U.S. SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
FORM 10QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the period ended June 30, 2003
Commission file number 333-47986
TELKONET, INC.
(Name of Small Business Issuer in Its Charter)
Utah 87-0627421
(State of Incorporation) (IRS Employer Identification No.)
902 A Commerce Road Annapolis, Maryland 21401
(Address of Principal Executive Offices)
(410) 897-5900
Issuer's Telephone Number
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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. Yes x No
--- ---
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 23,793,264 shares of Common Stock
($.001 par value) as of August 12, 2003.
Transitional small business disclosure format: Yes No x
--- ---
TELKONET, INC.
Quarterly Report on Form 10-QSB for the
Quarterly Period Ending June 30, 2003
Table of Contents
Page #
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets:
June 30, 2003 and December 31, 2002 3
Condensed Consolidated Statements of Losses:
Three Months Ended June 30, 2003 and 2002
Six Months Ended June 30, 2003 and 2002
November 3, 1999 (Date of Inception) through June 30, 2003 4
Consolidated Statement of Deficiency in Stockholders' Equity
November 3, 1999 (Date of Inception) through June 30, 2003 5 - 8
Condensed Consolidated Statements of Cash Flows:
Six Months Ended June 30, 2003 and 2002
November 3, 1999 (Date of Inception) through June 30, 2003 9 - 10
Notes to Unaudited Condensed Consolidated Financial Information:
June 30, 2003 11 - 20
Item 2. Management's Plan of Operation 21 - 24
Item 3. Controls and Procedures 24
PART II. OTHER INFORMATION 24
Item 1. Legal Proceedings 24
Item 2. Changes in Securities 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 25 - 29
2
Item 1. Financial Statements (Unaudited)
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) (Audited)
June 30, December 31,
2003 2002
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,580,779 $ 18,827
Inventory, net 449,487 39,790
Other receivable -- 1,550
Prepaid expenses and deposits 75,785 4,625
------------ ------------
Total current assets 5,106,051 64,792
PROPERTY AND EQUIPMENT:
Furniture and equipment, at cost 161,462 73,215
Less: accumulated depreciation 54,628 35,252
------------ ------------
106,833 37,963
OTHER ASSETS
Financing costs, less accumulated amortization of $164,449 and
$101,692 at June 30, 2003 and December 31, 2002, respectively 217,060 192,600
$ 5,429,945 $ 295,355
============ ============
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 981,038 $ 518,865
Notes payable and capital leases 309,291 310,000
Due to shareholders 7,500 130,330
------------ ------------
Total current liabilities 1,297,829 959,195
Convertible debentures, net of discounts - including related
parties (Note B) 1,453,720 862,682
Senior notes payable (Note C) 5,000,000 --
COMMITMENTS AND CONTINGENCIES -- --
DEFICIENCY IN STOCKHOLDERS' EQUITY
Preferred stock, par value $.001 per share; 15,000,000 shares
authorized; none issued at June 30, 2003 and December 31, 2002
(Note E) -- --
Common stock, par value $.001 per share; 100,000,000 shares
authorized; 15,977,795 and 15,721,131 shares issued and
outstanding at June 30, 2003 and December 31, 2002, respectively
(Note E) 15,978 15,721
Additional paid-in-capital 7,580,809 4,916,433
Accumulated deficit during development stage (9,918,391) (6,458,676)
------------ ------------
Deficiency in stockholders' equity (2,321,604) (1,526,522)
------------ ------------
$ 5,429,945 $ 295,355
------------ ------------
See accompanying footnotes to the unaudited condensed consolidated financial information
3
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF LOSSES
(UNAUDITED)
For the period from
November 3, 1999
For The Three Months Ended For The Six Months Ended (date of inception)
June 30, June 30, through
2002 (As 2002 (As June 30, 2003
Restated Restated (As Restated
2003 - Note F) 2003 - Note F) - Note F)
------------- ------------- ------------- ------------- -------------
Costs and Expenses:
Research and Development $ 282,821 $ 331,704 $ 597,550 $ 602,283 $ 3,010,021
Selling, General and Administrative 1,173,675 236,321 1,693,797 357,831 4,360,918
Non-Employee Stock Options (Note D) 67,884 113,115 286,904 226,230 750,954
Depreciation and Amortization 48,589 21,743 82,133 71,196 219,077
------------- ------------- ------------- ------------- -------------
Total Operating Expense 1,572,969 702,883 2,660,384 1,257,540 8,340,971
Loss from Operations (1,572,969) (702,883) (2,660,384) (1,257,540) (8,340,971)
Other Income (Expense) -- -- -- -- 4,579
Interest Income (Expense) (446,003) (126,148) (799,332) (217,594) (1,582,000)
Provision for Income Tax -- -- -- -- --
------------- ------------- ------------- ------------- -------------
(446,003) (126,148) (799,332) (217,594) (1,577,421)
Net Loss $ (2,018,972) $ (829,031) $ (3,459,715) $ (1,475,134) $ (9,918,391)
============= ============= ============= ============= =============
Loss per common share (basic and
assuming dilution) $ (0.13) $ (0.06) $ (0.22) $ (0.09) $ (0.62)
============= ============= ============= ============= =============
Weighted average common shares
outstanding 15,827,613 14,154,678 15,774,666 17,244,540 15,998,108
See accompanying footnotes to the unaudited condensed consolidated financial information
4
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO JUNE 30, 2003
Deficit
Pref- Common Accumulated
Pref- erred Common Additional Stock During
erred Stock Common Stock Paid in Subscr- Development
Shares Amount Shares Amount Capital iption Stage Total
-------- ------- ----------- ------------ ------------ -------- ------------ ------------
Net Loss -- -- -- -- -- -- $ (33,973) $ (33,973)
-------- ------- ----------- ------------ ------------ -------- ------------ ------------
BALANCE AT DECEMBER 31, 1999 -- -- -- -- -- -- (33,973) (33,973)
Shares issued to founders
January 2000, in exchange
for services and costs
valued at $ 0.60 per share -- -- 19,300 193 11,387 -- -- 11,580
Shares issued in June 2000,
for cash in connection
with private placement at
$375 per share, net of costs -- -- 1,735 17 644,219 -- -- 644,236
Shares issued in July 2000,
for warrants exercised at a
price of $375 per share -- -- 190 -- 71,250 -- -- 71,250
Shares issued in August 2000,
in connection with the
merger of Comstock Coal and
Telkonet Communications, Inc -- -- 21,775,335 21,775 -- -- -- 21,775
August 2000, retirement of
Telkonet Communications, Inc
shares -- -- (21,225) (210) -- -- -- (210)
Shares issued in October 2000,
in exchange for warrants
exercised at a price of $1
per share -- -- 29,145 29 29,115 -- -- 29,144
Shares issued in October 2000,
in exchange for warrants
exercised at a price of
$ 0.40 per share -- -- 10,891 11 4,345 -- -- 4,356
Net loss -- -- -- -- -- -- (929,720) (929,720)
-------- ------- ----------- ------------ ------------ -------- ------------ ------------
BALANCE AT DECEMBER 31, 2000 -- $ -- 21,815,371 $ 21,815 $ 760,316 $ -- $ (963,693) $ (181,562)
======== ======= =========== ============ ============ ======== ============ ============
See accompanying footnotes to the unaudited condensed consolidated financial information
5
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO JUNE 30, 2003
Deficit
Accumulated
Pref- Common During
Pref- erred Common Additional Stock Develop-
erred Stock Common Stock Paid in Subscr- ment
Shares Amount Shares Amount Capital iption Stage Total
------- ------- ------------ -------- ----------- ------- ------------ ------------
Balance Forward -- $ -- 21,815,371 $21,815 $ 760,316 $ -- $ (963,693) $ (181,562)
Shares issued in June 2001,
for cash in connection with a
private placement, shares
issued at $.50 a share, net
of costs -- -- 260,000 260 129,740 -- -- 130,000
1,839,378 warrants issued in
June 2001, valued at $0.13 per
warrant, in exchange for
services -- -- -- -- 237,035 -- -- 237,035
