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, 2015
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 $0.23 per share on the Over the
Counter Bulletin Board) of the registrant as of June 30, 2015: $27,812,335.
Number of outstanding shares of the registrant’s par value $0.001 common stock as of March 22, 2016: 127,054,848.
Parts I and II incorporate information by reference from the Annual Report to Shareholders for the fiscal year ended December 31, 2015.
Part III is incorporated by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held on June 27, 2016.
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 intelligent automation solutions designed to optimize energy efficiency, comfort and analytics in support of the
emerging Internet of Things (“IoT”). Telkonet’s business is based on two synergistic divisions, its EcoSmart division offering intelligent
automation solutions and its EthoStream division providing the underlying networking technology.
Telkonet’s EcoSmart Platform is comprised of four main pillars.
ECOSMART
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EcoSmart Suite: The suite of intelligent hardware products designed and developed to provide monitoring, management,
command and control over individual and grouped energy consumption throughout building environments.
EcoCentral: The cloud-based dashboard and analytics platform that provides visualization and remote management of
Telkonet’s monitoring, reporting and analytics through deployed EcoSmart and integrated products.
EcoCare: Telkonet’s full offering of professional support and maintenance services including 24/7 monitoring,
engineering, analytics, reporting, software and hardware updates, extended warranty, project and relationship
management and onsite support.
EcoMobile: Native iOS and Android applications provided by Telkonet to its partners, customers and end users and
guests enabling provisioning, management and access and control over EcoSmart deployments and functionality.
The EcoSmart Platform provides comprehensive energy and operational savings, management monitoring, reporting, analytics and virtual
engineering of a customer’s portfolio and/or property’s room-by-room energy consumption and increased comfort and productivity through
a more intelligent and automated environment. Telkonet has deployed more than a half million intelligent devices worldwide in properties
and buildings 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 markets – all whilst improving occupant comfort and convenience.
1
Controlling energy consumption can make a significant impact on a building 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.
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, and 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 using an
industry-standard mesh networking technology.
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EcoTouch: One of the newest additions to Telkonet’s suite of hardware, the EcoTouch is an all touch capacitive
thermostat interface available in wired and wireless models offering the most aesthetic alternative to building controls
available on the market today.
EcoInsight: A programmable and controllable wired thermostat with over 125 configurable settings used to control the
efficiency of HVAC through the use of environment variables and triggers.
EcoAir: A wireless thermostat interface mirroring the EcoInsight footprint while enabling the relocation of in room
controls without the usual construction expense and downtime.
EcoSource: The remote HVAC control device associated with Telkonet’s thermostat interfaces allowing control while
removing the need for expensive rewiring and construction. The EcoSource may also be used for third-party integrations,
monitoring and control scenarios.
EcoConnect: An Ethernet to Zigbee interpreter that serves as the bridge for all EcoSmart devices connected to the
intelligent automation 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 environments with ultra, high-sensitive sensors designed to detect
motion, body heat, humidity 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: The 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: The 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 and monitoring the consumption and
efficiency of energy flow when a light is enabled.
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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
2
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EcoCentral
EcoGuard: The EcoSmart control that acts as the replacement for an in-wall outlet and 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 as well as providing monitoring of energy flow and efficiency when a plug is enabled.
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.
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. 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 building 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 end users or 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, timeshares, casinos, etc.
·
Educational: residence halls, dormitories 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 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.
3
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 named – Recovery Time.
Recovery Time Technology
EcoSmart’s entire 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 customer’s pre-defined period 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 causes 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;
4
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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.
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 options. Backlight friendly for visually impaired;
· Web-based access with extremely powerful yet simple to use EcoCentral dashboard 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);
5
· Offers rapid return on investment, typical ROI of two to three years; and
· Mobile applications facilitating installation, management and end-user accessibility.
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, multiple dwelling unit (“MDU”), 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 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 2014 report issued by Navigant Research, titled, “Energy Efficient Buildings: Global Outlook”, stated that the global market for energy
efficient building products and services is on the rise.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 Navigant report, the total market for energy efficiency in buildings will reach $623 billion by 2023, an increase of
more than 100% from the 2014 market value of $307 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, MDU 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.
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3 Center for Climate and Energy Efficiency - http://www.c2es.org/technology/overview/buildings
4 Energy Efficient Buildings: Global Outlook - https://www.navigantresearch.com/research/energy-efficient-buildings-global-outlook
6
COST OF ENERGY
Electricity
District Heat
Fuel Oil
Natural Gas
Educational Buildings
($8,111 million)
Healthcare Buildings
($4,882 million)
Office Buildings
($17,005 million)
Lodging Buildings
($5,228 million)
Education Industry
76%
80%
87%
79%
7%
N/A
4%
N/A
2%
1%
1%
%
15%
19%
8%
8%
Source: Energy Information Administration, 2003
Commercial Buildings Energy Consumption Survey
Telkonet’s most rapidly emerging market is the educational industry where we 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 4,600 rooms across 14 dormitories have been completed and have yielded
run-time and energy consumption reductions, operational savings from reduced field labor expenses and extension of equipment lifecycle.
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, Military Academy at West Point, 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.
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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
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.
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%.
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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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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.
Competition
We currently compete primarily within commercial and industrial markets, including the hospitality, education, healthcare, public housing,
MDU, 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 Inncom and Schneider Electric, with each
offering some level of comparable products to our standalone and/or 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 pillar platform;
Integration with property and building management systems (PMS & BMS);
· Utility demand-based program integration;
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Existing customer relationships through extensive history in the market; and
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.
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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.
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 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:
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
Intercontinental Hotels Group
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· 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.
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 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.
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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, MDU, 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, 2015 and 2014, no single customer represented 10% or more of our revenues. Recurring revenue
distributed across a network of approximately 2,300 customers approximated $4,200,000 for the year ended December 31, 2015.
Intellectual Property
We acquired certain intellectual properties 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.
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, 2015 and 2014, we spent $1,605,667 and $1,312,488, respectively, on research and development
activities. Telkonet’s EcoSmart related development efforts in 2015 and continuing into 2016 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 2015 and continuing into 2016 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.
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Other Information
Employees
As of March 22, 2016, we had 108 full-time employees. During 2015, significant positions filled included chief financial officer, controller
and channel account manager. We will continue to hire additional personnel as necessary to meet future operating requirements. We
anticipate that we may need to hire additional staff in the areas of customer support, field services, engineering, sales and marketing, and
administration.
Environmental Matters
We do not anticipate any material effect on our capital expenditures, earnings or competitive position due to compliance with government
regulations involving environmental matters.
ITEM 1A. RISK FACTORS.
Our results of operations, financial condition and cash flows can be adversely affected by various risks. These risks include, but are not
limited to, the principal factors listed below and the other matters set forth in this annual report on Form 10-K. You should carefully
consider all of these risks.
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.
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In addition, if the market for technology stocks or the stock market in general experiences a loss of investor confidence, the trading price of
our common stock could decline for reasons unrelated to our business, financial condition or results of operations. If any of the foregoing
occurs, it could cause our stock price to fall and may expose us to class action lawsuits that, even if unsuccessful, could be costly to defend
and a distraction to management.
Anti-takeover provisions in our charter documents and Utah law could discourage delay or prevent a change of control of our Company
and may affect the trading price of our common stock.
We are a Utah corporation and the anti-takeover provisions of the Utah Control Shares Acquisition Act may discourage, delay or prevent a
change of control by limiting the voting rights of control shares acquired in a control share acquisition. In addition, our Amended and
Restated Articles of Incorporation and bylaws may discourage, delay or prevent a change in our management or control over us that
shareholders may consider favorable. Among other things, our Amended and Restated Articles of Incorporation and bylaws:
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authorize the issuance of “blank check” preferred stock that could be issued by our board of directors 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 trading market for our common stock.
Our common stock is currently quoted on the OTCQB, operated by the OTC Markets Group. However, there is no guarantee that our
common stock will be actively traded on the OTCQB, 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.
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, 2015, we had outstanding employee options to purchase a total of 1,825,225 shares of common stock at exercise prices
ranging from $0.14 to $5.60 per share, with a weighted average exercise price of $0.28. As of December 31, 2015, we had warrants
outstanding to purchase a total of 5,638,410 shares of common stock at exercise prices ranging from $0.13 to $3.00 per share, with a
weighted average exercise price of $0.20. 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, 2015 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, 2015, 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.
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Products sold by our competitors could become more popular than our products or render our products obsolete.
The market for our products and services is highly competitive. Some of our competitors have longer operating histories, greater name
recognition and substantially greater financial, technical, sales, marketing and other resources. These competitors may, among other things,
undertake more extensive marketing campaigns, adopt more aggressive pricing policies, obtain more favorable pricing from suppliers and
manufacturers and exert more influence on the sales channel than we can. As a result, we may not be able to compete successfully with
these competitors, and these competitors may develop or market technologies and products that are more widely accepted than those being
developed by us or that would render our products obsolete or noncompetitive. We anticipate that competitors will also intensify their
efforts to penetrate our target markets. These competitors may have more advanced technology, more extensive distribution channels,
stronger brand names, bigger promotional budgets and larger customer bases than we do. These companies could devote more capital
resources to develop, manufacture and market competing products than we could. If any of these companies are successful in competing
against us, our sales could decline, our margins could be negatively impacted, and we could lose market share, any of which could seriously
harm our business, results of operations, and prospects.
Infringement by third parties on our proprietary technology and development of substantially equivalent proprietary technology by our
competitors could negatively impact our business.
