U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10QSB/A
(Amendment No 2)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the period ended March 31, 2003
Commission file number 000-27305
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: 15,811,129 shares of Common Stock
($.001 par value) as of May 9, 2003.
Transitional small business disclosure format: Yes No x
--- ---
TELKONET, INC.
Quarterly Report on Form 10-QSB for the
Quarterly Period Ending March 31, 2003
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets: 3
March 31, 2003 and December 31, 2002
Condensed Consolidated Statements of Losses: 4
Three Months Ended March 31, 2003 and 2002
November 3, 1999 (Date of Inception) through March 31, 2003
Consolidated Statement of Deficiency in Stockholders' Equity: 5
November 3, 1999 (Date of Inception) through March 31, 2003
Condensed Consolidated Statements of Cash Flows: 8
Three Months Ended March 31, 2003 and 2002
November 3, 1999 (Date of Inception) through March 31, 2003
Notes to Unaudited Condensed Consolidated Financial Information: 10
March 31, 2003
Item 2. Plan of Operation 19
Item 3. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
2
Item 1. Financial Statements (Unaudited)
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) (Audited)
March 31, December 31,
2003 2002
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 663,571 $ 18,827
Inventory, net 275,941 39,790
Due from shareholders 10,000 --
Other receivable 1,550 1,550
Prepaid expenses and deposits 100,857 4,625
------------- -------------
Total current assets 1,051,918 64,792
PROPERTY AND EQUIPMENT:
Furniture and equipment, at cost 79,754 73,215
Less: accumulated depreciation 37,439 35,252
------------- -------------
42,315 37,963
OTHER ASSETS
Financing costs, less accumulated amortization of $133,049 and
$101,692 at March 31, 2003 and December 31, 2002, respectively 248,460 192,600
$ 1,342,693 $ 295,355
============= =============
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 571,045 $ 518,865
Notes payable 250,000 310,000
Due to Shareholders 7,500 130,330
------------- -------------
Total current liabilities 828,545 959,195
Convertible debentures, net of discounts - including related
parties (Note B) 1,148,075 862,682
COMMITMENTS AND CONTINGENCIES -- --
DEFICIENCY IN STOCKHOLDERS' EQUITY
Preferred stock, par value $.001 per share; 15,000,000 shares
authorized; none issued at March 31, 2003 and December 31, 2002 -- --
Common stock, par value $.001 per share; 100,000,000 shares
authorized; 15,721,131 shares issued and outstanding at March
31, 2003 and December 31, 2002 15,721 15,721
Additional paid-in-capital 7,249,770 4,916,433
Accumulated deficit during development stage (7,899,418) (6,458,676)
------------- -------------
Deficiency in stockholders' equity (633,927) (1,526,522)
------------- -------------
$ 1,342,693 $ 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
Three Months ended March 31, November 3, 1999 (date
2002 (As of inception) through
Restated March 31, 2003 (As
2003 - Note D)) Restated - Note D)
------------- ------------- ------------------
Costs and Expenses:
Research and Development $ 314,728 $ 270,579 $ 2,727,200
Selling, General and Administrative 739,142 234,625 3,870,313
Depreciation and Amortization 33,544 49,453 170,488
------------- ------------- -------------
Total Operating Expense 1,087,414 554,657 6,768,001
Loss from Operations (1,087,414) (554,657) (6,768,001)
Other Income (Expense) -- -- 4,579
Interest Income (Expense) (353,329) (91,446) (1,135,997)
Provision for Income Tax -- -- --
------------- ------------- -------------
(353,329) (91,446) (1,131,418)
Net Loss $ (1,440,743) $ (646,103) $ (7,899,419)
============= ============= =============
Loss per common share (basic and assuming
dilution) $ (0.09) $ (0.07) $ (0.49)
============= ============= =============
Weighted average common shares outstanding 15,721,131 9,313,563 16,050,030
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 MARCH 31, 2003
Deficit
Accumulated
Pref- Common During
Pref- erred Common Additional Stock Develop-
erred Stock Stock Paid in Subscr- ment
Shares Amount Common 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 MARCH 31, 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 $1,000 $ (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 MARCH 31, 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)
====== ======= ============ ========= ============ ============ ============ ============
Stock based compensation for
the issuance of stock options
to consultants in exchange for
services (Note C) -- -- -- -- 219,020 -- -- 219,020
Stock based compensation for
the issuance of warrants in
exchange for financing costs
(Note C) -- -- -- -- 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 -- -- -- -- -- -- (1,440,743) (1,440,743)
------ ------- ------------ -------- ------------ ------------ ------------ ------------
BALANCE AT MARCH 31, 2003 -- $ -- 15,721,131 $ 15,721 $ 7,249,770 $ -- $(7,899,419) $ (633,927)
====== ======= ============ ========= ============ ============ ============ ============
See accompanying footnotes to the unaudited condensed consolidated financial information
7
