UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2013
Commission file number: 001-31972
TELKONET, INC.
(Exact name of registrant as specified in its charter)
Utah
(State or Other Jurisdiction of Incorporation or Organization)
87-0627421
(I.R.S. Employer Identification No.)
20800 Swenson Drive Suite 175, Waukesha, WI
(Address of Principal Executive Offices)
53186
(Zip Code)
(414) 223-0473
(Registrant’s Telephone Number, Including Area Code)
Securities Registered pursuant to section 12(b) of the Act: None
Title of each class
None
Name of each exchange on which registered
None
Securities Registered pursuant to section 12(g) of the Act: Common Stock, $.001 par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(b) of the Act. o Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained in this form, and no
disclosure will be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference
in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) o Yes x No
Aggregate market value of the voting stock held by non-affiliates (based upon the closing sale price of $0.32 per share on the Over the
Counter Bulletin Board) of the registrant as of June 28, 2013: $33,385,731.
Number of outstanding shares of the registrant’s par value $0.001 common stock as of March 22, 2014: 125,035,612.
Parts I and II incorporate information by reference from the Annual Report to Shareholders for the fiscal year ended December 31, 2013.
Part III is incorporated by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held on June 12, 2014.
TELKONET, INC.
FORM 10-K
INDEX
Part I
Item 1.
Description of Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosures
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Registrant’s Purchases of Securities
Part II
Item 6.
Selected Financial Data
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
Part III
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
Item 15.
Exhibits and Financial Statement Schedules
Signatures
Part IV
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ITEM 1. DESCRIPTION OF BUSINESS.
PART I
Some of the statements contained in this Annual Report on Form 10-K discuss future expectations, contain projections of results of
operations or financial condition or state other “forward-looking” information. Those statements include statements regarding the intent,
belief or current expectations of Telkonet, Inc. (“we,” “us,” “our” or the “Company”) and our management team. Words such as
“expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” and
variations of these words, as well as similar expressions, are intended to identify such forward-looking statements. In addition, any
statements that refer to projections of our future financial performance, our anticipated growth, trends in our businesses, and other
characterizations of future events or circumstances are forward-looking statements. Any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those projected in the
forward-looking statements. These risks and uncertainties include but are not limited to those risks and uncertainties set forth in Item 1A of
this report. In light of the significant risks and uncertainties inherent in the forward-looking statements included in this report, the
inclusion of such statements should not be regarded as a representation by us or any other person that our objectives and plans will be
achieved.
Business
GENERAL
Telkonet, Inc. (the ”Company”, “Telkonet”), formed in 1999 and incorporated under the laws of the state of Utah, is made up of two
synergistic business divisions, EcoSmart Energy Management Technology and EthoStream High Speed Internet Access (HSIA) Network.
ECOSMART ENERGY MANAGEMENT TECHNOLOGY
Our EcoSmart Suite of products (which include Telkonet’s legacy “SmartEnergy” products) provides comprehensive savings, management
and reporting of a building's room-by-room energy consumption. Telkonet's energy management products are currently installed in over
200,000 rooms in properties within the hospitality, military, educational and healthcare markets. The EcoSmart technology platform is
rapidly being recognized as a leading solution-provider for reducing energy consumption and carbon footprints, and eliminating the need
for new energy generation in these marketplaces – all whilst improving occupant comfort and convenience.
Controlling energy consumption can make a significant impact on a property owner’s bottom line, as heating, ventilation and air
conditioning (“HVAC”) costs represent a substantial portion of a facility’s overall utility bill. Hospitality is a key market for Telkonet.
According to the EPA EnergySTAR for Hospitality analysis, the median hotel uses approximately 70,000 Btu/ft2 from all energy sources.
On average, America’s approximately 47,000 hotels spend $2,196 per available room each year on energy. This represents about 6 % of all
operating costs. Through a strategic approach to energy efficiency, a 10 % reduction in energy consumption would have the same financial
effect as increasing the average daily room rate by $0.62 in limited-service hotels and by $1.35 in full-service hotels.
Energy is very often wasted by heating and cooling rooms that are not occupied. These spaces with intermittent occupancy constitute
Telkonet’s target markets, and our experience, supported by independent research, suggests these rooms are unoccupied between 30% to
70% of the time.
Rooms with intermittent occupancy are most commonly found in the following market sectors:
· Hospitality: hotels, motels, resorts, casinos, etc.
·
Educational: residence halls, dormitories, apartments and other campus living options. Also K-12 environments with distributed
and portable classrooms.
· Military: residence halls, barracks, apartments and other campus living options.
· Health care: medical office buildings, assisted and independent living facilities.
Continually running HVAC equipment in vacant rooms also increases the maintenance overhead and shortens the equipment’s working
life. It all adds up to unnecessary waste and cost.
1
EcoSmart Suite of Energy Management Products
EcoSmart offers a product suite capable of creating a network of in-room energy management devices that can be configured to meet the
requirements of most building environments. Telkonet can provide and install any combination of its proprietary intelligent thermostats,
occupancy sensors, door contacts, lighting and plug load control devices. All products can be wirelessly networked to enhance energy
efficiency and provide remote monitoring capability. Telkonet offers a modular approach that can be scaled from small deployments to
portfolios of large properties - the heart of the network is the thermostat, once installed all other devices can be effortlessly added at any
time.
EcoInsight - a programmable controllable thermostat with over 125 configurable settings used to control the efficiency of HVAC
- heating, ventilating, and air conditioning systems.
EcoConnect - serves as coordinator of the devices connected to the energy management network, managing approximately 30-70
thermostats.
EcoCommander - a network-edge gateway server that provides real-time data aggregation, reporting and management of the
EcoSmart product suite.
EcoView - a remote occupancy sensor that monitors rooms with ultra, high-sensitive sensors designed to detect motion, body heat,
and ambient light level. All sensors are programmed to ensure accurate occupancy detection. EcoViews may be hardwired or communicate
wirelessly.
EcoWave - a 2-component package that includes a revolutionary remote interface wireless thermostat (EcoAir) and powerful
control solution offering distributed management over in-room HVAC units. The wireless EcoAir allows the user interface to be mounted in
a convenient location with good visibility of the room to optimize occupancy detection.
EcoSwitch - an EcoSmart energy management product with the appearance of a traditional light switch. Turning lights off, even
for a short time, saves energy and extends lamp life. The EcoSwitch stops the flow of electricity to lights, conserving electricity that would
have otherwise been wasted on an empty space.
EcoGuard - has the ability to monitor and stop the flow of power to one or both outlets, based on occupancy, it can turn off lamps,
televisions, appliances, and any other energy-consuming loads that are plugged in, preventing a property from consuming power in an
empty room. The EcoGuard completely disconnects devices from the power supply, preventing lights and other in-room electronics from
needlessly consuming energy.
EcoContact - a remote, wireless door/window contact with the ability to provide additional occupancy data and control HVAC
operability when doors or windows are open.
EcoCentral Virtual Engineer Command Center - the Cloud-Based Energy Management Command Center offers
comprehensive facility control from anywhere and a wealth of convenient features, including EcoSmart device control, cloud-based data
backup, and the ability to process room access and comfort data into usable, actionable reports.
Intelligent Energy Management
Telkonet’s EcoSmart energy management technology is a leading intelligent and advanced solution designed to deliver at all levels by
controlling a building’s HVAC usage and improving energy efficiency one room at a time, all data is presented on room-by-room basis,
allowing very granular management of in-room energy use and environmental conditions. It achieves this by using a combination of wired
and wireless technology components, including occupancy sensors and intelligent programmable thermostats connected with packaged
terminal air conditioner (“PTAC”) controllers or any other terminal equipment HVAC products, to adjust and maintain a room’s
temperature according to occupancy, eliminating wasteful heating and cooling of unoccupied rooms. All these things can be done from the
thermostat or via any web-connected device, such as smart phones, tablets and laptop computers.
EcoSmart is an energy management system that delivers optimum, individual room energy savings without compromising occupant
comfort, thanks to a proprietary technology – Recovery Time™.
2
Recovery Time™ Technology
All EcoSmart systems feature Recovery Time™, technology designed to maximize energy efficiency without sacrificing occupant comfort.
When a room is occupied, the temperature selected by the occupant will be maintained by the EcoSmart system. However, whenever the
occupancy sensor determines that the room is unoccupied, the system adjusts the room temperature using Recovery Time™. Unlike other
systems, Recovery Time™ technology constantly performs calculations that evaluate how far each room’s temperature can drift from the
occupant’s preferred setting (“set-point”), to harvest energy savings while still being able to return to the occupant’s set-point within a pre-
defined amount of time.
When determining the temperature setting, Recovery Time™ technology considers how long it will take to return the temperature to the
occupant’s setpoint once they return to their room. The temperature will only drift far enough to ensure the system will return to the
occupant’s preferred temperature setting within minutes upon their return to the room. The specific length of the recovery time is selected
by property management at the time of the installation; however, it can be altered at any time by management.
How do others do it?
When the room is occupied the occupant selects a set-point. When the occupant leaves, the thermostat reverts to an energy-saving set-point
which is a fixed number of degrees different than the occupant set-point (lower in winter and higher in summer). In some products the set-
point is a fixed temperature selected by the property owner. The problem is that each room will take a different amount of time to return to
the occupant set-point – variables such as the outdoor temperature and the room orientation to sun or wind will dramatically affect the
length of time the HVAC unit has to run to recover the room temperature to set-point. Maintenance condition of the HVAC unit will also
affect the time (a dirty filter or coil offers less heat transfer and will take longer and will cause unit to work harder). Other variables affect
time as well, like whether the drapes are open or closed. The result is a very uneven distribution of temperatures from room to room and
ultimately an unsatisfied occupant/guest.
EcoSmart Delivers Room-by-Room Savings
Telkonet’s approach is different, since each room’s environment is different; every room is evaluated independently in real-time to
determine its energy efficient temperature, or setback. Recovery Time™ technology constantly calculates in real-time how far the room
temperature can drift by taking into consideration all the environmental characteristics that impact the temperature in the room, including:
·
·
·
·
·
·
·
The occupant’s preferred temperature setting;
The location of the room within the building;
The window placement – facing the sun or shade;
If the drapes are open or closed;
If the climate is dry or humid;
The varying weather conditions throughout the day; and
The condition of the HVAC unit, such as age and efficiency.
Through the constant monitoring of the HVAC unit’s ability to drive the temperature and the real-time adjustment of the setback
temperature, rooms are never excessively hot or cold when an occupant returns to the room. The room will always be just minutes away
from an occupant’s desired comfort setting. As a result, Recovery Time™ technology delivers room-by-room, occupant-by-occupant
savings.
Our EcoSmart platforms maximize energy reductions while at the same time ensuring occupant comfort, maximizing energy savings and
extending equipment life expectancy – often by more than 40%. This technology is particularly attractive to customers in the hospitality
industry, as well as the education, healthcare, public housing and government/military markets, who are continually seeking ways to reduce
costs and meet federal and state mandates without impacting building occupant comfort. By reducing energy consumption automatically
when a space is unoccupied utilizing the suite of EcoSmart energy management products, our customers are able to realize significant cost
savings without diminishing occupant comfort.
3
Telkonet’s EcoSmart technology may also be integrated with utility controls, property management systems and building automation
systems to be used in load shedding initiatives using industry standard communication protocols to ensure widespread adoption and easy to
use interfaces. This feature provides management companies and utilities enhanced opportunities for cost savings, environmental
protections and energy management. Telkonet’s energy management systems are lowering HVAC costs in hundreds of thousands of rooms
worldwide and qualify for most state and federal energy efficiency and rebate programs.
Competitive Advantages
We believe our energy management platform, with our proprietary Recovery Time™ technology, delivers extensive benefits over
competing products, including:
· Maximum energy savings - evaluating each room’s environmental conditions, including room location, window placement,
humidity, time-of-day, weather conditions, and operating efficiency of HVAC equipment;
·
·
·
Longer life and reduced maintenance of HVAC units through reduced runtimes and proactive equipment monitoring;
Increased occupant control & comfort;
Simple to use and easy to read thermostat. Backlight friendly for visually impaired;
· Web-based access with extremely powerful yet simple to use EcoCentral web interface;
·
·
Speed and ease of installation of in-room devices and network infrastructure;
Extensive range of HVAC system compatibility;
· Adaptive learning and system programming;
· Utility-integrated events capabilities;
·
·
·
·
·
Remote HVAC control network;
24/7 EcoCare remote monitoring and diagnostics services;
Plug load, lighting and HVAC controls;
Extensive 3rd-party integrations;
Based on industry standard software and communication protocols (Linux, ZigBee); and
· Offers rapid return on investment, typical ROI of two to three years.
Our open, scalable and standards-based architecture allows the EcoSmart platform to integrate seamlessly with back-office management
systems, property management systems, building automation systems and utility demand/response programs as well as additional third-
party network architecture to recognize increased efficiency and savings. This approach enables the development of customized energy
management deployments while protecting existing investments.
Based on these platform features and capabilities, we’ve been awarded, and continue to receive, contracts in the hospitality, military,
educational, healthcare and utility industries. In addition, we believe that our relationships with utility-sponsored direct install and rebate-
funded programs provide us with a significant advantage over our competitors in the commercial occupancy-based energy management
market. Our direct go-to-market strategy, not encumbered by inflexible distribution agreements, offers further advantages in working with
energy efficiency providers who support utilities in implementing energy efficiency and demand reduction programs.
Our EcoSmart platform has been developed to maximize energy efficiency and savings. Our technology allows users to decrease heating
and cooling, lighting and plugload energy consumption and extend equipment life without diminishing occupant comfort. By providing
Internet-based remote management over in-room energy efficiency, EcoSmart decreases the cost to operate an enterprise-wide system by
improving the efficiency and operational effectiveness of onsite engineering resources.
4
Given the population growth in the United States and the increasing demand for energy, we believe additional energy-related infrastructure
will be needed. We believe the use of Smart Grid technologies and energy efficiency management platforms are affordable alternatives to
building additional power generation through leveraging existing resources and providing enhanced energy savings. While requiring
investments that are not typical for most utilities, we believe the long-term savings resulting from these investments will outweigh the
costs.
Industry and Market Overview
According to the U.S. Department of Energy, 18% of all the energy produced in the United States is employed to cool, heat, light, or
accomplish other functions within commercial buildings. In an effort to remain competitive and manage expenses, governments, building
owners, building tenants, and companies in general are looking for ways to become more efficient both fiscally and environmentally. The
American Council for an Energy Efficient Economy reported that the cost of saving one unit of energy through energy efficiency is one-
fifth (1/5) the cost required to generate that same unit of energy. As a result, we feel that the growth opportunities in the energy
management market have just begun.
A 2011 report issued by Pike Research, titled, “Global Market for Energy Efficient Buildings to Surpass $100 Billion by 2017”, stated that
the market for energy efficiency services and equipment is on the rise as national governments look to reduce energy consumption by
improving the efficiency of the building stock. With buildings being one of the largest sources of energy consumption, the opportunity to
improve efficiency is significant, ranging from high-efficiency HVAC systems to the utilization of energy-efficient lighting technologies to
business models such as energy performance contracting as employed by energy service companies (“ESCOs”) around the world.
According to the Pike report, the total market for energy efficiency in buildings will reach $103.5 billion by 2017, an increase of more than
50% from the 2011 market value of $67.9 billion.
Simply put, all industries are prime candidates for energy management and the industries that are most ripe for undertaking these initiatives
are those that utilize energy “on-demand” or intermittently, such as those in the hospitality, educational, military and healthcare industries.
Providing energy, and engaging the equipment to supply it, to those rooms and spaces only when occupied results in significant energy
savings in addition to affording longer life and reduced maintenance to the HVAC systems.
COST OF ENERGY
Electricity
District Heat
Fuel Oil
Natural Gas
Educational Buildings
($8,111 million)
Healthcare Buildings
($4,882 million)
Office Buildings
($17,005 million)
Lodging Buildings
($5,228 million)
Education Industry
76%
7%
80%
N/A
87%
4%
79%
N/A
2%
1%
1%
3%
15%
19%
8%
18%
Source: Energy Information Administration, 2003
Commercial Buildings Energy Consumption Survey
Telkonet’s most rapidly emerging market is the educational industry as we continue to expand our presence in this marketplace through a
concerted and focused approach, which involves strategic relationships with enterprise ESCOs throughout the USA. Telkonet partners with
ESCOs to include our EcoSmart energy management platform for deployment within resident halls on university campuses. The ESCOs
bundle our technology with other facility improvement measures designed to reduce operating costs across the entire campus, some of
these initiatives provide attractive returns on customer investments, such as EcoSmart for dormitories and lighting upgrades, while others
such as roofs and windows have poor returns on investment but are needed infrastructure improvements. ESCOs bundle these facility
improvements into a project that has acceptable returns and meets state mandated guidelines. The ESCOs then structure self-funding
financial transactions called “Performance Contracts” in which the savings are greater than the repayment costs. The ESCOs will typically
guarantee the financial and operational performance in this type of engagement. This approach removes many of the capital funding issues
that stand in the way of implementing energy efficient technologies and shifts the technology and performance risk from the institution to
the ESCOs.
5
In July 2008, we entered into an agreement with New York University to implement Telkonet’s networked energy management platform to
centrally manage energy consumption in its dormitories. Telkonet worked with the University to use its existing building infrastructure to
remotely manage and track energy consumption. Approximately 4,000 rooms across 11 dormitories have been completed and have yielded
run-time and energy consumption reductions, operational savings from reduced field labor expenses and extension of equipment lives.
Since this time, we have grown our Educational deployments to include such customers as the University of California Davis, Northern
Oklahoma College, the Massachusetts Institute of Technology, Kansas State University, Fordham University, West Point Military
Academy and Columbia University.
The opportunities in this market are certainly not limited to higher education institutions. A report by EnergySTAR, a joint program of the
U.S. Environmental Protection Agency and the U.S. Department of Energy, showed that our nation’s 17,450 K-12 schools spend more than
$6 billion on energy and that as much as 30% of a district’s total energy is used inefficiently or unnecessarily.
We believe that our EcoSmart platform is an important tool for participants in the educational industry seeking to control student-related
energy costs. We have focused our sales efforts on members of the educational industry who are seeking to expand their energy efficiency
initiatives as well as the ESCOs who target the educational marketplace and have thus far had some success with at least one school district
installing EcoSmart in each classroom throughout the district.
Hospitality Industry
According to EnergySTAR, the cost of energy for America's 47,000 hotels averages $2,196 per available room each year. As the cost of
energy continues to increase, energy efficiency projects can provide an immediate and significant reduction in energy expenses. A 10%
reduction in energy costs is equivalent to increasing revenue per available room by $0.60 for limited service hotels and by more than $2.00
for full-service hotels. With EcoSmart, Telkonet can also reduce equipment runtime in unoccupied rooms by 20 to 45% while maintaining
guest comfort, making the solution uniquely suited for energy management projects in the hospitality market.
Any successful hotelier must focus on achieving the critical balance between guest comfort and operating margins--and maintaining this
balance in the long-term. Telkonet's proprietary Recovery Time™ technology allows EcoSmart to maximize energy savings without
compromising guest comfort. In fact, hoteliers with EcoSmart can guarantee an indoor environment unique for each property or brand,
where each room returns to the guest set-point within six minutes, regardless of room assignment. This dynamic technology sets Telkonet
apart from fixed setback energy management systems, where the setback temperature is a fixed temperature or a fixed deviation. Both fixed
setback approaches make it extremely difficult to predict how long it will take the room to return to the set-point after the guest re-enters
the room, resulting in potentially lower energy savings and uncomfortable room temperatures.
The green button option on Telkonet’s intelligent thermostat allows a more aggressive energy savings profile to be loaded when pressed by
the occupant and is designed to engage occupants who are committed to green and sustainability. Some hotels reward pressing the button
through the affinity program with special guest loyalty points.
Military Industry
With the Department of Defense (“DOD”) being the single largest energy consumer in the United States, accounting for about 90 percent
of the federal government’s energy use and using over 30 million mega-watt hours of electricity per year, we view this market as
strategically significant to Telkonet’s interests.
Our energy management platform is already successfully incorporated into the energy initiatives in several military housing sites, military
academies and barracks. In October 2009, Executive Order 13514, "Federal Leadership in Environmental, Energy and Economic
Performance," was signed and set into action numerous energy requirements in areas such as Sustainable Buildings and Communities,
Greenhouse Gas Management and Pollution Prevention and Waste Reduction, among others. The American Recovery and Reinvestment
Act (“ARRA”) has jump-started energy management throughout US government and military facilities by providing $4.26 billion in
funding for the Department of Defense Facilities Sustainment, Restoration, and Modernization Program. Telkonet has benefited and
continues to make use of ARRA funding and other government contracts to provide EcoSmart for use on military bases and other facilities,
helping both the DOD and the government as a whole achieve their long-term energy efficiency goals.
6
Healthcare Industry
Healthcare is an additional emerging market for energy management as currently, healthcare organizations in the United States spend over
$6.5 billion on energy each year and that number continues to rise to meet patients’ needs. Although hospitals have many specific
regulatory mandates, we have been working closely with operators and developers of healthcare support facilities, like medical office
buildings, assisted living and other similar facilities, to integrate our EcoSmart energy management initiatives into efficiency opportunities
supported by state and federal energy programs. These types of facilities offer a commercial environment similar to the hospitality or
educational housing markets, and the increasing growth of the elderly and assisted living markets presents attractive potential for energy
efficiency. This market is expected to grow rapidly over the next several years due to its energy savings capabilities. For example, hospital
energy managers can use energy efficiency strategies to offset high costs caused by growing plug loads and rising energy prices. A typical
200,000-square-foot, 50-bed hospital in the U.S. annually spends $680,000—or roughly $13,611 per bed—on electricity and natural gas. By
increasing energy efficiency, hospitals can improve the bottom line and free up funds to invest in new technologies and improve patient
care.
