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, 2014
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
Non-accelerated filer o
(Do not check if a smaller reporting company)
Accelerated filer o
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 $0.19 per share on the Over the
Counter Bulletin Board) of the registrant as of June 30, 2014: $22,926,069.
Number of outstanding shares of the registrant’s par value $0.001 common stock as of March 22, 2015: 125,035,612.
Parts I and II incorporate information by reference from the Annual Report to Shareholders for the fiscal year ended December 31, 2014.
Part III is incorporated by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held on June 11, 2015.
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 the creator of the
EcoSmart Platform of in-room automation solutions integrated to optimize energy efficiency, comfort and analytics to support the emerging
Internet of Things (“IoT”). Telkonet’s business is based on two synergistic divisions, its EcoSmart division offering intelligent automation
solutions and EthoStream division providing the underlying networking technology.
Our EcoSmart Platform is comprised of four main components.
ECOSMART
·
·
·
·
EcoSmart Suite: is the suite of hardware products designed and developed to provide management reporting, analytics and control
over individual and grouped energy consumption.
EcoCentral Virtual Engineer: is the cloud-based management platform that provides Telkonet’s remote monitoring, management
reporting and analytics over the deployed EcoSmart products.
EcoCare: is Telkonet’s full offering of professional services including 24/7 monitoring, engineering analytics and reporting, project
and relationship management and onsite support.
EcoMobile: are the native iOS and Android applications that Telkonet provides to its partners, customers and end users to
provision, manage and access EcoSmart deployments and functionality.
The EcoSmart Platform provides comprehensive savings, management reporting, analytics and virtual engineering of a customer’s portfolio
and/or property’s room-by-room energy consumption. Telkonet has deployed more than a half million intelligent devices worldwide in
properties within the hospitality, military, educational, healthcare and other commercial markets. The EcoSmart Platform is rapidly being
recognized as a leading solution for reducing energy consumption, operational costs 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. 1
On average, America’s approximately 53,000 hotels spend $2,196 per available room each year on energy. 2 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 $0.60 in limited-service hotels and by $2.00 in full-service hotels.
_______________
1 Facility Type: Hotels & Motels - http://www.energystar.gov/ia/business/EPA_BUM_CH12_HotelsMotels.pdf
2 AH&LA 2013 At-a-Glance Statistical Figures - http://www.ahla.com/content.aspx?id=36332
1
Energy is very often wasted through the lighting, powering, heating and cooling of unoccupied spaces. These spaces with intermittent
occupancy constitute Telkonet’s target markets, and our experience, supported by independent research and customer data, suggests these
rooms are unoccupied as much as 70% of the time.
EcoSmart Suite
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 to create an intelligent automated environment. All products can be
wirelessly networked to enhance energy efficiency, provide remote monitoring capability and develop increased analytical savings based on
the in-room performance. 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.
·
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·
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·
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·
EcoInsight: a programmable and controllable wired thermostat with over 125 configurable settings used to control the efficiency of
HVAC.
EcoConnect: serves as Zigbee to Ethernet coordinator of the devices connected to the energy management network, managing
approximately 30 - 70 device connections each.
EcoCommander: EcoSmart’s network-edge gateway server that provides real-time proactive data aggregation, analytics, reporting
and management of the EcoSmart product suite.
EcoSense: 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. EcoSense may be hardwired or
programmed to communicate wirelessly and may be battery operated or utilize external power.
EcoWave: a 2-component package that includes a revolutionary remote interface wireless thermostat (EcoAir) and powerful
mechanical control solution (EcoSource) 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 and can
be battery operated or utilize external power.
EcoSwitch: an EcoSmart energy management product with the appearance of a traditional ‘rocker’ 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 control 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 and other consumption measures when doors or windows are open.
2
EcoCentral Virtual Engineer
Telkonet’s EcoSmart Platform functions as a comprehensive solution for intelligent automation and energy management. The platform has
a well-developed upgrade path with the final and complete version of the platform offering real-time control and analytics provided through
a cloud computing platform called EcoCentral Virtual Engineer. EcoCentral earns its name through its ability to direct user resources where
they add the most value. From monitoring equipment operation to determine where engineering efforts are needed to notifying staff when
performance is degrading, EcoCentral creates a comprehensive tool for providing insight and access into EcoSmart Platform deployments
either individually or across an entire portfolio.
EcoCare
EcoCare is Telkonet’s complete offering of professional services including call support, repair and replacement services, periodic reporting,
communication with customers’ utility and ISP partners and more. Telkonet provides three static packages of EcoCare services as well as
allows customers to create their own package of services ala carte. EcoCare allows EcoSmart customers to ensure that they continue to
recognize the savings estimated and benefit from the intended return on investment (ROI). Standard EcoCare contracts range from three to
five years and have automatic renewal terms built into the individual contract.
EcoMobile
Telkonet’s EcoMobile tools provide native iOS and Android applications for use by partners, customers and guests. These mobile tools
extend the value of the EcoSmart Platform and give greater functionality and more efficient commissioning and deployment abilities to the
user. We have identified where, by providing more accessibility, we can create additional charged-for services that increase customer
savings, improve guest experience and integrate more fully with customer environments to create a tight relationship with our customers.
Target Markets
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.
·
Public Housing: apartments, campus living, dormitories and other.
Continually powered equipment and appliances in vacant rooms also increases the maintenance overhead and shortens its’ working life. As
a result, building owners and managers experience unnecessary waste and cost.
Intelligent Energy Management
Telkonet’s EcoSmart energy management platform is a leading intelligent and advanced automation solution designed to deliver at all
levels by controlling a building’s lighting, plugload and HVAC usage and improving energy efficiency one room at a time. All data may be
presented on a grouped, property or room-by-room basis, allowing very granular management of in-room energy use and environmental
conditions. The platform 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, managed wireless light switches and in wall electrical plugs to adjust and maintain energy consumption
including a room’s temperature according to occupancy, eliminating wasteful heating and cooling of unoccupied rooms. All these things
can be done from the in-room devices or via any web-connected device, such as smart phones, tablets and laptop computers.
EcoSmart is an energy management platform that delivers optimal, individual room energy savings without compromising occupant
comfort, thanks to a proprietary technology – Recovery Time.
3
Recovery Time Technology
All EcoSmart’s solution features 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 individual 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 set-point 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?
The occupant selects a set-point when the room is occupied. 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 the 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:
·
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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, our customers are able to realize significant cost savings without diminishing occupant comfort.
4
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 intelligent automation 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;
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Longer life and reduced maintenance of HVAC units through reduced run times 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;
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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;
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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 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.
5
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.
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.3 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 are in their infancy.
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.4 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)
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
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3 Center for Climate and Energy Efficiency - http://www.c2es.org/technology/overview/buildings
4 Global Market for Energy Efficient Buildings to Surpass $100 Billion by 2017 - http://www.navigantresearch.com/newsroom/global-
market-for-energy-efficient-buildings-to-surpass-100-billion-by-2017
6
Education Industry
Telkonet’s most rapidly emerging market is the educational industry where continue to expand our presence in this space 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 residence 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.
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 4,100 rooms across 12 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, North Carolina State University, University of
Akron, University of Notre Dame, Fordham University, West Point Military Academy, Columbia University, University of Wisconsin-
Oshkosh and others.
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.5
We believe that our EcoSmart Platform is an important tool for participants in the education industry seeking to control student-related
energy costs. We have focused our sales efforts on members of the education 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 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.6 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. The Company
has proven that its EcoSmart Platform can deliver a return on investment in less than three years for hospitality customers.
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.
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5 https://www.energystar.gov/ia/news/downloads/K-12_Challenge.pdf
6 http://www4.eere.energy.gov/alliance/sites/default/files/uploaded-files/better-buildings-alliance-annual-report-2013.pdf
7
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.7
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.8 The American Recovery and Reinvestment
Act (“ARRA”) 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 benefited and continues to make
use of government 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.