72,668 stock options issued in
June 2001, valued at $ 0.09 per
stock option, in exchange for
services -- -- -- -- 6,375 -- -- 6,375
245,287 warrants issued in
July 2001, valued at $0.08 per
warrant, in exchange for
services -- -- -- -- 18,568 -- -- 18,568
36,917 stock options issued in
July 2001, valued at $ 0.08 per
warrant, in exchange for
services -- -- -- -- 2,795 -- -- 2,795
Shares issued in August 2001,
for cash in connection with a
private placement, shares
issued at $.50 a share, net of
costs -- -- 40,000 40 19,960 -- -- 20,000
241,000 warrants issued in
August 2001, valued at $ 0.39
per warrant in exchange for
financing costs -- -- -- -- 85,818 -- -- 85,818
150,000 warrants issued in
August 2001, valued at $ 0.16
per warrant, in exchange for
services -- -- -- -- 23,340 -- -- 23,340
36,917 stock options issued
in August 2001, valued at
$0.06 per stock option, in
exchange for services -- -- -- -- 2,422 -- -- 2,422
25,000 warrants issued in
September 2001, valued at
$0.30 per warrant in exchange
for services -- -- -- -- 7,380 -- -- 7,380
95,000 warrants issued in
October 2001, valued at
$0.21 per warrant, in exchange
for services -- -- -- -- 19,558 -- -- 19,558
25,000 warrants issued in
November 2001, valued at
$0.33 per warrant, in exchange
for services -- -- -- -- 8,218 -- -- 8,218
25,000 warrants issued in
December 2001, valued at
$0.30 per warrant, in exchange
for services -- -- -- -- 7,380 -- -- 7,380
Beneficial conversion feature
of convertible debentures
(Note B) -- -- -- -- 837,874 -- -- 837,874
Value of warrants attached to
convertible debentures (Note B) -- -- -- -- 77,254 -- -- 77,254
Net loss -- -- -- -- -- -- (1,716,495) (1,716,495)
------- ------- ------------ -------- ----------- ------- ------------ ------------
BALANCE AT DECEMBER 31, 2001
(AS RESTATED- NOTE D) -- $ -- 22,115,371 $22,115 $2,244,033 $ -- $(2,680,188) $ (414,040)
======= ======= ============ ======== =========== ======= ============ ============
See accompanying footnotes to the unaudited condensed consolidated financial information
6
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO JUNE 30, 2003
Deficit
Accumulated
Pref- Common During
Pref- erred Common Additional Stock Develop-
erred Stock Common Stock Paid in Subscr- ment
Shares Amount Shares Amount Capital iption Stage Total
------ ------- ------------ -------- ------------ ------------ ------------ ------------
Balance Forward -- $ -- 22,115,371 $ 22,115 $ 2,244,033 $ -- $(2,680,188) $ (414,040)
Shares issued in February 2002,
in exchange for convertible
debentures interest, at $.50
per share -- -- 43,586 44 21,749 -- -- 21,793
Shares issued in March 2002,
to a founder in exchange for
shares canceled -- -- 5,250,000 5,250 (5,250) -- -- --
Shares canceled in March 2002
in connection with capital
restructure -- -- (13,480,961) (13,481) 13,481 -- -- --
Shares issued in June 2002,
for warrants exercised at $1.00
per share for services rendered -- -- 47,906 48 47,857 -- -- 47,906
Shares issued in June 2002, for
warrants exercised at $.40 per
share for services rendered -- -- 26,443 26 10,551 -- -- 10,577
Shares issued in June 2002 to
founders, for options exercised
at $1.00 per share -- -- 1,000,000 1,000 999,000 -- -- 1,000,000
Shares issued in June 2002, for
warrants exercised at $1.0025
per share, for services rendered -- -- 80,039 80 80,158 -- -- 80,238
Shares issued in June 2002, for
warrants exercised at $ .41, in
connection with original private
placement -- -- 189,327 189 77,720 -- -- 77,910
Shares issued in July 2002, for
warrants exercised at $ .40, in
connection with original private
placement -- -- 41,970 42 16,830 -- -- 16,872
Shares issued in July 2002 to
founders, for options exercised
at $1.00 per share -- -- 1,000,000 1,000 999,000 -- -- 1,000,000
Shares issued in August 2002,
for warrants exercised at $.43,
in connection with original
private placement -- -- 542,500 543 232,459 -- -- 233,001
Shares issued in August 2002,
for warrants exercised at $.40,
in connection with original
private placement -- -- 193,302 193 77,127 -- -- 77,320
Shares issued in October 2002,
for warrants exercised at $.40,
in connection with original
private placement -- -- 77,048 77 30,896 -- -- 30,973
Shares issued in October 2002,
for warrants exercised at $0.50
per share in connection with
original private placement -- -- 400,000 400 199,600 -- -- 200,000
Common stock subscription -- -- -- -- -- (1,805,400) -- (1,805,400)
Return of founders shares in
connection with stock
subscription -- -- (1,805,400) (1,805) (1,803,595) 1,805,400 -- --
Stock based compensation for
the issuance of stock options
to consultants in exchange for
services -- -- -- -- 452,459 -- -- 452,459
Stock based compensation for
the issuance of warrants to
consultants in exchange for
services -- -- -- -- 170,330 -- -- 170,330
Stock based compensation for
the issuance of warrants to
consultants in exchange for
financing costs -- -- -- -- 86,474 -- -- 86,474
Beneficial conversion feature
of convertible debentures
(Note B) -- -- -- -- 840,877 -- -- 840,877
Value of warrants attached to
convertible debentures (Note B) -- -- -- -- 124,677 -- -- 124,677
Net Loss -- -- -- -- -- -- (3,778,488) (3,778,488)
------ ------- ------------ -------- ------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 2002 -- $ -- 15,721,131 $ 15,721 $ 4,916,433 $ -- $(6,458,676) $(1,526,522)
====== ======= ============ ========= ============ ============ ============ ============
See accompanying footnotes to the unaudited condensed consolidated financial information
7
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENT OF DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO JUNE 30, 2003
Deficit
Pref- Common Accumulated
Pref- erred Common Additional Stock During
erred Stock Common Stock Paid in Subscr- Development
Shares Amount Shares Amount Capital iption Stage Total
-------- ------- ----------- -------- ----------- ------------ ------------ ------------
BALANCE FORWARD -- $ -- 15,721,131 $15,721 $4,916,433 -- $(6,458,676) $(1,526,522)
Shares issued in April 2003
in exchange for convertible
debentures at $ .50 per share
(Note E) -- -- 40,000 40 19,960 -- -- 20,000
Shares issued in April 2003
in exchange for services @
$1.54 per share (Note E) -- -- 49,998 50 76,695 -- -- 76,745
Shares issued in June 2003
for employee options exercised
at $1.00 per share (Note E) -- -- 83,333 83 83,250 -- -- 83,333
Shares issued in June 2003
for non-employee options
exercised at $1.00 per share
(Note E) -- -- 83,333 83 83,250 -- -- 83,333
Stock based compensation for
the issuance of stock options
to consultants in exchange for
services (Note D) -- -- -- -- 286,904 -- -- 286,904
Stock based compensation for
the issuance of warrants in
exchange for financing costs
(Note D) -- -- -- -- 87,217 -- -- 87,217
Beneficial conversion feature
of convertible debentures
(Note B) -- -- -- -- 1,761,675 -- -- 1,761,675
Value of warrants attached
to convertible debentures
(Note B) -- -- -- -- 265,425 -- -- 265,425
Net Loss -- -- -- -- -- -- (3,459,715) (3,459,715)
-------- ------- ----------- -------- ----------- ------------ ------------ ------------
BALANCE AT JUNE 30, 2003 -- $ -- 15,977,795 $15,978 $7,580,809 $ -- $(9,918,391) $(2,321,604)
======== ======= =========== ======== =========== ============ ============ ============
See accompanying footnotes to the unaudited condensed consolidated financial information
8
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the period
from November
3, 1999 (date
Six Months Ended June 30, of inception)
------------------------- through
2002 (As June 30, 2003
Restated (As Restated
2003 - Note F) - Note F)
------------ ------------ -------------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from development stage operations $(3,459,715) $(1,475,134) $ (9,918,391)
Adjustments to reconcile net loss from development
stage operations to cash used for operating
activities
Amortization of debt discount - beneficial