Utility Industry
We believe that the utility industry is one of the fastest developing market segments in the United States. With more than $4.5 billion
released to the industry through the ARRA for Smart Grid, the utility industry has become a growing percentage of our revenue, both
through direct sales to utilities and partnerships with energy service companies executing state and local energy efficiency
programs. Strategic relationships with regional ESCOs are key to the continued expansion of energy efficiency initiatives. In Pike’s 2011
research report, it was estimated that the ESCO market will represent the largest segment of the energy efficient buildings industry in the
coming years, with revenues more than doubling from $30.1 billion in 2011 to $66.0 billion worldwide by 2017, a projected compound
annual growth rate of 14%.
We continue to strengthen our focus on our targeted market segments in order to expand market share and take advantage of existing
incentives for energy management. We expect continued expansion in the space, and specifically in commercial segments due to
increasing state and federal programs promoting energy efficiency. Our residential initiatives are also key to the future expansion of
Telkonet’s EcoSmart programs within the developing Smart Grid environment.
Public Housing
Another emerging market for Telkonet’s energy management is public housing, which are properties owned and managed by the
government. The tenants occupying these properties must meet specific eligibility requirements, and their utility bills are typically the
government’s responsibility. Many of the ESCO clients that Telkonet supports today have dedicated teams pursuing opportunities with the
owners and operators of government-subsidized housing. Our solutions are tailor made for these applications to conserve energy, enable
remote monitoring control and improve occupant comfort.
Competition
We currently compete primarily within commercial and industrial markets, including the hospitality, education, healthcare, public housing,
government, utility and military sectors. Within each target market, we offer savings through our intelligent energy management
platform. Our products offer significant competitive and complementary benefits when compared with alternative offerings including
Building Automation Systems (“BAS”) or Building Management Systems (“BMS”), static temperature occupancy-based systems,
scheduling/programmable thermostats and high-efficiency HVAC systems.
We participate in a relatively small competitive field within the hospitality industry, with the majority of the energy management sales
handled by fewer than seven manufacturers. The key competitors in the market segment are Onity, Inc., Inncom International Inc. and
Schneider Electric, with each offering comparable products to our standalone and networked energy management platforms. Telkonet’s
key differentiators in the hospitality segment include:
·
Recovery Time™ technology;
· Mesh-networked platform;
·
Integration with property and building management systems (PMS & BMS);
· Utility demand-based program integration; and
·
Broad HVAC compatibility.
7
The educational space is a relatively new market for occupancy-based controls. We’ve introduced our EcoSmart platform for use within
student dormitories, which traditionally had few, if any, controls. More recently we have also been requested to install our products into
classrooms, which traditionally have been an environment for building automated systems or building management systems. Since the
dormitory environment is very similar to the hospitality market, we believe we offer similarly scaled energy savings. Since the market is
still in its infancy, very few comparable offerings have entered the market but competitors within the hospitality segment are beginning to
respond. Our EcoSmart platform provides a significant advantage within the educational industry through:
·
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·
·
Reduced cost as compared to BAS/BMS systems;
Ease of installation relative to traditional wired systems;
Range of product compatibility;
Centralized platform management with room by room performance reporting; and
· Data that is widely and easily available to promote student engagement.
The healthcare and government/military markets are very similar in scope when relating to energy management systems. A key
differentiator in these environments is the specific implementation that is being considered. Each market utilizes BAS/BMS for wide scale
energy management initiatives. When specifically addressing housing environments including elderly care and assisted living environments
and military dormitories or barracks, Telkonet’s EcoSmart platform is able to provide increased energy savings and efficiency. Competitors
operating in the BAS/BMS space include Honeywell, Schneider Electric, Johnson Controls, Siemens, Trane and others, many of whom
Telkonet partners with to provide a comprehensive and integrated energy management solution to effectively address energy efficiency
opportunities in all types of facilities.
ETHOSTREAM HIGH SPEED INTERNET ACCESS (HSIA) NETWORK
EthoStream is one of the largest public High-Speed Internet Access (“HSIA”) providers in the world, providing services to more than 8.0
million users monthly across a network of approximately 2,300 locations. With a wide range of product and service offerings and one of the
most comprehensive management platforms available for HSIA networks, EthoStream offers solutions for any public access location.
EthoStream provides cutting-edge technology, proactive system monitoring and 24/7/365 in-house technical support--and will engineer a
seamless browsing experience to produce quality network access for users. EthoStream has the ability to power mobile computing in any
market, and can provide a complete family of wired, wireless, and custom-designed hybrid solutions to outfit diverse property types. From
hospitality properties to university campuses, coffee shops to municipal buildings, the high-speed Internet access solutions EthoStream has
developed are versatile enough to deploy in any venue. EthoStream offers customized gateway servers to provide solutions that are
infinitely scalable and easily upgradable, giving all customers the benefit of future-proof connectivity.
Our EthoStream Gateway Server line provides industry-leading HSIA technology to the hospitality and public Internet access industry, with
advanced features based on in-house product design and development, including the following:
· Dual ISP bandwidth aggregation for faster overall speed;
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ISP redundancy to eliminate network downtime;
Enhanced quality of service;
Real-time meeting room scheduling;
Comprehensive service analytics;
Standards-based monitoring and control; and
· Major franchise certified.
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We maintain a U.S.-based customer support center operating 24 hours a day, seven days a week, and employ a dedicated, in-house support
team using integrated, web-based management tools enabling proactive industry-leading support. We believe our customer service
offerings, along with established relationships through our vendor agreements with some of the largest hospitality franchises and
management groups, distinguish us from our competitors in the hospitality HSIA industry. Current customers include:
Intercontinental Hotels Group
Benchmark Hospitality
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Choice Hotels International
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Crescent Hotels & Resorts
· Destination Hotels & Resorts
· Hilton Worldwide
· Hyatt Hotels & Resorts
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· Kohler Hospitality
· Marcus Hotels & Resorts
· Marriott International
Red Lion Hotels
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Shaner Hospitality
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Starwood Hotels & Resorts
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Summit Hotel Properties
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TMI Communications
· Worldmark by Wyndham
· Wyndham Hotels & Resorts
EthoStream Advantages
The Total Solution
EthoStream offers a complete package of services required for quality wired and wireless high-speed Internet access. Dedicated employees
conduct site surveys, install equipment, and provide service after installation with on-site and remote support. EthoStream employs a
knowledgeable, well-trained staff of support technicians, so users can rely on an in-house team to provide rapid, friendly assistance for any
issue.
Properties Have Control over Their HSIA
EthoStream has a unique product at the core of every Internet solution: the Remote Management Console (“RMC”). This web-based
management platform interacts in real-time with a property's EthoStream server and integrates directly with the support center in
Milwaukee. The RMC allows managers to make instant changes to the entire high-speed Internet system and access information to generate
usage reports.
Pro-active 24/7 In-House Support Team
Thanks to the unique capabilities of the RMC, EthoStream support representatives have an active presence at each location and can easily
assist users with any issues that may arise. Rather than working from a script-based support program, the support center anticipates user
needs and quickly resolves issues.
Custom-Designed Internet Solutions
By developing products and services within the Company instead of outsourcing, EthoStream ensures that customers receive only top-tier
equipment. As engineers continue to improve product capabilities, technicians will remotely update product software on a monthly basis.
Competition
Telkonet’s EthoStream Hospitality Network competes with a wide variety of companies in the hospitality industry ranging from media
companies to traditional HSIA solution providers. Although this industry has many service providers, according to publicly available data,
only a few HSIA service providers have significant customer bases. Those competitors include Guest-tek, Sonifi Solutions, iBahn and
AT&T.
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Market Outlook
We believe that growth of the EthoStream Hospitality Network will be derived from several key areas :
· New customer growth within the full-service hospitality market and through additional preferred vendor agreements with
franchisors;
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Competitive customer acquisition through a superior product and service offering;
· Upgrading of EthoStream’s approximately 2,300 customers due to aging equipment and standards; and
· Ongoing sales to current customers through integration of additional in-room technologies such as lighting, telephony, media
centers and energy management products.
Series 5 Smart Grid
Telkonet’s Series 5 Smart Grid networking technology allows commercial, industrial and consumer users to connect intelligent devices to a
communications network using the existing low voltage electrical grid. Series 5 technology uses power line communications, or PLC,
technology to transform existing electrical infrastructure into a communications backbone. Operating at 200 Mbps, the PLC platform
offers a secure alternative in grid communications, transforming a traditional electrical distribution system into a “smart grid” that delivers
electricity in a manner that can save energy, reduce cost and increase reliability.
On March 4, 2011, the Company sold its Series 5 power line communications product line and related business assets to Dynamic Ratings,
Inc. (“Dynamic Ratings”). The sales price was $1,000,000 in cash. In connection with the sale, Dynamic Ratings lent $700,000 to the
Company in the form of a 6% promissory note dated March 4, 2011. Concurrently with the sale, the Company entered into a
Distributorship Agreement and a Consulting Agreement with Dynamic Ratings. Under the Distributorship Agreement, the Company was
designated as a distributor of the Series 5 product to non-utility markets and will receive preferred pricing for purchases of Series 5
product. Under the Consulting Agreement, the Company agreed to provide Dynamic Ratings with ongoing transition assistance and
consulting services for the Series 5 product. The Consulting Agreement expired on March 31, 2013. The Distributorship Agreement had an
initial term that was to expire on March 31, 2014, but was automatically renewed for one year.
Inventory
While we are dependent, in certain situations, on a limited number of vendors to provide certain inventory and components, we’ve not
experienced significant problems or issues purchasing any essential materials, parts or components. We obtain the majority of our
inventory from ATR Manufacturing, a Chinese company, which provides substantially all the manufacturing requirements for Telkonet’s
energy management platform.
Customers
We are neither limited to, nor reliant upon, a single or narrowly segmented customer base to derive our revenues. Our current primary
focus is in the hospitality, commercial, education, utility, healthcare and government/military markets and expanding into the consumer
market as part of our long term strategic growth.
For the years ended December 31, 2013 and 2012, no single customer represented 10% or more of our revenues. Recurring revenue
distributed across a network of approximately 2,300 customers approximated $3,800,000 for the year ended December 31, 2013.
Intellectual Property
We acquired certain intellectual property by acquisition, including but not limited to, Patent No. D569, 279, titled “Thermostat.” Patent
No. D569279 issued by the USPTO in May 2008 was granted on the ornamental design of a thermostat device and expired in May 2013 .
The expiration of this patent could allow third parties to launch competing products. While we viewed this patent as valuable, we do not
view any single patent as material to the Company as a whole.
10
In addition, we currently have multiple patent applications under examination, and intend to file additional patent applications that we deem
to be economically beneficial.
There can be no assurance that any of our current or future patent applications will be granted, or, if granted, that such patents will provide
necessary protection for our technology or our product offerings, or be of commercial benefit to us.
Government Regulation
We are subject to regulation in the United States by the Federal Communications Commission, or FCC. FCC rules permit the operation of
unlicensed digital devices that radiate radio frequency emissions if the manufacturer complies with certain equipment authorization
procedures, technical requirements, marketing restrictions and product labeling requirements.
Future products designed by us will require testing for compliance with FCC and CE compliance. Moreover, if in the future, the FCC or
EU changes its technical requirements, further testing and/or modifications may be necessary in order to achieve compliance.
Research & Development
During the years ended December 31, 2013 and 2012, we spent $1,174,048 and $984,853, respectively, on research and development
activities. In 2013 and 2012, research and development largely focused on the development of Telkonet's EcoSmart technology; in
particular, expanding the product line to include the EcoGuard and EcoSwitch as well as enhancing existing components to serve a wider
range of markets and customers. Several development efforts centered around integration of third party devices and software, in addition to
continued enhancement of the EcoCentral web management system. The engineering behind the EcoSmart products requires continuous
development to allow Telkonet to meet the latest standards for wireless and controls technologies.
The primary focus of development within the EthoStream division is related to adjustments required by Marriott-branded properties,
including a special portal and system design architecture as well as enhanced reporting. These efforts resulted in a necessary certification
and will be beneficial for all current and new full-service customers moving forward.
Other Information
Employees
As of March 21, 2014, we had 98 full-time employees. During 2013, significant positions filled included additional sales account
executives, a marketing director and multiple engineering resources. We will continue to hire additional personnel as necessary to meet
future operating requirements. We anticipate that we may need to hire additional staff in the areas of customer support, field services,
engineering, sales and marketing, and administration.
Environmental Matters
We do not anticipate any material effect on our capital expenditures, earnings or competitive position due to compliance with government
regulations involving environmental matters.
ITEM 1A. RISK FACTORS.
Our results of operations, financial condition and cash flows can be adversely affected by various risks. These risks include, but are not
limited to, the principal factors listed below and the other matters set forth in this annual report on Form 10-K. You should carefully
consider all of these risks.
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The market price of our common stock has been and may continue to be volatile.
Risks Relating to the Ownership of Our Common Stock
The trading price of our common stock has been and may continue to be highly volatile and could be subject to wide fluctuations in
response to various factors. Some of the factors that may cause the market price of our common stock to fluctuate include:
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fluctuations in our quarterly financial and operating results or the quarterly financial results of companies perceived to be
similar to us;
changes in estimates of our financial results or recommendations by securities analysts;
potential deterioration of investor confidence resulting from material weaknesses in our internal control over financial
reporting;
our ability to settle sales tax obligations in a timely, cost-effective manner;
our ability to raise and generate working capital to meet our obligations in the ordinary course of business;
changes in general economic, industry and market conditions;
failure of any of our products to achieve or maintain market acceptance;
changes in market valuations of similar companies;
failure of our products to operate as advertised;
success of competitive products;
changes in our capital structure, such as future issuances of securities or the incurrence of additional debt;
announcements by us or our competitors of significant products, contracts, acquisitions or strategic alliances;
regulatory developments in the United States, foreign countries or both;
litigation involving our Company, our general industry or both;
additions or departures of key personnel; and
investors’ general perception of us.
In addition, if the market for technology stocks or the stock market in general experiences a loss of investor confidence, the trading price of
our common stock could decline for reasons unrelated to our business, financial condition or results of operations. If any of the foregoing
occurs, it could cause our stock price to fall and may expose us to class action lawsuits that, even if unsuccessful, could be costly to defend
and a distraction to management.
Anti-takeover provisions in our charter documents and Utah law could discourage delay or prevent a change of control of our Company
and may affect the trading price of our common stock.
We are a Utah corporation and the anti-takeover provisions of the Utah Control Shares Acquisition Act may discourage, delay or prevent a
change of control by limiting the voting rights of control shares acquired in a control share acquisition. In addition, our Amended and
Restated Articles of Incorporation and bylaws may discourage, delay or prevent a change in our management or control over us that
shareholders may consider favorable. Among other things, our Amended and Restated Articles of Incorporation and bylaws:
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authorize the issuance of “blank check” preferred stock that could be issued by our board of directors to thwart a takeover
attempt;
provide that vacancies on our board of directors, including newly created directorships, may be filled only by a majority vote of
directors then in office, except a vacancy occurring by reason of the removal of a director without cause shall be filled by vote
of the shareholders; and
limit who may call special meetings of shareholders.
These provisions could have the effect of delaying or preventing a change of control, whether or not it is desired by, or beneficial to, our
shareholders.
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We do not currently intend to pay dividends on our common stock and, consequently, the ability to achieve a return on an investment in
our common stock will depend on appreciation in the price of our common stock.
We do not expect to pay cash dividends on our common stock. Any future dividend payments are within the absolute discretion of our
board of directors and will depend on, among other things, our results of operations, working capital requirements, capital expenditure
requirements, financial condition, contractual restrictions, business opportunities, anticipated cash needs, provisions of applicable law and
other factors that our board of directors may deem relevant. We may not generate sufficient cash from operations in the future to pay
dividends on our common stock.
Our common stock is thinly traded and there may not be an active, liquid trading market for our common stock.
Our common stock is currently quoted on the Over the Counter Bulletin Board, or OTCBB. However, there is no guarantee that our
common stock will be actively traded on the OTCBB, or that the volume of trading will be sufficient to allow for timely trades. Investors
may not be able to sell their shares quickly or at the latest market price if trading in our stock is not active or if trading volume is limited. In
addition, if trading volume in our common stock is limited, trades of relatively small numbers of shares may have a disproportionate effect
on the market price of our common stock.
In addition, some aspects of the OTCBB may deter investors from purchasing our common stock, which can suppress trading in our
common stock. For example, the OTCBB lacks the strict listing standards of a national stock exchange regarding corporate governance, a
minimum stock price, and various matters which have to be approved by shareholders. The only requirement for inclusion in the OTCBB is
that the issuer be current in its SEC reporting requirements, and that the issuer obligates itself to file periodic reports and otherwise comply
with those provisions of the 1934 Act applicable to it. Shareholders of OTCBB companies frequently have difficulty in getting buy/sell
orders filled promptly, and/or at expected prices. OTCBB companies generally have lower trading volume, which contributes to the
illiquidity of investing in such companies. Trading activity on the OTCBB is not conducted as efficiently as trades of national stock
exchange-listed securities. There are no automated systems for negotiating trades on the OTCBB, so trades must be conducted by
telephone by a broker-dealer. In times of heavy market volume, the limitations of this process may increase the time it takes to make trades
and the price of the stock may fluctuate in the interim. These factors may make it difficult for investors to buy additional shares or to sell
the shares that they hold.
Our common stock is subject to “Penny Stock” restrictions.
As long as the price of our common stock remains at less than $5 per share, we will be subject to so-called penny stock rules which could
decrease our stock’s market liquidity. The SEC has adopted regulations which define a “penny stock” to include any equity security that
has a market price of less than $5 per share or an exercise price of less than $5 per share, subject to certain exceptions. For any transaction
involving a penny stock, unless exempt, the rules require the delivery to and execution by the retail customer of a written declaration of
suitability relating to the penny stock, which must include disclosure of the commissions payable to both the broker/dealer and the
registered representative and current quotations for the securities. Finally, the broker/dealer must send monthly statements disclosing
recent price information for the penny stocks held in the account and information on the limited market in penny stocks. Those
requirements could adversely affect the market liquidity of our common stock. There can be no assurance that the price of our common
stock will rise above $5 per share so as to avoid these regulations.
Further issuances of equity securities may be dilutive to current stockholders.
It is possible that we will be required to seek additional capital in the future. This capital funding could involve one or more types of equity
securities, including convertible debt, common or convertible preferred stock and warrants to acquire common or preferred stock. Such
equity securities could be issued at or below the then-prevailing market price for our common stock. Any issuance of additional shares of
our common stock will be dilutive to existing stockholders and could adversely affect the market price of our common stock.
The exercise of conversion rights, options and warrants outstanding and available for issuance may adversely affect the market price of
our common stock.
As of December 31, 2013, we had outstanding employee options to purchase a total of 1,735,225 shares of common stock at exercise prices
ranging from $0.14 to $5.60 per share, with a weighted average exercise price of $0.47. As of December 31, 2013, we had warrants
outstanding to purchase a total of 9,359,914 shares of common stock at exercise prices ranging from $0.13 to $3.00 per share, with a
weighted average exercise price of $0.32. The exercise of outstanding options and warrants and the sale in the public market of the shares
purchased upon such exercise will be dilutive to existing stockholders and could adversely affect the market price of our common stock.
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The industry within which we operate is intensely competitive and rapidly evolving.
Risks Related to Our Business
We operate in a highly competitive, quickly changing environment, and our future success will depend on our ability to develop and
introduce new products and product enhancements that achieve broad market acceptance in the markets within which we compete. We will
also need to respond effectively to new product announcements by our competitors by quickly introducing competitive products.
Delays in product development and introduction could result in:
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loss of or delay in revenue and loss of market share; and
negative publicity and damage to our reputation and the reputation of our product offerings; and
decline in the average selling price of our products.
We have identified material weaknesses in our internal controls as of December 31, 2013 that, if not properly remediated, could result in
material misstatements in our financial statements.
Based on an evaluation of our disclosure of internal controls and procedures as of December 31, 2013, our management has concluded that,
as of such date, there were material weaknesses in our internal control over financial reporting relating to the need for a stronger internal
control environment. A material weakness is a control deficiency, or a combination of control deficiencies, in internal control over
financial reporting, such that there is a more than a remote likelihood that a material misstatement of annual or interim financial statements
would not be prevented or detected. Until these material weaknesses in our internal control over financial reporting are remediated, there is
reasonable possibility that material misstatements of our annual or interim consolidated financial statements could occur and not be
prevented or detected by our internal controls in a timely manner.
Government regulation of our products could impair our ability to sell such products in certain markets.
technical
The rules of the FCC, permit the operation of unlicensed digital devices that radiate radio frequency emissions if the manufacturer complies
with certain equipment authorization procedures,
labeling
requirements. Differing technical requirements apply to “Class A” devices intended for use in commercial settings, and “Class B” devices
intended for residential use to which more stringent standards apply. An independent, FCC-certified testing lab has verified that our iWire
System product suite complies with the FCC technical requirements for Class A and Class B digital devices. No further testing of these
devices is required, and the devices may be manufactured and marketed for commercial and residential use. Additional devices designed
by us for commercial and residential use will be subject to the FCC rules for unlicensed digital devices. Moreover, if in the future, the FCC
changes its technical requirements for unlicensed digital devices, further testing and/or modifications of devices may be necessary. Failure
to comply with any FCC technical requirements could impair our ability to sell our products in certain markets and could have a negative
impact on our business and results of operations.
restrictions and product
requirements, marketing
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Products sold by our competitors could become more popular than our products or render our products obsolete.