Healthcare Industry
Healthcare is an 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.9 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 ARRA for programs related to Smart Grids, 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 platform 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 paid for by government
programs. 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.
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7 http://en.wikipedia.org/wiki/Energy_usage_of_the_United_States_military
8 https://www.whitehouse.gov/administration/eop/ceq/sustainability
9 http://www.epa.gov/statelocalclimate/local/topics/commercial-industrial.html
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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 automation platform. Our
products offer significant competitive and complementary benefits when compared with alternative offerings including Building
Automation Systems
temperature occupancy-based systems,
(“BAS”) or Building Management Systems
scheduling/programmable thermostats and high-efficiency HVAC systems.
(“BMS”), static
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 some level of comparable products to our standalone and networked products. Telkonet’s key
differentiators in the hospitality segment include:
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Recovery Time technology;
· Mesh-networked environment;
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Comprehensive four-part platform;
Integration with property and building management systems (PMS & BMS);
· Utility demand-based program integration; and
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Broad HVAC compatibility.
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 facilities 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.
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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.
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
Choice Hotels International
Crescent Hotels & Resorts
Cobblestone Hotels
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· 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
· White Lodging Services
· 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.
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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.
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.
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 contract manufacture the majority
of our inventory with ATR Manufacturing, a Chinese company, which provides substantially all the manufacturing requirements for
Telkonet’s energy management platform. For our HSIA networks, we obtain the majority of our inventory from WAV, Inc.
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, 2014 and 2013, 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, 2014.
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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 will expire in May of
2022. 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.
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 (“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 European Commission (“EC”) standards. Moreover, if in
the future, the FCC or EC 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, 2014 and 2013, we spent $1,312,488 and $1,174,048, respectively, on research and development
activities. Telkonet’s EcoSmart related development efforts in 2014 and continuing into 2015 are focused on three major areas. The first is
around continuous software improvements to maintain compatibility with changing industry equipment and standards as well as moving
towards a more mobile platform. The second area is a focus on development with third party device providers for integrated solutions. The
growth in connected devices is driving demand for a smart hotel room with many devices working together. This new smart room requires
working closely with strategic partners to build a more tightly integrated solution. The final area we continue to focus on is new product
development. Telkonet is preparing new product releases and is continuing to innovate with hardware development beyond its current
EcoSmart Platform.
The focus of EthoStream during 2014 and continuing into 2015 has been in both software and infrastructure improvements to better support
and grow its customer base. Development efforts have focused on portal design changes and hotel property management system interface
enhancements to attract new brands. The development of new updated web based management tools will be necessary to maintain our
competitiveness. Continuous development of EthoStream’s EGS platform will be required by several brands to maintain compliance as an
approved vendor.
Other Information
Employees
As of March 20, 2015, we had 100 full-time employees. During 2014, significant positions filled included a director of field services, a
director of sales and marketing, a channel account manager and a director of engineering. 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.
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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.
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 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.
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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 in response to 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.
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.
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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, 2014, we had outstanding employee options to purchase a total of 1,930,225 shares of common stock at exercise prices
ranging from $0.14 to $5.60 per share, with a weighted average exercise price of $0.40. As of December 31, 2014, we had warrants
outstanding to purchase a total of 7,915,533 shares of common stock at exercise prices ranging from $0.13 to $3.00 per share, with a
weighted average exercise price of $0.27. 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.
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, 2014 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, 2014, 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.
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, technical requirements, marketing restrictions and product labeling requirements.
Differing technical requirements apply to “Class A” devices intended for use in commercial settings, and “Class B” devices intended for
residential use to which more stringent standards apply. An independent, FCC-certified testing lab has verified that 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.
15
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.
18
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.
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, 2015, our independent registered public accounting firm’s report on our consolidated financial statements for
the year ended December 31, 2014 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 22, 2015, we
have issued 125,035,612 shares of common stock and have approximately 14,509,303 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, 2014, we have incurred cumulative losses of $121,906,017 and have never generated enough funds
through operations to support our business. For the year ended December 31, 2014, we had an operating cash flow deficit of $4,601. As of
December 31, 2014, we have a working capital deficit (current liabilities in excess of current assets) of $420,106. 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.
19
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.
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 2013 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 $1.0 million, respectively, at December 31, 2014, resulting from past acquisitions.
We evaluate this goodwill for impairment based on the fair value of the reporting unit 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 the reporting unit 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 unit. 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, 2013 and up to May 31, 2014, we were in violation of a financial performance covenant under the
Agreement. The Bank had chosen not to exercise any default provisions. On May 31, 2014, the Company and the Bank mutually agreed to
terminate the Agreement and the Company paid the remaining outstanding principal balance of $50,000.
On September 30, 2014, the Company and its wholly owned subsidiary, EthoStream LLC, as co-borrowers (collectively, the “Borrowers”),
entered into a Loan and Security Agreement (the “Loan Agreement”) with Heritage Bank of Commerce, a California state chartered bank
(“Heritage Bank”), governing a new revolving credit facility in a principal amount not to exceed $2,000,000 (the “Credit Facility”). See
“Management’s Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources” for more
information regarding the Loan 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.
20
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
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.
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 infringe 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 owes the duty to defend and indemnify with respect to services provided by Telkonet to Ramada and it
assumed Ramada’s defense.
On October 1, 2013, the Company entered into a settlement agreement with Linksmart. The Company 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 was paid in full at September 30,
2014.
Eric Sprangers v. Telkonet, Inc. and Ethostream, LLC
On or about April 23, 2014, Eric Sprangers filed a complaint against Telkonet, Inc. and Ethostream, LLC (the “Companies”) in the United
States District Court for the Eastern District of Wisconsin. The Complaint, filed by Sprangers on behalf of himself and a putative class of
allegedly similarly situated employees of the Companies, claims that the Companies failed to pay him and the putative class members
overtime compensation in violation of the federal Fair Labor Standards Act (“FLSA”). Among other things, the complaint seeks payment to
the putative class members of back overtime, liquidated damages and penalties as provided in the FLSA, and an award of costs and
attorneys’ fees. On or about May 22, 2014, the Companies filed an answer to the complaint in which the Companies deny that they failed to
pay overtime compensation in violation of the FLSA. On July 25, 2014, Sprangers accepted a Rule 68 offer of judgment that was made by
the Companies on July 11, 2014 in the amount of $10,000, plus an additional amount for attorneys’ fees, costs and expenses to be
determined by the Court. On September 12, 2014, the Court ordered judgment consistent with the accepted offer of judgment. The
additional attorney fees were $9,939. Per the judgment, the offer and attorney fees were to be paid in two installments, September 23, 2014
and October 23, 2014. The Company complied with the judgment.
ITEM 4. MINE SAFETY DISCLOSURES.
None.
21
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, 2014 and 2013.
Year Ended December 31, 2014
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Year Ended December 31, 2013
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Record Holders
$
$
High
Low
0.30 $
0.24
0.19
0.18
0.34 $
0.33
0.32
0.28
0.20
0.17
0.13
0.12
0.13
0.17
0.22
0.16
As of March 22, 2015, we had 204 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, 2014.
Number of
securities to be
issued upon
exercise of
outstanding
options, warrants
and rights
(a)
1,930,225 $
–
Weighted-average
exercise price of
outstanding
options, warrants
and rights
(b)
0.40
–
Number of
securities
remaining
available for
future issuance
under equity
compensation
plans (excluding
securities
reflected in
column (a))
(c)
5,747,553
–
1,930,225 $
0.40
5,747,553
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.
22
ITEM 6. SELECTED FINANCIAL DATA
This item is not applicable.