Our success depends partly on our ability to maintain patent and trade secret protection, to obtain future patents and licenses and to operate
without infringing on the proprietary rights of third parties. There can be no assurance that the measures we have taken to protect our
intellectual property rights, including intellectual property rights of third parties integrated into our Telkonet iWire System product suite
and our EcoSmart Suite of products will prevent misappropriation or circumvention. A patent associated with our Recovery Time
technology expired in February 2014. To the extent any competitors are successful in creating competing technologies, this could have an
adverse impact on our business and financial results. In addition, there can be no assurance that any patent application, when filed, will
result in an issued patent, or that our existing patents, or any patents that may be issued in the future, will provide us with significant
protection against competitors. Moreover, there can be no assurance that any patents issued to, or licensed by, us will not be infringed upon
or circumvented by others. Infringement by third parties on our proprietary technology could negatively impact our business. Moreover,
litigation to establish the validity of patents, to assert infringement claims against others, and to defend against patent infringement claims
can be expensive and time-consuming, even if the outcome is in our favor. We also rely on unpatented proprietary technology, and no
assurance can be given that others will not independently develop substantially equivalent proprietary information, techniques or processes
or that we can meaningfully protect our rights to such unpatented proprietary technology. If our competitors develop substantially
equivalent technology and we are unable to enforce any intellectual property rights with respect to such technology in a cost-effective
manner or at all, our business and operations would suffer significant harm.
We may incur substantial damages due to litigation.
We cannot be certain that our products do not and will not infringe issued patents or other intellectual property rights of others. If it were
determined that our products infringe the intellectual property rights of another, we could be required to pay substantial damages or be
enjoined from licensing or using the infringing products or technology. Additionally, if it were determined that our products infringe the
intellectual property rights of others, we would need to obtain licenses from these parties or substantially re-engineer our products in order
to avoid infringement. We might not be able to obtain the necessary licenses on acceptable terms or at all, or to re-engineer our products
successfully. Any of the foregoing could cause us to incur significant costs and prevent us from selling our products.
We depend on a small team of senior management and may have difficulty attracting and retaining additional personnel.
Our future success will depend in large part upon the continued services and performance of senior management and other key personnel.
If we lose the services of any member of our senior management team, our overall operations could be materially and adversely affected. In
addition, our future success will depend on our ability to identify, attract, hire, train, retain and motivate other highly skilled technical,
managerial, marketing, purchasing and customer service personnel when they are needed. Competition for these individuals is intense. We
cannot ensure that we will be able to successfully attract, integrate or retain sufficiently qualified personnel when the need arises. Any
failure to attract and retain the necessary technical, managerial, marketing, purchasing and customer service personnel could have a
negative effect on our financial condition and results of operations.
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Any acquisitions we make could result in difficulties in successfully managing our business and consequently harm our financial
condition.
We may seek to expand by acquiring complementary businesses in our current or ancillary markets. We cannot accurately predict the
timing, size and success of our acquisition efforts and the associated capital commitments that might be required. We expect to face
competition for acquisition candidates, which may limit the number of acquisition opportunities available to us and may lead to higher
acquisition prices. There can be no assurance that we will be able to identify, acquire or profitably manage additional businesses or
successfully integrate acquired businesses, if any, without substantial costs, delays or other operational or financial difficulties. In addition,
acquisitions involve a number of other risks, including:
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failure of the acquired businesses to achieve expected results;
diversion of management’s attention and resources to acquisitions;
failure to retain key customers or personnel of the acquired businesses;
disappointing quality or functionality of acquired equipment and people; and
risks associated with unanticipated events, liabilities or contingencies.
Client dissatisfaction or performance problems at a single acquired business could negatively affect our reputation. The inability to acquire
businesses on reasonable terms or successfully integrate and manage acquired companies, or the occurrence of performance problems at
acquired companies, could result in dilution, unfavorable accounting treatment or one-time charges and difficulties in successfully
managing our business.
Our inability to obtain capital, use internally generated cash or debt, or use shares of our common stock to finance our operations or
future acquisitions could impair the growth and expansion of our business.
Reliance on internally generated cash or debt to finance our operations or complete acquisitions could substantially limit our operational
and financial flexibility. The extent to which we will be able or willing to use shares of our common stock to consummate acquisitions will
depend on the market value of our common stock which will vary, and our liquidity. Using shares of our common stock for this purpose
also may result in significant dilution to our then existing stockholders. To the extent that we are unable to use our common stock to make
future acquisitions, our ability to grow through acquisitions may be limited by the extent to which we are able to raise capital through debt
or additional equity financings. No assurance can be given that we will be able to obtain the necessary capital to finance any acquisitions or
our other cash needs. If we are unable to obtain additional capital on acceptable terms, we may be required to reduce the scope of any
expansion or redirect resources committed to internal purposes. In addition to requiring funding for acquisitions, we may need additional
funds to implement our internal growth and operating strategies or to finance other aspects of our operations. Our failure to: (i) obtain
additional capital on acceptable terms; (ii) use internally generated cash or debt to complete acquisitions because it significantly limits our
operational or financial flexibility; or (iii) use shares of our common stock to make future acquisitions, may hinder our ability to actively
pursue any acquisitions.
Potential fluctuations in operating results could have a negative effect on the price of our common stock.
Our operating results may fluctuate significantly in the future as a result of a variety of factors, most of which are outside our control,
including:
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the level of use of the Internet;
the demand for high-tech goods;
the amount and timing of capital expenditures and other costs relating to the expansion of our operations;
price competition or pricing changes in the industry;
technical difficulties or system downtime;
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changes in governmental policies;
economic conditions specific to the internet and communications industry; and
general economic conditions.
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.
Our financial performance may hinder our ability to obtain future financing and liquidity.
Risks Relating to Our Financial Results and Need for Financing
Our liquidity may be hindered by 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.
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, 2016, we
have issued 127,054,848 shares of common stock and have approximately 12,127,180 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, 2015, we have incurred cumulative losses of $122,095,121 and have never generated enough funds
through operations to support our business. For the year ended December 31, 2015, we had an operating cash flow deficit of $401,920. As
of December 31, 2015, we have a working capital deficit (current liabilities in excess of current assets) of $33,312. 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.
We have goodwill and intangible assets of approximately $5.8 million and $0.8 million, respectively, at December 31, 2015, 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 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. On February 17, 2016, an amendment to the Credit Facility was executed extending the
maturity date to September 30, 2018, unless earlier accelerated under the terms of 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
20
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.
Until December 2015, the Company leased 16,416 square feet of commercial office space in Germantown, Maryland. The lease
commitments expired 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.
In January 2016, the Company entered into a lease agreement for 2,237 square feet of commercial office space in Germantown, Maryland
for its Maryland employee’s. The Germantown lease expires at the end of January 2017.
ITEM 3. LEGAL PROCEEDINGS.
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.
ITEM 4. MINE SAFETY DISCLOSURES.
None.
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, 2015 and 2014.
Year Ended December 31, 2015
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Year Ended December 31, 2014
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Record Holders
$
$
High
Low
0.23 $
0.25
0.28
0.28
0.30 $
0.24
0.19
0.18
0.13
0.16
0.18
0.18
0.20
0.17
0.13
0.12
As of March 22, 2015, we had 208 record holders of our common stock and 127,054,848 shares of our common stock issued and
outstanding.
21
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, 2015.
Number of
securities to be
issued upon
exercise of
outstanding
options,
warrants and
rights
(a)
1,825,225 $
-
Weighted-
average
exercise price of
outstanding
options,
warrants and
rights
(b)
0.28
-
Number of
securities
remaining
available for
future issuance
under equity
compensation
plans
(excluding
securities
reflected in
column (a))
(c)
5,747,553
-
1,825,225 $
0.28
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.
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 the Company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and
accompanying notes. On an ongoing basis, the Company evaluates significant estimates used in preparing its consolidated financial
statements including those related to revenue recognition and allowances for uncollectible accounts receivable, inventory obsolescence,
long-lived and intangible asset valuations, impairment assessments, taxes and related valuation allowance, income tax provisions, stock-
based compensation, and contingencies. The Company bases its estimates on historical experience, underlying run rates and various other
assumptions that the Company believes 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.
22
Revenue Recognition
For revenue from product sales, the Company recognizes 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. Assuming all conditions for revenue recognition have been satisfied, product revenue is
recognized when products are shipped and installation revenue is recognized when the services are completed. 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 the Company’s
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. The Company determines 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 the Company cannot establish VSOE of selling price for a specific product or service included in a multiple-element
arrangement, the Company uses third-party evidence of selling price. The Company determines 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 the Company would sell a product or service if it were sold on a
stand-alone basis. When neither VSOE nor TPE exists for all elements, the Company determines ESP for the arrangement
element based on sales, cost and margin analysis, as well as other inputs based on the Company’s pricing practices. Adjustments
for other market and Company-specific factors are made as deemed necessary in determining ESP.
Under the estimated selling price method, revenue is recognized in MEAs based on estimated selling prices for all of the elements in the
arrangement, assuming all other conditions for revenue recognition have been satisfied. To determine the estimated selling price, the
Company establishes the selling price for its products and installation services using the Company’s established pricing guidelines, which
the proceeds are allocated between the elements and the arrangement.
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.
The Company provides call center support services to properties installed by the Company and also to properties installed by other
providers. In addition, the Company provides the property with the portal to access the Internet. The Company receives monthly service
fees from such properties for its services and Internet access. The Company recognizes 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. The Company reports such revenues as recurring revenues. Deferred
revenue includes deferrals for the monthly support service fees and Internet access.
23
Accounts Receivable
Accounts receivable are uncollateralized customer obligations due under normal trade terms. 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. 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.