conversion feature of convertible debentures 538,425 183,926 1,071,847
Amortization of debt discount - value of warrants
attached to convertible debentures 72,614 16,452 120,556
Stock options and warrants issued in exchange for
services rendered 286,904 -- 1,242,766
Common stock issued in exchange for services
rendered 76,745 138,722 227,047
Common stock issued in exchange for conversion of
interest -- 21,793 21,793
Impairment of property and equipment -- -- 39,287
Depreciation and amortization of financing costs 82,133 71,196 219,077
Increase (decrease) in:
Other receivable 1,550 -- --
Inventory (409,696) -- (449,487)
Prepaid expenses and deposits (71,160) -- (75,785)
Accounts payable and accrued expenses, net 462,173 201,051 981,038
------------ ------------ -------------
NET CASH USED IN OPERATING ACTIVITIES (2,420,027) (841,994) (6,520,252)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net of disposals (28,957) (19,499) (141,459)
------------ ------------ -------------
NET CASH USED IN INVESTING ACTIVITIES (28,957) (19,499) (141,459)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net of costs -- 99,702 1,751,224
Proceeds from (repayments of) stockholder advances (122,830) -- 7,500
Proceeds from issuance of convertible debentures,
net of costs 2,027,100 715,407 4,067,100
Proceeds from issuance of senior notes, net of costs 5,000,000 -- 5,000,000
Proceeds from exercise of stock options 166,666 -- 166,666
Repayments of loans (60,000) 166,500 (150,000)
Proceeds from loans -- -- 400,000
------------ ------------ -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 7,010,935 981,609 11,242,490
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS 4,561,952 120,116 4,580,779
Cash and cash equivalents at the beginning of the
period 18,827 21,885 --
------------ ------------ -------------
Cash and cash equivalents at the end of the period $ 4,580,779 $ 142,001 $ 4,580,779
------------ ------------ -------------
See accompanying footnotes to the unaudited condensed consolidated financial information
9
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the period
from November
3, 1999 (date
Six Months Ended June 30, of inception)
------------------------- through
2002 (As June 30, 2003
Restated (As Restated
2003 - Note F) - Note F)
------------ ------------ -------------
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for interest $ 10,423 $ 17,216 $ 35,388
Income taxes paid -- -- --
Non-cash transactions: -- -- --
Issuance of stock options and warrants in exchange for
services rendered 286,904 -- 1,242,766
Issuance of stock warrants in exchange for financing costs 87,217 -- 173,691
Common stock issued for services rendered 76,745 138,722 227,047
Common stock issued in exchange for interest -- 21,793 21,793
Common stock issued in exchange for conversion of convertible
debenture 20,000 -- 20,000
Notes payable issued in connection with capital lease 59,291 -- 59,291
Beneficial conversion feature on convertible debentures 1,761,675 693,018 3,440,426
Value of warrants attached to convertible debentures 265,425 56,082 467,356
Acquisition:
Assets Acquired -- -- 1
Accumulated Deficit -- -- 2,643
Liabilities Assumed -- -- (2,642)
------------ ------------ ------------
$ -- $ -- $ 1
------------ ------------ ------------
See accompanying footnotes to the unaudited condensed consolidated financial information
10
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE A - SUMMARY OF ACCOUNTING POLICIES
General
-------
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-QSB. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Accordingly, the results from operations for the six-month period ended June 30,
2003, are not necessarily indicative of the results that may be expected for the
year ended December 31, 2003. The unaudited condensed consolidated financial
statements should be read in conjunction with the consolidated December 31, 2002
financial statements and footnotes thereto included in the Company's SEC Form
10-KSB.
Basis of Presentation
---------------------
Telkonet, Inc. (the "Company"), formerly Comstock Coal Company, Inc., was formed
on November 3, 1999 under the laws of the state of Utah. The Company is a
development stage enterprise, as defined by Statement of Financial Accounting
Standards No. 7 ("SFAS 7") and is seeking to develop, produce and market
proprietary equipment enabling the transmission of voice and data over electric
utility lines. From its inception through the date of these financial
statements, the Company has recognized no revenues and has incurred significant
operating expenses.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Telkonet Communications, Inc. Significant
intercompany transactions have been eliminated in consolidation.
Reclassification
----------------
Certain reclassifications have been made to conform to prior periods' data to
the current presentation. These reclassifications had no effect on reported
losses.
Concentrations of Credit Risk
-----------------------------
Financial instruments and related items, which potentially subject the Company
to concentrations of credit risk, consist primarily of cash, cash equivalents.
The Company places its cash and temporary cash investments with credit quality
institutions. At times, such investments may be in excess of the FDIC insurance
limit.
Stock Based Compensation
------------------------
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS 123." This statement
amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in APB
Opinion No. 25 and related interpretations. Accordingly, compensation expense
for stock options is measured as the excess, if any, of the fair market value of
the Company's stock at the date of the grant over the exercise price of the
related option. The Company has adopted the annual disclosure provisions of SFAS
No. 148 in its financial reports for the year ended December 31, 2002 and for
the quarter ended June 30, 2003.
11
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE A - SUMMARY OF ACCOUNTING POLICIES
Stock Based Compensation (Continued)
------------------------------------
Had compensation costs for the Company's stock options been determined based on
the fair value at the grant dates for the awards, the Company's net loss and
losses per share would have been as follows (transactions involving stock
options issued to employees and Black-Scholes model assumptions are presented in
Note D):
For the three months ended For the six months ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Net loss - as reported $(2,018,972) $ (829,031) $(3,459,715) $(1,475,134)
Add: Total stock based employee compensation
expense as reported under intrinsic value method
(APB. No. 25) -- -- -- --
Deduct: Total stock based employee compensation
expense as reported under fair value based method
(SFAS No. 123) (1,129,199) (52,708) (1,291,134) (105,416)
------------ ------------ ------------ ------------
Net loss - Pro Forma $(3,148,171) $ (881,739) $(4,750,849) $(1,580,550)
Net loss attributable to common stockholders - Pro
forma $(3,148,171) $ (881,739) $(4,750,849) $(1,580,550)
Basic (and assuming dilution) loss per share - as
reported $ (0.13) $ (0.06) $ (0.22) $ (0.09)
Basic (and assuming dilution) loss per share - Pro
forma $ (0.20) $ (0.06) $ (0.30) $ (0.09)
New Accounting Pronouncements
-----------------------------
In April 2003, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 149, AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES. SFAS 149 amends SFAS No. 133 to provide clarification on the
financial accounting and reporting of derivative instruments and hedging
activities and requires that contracts with similar characteristics be accounted
for on a comparable basis. The provisions of SFAS 149 are effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 will not
have a material impact on the Company's results of operations or financial
position.