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 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 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 605-25. Arrangements under such contracts may 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 equipment has value to
the customer on a stand-alone basis, and (ii) delivery of the undelivered service 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 – In most instances, products are sold separately in stand-alone arrangements. Services are also sold separately through
renewals of contracts with varying periods. We determine VSOE based on 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.
23
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.
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, 2014 and 2013, the Company experienced approximately
between 1% and 3% of returns related to product warranties. As of December 31, 2014 and 2013, the Company recorded warranty
liabilities in the amount of $44,288 and $77,943, respectively, using this experience factor range.
Income Taxes
The Company accounts for income taxes in accordance with ASC 740-10. 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.
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.
24
Significant assumptions used in our goodwill impairment test at December 31, 2013 included: expected revenue growth rates, reporting
unit profit margins, working capital levels, discount rates of 12.4% for Ethostream and 21.8% 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. At December 31, 2013, the carrying value of Smart Systems International
goodwill was fully written down to zero.
Significant assumptions used in our goodwill impairment test at December 31, 2014 for Ethostream included: expected revenue growth
rates, reporting unit profit margins, working capital levels, discount rates of 10.8% 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. We
performed our annual goodwill impairment test and determined that there was no impairment, since the fair value of the EthoStream
reporting unit substantially exceeded the carrying value.
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 $353,000 and
$1,100,000 accrued for this exposure as of December 31, 2014 and 2013, 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 $200,000, not including any
applicable interest and penalties.
Prior to 2014, the Company successfully executed and paid in full VDAs in nineteen states totaling approximately $286,000 and is current
with the subsequent filing requirements.
During 2014, the Company successfully executed and paid in full VDAs in twelve states totaling approximately $407,000 and is current
with the subsequent filing requirements.
EBITDA
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 (“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 is one of the measures used for determining our debt covenant compliance. 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.
25
RECONCILIATION OF NET INCOME (LOSS) TO ADJUSTED EBITDA
FOR THE YEARS ENDED DECEMBER 31,
(Unaudited)
Net income (loss)
Interest expense, net
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
$
$
2014
2013
42,830 $
40,273
201,853
275,236
560,192
–
–
15,046
575,238 $
(3,994,731)
18,141
349,823
258,517
(3,368,250)
(41,902)
2,774,016
89,565
(546,571)
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
Revenues
The table below outlines our product versus recurring revenues for comparable periods:
2014
Year Ended December 31,
2013
Variance
Product
Recurring
Total
$
$
10,973,544
3,822,987
14,796,531
74% $
26%
100% $
10,123,407
3,766,439
13,889,846
73% $
27%
100% $
850,137
56,548
906,685
8%
2%
7%
Product revenue
Product revenue principally arises from the sale and installation of EcoSmart energy management platform, SmartGrid and High Speed
Internet Access equipment. The EcoSmart Suite of products consists 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. We market and
sell to the hospitality, education, healthcare and government/military markets.
For the year ended December 31, 2014, product revenue increased $0.85 million, or 8% when compared to the prior year. Product revenue
in 2014 included approximately $5.98 million attributed to the sale and installation of energy management platform products,
approximately $4.99 million for the sale and installation of HSIA products. $0.58 million of the $0.85 million increase in product revenue
can be attributed to sales from channel partnerships and value added resellers. The Company has been making a concerted effort to increase
channel partner relationships and expects this trend to continue.
26
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, Telkonet’s EcoCare service and support program 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.
Recurring revenue includes approximately 2,300 hotels in our broadband network portfolio. We currently support approximately 237,000
HSIA rooms, with approximately 8.0 million monthly users. For the year ended December 31, 2014, recurring revenue increased $0.06
million or by 2% when compared to the prior year. The increase of recurring revenue was primarily attributed to a $0.13 million increase in
support revenue offset by a $0.06 million reduction of advertising revenue. The support revenue increase is due to the rollout of the
Company’s EcoCare service and support program for the EcoSmart Suite of products.
Cost of Sales
2014
Year ended December 31,
2013
Variance
Product
Recurring
Total
$
$
6,504,630
1,053,215
7,557,845
59% $
28%
51% $
6,034,294
1,069,558
7,103,852
60% $
28%
51% $
470,336
(16,343)
453,993
8%
-2%
6%
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, 2014, cost of product sales increased by 8% 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, 2014, costs of recurring revenue decreased by 2% when compared to the prior year. The majority of the decrease was for
salaries and wages.
Gross Profit
2014
Year ended December 31,
2013
Variance
Product
Recurring
Total
$
$
4,468,914
2,769,772
7,238,686
41% $
72%
49% $
4,089,113
2,696,881
6,785,994
40% $
72%
49% $
379,801
72,891
452,692
9%
3%
7%
Gross Profit on Product Revenue
Gross profit on product revenue for the year ended December 31, 2014 increased by 9% compared to the prior year period. The variance
was a result of increased product sales and installations. Gross profit as a percentage of sales increased a fraction of a percentage point for
the year ended December 31, 2014.
Gross Profit on Recurring Revenue
For the year ended December 31, 2014, our gross profit increased by 3% when compared to the prior year. The variance was mainly
attributed to a decrease in support staff wages and benefits.
27
Operating Expenses
2014
Year ended December 31,
2013
Variance
Total
$
6,953,730 $
10,454,663 $
(3,500,933)
-33%
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, 2014, operating expenses decreased by 33%
when compared to the prior year. This decrease 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 decreased by $0.73 million or 9%.
Research and Development
2014
Year ended December 31,
2013
Variance
Total
$
1,312,488 $
1,174,048 $
138,440
12%
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 12% for the year ended December 31, 2014. This increase is attributed to additional wages and
salaries of $0.14 million, the Company hired a Director of Engineering during 2014. Costs of $0.01 million is associated with the
development of our EcoTouch and EcoConnect Plus next generation products.
Selling, General and Administrative Expenses
2014
Year ended December 31,
2013
Variance
Total
$
5,366,006 $
6,248,082 $
(882,076)
-14%
Selling, general and administrative expenses decreased for the year ended December 31, 2014 over the prior year by 14%. Bad debt
expense decreased $0.27 million, the majority due to a $0.10 million bad debt write off in 2013 and the subsequent recovery of that write
off in 2014. A decrease in sales and use tax by approximately $0.48 million due to the Company settling twelve VDA’s with various states.
Legal fees decreased due to the Linksmart Wireless Technology, LLC litigation settlement of approximately $0.12 million in 2013 and
accounting fees decreased $0.12 million. Bonus and stock option expense decreased by $0.16 million. These decreases were offset by
increases in rent of $0.09 million attributed to the Waukesha, WI lease, commissions of $0.10 million and director fees of $0.04 million.
Goodwill Impairment
Year ended December 31,
2014
2013
Variance
Total
$
– $
2,774,016 $
(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.
Provision for Income Taxes
2014
Year ended December 31,
2013
Variance
Total
$
201,853 $
349,823 $
(147,970)
-46%
During the year ended December 31, 2013, the Company recorded a $0.35 million deferred tax liability from timing differences between
book and tax amortization of goodwill. The decrease is attributed to the relative amount of tax amortization of goodwill recognized in each
year.
28
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 deficit (current assets in excess of current liabilities) improved by $150,295 during the year ended December 31, 2014
from a working capital deficit of $570,401 at December 31, 2013 to a working capital deficit of $420,106 at December 31, 2014.
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 would be payable by the
Company in three equal annual installments. The first of these three installments would 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 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 Loan Agreement in whole or in part at any time without
penalty. The Loan Agreement was secured by substantially all of the Company’s assets. On September 24, 2014, the Department signed a
subordination agreement of all the Company’s security interests. 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, 2014 and 2013 were $103,979 and $154,463, 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 year ended December 31, 2013, the non-cash reduction of
principal calculated under these provisions and applied to the Note was $41,902. 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, 2014 and 2013 was $289,973 and $506,024,
respectively.
