designed specifically for the Company’s most
senior executive officers, including the Chief Executive Officer, Chief
Financial Officer and the other executive officers named in the Summary
Compensation Table (collectively, the “named executive officers”). Additionally,
the Compensation Committee is charged with the review and approval of all annual
compensation decisions relating to named executive officers.
The
Compensation Committee is composed of 3 independent, non-management members of
the Board of Directors. Each year the Company reviews any and all relationships
that each director has with the Company and the Board of Directors subsequently
reviews these findings.
The
responsibilities of the Compensation Committee, as stated in its charter,
include the following:
|
·
|
annually
review and approve for the CEO and the executive officers of the Company
the annual base salary, the annual incentive bonus, including the specific
goals and amount, equity compensation, employment agreements, severance
arrangements, and change in control agreements/provisions, and any other
benefits, compensation or
arrangements.
|
|
·
|
make
recommendations to the Board with respect to incentive compensation plans,
including reservation of shares for issuance under employee benefit
plans.
|
|
·
|
annually
review and recommend to the Board of Directors for its approval the
compensation, including cash, equity or other compensation, for members of
the Board of Directors for their service as a member of the Board of
Directors, a member of any committee of the Board of Directors, a Chair of
any committee of the Board of Directors, and the Chairman of the Board of
Directors.
|
|
·
|
annually
review the performance of the Company’s Chief Executive
Officer.
|
|
·
|
make
recommendations to the Board of Directors on the Company’s executive
compensation practices and policies, including the evaluation of
performance by the Company’s executive officers and issues of management
succession.
|
|
·
|
review
the Company’s compliance with employee benefit
plans.
|
|
·
|
make
regular reports to the Board.
|
|
·
|
annually
review and reassess the adequacy of the Compensation Committee charter and
recommend any proposed changes to the Board for
approval.
|
The
Compensation Committee is also responsible for completing an annual report on
executive compensation for inclusion in the Company's proxy statement. In
addition to such annual report, the Compensation Committee maintains written
minutes of its meetings, which minutes are filed with the minutes of the
meetings of the Board.
Overview
of Compensation Program
In order
to recruit and retain the most qualified and competent individuals as senior
executives, the Company strives to maintain a compensation program that is
competitive in the global labor market. The purpose of the Company’s
compensation program is to reward exceptional organizational and individual
performance.
The
following compensation objectives are considered in setting the compensation
programs for our named executive officers:
|
·
|
drive
and reward performance which supports the Company’s core
values;
|
|
·
|
provide
a percentage of total compensation that is “at-risk,” or variable, based
on predetermined performance
criteria;
|
|
·
|
design
competitive total compensation and rewards programs to enhance the
Company’s ability to attract and retain knowledgeable and experienced
senior executives; and
|
|
·
|
set
compensation and incentive levels that reflect competitive market
practices.
|
Compensation
Elements and Rationale
Compensation
for Named Executive Officers Other than the CEO
Compensation
for the named executive officers, other than the CEO, is made in the CEO’s sole
and exclusive discretion. While the Compensation Committee provides its
recommendations with respect to compensation for the named executive officers
(other than the CEO) as described in greater detail below, the CEO is only
required to consider the Compensation Committee’s recommendations, but is not
bound by its findings.
Compensation
for the Company’s CEO
To reward
both short and long-term performance in the compensation program and in
furtherance of the Company’s compensation objectives noted above, the Company’s
compensation program for the CEO is based on the following
objectives:
The
Compensation Committee believes that a significant portion of the CEO’s
compensation should be tied not only to individual performance, but also to the
Company’s performance as a whole measured against both financial and
non-financial goals and objectives. During periods when performance meets or
exceeds these established objectives, the CEO should be paid at or more than
expected levels. When the Company’s performance does not meet key objectives,
incentive award payments, if any, should be less than such levels.
|
(ii)
|
Incentive
Compensation
|
A large
portion of compensation should be paid in the form of short-term and long-term
incentives, which are calculated and paid based primarily on financial measures
of profitability and stockholder value creation. The CEO has the incentive of
increasing Company profitability and stockholder return in order to earn a major
portion of his compensation package.
|
(iii)
|
Competitive Compensation
Program
|
The
Compensation Committee reviews the compensation of chief executive officers at
peer companies to ensure that the compensation program for the CEO is
competitive. The Company believes that a competitive compensation program will
enhance its ability to retain a capable CEO.