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY. SFAS 150
establishes standards on the classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. The provisions
of SFAS 150 are effective for financial instruments entered into or modified
after May 31, 2003 and to all other instruments that exist as of the beginning
of the first interim financial reporting period beginning after June 15, 2003.
The adoption of SFAS 150 will not have a material impact on the Company's
results of operations or financial position.
12
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE
A summary of convertible promissory notes payable at June 30, 2003 and December
31, 2002 is as follows:
June 30, 2003 December 31, 2002
------------- -----------------
Convertible notes payable ("Debenture-1"), in
quarterly installments of interest only at 8% per
annum, unsecured and due three years from the date of
the note with the latest maturity May 2005;
Noteholder has the option to convert unpaid note
principal together with accrued and unpaid interest
to the Company's common stock at a rate of $.50 per
share six months after issuance. $ 1,669,100 $ 1,689,100
Debt Discount - beneficial conversion feature, net
of accumulated amortization of $787,014 and
$531,858 at June 30, 2003 and December 31, 2002,
respectively (743,878) (999,034)
Debt Discount - value attributable to warrants
attached to notes, net of accumulated amortization
of $69,428 and $47,216 at June 30, 2003 and
December 31, 2002, respectively (63,908) (86,120)
--------------- --------------
861,314 603,946
Convertible notes payable ("Series B Debenture"), in
quarterly installments of interest only at 8% per
annum, unsecured and due three years from the date of
the note with the latest maturity February 2006;
Noteholder has the option to convert unpaid note
principal together with accrued and unpaid interest
to the Company's common stock at a rate of $.55 per
share six months after issuance. 2,500,000 472,900
Debt Discount - beneficial conversion feature, net of
accumulated amortization of $284,833 and $1,564 at
June 30, 2003 and December 31, 2002, respectively (1,624,702) (146,295)
Debt Discount - value attributable to warrants
attached to notes, net of accumulated amortization of
$51,128 and $726 at June 30, 2003 and December 31,
2002, respectively (282,892) (67,869)
--------------- --------------
592,406 258,736
--------------- --------------
Total $ 1,453,720 $ 862,682
--------------- --------------
Less: current portion - -
--------------- --------------
$ 1,453,720 $ 862,682
--------------- --------------
13
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE (CONTINUED)
Convertible Debentures
----------------------
During the year ended December 31, 2001, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $940,000, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of
November 2004. Noteholder has the option to convert any unpaid note principal
together with accrued and unpaid interest to the Company's common stock at a
rate of $.50 per share six months after issuance. In accordance with EMERGING
ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR CONVERTIBLE SECURITIES WITH A
BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY ADJUSTABLE CONVERSION RATIOS
("EITF 98-5"), the Company recognized an imbedded beneficial conversion feature
present in the Debenture-1 note. The Company allocated a portion of the proceeds
equal to the intrinsic value of that feature to additional paid in capital. The
Company recognized and measured an aggregate of $837,874 of the proceeds, which
is equal to the intrinsic value of the imbedded beneficial conversion feature,
to additional paid in capital and a discount against the Debenture-1. The debt
discount attributed to the beneficial conversion feature is amortized over the
Debenture-1's maturity period (three years) as interest expense.
In connection with the placement of the Debenture-1 notes, the Company issued
non-detachable warrants granting the holders the right to acquire 940,000 shares
of the Company's common stock at $1.00 per share. In accordance with EMERGING
ISSUES TASK FORCE ISSUE 00-27, APPLICATION OF ISSUE NO. 98-5 TO CERTAIN
CONVERTIBLE INSTRUMENTS ("EITF - 0027"), the Company recognized the value
attributable to the warrants in the amount of $77,254 to additional paid in
capital and a discount against the Debenture-1. The Company valued the warrants
in accordance with EITF 00-27 using the Black-Scholes pricing model and the
following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.25%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.
During the year ended December 31, 2002, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $749,100, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of May
2005. Noteholders have the option to convert any unpaid note principal together
with accrued and unpaid interest to the Company's common stock at a rate of $.50
per share six months after issuance.
In accordance with EMERGING ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR
CONVERTIBLE SECURITIES WITH A BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY
ADJUSTABLE CONVERSION RATIOS ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Debenture-1 note. The Company
allocated a portion of the proceeds equal to the intrinsic value of that feature
to additional paid in capital. The Company recognized and measured an aggregate
of $693,018 of the proceeds, which is equal to the intrinsic value of the
imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Debenture-1. The debt discount attributed to the beneficial
conversion feature is amortized over the Debenture-1's maturity period (three
years) as interest expense.
In connection with the placement of the Debenture-1 notes in 2002, the Company
issued non-detachable warrants granting the holders the right to acquire 749,100
shares of the Company's common stock at $1.00 per share. In accordance with
EMERGING ISSUES TASK FORCE ISSUE 00-27, APPLICATION OF ISSUE NO. 98-5 TO CERTAIN
CONVERTIBLE INSTRUMENTS ("EITF -0027"), the Company recognized the value
attributable to the warrants in the amount of $56,082 to additional paid in
capital and a discount against the Debenture-1. The Company valued the warrants
in accordance with EITF 00-27 using the Black-Scholes pricing model and the
following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.67%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.
14
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE (CONTINUED)
Series B Debentures
In October and December 2002, the Company issued convertible promissory notes
(the "Series B Debenture") to Company officers, shareholders, and sophisticated
investors in exchange for $472,900, exclusive of placement costs and fees .The
Series B Debenture accrues interest at 8% per annum and is payable and due three
years from the date of the note with the latest maturity date of December 2005.
Noteholders have the option to convert any unpaid note principal together with
accrued and unpaid interest to the Company's common stock at a rate of $.55 per
share six months after issuance.
In accordance with EMERGING ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR
CONVERTIBLE SECURITIES WITH A BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY
ADJUSTABLE CONVERSION RATIOS ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Series B Debenture note. The
Company allocated a portion of the proceeds equal to the intrinsic value of that
feature to additional paid in capital. The Company recognized and measured an
aggregate of $147,859 of the proceeds, which is equal to the intrinsic value of
the imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Series B Debenture. The debt discount attributed to the
beneficial conversion feature is amortized over the Series B Debenture's
maturity period (three years) as interest expense.
In connection with the placement of the Series B Debenture notes in 2002, the
Company issued non-detachable warrants granting the holders the right to acquire
472,900 shares of the Company's common stock at $1.00 per share. In accordance
with EMERGING ISSUES TASK FORCE ISSUE 00-27, APPLICATION OF ISSUE NO. 98-5 TO
CERTAIN CONVERTIBLE INSTRUMENTS ("EITF -0027"), the Company recognized the value
attributable to the warrants in the amount of $68,595 to additional paid in
capital and a discount against the Series B Debenture. The Company valued the
warrants in accordance with EITF 00-27 using the Black-Scholes pricing model and
the following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.67%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Series B Debenture's maturity period (three years) as interest expense.