The market for our products and services is highly competitive. Some of our competitors have longer operating histories, greater name
recognition and substantially greater financial, technical, sales, marketing and other resources. These competitors may, among other
things, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, obtain more favorable pricing from
suppliers and manufacturers and exert more influence on the sales channel than we can. As a result, we may not be able to compete
successfully with these competitors, and these competitors may develop or market technologies and products that are more widely accepted
than those being developed by us or that would render our products obsolete or noncompetitive. We anticipate that competitors will also
intensify their efforts to penetrate our target markets. These competitors may have more advanced technology, more extensive distribution
channels, stronger brand names, bigger promotional budgets and larger customer bases than we do. These companies could devote more
capital resources to develop, manufacture and market competing products than we could. If any of these companies are successful in
competing against us, our sales could decline, our margins could be negatively impacted, and we could lose market share, any of which
could seriously harm our business, results of operations, and prospects.
Infringement by third parties on our proprietary technology and development of substantially equivalent proprietary technology by our
competitors could negatively impact our business.
Our success depends partly on our ability to maintain patent and trade secret protection, to obtain future patents and licenses and to operate
without infringing on the proprietary rights of third parties. There can be no assurance that the measures we have taken to protect our
intellectual property rights, including intellectual property rights of third parties integrated into our Telkonet iWire System product suite
and our EcoSmart suite of products will prevent misappropriation or circumvention. A patent associated with our Recovery Time™
technology expired in February 2014. To the extent any competitors are successful in creating competing technologies, this could have an
adverse impact on our business and financial results. In addition, there can be no assurance that any patent application, when filed, will
result in an issued patent, or that our existing patents, or any patents that may be issued in the future, will provide us with significant
protection against competitors. Moreover, there can be no assurance that any patents issued to, or licensed by, us will not be infringed upon
or circumvented by others. Infringement by third parties on our proprietary technology could negatively impact our business. Moreover,
litigation to establish the validity of patents, to assert infringement claims against others, and to defend against patent infringement claims
can be expensive and time-consuming, even if the outcome is in our favor. We also rely on unpatented proprietary technology, and no
assurance can be given that others will not independently develop substantially equivalent proprietary information, techniques or processes
or that we can meaningfully protect our rights to such unpatented proprietary technology. If our competitors develop substantially
equivalent technology and we are unable to enforce any intellectual property rights with respect to such technology in a cost-effective
manner or at all, our business and operations would suffer significant harm.
We may incur substantial damages due to litigation.
We cannot be certain that our products do not and will not infringe issued patents or other intellectual property rights of others. If it were
determined that our products infringe the intellectual property rights of another, we could be required to pay substantial damages or be
enjoined from licensing or using the infringing products or technology. Additionally, if it were determined that our products infringe the
intellectual property rights of others, we would need to obtain licenses from these parties or substantially re-engineer our products in order
to avoid infringement. We might not be able to obtain the necessary licenses on acceptable terms or at all, or to re-engineer our products
successfully. Any of the foregoing could cause us to incur significant costs and prevent us from selling our products.
We depend on a small team of senior management and may have difficulty attracting and retaining additional personnel.
Our future success will depend in large part upon the continued services and performance of senior management and other key
personnel. If we lose the services of any member of our senior management team, our overall operations could be materially and adversely
affected. In addition, our future success will depend on our ability to identify, attract, hire, train, retain and motivate other highly skilled
technical, managerial, marketing, purchasing and customer service personnel when they are needed. Competition for these individuals is
intense. We cannot ensure that we will be able to successfully attract, integrate or retain sufficiently qualified personnel when the need
arises. Any failure to attract and retain the necessary technical, managerial, marketing, purchasing and customer service personnel could
have a negative effect on our financial condition and results of operations.
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Any acquisitions we make could result in difficulties in successfully managing our business and consequently harm our financial
condition.
We may seek to expand by acquiring complementary businesses in our current or ancillary markets. We cannot accurately predict the
timing, size and success of our acquisition efforts and the associated capital commitments that might be required. We expect to face
competition for acquisition candidates, which may limit the number of acquisition opportunities available to us and may lead to higher
acquisition prices. There can be no assurance that we will be able to identify, acquire or profitably manage additional businesses or
successfully integrate acquired businesses, if any, without substantial costs, delays or other operational or financial difficulties. In addition,
acquisitions involve a number of other risks, including:
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failure of the acquired businesses to achieve expected results;
diversion of management’s attention and resources to acquisitions;
failure to retain key customers or personnel of the acquired businesses;
disappointing quality or functionality of acquired equipment and people; and
risks associated with unanticipated events, liabilities or contingencies.
Client dissatisfaction or performance problems at a single acquired business could negatively affect our reputation. The inability to acquire
businesses on reasonable terms or successfully integrate and manage acquired companies, or the occurrence of performance problems at
acquired companies, could result in dilution, unfavorable accounting treatment or one-time charges and difficulties in successfully
managing our business.
Our inability to obtain capital, use internally generated cash or debt, or use shares of our common stock to finance our operations or
future acquisitions could impair the growth and expansion of our business.
Reliance on internally generated cash or debt to finance our operations or complete acquisitions could substantially limit our operational
and financial flexibility. The extent to which we will be able or willing to use shares of our common stock to consummate acquisitions will
depend on the market value of our common stock which will vary, and our liquidity. Using shares of our common stock for this purpose
also may result in significant dilution to our then existing stockholders. To the extent that we are unable to use our common stock to make
future acquisitions, our ability to grow through acquisitions may be limited by the extent to which we are able to raise capital through debt
or additional equity financings. No assurance can be given that we will be able to obtain the necessary capital to finance any acquisitions
or our other cash needs. If we are unable to obtain additional capital on acceptable terms, we may be required to reduce the scope of any
expansion or redirect resources committed to internal purposes. In addition to requiring funding for acquisitions, we may need additional
funds to implement our internal growth and operating strategies or to finance other aspects of our operations. Our failure to: (i) obtain
additional capital on acceptable terms; (ii) use internally generated cash or debt to complete acquisitions because it significantly limits our
operational or financial flexibility; or (iii) use shares of our common stock to make future acquisitions, may hinder our ability to actively
pursue any acquisitions.
Potential fluctuations in operating results could have a negative effect on the price of our common stock.
Our operating results may fluctuate significantly in the future as a result of a variety of factors, most of which are outside our control,
including:
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the level of use of the Internet;
the demand for high-tech goods;
the amount and timing of capital expenditures and other costs relating to the expansion of our operations;
price competition or pricing changes in the industry;
technical difficulties or system downtime;
changes in governmental policies;
economic conditions specific to the internet and communications industry; and
general economic conditions.
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Our financial results may also be significantly impacted by certain accounting treatment of acquisitions, financing transactions or other
matters. Such accounting treatment could have a material impact on our results of operations and have a negative impact on the price of our
common stock.
We rely on a limited number of third party suppliers. If these companies fail to perform or experience delays, shortages, or increased
demand for their products or services, we may face shortages, increased costs, and may be required to suspend deployment of our
products and services.
We depend on a limited number of third party suppliers to provide the components and the equipment required to deliver our solutions. If
these providers fail to perform their obligations under our agreements with them or we are unable to renew these agreements, we may be
forced to suspend the sale and deployment of our products and services and enrollment of new customers, which would have an adverse
effect on our business, prospects, financial condition and operating results.
Our management and operational systems might be inadequate to handle our potential growth.
We may experience growth that could place a significant strain upon our management and operational systems and resources. Failure to
manage our growth effectively could have a material adverse effect upon our business, results of operations and financial condition. Our
ability to compete effectively and to manage future growth will require us to continue to improve our operational systems, organization and
financial and management controls, reporting systems and procedures. We may fail to make these improvements effectively. Additionally,
our efforts to make these improvements may divert the focus of our personnel. We must integrate our key executives into a cohesive
management team to expand our business. If new hires perform poorly, or if we are unsuccessful in hiring, training and integrating these
new employees, or if we are not successful in retaining our existing employees, our business may be harmed. To manage the growth we
will need to increase our operational and financial systems, procedures and controls. Our current and planned personnel, systems,
procedures and controls may not be adequate to support our future operations. We may not be able to effectively manage such growth, and
failure to do so could have a material adverse effect on our business, financial condition and results of operations.
We may be affected if the United States participates in wars or military or other action or by international terrorism.
Involvement in a war or other military action or acts of terrorism may cause significant disruption to commerce throughout the world. To
the extent that such disruptions result in (i) delays or cancellations of customer orders, (ii) a general decrease in consumer spending on
information technology, (iii) our inability to effectively market and distribute our services or products or (iv) our inability to access capital
markets, our business and results of operations could be materially and adversely affected. We are unable to predict whether the
involvement in a war or other military action will result in any long-term commercial disruptions or if such involvement or responses will
have any long-term material adverse effect on our business, results of operations, or financial condition.
Our exposure to the credit risk of our customers and suppliers may adversely affect our financial results.
We sell our products to customers that have in the past, and may in the future, experience financial difficulties. If our customers experience
financial difficulties, we could have difficulty recovering amounts owed to us from these customers. While we perform credit evaluations
and adjust credit limits based upon each customer’s payment history and credit worthiness, such programs may not be effective in reducing
our exposure to credit risk. We evaluate the collectability of accounts receivable, and based on this evaluation make adjustments to the
allowance for doubtful accounts for expected losses. Actual bad debt write-offs may differ from our estimates, which may have a material
adverse effect on our financial condition, operating results and cash flows.
Our suppliers may also experience financial difficulties, which could result in our having difficulty sourcing the materials and components
we use in producing our products and providing our services. If we encounter such difficulties, we may not be able to produce our products
for our customers in a timely fashion which could have an adverse effect on our results of operations, financial condition and cash flows.
Changes in the economy and credit markets may adversely affect our future results of operations.
Our operations and performance depend to some degree on general economic conditions and their impact on our customers’ finances and
purchase decisions. As a result of economic events, potential customers may elect to defer purchases of capital equipment items, such as
the products we manufacture and supply. Additionally, the credit markets and the financial services industry are subject to change. While
the ultimate outcome of these events cannot be predicted, it may have a material adverse effect on our customers’ ability to fund their
operations thus adversely impacting their ability to purchase our products or to pay for our products on a timely basis, if at all. These and
other economic factors could have a material adverse effect on demand for our products, the collection of payments for our products and on
our financial condition and operating results.
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We may not be able to obtain payment and performance bonds, which could have a material adverse effect on our business.
Our ability to deploy our EcoSmart Suite of products into the energy management initiatives in federal funded or assisted projects may rely
on our ability to obtain payment and performance bonds which may be an essential element to work orders for the installation of our
products and services. If we are unable to obtain payment and performance bonds in a timely fashion as required by an applicable work
order, we may not be entitled to payment under the work order until such bonds have been provided or until such a requirement is expressly
waived. In addition, any delays due to a failure to furnish bonds may not entitle us to a price increase for the work or an extension of time
to complete the work and may entitle the other party to terminate our work order without liability and to indemnify such party from
damages suffered as a result of our failure to deliver the bonds and the termination of the work order. As a result, the failure to obtain bonds
where required could negatively impact our business, results of operations, and prospects.
Risks Relating to Our Financial Results and Need for Financing
Our independent registered public accounting firm has expressed substantial doubt about our ability to continue as a going concern,
which may hinder our ability to obtain future financing.
In its report dated March 31, 2014, our independent registered public accounting firm’s report on our consolidated financial statements for
the year ended December 31, 2013 included an explanatory paragraph relating to our ability to continue as a going concern based on our
history of operating cash flow deficits, liquidity constraints and negative working capital. Our ability to continue as a going concern is
subject to our ability to generate a profit, positive operating cash flows and/or obtain necessary funding from outside sources, including by
the sale of our securities or assets, or to obtain loans from financial institutions, where possible. Our history of net operating losses and the
uncertainty regarding contingent liabilities cast doubt on our ability to meet such goals.
We have a limited number of shares of common stock available for future issuance which could adversely affect our ability to raise
capital or consummate acquisitions.
We are currently authorized to issue 190,000,000 shares of common stock under our Articles of Incorporation. As of March 15, 2014, we
have issued 125,035,612 shares of common stock and have approximately 21,706,278 shares of common stock committed for issuance
giving effect to the assumed exercise of all outstanding warrants and options and assumed conversion of preferred stock. Due to the limited
number of authorized shares available for issuance and because of the significant competition for acquisitions, we may not able to
consummate an acquisition until we increase the number of shares we are authorized to issue. To facilitate the possibility and flexibility of
raising additional capital or the completion of potential acquisitions, we would need to seek stockholder approval to increase the number of
our authorized shares of common stock. We can provide no assurance that we will succeed in amending our Articles of Incorporation to
increase the number of shares of common stock we are authorized to issue.
We have a history of operating losses and an accumulated deficit and may incur losses in the foreseeable future.
Since inception through December 31, 2013, we have incurred cumulative losses of $121,948,847 and have never generated enough funds
through operations to support our business. For the year ended December 31, 2013, we had an operating cash flow of $2,641. As of
December 31, 2013, we have a working capital deficit (current liabilities in excess of current assets) of $570,401. Because of the numerous
risks and uncertainties associated with our technology, the industry in which we operate, and other factors, we are unable to predict the
extent of any future losses or if we will remain profitable. If we are unable to generate sufficient revenues from our operations to meet our
working capital requirements, we expect to finance our future cash needs through public or debt financings. We cannot be certain that
additional funding will be available on acceptable terms, or at all.
Our business activities might require additional financing that might not be obtainable on acceptable terms, if at all, which could have a
material adverse effect on our financial condition, liquidity and our ability to operate going forward.
The actual amount of capital required to fund our operations and development may vary materially from our estimates. If our operations
fail to generate the cash that we expect, we may have to seek additional capital to fund our business. If we are required to obtain additional
funding in the future, we may have to sell assets, seek debt financing or obtain additional equity capital. In addition, any indebtedness we
incur in the future could subject us to restrictive covenants limiting our flexibility in planning for, or reacting to changes in, our business. If
we do not comply with such covenants, our lenders could accelerate repayment of our debt or restrict our access to further borrowings.
18
If we raise funds by selling more stock, your ownership in us will be diluted, and we may grant future investors rights superior to those of
the common stock that you hold. If we are unable to obtain additional capital when needed, we may have to delay, modify or abandon some
of our expansion plans. This could slow our growth, negatively affect our ability to compete in our industry and adversely affect our
financial condition.
A significant portion of our total assets consists of goodwill and intangible assets, which are subject to periodic impairment analysis,
and a significant impairment determination could have an adverse effect on our results of operations and financial condition even
without a significant loss of revenue or increase in cash expenses attributable to such period.
In connection with the preparation of the Annual Report on Form 10-K, the management of the Company assessed and determined that the
estimated carrying value of the Company’s Smart Systems International reporting unit exceeded its estimated fair value. As a result, the
Company recorded a material impairment charge of $2.8 million to goodwill for the year ended December 31, 2013. The impairment
charge resulted in eliminating the remaining balance of Smart Systems International reporting unit asset. We have goodwill and intangible
assets of approximately $5.8 million and $1.3 million, respectively, at December 31, 2013, resulting from past acquisitions. We evaluate
this goodwill for impairment based on the fair value of the reporting units to which this goodwill relates at least once a year during the
fourth quarter, or more frequently if conditions exist that indicate a potential impairment. This estimated fair value could change if we are
unable to achieve operating results at the levels that have been forecasted, the market valuation of those reporting units decreases based on
transactions involving similar companies, or there is a permanent, negative change in the market demand for the services offered by the
reporting units. These changes could result in an additional impairment of the existing goodwill balance in the future that could require a
material non-cash charge to our results of operations.
Our failure to comply with covenants under debt instruments could trigger prepayment obligations or other penalties.
Our failure to comply with the covenants under our debt instruments could result in an event of default, which, if not cured or waived,
could result in us being required to repay these borrowings before their due date or could result in other penalties. If we are forced to
refinance these borrowings on less favorable terms, our results of operations and financial condition could be adversely affected by
increased costs and rates. On May 31, 2013, we entered into a Revolving Credit Facility (the “Agreement”) with Bridge Bank, NA (the
“Bank”). As of September 30 and December 31, 2013, we were in violation of a financial performance covenant under the Agreement. The
outstanding balance at March 31, 2014 is $200,000. The Company is currently in negotiations with the Bank to modify the existing
Agreement. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital
Resources” for more information regarding the Agreement.
If we fail to remain current on our reporting requirements, we could be removed from the OTC Bulletin Board, which would limit the
ability of broker-dealers to sell our securities and the ability of stockholders to sell their securities in the secondary market.
Companies trading on the OTC Bulletin Board, such as us, must be reporting issuers under Section 12 of the Securities Exchange Act of
1934, as amended, or the Exchange Act, and must be current in their reports under Section 13 of the Exchange Act in order to maintain price
quotation privileges on the OTC Bulletin Board. If we fail to remain current on our reporting requirements, we could be removed from the
OTC Bulletin Board. As a result, the market liquidity for our securities could be severely adversely affected by limiting the ability of
broker-dealers to sell our securities and the ability of stockholders to sell their securities in the secondary market.
We have debt agreements that contain certain events of default and are collateralized by substantially all of our assets.
We have a $300,000 loan agreement with the State of Wisconsin’s Department of Commerce that matures in December 2016. Our debt
agreement contains certain events of default, including, among other things, failure to pay, violation of covenants, and certain other
expressly enumerated events. The State of Wisconsin holds a first priority security interest in our assets. If we were to trigger an event of
default under the agreement, it would have a significant negative impact on our business.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
19
ITEM 2. PROPERTIES.
The Company presently leases approximately 14,000 square feet of office space in Milwaukee, Wisconsin for its operations facility. The
Milwaukee lease expires in March 2020.
The Company presently leases 16,416 square feet of commercial office space in Germantown, Maryland. The lease commitments expire in
December 2015. On July 15, 2011, the Company executed a sublease agreement for 11,626 square feet of commercial office space in
Germantown, Maryland and ceased utilizing this space for the Company’s benefit. Because we no longer have access to this subleased
space, we recorded a charge of $59,937 in accrued liabilities and expenses related to this abandonment during 2011. On June 27, 2012 the
subtenant exercised the option to extend the expiration of the term of the sublease from January 31, 2013 to December 31, 2015 and we
recorded an additional charge of $132,174 during the year ended December 31, 2012. The remaining liability at December 31, 2013 and
2012 was $91,981 and $135,975, respectively.
On October 7, 2013 the Company entered into a commercial office lease agreement. The 87 month lease, provides the Company
approximately 6,362 square feet of office space in Waukesha, Wisconsin to be used for its corporate headquarters. The initial base rent is
approximately $6,097 per month and the total minimum rental commitment under this lease is anticipated to be approximately $627,956.
ITEM 3. LEGAL PROCEEDINGS.
Linksmart Wireless Technology, LLC v. T-Mobile USA, Inc.
On July 1, 2008, Linksmart Wireless Technology, LLC, or Linksmart, filed a civil lawsuit in the Eastern District of Texas against
EthoStream, LLC, our wholly-owned subsidiary and 22 other defendants (Linksmart Wireless Technology, LLC v. T-Mobile USA, Inc., et
al, U.S. District Court, for the Eastern District of Texas, Marshall Division, No. 2:08-cv-00264). This lawsuit alleged that the defendants’
services infringed a wireless network security patent held by Linksmart.
Defendant Ramada Worldwide, Inc. provided us with notice of the suit and demanded that we defend and indemnify it pursuant to
indemnification provisions of a vendor direct supplier agreement between EthoStream and WWC Supplier Services, Inc., a Ramada
affiliate. After a review of that agreement, it was determined that EthoStream owed the duty to defend and indemnify with respect to
services provided by Telkonet to Ramada and it assumed Ramada’s defense.
The parties in the lawsuit agreed to and the Court ordered a stay of the litigation pending the conclusion of a reexamination proceeding in
the U.S. Patent and Trademark Office relating to the patent involved in the lawsuit. The case was reopened in early 2012 based on the
expectation that a reexamination certificate would be issued by the Patent Office. The reexamination certificate has been issued. After the
case resumed, the parties agreed to a “transfer” of the case from the Eastern District of Texas to the Central District of California. To
accomplish the “transfer,” with the agreement of the parties, the Texas case was dismissed and a new action was filed in California on
April 5, 2012. (Linksmart Wireless Technology, LLC v. T-Mobile USA, Inc., et al, U.S. District Court, for the Central District of California,
Southern Division, No. SACV 12-522-JST).
On October 1, 2013, the Company entered into a settlement agreement with Linksmart. The Company has agreed to pay $115,000, payable
in twelve installments of $9,583 due on the first of each month beginning October 1, 2013.
ITEM 4. MINE SAFETY DISCLOSURES.
None.
20
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
Our common stock is currently quoted on the OTC Bulletin Board under the symbol “TKOI.”
The following table sets forth the quarterly high and low bid prices for our common stock for the years ended December 31, 2013 and 2012.