29
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 was subject to a borrowing base that was 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 was available for working capital and other lawful general
corporate purposes. As of December 31, 2013 and March 31, 2014, the Company was in violation of a financial performance covenant.
Although the Company’s violation of the financial performance covenant constituted a default under the Agreement, the Bank did not
pursue any remedies under the default provisions of the Agreement. On May 31, 2014, the Company and the Bank mutually agreed to
terminate the Agreement and the Company paid the remaining outstanding principal balance of $50,000.
On September 30, 2014, the Company and its wholly owned subsidiary, EthoStream LLC, as co-borrowers (collectively, the “Borrowers”),
entered into a Loan and Security Agreement (the “Loan Agreement”) with Heritage Bank of Commerce, a California state chartered bank
(“Heritage Bank”), governing a new revolving credit facility in a principal amount not to exceed $2,000,000 (the “Credit Facility”).
Availability of borrowings under the Credit Facility from time to time is subject to a borrowing base calculation based on the Company’s
eligible accounts receivable and eligible inventory each multiplied by an applicable advance rate, with an overall limitation tied to the
Company’s eligible accounts receivable. The Loan Agreement is available for working capital and other lawful general corporate purposes.
The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 6.25% at December 31,
2014. The Credit Facility matures on September 30, 2016, unless earlier accelerated under the terms of the Loan Agreement. On October 9,
2014, as part of the Loan Agreement, Heritage Bank was granted a warrant to purchase 250,000 shares of Telkonet common stock. The
warrant has an exercise price of $0.20 and expires October 9, 2021.
The Loan Agreement contains customary covenants that place restrictions on, among other things, the incurrence of debt, granting of liens
and sale of assets. The Credit Agreement also contains financial covenants that require the Borrowers to maintain a minimum EBITDA
level, measured quarterly, and a minimum asset coverage ratio, measured monthly. A violation of any of these covenants could result in an
event of default under the Loan Agreement. Upon the occurrence of such an event of default or certain other customary events of defaults,
payment of any outstanding amounts under the Credit Facility may be accelerated and Heritage Bank’s commitment to extend credit under
the Loan Agreement may be terminated. The Loan Agreement contains other representations and warranties, covenants, and other
provisions customary to transactions of this nature. As of December 31, 2014, the Company was in compliance with the financial covenants
that required the Company to maintain a minimum EBITDA level and minimum asset coverage ratio. The outstanding balance on the
Credit Facility is $628,204 at December 31, 2014 leaving an available borrowing base of approximately $241,000.
Cash flow analysis
Cash used in continuing operations was $4,601 during the year ended December 31, 2014 and cash provided by operations was $2,641
during the year ended December 31, 2013. As of December 31, 2014, our primary capital needs included costs incurred to increase energy
management sales, inventory procurement, funding performance bonds and managing current liabilities.
Cash provided by investing activities was $198,333 during the year ended December 31, 2014 and cash used in investing activities was
$407,577 during the year ended December 31, 2013, respectively. During the year ended December 31, 2012, the Company was awarded a
contract with 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. In 2014, the Company satisfied all obligations
related to the bonding requirement and the cash was released. During the year ended December 31, 2014, the Company purchased
approximately $120,668 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.
Cash provided by financing activities was $361,669 during the year ended December 31, 2014. Cash borrowed from the line of credit was
$628,204 and cash used in financing activities to repay indebtedness was $266,535. Cash used in financing activities to repay indebtedness
was $186,150 during the year ended December 31, 2013.
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, 2014
includes an explanatory paragraph relating to our ability to continue as a going concern. Although we reported net income for 2014, we
have incurred operating losses and operating cash flow 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.
30
Management expects that global economic conditions along with competition will continue to present a challenging operating environment
through 2015; therefore working capital management will continue to be a high priority for 2015.
The Company continues to manage the approximate $353,000 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 $200,000, not including any
applicable interest and penalties.
Prior to 2014, the Company successfully executed and paid in full VDAs in nineteen states totaling approximately $286,000 and is current
with the subsequent filing requirements.
During 2014, the Company successfully executed and paid in full VDAs in twelve states totaling approximately $407,000 and is current
with the subsequent filing requirements. In addition, the Company executed VDAs with three other states and has established payment
plans with these states.
On November 19, 2014, greater than 50% of the shares of Series A issued on the Series A Original Issue Date, November, 16, 2009,
remained outstanding. For a period of 180 days thereafter, if the holders of at least a majority of the 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 would be payable by
the Company in three equal annual installments with the first of these three installments due within 60 days of the requisite holders’ written
notice requesting redemption. As of December 31, 2014, the aggregate redemption price was $1,303,859.
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 new accounting pronouncements.
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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
This item is not applicable.
31
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, 2014 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, 2014 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 hire additional personnel to remediate these control deficiencies in the future.
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, 2014 and 2013 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, 2014 and 2013 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, 2014, 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.
32
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 11, 2015.
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 11, 2015.
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 11, 2015.
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 11, 2015.
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 11, 2015.
33
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 years ended December 31, 2014 and 2013
Consolidated Balance Sheets as of December 31, 2014 and 2013
Consolidated Statements of Operations for the Years ended December 31, 2014 and 2013
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2014 and 2013
Consolidated Statements of Cash Flows for Years ended December 31, 2014 and 2013
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.
34
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 31,
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 Amended and Restated Articles of Incorporation (incorporated by reference to our Form 8-K (No. 001-31972),
filed November 18, 2009)
Amendment to Amended and Restated Articles of Incorporation (incorporated by reference to our Form 8-K filed on August 9,
2010)
Amendment to Amended and Restated 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, 2010)
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 13, 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)
35
10.8
10.9
10.10
10.11
10.12
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)
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)
Form of Director 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 13, 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 13, 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 15, 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 15, 2013)
*10.19
Employment Agreement by and between Telkonet, Inc. and Richard E. Mushrush, dated as of May 1, 2014 (incorporated by
reference to our Form 8-K filed May 14, 2014)
*10.20
Employment Agreement by and between Telkonet, Inc. and Matthew P. Koch, dated as of May 1, 2014 (incorporated by
reference to our Form 8-K filed May 14, 2014)
*10.21
10.22
10.23
10.24
14
21
23.1
31.1
31.2
32.1
32.2
101.INS
101.SCH
101.CAL
101.DEF
101.LAB
101.PRE
Employment Agreement by and between Telkonet, Inc. and Gerrit J. Reinders, dated as of May 1, 2014 (incorporated by
reference to our Form 8-K filed May 14, 2014)
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 May 6, 2013)
Business Financing Agreement, dated May 31, 2013, by and between Telkonet, Inc. and Bridge Bank N.A.(incorporated by
reference to our Form 8-K filed June 6, 2013)
Loan and Security Agreement, dated September 30, 2014, by and between Telkonet, Inc. and Heritage Bank of
Commerce(incorporated by reference to our Form 8-K filed October 2, 2014)
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
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
XBRL Instance Document
XBRL Schema Document
XBRL Calculation Linkbase Document
XBRL Definition Linkbase Document
XBRL Label Linkbase Document
XBRL Presentation Linkbase Document
* Indicates management contract or compensatory plan or arrangement.