Inventory Obsolescence
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 when it is determined that the Company’s carrying cost of such excess and obsolete inventories cannot be recovered in full, a charge is
taken against income for the difference between the carrying cost and the estimated realizable amount.
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, 2015 and 2014, the Company experienced approximately
between 1% and 3% of returns related to product warranties. As of December 31, 2015 and 2014, the Company recorded warranty
liabilities in the amount of $66,555 and $44,288, 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.
24
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 the
annual 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.
Significant assumptions used in our goodwill impairment test at December 31, 2015, for Ethostream included: expected revenue growth
rates, reporting unit profit margins, working capital levels, discount rates of 10.6% 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 $230,000 and
$353,000 accrued for this exposure as of December 31, 2015 and 2014, 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 $30,000, not including any
applicable interest and penalties.
Prior to 2015, the Company successfully executed and paid in full VDAs in thirty one states totaling approximately $695,000 and is current
with the subsequent filing requirements.
During the year ended December 31, 2015, the Company executed two VDA’s totaling approximately $55,000. The Company is currently
in negotiations with one state.
25
EBITDA
Management believes that certain non-GAAP financial measures may be useful to investors 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. Adjusted EBITDA is not, and
should not be considered, an alternative to net income (loss), income (loss) from operations, or any other measure for determining operating
performance of liquidity, as determined under accounting principles generally accepted in the United States (GAAP). In assessing the
overall health of its business for the years ended December 31, 2015 and 2014, the Company excluded items in the following general
category described below:
· Stock-based compensation: The Company believes that because of the variety of equity awards used by companies, varying
methodologies for determining stock-based compensation and the assumptions and estimates involved in those determinations, the
exclusion of non-cash stock-based compensation enhances the ability of management and investors to understand the impact of non-
cash stock-based compensation on our operating results. Further, the Company believes that excluding stock-based compensation
expense allows for a more transparent comparison of its financial results to the previous year.
RECONCILIATION OF NET (LOSS) INCOME TO ADJUSTED EBITDA
FOR THE YEARS ENDED DECEMBER 31,
Net (loss) income
Interest expense, net
Provision for income taxes
Depreciation and amortization
EBITDA
Adjustments:
Stock-based compensation
Adjusted EBITDA
Results of Operations
2015
2014
$
$
(189,104) $
69,441
197,072
273,507
350,916
14,383
365,299 $
42,830
40,273
201,853
275,236
560,192
15,046
575,238
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Revenues
The table below outlines our product versus recurring revenues for comparable periods:
2015
Year Ended December 31,
2014
Variance
Product
Recurring
Total
$
$
10,908,704
4,175,222
15,083,926
72% $
28%
100% $
10,973,544
3,822,987
14,796,531
74% $
26%
100% $
(64,840)
352,235
287,395
-1%
9%
2%
26
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. The Company
markets and sells to the hospitality, education, healthcare and government/military markets.
For the year ended December 31, 2015, product revenue decreased $0.06 million, or 1% when compared to the prior year. Product revenue
in 2015 included approximately $7.24 million attributed to the sale and installation of energy management platform products and
approximately $3.67 million for the sale and installation of HSIA products. Energy management platform products increased $1.26 million
while HSIA product revenue decreased $1.32 million. During 2014, a significant portion of HSIA installations were related to an
equipment upgrade of a large hotel chain with several brands with no similar upgrade by a major chain occurring during the year ended
December 31, 2015. The Company’s commitment to access distribution channels through resellers and value added distribution partners
continues to gain momentum. Product revenue attributed to sales from channel partnerships and value added resellers increased $1.16
million for the year ended December 31, 2015 to $5.89 million compared to $4.73 million in 2014. The Company has been making a
concerted effort to increase channel partner relationships and expects this trend to continue.
Recurring Revenue
Recurring revenue is primarily attributed to recurring services. The Company recognizes revenue ratably over the service month for
monthly support revenues and defers revenue for annual support services over the term of the service period. The recurring revenue
consists primarily of HSIA support services, and Telkonet’s EcoCare service and support program. Advertising revenue, which is
approximately 1% of the Company’s support 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 the Company’s
recurring revenue is derived from fees, less payback costs, associated with less than 1% of its hospitality customers who do not internally
manage guest-related, internet transactions.
Recurring revenue includes approximately 2,300 hotels in the Company’s broadband network portfolio. The Company currently supports
approximately 234,000 HSIA rooms with approximately 8.0 million monthly users. For the year ended December 31, 2015, recurring
revenue increased by 9% when compared to the prior year. For the year end comparison, the variance in recurring revenue was partially
attributed to a $0.17 million increase associated with the rollout of the Company’s EcoCare service and support program for the EcoSmart
Suite of products. Support revenue from the Company’s HSIA support services added approximately $0.17 million compared to the prior
year. Advertising revenue contributed a $0.01 million increase.
Cost of Sales
2015
Year ended December 31,
2014
Variance
Product
Recurring
Total
$
$
5,734,954
1,010,662
6,745,616
53% $
24%
45% $
6,504,630
1,053,215
7,557,845
59% $
28%
51% $
(769,676)
(42,553)
(812,229)
-12%
-4%
-11%
Costs of Product Sales
Costs of product sales include equipment and installation labor related to the sale of broadband networking equipment, including EcoSmart
technology and Telkonet iWire. For year ended December 31, 2015, product costs decreased by 12% compared to the prior year. A $0.26
million decrease in outside contractor services was a result of a contract requiring EthoStream to use an outside contractor for an HSIA
installation and Telkonet using an outside contractor for a large university installation during the year ended December 31, 2014. No
similar contract requirements for installations took place for the year ended December 31, 2015. A materials cost decrease of $0.31 million
was the result of the decrease in HSIA product revenue. Because of strong competition, HSIA products carry smaller gross margins than
the Company’s EcoSmart Suite of products. The remaining decrease of $0.26 million was a result of a decrease in travel expense, parts and
supplies, a broadband equipment rebate, salaries and international freight charges for inventory procurement offset by an increase in
warranty expense of $0.06 million.
Costs of Recurring Revenue
Recurring costs are comprised of labor and telecommunication services for our Customer Service department. For the year ended
December 31, 2015, costs of recurring revenue decreased by 4% when compared to the prior year. The decrease was $0.02 million for
salaries and $0.02 million of telecom expenses. Customer Service department personnel was reduced by one during the year ended
December 31, 2015.
27
Gross Profit
2015
Year ended December 31,
2014
Variance
Product
Recurring
Total
$
$
5,173,750
3,164,560
8,338,310
47% $
76%
55% $
4,468,914
2,769,772
7,238,686
41% $
72%
49% $
704,836
394,788
1,099,624
16%
14%
15%
Gross Profit on Product Revenue
Gross profit for the year ended December 31, 2015 increased by 16% when compared to the prior year. The actual gross profit percentages
increased during 2015, driven by an increase in product sales of the Company’s EcoSmart energy management platform which have higher
gross margins than the Company’s HSIA products. Also contributing to the favorable variance were a decrease in the Company’s lower of
cost or market inventory valuation and other adjustments of $0.10 million, and a reduction in outside service costs associated with HSIA
and EcoSmart installations of $0.26 million.
Gross Profit on Recurring Revenue
For the year ended December 31, 2015, our gross profit increased by 14% when compared to the prior year. The variance was mainly
attributed to an increase in sales and a decrease in support staff wages and benefits as discussed above.
Operating Expenses
Year ended December 31,
2015
2014
Variance
Total
$
8,260,901 $
6,953,730 $
1,307,171
19%
The Company’s operating expenses are comprised of research and development, selling, general and administrative expenses, depreciation
and amortization expense. During the year ended December 31, 2015, operating expenses increased by 19% when compared to the prior
year as outlined below.
Research and Development
2015
Year ended December 31,
2014
Variance
Total
$
1,605,667 $
1,312,488 $
293,179
22%
Research and development costs are related to both present and future products and are expensed in the period incurred. Current research
and development costs are associated with product development and integration. During the year ended December 31, 2015, research and
development costs increased 22% when compared to the prior year. The majority of the variance is due to an approximate $0.22 million
increase in expenditures for salaries and recruiting. The additional personnel were needed for developing the Company’s new EcoTouch
thermostat. The EcoTouch thermostat was released for sale to customers during the three month period ending June 30, 2015. The
remaining increase of $0.07 was attributed to manufacturing retooling costs.
Selling, General and Administrative Expenses
2015
Year ended December 31,
2014
Variance
Total
$
6,381,727 $
5,366,006 $
1,015,721
19%
28
Selling, general and administrative expenses increased the year ended December 31, 2015 over the prior year by 19%. Prior to and
including the year ended December 31, 2014, thirty one VDA’s were settled with states for amounts that were less than the Company had
accrued resulting in a benefit of approximately $0.37 million being recognized during the year ended December 31, 2014 compared to the
year ended December 31, 2015 of $0.10 million. Project management, marketing and executive salary, wages and benefits increased $0.52
million for the year ended December 31, 2015 compared with the year ended December 31, 2014. The Company added a new Chief
Financial Officer, a new Channel Account Manager and an Account Executive for direct sales. The variance for bad debt expense was
$0.10 million, the result of a debt recovery of approximately $0.10 million during the year ended December 31, 2014 with no similar bad
debt recoveries in the year ended December 31, 2015. The Company credited back unconfirmed accounts payable of $0.12 million during
the year ended December 31, 2014 with no similar transactions during 2015. Increased expenses for accounting fees of approximately $0.07
million, tradeshow expenses of approximately $0.09 million, bank, credit card and payroll processing fees of $0.04 million and director fees
of approximately $0.02 million also contributed to the increase for the year ended December 31, 2015. These increases were offset by
decreases in commissions, legal, financing fees and public company expenses of approximately $0.22 million.