Year Ended December 31, 2013
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Year Ended December 31, 2012
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Record Holders
$
$
High
Low
0.34 $
0.33
0.32
0.28
0.23 $
0.21
0.21
0.18
0.13
0.17
0.22
0.16
0.14
0.13
0.12
0.13
As of March 21, 2014, we had 206 record holders of our common stock and 125,035,612 shares of our common stock issued and
outstanding.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information concerning securities authorized for issuance pursuant to equity compensation plans approved by
the Company’s stockholders and equity compensation plans not approved by the Company’s stockholders as of December 31, 2013.
Number of
securities to be
issued upon
exercise of
outstanding
options, warrants
and rights
(a)
1,735,225 $
-
Weighted-average
exercise price of
outstanding
options, warrants
and rights
(b)
0.43
-
Number of
securities
remaining
available for
future issuance
under equity
compensation
plans (excluding
securities
reflected in
column (a))
(c)
5,947,553
-
1,735,225 $
0.43
5,947,553
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Total
Dividend Policy
The Company has never paid dividends on its common stock and does not anticipate paying dividends in the foreseeable future. It is also
subject to certain contractual restrictions on paying dividends on its common stock under the terms of its Series A and B preferred stock.
Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 6. SELECTED FINANCIAL DATA
This item is not applicable.
21
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the
accompanying financial statements and related notes thereto.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying
notes. On an ongoing basis, we evaluate significant estimates used in preparing our consolidated financial statements including those
related to revenue recognition, fair value of financial instruments, guarantees and product warranties, stock based compensation, potential
impairment of goodwill and other long-lived assets, contingent liabilities and business combinations. We base our estimates on historical
experience, underlying run rates and various other assumptions that we believe to be reasonable, the results of which form the basis for
making judgments about the carrying values of assets and liabilities. Actual results could differ from these estimates. The following are
critical judgments, assumptions, and estimates used in the preparation of the consolidated financial statements.
Revenue Recognition
For revenue from product sales, we recognize revenue in accordance with ASC 605-10, “Revenue Recognition” and ASC 605-10-S99
guidelines that require that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination
of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the selling prices of the products delivered and
the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other
adjustments are provided for in the same period the related sales are recorded. The guidelines also address the accounting for
arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets.
Multiple-Element Arrangements (“MEAs”): The Company accounts for contracts that have both product and installation under the MEAs
guidance in ASC 605. The Company believes the volume of these contracts will continue to increase. Arrangements under such contracts
include multiple deliverables, a combination of equipment and services. The deliverables included in the MEAs are separated into more
than one unit of accounting when (i) the delivered element has value to the customer on a stand-alone basis, and (ii) delivery of the
undelivered element(s) is probable and substantially in our control. Arrangement consideration is then allocated to each unit, delivered or
undelivered, based on the relative selling price of each unit of accounting based first on vendor-specific objective evidence (“VSOE”) if it
exists, second on third-party evidence (“TPE”) if it exists and on estimated selling price (“ESP”) if neither VSOE or TPE exist.
· VSOE – Based on its pricing and discounting practices for the specific product or service when sold separately, considering
geographical, customer, and other economic or marketing variables, as well as renewal rates or stand-alone prices for the
service element(s).
·
·
TPE – If we cannot establish VSOE of selling price for a specific product or service included in a multiple-element
arrangement, we use third-party evidence of selling price. We determine TPE based on sales of comparable amount of similar
product or service offered by multiple third parties considering the degree of customization and similarity of product or service
sold.
ESP – The estimated selling price represents the price at which we would sell a product or service if it were sold on a stand-
alone basis. When neither VSOE nor TPE exists for all elements, we determine ESP for the arrangement element based on
sales, cost and margin analysis, as well as other inputs based on our pricing practices. Adjustments for other market and
Company-specific factors are made as deemed necessary in determining ESP.
When MEAs include an element of customer training, it is not essential to the functionality, efficiency or effectiveness of the MEA.
Therefore the Company has concluded that this obligation is inconsequential and perfunctory. As such, for MEAs that include training,
customer acceptance of said training is not deemed necessary in order to record the related revenue, but is recorded when the installation
deliverable is fulfilled. Historically, training revenues have not been significant.
22
We provide call center support services to properties installed by us and also to properties installed by other providers. In addition, we
provide the property with the portal to access the Internet. We receive monthly service fees from such properties for our services and
Internet access. We recognize the service fee ratably over the term of the contract. The prices for these services are fixed and determinable
prior to delivery of the service. The fair value of these services is known due to objective and reliable evidence from standalone executed
contracts. We report such revenues as recurring revenues.
Total revenues do not include sales tax as we consider ourselves a pass through conduit for collecting and remitting sales taxes.
Fair Value of Financial Instruments
The Company accounts for the fair value of financial instruments in accordance with ASC 820, which defines fair value for accounting
purposes, establishes a framework for measuring fair value and expands disclosure requirements regarding fair value measurements. Fair
value is defined as an exit price, which is the price that would be received upon sale of an asset or paid upon transfer of a liability in an
orderly transaction between market participants at the measurement date. The degree of judgment utilized in measuring the fair value of
assets and liabilities generally correlates to the level of pricing observability. Financial assets and liabilities with readily available, actively
quoted prices or for which fair value can be measured from actively quoted prices in active markets generally have more pricing
observability and require less judgment in measuring fair value. Conversely, financial assets and liabilities that are rarely traded or not
quoted have less price observability and are generally measured at fair value using valuation models that require more judgment. These
valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price
transparency of the asset, liability or market and the nature of the asset or liability. We have categorized our financial assets and liabilities
that are recurring, at fair value into a three-level hierarchy in accordance with these provisions.
Guarantees and Product Warranties
The Company records a liability for potential warranty claims. The amount of the liability is based on the trend in the historical ratio of
claims to sales. The products sold are generally covered by a warranty for a period of one year. In the event the Company determines that
its current or future product repair and replacement costs exceed its estimates, an adjustment to these reserves would be charged to earnings
in the period such determination is made. During the years ended December 31, 2013 and 2012, the Company experienced approximately
between 1% and 4% of returns related to product warranties. As of December 31, 2013 and 2012, the Company recorded warranty
liabilities in the amount of $77,943 and $69,743, respectively, using this experience factor range.
Stock Based Compensation
We account for our stock based awards in accordance with ASC 718, which requires a fair value measurement and recognition of
compensation expense for all share-based payment awards made to our employees and directors, including employee stock options and
restricted stock awards.
We estimate the fair value of stock options granted using the Black-Scholes valuation model. This model requires us to make estimates and
assumptions including, among other things, estimates regarding the length of time an employee will retain vested stock options before
exercising them and the estimated volatility of our common stock price. The fair value is then amortized on a straight-line basis over the
requisite service periods of the awards, which is generally the vesting period. Changes in these estimates and assumptions can materially
affect the determination of the fair value of stock-based compensation and consequently, the related amount recognized in our consolidated
statements of operations.
Goodwill and Other Intangibles
In accordance with the accounting guidance on goodwill and other intangible assets, we perform an annual impairment test of goodwill at
our reporting unit level and other intangible assets at our unit of account level, or more frequently if events or circumstances change that
would more likely than not reduce the fair value of our reporting units below their carrying value. Amortization is recorded for other
intangible assets with determinable lives using the straight line method over the 12 year estimated useful life. Goodwill is subject to a
periodic impairment assessment by applying a fair value test based upon a two-step method. The first step of the process compares the fair
value of the reporting unit with the carrying value of the reporting unit, including any goodwill. We utilize a discounted cash flow
valuation methodology (income approach) to determine the fair value of the reporting unit. This approach is developed from
management’s forecasted cash flow data. If the fair value of the reporting unit exceeds the carrying amount of the reporting unit, goodwill
is deemed not to be impaired. If the carrying amount exceeds fair value, we calculate an impairment loss. Any impairment loss is
measured by comparing the implied fair value of goodwill to the carrying amount of goodwill at the reporting unit, with the excess of the
carrying amount over the fair value recognized as an impairment loss.
23
Significant assumptions used in our goodwill impairment test at December 31, 2013 and 2012 included: expected revenue growth rates,
reporting unit profit margins, working capital levels, discount rates of 12.4% and 12.9% for Ethostream and 21.8% and 17.5% for SSI,
respectively, and a terminal value multiple. The expected future revenue growth rates and the expected reporting unit profit margins were
determined after considering our historical revenue growth rates and reporting unit profit margins, our assessment of future market
potential, and our expectations of future business performance. At December 31, 2013, the Company determined that the value of Smart
Systems International’s goodwill was impaired based upon management’s assessment of operating results and forecasted discounted cash
flow and has recorded an impairment charge of $2,774,016. The goodwill and intangible asset impairment charge was non-cash in nature
and did not impact our liquidity, cash flows provided by operating activities or future operations.
Long-Lived Assets
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable in accordance with ASC 360-10. Recoverability is measured by comparison of the carrying amount to the future net
undiscounted cash flows which the assets are expected to generate. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets exceeds its fair value.
Contingent Liabilities - Sales Tax
During 2012, the Company engaged a sales tax consultant to assist in determining the extent of its potential sales tax exposure. Based upon
this analysis, management determined the Company had probable exposure for certain unpaid obligations, including interest and penalty, of
approximately $1,100,000 including and prior to the year ended December 31, 2011. The Company had approximately $1,100,000 and
$1,200,000 accrued for this exposure as of December 31, 2013 and 2012, respectively.
The Company continues to manage the liability by establishing voluntary disclosure agreements (VDAs) with the applicable states, which
establishes a maximum look-back period and payment arrangements. However, if the aforementioned methods prove unsuccessful and the
Company is examined or challenged by taxing authorities, there exists possible exposure of an additional $450,000, not including any
applicable interest and penalties.
During 2012, the Company successfully executed and paid in full VDAs in five states totaling approximately $23,000 and is current with
the subsequent filing requirements.
During 2013, the Company successfully executed and paid in full VDAs in fourteen states totaling approximately $263,000 and is current
with the subsequent filing requirements. VDAs have been submitted with an additional fifteen states and the Company is awaiting
notification of acceptance. Two states offer no voluntarily disclosure program.
EBITDA
The Company defines EBITDA as net income (loss), excluding income tax expense (benefit), interest expense, interest income, and
depreciation and amortization expense. Management believes that certain non-GAAP financial measures may be useful in certain instances
to provide additional meaningful comparisons between current results and results in prior operating periods. Adjusted earnings before
interest, taxes, depreciation and amortization and other non-operating income and expenses (“Adjusted EBITDA”) is a metric used by
management and frequently used by the financial community. Adjusted EBITDA provides insight into an organization’s operating trends
and facilitates comparisons between peer companies, since interest, taxes, depreciation and amortization can differ greatly between
organizations as a result of differing capital structures and tax strategies. Adjusted EBITDA excludes certain items that are unusual in
nature or not comparable from period to period. While management believes that non-GAAP measurements are useful supplemental
information, such adjusted results are not intended to replace our GAAP financial results.
24
RECONCILIATION OF NET INCOME (LOSS) TO ADJUSTED EBITDA
FOR THE YEARS ENDED DECEMBER 31,
(Unaudited)
Net income (loss)
Interest expense, net
(Benefit) provision for income taxes
Depreciation and amortization
EBITDA
Adjustments:
Gain on sale of product line
Impairment of goodwill
Stock-based compensation
Adjusted EBITDA
Results of Operations
2013
2012
$
$
(3,994,731) $
18,141
349,823
258,517
(3,368,250)
(41,902)
2,774,016
89,565
(546,571) $
390,080
26,274
(31,271)
260,830
645,913
(15,408)
–
201,643
832,148
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Revenues
The table below outlines our product versus recurring revenues for comparable periods:
2013
Year Ended December 31,
2012
Variance
Product
Recurring
Total
$
$
10,123,407
3,766,439
13,889,846
73% $
27%
100% $
8,537,170
4,221,206
12,758,376
67% $
33%
100% $
1,586,237
(454,767)
1,131,470
19%
-11%
9%
Product revenue
Product revenue principally arises from the sale and installation of EcoSmart Suite of products, SmartGrid and High Speed Internet
Access equipment. These include TSE, Telkonet Series 5, Telkonet iWire, and wireless networking products. We market and sell to the
hospitality, education, healthcare and government/military markets. The Telkonet Series 5 and the Telkonet iWire products consist of the
Telkonet Gateways, Telkonet Extenders, the patented Telkonet Coupler, and Telkonet iBridges. The EcoSmart Suite of products consist of
thermostats, sensors, controllers, wireless networking products switches, outlets and a control platform. The HSIA product suite consists of
gateway servers, switches and access points.
For the year ended December 31, 2013, product revenue increased $1.59 million when compared to the prior year. Product revenue in
2013 included approximately $5.00 million attributed to the sale and installation of energy management products, approximately $4.97
million for the sale and installation of HSIA products, and approximately $0.15 million attributable to the sale of Telkonet Series 5 Smart
Grid products. The increase in product revenue can be attributed to management’s commitment of resources to sales and marketing efforts
and personnel.
Recurring Revenue
Recurring revenue is primarily attributed to recurring services. The Company recognizes revenue ratably over the service month for
monthly support revenues and defers revenue for annual support services over the term of the service period. The recurring revenue
consists primarily of HSIA support services and advertising revenue. Advertising revenue is based on impression-based statistics for a
given period from customer site visits to the Company’s login portal page under the terms of advertising agreements entered into with
third-parties. A component of our recurring revenue is derived from fees, less payback costs, associated with approximately 1% of our
hospitality customers who do not internally manage guest-related, internet transactions.
25
Recurring revenue includes approximately 2,300 hotels in our broadband network portfolio. We currently support approximately 234,000
HSIA rooms, with approximately 8.0 million monthly users. For the year ended December 31, 2013, recurring revenue decreased by 11%
when compared to the prior year. The decrease of recurring revenue was primarily attributed to a $0.15 million decrease in advertising
revenue and a $0.30 million decrease due to a reduction of HSIA customers. The reduction of HSIA customers can be attributed to
management’s decision not to pursue renewing customer accounts with lower profit margins.
Cost of Sales
2013
Year ended December 31,
2012
Variance
Product
Recurring
Total
$
$
6,034,294
1,069,558
7,103,852
60% $
28%
51% $
4,726,241
1,178,077
5,904,318
55% $
28%
46% $
1,308,053
(108,519)
1,199,534
28%
-9%
20%
Costs of Product Sales
Costs of product sales include equipment and installation labor related to the sale of SmartGrid and broadband networking equipment,
including EcoSmart technology and Telkonet iWire. For the year ended December 31, 2013, cost of product sales increased by 28% when
compared to the prior year. The increase was attributed to the additional cost of materials associated with the increase in product sales as
well as salaries and travel expenses associated with the installations.
Costs of Recurring Revenue
Recurring costs are comprised of labor and telecommunication services for our Customer Service department. For the year ended
December 31, 2013, costs of recurring revenue decreased by 9% when compared to the prior year. This variance is partially attributed to
$0.19 million decrease in Internet Service Provider costs. The majority of the decrease in costs of recurring revenue was associated with
management’s decision not to pursue renewing customer accounts with lower profit margins. The decrease was partially offset by an
increase in salaries and wages.
Gross Profit
2013
Year ended December 31,
2012
Variance
Product
Recurring
Total
$
$
4,089,113
2,696,881
6,785,994
40% $
72%
49% $
3,810,929
3,043,129
6,854,058
45% $
72%
54% $
278,184
(346,248)
(68,064)
7%
-11%
-1%
Gross Profit on Product Revenue
Gross profit on product revenue for the year ended December 31, 2013 increased by 7% compared to the prior year period. The variance
was a result of increased product sales and installations. Gross profit as a percentage of sales decreased approximately 5% for the year
ended December 31, 2013. The decrease is attributed to the lower margins on HSIA product compared to energy management product.
HSIA product revenue grew by approximately $2.10 million for the year ended December 31, 2013.
Gross Profit on Recurring Revenue
For the year ended December 31, 2013, our gross profit decreased by 11% when compared to the prior year. The variance was mainly
attributed to a $0.15 million decrease in advertising revenue which yields higher gross margins.
26
Operating Expenses
2013
Year ended December 31,
2012
Variance
Total
$
10,454,663 $
6,484,383 $
3,970,280
61%
The Company’s operating expenses are comprised of research and development, selling, general and administrative expenses, goodwill
impairment and depreciation and amortization expense. During the year ended December 31, 2013, operating expenses increased by 61%
when compared to the prior year. This increase is primarily related to a non-cash goodwill impairment charge on Smart Systems
International of $2.77 million in 2013. Excluding this non-cash charge, operating expenses would have increased by $1.20 million or 18%.
Research and Development
2013
Year ended December 31,
2012
Variance
Total
$
1,174,048 $
984,853 $
189,195
19%
Our research and development costs related to both present and future products are expensed in the period incurred. Total expenses for
research and development increased by 19% for the year ended December 31, 2013. This increase is attributed to additional expenditures
for salaries, consulting fees, and certification and testing costs associated with the continued development of our next generation energy
efficiency products.
Selling, General and Administrative Expenses
2013
Year ended December 31,
2012
Variance
Total
$
6,248,082 $
5,238,700 $
1,009,382
19%
Selling, general and administrative expenses increased for the year ended December 31, 2013 over the prior year by 19%. The majority of
this increase was attributed to salaries and wages of approximately $0.40 million, commissions of approximately $0.17 million, the
Linksmart Wireless Technology, LLC litigation settlement of approximately $0.12 million and bad debts of approximately $0.19 million.
Goodwill Impairment
2013
2012
Variance
Year ended December 31,
Total
$
2,774,016 $
0 $
2,774,016
100%
During the year ended December 31, 2013, the Company recorded a $2.77 million goodwill impairment charge on Smart Systems
International.
Liquidity and Capital Resources
We have financed our operations since inception primarily through private and public offerings of our equity securities, the issuance of
various debt instruments and asset based lending.
Working Capital
Our working capital (current assets in excess of current liabilities) decreased by $985,050 during the year ended December 31, 2013 from a
working capital surplus of $414,649 at December 31, 2012 to working a capital deficit of $570,401 at December 31, 2013.
27
Series A Preferred
The Company has designated 215 shares of preferred stock as Series A Preferred Stock (“Series A”). Under certain circumstances, on
November 19, 2014 and for a period of 180 days thereafter, we may be required to redeem the shares of Series A for $5,000 per share plus
any accrued but unpaid dividends. The aggregate redemption price payable to holders of shares of Series A will be payable by the
Company in three equal annual installments. The first of these three installments will be due within 60 days of the requisite holders’ written
notice requesting redemption. For information regarding the Series A, please see Note I of the notes to consolidated financial statements.
Business Loan
On September 11, 2009, the Company entered into a Loan Agreement in the aggregate principal amount of $300,000 with the Wisconsin
Department of Commerce (the “Department”). The outstanding principal balance bears interest at the annual rate of 2%. Payment of
interest and principal is to be made in the following manner: (a) payment of any and all interest that accrues from the date of disbursement
commenced on January 1, 2010 and continued on the first day of each consecutive month thereafter through and including December 31,
2010; (b) commencing on January 1, 2011 and continuing on the first day of each consecutive month thereafter through and including
November 1, 2016, the Company shall pay equal monthly installments of $4,426; followed by a final installment on December 1, 2016
which shall include all remaining principal, accrued interest and other amounts owed by the Company to the Department under the Loan
Agreement. The Company may prepay amounts outstanding under the credit facility in whole or in part at any time without penalty. The
Loan Agreement is secured by substantially all of the Company’s assets and the proceeds from this loan were used for the working capital
requirements of the Company. The Loan Agreement contains covenants which required, among other things, that the Company keep and
maintain 75 existing full-time positions and create and fill 35 additional full-time positions in Milwaukee, Wisconsin by December 31,
2012. On June 18, 2012, the Department agreed to permanently waive all penalties associated with the Company’s noncompliance with this
covenant. The outstanding borrowings under the agreement as of December 31, 2013 and 2012 were $154,463 and $203,947, respectively.
Promissory Note
On March 4, 2011, the Company sold all its Series 5 PLC product line assets to Wisconsin-based Dynamic Ratings, Inc. (“Purchaser”)
under an Asset Purchase Agreement (“APA”). Per the APA, the Company signed an unsecured Promissory Note (the “Note”) due to
Purchaser in the aggregate principal amount of $700,000. The outstanding principal balance bears interest at the annual rate of 6% and was
originally due on March 31, 2014. The Note may be prepaid in whole or in part, without penalty at any time. The Note contains certain
earn-out provisions that encompass both the Company’s and Purchaser’s revenue volumes. Amounts earned under the earn-out provisions
were applied against the Note on June 30, 2012 and June 30, 2013. For the periods ended June 30, 2013 and June 30, 2012, the non-cash
reduction of principal calculated under these provisions and applied to the Note was $41,902 and $15,408, respectively. Payments not
made when due, by maturity acceleration or otherwise, shall bear interest at the rate of 12% per annum from the date due until fully paid.
Effective April 30, 2013, Purchaser approved an amendment to certain terms of the Note. Telkonet commenced a monthly payment of
principal and interest of $20,000 to be applied against the outstanding balance starting May 1, 2013. The interest rate remains unchanged at
6% and the maturity date was extended to January 1, 2016. The outstanding principal balance of the Note as of December 31, 2013 and
2012 was $506,024 and $684,592, respectively.