In January and February 2003, the Company issued convertible promissory notes
(the "Series B Debenture") to Company officers, shareholders, and sophisticated
investors in exchange for $2,027,100, exclusive of placement costs and fees .The
Series B Debenture accrues interest at 8% per annum and is payable and due three
years from the date of the note with the latest maturity date of February 2006.
Noteholders have the option to convert any unpaid note principal together with
accrued and unpaid interest to the Company's common stock at a rate of $.55 per
share six months after issuance.
In accordance with EMERGING ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR
CONVERTIBLE SECURITIES WITH A BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY
ADJUSTABLE CONVERSION RATIOS ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Series B Debenture note. The
Company allocated a portion of the proceeds equal to the intrinsic value of that
feature to additional paid in capital. The Company recognized and measured an
aggregate of $1,761,675 of the proceeds, which is equal to the intrinsic value
of the imbedded beneficial conversion feature, to additional paid in capital and
a discount against the Series B Debenture. The debt discount attributed to the
beneficial conversion feature is amortized over the Series B Debenture's
maturity period (three years) as interest expense.
In connection with the placement of the Series B Debenture notes in January and
February 2003, the Company issued non-detachable warrants granting the holders
the right to acquire 2,027,100 shares of the Company's common stock at $1.00 per
share. In accordance with EMERGING ISSUES TASK FORCE ISSUE 00-27, APPLICATION OF
ISSUE NO. 98-5 TO CERTAIN CONVERTIBLE INSTRUMENTS ("EITF -0027"), the Company
recognized the value attributable to the warrants in the amount of $265,425 to
additional paid in capital and a discount against the Series B Debenture. The
Company valued the warrants in accordance with EITF 00-27 using the
Black-Scholes pricing model and the following assumptions: contractual terms of
3 years, an average risk free interest rate of 1.25%, a dividend yield of 0%,
and volatility of 26%. The debt discount attributed to the value of the warrants
issued is amortized over the Series B Debenture's maturity period (three years)
as interest expense.
The Company amortized the Debenture 1 and the Series B Debenture debt discount
attributed to the beneficial conversion feature and the value of the attached
warrants and recorded non-cash interest expense of $611,039 and $200,377 for the
six month ended June 30, 2003 and 2002, respectively.
15
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE C - SENIOR NOTES PAYABLE
In April, May and June 2003, the Company issued Senior Note to Company officers,
shareholders, and sophisticated investors in exchange for $5,000,000, exclusive
of placement costs and fees .The Senior Note is in units of $100,000, in
quarterly installments of interest at 8% per annum and is due three years from
the date of the note with the latest maturity date of June 2006. Attached to
each unit of the Senior Note are 125,000 warrants to purchase the common stock
of the Company. The warrants have a three-year contractual life and are
exercisable immediately after the issuance of the note at exercise price of
$1.00 per share. The Senior Notes are secured by a first lien priority security
interest in all intellectual property assets of the Company. The Company plans
to use the proceeds from Senior Note for expansion of sales, marketing and
strategic partnership programs, build of required infrastructure and as working
capital.
NOTE D - STOCK OPTIONS AND WARRANTS
Employee Stock Options
----------------------
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to employees
of the Company under a non-qualified employee stock option plan.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighted Weighted
Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
$1.00 6,775,000 9.19 $1.00 1,769,935 $1.00
$1.51 200,000 9.75 $1.51 16,667 $1.51
$2.35 465,000 9.75 $2.35 38,751 $2.35
$3.43 25,000 9.75 $3.43 2,083 $3.43
----------- ------ ------ ----------- ------
7,465,000 9.27 $1.11 1,827,436 $1.04
----------- ------ ------ ----------- ------
Transactions involving stock options issued to employees are summarized as
follows:
Weighted Average
Number of Shares Price Per Share
---------------- ---------------
Outstanding at January 1, 2001 840,000 -
Granted 215,000 $ 1.00
Exercised - -
Canceled or expired - -
------------- --------------
Outstanding at December 31, 2001 1,055,000 1.00
------------- --------------
Granted 2,835,000 1.00
Exercised (1,000,000) 1.00
Canceled or expired (1,440,000) 1.00
------------- --------------
Outstanding at December 31, 2002 1,450,000 $ 1.00
------------- --------------
Granted 6,098,333 1.11
Exercised (83,333) 1.00
Canceled or expired - -
------------- --------------
Outstanding at June 30, 2003 7,465,000 $ 1.11
------------- --------------
16
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE D - STOCK OPTIONS AND WARRANTS (CONTINUED)
Employee Stock Options (Continued)
----------------------------------
The weighted-average fair value of stock options granted to employees during the
period ended June 30, 2003 and 2002 and the weighted-average significant
assumptions used to determine those fair values, using a Black-Scholes option
pricing model are as follows:
2003 2002
---- ----
Significant assumptions (weighted-average):
Risk-free interest rate at grant date 1.25% 1.67%
Expected stock price volatility 26% 26%
Expected dividend payout - -
Expected option life-years (a) 10 10
(a) The expected option life is based on contractual expiration dates.
If the Company recognized compensation cost for the non-qualified employee stock
option plan in accordance with SFAS No. 123, the Company's pro forma net loss
and net loss per share would have been $(4,750,849) and $(0.30) for the period
ended June 30, 2003 and $(1,580,550) and $(0.09) for the period ended June 30,
2002, respectively.
Non-Employee Stock Options
--------------------------
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to the
Company consultants. These options were granted in lieu of cash compensation for
services performed.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighed Weighted
Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$ 1.00 2,871,667 9.18 $ 1.00 1,598,750 $ 1.00
Transactions involving options issued to non-employees are summarized as
follows:
Weighted Average
Number of Shares Price Per Share
---------------- ---------------
Outstanding at January 1, 2001 246,502 $ 0.70
Granted - -
Exercised - -
Canceled or expired - -
-------------- --------------
Outstanding at December 31, 2001 246,502 0.70
-------------- --------------
Granted 2,455,000 1.00
Exercised (1,146,502) 0.96
Canceled or expired - -
-------------- --------------
Outstanding at December 31, 2002 1,555,000 $ 1.00
-------------- --------------
Granted 1,400,000 1.00
Exercised (83,333) 1.00
Canceled or expired - -
-------------- --------------
Outstanding at June 30, 2003 2,871,667 $ 1.00
-------------- --------------
17
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE D - STOCK OPTIONS AND WARRANTS (CONTINUED)
Non-Employee Stock Options (Continued)
--------------------------------------
The estimated value of the options granted to consultants during the period
ended June 30, 2003 was determined using the Black-Scholes option pricing model
and the following assumptions: contractual term of 10 years, a risk free
interest rate of 1.25%, a dividend yield of 0% and volatility of 26%. The amount
of the expense charged to operations in connection with granting the options was
$286,904 and $226,230 during the period June 30, 2003 and 2002, respectively.
Warrants
--------
The following table summarizes the changes in warrants outstanding and the
related prices for the shares of the Company's common stock issued to
non-employees of the Company. These warrants were granted in lieu of cash
compensation for services performed or financing expenses and in connection with
placement of convertible debentures.