Financial Metrics Used in
Compensation Programs
Several
financial metrics are commonly referenced in defining Company performance for
the CEO’s executive compensation. These metrics include quarterly metrics to
target cash flow break even and specific revenue goals to define Company
performance for purposes of setting the CEO’s compensation.
Compensation Benchmarking Relative to
Market
The
Company sets the CEO’s compensation by evaluating peer group companies. Peer
group companies are chosen based on size, industry, annual revenue and whether
they are publicly or privately held. Based on these criteria, the Compensation
Committee has identified 29 companies in the Company’s peer group. These peer
group companies include Catapult Communications Corp., Endwave Corp., Carrier
Access Corp., Crystal Technology, Echelon Corp. and FiberTower Corp. The
Compensation Committee has concluded that the CEO’s compensation falls within
the 50th
percentile of compensation for chief executive officers within the peer group
companies.
Review of Senior Executive
Performance
The
Compensation Committee reviews, on an annual basis, each compensation package
for the named executive officers. In each case, the Compensation Committee takes
into account the scope of responsibilities and experience and balances these
against competitive salary levels. The Compensation Committee has the
opportunity to meet with the named executive officers at least once per year,
which allows the Compensation Committee to form its own assessment of each
individual’s performance. As indicated above, with the exception of the CEO,
recommendations with respect to compensation packages for the named executive
officers must be considered by the CEO in connection with establishing
compensation for those named executive officers. However, the recommendations of
the Compensation Committee with respect to the compensation paid to the named
executive officers (other than the CEO) will not be binding on the
CEO.
Components of the Executive
Compensation Program
The
Compensation Committee believes the total compensation and benefits program for
named executive officers should consist of the following:
|
·
|
retirement,
health and welfare benefits;
|
|
·
|
perquisites
and perquisite allowance payments;
and
|
Base Salaries
With the
exception of the CEO, whose compensation is set by the Compensation Committee
and approved by the Board of Directors, base salaries and merit increases for
the named executive officers are determined by the CEO in his discretion after
consideration of a competitive analysis recommendation provided by the
Compensation Committee. The Compensation Committee’s recommendation is
formulated through the evaluation of the compensation of similar executives
employed by companies in the Company’s peer group.
Stock Incentive
Plan
Under the
Company’s Stock Incentive Plan (the “Plan”) incentive stock options and
non-qualified options to purchase shares of the Company’s common stock may be
granted to key employees. An important objective of the long-term incentive
program is to strengthen the relationship between the long-term value of the
Company’s stock price and the potential financial gain for employees as well as
the retention of senior management and key personnel. Stock options provide
named executive officers with the opportunity to purchase the Company’s common
stock at a price fixed on the grant date regardless of future market price.
Stock options generally vest ratably on a quarterly basis and become exercisable
over a five-year vesting period. A stock option becomes valuable only if the
Company’s common stock price increases above the option exercise price (at which
point the option will be deemed “in-the-money”) and the holder of the option
remains employed during the period required for the option to “vest” thus,
providing an incentive for an option holder to remain employed by the Company.
In addition, stock options link a portion of an employee’s compensation to
stockholders’ interests by providing an incentive to increase the market price
of the Company stock.
The
Company practice is that the exercise price for each stock option is equal to
the fair market value on the date of grant. Under the terms of the Plan, the
option price will not be less than the fair market value of the shares on the
date of grant or, in the case of a beneficial owner of more than 5.0% of the
Company’s outstanding common stock on the date of grant, the option price will
not be less than 110% of the fair market value of the shares on the date of
grant.
There is
a limited term in which Plan participants can exercise stock options, known as
the “option term.” The option term is generally ten years from the date of
grant. At the end of the option term, the right to exercise any unexercised
options expires. Option holders generally forfeit any unvested options if their
employment with the Company terminates.
Certain
key executives may be a party to option agreements containing clauses that cause
their options to become immediately and fully vested and exercisable upon a
Change of Control, as defined in the Plan. Additionally, death or disability of
the executive during his or her employment period may cause certain stock
options to immediately vest and become exercisable per the terms outlined in the
stock option award agreement.