Revolving Credit Facility
On May 31, 2013, the Company entered into a Revolving Credit Facility (the “Agreement”) with Bridge Bank, NA, (the “Bank”) in a
principal amount not to exceed $2,000,000. The Agreement is subject to a borrowing base that is equal to the sum of 80% of the Company’s
eligible accounts receivable and 25% of the eligible inventory. On August 1, 2013 the Agreement was modified to include the eligible
receivables and the eligible inventory of Ethostream. The Agreement is available for working capital and other lawful general corporate
purposes. The outstanding principal balance of the facility bears interest at Prime Rate plus 2.75%. The Company’s borrowing base at
December 31, 2013 was approximately $791,000 and the outstanding balance was zero. As of September 30 and December 31, 2013, the
Company was in violation of a financial performance covenant. The outstanding balance at March 31, 2014 is $200,000. The Company is
currently in negotiations with the Bank to modify the existing Agreement.
Cash flow analysis
Cash provided by operations was $2,641 during the year ended December 31, 2013 and cash used in operations was $188,985 during the
year ended December 31, 2012. As of December 31, 2013, our primary capital needs included costs incurred to increase energy
management sales, inventory procurement, funding performance bonds and managing current liabilities.
28
Cash used in investing activities was $407,577 during the year ended December 31, 2013 and cash provided by investing activities was
$47,905 during the year ended December 31, 2012. During the year ended December 31, 2012, the Company was awarded a contract that
included a bonding requirement. During the year ended December 31, 2013, the Company satisfied this requirement with cash collateral
supported by an irrevocable standby letter of credit in the amount of $382,000.
Cash used in financing activities to repay indebtedness was $186,150 during the year ended December 31, 2013. Cash provided by
financing activities was $343,747 during the year ended December 31, 2012. The Company received proceeds of $405,000 from the
exercise of 3,115,390 Series B Convertible Redeemable Preferred Stock warrants for common stock during 2012.
We are working to manage our current liabilities while we continue to make changes in operations to improve our cash flow and liquidity
position.
Our independent registered public accounting firm’s report on our consolidated financial statements for the year ended December 31, 2013
includes an explanatory paragraph relating to our ability to continue as a going concern. We have incurred operating losses and operating
cashflow deficits in past years and we are dependent upon our ability to continue profitable operations and/or obtain necessary funding from
outside sources, including by the sale of our securities, or obtaining loans from financial institutions, where possible. These factors, among
others, raise doubt about our ability to continue as a going concern and may also affect our ability to obtain financing in the future.
Management expects that global economic conditions will continue to present a challenging operating environment through 2014; therefore
working capital management will continue to be a high priority for 2014.
The Company continues to manage the approximate $1,100,000 sales tax liability by establishing VDAs with the applicable states, which
establish a maximum look-back period and payment arrangements. However, if the aforementioned methods prove unsuccessful and the
Company is examined or challenged by taxing authorities, there exists possible exposure of an additional $450,000, not including any
applicable interest and penalties.
During 2013, the Company successfully executed and paid in full VDAs in fourteen states totaling approximately $263,000 and is current
with the subsequent filing requirements. The Company has submitted VDAs with an additional fifteen states and awaits notification of
acceptance. Two states offer no voluntarily disclosure program. During 2012, the Company successfully executed and paid in full VDAs in
five states totaling approximately $23,000 and is current with the subsequent filing requirements. The Company has submitted VDAs with
an additional twenty-seven states and awaits notification of acceptance. The Company also confirmed that one customer had self-assessed,
further reducing our liability and expense associated with that liability by approximately $151,000.
Inflation
We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to
become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our
inability or failure to do so could adversely affect our business, financial condition and results of operations.
Off-Balance Sheet Arrangements
None.
New Accounting Pronouncements
See Note B of the Consolidated Financial Statements for a description of a new accounting pronouncement.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
This item is not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See the Consolidated Financial Statements and Notes thereto commencing on Page F-1.
29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
On June 3, 2013, the Audit Committee of the Board of Directors of the Company dismissed Baker Tilly Virchow Krause, LLP (“Baker
Tilly”) as the Company’s independent registered public accounting firm, and appointed BDO USA, LLP (“BDO”) as the Company’s new
independent registered public accounting firm.
Baker Tilly’s reports on the Company’s consolidated financial statements for each of the fiscal years ended December 31, 2012 and 2011
did not contain an adverse opinion or disclaimer of opinion, nor were they qualified or modified as to audit scope, or accounting principle,
except that the reports of Baker Tilly on the Company’s consolidated financial statements for each of fiscal year 2012 and fiscal year 2011
contained an explanatory paragraph, which noted that there was substantial doubt about the Company’s ability to continue as a going
concern.
During the fiscal years ended December 31, 2012 and 2011, and the subsequent interim period through June 3, 2013, there were no
disagreements between the Company and Baker Tilly on any matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which disagreements, if not resolved to Baker Tilly’s satisfaction, would have caused them to make reference
to the subject matter of the disagreement in connection with their reports on the financial statements of the Company for such years.
In connection with its audit of the Company's consolidated financial statements for the years ended December 31, 2012 and 2011, Baker
Tilly noted in its required communications to the Company and the Audit Committee of the Board of Directors that they had found material
weaknesses in the Company's internal control over financial reporting, noting internal controls necessary for the company to develop
reliable financial statements did not exist. No other reportable events described in Item 304(a)(1)(v) of Regulation S-K occurred during the
fiscal years ended December 31, 2012 and 2011 or during the subsequent interim period through June 03, 2013.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that material information required to be disclosed in our
periodic reports filed under the Securities Exchange Act of 1934, as amended, or 1934 Act, is recorded, processed, summarized, and
reported within the time periods specified in the SEC’s rules and forms and to ensure that such information is accumulated and
communicated to our management, including our chief executive officer and chief financial officer as appropriate, to allow timely decisions
regarding required disclosure. Due to the lack of a segregation of duties and the failure to implement adequate internal control over
financial reporting, our principal executive officer and principal financial officer have concluded that our disclosure controls and
procedures were ineffective as of the end of the period covered by this report.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal
control over financial reporting is designed to provide reasonable assurances regarding the reliability of financial reporting and the
preparation of the financial statements of the Company in accordance with U.S. generally accepted accounting principles, or GAAP.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree or compliance with the policies or procedures may deteriorate.
With the participation of our Chief Executive Officer, our management conducted an evaluation of the effectiveness of our internal control
over financial reporting as of December 31, 2013 based on the framework in Internal Control—Integrated Framework (1992) issued by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based on our evaluation and the material weaknesses
described below, management concluded that the Company did not maintain effective internal control over financial reporting as of
December 31, 2013 based on the COSO framework criteria. Management has identified control deficiencies regarding the lack of
segregation of duties, failure to implement adequate internal control over financial reporting and the need for a stronger internal control
environment. Management of the Company believes that these material weaknesses are due to the small size of the Company’s accounting
staff. The small size of the Company’s accounting staff may prevent adequate controls in the future, such as segregation of duties, due to
the cost/benefit of such remediation. We do expect to retain additional personnel to remediate these control deficiencies in the future.
30
These control deficiencies could result in a misstatement of account balances resulting in a more than remote likelihood that a material
misstatement to our financial statements may not be prevented or detected on a timely basis. Accordingly, we have determined that these
control deficiencies as described above constitute material weaknesses.
In light of these material weaknesses, we performed additional analyses and procedures in order to conclude that our consolidated financial
statements for the year ended December 31, 2013 and 2012 included in this Annual Report on Form 10-K were fairly stated in accordance
with GAAP. Accordingly, management believes that despite our material weaknesses, our financial statements for the years ended
December 31, 2013 and 2012 are fairly stated, in all material respects, in accordance with GAAP.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities
and Exchange Commission that permit us to provide only management’s report in this Annual Report on Form 10-K.
Changes in Internal Controls
During the year ended December 31, 2013, there have been no changes in our internal control over financial reporting that have materially
affected or are reasonably likely to materially affect our internal controls over financial reporting.
ITEM 9B. OTHER INFORMATION.
None.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
PART III
Pursuant to General Instruction G(3), information on directors and executive officers of the Registrant and corporate governance matters is
incorporated by reference from our definitive proxy statement for the annual shareholder meeting to be held on June 12, 2014.
Code of Ethics
The Board has approved, and Telkonet has adopted, a Code of Ethics that applies to all directors, officers and employees of the Company.
A copy of the Company’s Code of Ethics was filed as Exhibit 14 to the Company’s Annual Report on Form 10-KSB for the year ended
December 31, 2003 (filed with the Securities and Exchange Commission on March 30, 2004). In addition, the Company will provide a copy
of its Code of Ethics free of charge upon request to any person submitting a written request to the Company’s Chief Executive Officer.
ITEM 11. EXECUTIVE COMPENSATION.
Pursuant to General Instruction G(3), information on executive compensation is incorporated by reference from our definitive proxy
statement for the annual shareholder meeting to be held on June 12, 2014.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.
Pursuant to General Instructions G(3), information on security ownership of certain beneficial owners and management and related
stockholder matters are incorporated by reference from our definitive proxy statement for the annual shareholder meeting to be held on
June 12, 2014.
31
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Pursuant to General Instruction G(3), information on certain relationships and related transactions and director independence is
incorporated by reference from our definitive proxy statement for the annual shareholder meeting to be held on June 12, 2014.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Pursuant to General Instruction G(3), information on principal accounting fees and services is incorporated by reference from our definitive
proxy statement for the annual shareholder meeting to be held on June 12, 2014.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a)
Documents filed as part of this report.
PART IV
(1)
Financial Statements. The following financial statements are included in Part II, Item 8 of this Annual Report on Form 10-K:
Report of BDO USA, LLP on Consolidated Financial Statements as of and for the year ended December 31, 2013
Report of Baker Tilly Virchow Krause LLP on Consolidated Financial Statements as of and for the year ended December 31,
2012
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Operations for the Years ended December 31, 2013 and 2012
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2013 and 2012
Consolidated Statements of Cash Flows for Years ended December 31, 2013 and 2012
Notes to Consolidated Financial Statements
(2)
Financial Statement Schedules
Additional Schedules are omitted as the required information is inapplicable or the information is presented in the financial
statements or related notes
(3)
Exhibits required to be filed by Item 601 of Regulation S-K
See Exhibit Index located immediately following this Item 15
The exhibits filed herewith are attached hereto (except as noted) and those indicated on the Exhibit Index which are not filed
herewith were previously filed with the Securities and Exchange Commission as indicated and are incorporated herein by
reference.
32
The following exhibits are included herein or incorporated by reference:
EXHIBIT INDEX
Exhibit
Number
2.1
2.2
2.3
3.1
3.2
3.3
3.4
3.5
3.6
3.7
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
10.1
10.2
10.3
10.4
10.5
10.6
Description Of Document
Asset Purchase Agreement by and between Telkonet, Inc. and Smart Systems International, dated as of February 23, 2007
(incorporated by reference to our Form 8-K filed on March 2, 2007)
Unit Purchase Agreement by and among Telkonet, Inc., EthoStream, LLC and the members of EthoStream, LLC dated as of
March 15, 2007 (incorporated by reference to our Form 8-K filed on March 16, 2007)
Asset Purchase Agreement by and between Telkonet Inc. and Dynamic Ratings, Inc. dated as of March 4, 2011(incorporated by
reference to our Form 8-K filed on March 9, 2011)
Articles of Incorporation of the Company (incorporated by reference to our Form 8-K (No. 000-27305), filed on August 30,
2000 and our Form S-8 (No. 333-47986), filed on October 16, 2000)
Bylaws of the Company (incorporated by reference to our Registration Statement on Form S-1 (No. 333-108307), filed on
August 28, 2003
Amendment to Articles of Incorporation (incorporated by reference to our Form 8-K (No. 001-31972), filed November 18,
2009)
Amendment to the Articles of Incorporation (incorporated by reference to our Form 8-K filed on August 9, 2010)
Amendment to the Articles of Incorporation, (incorporated by reference to our Form 8-K filed on April 13, 2011)
Bylaws of the Registrant (incorporated by reference to our Registration Statement on Form S-1 (No. 333-108307), filed on
August 28, 2003)
Amendment to the Articles of Incorporation filed with the Secretary of State of Utah (incorporated by reference to our Form 8-
K filed on April 8, 2011)
Senior Convertible Note by Telkonet, Inc. in favor of Portside Growth & Opportunity Fund (incorporated by reference to our
Form 8-K (No. 001-31972), filed on October 31, 2005)
Warrant to Purchase Common Stock by Telkonet, Inc. in favor of Kings Road Investments Ltd. (incorporated by reference to
our Form 8-K (No. 001-31972), filed on October 31, 2005)
Form of Warrant to Purchase Common Stock (incorporated by reference to our Current Report on Form 8-K (No. 001-31972),
filed on September 6, 2006)
Form of Accelerated Payment Option Warrant to Purchase Common Stock (incorporated by reference to our Registration
Statement on Form S-3 (No. 333-137703), filed on September 29, 2006)
Form of Warrant to Purchase Common Stock (incorporated by reference to our Form 8-K (No. 001-31972) filed on May 12,
2008)
Promissory Note, dated September 11, 2009, by and between Telkonet Inc. and the Wisconsin Department of Commerce
(incorporated by reference to our Form 8-K (No. 001-31972) filed on September 17, 2009)
Form of Warrant to Purchase Common Stock (incorporated by reference to our Form 8-K filed on November 18, 2009)
Form of Warrant to Purchase Common Stock (incorporated by reference to our Form 8-K filed on August 9, 2009)
Promissory Note, dated March 4, 2011, issued by Telkonet Inc. to Dynamic Ratings, Inc (incorporated by reference to our Form
8-K filed on March 9, 2011)
Form of Warrant to Purchase Common Stock (incorporated by reference to our Form 8-K filed on April 8, 2011)
Amended and Restated Stock Option Plan (incorporated by reference to our Registration Statement on Form S-8 (No. 333-
161909), filed on September 14, 2009)
Loan Agreement, dated September 11, 2009, by and between Telkonet, Inc. and the Wisconsin Department of Commerce
(incorporated by reference to our Form 8-K (No. 001-31972) filed on September 17, 2009)
General Business Security Agreement, dated September 11, 2009, by and between Telkonet, Inc. and the Wisconsin Department
of Commerce (incorporated by reference to our Form 8-K (No. 001-31972) filed on September 17, 2009)
Series A Convertible Redeemable Preferred Stock Securities Purchase Agreement, dated November 16, 2009 (incorporated by
reference to our Form 8-K filed on November 18, 2009)
Series A Convertible Redeemable Preferred Stock Registration Rights Agreement, dated November 16, 2009 (incorporated by
reference to our Form 8-K filed on November 18, 2009)
Form of Executive Officer Reimbursement Agreement (incorporated by reference to our Form 8-K filed on November 18,
2009)
10.7
Form of Director and Officer Indemnification Agreement (incorporated by reference to our Form 10-K filed on March 31,
2010)
10.8
Series B Convertible Redeemable Preferred Stock Securities Purchase Agreement, dated August 4, 2010 (incorporated by
reference to our Form 8-K filed on August 9, 2010)
33
10.9
Series B Convertible Redeemable Preferred Stock Registration Rights Agreement, dated August 4, 2010 (incorporated by
reference to our Form 8-K filed on August 9, 2010)
10.10
10.11
10.12
Form of Executive Officer Reimbursement Agreement (incorporated by reference to our Form 8-K filed on August 9, 2010)
Form of Transition Agreement and Release (incorporated by reference to our Form 8-K filed on August 9, 2010)
2010 Stock Option and Incentive Plan (incorporated by reference to our Definitive Proxy Statement filed on September 29,
2010)
10.13
Distribution Agreement by and between, Telkonet Inc. and Dynamic Ratings, Inc., dated as of March 4, 2011(incorporated by
reference to our Form 8-K filed on March 9, 2011)
10.14
Consulting Agreement by and between Telkonet Inc. and Dynamic Ratings, Inc, dated as of March 4, 2011 (incorporated by
reference to our Form 8-K filed on March 9, 2011)
10.15
Securities Purchase Agreement, dated April 8, 2011, by and among Telkonet, Inc. and the parties listed therein, (incorporated by
reference to our Form 8-K filed on April 8, 2011)
10.16
Registration Rights Agreement, dated April 8, 2011, by and among Telkonet, Inc. and the parties listed therein, (incorporated by
reference to our Form 8-K filed on April 8, 2011)
*10.17
Employment Agreement by and between Telkonet, Inc. and Jason L. Tienor, dated as of May 1, 2013 (incorporated by reference
to our Form 8-K filed May 14, 2013)
*10.18
Employment Agreement by and between Telkonet, Inc. and Jeffrey J. Sobieski, dated as of May 1, 2013 (incorporated by
reference to our Form 8-K filed May 14, 2013)
*10.19
Employment Agreement by and between Telkonet, Inc. and Richard E. Mushrush, dated as of May 1, 2013 (incorporated by
reference to our Form 8-K filed May 14, 2013)
*10.20
Employment Agreement by and between Telkonet, Inc. and Matthew P. Koch, dated as of May 1, 2013 (incorporated by
reference to our Form 8-K filed May 14, 2013)
*10.21
Employment Agreement by and between Telkonet, Inc. and Gerrit J. Reinders, dated as of May 1, 2013 (incorporated by
reference to our Form 8-K filed May 14, 2013)
10.22
Amendment to Consulting Agreement, dated April 30, 2013, by and between Telkonet, Inc. and Dynamic Ratings, Inc.
(incorporated by reference to our Form 8-K filed June 6, 2013)
10.23
Business Financing Agreement, dated May 31, 2013, by and between Telkonet, Inc. and Bridge Bank N.A.(incorporated by
14
21
23.1
23.2
31.1
31.2
32.1
32.2
reference to our Form 8-K filed June 6, 2013)
Code of Ethics (incorporated by reference to our Form 10-KSB (No. 001-31972), filed on March 30, 2004)
Telkonet, Inc. Subsidiaries (incorporated by reference to our Form 10-K (No. 001-31972) filed March 16, 2007)
Consent of BDO USA, LLP, Independent Registered Public Accounting Firm
Consent of Baker Tilly Virchow Krause LLP, Independent Registered Public Accounting Firm
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Jason L. Tienor
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Richard E. Mushrush
Certification of Jason L. Tienor pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Certification of Richard E. Mushrush pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
101.INS
XBRL Instance Document
101.SCH XBRL Schema Document
101.CAL XBRL Calculation Linkbase Document
101.DEF XBRL Definition Linkbase Document
101.LAB XBRL Label Linkbase Document
101.PRE XBRL Presentation Linkbase Document
* Indicates management contract or compensatory plan or arrangement.
34
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
SIGNATURES
Dated: March 31, 2014
TELKONET, INC.
/s/ Jason L. Tienor
Jason L. Tienor
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf
of the registrant and in the capacities and on the dates indicated.
Name
Position
/s/ Jason L. Tienor
Jason Tienor
Chief Executive Officer and Director
(principal executive officer)
/s/ Richard E. Mushrush
Richard E. Mushrush
Controller & Acting Chief Financial Officer
(principal financial officer) (principal accounting officer)
Date
March 31, 2014
March 31, 2014
/s/ / William H. Davis
William H. Davis
/s/ Glenn A. Garland
Glenn A. Garland
/s/ Tim S. Ledwick
Tim S. Ledwick
Chairman of the Board
March 31, 2014
Director
Director
35
March 31, 2014
March 31, 2014
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
FORMING A PART OF ANNUAL REPORT
PURSUANT TO THE SECURITIES EXCHANGE ACT OF 1934
TELKONET, INC.
F-1
TELKONET, INC.
Index to Financial Statements
Report of Independent Registered Public Accounting Firm-BDO USA, LLP
Report of Independent Registered Public Accounting Firm-Baker Tilly Virchow Krause, LLP
Consolidated Balance Sheets at December 31, 2013 and 2012
Consolidated Statements of Operations for the Years ended December 31, 2013 and 2012
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2013 and 2012
Consolidated Statements of Cash Flows for the Years ended December 31, 2013 and 2012
Notes to Consolidated Financial Statements
F-3
F-4
F-5
F-6
F-7-F-8
F-9-F-10
F-11
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Telkonet, Inc.
Waukesha, Wisconsin
We have audited the accompanying consolidated balance sheet of Telkonet, Inc. (the “Company”) as of December 31, 2013 and the related
consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial
reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
Telkonet, Inc. as of December 31, 2013, and the results of its operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As
discussed in Note A to the consolidated financial statements, the Company has a history of losses from operations, a working capital
deficiency, and an accumulated deficit of $121,948,847 that raise substantial doubt about its ability to continue as a going concern.
Management’s plans in regard to these matters are also described in Note A. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ BDO USA, LLP
Milwaukee, Wisconsin
March 31, 2014
F-3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders, Audit Committee and Board of Directors
Telkonet, Inc.