Income Tax Expense
2015
Year ended December 31,
2014
Variance
Total
$
197,072 $
201,853 $
4,781
-2%
The Company has indefinite-lived goodwill, which is not amortized for financial reporting purposes. However, this asset is amortized over
15 years for tax purposes. As such, income tax expense and a deferred income tax liability arise as a result of the tax-deductibility of this
asset. The resulting deferred income tax liability, which is expected to continue to increase over time, will have an indefinite life, resulting
in what is referred to as a “naked tax credit.” This deferred income tax liability could remain on the Company’s balance sheet permanently
unless there is an impairment of the related asset (for financial reporting purposes), or the business to which those assets relate were to be
disposed of. Due to the fact that the aforementioned deferred income tax liability could have an indefinite life, it is not netted against the
Company’s deferred tax assets when determining the required valuation allowance. Doing so would result in the understatement of the
valuation allowance and related income tax expense. The majority of the Company’s income tax expense for the years ended December 31,
2015 and 2014, is due to this asset amortization for tax purposes.
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.
The Company reported a net loss of $189,104 for the year ended December 31, 2015, had cash used in operating activities of $401,920, had
an accumulated deficit of $122,095,121 and total current liabilities in excess of current assets of $33,312 as of December 31, 2015. Since
inception, the Company’s primary sources of ongoing liquidity for operations have come through private and public offerings of equity
securities, and the issuance of various debt instruments and asset-based lending. For the years ended December 31, 2014, the Company’s
independent registered public accounting firm’s report on the consolidated financial statements included an explanatory paragraph relating
to the Company’s ability to continue as a going concern, which was based on the Company’s history of losses from operations, cash used to
support operating activities, and the uncertainty regarding contingent liabilities cast doubt on the Company’s ability to satisfy such
liabilities.
The Company’s liquidity plan includes reviewing options for raising additional capital including, but not limited to, asset-based or equity
financing, private placements, and/or disposition of assets. Management believes that with additional financing, the Company will be able
to fund required working capital, research and development and marketing expenses attendant to promoting revenue growth. However, any
equity financing may be dilutive to stockholders and any additional debt financing would increase expenses and may involve restrictive
covenants. While we have been successful in securing financing through September 30, 2018 to provide adequate funding for working
capital purposes, there is no assurance that obtaining additional or replacement financing, if needed, will sufficiently fund future
operations, repay existing debt or implement the Company’s growth strategy. The Company’s failure to execute on this strategy may have a
material adverse effect on its business, results of operations and financial position.
Working Capital
Our working capital (current assets in excess of current liabilities) improved by $386,794 during the year ended December 31, 2015 from a
working capital deficit of $420,106 at December 31, 2014 to a working capital deficit of $33,312 at December 31, 2015.
29
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, 2015 and 2014 were $52,579 and $103,979, 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. 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. During the year ended December 31, 2015, the Company made additional payments of $20,000 in
aggregate beyond the required monthly payments of principal and interest. The outstanding principal balance of the Note as of December
31, 2015 and 2014 was $40,761 and $289,973, respectively.
Revolving Credit Facility
On September 30, 2014, the Company and its wholly owned subsidiary, EthoStream, 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 6.50% at December 31,
2015 and 6.25% at December 31, 2014, respectively. 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. On
February 17, 2016, an amendment to the Credit Facility was executed extending the maturity date to September 30, 2018, unless earlier
accelerated under the terms of the Loan Agreement.
The Loan Agreement also contains financial covenants that place restrictions on, among other things, the incurrence of debt, granting of
liens and sale of assets. The Loan 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, 2015, the Company was in compliance with all financial covenants.
The outstanding balance on the Credit Facility was $901,771 and $628,204 at December 31, 2015 and 2014, respectively. The remaining
available borrowing capacity was approximately $532,700 at December 31, 2015.
Cash Flow Analysis
Cash used in continuing operations was $401,920 and $4,601 during the years ended December 31, 2015 and 2014. As of December 31,
2015, our primary capital needs included costs incurred to increase energy management sales, inventory procurement, funding performance
bonds and managing current liabilities. The working capital changes during the year ended December 31, 2015 were primarily related to an
approximately $820,000 increase in accounts receivable, offset by a $215,000 reduction in inventory and a $208,000 reduction in accounts
payable. The working capital changes during the year ended December 31, 2014 were primarily related to an approximately $907,000
decrease in accrued liabilities and expenses, offset by an $225,000 increase in inventory, a $317,000 increase in customer deposits and a
$275,000 reduction in accounts receivable. Accounts receivable fluctuates based on the negotiated billing terms with customers and
collections. We purchase inventory based on forecasts and orders, and when those forecasts and orders change, the amount of inventory
may also fluctuate. Accounts payable fluctuates with changes in inventory levels, volume of inventory purchases, and negotiated supplier
and vendor terms.
30
Cash used in investing activities was $10,358 during the year ended December 31, 2015 and cash provided by investing activities was
$198,332 during the year ended December 31, 2014. During the year ended December 31, 2015, the Company purchased approximately
$42,081 in furniture and fixtures and computer hardware. These assets will be depreciated over their respective estimated useful lives.
Approximately $31,723 of cash was released from projects requiring bonding. 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 $235,455 and $361,669 during the years ended December 31, 2015 and 2014, respectively. The
increase in cash borrowed from the line of credit was $273,567 and cash proceeds from the exercise of Series B preferred warrants was
$262,500. During the year ended December 31, 2015, the Company made additional principal payments of $20,000 in aggregate beyond
the required monthly payments of principal and interest for the Promissory Note with Dynamic Ratings, Inc. Cash used in financing
activities to repay indebtedness was $300,612 during the year ended December 31, 2015. Cash borrowed from the line of credit was
$628,204 and cash used in financing activities to repay indebtedness was $266,535 for the year ended December 31, 2014.
We are working to manage our current liabilities while we continue to make changes in operations to improve our cash flow and liquidity
position.
Management expects that global economic conditions, in particular the decreasing price of energy, along with competition will continue to
present a challenging operating environment through 2016; therefore working capital management will continue to be a high priority for
2016. The Company’s estimated cash requirements for our operations for the next 12 months is not anticipated to differ significantly from
our present cash requirements for our operations.
Inflation
We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to
become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our
inability or failure to do so could adversely affect our business, financial condition and results of operations.
Off-Balance Sheet Arrangements
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.
31
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.
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, as defined in Rule 13a-
15(f) under the Securities and Exchange Act of 1934. 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, 2015 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, 2015 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, 2015 and 2014 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, 2015 and 2014 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.
32
Changes in Internal Controls
During the year ended December 31, 2015, 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.
33
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 27, 2016.
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 27, 2016.
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 27, 2016.
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 27, 2016.
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 27, 2016.
34
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, 2015 and 2014
Consolidated Balance Sheets as of December 31, 2015 and 2014
Consolidated Statements of Operations for the Years ended December 31, 2015 and 2014
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2015 and 2014
Consolidated Statements of Cash Flows for Years ended December 31, 2015 and 2014
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.
35
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
10.7
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)
Form of Director and Officer Indemnification Agreement (incorporated by reference to our Form 10-K filed on March 31, 2010)
36
10.8
Series B Convertible Redeemable Preferred Stock Securities Purchase Agreement, dated August 4, 2010 (incorporated by
reference to our Form 8-K filed on August 9, 2010)
10.9
Series B Convertible Redeemable Preferred Stock Registration Rights Agreement, dated August 4, 2010 (incorporated by
reference to our Form 8-K filed on August 9, 2010)
10.10
10.11
10.12
10.13
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)
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, 2015 (incorporated by reference
to our Form 8-K filed June 6, 2015)
*10.18
Employment Agreement by and between Telkonet, Inc. and Jeffrey J. Sobieski, dated as of May 1, 2015 (incorporated by
reference to our Form 8-K filed June 6, 2015)
*10.19
Employment Agreement by and between Telkonet, Inc. and Matthew P. Koch, dated as of May 1, 2015 (incorporated by
reference to our Form 8-K filed June 6, 2015)
*10.20
Employment Agreement by and between Telkonet, Inc. and Gerrit J. Reinders, dated as of May 1, 2015 (incorporated by
reference to our Form 8-K filed June 6, 2015)
*10.21
Employment Agreement by and between Telkonet, Inc. and F. John Stark III, dated as of November 14, 2015 (incorporated by
reference to our Form 8-K filed November 17, 2015)
10.22
Amendment to Consulting Agreement, dated April 30, 2013, by and between Telkonet, Inc. and Dynamic Ratings, Inc.
(incorporated by reference to our Form 8-K filed May 6, 2013)
10.23
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)
10.24
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)
10.25
Amendment to Loan and Security Agreement, dated February 17, 2016, by and between Telkonet, Inc. and Heritage Bank of
Commerce(incorporated by reference to our Form 8-K filed February 23, 2016)
14
21
23.1
31.1
31.2
32.1
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 F. John Stark III
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
32.2
Certification of F. John Stark III pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
101.INS XBRL Instance Document
101.SCH XBRL Schema Document
101.CAL XBRL Calculation Linkbase Document
101.DEF XBRL Definition Linkbase Document
101.LAB XBRL Label Linkbase Document
101.PRE XBRL Presentation Linkbase Document
* Indicates management contract or compensatory plan or arrangement.
37
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 30, 2016
TELKONET, INC.
/s/ Jason L. Tienor
Jason L. Tienor
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf
of the registrant and in the capacities and on the dates indicated.