36
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, 2015
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
/s/ Jason L. Tienor
Jason Tienor
/s/ Richard E. Mushrush
Richard E. Mushrush
/s/ / William H. Davis
William H. Davis
/s/ Tim S. Ledwick
Tim S. Ledwick
/s/ Kellogg L. Warner
Kellogg L. Warner
/s/ Jeffrey P. Andrews
Jeffrey P. Andrews
Position
Chief Executive Officer and Director
(principal executive officer)
Controller & Acting Chief Financial Officer
(principal financial officer)
(principal accounting officer)
Date
March 31, 2015
March 31, 2015
Chairman of the Board
March 31, 2015
Director
Director
Director
37
March 31, 2015
March 31, 2015
March 31, 2015
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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
Consolidated Balance Sheets at December 31, 2014 and 2013
Consolidated Statements of Operations for the Years ended December 31, 2014 and 2013
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2014 and 2013
Consolidated Statements of Cash Flows for the Years ended December 31, 2014 and 2013
Notes to Consolidated Financial Statements
F-3
F-4
F-5
F-6 - F-7
F-8 - F-9
F-10
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 sheets of Telkonet, Inc. (the “Company”) as of December 31, 2014 and 2013 and
the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended
December 31, 2014. 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 audits.
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 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 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 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. at December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the two years in the period
ended December 31, 2014, 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 $121,906,017 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, 2015
F-3
TELKONET, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2014 AND 2013
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash on deposit
Accounts receivable, net
Inventories, net
Prepaid expenses
Total current assets
Property and equipment, net
Other assets:
Goodwill
Intangible assets, net
Deposits
Deferred financing costs, net
Total other assets
Total Assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Accrued liabilities and expenses
Notes payable – current
Line of credit
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,
2014
December 31,
2013
$
1,128,072 $
63,000
1,460,422
1,027,250
95,282
3,774,026
572,672
382,000
1,659,756
939,382
171,216
3,725,026
131,750
44,638
5,796,430
1,016,937
34,238
33,582
6,881,187
5,796,430
1,258,617
34,238
–
7,089,285
$
10,786,963 $
10,858,949
$
1,680,692 $
1,090,025
279,740
628,204
120,754
394,717
4,194,132
140,575
114,212
534,661
789,448
1,843,589
1,997,157
265,985
–
111,291
77,405
4,295,427
130,920
394,502
335,275
860,697
Redeemable preferred stock:
15,000,000 shares authorized, par value $.001 per share
Series A; 215 shares issued, 185 shares outstanding at December 31, 2014 and 2013,
respectively, preference in liquidation of $1,303,859 and $1,229,832 as of December 31,
2014 and 2013, respectively
Total redeemable preferred stock
Commitments and contingencies
Stockholders’ Equity
Series B; 538 shares issued, 55 shares outstanding at December 31, 2014 and 2013,
respectively, preference in liquidation of $372,030 and $350,005 as of December 31, 2014
and 2013, respectively
Common stock, par value $.001 per share; 190,000,000 shares authorized; 125,035,612
shares issued and outstanding at December 31, 2014 and 2013, respectively
Additional paid-in-capital
Accumulated deficit
Total stockholders’ equity
1,303,859
1,303,859
1,165,625
1,165,625
372,030
324,063
125,035
125,908,476
(121,906,017)
4,499,524
125,035
126,036,949
(121,948,847)
4,537,200
Total Liabilities and Stockholders’ Equity
$
10,786,963 $
10,858,949
See accompanying notes to consolidated financial statements
F-4
TELKONET, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013
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
Income (Loss) from Operations
Other (Expenses) Income:
Interest income (expense), net
Gain on sale of product line
Total Other (Expenses) Income
Income (Loss) Before Provision for Income Taxes
Provision for Income Taxes
Net Income (Loss)
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
2014
2013
$
10,973,544 $
3,822,987
14,796,531
10,123,407
3,766,439
13,889,846
6,504,630
1,053,215
7,557,845
6,034,294
1,069,558
7,103,852
7,238,686
6,785,994
1,312,488
5,366,006
–
275,236
6,953,730
1,174,048
6,248,082
2,774,016
258,517
10,454,663
284,956
(3,668,669)
(40,273)
–
(40,273)
(18,141)
41,902
23,761
244,683
(3,644,908)
201,853
349,823
42,830
(3,994,731)
(138,233)
(905,977)
(95,403) $
(4,900,708)
(0.00) $
(0.00) $
125,035,612
125,035,612
(0.04)
(0.04)
114,670,433
114,670,433
$
$
$
See accompanying notes to consolidated financial statements
F-5
TELKONET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013
Series B
Preferred
Stock
Shares
Series B
Preferred
Stock
Amount
Common
Shares
Common
Stock
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Total
Stockholders’
Equity
Balance at January 1, 2013
–
– 108,103,001 $
108,103 $124,188,415 $(117,954,116) $
6,342,402
Stock-based compensation
expense related to
employee stock options
Shares issued on conversion
of preferred stock at
approximately $0.13 per
share
Shares issued for cashless
–
–
–
–
89,565
–
89,565
–
– 16,846,139
16,846
2,665,032
–
2,681,878
Series B warrants exercised
–
–
86,472
86
(86)
–
–
Accretion of redeemable
preferred stock discount
Accretion of redeemable
preferred stock dividends
Reclassification from
temporary equity to
permanent equity
Net loss
Balance at December 31,
2013
–
–
–
–
(705,170)
–
(705,170)
–
–
–
–
(200,807)
–
(200,807)
55
324,063
–
–
–
–
–
–
–
–
324,063
–
(3,994,731)
(3,994,731)
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-6
TELKONET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013
Series B
Preferred
Stock
Shares
Series B
Preferred
Stock
Amount
Common
Shares
Common
Stock
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Total
Stockholders’
Equity
Balance at January 1, 2014
55 $
324,063 125,035,612 $
125,035 $126,036,949 $(121,948,847) $
4,537,200
Stock-based compensation
expense related to
employee stock options
Accretion of redeemable
preferred stock discount
Accretion of redeemable
preferred stock dividends
Value of warrants issued in
conjunction with line of
credit
Value of warrants issued for
consulting
Net income
Balance at December 31,
2014
–
–
–
–
15,046
–
15,046
–
25,942
–
–
(90,149)
–
(64,207)
–
22,025
–
–
(96,051)
–
(74,026)
–
–
–
–
37,897
–
37,897
–
–
–
–
–
–
–
–
4,784
–
4,784
–
42,830
42,830
55 $
372,030 125,035,612 $
125,035 $125,908,476 $(121,906,017) $
4,499,524
See accompanying notes to the consolidated financial statements
F-7
TELKONET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013
Cash Flows from Operating Activities:
Net income (loss)
Adjustments to reconcile net income (loss) from operations to cash (used in) provided
by operating activities:
Gain on sale of product line
Stock-based compensation expense
Amortization of deferred financing costs
Depreciation
Amortization
Provision for doubtful accounts, net of recoveries
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 (Used In) Provided By Operating Activities
Cash Flows From Investing Activities:
Purchase of property and equipment
Change in restricted cash
Net Cash Provided By (Used In) Investing Activities
Cash Flows From Financing Activities:
Proceeds from line of credit
Payments on notes payable
Net Cash Provided By (Used In) Financing Activities
Net increase (decrease) 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
2014
2013
$
42,830 $
(3,994,731)
–
15,046
9,100
33,556
241,680
(76,910)
199,386
–
276,244
(87,868)
75,934
(162,897)
(907,132)
9,463
317,312
9,655
(4,601)
(120,668)
319,000
198,332
628,204
(266,535)
361,669
555,400
572,672
1,128,072 $
$
(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
See accompanying notes to consolidated financial statements
F-8
TELKONET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013
Supplemental Disclosures of Cash Flow Information:
Cash transactions:
Cash paid during the year for interest
Cash paid during the year for income taxes, net of refunds
Non-cash transactions:
Accretion of discount on redeemable preferred stock
Accretion of dividends on redeemable preferred stock
Conversion of preferred stock to common stock
2014
2013
$
39,014 $
1,420
90,149
96,051
–
29,064
9,967
705,170
200,807
2,681,878
See accompanying notes to consolidated financial statements
F-9
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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”, “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.