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the period
from November
3, 1999 (date
of inception)
Three Months Ended March 31, through
2002 (As March 31, 2003
Restated - (As Restated -
2003 Note D) Note D)
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from development stage operations $(1,440,743) $ (646,103) $(7,899,419)
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 251,722 71,688 785,144
Amortization of debt discount - value of warrants attached to
convertible debentures 33,672 6,713 81,614
Stock options and warrants issued in exchange for services rendered 219,020 -- 1,174,882
Common stock issued in exchange for services rendered -- -- 150,302
Common stock issued in exchange for conversion of interest -- 21,793 21,793
Impairment of property and equipment -- -- 39,287
Depreciation and amortization 33,544 49,453 170,488
Increase (decrease) in:
Other receivable -- -- (1,550)
Inventory (236,150) -- (275,941)
Prepaid expenses and deposits (96,232) -- (100,857)
Accounts payable and accrued expenses, net 52,180 144,551 571,044
------------ ------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (1,182,987) (351,905) (5,283,212)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net of disposals (6,539) (12,731) (119,041)
------------ ------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (6,539) (12,731) (119,041)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net of costs -- -- 1,751,224
Advance to shareholders (10,000) -- (10,000)
Proceeds from (repayments of) stockholder advances (122,830) 114,000 7,500
Proceeds from issuance of convertible debentures, net of costs 2,027,100 337,007 4,067,100
Repayments of loans (60,000) (37,500) (150,000)
Proceeds from loans -- -- 400,000
------------ ------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,834,270 413,507 6,065,824
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS 644,744 48,871 663,571
Cash and cash equivalents at the beginning of the period 18,827 21,885 --
------------ ------------ ------------
Cash and cash equivalents at the end of the period $ 663,571 $ 70,756 $ 663,571
------------ ------------ ------------
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
of inception)
Three Months Ended March 31, through
2002 (As March 31, 2003
Restated - (As Restated -
2003 Note D) Note D)
------------ ------------ ------------
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for interest $ 4,163 $ 11,807 $ 29,128
Income taxes paid -- -- --
Non-cash transactions:
Issuance of stock options and warrants in exchange for services
rendered 219,020 -- 1,174,882
Issuance of stock warrants in exchange for financing costs 87,217 -- 173,691
Common stock issued for services rendered -- -- 150,302
Common stock issued in exchange for interest -- 21,793 21,793
Beneficial conversion feature on convertible debentures 1,761,675 268,863 3,440,426
Value of warrants attached to convertible debentures 265,425 40,199 467,356
Acquisition:
Assets Acquired -- -- 1
Accumulated Deficit -- -- 2,643
Liabilities Assumed -- -- (2,642)
------------ ------------ ------------
$ -- $ -- $ 1
------------ ------------ ------------
See accompanying footnotes to the unaudited condensed consolidated financial information
9
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 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 three-month period ended March
31, 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.
Stock Based Compensation
------------------------
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS 123." This statement
amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary charge to the fair value based
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in APB
Opinion No. 25 and related interpretations. Accordingly, compensation expense
for stock options is 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 March 31, 2003.
10
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 2003
(UNAUDITED)
NOTE A - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
---------------------------------------------------
Stock Based Compensation (Continued)
------------------------------------
Had compensation costs for the Company's stock options been determined based on
the fair value at the grant dates for the awards, the Company's net loss and
losses per share would have been as follows (transactions involving stock
options issued to employees and Black-Scholes model assumptions are presented in
Note C):
For the three month ended March 31
2003 2002
---- ----
Net loss - as reported $ (1,440,743) $ (646,103)
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) (161,935) (52,708)
------------- -----------
Net loss - Pro Forma $ (1,602,678) $ (698,811)
Net loss attributable to common stockholders - Pro forma $ (1,602,678) $ (698,811)
Basic (and assuming dilution) loss per share - as reported $ (0.10) $ (0.08)
Basic (and assuming dilution) loss per share - Pro forma $ (0.10) $ (0.08)
New Accounting Pronouncements
-----------------------------
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation 46 changes the criteria by which one
company includes another entity in its consolidated financial statements.
Previously, the criteria were based on control through voting interest.