Name
Position
Date
/s/ Jason L. Tienor
Jason Tienor
/s/ F. John Stark III
F. John Stark III
/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
Chief Executive Officer and Director
(principal executive officer)
March 30, 2016
Chief Financial Officer
(principal financial officer)
March 30, 2016
Chairman of the Board
March 30, 2016
March 30, 2016
March 30, 2016
March 30, 2016
Director
Director
Director
38
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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, 2015 and 2014
Consolidated Statements of Operations for the Years ended December 31, 2015 and 2014
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2015 and 2014
Consolidated Statements of Cash Flows for the Years ended December 31, 2015 and 2014
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, 2015 and 2014 and
the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended
December 31, 2015. 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 presentation of the financial statements. 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, 2015 and 2014, and the results of its operations and its cash flows for each of the two years in the period
ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO USA, LLP
Milwaukee, Wisconsin
March 30, 2016
F-3
TELKONET, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2015 AND 2014
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash on deposit
Accounts receivable, net
Inventories
Prepaid expenses and other current assets
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
Deferred lease liability – current
Customer deposits
Total current liabilities
Long-term liabilities:
Deferred lease liability - long term
Notes payable – long term
Deferred income taxes
Total long-term liabilities
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, preference in
liquidation of $1,303,859 as of December 31, 2014
Total redeemable preferred stock
Commitments and contingencies
Stockholders’ Equity
Series A, par value $.001 per share; 215 shares issued, 185 shares outstanding at December
December 31,
2015
December 31,
2014
$
951,249 $
31,277
2,263,347
812,052
157,500
4,215,425
1,128,072
63,000
1,460,422
1,027,250
95,282
3,774,026
142,004
131,750
5,796,430
775,257
34,001
14,633
6,620,321
5,796,430
1,016,937
34,238
33,582
6,881,187
$
10,977,750 $
10,786,963
$
1,754,566 $
882,041
93,340
901,771
291,965
15,214
309,840
4,248,737
103,804
–
734,047
837,851
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
–
–
1,303,859
1,303,859
31, 2015, preference in liquidation of $1,377,886 as of December 31, 2015
1,340,566
–
Series B, par value $.001 per share; 538 shares issued, 55 shares outstanding at December 31,
2015 and 2014, preference in liquidation of $394,055 and $372,030 as of December 31,
2015 and 2014, respectively
Common stock, par value $.001 per share; 190,000,000 shares authorized; 127,054,848 and
125,035,612 shares issued and outstanding at December 31, 2015 and 2014, respectively
Additional paid-in-capital
Accumulated deficit
Total stockholders’ equity
382,951
372,030
127,054
126,135,712
(122,095,121)
5,891,162
125,035
125,908,476
(121,906,017)
4,499,524
Total Liabilities and Stockholders’ Equity
$
10,977,750 $
10,786,963
See accompanying notes to consolidated financial statements
F-4
TELKONET, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014
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
Depreciation and amortization
Total Operating Expenses
Income from Operations
Other (Expenses) Income:
Interest (expense), net
Total Other (Expenses)
Income Before Provision for Income Taxes
Provision for Income Taxes
Net (Loss) Income
Accretion of preferred dividends and discount
Net loss attributable to common stockholders
Net loss per common share:
Net loss attributable to common stockholders per common share – basic
Net loss attributable to common stockholders per common share – diluted
Weighted Average Common Shares Outstanding – basic
Weighted Average Common Shares Outstanding – diluted
2015
2014
$
10,908,704 $
4,175,222
15,083,926
10,973,544
3,822,987
14,796,531
5,734,954
1,010,662
6,745,616
6,504,630
1,053,215
7,557,845
8,338,310
7,238,686
1,605,667
6,381,727
273,507
8,260,901
1,312,488
5,366,006
275,236
6,953,730
77,409
284,956
(69,441)
(69,441)
7,968
197,072
(40,273)
(40,273)
244,683
201,853
(189,104)
42,830
(18,253)
(138,233)
(207,357) $
(95,403)
(0.00) $
(0.00) $
125,859,903
125,859,903
(0.00)
(0.00)
125,035,612
125,035,612
$
$
$
See accompanying notes to consolidated financial statements
F-5
TELKONET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014
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
–
–
–
25,942
–
22,025
–
–
–
–
–
–
–
–
–
–
–
–
–
15,046
–
15,046
–
(90,149)
–
(64,207)
–
(96,051)
–
(74,026)
–
37,897
–
37,897
–
–
4,784
–
4,784
–
42,830
42,830
Balance at December 31, 2014
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-6
TELKONET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014
Series A
Series A
Preferred
Preferred
Stock
Stock
Shares Amount
Series B
Preferred
Series B
Preferred
Stock
Stock Common
Shares
Amount
Shares
Common
Stock
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Total
Stockholders’
Equity
– $
–
55 $ 372,030 125,035,612 $ 125,035 $125,908,476 $(121,906,017) $
4,499,524
–
–
–
–
2,019,236
2,019
260,481
–
262,500
–
–
–
–
–
–
14,383
–
14,383
–
18,454
–
10,921
–
–
(47,628)
–
(18,253)
Balance at January 1,
2015
Shares issued to
preferred
stockholders for
warrants exercised at
$0.13 per share
Stock-based
compensation
expense related to
employee stock
options
Accretion of
redeemable preferred
stock dividends
Reclassification from
temporary equity to
permanent equity
Net loss
–
–
185 1,322,112
–
–
–
–
–
–
–
–
–
–
–
1,322,112
(189,104)
(189,104)
Balance at December
31, 2015
185 $1,340,566
55 $ 382,951 127,054,848 $ 127,054 $126,135,712 $(122,095,121) $
5,891,162
See accompanying notes to the consolidated financial statements
F-7
TELKONET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014
Cash Flows from Operating Activities:
Net (loss) income
Adjustments to reconcile net (loss) income from operations to cash used in operating
activities:
Stock-based compensation expense
Amortization of deferred financing costs
Depreciation
Amortization
Provision for doubtful accounts, net of recoveries
Deferred income taxes
Changes in assets and liabilities:
Accounts receivable
Inventories
Prepaid expenses and other current assets
Deposits and other long term assets
Accounts payable
Accrued liabilities and expenses
Deferred revenue
Customer deposits
Deferred lease liability
Net Cash Used In Operating Activities
Cash Flows From Investing Activities:
Purchase of property and equipment
Change in restricted cash
Net Cash (Used In) Provided By Investing Activities
Cash Flows From Financing Activities:
Payments on notes payable
Proceeds from exercise of warrants
Net proceeds from line of credit
Net Cash Provided By Financing Activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at the beginning of the year
Cash and cash equivalents at the end of the year
2015
2014
$
(189,104) $
42,830
14,383
18,949
31,827
241,680
19,951
199,386
(822,876)
215,198
(62,218)
237
73,874
(207,984)
171,211
(84,877)
(21,557)
(401,920)
(42,081)
31,723
(10,358)
(300,612)
262,500
273,567
235,455
(176,823)
1,128,072
951,249 $
$
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
(266,535)
–
628,204
361,669
555,400
572,672
1,128,072
See accompanying notes to consolidated financial statements
F-8
TELKONET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014
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
2015
2014
$
54,428 $
(10,431)
–
47,628
39,014
1,420
90,149
96,051
See accompanying notes to consolidated financial statements
F-9
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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.
The Company operates in one reportable segment based on management’s view of its business for purposes of evaluating performance and
making operating decisions. The Company utilizes shared services including but not limited to, human resources, payroll, finance, sales,
support services, as well as certain shared assets and sales, general and administrative costs. The Company’s approach is to make
operational decisions and assess performance based on delivering products and services that together provide solutions to its customer base,
utilizing a functional management structure and shared services where possible. Based upon this business model, the chief operating
decision maker only reviews consolidated financial information.
Liquidity and Financial Condition
The Company reported a net loss of $189,104 for the year ended December 31, 2015, had cash used in operating activities of $401,920, had
an accumulated deficit of $122,095,121 and total current liabilities in excess of current assets of $33,312 as of December 31, 2015. Since
inception, the Company’s primary sources of ongoing liquidity for operations have come through private and public offerings of equity
securities, and the issuance of various debt instruments and asset-based lending. For the years ended December 31, 2014, the Company’s
independent registered public accounting firm’s report on the consolidated financial statements included an explanatory paragraph relating
to the Company’s ability to continue as a going concern, which was based on the Company’s history of losses from operations, cash used to
support operating activities, and the uncertainty regarding contingent liabilities cast doubt on the Company’s ability to satisfy such
liabilities.
As discussed in Note H, the Series A preferred stock became redeemable at the option of the preferred stock holders on November 19, 2014
and for a period of 180 days thereafter, provided that at least 50% of the holders provide written notice to the Company requesting
redemption. As of December 31, 2015, no redemption of the preferred stock occurred and any future redemption of the Series A or B
preferred stock would be entirely at the option of the Company. Furthermore, on February 17, 2016, an amendment to the revolving credit
facility with Heritage Bank of Commerce was executed extending the maturity date of the revolving credit facility to September 30, 2018,
unless earlier accelerated under the terms of the Loan and Security Agreement (the “Loan Agreement”). The Loan Agreement is available
for working capital and other lawful general corporate purposes. The outstanding principal balance of the revolving credit facility bears
interest at the Prime Rate plus 3.00%. The outstanding balance was $901,771 as of December 31, 2015 and the remaining available
borrowing capacity was approximately $532,700. As of December 31, 2015, the Company was in compliance with all financial covenants.