Warrants Outstanding Warrants Exercisable
-------------------- --------------------
Weighted Average Weighed Weighted
Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$ .50 815,000 8.00 $ .50 815,000 $ .50
$ .53 354,460 3.00 $ .53 354,460 $ .53
$ .66 229,700 3.00 $ .66 229,700 $ .66
$ 1.00 10,639,100 3.00 $ 1.00 10,639,100 $ 1.00
$ 2.54 50,000 3.00 $ 2.54 50,000 $ 2.54
$ 2.97 35,000 3.00 $ 2.97 35,000 $ 2.97
----------- -------- ---------- ------------ ----------
12,123,260 3.34 $ 0.96 12,123,260 $ 0.96
----------- -------- ---------- ------------ ----------
Transactions involving warrants are summarized as follows:
Weighted Average
Number of Shares Price Per Share
---------------- ---------------
Outstanding at January 1, 2001 1,210,572 $ 1.00
Granted 3,528,665 0.67
Exercised - -
Canceled or expired (1,210,572) 1.00
--------------- --------------
Outstanding at December 31, 2001 3,528,665 $ 0.67
--------------- --------------
Granted 1,667,460 0.87
Exercised (1,650,675) 0.51
Canceled or expired (13,990) 1.00
--------------- --------------
Outstanding at December 31, 2002 3,531,460 $ 0.84
--------------- --------------
Granted 8,591,800 1.01
Exercised - -
Canceled or expired - -
--------------- --------------
Outstanding at June 30, 2003 12,123,260 $ 0.96
--------------- --------------
The estimated value of the compensatory warrants granted to non-employees in
exchange for services and financing expenses during the period ended June 30,
2003 was determined using the Black-Scholes pricing model and the following
assumptions: contractual term of 3 to 8 years, a risk free interest rate of
1.25%, a dividend yield of 0% and volatility of 26%. The amount of the expense
charged to operations for compensatory warrants granted in exchange for
financing expenses was $0 and $85,620 during the period ended June 30, 2003 and
2002, respectively. The Company also capitalized financing costs of $87,732 and
$39,346 for compensatory warrants granted in connection with placement of
convertible debentures for the period ended June 30, 2003 and 2002,
respectively. The financing cost was amortized over the life (three years) of
the convertible debenture.
18
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE E - CAPITAL STOCK
The Company has authorized 15,000,000 shares of preferred stock, with a par
value of $.001 per share. As of June 30, 2003 and December 31, 2002, the Company
has no preferred stock issued and outstanding. The company has authorized
100,000,000 shares of common stock, with a par value of $.001 per share. As of
June 30, 2003 and December 31, 2002, the Company has 15,977,795 and 15,721,131
shares of common stock issued and outstanding, respectively.
In April 2003, the Company issued 40,000 shares of common stock at $0.50 per
share to one of its Debenture-1 noteholder in exchange for $20,000 of conversion
of debts.
In April 2003, the Company issued 49,998 shares of common stock at approximately
$1.54 per share to consultants for in exchange for services rendered, which
approximated the fair value of the shares issued during the period the services
were completed and rendered. Compensation costs of $76,745 were charged to
income during the period ended June 30, 2003.
In June 2003, the Company issued 83,333 shares of common stock to an employee in
exchange for exercised employee stock options at $1.00 per share, totaling
$83,333. Additionally, the Company issued 83,333 shares of common stock to a
consultant in exchange for exercised non-employee stock options at $1.00 per
share, totaling $83,333.
Share amounts presented in the consolidated balance sheets and consolidated
statements of stockholders' equity reflect the actual share amounts outstanding
for each period presented.
NOTE F - RESTATEMENT OF FINANCIAL STATEMENTS
The Company has restated its financial statements for the year ended December
31, 2001 and for the period ended June 30, 2002 to correct the following errors
in the financial statements previously filed:
o For the year ended December 31, 2001, the Company erroneously
recorded the Black-Scholes value of the 940,000 warrants
attached to its convertible debentures as an asset (financing
cost), and amortized over the maturity period (three year) of
the note.
o For the year ended December 31, 2001, the Company erroneously
recorded the beneficial conversion feature of its convertible
debentures as an asset (financing cost) and the beneficial
conversion feature was erroneously amortized over six-months
(from the issuance of the note to the earliest conversion
date).
o For the year ended December 31, 2001, the Company erroneously
recorded impairment of property and equipment as research and
development expense.
o For the period ended June 30, 2002, the Company erroneously
did not record and amortize the beneficial conversion feature
of its convertible debentures and value of warrants attached
to the convertible debentures.
The net effect of the correction of these errors was to:
o Decrease the Company's reported net loss for the year ended
December 31, 2001 by $289,645 from $(2,006,140) to
$(1,716,495). Increase the Company's reported net loss for the
period June 30, 2002 by $231,830 from $(1,243,304) to
$(1,475,134).
o Decrease the loss per share for the year ended December 31,
2001 by $.01 from $(.09) to $(.08) per share. Increase the
loss per share for the period ended June 30, 2002 by $.02 from
$(.07) to $(.09) per share.
o Decrease the deficiency accumulated during the development
stage from November 3, 1999 to June 30, 2002, by $57,815 from
$(4,213,137) to $(4,155,322).
o Decrease other assets (financing costs) as of June 30, 2002,
by $507,728 from $628,525 to $120,797.
o Increase debt discount as of June 30, 2002, by $1,362,523 from
$0 to $1,362,523.
o Increase additional paid in capital as of June 30, 2002, by
$771,979 from $3,466,421 to $4,238,400.
19
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
JUNE 30, 2003
(UNAUDITED)
NOTE G - SUBSEQUENT EVENTS
Subsequent to the date of the financial statements, the Debenture-1 Noteholders
(see Note B) put forth to the Company its demand registration request for the
registration of common shares of the Company sufficient to cover the conversion
of their debentures and exercise of the attached warrants. Accordingly, the
Company notified the Series B Debenture Noteholder (Note B), Senior Noteholders
(Note C) and Warrant holders with piggy-back registration rights requesting
their election to participate in the registration. The Company anticipates
additional cash resources generated as the result of exercise of the warrants
however the amount of funding cannot be determined until September 12th, at
which time the exercise price is required to be paid to the Company. In August
2003, the Company issued an aggregate of 7,514,541 shares of common stock in
connection with the conversion of Debenture-1 of $1,517,100 and Series B
Debentures of $2,180,000 and the issuance of common stock related accrued
interest of $187,039 and $85,586, respectively. The proforma balance sheet below
represents the effect of the conversion of the debentures as if it had occurred
as of June 30, 2003.
SUMMARY PROFORMA BALANCE SHEET
Unaudited Proforma Adjustments Proforma
June 30, 2003 Dr. Cr. June 30, 2003
ASSETS:
Cash 4,580,779 3,000,000 7,580,779
Other current assets 525,272 525,272
----------------------------------------------------------
Total current assets 5,106,051 3,000,000 8,106,051
Other assets 323,893 323,893
----------------------------------------------------------
Total Assets 5,429,945 3,000,000 8,429,945
==========================================================
LIABILITIES & SHAREHOLDER'S EQUITY
Current liabilities 1,297,829 272,625 - 1,025,204
Convertible debentures - net of discounts 1,453,720 1,453,720 -
Senior notes 5,000,000 5,000,000
Shareholder's (deficiency) equity (2,321,604) 4,726,345 2,404,741
----------------------------------------------------------
Total liabilities & shareholder's equity 5,429,945 1,726,345 4,726,345 8,429,945
==========================================================
NOTES TO PROFORMA BALANCE SHEET:
(1) Conversion of convertible debentures
(2) Assumes 30% exercise warrants.