Interpretation 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. A company that consolidates a variable
interest entity is called the primary beneficiary of that entity. The
consolidation requirements of Interpretation 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation requirements
apply to older entities in the first fiscal year or interim period beginning
after June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company does not expect the
adoption to have a material impact to the Company's financial position or
results of operations.
11
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 2003
(UNAUDITED)
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE
---------------------------------------------
A summary of convertible promissory notes payable at March 31, 2003 and December
31, 2002 is as follows:
March 31, 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. $ 1,689,100 $ 1,689,100
Debt Discount - beneficial conversion feature, net
of accumulated amortization of $659,436 and
$531,858 at March 31, 2003 and December 31, 2002,
respectively (871,456) (999,034)
Debt Discount - value attributable to warrants
attached to notes, net of accumulated amortization
of $58,322 and $47,216 at March 31, 2003 and
December 31, 2002, respectively (75,014) (86,120)
------------ ------------
742,630 603,946
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 $125,708 and $1,564
at March 31, 2003 and December 31, 2002,
respectively (1,783,827) (146,295)
Debt Discount - value attributable to warrants
attached to notes, net of accumulated amortization
of $23,292 and $726 at March 31, 2003 and December
31, 2002, respectively (310,728) (67,869)
------------ ------------
405,445 258,736
------------ ------------
Total $ 1,148,075 $ 862,682
------------ ------------
Less: current portion -- --
------------ ------------
$ 1,148,075 $ 862,682
============ ============
12
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 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 4.25%, a dividend yield of 0%, and volatility of 21%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.
During the year ended December 31, 2002, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $749,100, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of May
2005. Noteholders have the option to convert any unpaid note principal together
with accrued and unpaid interest to the Company's common stock at a rate of $.50
per share six months after issuance.
In accordance with EMERGING ISSUES TASK FORCE ISSUE 98-5, ACCOUNTING FOR
CONVERTIBLE SECURITIES WITH A BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY
ADJUSTABLE CONVERSION RATIOS ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Debenture-1 note. The Company
allocated a portion of the proceeds equal to the intrinsic value of that feature
to additional paid in capital. The Company recognized and measured an aggregate
of $693,018 of the proceeds, which is equal to the intrinsic value of the
imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Debenture-1. The debt discount attributed to the beneficial
conversion feature is amortized over the Debenture-1's maturity period (three
years) as interest expense.
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.
13
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 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.
14
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 2003
(UNAUDITED)
NOTE B - CONVERTIBLE PROMISSORY NOTES PAYABLE (CONTINUED)
---------------------------------------------------------
Series B Debentures
-------------------
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 $285,394 and $78,401 for the
three month ended March 31, 2003 and 2002, respectively.
NOTE C - 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 3,475,000 9.08 $ 1.00 939,518 $ 1.00
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 2,025,000 1.00
Exercised -- --
Canceled or expired -- --
------------- -----------
Outstanding at March 31, 2003 3,475,000 $ 1.00
============= ===========
15
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 2003
(UNAUDITED)
NOTE C - STOCK OPTIONS AND WARRANTS (CONTINUED)
-----------------------------------------------
The weighted-average fair value of stock options granted to employees during the
period ended March 31, 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 $(1,602,678) and $(0.10) for the period
ended March 31, 2003 and $(698,811) and $(0.08) for the period ended March 31,
2002, respectively.