The
Compensation Committee awards options to named executive officers upon
commencement of their employment with the Company, and for successfully
achieving or exceeding predetermined individual and Company performance goals.
In determining whether to award stock options and the number of stock options
granted to a named executive officer, the Compensation Committee reviews the
compensation of executives at peer group companies to ensure that the
compensation program is competitive.
Retirement,
Health and Welfare Benefits
The
Company offers a variety of health and welfare and retirement programs to all
eligible employees. The named executive officers generally are eligible for the
same benefit programs on the same basis as the rest of the broad-based
employees. The Company’s health and welfare programs include medical, dental,
vision, life, accidental death and disability, and short and long-term
disability insurance. In addition to the foregoing, the named executive officers
are eligible to participate in the Company’s 401(k) Profit Sharing
Plan.
401(k) Profit
Sharing Plan
Telkonet
maintains a defined contribution profit sharing plan for employees (the
“Telkonet 401(k)”) that is administered by a committee of trustees appointed by
the Company. All Company employees are eligible to participate upon the
completion of six months of employment, subject to minimum age
requirements. Contributions by employees under the Telkonet 401(k) are
immediately vested and each employee is eligible for distributions upon
retirement, death or disability or termination of employment. Depending upon the
circumstances, these payments may be made in installments or in a single lump
sum.
MSTI
maintains a defined contribution profit sharing plan for employees (the “MSTI
401(k)”) that is administered by a committee of trustees appointed by the
Company. All Company employees are eligible to participate upon the completion
of three months of employment, subject to minimum age requirements. Each
year the Company makes a contribution to the MSTI 401(k) without regard to
current or accumulated net profits of the Company. These contributions are
allocated to participants in amounts of 100% of the participants’ contributions
up to 1% of each participant’s gross pay, then 10% of the next 5% of each
participant’s gross pay (a higher contribution percentage may be determined at
the Company’s discretion). In addition, the Company makes a one-time, annual
contribution of 3% of each participant’s gross pay to each participant’s
contribution account in the MSTI 401(k) plan. Participants become vested in
equal portions of their Company contribution account for each year of service
until full vesting occurs upon the completion of six years of service.
Distributions are made upon retirement, death or disability in a lump sum or in
installments.
Perquisites
The
Company leases a vehicle for the use of Telkonet's CEO. The lease will
expire in September 2008. Additionally, in the first quarter of 2007 the Company
began providing monthly car allowance stipends to certain executives of
Telkonet, MSTI and Ethostream.
EXECUTIVE
COMPENSATION
The
following table sets forth certain information with respect to compensation for
services in all capacities for the years ended December 31, 2007, 2006 and
2005 paid to our Chief Executive Officer (principal executive officer), Chief
Financial Officer (principal financial officer) and the three other most highly
compensated executive officers who were serving as such as of December 31,
2007.
Summary
Compensation Table
Name
and Principal Position
|
Year
|
Salary
($)
|
Bonus
($)
|
Stock
Awards
($)
|
Option
Awards
($)
(6)(7)(8)
|
Non-Equity
Incentive
Plan
Compensation
($)
|
Change
in
Pension
Value
and
Nonqualified
Deferred
Compensation
Earnings
($)
|
All
Other
Compen-sation
($)
|
Total
($)
|
Jason
Tienor
|
2007
|
$133,022
|
$0
|
$0
|
$111,230
|
$0
|
$0
|
$6,139
|
$250,391
|
President
and Chief
|
2006
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
Executive
Officer (1)
|
2005
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