In 2007, the Company acquired substantially all of the assets of Smart Systems International (“SSI”), which was a provider of energy
management products and solutions to customers in the United States and Canada and the precursor to the Company’s EcoSmart platform.
The EcoSmart platform provides comprehensive savings, management reporting, analytics and virtual engineering of a customer’s portfolio
and/or property’s room-by-room energy consumption. Telkonet has deployed more than a half million intelligent devices worldwide in
properties within the hospitality, military, educational, healthcare and other commercial markets. The EcoSmart platform is rapidly being
recognized as a leading solution for reducing energy consumption, operational costs and carbon footprints, and eliminating the need for
new energy generation in these marketplaces – all whilst improving occupant comfort and convenience.
In 2007, the Company acquired 100% of the outstanding membership units of EthoStream, LLC (“EthoStream”). EthoStream is one of the
largest public 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.
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 net income of
$42,830 and a net loss of $3,994,731 for the years ended December 31, 2014 and 2013, respectively, and has an accumulated deficit of
$121,906,017 and total current liabilities in excess of current assets of $420,106 as of December 31, 2014.
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 2015 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. On September 30, 2014, the Company and its wholly-owned subsidiary, EthoStream LLC, as co-borrowers (collectively, the
“Borrowers”), entered into a Loan and Security Agreement (the “Loan Agreement”) with Heritage Bank of Commerce, a California state
chartered bank (“Heritage Bank”), governing a new revolving credit facility in a principal amount not to exceed $2,000,000 (the “Credit
Facility”). Availability of borrowings under the Credit Facility from time to time is subject to a borrowing base calculation based on the
Company’s eligible accounts receivable and eligible inventory each multiplied by an applicable advance rate, with an overall limitation tied
to the Company’s eligible accounts receivable. The Loan Agreement is available for working capital and other lawful general corporate
purposes. The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%. The Credit Facility matures
on September 30, 2016, unless earlier accelerated under the terms of the Loan Agreement. The outstanding balance was $628,204 on the
Credit Facility as of December 31, 2014 and the remaining available borrowing capacity was approximately $241,000 at December 31,
2014. There exists a possibility the Company may not meet a certain required covenant for the period ending March 31, 2015. We have
notified Heritage Bank about the possible violation and are in negotiations regarding remedies in the event this violation occurs.
F-10
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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.
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 was to
expire September 30, 2014, or sooner if the Company satisfied all obligations under the arrangement. The amount is presented as restricted
cash on deposit on the consolidated balance sheet as of December 31, 2013. In March 2014, the Company satisfied all obligations related to
the bonding requirement and the cash was released.
During 2014, the Company was again awarded a contract with a bonding requirement. The Company satisfied this requirement during the
year ended December 31, 2014 with cash collateral supported by an irrevocable standby letter of credit in the amount of $63,000 which is to
expire December 31, 2015, or sooner if the Company satisfies all obligations under the arrangement. The amount is presented as restricted
cash on deposit on the consolidated balance sheet as of December 31, 2014.
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 $36,873 and $156,966 at December 31, 2014 and 2013, respectively. 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 Accounting Standards Codification (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, line of
credit, 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 line of credit and notes payable. The carrying amount of the line of credit and notes
payable approximates fair value due to the interest rate and terms approximating those available to us for similar obligations.
F-11
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
The Company accounts for the fair value of financial instruments in accordance with 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.
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 platform. 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 income (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, 2014 and 2013, there were 9,845,758 and 11,095,139 shares of common stock underlying
options and warrants excluded due to these instruments being anti-dilutive, respectively.
F-12
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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.
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 605-25. Arrangements under such contracts may 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 equipment has value to
the customer on a stand-alone basis, and (ii) delivery of the undelivered service 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 – In most instances, products are sold separately in stand-alone arrangements. Services are also sold separately through
renewals of contracts with varying periods. We determine VSOE based on 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.
F-13
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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, 2014 and 2013, the Company experienced
returns of approximately 1% to 3% of material’s included in the cost of sales. As of December 31, 2014 and 2013, the Company recorded
warranty liabilities in the amount of $44,288 and $77,943, respectively, using this experience factor range.
Product warranties for the years ended December 31 is as follows:
Beginning balance
Warranty claims incurred
Provision charged to expense
Ending balance
Advertising
2014
2013
$
$
77,943 $
(45,710)
12,055
44,288 $
69,743
(9,106)
17,306
77,943
The Company follows the policy of charging the costs of advertising to expenses as incurred. The Company incurred $15,021 and $21,499
in advertising costs during the years ended December 31, 2014 and 2013, 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 2014 and 2013 were $1,312,488 and
$1,174,048, 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.
F-14
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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 2014 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, 2014 and 2013 was
$15,046 and $89,565, 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, 2014 and 2013 was $46,673 and $91,981, respectively.
NOTE B – NEW ACCOUNTING PRONOUNCEMENTS
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 was effective for reporting periods beginning after December 15, 2013. The Company applied this guidance in the
current year and did not have a material impact on the Company's statement of operations, financial position or cash flows.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all
existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised
goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those
goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates
may be required within the revenue recognition process than are required under existing U.S. GAAP. The standard is effective for annual
periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full
retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical
expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption
(which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our
consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017.
In June 2014, the FASB issued ASU No. 2014-12, Compensation-Stock Compensation (Topic 718). Under ASU No. 2014-12 an award
with a performance target generally requires an employee to render service until the performance target is achieved. In some cases,
however, the terms of an award may provide that the performance target could be achieved after an employee completes the requisite
service period. That is, the employee would be eligible to vest in the award regardless of whether the employee is rendering service on the
date the performance target is achieved. This ASU will be effective for reporting periods beginning after December 15, 2015. The
Company does not believe this guidance will have a material impact on the Company's future statement of operations, financial position or
cash flows.
F-15
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure
of Uncertainties about an Entity’s Ability to Continue as a Going Concern which requires management to evaluate, in connection with
preparing financial statements for each annual and interim reporting period, whether there are conditions or events, considered in the
aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the
financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable)
and provide related disclosures. ASU 2014-15 is effective for annual periods beginning after December 15, 2016 and thereafter. Early
adoption is permitted. We are currently evaluating the impact of our pending adoption of ASU 2014-15 on our consolidated financial
statements.
NOTE C – INTANGIBLE ASSETS AND GOODWILL
Total identifiable intangible assets acquired and their carrying values at December 31, 2014 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 $
(1,883,063) $
(1,883,063)
–
–
–
(1,883,063) $
– $
–
(3,000,000)
(5,874,016)
(8,874,016)
(8,874,016) $
1,016,937
1,016,937
5,796,430
–
5,796,430
6,813,367
12.0
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 amortization expense charged to operations for the years ended December 31, 2014 and 2013 was $241,680 per year.
F-16
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
Estimated future amortization expense as of December 31, 2014 is as follows:
Years Ended December 31,
2015
2016
2017
2018
2019
Total
$
$
241,680
241,680
241,680
241,680
50,217
1,016,937
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, 2009 and 2008, the Company determined that a portion of the
value of EthoStream’s goodwill had been impaired based upon management’s assessment of operating results and forecasted discounted
cash flow and wrote off $1,000,000 and $2,000,000, respectively, of its value. 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 included: expected revenue growth rates, reporting
unit profit margins, working capital levels, discount rates of 12.4% for EthoStream and 21.8% 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.
Significant assumptions used in our goodwill impairment test at December 31, 2014 for EthoStream included: expected revenue growth
rates, reporting unit profit margins, working capital levels, discount rate of 10.8% 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.