Milwaukee, Wisconsin
We have audited the accompanying consolidated balance sheets of Telkonet, Inc. (the "Company") as of December 31, 2012 and the
related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are
free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of its internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
Telkonet, Inc. as of December 31, 2012 and the results of their operations and cash flows for the years then ended, in conformity with U.S.
generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As
discussed in Note A to the consolidated financial statements, the Company has a history of operating losses and negative cash flows from
operations, and an accumulated deficit of $117,954,116 that raise substantial doubt about the Company's ability to continue as a going
concern as of December 31, 2012. In order to sustain continued operations and meet its obligations, the Company is dependent on the
availability of future funding and maintaining profitability. Management's plans in regard to these matters are also described in Note A. The
consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Baker Tilly Virchow Krause, LLP
Milwaukee, Wisconsin
April 1, 2013
F-4
TELKONET, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2013 AND 2012
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash on deposit
Accounts receivable, net
Inventories
Prepaid expenses
Total current assets
Property and equipment, net
Other assets:
Goodwill
Intangible assets, net
Deposits
Total other assets
Total Assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Notes payable – current
Accrued liabilities and expenses
Deferred revenues
Customer deposits
Total current liabilities
Long-term liabilities:
Deferred lease liability
Notes payable – long term
Deferred income taxes
Total long-term liabilities
December 31,
2013
December 31,
2012
$
572,672 $
382,000
1,659,756
939,382
171,216
3,725,026
1,163,758
–
3,026,107
654,912
189,879
5,034,656
44,638
35,898
5,796,430
1,258,617
34,238
7,089,285
8,570,446
1,500,297
34,238
10,104,981
$
10,858,949 $
15,175,535
$
1,843,589 $
265,985
1,997,157
111,291
77,405
4,295,427
130,920
394,502
335,275
860,697
1,967,030
74,611
2,342,047
117,556
118,763
4,620,007
133,609
813,928
–
947,537
Redeemable preferred stock:
15,000,000 shares authorized, par value $.001 per share
Series A; 215 shares issued, 185 shares outstanding at December 31, 2013 and 2012,
respectively, preference in liquidation of $1,229,832 and $1,176,076 as of December 31,
2013 and 2012, respectively
Series B; 538 shares issued, 493 shares outstanding at December 31, 2012, preference in
liquidation of $2,884,833 as of December 31, 2012
Total redeemable preferred stock
Commitments and contingencies
Stockholders’ Equity
Series B preferred stock; 538 shares issued, 55 shares outstanding at December 31, 2013,
preference in liquidation of $350,005 as of December 31, 2013
Common stock, par value $.001 per share; 190,000,000 shares authorized; 125,035,612 and
108,103,001 shares issued and outstanding at December 31, 2013 and December 31, 2012,
respectively
Additional paid-in-capital
Accumulated deficit
Total stockholders’ equity
1,165,625
1,041,837
–
1,165,625
2,223,752
3,265,589
324,063
–
125,035
126,036,949
(121,948,847)
4,537,200
108,103
124,188,415
(117,954,116)
6,342,402
Total Liabilities and Stockholders’ Equity
$
10,858,949 $
15,175,535
See accompanying notes to consolidated financial statements.
F-5
TELKONET, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012
Revenues, net:
Product
Recurring
Total Net Revenues
Cost of Sales:
Product
Recurring
Total Cost of Sales
Gross Profit
Operating Expenses:
Research and development
Selling, general and administrative
Impairment of goodwill
Depreciation and amortization
Total Operating Expenses
(Loss) Income from Operations
Other (Expenses) Income:
Interest income (expense), net
Gain on sale of product line
Total Other Income (Expense)
(Loss) Income Before Provision for Income Taxes
Provision (Benefit) for Income Taxes
Net (Loss) Income
Accretion of preferred dividends and discount
Net loss attributable to common stockholders
Net loss per common share:
Net loss attributable to common stockholders per common share – basic
Net loss attributable to common stockholders per common share – diluted
Weighted Average Common Shares Outstanding – basic
Weighted Average Common Shares Outstanding – diluted
2013
2012
$
10,123,407 $
3,766,439
13,889,846
8,537,170
4,221,206
12,758,376
6,034,294
1,069,558
7,103,852
4,726,241
1,178,077
5,904,318
6,785,994
6,854,058
1,174,048
6,248,082
2,774,016
258,517
10,454,663
984,853
5,238,700
–
260,830
6,484,383
(3,668,669)
369,675
(18,141)
41,902
23,761
(3,644,908)
349,823
(26,274)
15,408
(10,866)
358,809
(31,271)
(3,994,731)
390,080
(905,977)
(897,638)
$
(4,900,708) $
(507,558)
$
$
(0.04) $
(0.04) $
114,670,433
114,670,433
0.00
0.00
105,788,739
107,387,408
See accompanying notes to consolidated financial statements.
F-6
TELKONET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012
Common
Shares
Common
Stock
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Balance at January 1, 2012
104,349,507 $
104,350 $ 124,483,163 $ (118,344,196) $
Shares issued to directors and
management at approximately $0.16 per
share
Stock-based compensation expense
related to employee stock options
Shares issued to preferred stockholders
638,104
637
101,363
–
–
99,643
for warrants exercised at $0.13 per share
3,115,390
3,116
401,884
Accretion of redeemable preferred stock
discount
Accretion of redeemable preferred stock
dividends
Net income
–
–
–
–
–
–
(625,574)
(272,064)
Balance at December 31, 2012
108,103,001 $
108,103 $ 124,188,415 $ (117,954,116) $
6,342,402
See accompanying notes to the consolidated financial statements.
F-7
–
390,080
390,080
Total
Stockholders’
Equity
6,243,317
–
–
–
–
–
102,000
99,643
405,000
(625,574)
(272,064)
TELKONET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012
Series B
Preferred
Stock
Shares
Series B
Preferred
Stock
Amount
Common
Shares
Common
Stock
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Total
Stockholders’
Equity
6,342,402
Balance at January 1, 2013
– $
– 108,103,001 $ 108,103 $124,188,415 $(117,954,116) $
Stock-based compensation expense related to
employee stock options
Shares issued on conversion of preferred stock
–
–
–
–
89,565
–
89,565
at approximately $0.13 per share
–
–
16,846,139
16,846
2,665,032
–
2,681,878
Shares issued for cashless Series B warrants
exercised
Accretion of redeemable preferred stock
discount
Accretion of redeemable preferred stock
dividends
Reclassification from temporary equity to
permanent equity
Net loss
–
–
86,472
86
(86)
–
–
–
–
–
–
(705,170)
–
(705,170)
–
–
–
–
(200,807)
–
(200,807)
55
324,063
–
–
–
–
–
–
–
–
324,063
–
(3,994,731)
(3,994,731)
Balance at December 31, 2013
55 $ 324,063 125,035,612 $ 125,035 $126,036,949 $(121,948,847) $
4,537,200
See accompanying notes to the consolidated financial statements.
F-8
TELKONET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012
Cash Flows from Operating Activities:
Net (loss) income
Adjustments to reconcile net (loss) income from operations to cash provided by (used
2013
2012
$
(3,994,731) $
390,080
in) operating activities:
Gain on sale of product line
Provision for lease loss
Stock-based compensation expense
Depreciation
Amortization
Provision for doubtful accounts
Deferred income taxes
Goodwill impairment
Changes in assets and liabilities:
Accounts receivable
Inventories
Prepaid expenses
Accounts payable
Accrued liabilities and expenses
Deferred revenue
Customer deposits
Deferred lease liability
Net Cash Provided By (Used In) Operating Activities
Cash Flows From Investing Activities:
Purchase of property and equipment
Deposits of restricted cash
Net Cash (Used In) Provided By Investing Activities
Cash Flows From Financing Activities:
Payments on notes payable
Proceeds from exercise of warrants
Net Cash (Used In) Provided By Financing Activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at the beginning of the year
Cash and cash equivalents at the end of the year
(41,902)
–
89,565
16,837
241,680
197,151
335,275
2,774,016
1,169,200
(284,470)
18,663
(123,441)
(344,890)
(6,265)
(41,358)
(2,689)
2,641
(25,577)
(382,000)
(407,577)
(186,150)
–
(186,150)
(591,086)
1,163,758
$
572,672 $
(15,408)
132,174
201,643
19,150
241,680
7,637
–
–
(1,727,733)
(332,702)
(32,214)
718,644
33,665
62,027
97,399
14,973
(188,985)
(43,095)
91,000
47,905
(61,253)
405,000
343,747
202,667
961,091
1,163,758
See accompanying notes to consolidated financial statements.
F-9
TELKONET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012
Supplemental Disclosures of Cash Flow Information:
Cash transactions:
Cash paid during the year for interest
Cash paid during the year for income taxes
Non-cash transactions:
Accretion of discount on redeemable preferred stock
Accretion of dividends on redeemable preferred stock
Conversion of preferred stock to common stock
2013
2012
$
29,064 $
9,967
705,170
200,807
2,681,878
18,320
28,729
625,574
272,064
–
See accompanying notes to consolidated financial statements.
F-10
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
NOTE A – SUMMARY OF ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements
follows.
Business and Basis of Presentation
Telkonet, Inc. (the “Company”), formed in 1999 and incorporated under the laws of the state of Utah, is made up of two synergistic
business divisions, EcoSmart Energy Management Technology and EthoStream High Speed Internet Access (HSIA) Network. Prior to
January 1, 2007, the Company was primarily engaged in the business of developing, producing and marketing proprietary equipment
enabling the transmission of voice and data communications over a building’s internal electrical wiring.
In March 2007, the Company acquired substantially all of the assets of Smart Systems International (“SSI”), a provider of energy
management products and solutions to customers in the United States and Canada.
In March 2007, the Company acquired 100% of the outstanding membership units of EthoStream, LLC, a network solutions integration
company that offers installation, sales and service to the hospitality industry. The EthoStream acquisition enabled Telkonet to provide
installation and support for power line communications or PLC, products and third party applications to customers across North America.
In March 2011, the Company sold all its Series 5 PLC power line carrier product line and related assets to Wisconsin-based Dynamic
Ratings, Inc. under an Asset Purchase Agreement.
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Telkonet Communications,
Inc., and EthoStream, LLC. All significant intercompany balances and transactions have been eliminated in consolidation.
Going Concern
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in
the United States of America, which contemplate continuation of the Company as a going concern. The Company reported a net loss of
$3,994,731 for the year ended December 31, 2013, and has an accumulated deficit of $121,948,847 and total current liabilities in excess of
current assets of $570,401 as of December 31, 2013.
Our ability to continue as a going concern is subject to our ability to consistently generate a profit and positive operating cash flows and/or
obtain necessary funding from outside sources, including by the sale of our securities or assets, or obtaining loans from financial
institutions, where possible. We may also experience net operating losses in the future and the uncertainty regarding contingent liabilities
cast doubt on our ability to satisfy such liabilities and the Company cannot make any representations for fiscal 2014 and beyond. The
accompanying consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
Anticipated cash flows from operations may be insufficient to satisfy the Company’s ongoing capital requirements for at least the next 12
months. In May 2013, the Company entered into a Revolving Credit Facility, the principal not to exceed $2,000,000. This credit facility is
available for working capital and other lawful business purposes. The Company’s borrowing base at December 31, 2013 was
approximately $791,000 and the outstanding balance was zero. As of September 30 and December 31, 2013, the Company was in violation
of a financial performance covenant. The outstanding balance at March 31, 2014 is $200,000. The Company is currently in negotiations
with the Bank to modify the existing Agreement.
Management intends to review the options for raising capital including, but not limited to, through asset-based financing, private
placements, and/or disposition of assets. Management believes that with this financing, the Company will be able to generate additional
revenues that will allow the Company to continue as a going concern. There can be no assurance that the Company will be successful in
obtaining additional funding.
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 and trade receivables. 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.
F-11
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an original maturity date of three months or less to be cash
equivalents.
Restricted Cash on Deposit
During 2012, the Company was awarded a contract with a bonding requirement. The Company satisfied this requirement during the year
ended December 31, 2013, with cash collateral supported by an irrevocable standby letter of credit in the amount of $382,000 which expires
September 30, 2014, however, the Company can be released prior to expiration if the Company has satisfied all obligations. The amount is
presented as restricted cash on deposit on the consolidated balance sheets. During March 2014, the Company satisfied all obligations
related to the bonding requirement and the cash was released.
Accounts Receivable
The Company records allowances for doubtful accounts based on customer-specific analysis and general matters such as current assessment
of past due balances and economic conditions. The Company writes off accounts receivable when they become uncollectible. The
allowance for doubtful accounts was $156,966 and $70,807 at December 31, 2013 and 2012. Management identifies a delinquent customer
based upon the delinquent payment status of an outstanding invoice, generally greater than 30 days past due date. The delinquent account
designation does not trigger an accounting transaction until such time the account is deemed uncollectible. The allowance for doubtful
accounts is determined by examining the reserve history and any outstanding invoices that are over 30 days past due as of the end of the
reporting period. Accounts are deemed uncollectible on a case-by-case basis, at management’s discretion based upon an examination of the
communication with the delinquent customer and payment history. Typically, accounts are only escalated to “uncollectible” status after
multiple attempts at collection have proven unsuccessful.
Property and Equipment
In accordance with ASC 360 “Property Plant and Equipment”, property and equipment is stated at cost and is depreciated using the
straight-line method over the estimated useful lives of the assets. The estimated useful lives range from 2 to 10 years.
Fair Value of Financial Instruments
Our financial instruments include cash and cash equivalents, restricted cash on deposit, accounts receivable, accounts payable, notes
payable, and certain accrued liabilities. The carrying amounts of these assets and liabilities approximate fair value due to the short maturity
of these instruments, except for the notes payable. The carrying amount of the notes payable approximates fair value due to the interest rate
and terms approximating those available to us for similar obligations.
The Company accounts for the fair value of financial instruments in accordance with Accounting Standards Codification (ASC) 820, which
defines fair value for accounting purposes, established a framework for measuring fair value and expanded disclosure requirements
regarding fair value measurements. Fair value is defined as an exit price, which is the price that would be received upon sale of an asset or
paid upon transfer of a liability in an orderly transaction between market participants at the measurement date. The degree of judgment
utilized in measuring the fair value of assets and liabilities generally correlates to the level of pricing observability. Financial assets and
liabilities with readily available, actively quoted prices or for which fair value can be measured from actively quoted prices in active
markets generally have more pricing observability and require less judgment in measuring fair value. Conversely, financial assets and
liabilities that are rarely traded or not quoted have less price observability and are generally measured at fair value using valuation models
that require more judgment. These valuation techniques involve some level of management estimation and judgment, the degree of which
is dependent on the price transparency of the asset, liability or market and the nature of the asset or liability. We have categorized our
financial assets and liabilities that are recurring, at fair value into a three-level hierarchy in accordance with these provisions.
·
·
·
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted
assets or liabilities;
Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for
substantially the full term of the asset or liability; or
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and are
unobservable.
F-12
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
Goodwill and Other Intangibles
In accordance with the accounting guidance on goodwill and other intangible assets, we perform an annual impairment test of goodwill and
other intangible assets at our reporting unit level, or more frequently if events or circumstances change that would more likely than not
reduce the fair value of our reporting units below their carrying value. Amortization is recorded for other intangible assets with
determinable lives using the straight line method over the 12 year estimated useful life. Goodwill is subject to a periodic impairment
assessment by applying a fair value test based upon a two-step method. The first step of the process compares the fair value of the
reporting unit with the carrying value of the reporting unit, including any goodwill. We utilize a discounted cash flow valuation
methodology to determine the fair value of the reporting unit. This approach is developed from management’s forecasted cash flow
data. If the fair value of the reporting unit exceeds the carrying amount of the reporting unit, goodwill is deemed not to be impaired. If the
carrying amount exceeds fair value, we calculate an impairment loss. Any impairment loss is measured by comparing the implied fair
value of goodwill to the carrying amount of goodwill at the reporting unit, with the excess of the carrying amount over the fair value
recognized as an impairment loss.
Long-Lived Assets
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable in accordance with ASC 360-10. Recoverability is measured by comparison of the carrying amount to the future net cash
flows which the assets are expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured
by the amount by which the carrying amount of the assets exceeds their fair value.
Inventories
Inventories consist of routers, switches and access points for Ethostream’s internet access solution and thermostats, sensors and controllers
for Telkonet’s EcoSmart product suite. These inventories are purchased for resale and do not include manufacturing labor and
overhead. Inventories are stated at the lower of cost or market determined by the first in, first out (FIFO) method. The Company’s
inventories are subject to technological obsolescence. Management evaluates the net realizable value of its inventories on a quarterly basis
and records a provision for estimated losses based upon changes in demand and new product introductions.
Income (Loss) per Common Share
The Company computes earnings per share under ASC 260-10, “Earnings Per Share”. Basic net income (loss) per common share is
computed by dividing net loss by the weighted average number of shares outstanding of common stock. Diluted income (loss) per share is
computed using the weighted average number of common and common stock equivalent shares outstanding during the year. Dilutive
common stock equivalents consist of shares issuable upon the exercise of the Company's outstanding stock options and warrants. For the
years ended December 31, 2013 and 2012, there were 11,095,139 and 10,512,394 shares of common stock underlying options and warrants
excluded due to these instruments being anti-dilutive, respectively.
Use of Estimates
The preparation of financial statements in conformity with United States of America (U.S.) generally accepted accounting principles
(GAAP) require management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. Estimates are used when accounting for items and matters such as revenue recognition and
allowances for uncollectible accounts receivable, inventory obsolescence, depreciation and amortization, long-lived and intangible asset
valuations, impairment assessments, taxes and related valuation allowance, income tax provisions, stock-based compensation, and
contingencies. We believe that the estimates, judgments and assumptions are reasonable, based on information available at the time they
are made. Actual results may differ from those estimates.
Income Taxes
The Company accounts for income taxes in accordance with ASC 740-10 “Income Taxes.” Under this method, deferred income taxes
(when required) are provided based on the difference between the financial reporting and income tax bases of assets and liabilities and net
operating losses at the statutory rates enacted for future periods. The Company has a policy of establishing a valuation allowance when it is
more likely than not that the Company will not realize the benefits of its deferred income tax assets in the future.
F-13
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
The Company adopted ASC 740-10-25, which prescribes a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740-10-25 also provides guidance on
derecognition, classification, treatment of interest and penalties, and disclosure of such positions.
Revenue Recognition
For revenue from product sales, we recognize revenue in accordance with ASC 605-10, “Revenue Recognition” and ASC 605-10-S99
guidelines that require that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination
of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the selling prices of the products delivered and
the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other
adjustments are provided for in the same period the related sales are recorded. The guidelines also address the accounting for
arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets.
Multiple-Element Arrangements (“MEAs”): The Company accounts for contracts that have both product and installation under the MEAs
guidance in ASC 605. The Company believes the volume of these contracts will continue to increase. Arrangements under such contracts
include multiple deliverables, a combination of equipment and services. The deliverables included in the MEAs are separated into more
than one unit of accounting when (i) the delivered element has value to the customer on a stand-alone basis, and (ii) delivery of the
undelivered element(s) is probable and substantially in our control. Arrangement consideration is then allocated to each unit, delivered or
undelivered, based on the relative selling price of each unit of accounting based first on vendor-specific objective evidence (“VSOE”) if it
exists, second on third-party evidence (“TPE”) if it exists and on estimated selling price (“ESP”) if neither VSOE or TPE exist.
· VSOE – Based on its pricing and discounting practices for the specific product or service when sold separately, considering
geographical, customer, and other economic or marketing variables, as well as renewal rates or stand-alone prices for the
service element(s).
·
·
TPE – If we cannot establish VSOE of selling price for a specific product or service included in a multiple-element
arrangement, we use third-party evidence of selling price. We determine TPE based on sales of comparable amount of similar
product or service offered by multiple third parties considering the degree of customization and similarity of product or service
sold.
ESP – The estimated selling price represents the price at which we would sell a product or service if it were sold on a stand-
alone basis. When neither VSOE nor TPE exists for all elements, we determine ESP for the arrangement element based on
sales, cost and margin analysis, as well as other inputs based on our pricing practices. Adjustments for other market and
Company-specific factors are made as deemed necessary in determining ESP.
When MEAs include an element of customer training, it is not essential to the functionality, efficiency or effectiveness of the MEA.
Therefore the Company has concluded that this obligation is inconsequential and perfunctory. As such, for MEAs that include training,
customer acceptance of said training is not deemed necessary in order to record the related revenue, but is recorded when the installation
deliverable is fulfilled. Historically, training revenues have not been significant.
We provide call center support services to properties installed by us and also to properties installed by other providers. In addition, we
provide the property with the portal to access the Internet. We receive monthly service fees from such properties for our services and
Internet access. We recognize the service fee ratably over the term of the contract. The prices for these services are fixed and determinable
prior to delivery of the service. The fair value of these services is known due to objective and reliable evidence from standalone executed
contracts. We report such revenues as recurring revenues.
Sales Taxes
Unless provided with a resale or tax exemption certificate, the Company assesses and collects sales tax on sales transactions and records the
amount as a liability. It is recognized as a liability until remitted to the applicable state. Total revenues do not include sales tax as we
consider ourselves a pass through conduit for collecting and remitting sales taxes.
Guarantees and Product Warranties
The Company records a liability for potential warranty claims in cost of sales at the time of sale. The amount of the liability is based on the
trend in the historical ratio of claims to sales, the historical length of time between the sale and resulting warranty claim, new product
introductions and other factors. The products sold are generally covered by a warranty for a period of one year. In the event the Company
determines that its current or future product repair and replacement costs exceed its estimates, an adjustment to these reserves would be
charged to earnings in the period such determination is made. For the years ended December 31, 2013 and 2012, the Company experienced
returns of approximately 1% to 4% of material’s included in the cost of sales. As of December 31, 2013 and 2012, the Company recorded
warranty liabilities in the amount of $77,943 and $69,743, respectively, using this experience factor range.
F-14
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
Product warranties for the years ended December 31 is as follows:
Beginning balance
Warranty claims incurred
Provision charged to expense
Ending balance
Advertising
$
$
2013
2012
69,743 $
(9,106)
17,306
77,943 $
104,423
(66,278)
31,598
69,743
The Company follows the policy of charging the costs of advertising to expenses as incurred. The Company incurred $21,499 and $6,778
in advertising costs during the years ended December 31, 2013 and 2012, respectively.