|
|
|
|
|
|
|
|
|
|
Richard
J. Leimbach
|
2007
|
$133,491
|
$25,000
|
$0
|
$0
|
$0
|
$0
|
$0
|
$158,491
(9)
|
Chief
Financial
|
2006
|
$111,231
|
$5,000
|
$0
|
$0
|
$0
|
$0
|
$0
|
$116,231
|
Officer
|
2005
|
$102,340
|
$3,936
|
$0
|
$156,300
|
$0
|
$0
|
$0
|
$262,576
|
|
|
|
|
|
|
|
|
|
|
Ronald
W. Pickett
|
2007
|
$424,075
|
$150,000
|
$0
|
$0
|
$0
|
$0
|
$2,296
|
$576,371
(10)
|
President
and Chief
|
2006
|
$245,423
|
$0
|
$0
|
$0
|
$0
|
$0
|
$4,593
|
$250,016
|
Executive
Officer (2)
|
2005
|
$102,340
|
$200,000
|
$163,319
(3)
|
$0
|
$0
|
$0
|
$0
|
$465,659
|
|
|
|
|
|
|
|
|
|
|
Dorothy
E. Cleal
|
2007
|
$70,154
|
$0
|
$0
|
$55,615
|
$0
|
$0
|
$0
|
$125,769
|
Chief
Operating
|
2006
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
Officer
(4)
|
2005
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
|
|
|
|
|
|
|
|
|
|
Jeff
Sobieski
|
2007
|
$122,003
|
$0
|
$0
|
$0
|
$0
|
$0
|
$6,139
|
$128,142
|
Executive
Vice
|
2006
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
President
(5)
|
2005
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
|
|
|
|
|
|
|
|
|
|
James
F. Landry
|
2007
|
$175,698
|
$0
|
$0
|
$0
|
$0
|
$0
|
$0
|
$175,698
|
Chief
Technology
|
2006
|
$174,886
|
$6,789
|
$0
|
$0
|
$0
|
$0
|
$0
|
$181,675
|
Officer
|
2005
|
$176,508
|
$15,000
|
$0
|
$0
|
$0
|
$0
|
$0
|
$191,508
|
____________________
(1)
|
Mr.
Tienor was appointed as President and Chief Executive Officer of Telkonet,
Inc. on December 11, 2007. Prior to this appointment, Mr.
Tienor served as Chief Executive Officer of Ethostream, the Company’s
wholly-owned subsidiary since March 2007, and Chief Operating Officer of
Telkonet, Inc. since August 20,
2007.
|
(2)
|
Mr.
Pickett resigned as President and Chief Executive Officer on December 11,
2007.
|
(3)
|
In
the year ending December 31, 2005, 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.
|
(4)
|
Ms.
Cleal was appointed as Chief Operating Officer of Telkonet, Inc. on
December 11, 2007. Prior to this appointment, Ms. Cleal served
as Executive Vice President since August 20,
2007.
|
(5)
|
Mr.
Sobieski was appointed as Executive Vice President of Telkonet, Inc. on
December 11, 2007. Prior to this appointment, Mr. Sobieski
served as Chief Information Officer of Ethostream, the Company’s
wholly-owned subsidiary, since March
2007.
|
(6)
|
In
2005 the following assumptions were used to determine the fair value of
stock option awards granted: historical volatility of 71% expected option
life of 5.0 years and a risk-free interest rate of
4.5%.
|
(7)
|
In
2006 the following assumptions were used to determine the fair value of
stock option awards granted: historical volatility of 65% expected option
life of 5.0 years and a risk-free interest rate of
5.0%.
|
(8)
|
In
2007 the following assumptions were used to determine the fair value of
stock option awards granted: historical volatility of 70% expected option
life of 5.0 years and a risk-free interest rate of
4.8%.
|
(9)
|
Mr.
Leimbach received $8,750 in salary for his services as Vice President
Finance of MSTI, a position which he has held since July
2007.
|
(10)
|
Mr.
Pickett received $34,615 in salary for his services as President of MSTI,
a position which he has held since May
2007.
|
Employment
Agreements
Jason
Tienor, President and Chief Executive Officer, is employed pursuant to an
employment agreement dated March 15, 2007. Mr. Tienor’s employment
agreement has a term of three years, which may be extended by mutual agreement
of the parties thereto, and provides for an annual base salary of $148,000 per
year and bonuses and benefits based on Telkonet’s internal
policies. On August 20, 2007, Mr. Tienor’s annual salary was
increased to $200,000 and he remains eligible to participate in the incentive
and benefit plans pursuant to his existing employment agreement and Telkonet’s
internal policies.
Dorothy
(Dottie) Cleal, Chief Operating Officer, has been employed since August 20, 2007
with an annual salary of $190,000 and bonuses and benefits based upon Telkonet’s
internal policies. Ms. Cleal does not have a written employment
agreement.