Non-Employee Stock Options
--------------------------
The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to the
Company consultants. These options were granted in lieu of cash compensation for
services performed.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average Weighted Weighted
Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$ 1.00 5,855,000 9.71 $ 1.00 1,690,496 $ 1.00
Transactions involving options issued to non-employees are summarized as
follows:
Weighted Average
Number of Shares Price Per Share
----------- ----------
Outstanding at January 1, 2001
Granted 246,502 $ 0.70
Exercised -- --
Canceled or expired -- --
----------- ----------
Outstanding at December 31, 2001 246,502 0.70
----------- ----------
Granted 2,455,000 1.00
Exercised (1,146,502) 0.96
Canceled or expired -- --
----------- ----------
Outstanding at December 31, 2002 1,555,000 $ 1.00
----------- ----------
Granted 4,300,000 1.00
Exercised -- --
Canceled or expired -- --
----------- ----------
Outstanding at March 31, 2003 5,855,000 $ 1.00
=========== ==========
16
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 2003
(UNAUDITED)
NOTE C - STOCK OPTIONS AND WARRANTS (CONTINUED)
-----------------------------------------------
Non-Employee Stock Options (Continued)
--------------------------------------
The estimated value of the options granted to consultants during the period
ended March 31, 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
$219,020 and $113,115 during the period March 31, 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 Weighted Weighted
Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
--------------- ----------- ------------ -------------- ----------- --------------
$ .50 815,000 8.00 $ .50 815,000 $ .50
$ .53 354,460 3.00 $ .53 354,460 $ .53
$ 1.00 4,618,800 3.00 $ 1.00 4,618,800 $ 1.00
----------- -----------
5,788,260 5,788,260
=========== ===========
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 2,256,800 1.00
Exercised -- --
Canceled or expired -- --
----------- ----------
Outstanding at March 31, 2003 5,788,260 $ 0.90
=========== ==========
17
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 2003
(UNAUDITED)
NOTE C - STOCK OPTIONS AND WARRANTS (CONTINUED)
-----------------------------------------------
Warrants (Continued)
--------------------
The estimated value of the compensatory warrants granted to non-employees in
exchange for services and financing expenses during the period ended March 31,
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 services
and services was $0 and $42,944 during the period ended March 31, 2003 and 2002,
respectively. The Company also capitalized financing costs of $87,217 and $0 for
compensatory warrants granted in connection with placement of convertible
debentures for the period ended March 31, 2003 and 2002, respectively. The
financing cost was amortized over the life (three years) of the convertible
debenture.
NOTE D - RESTATEMENT OF FINANCIAL STATEMENTS
--------------------------------------------
The Company has restated its financial statements for the year ended December
31, 2001 and for the period ended March 31, 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 Match 31, 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 ended March 31, 2002 by
$95,482 from $(550,621) to $(646,103).
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 March 31, 2002 by $.01 from $(.06) to $(.07) per
share.
o Decrease the deficiency accumulated during the development stage by
$194,163 from $(3,520,454) to $(3,326,291).
o Decrease other assets by $518,357 from $661,050 to $142,693.
o Increase debt discount by $1,044,461 from $0 to $1,044,461.
o Increase additional paid in capital by $331,941 from $2,251,134 to
$2,583,075.
18
TELKONET, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL INFORMATION
MARCH 31, 2003
(UNAUDITED)
NOTE E - SUBSEQUENT EVENTS
--------------------------
Subsequent to the date of the financial statements, the Company entered into an
offering memorandum to sell up to $5,000,000 of Senior Notes in units of
$100,000 with interest at 8% payable quarterly and 125,000 warrants per unit to
purchase one share of the Common Stock of the Company. The warrants are
exercisable at anytime after issuance of the Senior Note at an exercise price of
$1.00 with a three year term. These notes are secured by a first lien priority
security interest in all intellectual property assets of the Company. The
proceeds are for expansion of sales, marketing and strategic partnership
programs, build require infrastructure and fund working capital. In May 2003,
the Company received $800,000 of proceeds from issuance of its Senior Notes.
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 and do 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 is now at a point in its business development cycle at which the system
requirements and hardware have been developed, market tested and the Company is
ready for market release of 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 anxious to sell these
connections to their new and existing customers. 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.
19
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, 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.
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 launch in 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 the
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 the Telkonet's business, operations
and infrastructure and the implementation of marketing programs, key agreements
and strategic alliances, the number of products offered by the Telkonet, the
number of returns experienced by the 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 twelve months as it transitions from a development stage company to
that of an active growth and acquisition stage company.
Costs and expenses
------------------
>From its inception on November 3, 1999 through March 31, 2003, Telkonet has
incurred operating expenses of $6,768,001. These expenses were associated
principally with compensation to employees, product development costs and
professional services. During the first quarter of 2003, Telkonet transitioned
20
its focus on bringing their initial offering of powerline communication products
to the hospitality sector of the commercial market with its Strategic Alliance
Agreement with Choice Hotels International, Inc. Expenses increased by 96% over
the first quarter of 2002 due to an increase in manpower expense related to the
expansion of the development team, pre-production costs for the PlugPlus
powerline products, and the ramp-up and increase in sales and marketing
activities.