Research and Development
The Company accounts for research and development costs in accordance with the ASC 730-10, “Research and Development”. Under ASC
730-10, all research and development costs must be charged to expense as incurred. Accordingly, internal research and development costs
are expensed as incurred. Third-party research and development costs are expensed when the contracted work has been performed or as
milestone results have been achieved. Company-sponsored research and development costs related to both present and future products are
expensed in the period incurred. Total expenditures on research and product development for 2013 and 2012 were $1,174,048 and
$984,853, respectively.
Stock-Based Compensation
We account for our stock-based awards in accordance with ASC 718-10,”Share-Based Compensation”, which requires a fair value
measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including
employee stock options and restricted stock awards. We estimate the fair value of stock options granted using the Black-Scholes valuation
model. This model requires us to make estimates and assumptions including, among other things, estimates regarding the length of time an
employee will hold vested stock options before exercising them, the estimated volatility of our common stock price and the number of
options that will be forfeited prior to vesting. The fair value is then amortized on a straight-line basis over the requisite service periods of
the awards, which is generally the vesting period. Changes in these estimates and assumptions can materially affect the determination of
the fair value of stock-based compensation and consequently, the related amount recognized in our consolidated statements of operations.
The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar
awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. For 2013 and prior
years, expected stock price volatility is based on the historical volatility of the Company’s stock for the related vesting periods.
Stock-based compensation expense in connection with options granted to employees for the year ended December 31, 2013 and 2012 was
$89,565 and $99,643, respectively.
Deferred Lease Liability
Rent expense is recorded on a straight-line basis over the term of the lease. Rent escalations and rent abatement periods during the term of
the lease create a deferred lease liability which represents the excess of cumulative rent expense recorded to date over the actual rent paid
to date.
Lease Abandonment
On July 15, 2011, the Company executed a sublease agreement for approximately 12,000 square feet of commercial office space in
Germantown, Maryland and ceased utilizing this space for the Company’s benefit. Because we no longer have access to this subleased
space, we have recorded a charge of $59,937 in accrued liabilities and expenses related to this abandonment during 2011. On June 27,
2012, the subtenant exercised the option to extend the expiration term of the sublease from January 31, 2013 to December 31, 2015 and we
recorded an additional charge of $132,174. The remaining liability at December 31, 2013 and 2012 was $91,981 and $135,975,
respectively.
F-15
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
Reclassifications
Certain amounts previously reported have been reclassified to conform to the current presentation.
NOTE B – NEW ACCOUNTING PRONOUNCEMENT
In July 2013, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an
Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus
of the FASB Emerging Issues Task Force), which applies to the presentation of unrecognized tax benefits as a liability on the balance sheet
when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax
law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax
law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such
purpose. This ASU is effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December
15, 2013. The Company is currently reviewing the provisions of this ASU but does not expect it to have a material effect on the Company's
financial condition, results of operations, and cash flows.
NOTE C – INTANGIBLE ASSETS AND GOODWILL
Total identifiable intangible assets acquired and their carrying values at December 31, 2013 are:
Cost
Accumulated
Amortization
Accumulated
Impairment
Carrying
Value
Weighted
Average
Amortization
Period
(Years)
Amortized Identifiable Intangible Assets:
Subscriber lists – EthoStream
Total Amortized Identifiable Intangible Assets
Goodwill – EthoStream
Goodwill – SSI
Total Goodwill
Total
$
$
2,900,000 $
2,900,000
8,796,430
5,874,016
14,670,446
17,570,446 $
(1,641,383) $
(1,641,383)
–
–
–
(1,641,383) $
– $
–
(3,000,000)
(5,874,016)
(8,874,016)
(8,874,016) $
1,258,617
1,258,617
5,796,430
-
5,796,430
7,055,047
12.0
Total identifiable intangible assets acquired and their carrying values at December 31, 2012 are:
Cost
Accumulated
Amortization
Accumulated
Impairment
Carrying
Value
Weighted
Average
Amortization
Period
(Years)
Amortized Identifiable Intangible Assets:
Subscriber lists – EthoStream
Total Amortized Identifiable Intangible Assets
Goodwill – EthoStream
Goodwill – SSI
Total Goodwill
Total
$
$
2,900,000 $
2,900,000
8,796,430
5,874,016
14,670,446
17,570,446 $
(1,399,703) $
(1,399,703)
–
–
–
(1,399,703) $
– $
–
(3,000,000)
(3,100,000)
(6,100,000)
(6,100,000) $
1,500,297
1,500,297
5,796,430
2,774,016
8,570,446
10,070,743
12.0
F-16
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
Total amortization expense charged to operations for the years ended December 31, 2013 and 2012 was $241,680 per year.
Estimated future amortization expense as of December 31, 2013 is as follows:
Years Ended December 31,
2014
2015
2016
2017
2018
2019
Total
$
$
241,680
241,680
241,680
241,680
241,680
50,217
1,258,617
The Company does not amortize goodwill. The Company recorded goodwill in the amount of $14,670,446 as a result of the acquisitions of
EthoStream and SSI during the year ended December 31, 2007. The Company evaluates goodwill for impairment based on the fair value of
the reporting units to which this goodwill relates at least once a year. We utilize a discounted cash flow valuation methodology (income
approach) to determine the fair value of the reporting unit. At December 31, 2011, the Company determined that a portion of the value for
Smart Systems International’s goodwill was impaired based upon management’s assessment of operating results and forecasted discounted
cash flow and wrote off $3,100,000 in connection with the impairment. At December 31, 2013, the Company determined that the remainder
of Smart Systems International’s goodwill was impaired based upon management’s assessment of operating results and forecasted
discounted cash flow and recorded an additional impairment charge of $2,774,016. Since acquisition, the Company has written off
$3,000,000 and $5,874,016 of goodwill for Ethostream and Smart Systems International, respectively.
Significant assumptions used in our goodwill impairment test at December 31, 2013 and 2012 included: expected revenue growth rates,
reporting unit profit margins, working capital levels, discount rates of 12.4% and 12.9% for Ethostream and 21.8% and 17.5% for SSI,
respectively, and a terminal value multiple. The expected future revenue growth rates and the expected reporting unit profit margins were
determined after considering our historical revenue growth rates and operating unit profit margins, our assessment of future market
potential, and our expectations of future business performance.
The carrying value of our goodwill could change if the Company is unable to achieve operating results at the levels that have been
forecasted, or if there is a permanent, negative change in the market demand for the services offered by the Company. These changes could
result in an impairment of the existing goodwill balance that could require an additional material non-cash charge to our results of
operations.
NOTE D – ACCOUNTS RECEIVABLE
Components of accounts receivable as of December 31, 2013 and 2012 are as follows:
Accounts receivable
Allowance for doubtful accounts
Accounts receivable, net
2013
2012
$
$
1,816,722 $
(156,966)
1,659,756 $
3,096,914
(70,807)
3,026,107
F-17
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
NOTE E – INVENTORIES
Components of inventories as of December 31, 2013 and 2012 are as follows:
Product purchased for resale
Reserve for obsolescence
Inventory, net
NOTE F – PROPERTY AND EQUIPMENT
$
$
2013
2012
997,332 $
(57,950)
939,382 $
768,812
(113,900)
654,912
The Company’s property and equipment as of December 31, 2013 and 2012 consists of the following:
Telecommunications and related equipment
Development test equipment
Computer software
Leasehold improvements
Office equipment
Office fixtures and furniture
Total
Accumulated depreciation
Total property and equipment
2013
2012
$
– $
45,752
55,677
2,675
20,706
36,515
161,325
(116,687)
$
44,638 $
117,637
113,787
189,033
2,675
351,302
237,811
1,012,245
(976,347)
35,898
Depreciation expense included as a charge to income was $16,837 and $19,150 for the years ended December 31, 2013 and 2012,
respectively.
NOTE G – ACCRUED LIABILITIES AND EXPENSES
Accrued liabilities and expenses as of December 31, 2013 and 2012 are as follows:
Accrued liabilities and expenses
Accrued payroll and payroll taxes
Accrued sales taxes, penalties, and interest
Accrued interest
Product warranties
Total accrued liabilities and expenses
NOTE H – LONG-TERM DEBT
Business Loan
$
$
2013
2012
405,073 $
430,871
1,080,482
2,788
77,943
1,997,157 $
717,731
345,384
1,188,136
21,053
69,743
2,342,047
On September 11, 2009, the Company entered into a Loan Agreement in the aggregate principal amount of $300,000 with the Wisconsin
Department of Commerce (the “Department”). The outstanding principal balance bears interest at the annual rate of 2%. Payment of
interest and principal is to be made in the following manner: (a) payment of any and all interest that accrues from the date of disbursement
commenced on January 1, 2010 and continued on the first day of each consecutive month thereafter through and including December 31,
2010; (b) commencing on January 1, 2011 and continuing on the first day of each consecutive month thereafter through and including
November 1, 2016, the Company is required to pay equal monthly installments of $4,426; followed by a final installment on December 1,
2016 which shall include all remaining principal, accrued interest and other amounts owed by the Company to the Department under the
Loan Agreement. The Company may prepay amounts outstanding under the credit facility in whole or in part at any time without penalty.
The Loan Agreement is secured by substantially all of the Company’s assets and the proceeds from this loan were used for the working
capital requirements of the Company. The Loan Agreement contains covenants which required, among other things, that the Company
keep and maintain 75 existing full-time positions and create and fill 35 additional full-time positions in Milwaukee, Wisconsin by
December 31, 2012. On June 18, 2012, the Department agreed to permanently waive all penalties associated with the Company’s
noncompliance with this covenant. The outstanding borrowings under the agreement as of December 31, 2013 and 2012 were $154,463 and
$203,947, respectively.
F-18
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
Promissory Note
On March 4, 2011, the Company sold all its Series 5 PLC product line assets to Wisconsin-based Dynamic Ratings, Inc. (“Purchaser”)
under an Asset Purchase Agreement (“APA”). Per the APA, the Company signed an unsecured Promissory Note (the “Note”) due to
Purchaser in the aggregate principal amount of $700,000. The outstanding principal balance bears interest at the annual rate of 6% and was
originally due on March 31, 2014. The Note may be prepaid in whole or in part, without penalty at any time. The Note contains certain
earn-out provisions that encompass both the Company’s and Purchaser’s revenue volumes. Amounts earned under the earn-out provisions
were applied against the Note on June 30, 2012 and June 30, 2013. For the quarters ended June 30, 2013 and June 30, 2012, the non-cash
reduction of principal calculated under these provisions and applied to the Note was $41,902 and $15,408, respectively. Payments not
made when due, by maturity acceleration or otherwise, shall bear interest at the rate of 12% per annum from the date due until fully paid.
Effective April 30, 2013, Purchaser approved an amendment to certain terms of the Note. Telkonet commenced a monthly payment of
principal and interest of $20,000 to be applied against the outstanding balance starting May 1, 2013. The interest rate remains unchanged at
6% and the maturity date was extended to January 1, 2016. The outstanding principal balance of the Note as of December 31, 2013 and
2012 was $506,024 and $684,592, respectively.
Revolving Credit Facility
On May 31, 2013, the Company entered into a Revolving Credit Facility (the “Agreement”) with Bridge Bank, NA, (the “Bank”) in a
principal amount not to exceed $2,000,000. The Agreement is subject to a borrowing base that is equal to the sum of 80% of the Company’s
eligible accounts receivable and 25% of the eligible inventory. On August 1, 2013 the Agreement was modified to include the eligible
receivables and the eligible inventory of Ethostream. The Agreement is available for working capital and other lawful general corporate
purposes. The outstanding principal balance of the facility bears interest at Prime Rate plus 2.75%. The Company’s borrowing base at
December 31, 2013 was approximately $791,000 and the outstanding balance was zero. As of September 30 and December 31, 2013, the
Company was in violation of a financial performance covenant. The outstanding balance at March 31, 2014 is $200,000. The Company is
currently in negotiations with the Bank to modify the existing Agreement.
Aggregate annual future maturities of long-term debt as of December 31, 2013 are as follows:
Years ending December 31,
2014
2015
2016
Less: Current portion
Notes payable long-term
Amount
265,985
280,295
114,207
660,487
(265,985)
394,502
$
$
NOTE I – REDEEMABLE PREFERRED STOCK
Series A
The Company has designated 215 shares of preferred stock as Series A Preferred Stock (“Series A”). Each share of Series A is convertible,
at the option of the holder thereof, at any time, into shares of our Common Stock at an initial conversion price of $0.363 per share. In the
event of a change of control (as defined in the purchase agreement with respect to the Series A), or at the holder’s option, on November 19,
2014 and for a period of 180 days thereafter, provided that at least 50% of the shares of Series A issued on the Series A Original Issue Date
remain outstanding as of November 19, 2014, and the holders of at least a majority of the then outstanding shares of Series A provide
written notice requesting redemption of all shares of Series A, we are required to redeem the Series A for the purchase price of $5,000 per
share, plus any accrued but unpaid dividends. The aggregate redemption price payable to holders of shares of Series A will be payable by
the Company in three equal annual installments. The first of these three installments will be due within 60 days of the requisite holders’
written notice requesting redemption. The Series A accrues dividends at an annual rate of 8% of the original purchase price, payable only
when, as, and if declared by the Board of Directors of Telkonet.
On November 16, 2009, the Company sold 215 shares of Series A with attached warrants to purchase an aggregate of 1,628,800 shares of
the Company’s common stock at $0.33 per share. The Series A shares were sold at a price per share of $5,000 and each Series A share is
convertible into approximately 13,774 shares of common stock at a conversion price of $0.363 per share. The Company received
$1,075,000 from the sale of the Series A shares. Since the Series A may ultimately be redeemable at the option of the holder, the carrying
value of the preferred stock, net of discount and accumulated dividends, has been classified as redeemable preferred stock on the
consolidated balance sheets.
F-19
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
A portion of the proceeds were allocated to the warrants based on their relative fair value, which totaled $287,106 using the Black Scholes
option pricing model. Further, the Company attributed a beneficial conversion feature of $70,922 to the Series A preferred shares based
upon the difference between the effective conversion price of those shares and the closing price of the Company’s common stock on the
date of issuance. The assumptions used in the Black-Scholes model were as follows: (1) dividend yield of 0%; (2) expected volatility
of 123%, (3) weighted average risk-free interest rate of 2.2%, (4) expected life of 5 years, and (5) fair value of Telkonet common stock of
$0.24 per share. The expected term of the warrants represents the estimated period of time until exercise and is based on historical
experience of similar awards and giving consideration to the contractual terms. The amounts attributable to the warrants and beneficial
conversion feature, aggregating $358,028, were recorded as a discount and deducted from the face value of the preferred stock. The
discount is being amortized over the period from issuance to November 19, 2014 (the initial redemption date) as a charge to additional
paid-in capital (since there is a deficit in retained earnings) and an increase to the net loss attributable to common stockholders.
The charge to additional paid in capital for amortization of Series A discount and costs for the years ended December 31, 2013 and 2012
was $70,032 and $74,614, respectively.
For the years ended December 31, 2013 and 2012, we have accrued dividends for Series A in the amount of $74,027 and $74,228,
respectively, and as of December 31, 2013 and 2012 there are cumulative accrued dividends of $304,832 and $251,076, respectively. The
accrued dividends have been charged to additional paid-in capital (since there is a deficit in retained earnings) and an increase to the net
loss attributable to common stockholders and the net unpaid accrued dividends been added to the carrying value of the preferred stock.
Series B
The Company has designated 538 shares of preferred stock as Series B Preferred Stock (“Series B”). Each share of Series B is convertible,
at the option of the holder thereof, at any time, into shares of our Common Stock at an initial conversion price of $0.13 per share. As a
result of the Series B conversions during the year ended December 31, 2013, the outstanding Series B shares will not become redeemable at
the option of the holders. The Series B accrues dividends at an annual rate of 8% of the original purchase price, payable only when, as, and
if declared by our Board of Directors.
On August 4, 2010, the Company sold 267 shares of Series B with attached warrants to purchase an aggregate of 5,134,626 shares of the
Company’s common stock at $0.13 per share. The Series B shares were sold at a price per share of $5,000 and each Series B share is
convertible into approximately 38,461 shares of common stock at a conversion price of $0.13 per share. The Company received $1,335,000
from the sale of the Series B shares. Up and until the quarter ended September 30, 2013, the Series B were redeemable at the option of the
holder, the carrying value of the preferred stock, net of discount and including accumulated dividends, has been classified as redeemable
preferred stock on the consolidated balance sheets. During the year ended December 31, 2013, shareholders converted 167 redeemable
preferred shares issued on August 4, 2010, to, in aggregate, 6,423,072 shares of common stock.
A portion of the proceeds was allocated to the warrants based on their relative fair value, which totaled $394,350 using the Black-Scholes
option pricing model. Further, the Company attributed a beneficial conversion feature of $394,350 to the Series B preferred shares based
upon the difference between the effective conversion price of those shares and the closing price of the Company’s common stock on the
date of issuance. The assumptions used in the Black-Scholes model were as follows: (1) dividend yield of 0%; (2) expected volatility
of 123%, (3) weighted average risk-free interest rate of 1.76%, (4) expected term of approximately 4 years, and (5) estimated fair value of
Telkonet common stock of $0.109 per share. The expected term of the warrants represents the estimated period of time until exercise and is
based on historical experience of similar awards and giving consideration to the contractual terms. The amounts attributable to the warrants
and beneficial conversion feature, aggregating $788,700, were recorded as a discount and deducted from the face value of the preferred
stock. The discount is being amortized over the period from issuance to November 19, 2014 (the initial redemption date) as a charge to
additional paid-in capital (since there is a deficit in retained earnings). During the year ended December 31, 2013, the remaining portion of
the discount of approximately $123,100 was accelerated and recognized immediately as a charge to additional paid-in capital and accretion
of preferred stock discounts and an increase to the net loss attributable to common stockholders for the 167 redeemable preferred shares
converted to common stock.
On April 8, 2011, the Company sold 271 additional shares of Series B with attached warrants to purchase an aggregate of 5,211,542 shares
of the Company’s common stock at $0.13 per share. The Series B shares were sold at a price per share of $5,000 and each Series B share is
convertible into approximately 38,461 shares of common stock at a conversion price of $0.13 per share. The Company received $1,355,000
from the sale of the Series B shares. During the year ended December 31, 2013, all 271 of the redeemable preferred shares issued on April
8, 2011, were converted to, in aggregate, 10,423,067 shares of common stock.
F-20
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
As a result of the Series B conversions during the year ended December 31, 2013, fewer than 50% of the Series B shares issued on the
Series B Original Issuance Date remain outstanding, and the balance of the outstanding Series B shares will not become redeemable at the
option of the holders. The redemption feature at the option of the holders is eliminated, thereby, resulting in the reclassification of
$324,063 from temporary equity, which was classified as “redeemable preferred stock” in the Company’s consolidated balance sheets, to
permanent equity.
A portion of the proceeds were allocated to the warrants based on their relative fair value, which totaled $427,895 using the Black-Scholes
option pricing model. Further, the Company attributed a beneficial conversion feature of $427,895 to the Series B shares based upon the
difference between the effective conversion price of those shares and the closing price of the Company’s common stock on the date of
issuance. The assumptions used in the Black-Scholes model are as follows: (1) dividend yield of 0%; (2) expected volatility of 129%,
(3) weighted average risk-free interest rate of 0.26%, (4) expected life of approximately 3.5 years, and (5) estimated fair value of Telkonet
common stock of $0.12 per share. The expected term of the warrants represents the estimated period of time until exercise and is based on
historical experience of similar awards and giving consideration to the contractual terms. The amounts attributable to the warrants and
beneficial conversion feature, aggregating $855,790, have been recorded as a discount and deducted from the face value of the Series B
shares. The discount is being amortized over the period from issuance to November 19, 2014 (the initial redemption date) as a charge to
additional paid-in capital (since there is a deficit in retained earnings). During the year ended December 31, 2013, the remaining discount
of approximately $261,300 was accelerated and recognized immediately as a charge to additional paid-in capital and accretion of preferred
stock discounts upon the 271 redeemable preferred stock conversions to common stock.
The charge to additional paid in capital for amortization of Series B discount and costs for the years ended December 31, 2013 and 2012
was $635,138 and $550,960, respectively.
For the years ended December 31, 2013 and 2012, we have accrued dividends for Series B in the amount of $126,780 and $197,836,
respectively, and cumulative accrued dividends of $75,005 and $419,833 as of December 31 2013 and 2012, respectively. The accrued
dividends have been charged to additional paid-in capital (since there is a deficit in retained earnings) and the net unpaid accrued dividends
been added to the carrying value of the preferred stock. During the year ended December 31, 2013, accrued dividends in the amount of
$491,878 were written down and credited back to additional paid-in capital upon the redeemable preferred share conversions to common
stock.
Preferred stock carries certain preference rights as detailed in the Company’s Amended Articles of Incorporation related to both the
payment of dividends and as to payments upon liquidation in preference to any other class or series of capital stock of the Company.
Liquidation preference of the preferred stock is based on the following order: first, Series B with a preference value of $350,005 and
second, Series A with a preference value of $1,229,832. Both series of preferred stock are equal in their dividend preference over common
stock.