Richard
J. Leimbach, Chief Financial Officer, has been employed by the Company since
January 26, 2004. Mr. Leimbach’s annual salary was increased from
$130,000 to $190,000 in December 2007 in connection with his appointment as
Chief Financial Officer. He is also eligible to receive bonuses and
benefits based upon Telkonet’s internal policies. Mr. Leimbach does
not have a written employment agreement. In addition, Mr. Leimbach
receives an annual salary of $25,000 for his services as Vice President Finance
of MSTI.
James F.
Landry, Chief Technology Officer, has been employed with the Company since
September 24, 2001. Mr. Landry’s annual salary in 2007 was $176,508 and he is
entitled to receive bonuses and benefits based upon Telkonet’s internal
policies. Mr. Landry does not have a written employment
agreement.
Jeff
Sobieski, Executive Vice President, Energy Management, is employed pursuant to
an employment agreement, dated March 15, 2007. Mr. Sobieski’s employment
agreement has a term of three years, which may be extended by mutual agreement
of the parties thereto, and provides for a base salary of $148,000 per year and
bonuses and benefits based upon Telkonet’s internal policies. On
December 11, 2007, Mr. Sobieski’s salary was increased to $190,000 and he
remains eligible to participate in the incentive and benefit plans pursuant to
his existing employment agreement and Telkonet’s internal policies.
Ronald W.
Pickett, President and Chief Executive Officer, was employed pursuant to an
employment agreement for an unspecified term that commenced January 30, 2003. As
of January 1, 2007, Mr. Pickett’s annual salary was $250,000 and he was entitled
to receive bonuses and benefits based upon Telkonet’s internal
policies. On March 19, 2007, Mr. Pickett’s annual base salary was increased
to $425,000, including compensation in the annual amount of $75,000 for his
service as President of MSTI, and he was awarded an incentive bonus of $150,000
for his performance as Chief Executive Officer during the year ended December
31, 2006. On
December 11, 2007, Mr. Pickett resigned as President and Chief Executive Officer
and on February 13, 2008, the Board of Directors approved a severance
compensation package of $350,000 plus benefits paid through 2008. In
addition, Mr. Pickett agreed to provide services as Vice Chairman of the Board
of Directors in 2008 for no additional compensation.
In
addition, to the foregoing, stock options are periodically granted to employees
under the Company’s Plan at the discretion of the Compensation Committee of the
Board of Directors. Executives of Telkonet are eligible to receive stock option
grants, based upon individual performance and the performance of Telkonet as a
whole.
GRANT
OF PLAN BASED AWARDS
The
following table sets forth information concerning stock options granted in the
fiscal year ended December 31, 2007, to the persons listed on the Summary
Compensation Table.
Name
|
Grant
Date
|
All
Other
Option
Awards:
Number
of
Securities
Underlying
Options
Granted
(#)
|
Exercise
Price or
Base
Price of
Option
Awards
($/sh)
|
Grant
Date
Fair
Value of Stock
and
Option Awards
|
Jason
Tienor
|
8/10/2007
|
100,000
|
$1.80
|
$111,230
|
Richard
J. Leimbach
|
n/a
|
0
|
n/a
|
n/a
|
Dorothy
E. Cleal
|
8/10/2007
|
50,000
|
$1.80
|
$55,615
|
Jeffrey
Sobieski
|
n/a
|
0
|
n/a
|
n/a
|
James
Landry
|
n/a
|
0
|
n/a
|
n/a
|
OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END TABLE
The
following table shows outstanding stock option awards classified as exercisable
and unexercisable as of December 31, 2007 for the named executive officers.
The table also shows unvested and unearned stock awards (both time-based awards
and performance-contingent) assuming a market value of $0.75 a share (the
closing market price of the Company’s stock on December 31,
2007).
OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END
|
Option
Awards
|
Stock
Awards
|
Name
|
Number
of
Securities
Underlying
Unexercised
Options
(#)
Exerciseable
|
Number
of
Securities
Underlying
Unexercised
Options
(#)
Unexerciseable
|
Equity
Incentive
Plan
Awards:
Number
of
Securities
Underlying
Unexercised
Unearned
Options
(#)
|
Option
Exercise
Price
($)
|
Option
Expiration
Date
|
Number
of
Shares
or
Units
of
Stock
That
Have
Not
Vested
(#)
|
Market
Value
of
Shares
or
Units
of
Stock
That
Have
Not
Vested
($)
|
Equity
Incentive
Plan
Awards:
Number
of
Unearned
Shares, Units
or
Other
Rights
That
Have
Not
Vested
(#)
|
Equity
Incentive
Plan
Awards:
Market
or Payout
Value
of Unearned Shares, Units
or
Other
Rights
That
Have
Not
Vested
($)
|
Jason
Tienor
|
5,000
|
95,000
|
-
|
$1.80
|
4/23/2012
(3)
|
-
|
-
|
-
|
-
|
Dorothy
Cleal
|
2,500
|
47,500
|
-
|
$1.80
|
4/23/2012
(3)
|
-
|
-
|
-
|
-
|
Richard
J. Leimbach
|
60,000
|
27,500
|
-
|
(1)
|
4/23/2012
(3)
|
-
|
-
|
-
|
-
|
James
F. Landry
|
450,000
|
50,000
|
-
|
(2)
|
4/23/2012
(3)
|
-
|
-
|
-
|
-
|
Jeffrey
Sobieski
|
-
|
-
|
-
|
N/A
|
N/A
|
-
|
-
|
-
|
-
|
Ronald
W. Pickett
|
-
|
-
|
-
|
N/A
|
N/A
|
-
|
-
|
-
|
-
|
(1)
|
Includes
27,500 and 10,000 vested and unvested options, respectively, exerciseable
at $2.59, and 32,500 and 17,500 vested and unvested options, respectively,
exerciseable at $5.08 per share.
|
(2)
|
Includes
250,000 fully vested options, exerciseable at $1.00 per share with
expiration dates ranging from 12/3/2011 to 7/1/2013 and 200,000 and 50,000
vested and unvested options, respectively, exerciseable at $3.45 per share
with an expiration dates of 5/1/2014.
|
(3)
|
All
options granted in accordance with the Telkonet Amended and Restated Stock
Incentive Plan (the “Plan”) have an outstanding term equal to the shorter
of ten years, or the expiration of the Plan. The Plan expires
on April 24, 2012.
|
OPTION
EXERCISES AND STOCK VESTED
There
were no options exercised by, or stock awards vested for the account of, the
named executive officers during 2007.
POTENTIAL
PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL
Each of
Mr. Tienor’s and Mr. Sobieski’s Employment Agreement obligate the Company to
continue to pay each executive’s base salary and provide continued participation
in employee benefit plans for the duration of the term of their employment
agreements in the event such executive is terminated without “cause” by the
Company or if the executive terminates his employment for “good reason.” “Cause”
is defined as the occurrence of any of the following: (i) theft, fraud,
embezzlement, or any other act of dishonesty by the executive; (ii) any material
breach by the executive of any provision of the employment agreement which
breach is not cured within a reasonable time (but not to exceed thirty (30) days
after written notification thereof to the executive by Telkonet; (iii) any
habitual neglect of duty or misconduct of the executive in discharging any of
his duties and responsibilities under the employment agreement after a written
demand for performance was delivered to the executive that specifically
identified the manner in which the board believed the executive had failed to
discharge his duties and responsibilities, and the executive failed to resume
substantial performance of such duties and responsibilities on a continuous
basis immediately following such demand; (iv) commission by the executive of a
felony or any offense involving moral turpitude; or (v) any default of the
executive’s obligations under the employment agreement, or any failure or
refusal of the executive to comply with the policies, rules and regulations of
Telkonet generally applicable to Telkonet employees, which default, failure or
refusal is not cured within a reasonable time (but not to exceed thirty (30)
days) after written notification thereof to the executive by Telkonet. If cause
exists for termination, the executive shall be entitled to no further
compensation, except for accrued leave and vacation and except as may be
required by applicable law. “Good reason” is defined as the occurrence of any of
the following: (i) any material adverse reduction in the scope of the
executive’s authority or responsibilities; (ii) any reduction in the amount of
the executive’s compensation or participation in any employee benefits; or (iii)
the executive’s principal place of employment is actually or constructively
moved to any office or other location 50 miles or more outside of Milwaukee,
Wisconsin.