F-10
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
The Company’s liquidity plan includes reviewing options for raising additional capital including, but not limited to, asset-based or equity
financing, private placements, and/or disposition of assets. Management believes that with additional financing, the Company will be able
to fund required working capital, research and development and marketing expenses attendant to promoting revenue growth. However, any
equity financing may be dilutive to stockholders and any additional debt financing would increase expenses and may involve restrictive
covenants. While we have been successful in securing financing through September 30, 2018 to provide adequate funding for working
capital purposes, there is no assurance that obtaining additional or replacement financing, if needed, will sufficiently fund future
operations, repay existing debt or implement the Company’s growth strategy. The Company’s failure to execute on this strategy may have a
material adverse effect on its business, results of operations and financial position.
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. The Company has never experienced any losses related to these
balances. With respect to trade receivables, the Company performs ongoing credit evaluations of its customers’ financial conditions and
limits the amount of credit extended when deemed necessary. The Company provides credit to its customers primarily in the United States
in the normal course of business. The Company routinely assesses the financial strength of its customers and, as a consequence, believes its
trade receivables credit risk exposure is limited.
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 2014, the Company was 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. The Company
continues to execute contracts with bonding requirements and maintains this cash collateral on deposit for current and future projects. The
amount is presented as restricted cash on deposit on the consolidated balance sheet as of December 31, 2015 and 2014. The outstanding
balance as of December 31, 2015 and 2014 was $31,277 and $63,000, respectively.
Accounts Receivable
Accounts receivable are uncollateralized customer obligations due under normal trade terms. 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 $23,343 and
$36,873 at December 31, 2015 and 2014, 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.
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 when it is determined that the Company’s carrying cost of such excess and obsolete inventories cannot be recovered in full, a charge is
taken against income for the difference between the carrying cost and the estimated realizable amount. The charge taken against income
was approximately $(2,000) and $46,600 for the years ended December 31, 2015 and 2014, respectively.
F-11
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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
The Company’s 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 (Level 1 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 the Company for
similar obligations (Level 2 instruments).
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. The Company categorizes 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, the Company performs an annual impairment test of
goodwill and other intangible assets at the reporting unit level, or more frequently if events or circumstances change that would more likely
than not reduce the fair value of the Company’s 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. The Company utilizes 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, the Company calculates 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
The Company reviews 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. Based on the annual assessment
for impairment performed during 2015 and 2014, no impairment was recorded.
F-12
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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 using the treasury stock method, which assumes that the proceeds to be received on exercise of outstanding stock options and
warrants are used to repurchase shares of the Company at the average market price of the common shares for 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, 2015 and 2014, there were 7,463,635 and 9,845,758 shares of common stock underlying options and warrants excluded due
to these instruments being anti-dilutive, respectively.
Use of Estimates
The preparation of financial statements in conformity with United States of America (U.S.) generally accepted accounting principles
(GAAP) require management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. Estimates are used when accounting for items and matters such as revenue recognition and
allowances for uncollectible accounts receivable, inventory obsolescence, depreciation and amortization, long-lived and intangible asset
valuations, impairment assessments, taxes and related valuation allowance, income tax provisions, stock-based compensation, and
contingencies. The Company believes 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, the Company recognizes 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. Assuming all conditions for revenue recognition have been satisfied, product revenue is
recognized when products are shipped and installation revenue is recognized when the services are completed. 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 the Company’s
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. The Company determines 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).
F-13
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
● TPE – If the Company cannot establish VSOE of selling price for a specific product or service included in a multiple-element
arrangement, the Company uses third-party evidence of selling price. The Company determines 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 the Company would sell a product or service if it were sold on a
stand-alone basis. When neither VSOE nor TPE exists for all elements, the Company determines ESP for the arrangement
element based on sales, cost and margin analysis, as well as other inputs based on the Company’s pricing practices. Adjustments
for other market and Company-specific factors are made as deemed necessary in determining ESP.
Under the estimated selling price method, revenue is recognized in MEAs based on estimated selling prices for all of the elements in the
arrangement, assuming all other conditions for revenue recognition have been satisfied. To determine the estimated selling price, the
Company establishes the selling price for its products and installation services using the Company’s established pricing guidelines, which
the proceeds are allocated between the elements and the arrangement.
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.
The Company provides call center support services to properties installed by the Company and also to properties installed by other
providers. In addition, the Company provides the property with the portal to access the Internet. The Company receives monthly service
fees from such properties for its services and Internet access. The Company recognizes 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. The Company reports such revenues as recurring revenues. Deferred
revenue includes deferrals for the monthly support service fees and Internet access.
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 the
Company is considered 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, 2015 and 2014, the Company experienced
returns of approximately 1% to 3% of material’s included in the cost of sales. As of December 31, 2015 and 2014, the Company recorded
warranty liabilities in the amount of $66,555 and $44,288, 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
$
$
2015
2014
44,288 $
(52,833)
75,100
66,555 $
77,943
(45,710)
12,055
44,288
The Company follows the policy of charging the costs of advertising to expenses as incurred. The Company incurred $15,978 and $15,021
in advertising costs during the years ended December 31, 2015 and 2014, respectively.
F-14
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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 2015 and 2014 were $1,605,667 and
$1,312,488, respectively.
Stock-Based Compensation
The Company accounts for 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 the Company’s employees and
directors, including employee stock options and restricted stock awards. The Company’s estimates the fair value of stock options granted
using the Black-Scholes valuation model. This model requires the Company 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
the Company’s 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 the Company’s consolidated statements of operations.
The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar
awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. For 2015 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, 2015 and 2014 was
$14,383 and $15,046, 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 the Company no longer had access to this
subleased space, a charge of $59,937 was recorded 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 an
additional charge of $132,174 was recorded. The remaining liability at December 31, 2015 and 2014 was $0 and $46,673, respectively.
NOTE B – NEW ACCOUNTING PRONOUNCEMENTS
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 guidance for this standard was initially effective for annual reporting periods beginning after
December 15, 2016, including interim periods within that reporting period, however in August 2015 the FASB delayed the effective date of
the standard for one full year. Companies will adopt the standard 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). The Company is currently evaluating the impact of its pending adoption of ASU 2014-09 on its
consolidated financial statements and has not yet determined the method by which it will adopt the standard in 2018.
F-15
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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.
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. The Company is currently evaluating the impact of its pending adoption of ASU 2014-15 on its consolidated
financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of
Debt Issuance Costs. This ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a
direct deduction from the carrying amount of the debt liability. In June 2015, at the Emerging Issues Task Force meeting, the FASB
clarified that ASU 2015-03 does not address debt issuance costs related to revolving credit debt arrangements. In connection therewith, at
the June 2015 meeting, the SEC staff announced that it would not object to the presentation of issuance costs related to revolving debt
arrangements as an asset that is amortized over the term of the arrangement, which was codified by FASB in ASU 2015-15 in August
2015. Currently, the Company presents deferred financing costs related to its revolving credit facility as an asset in the consolidated balance
sheets. ASU 2015-03 is 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.
In July 2015, the FASB issued ASU No. 2015-11, Inventory - Simplifying the Measurement of Inventory (Topic 330). This ASU requires
inventory to be subsequently measured using the lower of cost and net realizable value, thereby eliminating the market value approach. Net
realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of
completion, disposal and transportation. ASU 2015-11 is effective for reporting periods beginning after December 15, 2016 and is applied
prospectively. Early adoption is permitted. The Company is currently evaluating the impact of its pending adoption of ASU 2015-11 on its
consolidated financial statements.
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes - Balance Sheet Classification of Deferred Taxes (Topic 740),
which requires deferred tax liabilities and assets of the same tax jurisdiction or a tax filing group, as well as any related valuation
allowance, be offset and presented as a single noncurrent amount in the consolidated balance sheets. ASU No. 2015-17 is effective for
interim and annual periods beginning after December 15, 2016, with early adoption permitted. The ASU may be applied either
prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company does not believe this
guidance will have a material impact on the Company's future statement of operations or financial position.
In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard establishes a right-of-use (ROU) model that requires a
lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be
classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. ASU
2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified
retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of
the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently
evaluating the impact of its pending adoption of ASU 2016-02 on its consolidated financial statements.
F-16
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
NOTE C – INTANGIBLE ASSETS AND GOODWILL
Total identifiable intangible assets acquired and their carrying values at December 31, 2015 are:
Cost
Accumulated
Amortization
Accumulated
Impairment
Carrying
Value
Amortized Identifiable Intangible Assets:
Subscriber lists – EthoStream
$
Total Amortized Identifiable Intangible Assets
Goodwill – EthoStream
Goodwill – SSI
Total Goodwill
Total
2,900,000 $ (2,124,743) $
2,900,000
8,796,430
5,874,016
14,670,446
(2,124,743)
–
–
–
– $
–
(3,000,000)
(5,874,016)
(8,874,016)
$ 17,570,446 $ (2,124,743) $ (8,874,016) $
775,257
775,257
5,796,430
–
5,796,430
6,571,687
Total identifiable intangible assets acquired and their carrying values at December 31, 2014 are:
Cost
Accumulated
Amortization
Accumulated
Impairment
Carrying
Value
Amortized Identifiable Intangible Assets:
Subscriber lists – EthoStream
$
Total Amortized Identifiable Intangible Assets
Goodwill – EthoStream
Goodwill – SSI
Total Goodwill
2,900,000 $ (1,883,063) $
2,900,000
8,796,430
5,874,016
14,670,446
(1,883,063)
–
–
–
– $
–
(3,000,000)
(5,874,016)
(8,874,016)
Total
$ 17,570,446 $ (1,883,063) $ (8,874,016) $
1,016,937
1,016,937
5,796,430
–
5,796,430
6,813,367
Weighted
Average
Amortization
Period
(Years)
12.0
Weighted
Average
Amortization
Period
(Years)
12.0
Total amortization expense charged to operations for the years ended December 31, 2015 and 2014 was $241,680 per year. The weighted
average remaining amortization period for the subscriber list is 3.2 years.