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 remaining 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, 2014 and 2013 are as follows:
Accounts receivable
Allowance for doubtful accounts
Accounts receivable, net
$
$
2014
2013
1,497,295
(36,873)
1,460,422 $
1,816,722
(156,966)
1,659,756
F-17
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
NOTE E – INVENTORIES
Components of inventories as of December 31, 2014 and 2013 are as follows:
Product purchased for resale
Reserve for obsolescence
Inventory, net
NOTE F – PROPERTY AND EQUIPMENT
2014
2013
$
$
1,220,600 $
(193,350)
1,027,250 $
997,332
(57,950)
939,382
The Company’s property and equipment as of December 31, 2014 and 2013 consists of the following:
Development test equipment
Computer software
Leasehold improvements
Office equipment
Office fixtures and furniture
Total
Accumulated depreciation
Total property and equipment
$
$
2014
2013
45,752 $
55,677
2,675
20,706
157,183
281,993
(150,243)
131,750 $
45,752
55,677
2,675
20,706
36,515
161,325
(116,687)
44,638
Depreciation expense included as a charge to income was $33,556 and $16,837 for the years ended December 31, 2014 and 2013,
respectively.
NOTE G – ACCRUED LIABILITIES AND EXPENSES
Accrued liabilities and expenses as of December 31, 2014 and 2013 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
$
$
2014
2013
342,841 $
345,589
353,260
4,047
44,288
1,090,025 $
405,073
430,871
1,080,482
2,788
77,943
1,997,157
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 Loan Agreement in whole or in part at any time without
penalty. The Loan Agreement was secured by substantially all of the Company’s assets. On September 24, 2014, the Department signed a
subordination agreement of all the Company’s security interests. 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, 2014 and 2013 were $103,979 and $154,463, respectively.
F-18
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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 year ended December 31, 2013, the non-cash reduction of
principal calculated under these provisions and applied to the Note was $41,902. 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, 2014 and 2013 was $289,973 and $506,024,
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 was subject to a borrowing base that was 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 was available for working capital and other lawful general
corporate purposes. As of December 31, 2013 and March 31, 2014, the Company was in violation of a financial performance covenant.
Although the Company’s violation of the financial performance covenant constituted a default under the Agreement, the Bank did not
pursue any remedies under the default provisions of the Agreement. On May 31, 2014, the Company and the Bank mutually agreed to
terminate the Agreement and the Company paid the remaining outstanding principal balance of $50,000.
On September 30, 2014, the Company and its wholly owned subsidiary, EthoStream LLC, as co-borrowers (collectively, the “Borrowers”),
entered into a Loan and Security Agreement (the “Loan Agreement”) with Heritage Bank of Commerce, a California state chartered bank
(“Heritage Bank”), governing a new revolving credit facility in a principal amount not to exceed $2,000,000 (the “Credit Facility”).
Availability of borrowings under the Credit Facility from time to time is subject to a borrowing base calculation based on the Company’s
eligible accounts receivable and eligible inventory each multiplied by an applicable advance rate, with an overall limitation tied to the
Company’s eligible accounts receivable. The Loan Agreement is available for working capital and other lawful general corporate purposes.
The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 6.25% at December 31,
2014. The Credit Facility matures on September 30, 2016, unless earlier accelerated under the terms of the Loan Agreement. On October 9,
2014, as part of the Loan Agreement, Heritage Bank was granted a warrant to purchase 250,000 shares of Telkonet common stock. The
warrant has an exercise price of $0.20 and expires October 9, 2021.
The Loan Agreement contains customary covenants that place restrictions on, among other things, the incurrence of debt, granting of liens
and sale of assets. The Credit Agreement also contains financial covenants that require the Borrowers to maintain a minimum EBITDA
level, measured quarterly, and a minimum asset coverage ratio, measured monthly. A violation of any of these covenants could result in an
event of default under the Loan Agreement. Upon the occurrence of such an event of default or certain other customary events of defaults,
payment of any outstanding amounts under the Credit Facility may be accelerated and Heritage Bank’s commitment to extend credit under
the Loan Agreement may be terminated. The Loan Agreement contains other representations and warranties, covenants, and other
provisions customary to transactions of this nature. As of December 31, 2014, the Company was in compliance with the financial covenants
that required the Company to maintain a minimum EBITDA level and minimum asset coverage ratio. The outstanding balance on the
Credit Facility is $628,204 at December 31, 2014 leaving an available borrowing base of approximately $241,000. There exists a possibility
the Company may not meet a certain required covenant for the period ending March 31, 2015. We have notified Heritage Bank about the
possible violation and are in negotiations regarding remedies in the event this violation occurs.
Aggregate annual future maturities of long-term debt as of December 31, 2014 are as follows:
Years ending December 31,
2015
2016
Less: Current portion
Notes payable long-term
Amount
279,740
114,212
393,952
(279,740)
114,212
$
$
F-19
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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 a 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,
November, 16, 2009, 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
would be payable by the Company in three equal annual installments with the first of these three installments 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 including accumulated dividends, has been classified as redeemable preferred stock on the
consolidated balance sheets.
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 was 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, 2014 and 2013
was $64,207 and $70,032, respectively.
For the years ended December 31, 2014 and 2013, we have accrued dividends for Series A in the amount of $74,026 and $74,027,
respectively and cumulative accrued dividends of $378,859 and $304,832 as of December 2014 and 2013, respectively. The accrued
dividends have been charged to additional paid-in capital and an increase to the net loss attributable to common stockholders (since there is
a deficit in retained earnings) 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 a 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, had 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.
F-20
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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, a 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.
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, August 4, 2010, 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 during the year ended December 31, 2013.
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, 2014 and 2013
was $25,942 and $635,138, respectively.
For the years ended December 31, 2014 and 2013, we have accrued dividends for Series B in the amount of $22,025 and $126,780,
respectively, and cumulative accrued dividends of $97,030 and $75,005 as of December 31 2014 and 2013, 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 $372,030 and
second, Series A with a preference value of $1,303,859. Both series of preferred stock are equal in their dividend preference over common
stock.
F-21
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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, 2014 and
2013, there were 185 shares of Series A and 55 shares of Series B outstanding.
The Company has authorized 190,000,000 shares of common stock with a par value of $.001 per share. As of December 31, 2014 and 2013
the Company has 125,035,612 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.
NOTE K – STOCK OPTIONS AND WARRANTS
Employee Stock Options
The Company maintains an equity incentive plan, (the “Plan”). The Plan was 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 following table summarizes the changes in options outstanding and the related prices for the shares of the Company’s common stock
issued to employees of the Company under the Plan as of December 31, 2014.
Options Outstanding
Options Exercisable
Exercise Prices
$
$
$
0.01 - $0.15
0.16 - $0.99
1.00 - $5.60
Number
Outstanding
175,000
1,620,225
135,000
1,930,225
Weighted Average
Remaining
Contractual Life
(Years)
Weighted Average
Exercise Price
Number
Exercisable
Weighted Average
Exercise Price
2.82 $
7.98
1.53
7.06 $
0.14
0.18
3.29
0.40
175,000 $
1,284,791
135,000
1,594,791 $
0.14
0.18
3.29
0.44
Transactions involving stock options issued to employees are summarized as follows:
Outstanding at January 1, 2013
Granted
Exercised
Cancelled or expired
Outstanding at December 31, 2013
Granted
Exercised
Cancelled or expired
Outstanding at December 31, 2014
Number of
Shares
Weighted Average
Price Per Share
1,280,642 $
504,583
–
(50,000)
1,735,225 $
200,000
–
(5,000)
1,930,225 $
0.62
0.18
–
2.69
0.43
0.19
–
3.50
0.40
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, 2014 AND 2013
The following table summarizes the assumptions used to estimate the fair value of options granted during the years ended December 2014
and 2013, using the Black-Scholes option-pricing model:
Expected life of option (years)
Risk-free interest rate
Assumed volatility
Expected dividend rate
Expected forfeiture rate
2014
2013
10
2.77%
110%
0
0%
10
1.72%
124%
0
6%
The total estimated fair value of the options granted during the years ended December 31, 2014 and 2013 was $35,298 and $86,672. The
total fair value of underlying shares related to options that vested during the years ended December 31, 2014 and 2013 was $15,047 and
$124,208. Future compensation expense related to non-vested options at December 31, 2014 was $48,695 and will be recognized over the
next 3.41 years. The aggregate intrinsic value of the vested options was zero as of December 31, 2014 and 2013. Total stock-based
compensation expense recognized in the consolidated statements of operations for the years ended December 31, 2014 and 2013 was
$15,046 and $89,565, respectively.