In the
event Telkonet fails to renew the employment agreements upon expiration of the
term, then Telkonet shall continue to pay the executive's base salary and
provide the executive with continued participation in each employee benefit plan
in which the executive participated immediately prior to expiration of the term
for a period of three months following expiration of the term. Each of Messrs.
Tienor and Sobieski have agreed to not to compete with the Company or solicit
any Company employees for a period of one year following expiration or earlier
termination of the employment agreements.
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 $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.
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 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 are made to The Musser Group pursuant to a consulting agreement
described below under the heading “Certain Relationships and Related
Transactions.”
On July
1, 2005, the Company executed a consulting agreement with Mr. Blumenfeld
pursuant to which Mr. Blumenfeld was issued 10,000 shares of Company common
stock upon execution of the agreement, 10,000 shares of Company common 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. Under the terms
of the consulting agreement Mr. Blumenfeld was also entitled to receive a
commission equal to 5% on all international sales generated by him having gross
margins of 50% or more. This commission was payable in cash or common
stock, at Mr. Blumenfeld’s option. The agreement had a one year term,
and was renewable annually upon both parties’ agreement. The consulting
agreement expired on June 20, 2006 and was not renewed. On March 16, 2007, the
Board of Directors authorized a payment to Mr. Blumenfeld of $24,000 for Board
service between July 1, 2006, and December 31, 2006, which payments were
commensurate with the payments made to the other directors for Board service
during that time period. Effective January 1, 2007, Mr. Blumenfeld
began receiving compensation in accordance with the non-management director
compensation plan.
The
following table summarizes all compensation paid to the Company’s directors in
the year ended December 31, 2007.
Name
|
|
Fees
Earned
or
Paid
in
Cash
($)
|
|
|
Stock
Awards
($)
|
|
|
Option
Awards
($)
|
|
|
Non-Equity
Incentive
Plan Compensation
($)
|
|
|
Change
in
Pension
Value
and
Nonqualified
Deferred
Compensation Earnings
|
|
|
All
Other Compensation
($)
|
|
|
Total
($)
|
|
Warren
V. Musser
|
|
$ |
48,000 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
52,000 |
(1) |
|
$ |
100,000 |
|
Thomas
M. Hall
|
|
|
56,000 |
|
|
|
- |
|
|
|
60,217 |
(2) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
116,217 |
|
Thomas
C. Lynch
|
|
|
56,000 |
|
|
|
- |
|
|
|
60,217 |
(2) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
116,217 |
|
James
L. Peeler
|
|
|
52,000 |
|
|
|
- |
|
|
|
60,217 |
(2) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
112,217 |
|
Seth
D. Blumenfeld
|
|
|
67,950 |
(3) |
|
|
- |
|
|
|
60,217 |
(2) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
128,167 |
|
Ronald
W. Pickett
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Anthony
J. Paoni
|
|
|
37,000 |
|
|
|
- |
|
|
|
37,367 |
(2) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
74,367 |
|
(1)
|
fees
for director services performed by Mr. Musser and paid to the Musser Group
pursuant to a September 2003 consulting
agreement.
|
(2)
|
Stock
options granted pursuant to the 2007 non-management director compensation
plan.
|
(3)
|
Includes
a payment of $24,000 to Mr. Blumenfeld for his services as a director in
2006.
|
COMPENSATION
COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During
the year ended December 31, 2007, Messrs, Hall, Lynch and Paoni served as
members of the Company’s Compensation Committee. None of the members of the
Compensation Committee was an employee of the Company during the year ended
December 31, 2007 nor has any of them been an officer of the Company. No
executive officer of the Company served during the year ended December 31, 2007
as a member of a compensation committee or as a director of any entity of which
any of the Company’s directors served as an executive officer.
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, 2007.
|
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
|
9,421,366
|
$1.84
|
2,170,423
|
Equity
compensation plans not approved by security holders
|
-
|
-
|
-
|
Total
|
9,421,366
|
$1.84
|
2,170,423
|
The
following table sets forth, as of March 1, 2008, 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, 2008, there were no issued and
outstanding shares of any other class of the Company’s equity
securities.
Name
and Address of Beneficial Owner
|
Amount
and Nature of Beneficial Ownership
|
Percentage
of Class
|
|