NOTE J – CAPITAL STOCK
The Company has authorized 15,000,000 shares of preferred stock (designated and undesignated), with a par value of $.001 per share. The
Company has designated 215 shares as Series A preferred stock and 538 shares as Series B preferred stock. At December 31, 2013 and
2012, there were 185 shares of Series A outstanding. At December 31, 2013 and December 31, 2012, there were 55 and 493 shares of Series
B outstanding, respectively.
The Company has authorized 190,000,000 shares of common stock with a par value of $.001 per share. As of December 31, 2013 and 2012
the Company has 125,035,612 and 108,103,001 common shares issued and outstanding, respectively.
During the year ended December 31, 2013, 438 shares of Series B redeemable preferred stock were converted to, in aggregate, 16,846,139
shares of common stock.
During the year ended December 31, 2013, 86,472 warrants were exercised to an equal number of common shares. These warrants were
originally granted to the Company’s placement agent in lieu of cash compensation for services performed or financing expenses in
connection with the placement of the April 2011 Series B convertible preferred stock issuance.
F-21
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
During the year ended December 31, 2012, the Company issued 638,104 shares of common stock to directors and management for services
performed through December 31, 2012. These shares were valued at $102,000, which approximated the fair value of the shares when they
were issued.
During the year ended December 31, 2012, 3,115,390 of Series B preferred stock warrants were exercised to an equal number of common
shares at an exercise price of $0.13 per share. Proceeds received from these exercised warrants were $405,000.
NOTE K – STOCK OPTIONS AND WARRANTS
Employee Stock Options
The Company maintains an equity incentive plan established in 2010 as an incentive plan for officers, employees, non-employee directors,
prospective employees and other key persons. It is anticipated that providing such persons with a direct stake in the Company’s welfare will
assure a better alignment of their interests with those of the Company and its stockholders.
The Company considers employee stock options a component of the compensation package necessary to attract, retain and motivate key
employees. The value of these options is dependent upon an increase in the Company’s stock price relative to the exercise price, which is
determined on the date of grant.
The following table summarizes the changes in options outstanding and the related exercise prices for the stock options issued to employees
of the Company under the Plan.
Options Outstanding
Options Exercisable
Exercise Prices
$
$
$
0.01 - $0.15
0.16 - $0.99
1.00 - $5.99
Number
Outstanding
175,000
1,420,225
140,000
1,735,225
Weighted Average
Remaining
Contractual Life
(Years)
Weighted Average
Exercise Price
Number
Exercisable
Weighted Average
Exercise Price
3.82 $
8.73
2.45
7.73 $
0.14
0.18
3.29
0.43
175,000 $
1,195,225
140,000
1,510,225 $
0.14
0.18
3.29
0.47
Transactions involving stock options issued to employees are summarized as follows:
Outstanding at January 1, 2012
Granted
Exercised
Cancelled or expired
Outstanding at December 31, 2012
Granted
Exercised
Cancelled or expired
Outstanding at December 31, 2013
Number of
Shares
Weighted Average
Price Per Share
685,000 $
915,642
–
(320,000)
1,280,642 $
504,583
–
(50,000)
1,735,225 $
1.45
0.19
–
1.16
0.62
0.18
–
2.69
0.43
The expected life of awards granted represents the period of time that they are expected to be outstanding. We determine the expected life
based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules, exercise patterns and
pre-vesting and post-vesting forfeitures. We estimate the volatility of our common stock based on the calculated historical volatility of our
own common stock using the trailing 24 months of share price data prior to the date of the award. We base the risk-free interest rate used
in the Black-Scholes option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an
equivalent remaining term equal to the expected life of the award. We have not paid any cash dividends on our common stock and do not
anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-
Scholes option valuation model. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation for
those awards that are expected to vest. In accordance with ASC 718-10, we adjust share-based compensation for changes to the estimate of
expected equity award forfeitures based on actual forfeiture experience.
F-22
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
The following table summarizes the assumptions used to estimate the fair value of options granted during the years ended December 2013
and 2012, using the Black-Scholes option-pricing model:
Expected life of option (years)
Risk-free interest rate
Assumed volatility
Expected dividend rate
Expected forfeiture rate
2013
10
1.72%
124%
0
6%
2012
10
1.64-2.22%
95-105%
0
17%
The total estimated fair value of the options granted during the years ended December 31, 2013 and 2012 was $86,672 and $152,667. The
total fair value of underlying shares related to options that vested during the years ended December 31, 2013 and 2012 was $124,208 and
$85,041. Future compensation expense related to non-vested options at December 31, 2013 was $30,352 and will be recognized over the
next 3.75 years. The aggregate intrinsic value of the vested options was zero as of December 31, 2013 and 2012. Total stock-based
compensation expense recognized in the consolidated statements of operations for the years ended December 31, 2013 and 2012 was
$89,565 and $99,643, respectively.
Non-Employee Stock Options
There were no non-employees stock options issued or outstanding at December 31, 2013 or 2012.
Warrants
The following table summarizes the changes in warrants outstanding and the related exercise prices for the warrants issued to non-
employees of the Company.
Warrants Outstanding
Warrants Exercisable
Exercise Prices
Number
Outstanding
Weighted Average
Remaining
Contractual Life
(Years)
Weighted Average
Exercise Price
Number
Exercisable
Weighted Average
Exercise Price
$
0.13
0.33
3.00
7,230,778
1,628,800
500,336
9,359,914
2.11 $
0.88
1.61
1.87 $
0.13
0.33
3.00
0.32
7,230,778 $
1,628,800
500,336
9,359,914 $
0.13
0.33
3.00
0.32
Transactions involving warrants are summarized as follows:
Outstanding at January 1, 2012
Issued
Exercised
Canceled or expired
Outstanding at December 31, 2012
Issued
Exercised
Canceled or expired
Outstanding at December 31, 2013
Number of
Shares
Weighted Average
Exercise Price
14,921,920 $
–
(3,115,390)
(976,114)
10,830,416 $
–
(86,472)
(1,384,030)
9,359,914 $
0.50
–
0.13
2.20
0.45
–
0.13
1.36
0.32
The Company did not issue any warrants during the years ended December 31, 2013 and 2012. During the year ended December 31, 2013,
86,472 warrants were exercised. These warrants were originally granted to the Company’s placement agent in lieu of cash compensation for
services performed or financing expenses in connection with the placement of convertible preferred stock.
F-23
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
NOTE L – RELATED PARTY TRANSACTIONS
In connection with a customer contract that required bonding, William H. Davis, the Company’s Board Chairman and Jason L. Tienor, the
Company’s Chief Executive Officer and President, each signed a General Indemnity Agreement dated July 5, 2013 and July 8, 2013,
pledging personal property on behalf of the Company. The General Indemnity Agreement indemnifies the surety company for certain
losses incurred by the surety company for the benefit of the Company. As consideration for the assumption of the Indemnification
Obligations by Messrs. Davis and Tienor, the Company agreed to compensate each in the amount of $20,000, grossed up to accommodate
their 2013 federal income tax liability associated with the payments. The amounts owed to Messrs. Davis and Tienor as of December 31,
2013 were $10,000 and $17,000, respectively.
From time to time the Company may receive advances from certain of its officers in the form of salary deferment, cash advances to meet
short term working capital needs. These advances may not have formal repayment terms or arrangements. During the years ended
December 31, 2013 and 2012, there were no such arrangements.
NOTE M – INCOME TAXES
The Company follows ASC 740-10 “Income Taxes” which requires the recognition of deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the financial statement or tax returns. Under this method, deferred tax
liabilities and assets are determined based on the difference between financial statements and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected to reverse.
A reconciliation of tax expense computed at the statutory federal tax rate on income (loss) from operations before income taxes to the
actual income tax (benefit) / expense is as follows:
Tax provision (benefit) computed at the statutory rate
State taxes
Book expenses not deductible for tax purposes
Other
Change in valuation allowance for deferred tax assets
Income tax (benefit) provision
2013
2012
$
$
(1,239,269) $
5,849
19,572
526
(1,213,321)
1,563,145
349,823 $
121,995
9,330
12,968
990
145,283
(176,554)
(31,271)
During 2013, approximately $2,400,000 of state net operating loss carryforwards expired and the Company lowered its effective state tax
rate. The aggregate effect of these items resulted in a reduction to the allowance of approximately $200,000.
Deferred income taxes include the net tax effects of net operating loss (NOL) carry forwards and the temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets are as follows:
Deferred Tax Assets:
Net operating loss carryforwards
Intangibles
Credits
Other
Total deferred tax assets
Deferred Tax Liabilities:
Intangibles
Other
Total deferred tax liabilities
Valuation allowance
Net deferred tax liabilities
2013
2012
$
31,686,463 $
1,277,631
–
872,796
33,836,890
(335,275)
–
(335,275)
(33,836,890)
$
(335,275) $
33,384,938
259,953
–
1,207,240
34,852,131
–
–
–
(34,852,131)
–
A valuation allowance is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The ultimate realization of the deferred tax assets depends on the ability of the Company to generate sufficient taxable income of the
appropriate character in the future and in the appropriate taxing jurisdictions. As of December 31, 2013 and December 31, 2012, the
Company’s valuation allowance, established for the tax benefit that may not be realized, totaled approximately $33,800,000 and
$34,900,000, respectively. The decrease in the valuation allowance is related to state net operating losses that expired as of December 31,
2013.
F-24
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
At December 31, 2013 the Company had net operating loss carryforwards of approximately $88,600,000 and $53,800,000 for federal and
state income tax purposes which will expire at various dates from 2014 – 2033.
The Company’s NOL and tax credit carryovers may be significantly limited under Section 382 of the Internal Revenue Code (IRC). NOL
and tax credit carryovers are limited under Section 382 when there is a significant “ownership change” as defined in the IRC. During 2005
and in prior years, the Company may have experienced such ownership changes that could have imposed such limitations.
The limitation imposed by Section 382 would place an annual limitation on the amount of NOL and tax credit carryovers that can be
utilized. When the Company completes the necessary studies, the amount of NOL carryovers available may be reduced significantly.
However, since the valuation allowance fully reserves for all available carryovers, the effect of the reduction would be offset by a reduction
in the valuation allowance.
The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is generally no longer
subject to U.S. federal income tax examinations by tax authorities for years before 2007 and various states before 2007. Although these
years are no longer subject to examination by the Internal Revenue Service (IRS) and various state taxing authorities, net operating loss
carryforwards generated in those years may still be adjusted upon examination by the IRS or state taxing authorities if they have been or
will be used in a future period.
The Company follows the provisions of uncertain tax positions as addressed in FASB Accounting Standards Codification 740-10-65-1. The
Company recognized no liability for unrecognized tax benefits. The Company has no tax positions at December 31, 2013 and 2012 for
which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. The Company
recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expense. No such interest or
penalties were recognized during the periods presented. The Company had no accruals for interest and penalties at December 31, 2013. The
Company’s utilization of any net operating loss carryforwards may be unlikely due to its continuing losses.
NOTE N – COMMITMENTS AND CONTINGENCIES
Office Leases Obligations
In October 2013, the Company entered into a lease agreement for 6,362 square feet of commercial office space in Waukesha, Wisconsin
for its corporate headquarters. The Waukesha lease expires in April 2021.
The Company presently leases approximately 14,000 square feet of office space in Milwaukee, Wisconsin for its operations facility. The
Milwaukee lease expires in March 2020.
The Company presently leases 16,416 square feet of commercial office space in Germantown, Maryland. The lease commitments expire in
December 2015. On July 15, 2011, Telkonet executed a sublease agreement for 11,626 square feet of the office space in Germantown,
Maryland. The subtenant received one month rent abatement and had the option to extend the sublease from January 31, 2013 to December
31, 2015. On June 27, 2012 the subtenant exercised the option to extend the expiration of the term of the sublease from January 31, 2013 to
December 31, 2015.
Commitments for minimum rentals under non-cancelable leases as of December 31, 2013 are as follows:
Years ending December 31,
2014
2015
2016
2017
2018
2019 and thereafter
Total
F-25
$
$
459,994
494,806
245,274
251,740
258,381
422,182
2,132,377
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
Expected rent payments to be received under sublease agreement as of December 31, 2013 are as follows:
Years ending December 31,
2014
2015
Total
$
$
134,872
138,919
273,791
Rental expense charged to operations for the years ended December 31, 2013 and 2012 was $532,598 and $537,107, respectively. Rental
income received for the years ended December 31, 2013 and 2012 was $131,111 and $127,126, respectively.
Employment and Consulting Agreements
The Company has employment agreements with certain of its key employees which include non-disclosure and confidentiality provisions
for protection of the Company’s proprietary information.
Jason L. Tienor, President and Chief Executive Officer, is employed pursuant to an employment agreement with us dated May 1,
2013. Mr. Tienor’s employment agreement has a term of two (2) years, which may be extended by mutual agreement of the parties thereto,
and provides, among other things, for an annual base salary of $206,000 per year and bonuses and benefits based on our internal policies
and participation in our incentive and benefit plans.
Jeffrey J. Sobieski, Chief Technology Officer, is employed pursuant to an employment agreement with us dated May 1, 2013. Mr.
Sobieski’s employment agreement has a term of two (2) years, which may be extended by mutual agreement of the parties thereto, and
provides for a base salary of $195,700 per year and bonuses and benefits based upon our internal policies and participation in our incentive
and benefit plans.
Gerrit J. Reinders, Executive Vice President-Global Sales and Marketing, is employed pursuant to an employment agreement, dated May 1,
2013. Mr. Reinder’s employment agreement is for a term expiring on May 1, 2014, is renewable at the agreement of the parties and
provides for a base salary of at least $154,500 per year.
In addition to the foregoing, stock options are periodically granted to employees under the Company’s 2010 equity incentive plan at the
discretion of the Compensation Committee of the Board of Directors. Executives of the Company are eligible to receive stock option
grants, based upon individual performance and the performance of the Company as a whole.
Litigation
The Company is subject to legal proceedings and claims which arise in the ordinary course of its business. Although occasional adverse
decisions or settlements may occur, the Company believes that the final disposition of such matters should not have a material adverse
effect on its financial position, results of operations or liquidity.
Linksmart Wireless Technology, LLC v. T-Mobile USA, Inc.
On July 1, 2008, Linksmart Wireless Technology, LLC, or Linksmart, filed a civil lawsuit in the Eastern District of Texas against
EthoStream, LLC, our wholly-owned subsidiary and 22 other defendants (Linksmart Wireless Technology, LLC v. T-Mobile USA, Inc., et
al, U.S. District Court, for the Eastern District of Texas, Marshall Division, No. 2:08-cv-00264). This lawsuit alleged that the defendants’
services infringed a wireless network security patent held by Linksmart.
Defendant Ramada Worldwide, Inc. provided us with notice of the suit and demanded that we defend and indemnify it pursuant to a vendor
direct supplier agreement between EthoStream and WWC Supplier Services, Inc., a Ramada affiliate. After a review of that agreement, it
was determined that EthoStream owed the duty to defend and indemnify with respect to services provided by Telkonet to Ramada and it
assumed Ramada’s defense.
The parties in the lawsuit agreed to and the Court ordered a stay of the litigation pending the conclusion of a reexamination proceeding in
the U.S. Patent and Trademark Office relating to the patent involved in the lawsuit. The case was reopened in early 2012 based on the
expectation that a reexamination certificate would be issued by the Patent Office. The reexamination certificate has been issued. After the
case resumed, the parties agreed to a “transfer” of the case from the Eastern District of Texas to the Central District of California. To
accomplish the “transfer,” with the agreement of the parties, the Texas case was dismissed and a new action was filed in California on
April 5, 2012. (Linksmart Wireless Technology, LLC v. T-Mobile USA, Inc., et al, U.S. District Court, for the Central District of California,
Southern Division, No. SACV 12-522-JST).
F-26
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
On October 1, 2013, the Company entered into a settlement agreement with Linksmart. The Company has agreed to pay $115,000, payable
in twelve installments of $9,583 due on the first of each month beginning October 1, 2013. The balance remaining at December 31, 2013
was $86,250 and is in accounts payable on the accompanying consolidated balance sheet.
Indemnification Agreements
On March 31, 2010, the Company entered into Indemnification Agreements with director William H. Davis, and executives Jason L.
Tienor, President and Chief Executive Officer and Jeffrey J. Sobieski, then Chief Operating Officer. On November 3, 2010, the Company
entered into an Indemnification Agreement with Richard E. Mushrush, then Acting Chief Financial Officer.
The Indemnification Agreements provide that the Company will indemnify the Company's officers and directors, to the fullest extent
permitted by law, relating to, resulting from or arising out of any threatened, pending or completed action, suit or proceeding, or any inquiry
or investigation by reason of the fact that such officer or director (i) is or was a director, officer, employee or agent of the Company or (ii)
is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture,
trust or other enterprise if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the
Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. In
addition, the Indemnification Agreements provide that the Company will make an advance payment of expenses to any officer or director
who has entered into an Indemnification Agreement, in order to cover a claim relating to any fact or occurrence arising from or relating to
events or occurrences specified in this paragraph, subject to receipt of an undertaking by or on behalf of such officer or director to repay
such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Company as authorized under the
Indemnification Agreement.
Sales Taxes
During 2012, the Company engaged a sales tax consultant to assist in determining the extent of its potential sales tax exposure. Based upon
this analysis, management determined the Company had probable exposure for certain unpaid obligations, including interest and penalty, of
approximately $1,100,000 including and prior to the year ended December 31, 2011. The Company has approximately $1,100,000 and
$1,200,000 accrued for this exposure as of December 31, 2013 and 2012, respectively.
The Company continues to manage the liability by establishing voluntary disclosure agreements (VDAs) with the applicable states, which
establishes a maximum look-back period and payment arrangements. However, if the aforementioned methods prove unsuccessful and the
Company is examined or challenged by taxing authorities, there exists possible exposure of an additional $450,000, not including any
applicable interest and penalties.
During 2012, the Company successfully executed and paid in full VDAs in five states totaling approximately $23,000 and is current with
the subsequent filing requirements.
During 2013, the Company successfully executed and paid in full VDAs in fourteen states totaling approximately $263,000 and is current
with the subsequent filing requirements. It has submitted VDAs with an additional fifteen states and awaits notification of acceptance. Two
states offer no voluntarily disclosure program.
The following table sets forth the change in the sales tax accrual during the years ended December 31:
Balance, Beginning of year
Sales tax collected
Provisions
Interest and penalties
Payments
Balance, End of year
$
$
2013
2012
1,188,133 $
409,782
(138,352)
7,342
(386,423)
1,080,482 $
1,068,314
277,374
(119,255)
32,696
(70,996)
1,188,133
F-27
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 AND 2012
NOTE O – BUSINESS CONCENTRATION
For the years ended December 31, 2013 and 2012, no single customer represented 10% or more of our total net revenues.
Purchases from two suppliers approximated $2,700,000, or 68%, of total purchases for the year ended December 31, 2013 and
approximated $2,600,000, or 73%, of total purchases for the year ended December 31, 2012. Total due to these suppliers, net of deposits,
was $525,464 and $384,099 as of December 31, 2013 and 2012, respectively.
NOTE P – SUBSEQUENT EVENT
In 2014, the Company purchased approximately $120,000 of furniture and fixtures to furnish its new corporate office located in Waukesha,
Wisconsin. These assets will be depreciated over their respective estimated useful lives.
F-28
EXHIBIT 23.1
Telkonet, Inc.
Waukesha, Wisconsin
Consent of Independent Registered Public Accounting Firm
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-161909 and 333-175737) of
Telkonet, Inc. of our report dated March 31, 2014, relating to the consolidated financial statements, which appear in this Form 10-K. Our
report contains an explanatory paragraph regarding the Company’s ability to continue as a going concern.
/s/ BDO USA, LLP
Milwaukee, Wisconsin
March 31, 2014
EXHIBIT 23.2
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statements on Form S-8 (File No. 333-161909 and 333-175737) of
Telkonet, Inc. of our report dated April 1, 2013, relating to the consolidated financial statements of Telkonet, Inc. for the year ended
December 31, 2012, which includes an explanatory paragraph relating to Telkonet Inc.’s ability to continue as a going concern and appears
in this annual report on Form 10-K.
/s/ Baker Tilly Virchow Krause, LLP
Milwaukee, Wisconsin
March 31, 2014
EXHIBIT 31.1
I, Jason L. Tienor, certify that:
CERTIFICATIONS
1. I have reviewed this annual report on Form 10-K of Telkonet, Inc.;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;
4. The registrant other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-
15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under
our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control
over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: March 31, 2014
By: /s/ Jason L. Tienor
Jason L. Tienor
Chief Executive Officer
EXHIBIT 31.2
I, Richard E. Mushrush, certify that:
1. I have reviewed this annual report on Form 10-K of Telkonet, Inc.;
CERTIFICATIONS
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;
4. The registrant other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-
15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under
our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control
over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: March 31, 2014
By: /s/ Richard E. Mushrush
Richard E. Mushrush
Controller and Acting Chief Financial Officer
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Telkonet Inc. (the "Company") on Form 10-K for the year ended December 31, 2013 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I, Jason L. Tienor, Chief Executive Officer of Telkonet, certify,
pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
/s/ Jason L. Tienor
Jason L. Tienor
Chief Executive Officer
March 31, 2014
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Telkonet Inc. (the "Company") on Form 10-K for the period ended December 31, 2013 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I, Richard E. Mushrush, Controller and Acting Chief Financial
Officer of Telkonet, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
/s/ Richard E. Mushrush
Richard E. Mushrush
Controller and Acting Chief Financial Officer
March 31, 2014