Liquidity and Capital Resources
-------------------------------
To date the Company has not generated revenues to offset any development and
organizational expenses. As a result of the Company's operating losses from its
inception through March 31, 2003, Telkonet generated a cash flow deficit of
$5,283,212 from operating activities. The Company's current assets exceeded its
current liabilities by $223,373 as of March 31, 2003. For the period from
inception through March 31, 2003, the Company has accumulated losses of
$7,899,418. 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 in the past, additional financing is required in order to meet the
Telkonet's current and projected cash flow deficits from operations and
development. Telkonet is seeking financing in the form of a $5,000,000, 8%
senior note offering in order to provide the necessary working capital. These
notes provide for interest payable quarterly and includes warrants of 125,000
for each $100,000 units sold. The warrants are for the purchase of Common Stock
of the Company exercisable up to three years from issuance at a $1.00 exercise
price. While there are no assurances Telkonet will be successful in raising the
funds required, subsequent to March 31, 2003, the Company has received $800,000
of proceeds from the issuance of the Senior Notes.
By adjusting its operations and development to the level of capitalization ,
management belives it has suffucient 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.
The Company's independent certified public accountants have stated in their
report included in the Company's December 31, 2002 Form 10-KSB, that the Company
has incurred operating losses in the last two years, and that the Company is
dependent upon management's ability to develop profitable operations. These
factors among others may raise substantial doubt about the Company's ability to
continue as a going concern.
Product Research and Development
--------------------------------
Company-sponsored research and development costs related to both present and
future products are expended in the period incurred. Total expenditures on
research and product development for the first quarter of 2003 were $314,728
compared to $270,579 for the first quarter of 2002.
Acquisition or Disposition of Plant and Equipment
-------------------------------------------------
Telkonet does not anticipate the sale of any significant property, plant or
equipment during the next twelve months. The Company does not anticipate the
acquisition of any significant property, plant or equipment during the next 12
months, other than computer equipment and peripherals used in the Telkonet's
day-to-day operations.
Number of Employees
-------------------
During the period ended March 31, 2003, the Company had 14 employees. In order
for the Company to attract and retain quality personnel, the Company anticipates
it will continue to offer competitive salaries to current and future employees.
As the Company continues to expand, the Company will incur additional costs for
personnel. This projected increase in personnel is dependent upon the Company
generating revenues and obtaining sources of financing. There are no assurances
the Company 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 of such risk factors before making an investment decision with
respect to the Company's 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
21
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 their first product and other product
candidates. Telkonet expects negative cash flow from operations to continue for
the next 6 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.
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 the 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 March 31, 2003, there were approximately
15,721,131 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 the Telkonet's stock price.
Item 3. Controls and Procedures.
(a) Within the 90 days prior to the date of 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.
(b) Changes in Internal Controls.
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
(a) In March 2003, Jenson Services, Inc. and James P. Doolin filed an action
against the Company 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 the Company, through its agents, promised to undertake a
registration of Company securities and thereby allow the Plaintiffs to exercise
piggy-back registration rights under a registration rights agreement. The action
seeks damages from the Company in unspecified amounts. The Company believes that
the claims of the Plaintiffs are without merit, that it has meritorious defenses
to such claims, and the Company 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
22
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
No. Description
--- -----------
99.1 Certification of Ronald W. Pickett Pursuant
to Section 906 of the Sarbanes-Oxley Act of
2002 (filed herewith).
99.2 Certification of E. Barry Smith Pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002 (filed herewith).
(b) Reports on Form 8-K filed during the three months ended
March 31, 2003.
On January 2, 2003, the Company filed a Current Report on Form 8- K
dated January 2, 2003, reporting under Item 5, disclosing a capital structure
realignment from the retirement of common stock by Company Founders.
On January 31, 2003, the Company filed a Current Report on Form 8-K dated
January 31, 2003, reporting under Item 6, disclosing resignations and
appointments of certain Directors and officers of the Company.
On February 3, 2003, the Company filed a Current Report on Form 8-K dated
February 3, 2003, reporting under Item 6, disclosing resignations and
appointments of certain Directors and officers of the Company.
On March 4, 2003, the Company filed a Current Report on Form 8- K dated March 4,
2003, reporting under Item 5, disclosing the strategic alliance agreement with
Choice Hotels International.
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
May 19, 2003 By: /s/ Ronald W. Pickett
------------ -------------------------
Date Ronald W. Pickett
President
23
CERTIFICATIONS
I, Ronald W. Pickett, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Telkonet, Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations, and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14 for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
functions);
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize, and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions, with regard to significant deficiencies and material weaknesses.
Date: May 19, 2003
/s/ Ronald W. Pickett
------------------------------
Ronald W. Pickett
President
24
CERTIFICATIONS
I, E. Barry Smith, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Telkonet, Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations, and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14 for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
functions);
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize, and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions, with regard to significant deficiencies and material weaknesses.
Date: May 19, 2003
/s/ E. Barry Smith
------------------------------
E. Barry Smith
Chief Financial Officer
25