(3) Stock Issuance for debenture interest
20
Item 2. Management's Plan of Operation
The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto, included elsewhere within
this Report.
Description of the Company
--------------------------
Telkonet is a high technology systems application developer with a primary focus
on high-speed Internet distribution over the electrical power lines for the
commercial buildings, hotels, multi-dwelling residential units, government and
schools. Telkonet believes that through extensive research and development, it
has refined a business model that will provide marketable Internet services
across a wide spectrum of commercial and business end users. These products
provide connectivity over the existing electrical wiring does not require the
addition of costly wiring, or major disruption to business activity. In many
situations the Telkonet solution can be implemented more quickly and less
expensively than adding dedicated wiring or installing wireless systems.
Telkonet believes that utilizing the power line to deliver high-speed Internet
and telephone connectivity to these markets creates a significant and definitive
niche market opportunity for the Company. Telkonet's solutions overcome many of
the difficulties associated with powerline communications that historically have
prevented the achievement of high data transmission rates.
Telkonet has completed its development cycle of its commercial grade high-speed
Internet access product solution, manufactured product and has commenced
marketing its suite of PlugPlus products for high-speed Internet access.
As Internet access becomes a more critical tool, the demand for higher access
speeds has triggered the growth of broadband solutions, and as these roll out,
the desire for access to these emerging broadband networks provides
opportunities for Telkonet. The built-in dial-up modems that have become a part
of most new PCs are not suitable for higher speed connections. Hardwired network
connections with high construction costs and disruption of the workplace, or
complex wireless networks which have coverage and security issues are the only
solutions available today.
The Telkonet PlugPlus family of Internet access products provides a viable and
cost effective alternative to the challenges of hard-wired and wireless local
area networks (LANs). This solution set is comprised of three products, the
PLUGPLUS GATEWAY, PLUGPLUS COUPLER and the PLUGPLUS MODEM.
The Telkonet PlugPlus Solution is aimed at multi-user applications such as
hotels/motels, residential apartment complexes, government, schools and a
variety of small and medium sized businesses. High-speed Internet connections
are becoming widely available and providers are focused on meeting the demands
of new and existing customers needs for high-speed Internet access. Several
companies now specialize in providing T1 access and most telephone companies now
offer DSL products. Providers are also offering connectivity through Microwave
networks, 2-way Satellite, Fiber and Cable connections. However, these products
share in the same problem: getting the access to where the customers want it.
The Telkonet solution interfaces to the backbone of the Internet by taking the
signal from any of these broadband sources and, through the Telkonet PlugPlus
Gateway, distributing access to the Internet to the ultimate user over the
existing electrical wiring in the building. With the Telkonet PlugPlus Gateway
in place, access is provided by simply plugging the user's Telkonet PlugPlus
Modem into the nearest standard electrical outlet. Any existing electrical
outlet in the structure can provide immediate access to the Internet via a
Telkonet PlugPlus Modem. Moving the location of a PC, server, or printer is
accomplished by simply moving the PlugPlus Modem to another electrical outlet.
No additional wiring is required and changes can be made quickly and easily.
The Telkonet PlugPlus Gateway provides the connection to the incoming broadband
signal (DSL, TL, Satellite, and Cable Modem) and the Telkonet PlugPlus Modem
connects to a user device. Many PCs, each equipped with one Telkonet PlugPlus
Modem, can communicate amongst themselves and can share a single broadband
resource via the Telkonet PlugPlus Gateway.
Telkonet has applied for patents that cover its unique technology, and intends
to utilize recently announced advancements in transmission speeds to build next
generation devices for field tests and marketing demonstrations.
Telkonet will continue 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.
21
Forward Looking Statements
--------------------------
CERTAIN STATEMENTS INCLUDED HEREIN OR INCORPORATED BY REFERENCE CONSTITUTE
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995 (THE "REFORM ACT"). TELKONET DESIRES TO TAKE
ADVANTAGE OF CERTAIN "SAFE HARBOR" PROVISIONS OF THE REFORM ACT AND IS INCLUDING
THIS SPECIAL NOTE TO ENABLE THE COMPANY TO DO SO. FORWARD-LOOKING STATEMENTS
INCLUDED OR INCORPORATED BY REFERENCE IN THIS PART INVOLVE KNOWN AND UNKNOWN
RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH COULD CAUSE THE COMPANY'S ACTUAL
RESULTS, PERFORMANCE (FINANCIAL OR OPERATING) OR ACHIEVEMENTS TO DIFFER
MATERIALLY FROM THE FUTURE RESULTS, PERFORMANCE (FINANCIAL OR OPERATING) OR
ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD LOOKING STATEMENTS.
Management's Discussion and Analysis of Financial Condition and Results of
--------------------------------------------------------------------------
Operations
----------
Telkonet is commencing its transition from a development stage company with its
planned PlugPlus product suite launched during the second quarter 2003. Telkonet
may experience fluctuations in operating results in future periods due to a
variety of factors including, but not limited to, market acceptance of the
Internet and power line communication technologies as a medium for customers to
purchase Telkonet's products, Telkonet's ability to acquire and deliver high
quality products at a price lower than currently available to consumers,
Telkonet's ability to obtain additional financing in a timely manner and on
terms favorable to the Telkonet, Telkonet's ability to successfully attract
customers at a steady rate and maintain customer satisfaction, Telkonet
promotions, branding and sales programs, the amount and timing of operating
costs and capital expenditures relating to the expansion of Telkonet's business,
operations and infrastructure and the implementation of marketing programs, key
agreements and strategic alliances, the number of products offered by Telkonet,
the number of returns experienced by Telkonet, and general economic conditions
specific to the Internet, power-line communications, and the communications
industry.
Revenues
--------
To date, Telkonet has not generated any revenues as it was in the development
stage. Telkonet believes it will begin earning revenues from operations within
the next three to six months with the acceleration of its sales and marketing
efforts.
Costs and expenses
------------------
From its inception on November 3, 1999 through June 30, 2003, Telkonet has
incurred operating expenses of $8,340,971. These expenses were associated
principally with compensation to employees, product development costs,
professional services and costs associated with non-employee stock options.
Overall expenses increased for the three and six months ended June 30 2003 over
the comparable period in 2002 by $870,086 or 124% and $ $1,402,843 or 112%
respectively. These increases are principally due to an increase in payroll and
related costs for development, sales and marketing and administrative functions,
and external costs associated with product development, pre-production costs for
the PlugPlus powerline products, ramp-up of sales and marketing activities and
costs associated with non-employee stock options issued in connection with
services rendered.
Liquidity and Capital Resources
-------------------------------
To date Telkonet has not generated revenues to offset any development and
organizational expenses. As a result of Telkonet's operating losses from its
inception through June 30, 2003, Telkonet generated a cash flow deficit of
$6,520,252 from operating activities. Telkonet's current assets exceeded its
current liabilities by $3,808,222 as of June 30, 2003. For the period from
inception through June 30, 2003, Telkonet has accumulated losses of $9,918,391.
Consequently, its operations are subject to all risks inherent in the
establishment of a new business enterprise.
While Telkonet has raised capital to meet its working capital and financing
needs to date, additional financing may be required in order to meet Telkonet's
current and projected cash flow deficits from operations and development during
the next twelve months. Management belives it has sufficient capital resources
to meet projected cash flow deficits through the next twelve months. However, if
thereafter, we are not successful in generating sufficient liquidity from
operations or in raising sufficient capital resources on terms acceptable to us,
this could have a material adverse effect on our business, results of
operations, liquidity and financial condition.