Estimated future amortization expense as of December 31, 2015 is as follows:
Years Ended December 31,
2016
2017
2018
2019
Total
$
$
241,680
241,680
241,680
50,217
775,257
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. The Company utilizes 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.
F-17
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
The carrying value of the Company’s 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 the
Company’s results of operations. No impairment was recorded for the years ended December 31, 2015 and 2014, respectively.
NOTE D – ACCOUNTS RECEIVABLE
Components of accounts receivable as of December 31, 2015 and 2014 are as follows:
Accounts receivable
Allowance for doubtful accounts
Accounts receivable, net
NOTE E – PROPERTY AND EQUIPMENT
$
$
2015
2014
2,286,690 $
(23,343)
2,263,347 $
1,497,295
(36,873)
1,460,422
The Company’s property and equipment as of December 31, 2015 and 2014 consists of the following:
Development test equipment
Computer software
Leasehold improvements
Office equipment
Office fixtures and furniture
Total
Accumulated depreciation
Total property and equipment
$
$
2015
2014
26,925 $
55,677
2,675
20,731
182,045
288,053
(146,049)
142,004 $
45,752
55,677
2,675
20,706
157,183
281,993
(150,243)
131,750
Depreciation expense included as a charge to income was $31,827 and $33,556 for the years ended December 31, 2015 and 2014,
respectively.
NOTE F – ACCRUED LIABILITIES AND EXPENSES
Accrued liabilities and expenses as of December 31, 2015 and 2014 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 G – DEBT
Business Loan
$
$
2015
2014
198,906 $
386,521
229,768
291
66,555
882,041 $
342,841
345,589
353,260
4,047
44,288
1,090,025
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, 2015 and 2014 were $52,579 and $103,979, respectively.
F-18
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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. 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. During the year ended December 31, 2015, the Company made additional payments of $20,000 in
aggregate beyond the required monthly payments of principal and interest. The outstanding principal balance of the Note as of December
31, 2015 and 2014 was $40,761 and $289,973, respectively.
Revolving Credit Facility
On September 30, 2014, the Company and its wholly owned subsidiary, EthoStream, 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 6.50% at December 31,
2015 and 6.25% at December 31, 2014, respectively. 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. On
February 17, 2016, an amendment to the Credit Facility was executed extending the maturity date to September 30, 2018, unless earlier
accelerated under the terms of the Loan Agreement.
The Loan Agreement also contains financial covenants that place restrictions on, among other things, the incurrence of debt, granting of
liens and sale of assets. The Loan 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, 2015, the Company was in compliance with all financial covenants.
The outstanding balance on the Credit Facility was $901,771 and $628,204 at December 31, 2015 and 2014, respectively. The remaining
available borrowing capacity was approximately $532,700 at December 31, 2015.
NOTE H – 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 common stock at an initial conversion price of $0.363 per share. In the event
of a change of control (as defined in the purchase agreement with respect to the Series A), or at the holder’s option, on November 19, 2014
and for a period of 180 days thereafter, provided that at least 50% of the shares of Series A issued on the Series A Original Issue Date
remain outstanding as of November 19, 2014, and the holders of at least a majority of the then outstanding shares of Series A provide
written notice requesting redemption of all shares of Series A, the Company was required to redeem the Series A for the purchase price of
$5,000 per share, plus any accrued but unpaid dividends. By way of the redemption option available to holders of the Company’s Series A
shares having expired on May 18, 2015 with no Series A holders requesting redemption of their shares, the redemption feature at the option
of the holders was eliminated, thereby, resulting in the reclassification of $1,322,112 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,
2015.
F-19
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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. On November 19, 2014 and for a period of 180 days thereafter, the Series A were
redeemable at the option of the holder and 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. The redemption feature at the option of the holders
expired, thereby, resulting in the reclassification from temporary equity to permanent equity during the year ended December 31, 2015.
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 year ended December 31, 2014 was $64,207.
For the years ended December 31, 2015 and 2014, the Company recorded accrued dividends for Series A in the amount of $36,707 and
$74,026, respectively and had cumulative accrued dividends of $452,886 and $378,859 as of December 2015 and 2014, respectively. The
recorded accrued dividends have been charged to additional paid-in capital (since there is a deficit in retained earnings) and an increase to
the net income (loss) attributable to common stockholders and the net unpaid recorded 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 the Company’s 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 are not 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 the Company’s 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 was
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, 2011, shareholders converted 45 redeemable
preferred shares issued on August 4, 2010, to, in aggregate, 1,730,762 shares of common stock. During the year ended December 31, 2013,
shareholders converted 167 redeemable preferred shares issued on August 4, 2010, to, in aggregate, 6,423,072 shares of common stock.
A portion of the proceeds from the August 4, 2010 offering 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 was 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.
F-20
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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
was 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 from the April 18, 2011 offering 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 year ended December 31, 2014 was $25,942.
For the years ended December 31, 2015 and 2014, the Company recorded accrued dividends for Series B in the amount of $10,921 and
$22,025, respectively, and had cumulative accrued dividends of $119,055 and $97,030 as of December 31 2015 and 2014, respectively. The
recorded accrued dividends had been charged to additional paid-in capital (since there is a deficit in retained earnings) and the net unpaid
recorded accrued dividends have been added to the carrying value of the preferred 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 $394,055 and
second, Series A with a preference value of $1,377,886. Both series of preferred stock are equal in their dividend preference over common
stock.
NOTE I – 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, 2015 and
2014, 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, 2015 and 2014,
the Company had 127,054,848 and 125,035,612 common shares issued and outstanding, respectively.
During the year ended December 31, 2015, 2,019,236 warrants were exercised for an aggregate of 2,019,236 shares of the Company’s
common stock at $0.13 per share. These warrants were originally granted to shareholders of the August 4, 2010 Series B preferred stock
issuance. The Company received proceeds of $262,500 from the exercise of warrants.
F-21
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
NOTE J – 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. The Plan is administered by the Board of Director’s or
the compensation committee, which is comprised of not less than two Non-Employee Directors who are independent. A total of
10,000,000 shares of stock were reserved and available for issuance under the Plan. The exercise price per share for the Stock covered by a
stock option granted shall be determined by the Administrator at the time of grant but shall not be less than 100 percent of the fair market
value on the date of grant. The term of each stock option shall be fixed by the Administrator, but no stock option shall be exercisable more
than ten years after the date the stock option is granted. As of December 31, 2015, there were approximately 5,747,553 shares remaining
for issuance in the Plan.
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, 2015.
Options Outstanding
Options Exercisable
Weighted Average
Remaining
Contractual Life
(Years)
Exercise Prices
$
$
$
0.01 - $0.15
0.16 - $0.99
1.00 - $5.60
Number
Outstanding
175,000
1,570,225
80,000
1,825,225
Weighted Average
Exercise Price
Number
Exercisable
Weighted Average
Exercise Price
1.82 $
7.03
1.11
6.27 $
0.14
0.18
2.28
0.28
175,000 $
1,320,499
80,000
1,575,499 $
0.14
0.18
2.28
0.28
Transactions involving stock options issued to employees are summarized as follows:
Outstanding at January 1, 2014
Granted
Exercised
Cancelled or expired
Outstanding at December 31, 2014
Granted
Exercised
Cancelled or expired
Outstanding at December 31, 2015
Number of
Shares
Weighted
Average
Price Per Share
0.43
0.19
-
3.50
0.40
0.18
-
1.81
0.28
1,735,225 $
200,000
-
(5,000)
1,930,225 $
50,000
-
(155,000)
1,825,225 $
The expected life of awards granted represents the period of time that they are expected to be outstanding. The Company determines 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. The Company estimates the volatility of the Company’s common stock based on the
calculated historical volatility of the Company’s common stock using the trailing 24 months of share price data prior to the date of the
award. The Company bases 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. The Company has
not paid any cash dividends on the Company’s common stock and does not anticipate paying any cash dividends in the foreseeable future.
Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model. The Company uses
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, the Company adjusts share-based compensation for changes to the estimate of expected equity award
forfeitures based on actual forfeiture experience.
The following table summarizes the assumptions used to estimate the fair value of options granted during the years ended December 2015
and 2014, using the Black-Scholes option-pricing model:
Expected life of option (years)
Risk-free interest rate
Assumed volatility
Expected dividend rate
Expected forfeiture rate
2015
10
1.28%
135%
0
32%
2014
10
2.77%
110%
0
0%
F-22
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
The total estimated fair value of the options granted during the years ended December 31, 2015 and 2014 was $8,481 and $35,298. The
total fair value of underlying shares related to options that vested during the years ended December 31, 2015 and 2014 was $14,383 and
$15,046. Future compensation expense related to non-vested options at December 31, 2015 was $40,088 and will be recognized over the
next 5.0 years. The aggregate intrinsic value of the vested options was zero as of December 31, 2015 and 2014. Total stock-based
compensation expense recognized in the consolidated statements of operations for the years ended December 31, 2015 and 2014 was
$14,383 and $15,046, respectively.
Non-Employee Stock Options
There were no non-employees stock options issued or outstanding at December 31, 2015 or 2014.