Non-Employee Stock Options
There were no non-employees stock options issued or outstanding at December 31, 2014 or 2013.
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
$
0.13
0.18
0.20
3.00
7,230,778
50,000
250,000
384,755
7,915,533
Weighted Average
Remaining
Contractual Life
(Years)
Weighted Average
Exercise Price
Number
Exercisable
Weighted Average
Exercise Price
1.11 $
2.91
6.77
0.83
1.29 $
0.13
0.18
0.20
3.00
0.27
7,230,778 $
50,000
250,000
384,755
7,915,533 $
0.13
0.18
0.20
3.00
0.27
Transactions involving warrants are summarized as follows:
Outstanding at January 1, 2013
Issued
Exercised
Canceled or expired
Outstanding at December 31, 2013
Issued
Exercised
Canceled or expired
Outstanding at December 31, 2014
Number of
Shares
Weighted Average
Exercise Price
10,830,416 $
–
(86,472)
(1,384,030)
9,359,914 $
300,000
–
(1,744,381)
7,915,533 $
0.45
–
0.13
1.36
0.32
0.20
–
0.51
0.27
The Company issued 300,000 warrants during the year ended December 31, 2014. 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, 2014 AND 2013
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 certain 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 $29,000, grossed up to accommodate
their 2013 and 2014 federal income tax liability associated with the payments.
On July 17, 2014, Messer’s Davis and Tienor each signed a General Indemnity Agreement pledging personal property on behalf of the
Company for another customer contract that required bonding. The Company agreed to compensate each in the amount of $9,000, grossed
up to accommodate their 2014 federal income tax liability associated with the payments. The amounts owed to Messrs. Davis and Tienor as
of December 31, 2014 were $6,000 and $18,090 recorded in accounts payable and accrued expense respectively on the accompanying
consolidated balance sheet. 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, 2014 and 2013, 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 (benefits) computed at the statutory rate
State taxes
Book expenses not deductible for tax purposes
Expired capital losses
Other
Change in valuation allowance for deferred tax assets
Income tax expense
$
$
2014
2013
83,192 $
(26,756)
20,846
(176,627)
(345)
(99,690)
301,543
201,853 $
(1,239,269)
5,849
19,572
–
526
(1,213,322)
1,563,145
349,823
During 2014, approximately $200,000 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 $20,000.
F-24
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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 carry forwards
Intangibles
Other
Total deferred tax assets
Deferred Tax Liabilities:
Intangibles
Total deferred tax liabilities
Valuation allowance
Net deferred tax assets
2014
2013
$
31,909,052 $
1,141,121
728,937
33,779,110
31,686,463
1,277,631
872,796
33,836,890
(534,661)
(534,661)
(33,779,110)
$
(534,661) $
(335,275)
(335,275)
(33,836,890)
(335,275)
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, 2014 and 2013, the Company’s valuation
allowance, established for the tax benefit that may not be realized, totaled approximately $33,780,000 and $33,840,000, respectively. The
overall decrease in the valuation allowance is related to federal and state loss carryforwards that expired as of December 31, 2014, less
federal and state losses generated for the year ended December 31, 2014.
At December 31, 2014 the Company had net operating loss carryforwards of approximately $89,700,000 and $46,900,000 for federal and
state income tax purposes which will expire at various dates from 2015 – 2034.
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 impos ed 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 2010 and various states before 2010. 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 change in the liability for unrecognized tax benefits. The Company has no tax positions at December 31, 2014 or
2013 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,
2014 or 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.
F-25
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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, 2014 are as follows:
Years ending December 31,
2015
2016
2017
2018
2019
2020 and thereafter
Total
$
$
494,806
245,274
251,740
258,381
265,305
156,877
1,672,383
Expected rent payments to be received under sublease agreement as of December 31, 2014 are $138,919 for the year ended December 31,
2015.
Rental expenses charged to operations for the years ended December 31, 2014 and 2013 was $642,277 and $532,598, respectively. Rental
income received for the year ended December 31, 2014 and 2013 was $136,666 and $131,111, 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,
2014. Mr. Reinder’s employment agreement is for a term expiring on May 1, 2015, 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 infringe a wireless network security patent held by Linksmart.
F-26
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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.
On October 1, 2013, the Company entered into a settlement agreement with Linksmart. The Company 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 was paid in full at September 30,
2014.
Eric Sprangers v. Telkonet, Inc. and Ethostream, LLC
On or about April 23, 2014, Eric Sprangers filed a complaint against Telkonet, Inc. and Ethostream, LLC (the “Companies”) in the United
States District Court for the Eastern District of Wisconsin. The Complaint, filed by Sprangers on behalf of himself and a putative class of
allegedly similarly situated employees of the Companies, claims that the Companies failed to pay him and the putative class members
overtime compensation in violation of the federal Fair Labor Standards Act (“FLSA”). Among other things, the complaint seeks payment to
the putative class members of back overtime, liquidated damages and penalties as provided in the FLSA, and an award of costs and
attorneys’ fees. On or about May 22, 2014, the Companies filed an answer to the complaint in which the Companies deny that they failed to
pay overtime compensation in violation of the FLSA. On July 25, 2014, Sprangers accepted a Rule 68 offer of judgment that was made by
the Companies on July 11, 2014 in the amount of $10,000, plus an additional amount for attorneys’ fees, costs and expenses to be
determined by the Court. On September 12, 2014, the Court ordered judgment consistent with the accepted offer of judgment. The
additional attorney fees were $9,939. Per the judgment, the offer and attorney fees were to be paid in two installments, September 23, 2014
and October 23, 2014. The Company complied with the judgment.
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 $353,000 and
$1,100,000 accrued for this exposure as of December 31, 2014 and 2013, 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 $200,000, not including any
applicable interest and penalties.
Prior to 2014, the Company successfully executed and paid in full VDAs in nineteen states totaling approximately $286,000 and is current
with the subsequent filing requirements.
During the year ended December 31, 2014, the Company successfully executed and paid in full VDAs in twelve states totaling
approximately $407,000 and is current with the subsequent filing requirements.
F-27
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014 AND 2013
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
NOTE O – BUSINESS CONCENTRATION
$
$
2014
2013
1,080,482 $
426,599
(599,295)
–
(554,526)
353,260 $
1,188,133
409,782
(138,352)
7,342
(386,423)
1,080,482
For the years ended December 31, 2014 and 2013, no single customer represented 10% or more of our total net revenues.
As of December 31, 2014, one customer accounted for 13% of the Company’s net accounts receivable. As of December 31, 2013, one
customer accounted for 28% of the Company’s net accounts receivable.
Purchases from two suppliers approximated $3,700,000, or 76%, of total purchases for the year ended December 31, 2014 and
approximately $2,700,000, or 68%, of total purchases for the year ended December 31, 2013. Total due to these suppliers, net of deposits,
was $750,084 and $525,464 as of December 31, 2014 and 2013, respectively.
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, 2015, 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, 2015
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, 2015
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, 2015
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, 2014 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, 2015
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, 2014 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, 2015