22
During the second quarter, Telkonet completed its $5,000,000, 8.0% senior note
offering, the proceeds of which were used to provide the necessary working
capital. These notes provide for interest payable quarterly and include
non-detachable warrants to purchase 125,000 shares of our common stock for each
$100,000 units sold. The warrants are exercisable for three years from issuance
at an exercise price of $1.00 per share.
After June 30, 2003, the Series A Debenture noteholders demanded registration of
shares of common stock sufficient to cover the conversion of their debentures
and exercise of the attached warrants. Accordingly, Telkonet notified the Series
B Debenture Noteholder, Senior Noteholders and Warrant holders with piggy-back
registration rights of the right to participate in the registration. Telkonet
anticipates that additional cash resources will be generated as the result of
exercise of the warrants. However, the amount of such funding cannot be
determined until September 12, 2003, at which time the exercise price for the
warrants is required to be paid to Telkonet.
Telkonet's independent certified public accountants have stated in their report
included in Telkonet's December 31, 2002 Form 10-KSB, that Telkonet has incurred
operating losses in the last two years, and that Telkonet is dependent upon
management's ability to develop profitable operations. These factors, among
others, may raise substantial doubt about Telkonet's ability to continue as a
going concern.
Product Research and Development
--------------------------------
Company-sponsored research and development costs related to both present and
future products are expended in the period incurred. Total expenses for the
three and six months ended June 30, 2003 decreased over the comparable period in
2002 by $48,882 or 15.0% and $4,773 or 1.0% respectively. During the second
quarter of 2002, non-recurring costs of approximately $49,000 related to the
purchase of prototype units, PCB board testing and UL and FCC testing were
incurred.
Selling, General and Administrative
-----------------------------------
Selling, general and administrative expenses increased for the three and six
months ended June 30, 2003 over the comparable period in 2002 by $937,354 or
397% and $1,335,966 or 373.0%, respectively. These increases were related to
one-time costs associated with the Senior Note and Series B Debenture fund
raising including commissions, public relations and employee separation costs.
Acquisition or Disposition of Plant and Equipment
-------------------------------------------------
During the period ended June 30, 2003, Telkonet renewed certain operating
equipment leases and added a $1.00 buy-out option at the end of the new 18 month
lease term. Accordingly, the leases and the related debt obligations for
approximately $52,000 were capitalized. Telkonet does not anticipate the sale of
any significant property, plant or equipment during the next twelve months.
Telkonet does not anticipate the acquisition of any significant property, plant
or equipment during the next twelve months, other than leasehold improvements,
computer equipment and peripherals used in Telkonet's day-to-day operations.
Number of Employees
-------------------
During the period ended June 30, 2003, Telkonet had 17 employees. In order for
Telkonet to attract and retain quality personnel, Telkonet anticipates it will
continue to offer competitive salaries to current and future employees. As
Telkonet continues to expand, Telkonet will incur additional costs for
personnel. This projected increase in personnel is dependent upon Telkonet
generating revenues and obtaining sources of financing. There are no assurances
Telkonet will be successful in raising the funds required or generating revenues
sufficient to fund the projected increase in the number of employees.
Trends, Risks and Uncertainties
-------------------------------
Telkonet has sought to identify what it believes to be the most significant
risks to its business, but cannot predict whether or to what extent any of such
risks may be realized nor can there be any assurances that Telkonet has
identified all possible risks that might arise. Investors should carefully
consider all such risk factors before making an investment in Telkonet's common
stock. Telkonet's prospects must be evaluated with a view to the risks
encountered by a company in an early stage of development, particularly in light
of the uncertainties relating to the new and evolving power line modulation and
transmission technologies. Telkonet will be incurring costs to develop,
introduce and enhance its products, to establish marketing relationships, to
acquire and develop products that will compliment each other and to build an
administrative organization. To the extent that such expenses are not
subsequently followed by commensurate revenues, Telkonet's business, results of
operations and financial condition will be materially adversely affected. There
can be no assurance that Telkonet will be able to generate sufficient revenues
from the sale of its first product and other product candidates. Telkonet
expects negative cash flow from operations to continue for the next six months
as it continues to develop and market its business. Telkonet will be required to
sell additional equity or debt securities. The sale of additional equity or
convertible debt securities will result in additional dilution to Telkonet's
stockholders.
23
Potential fluctuations in quarterly operating results
-----------------------------------------------------
Telkonet's quarterly operating results may fluctuate significantly in the future
as a result of a variety of factors, most of which are outside Telkonet's
control, including: the level of use of the Internet; the demand for high-tech
goods; trends in broadband service provisioning, the amount and timing of
capital expenditures and other costs relating to the expansion of Telkonet's
operations; price competition or pricing changes in the industry; technical
difficulties; general economic conditions, and economic conditions specific to
the Internet and communications industry.
Limited public market, possible volatility of share price
---------------------------------------------------------
Telkonet's common stock is currently quoted on the NASD OTC Bulletin Board under
the ticker symbol "TLKO." As of June 30, 2003, there were approximately
15,977,795 shares of common stock outstanding. There can be no assurance that a
trading market will be sustained in the future. Factors such as, but not limited
to, technological innovations, new products, acquisitions or strategic alliances
entered into by Telkonet or its competitors, failure to meet securities
analysts' expectations, government regulatory action, patent or proprietary
rights developments, and market conditions for technology stocks in general
could have a material effect on the volatility of Telkonet's stock price.
Item 3. Controls and Procedures.
As of the end of the period covered by this Report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive and Chief Financial Officer, of the effectiveness
of the design and operation of our disclosure controls and procedures pursuant
to Rule 13a-14 under the Securities Exchange Act of 1934, as amended. Based upon
that evaluation, the Chief Executive and Chief Financial Officer concluded that
our disclosure controls and procedures are effective in timely alerting them to
material information required to be included in our periodic filings with the
U.S. Securities and Exchange Commission. There were no significant changes in
our internal controls or in other factors that could significantly affect these
internal controls subsequent to the date of our most recent evaluation.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In March 2003, Jenson Services, Inc. and James P. Doolin filed an action against
Telkonet in the Third Judicial District Court in and for Salt Lake County, State
of Utah. The action sets forth various counts all based on allegations that
Telkonet, through its agents, promised to undertake a registration of Telkonet
common stock and thereby allow the plaintiffs to exercise piggy-back
registration rights under a registration rights agreement. The action seeks
damages from Telkonet in unspecified amounts. Telkonet believes that the claims
of the plaintiffs are without merit, that it has meritorious defenses to such
claims, and Telkonet intends to defend itself against the plaintiffs' claims in
their entirety.
Item 2 - Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
24
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
No. Description
--- -----------
31.1 Certification of Ronald W. Pickett
Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of E. Barry Smith
Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Ronald W. Pickett
Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of E. Barry Smith
Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K filed during the three months
ended June 30, 2003.
On May 21, 2003, Telkonet filed a Current Report on Form 8- K dated May 21,
2003, reporting under Item 5, disclosing an update letter to shareholders
announcing the status of product and market development.
On June 26, 2003, Telkonet filed a Current Report on Form 8- K dated June 26,
2003, reporting under Item 5, disclosing an update letter to shareholders
announcing the completion of Senior Note offering.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Telkonet, Inc.
Registrant
Date: August 13, 2003 By: /s/ Ronald W. Pickett
--------------- ---------------------
Ronald W. Pickett
President
25