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
Weighted Average
Remaining
Contractual Life
(Years)
Exercise Prices
Number
Outstanding
$
0.13
0.18
0.20
3.00
5,211,542
50,000
250,000
126,868
5,638,410
Transactions involving warrants are summarized as follows:
Weighted Average
Exercise Price
Number
Exercisable
Weighted Average
Exercise Price
0.32 $
1.91
5.77
0.32
0.57 $
0.13
0.18
0.20
3.00
0.20
5,211,542 $
50,000
250,000
126,868
5,638,410 $
0.13
0.18
0.20
3.00
0.20
Outstanding at January 1, 2014
Issued
Exercised
Cancelled or expired
Outstanding at December 31, 2014
Issued
Exercised
Cancelled or expired
Outstanding at December 31, 2015
Number of
Shares
Weighted Average
Price Per Share
9,359,914 $
300,000
–
(1,744,381)
7,915,533
–
(2,019,236)
(257,887)
5,638,410 $
0.32
0.20
–
0.51
0.27
–
0.13
3.00
0.20
There were no warrants granted, 2,019,236 warrants exercised and 257,887 cancelled or forfeited during the year ended December 31,
2015. The Company issued 300,000 warrants and 1,744,381 warrants were cancelled or forfeited during the year ended December 31, 2014.
NOTE K – RELATED PARTY TRANSACTIONS
On July 17, 2014, Messrs. Davis and Tienor each signed a General Indemnity Agreement pledging personal property on behalf of the
Company for a 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.
On May 18 and June 4, 2015, Messrs. 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 $3,000,
grossed up to accommodate their 2015 federal income tax liability associated with the payments.
F-23
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
On July 15 and July 17, 2015, Messrs. 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 $2,000,
grossed up to accommodate their 2015 federal income tax liability associated with the payments. The amounts owed to Messrs. Davis and
Tienor as of December 31, 2015 and December 31, 2014, were $11,994 and $24,090, respectively, and are recorded in accounts payable and
accrued expense on the accompanying consolidated balance sheets.
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. As of December 31, 2015 and
2014, there were no such arrangements.
NOTE L – 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
$
$
2015
2014
2,709 $
8,850
28,811
149,838
(9,300)
180,908
16,164
197,072 $
83,192
(26,756)
20,846
(176,627)
(345)
(99,690)
301,543
201,853
During 2015, approximately $700,000 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 $60,000.
Deferred income taxes include the net tax effects of net operating loss (NOL) carry forwards and the temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets are as follows:
Deferred Tax Assets:
Net operating loss carry forwards
Intangibles
Other
Total deferred tax assets
Deferred Tax Liabilities:
Intangibles
Total deferred tax liabilities
Valuation allowance
Net deferred tax liabilities
2015
2014
$
32,047,724 $
991,875
726,013
33,765,612
31,909,052
1,141,121
728,937
33,779,110
(734,047)
(734,047)
(33,765,612)
$
(734,047) $
(534,661)
(534,661)
(33,779,110)
(534,661)
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, 2015 and 2014, the Company’s valuation
allowance, established for the tax benefit that may not be realized, totaled approximately $33,770,000 and $33,780,000, respectively. The
overall decrease in the valuation allowance is related to federal and state loss carryforwards that expired as of December 31, 2015, less
federal and state losses generated for the year ended December 31, 2015.
At December 31, 2015 the Company had net operating loss carryforwards of approximately $90,600,000 and $47,300,000, respectively, for
federal and state income tax purposes which will expire at various dates from 2016 – 2035.
F-24
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
The Company has indefinite-lived goodwill, which is not amortized for financial reporting purposes. However, this asset is amortized over
15 years for tax purposes. As such, income tax expense and a deferred income tax liability arise as a result of the tax-deductibility of this
asset. The resulting deferred income tax liability, which is expected to continue to increase over time, will have an indefinite life, resulting
in what is referred to as a “naked tax credit.” This deferred income tax liability could remain on the Company’s balance sheet permanently
unless there is an impairment of the related asset (for financial reporting purposes), or the business to which those assets relate were to be
disposed of. Due to the fact that the aforementioned deferred income tax liability could have an indefinite life, it is not netted against the
Company’s deferred tax assets when determining the required valuation allowance. Doing so would result in the understatement of the
valuation allowance and related income tax expense.
The Company’s NOL and tax credit carryovers may be significantly limited under Section 382 of the Internal Revenue Code (IRC). NOL
and tax credit carryovers are limited under Section 382 when there is a significant “ownership change” as defined in the IRC. During 2005
and in prior years, the Company may have experienced such ownership changes that could have imposed such limitations.
The limitation imposed by Section 382 would place an annual limitation on the amount of NOL and tax credit carryovers that can be
utilized. When the Company completes the necessary studies, the amount of NOL carryovers available may be reduced significantly.
However, since the valuation allowance fully reserves for all available carryovers, the effect of the reduction would be offset by a reduction
in the valuation allowance.
The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is generally no longer
subject to U.S. federal income tax examinations by tax authorities for years before 2011 and various states before 2011. 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, 2015 or
2014 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,
2015 or 2014. The Company’s utilization of any net operating loss carryforwards may be unlikely due to its continuing losses.
NOTE M – COMMITMENTS AND CONTINGENCIES
Office Leases Obligations
In October 2013, the Company entered into a lease agreement for 6,362 square feet of commercial office space in Waukesha, Wisconsin
for its corporate headquarters. The Waukesha lease expires in April 2021.
The Company presently leases approximately 14,000 square feet of office space in Milwaukee, Wisconsin for its operations facility. The
Milwaukee lease expires in March 2020.
The Company leased 16,416 square feet of commercial office space in Germantown, Maryland. The lease commitments expired 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.
In January 2016, the Company entered into a lease agreement for 2,237 square feet of commercial office space in Germantown, Maryland
for its Maryland employee’s. The Germantown lease expires at the end of January 2017.
F-25
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
Commitments for minimum rentals under non-cancelable leases as of December 31, 2015 are as follows:
Years ending December 31,
2016
2017
2018
2019
2020
2021
Total
$
$
248,274
254,740
258,381
265,305
128,863
28,014
1,183,577
Rental expenses charged to operations for the years ended December 31, 2015 and 2014 was $665,061 and $642,277, respectively. Sub-
rental income received for the year ended December 31, 2015 and 2014 was $138,234 and $136,666, 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, 2015. Mr.
Tienor’s employment agreement has a term of one (1) year, 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 the Company’s 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, 2015. Mr.
Sobieski’s employment agreement has a term of one (1) year, 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 the Company’s internal policies and participation in
the Company’s incentive and benefit plans.
F. John Stark III, Chief Financial Officer, is employed pursuant to an employment agreement with us dated November 14, 2015. Mr.
Stark’s employment agreement has a term of one (1) year, one (1) month, seventeen (17) days, which may be extended by mutual
agreement of the parties thereto, and provides for a base salary of $175,000 per year and bonuses and benefits based upon the Company’s
internal policies and participation in the Company’s incentive and benefit plans.
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.
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 April 24, 2012, the Company
entered into an Indemnification Agreement with director Timothy S. Ledwick. On April 1, 2014, the Company entered into Indemnification
Agreement’s with director’s Kellogg L. Warner and Jeffrey P. Andrews. On November 14, 2015, the Company entered into an
Indemnification Agreement with F. John Stark III, 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.
F-26
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2015 AND 2014
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 had approximately $230,000 and
$353,000 accrued for this exposure as of December 31, 2015 and 2014, 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 $30,000, not including any
applicable interest and penalties.
Prior to 2015, the Company successfully executed and paid in full VDAs in thirty one states totaling approximately $695,000 and is current
with the subsequent filing requirements.
During the year ended December 31, 2015, the Company executed two VDA’s totaling approximately $55,000. The Company is currently
in negotiations with one state.
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
Payments
Balance, End of year
NOTE N – BUSINESS CONCENTRATION
$
$
2015
2014
353,260 $
401,031
(117,700)
(406,823)
229,768 $
1,080,482
426,599
(599,295)
(554,526)
353,260
For the years ended December 31, 2015 and 2014, no single customer represented 10% or more of the Company’s total net revenues.
As of December 31, 2015, no single customer accounted for 10% of the Company’s net accounts receivable. As of December 31, 2014, one
customer accounted for 13% of the Company’s net accounts receivable.
Purchases from two suppliers approximated $3,800,000, or 80%, of total purchases for the year ended December 31, 2015 and
approximately $3,700,000, or 76%, of total purchases for the year ended December 31, 2014. Total due to these suppliers, net of deposits,
was $584,288 and $750,084 as of December 31, 2015 and 2014, respectively.
NOTE O – EMPLOYEE BENEFIT PLAN
The Company has an employee savings plan covering substantially all employees who are at least 21 years of age and have completed at
least 6 months of service. Effective January 01, 2012, the plan provides for matching contributions equal to 100% of each dollar
contributed by the employee up to 4% of the employee’s salary. The Company’s matching contributions vest immediately. The Company
may also elect to make discretionary contributions. The Company made contributions to the plan of approximately $153,325 and $126,600
for the years ended December 31, 2015 and 2014, respectively.
F-27
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 30, 2016, relating to the consolidated financial statements, which appear in this Form 10-K.
/s/ BDO USA, LLP
Milwaukee, Wisconsin
March 30, 2016
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 30, 2016
By: /s/ Jason L. Tienor
Jason L. Tienor
Chief Executive Officer
EXHIBIT 31.2
I, F. John Stark III, 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 30, 2016
By: /s/ F. John Stark III
F. John Stark III
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, 2015 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 30, 2016
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, 2015 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"), I, F. John Stark III, 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/ F. John Stark III
F. John Stark III
Chief Financial Officer
March 30, 2016