Table of Contents
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, 2018
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) 302-2299
(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 every Interactive Data File required to be submitted 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 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, smaller reporting company, or an emerging growth
company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
(Check one)
Large accelerated filer
Non-accelerated filer
Emerging growth company
o
þ
o
Accelerated filer
Smaller reporting company
o
þ
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial
accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
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 $0.13 per share on the Over the Counter Bulletin Board) of the registrant
as of June 30, 2018: $17,418,689.
Number of outstanding shares of the registrant’s par value $0.001 common stock as of March 26, 2019: 134,793,211.
Part III is incorporated by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held on May 23, 2019.
TELKONET, INC.
FORM 10-K
INDEX
Part I
Item 1.
Description of Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Properties
Legal Proceedings
Mine Safety Disclosures
Part II
Market for Registrant’s Common Equity, Related Stockholder Matters and Registrant’s Purchases of Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Item 9.
Financial Statements and Supplementary Data
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
Item 16.
Form 10-K Summary
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 smart energy management
platform, designed to reduce heating, ventilation and air conditioning (“HVAC”) runtimes, reduce energy consumption, and engage users. The platform is deployed primarily in
the hospitality, student housing, military barracks, senior living and public housing markets, and is specified by engineers, HVAC professionals, building owners, and building
operators. We currently operate in a single reportable business segment.
In October of 2016, the Company, under the direction and authority of the Board of Directors (the “Board”), committed to a plan to offer for sale Ethostream LLC, High-Speed
Internet Access (“HSIA”) subsidiary. While EthoStream is one of the largest public HSIA providers in the world, providing services to more than 12.0 million users monthly
across a network of approximately 1,800 locations, the Company will focus on its higher growth potential EcoSmart Platform line. As a result of this decision to sell Ethostream
LLC, the operating results of Ethostream for the year ended December 31, 2017 have been reclassified as discontinued operations and as assets and liabilities held for sale, as
applicable, in the consolidated financial statements. The sale closed on March 29, 2017.
Unless otherwise noted, all financial information in this Form 10-K will reflect results from the Company’s continuing operations.
Telkonet’s EcoSmart Platform is comprised of four primary pillars:
ECOSMART
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EcoSmart Product Suite: The suite of intelligent hardware products designed and developed to provide monitoring, management and reporting over individual and
grouped energy consumption throughout building environments. Products include thermostats, sensors, switches, and outlets.
EcoCentral: The cloud-based dashboard that provides visualization and remote management of Telkonet’s monitoring, reporting and analytics through deployed
EcoSmart and integrated products. EcoCentral is the intelligence behind the EcoSmart platform.
EcoCare: Telkonet’s 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. All professional support and maintenance staff reside in Telkonet’s headquarters.
EcoSmart Mobile: iOS and Android applications provided by Telkonet to its partners, customers and end users and guests enabling provisioning, management,
access and control over EcoSmart deployments and functionality.
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The EcoSmart Platform provides comprehensive energy and operational savings, management monitoring, reporting, analytics of a property or individual room by adding
intelligence to HVAC runtimes and through integrations with door locks, lighting, window coverings, and more end-user attributes. Telkonet has deployed more than 600,000
intelligent devices worldwide in properties and buildings within the hospitality, military, educational, healthcare and other commercial markets. The EcoSmart Platform is
rapidly becoming a leading solution for reducing energy consumption, operational costs and carbon footprints, and eliminating the need for new energy generation in these
markets – all while engaging and delighting guests.
Controlling energy consumption can make a significant impact on a building’s bottom line, as 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 Portfolio Manager 2015 analysis, the median hotel uses approximately 187 kBtu/ft2 from all
energy sources.[1] On average, America’s approximately 47,000 hotels spend $2,196 per available room each year on energy, representing 3% - 6% of all operating costs and
60% of carbon emissions[2]. Telkonet approaches the opportunity to reduce consumed energy by adding intelligence to a property’s HVAC and lighting systems.
Energy is 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 Product Suite
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EcoTouch Thermostat: As 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 a premium aesthetic. The EcoTouch allows building owners to match the thermostat with the design of their room by changing
the color of the outer edge and by selecting between black or white options.
EcoInsight Thermostat: 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 Thermostat: A wireless thermostat mirroring the EcoInsight footprint while enabling the relocation of in room controls without the usual construction
expense and downtime.
EcoSource Controller: 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.
EcoSmart VRF Controller: The newest product in the EcoSmart Suite, the VRF Controller works with most of the new variable refrigerant systems coming to
market. The devices replace the EcoSource where discrete relays are not available.
EcoConnect Bridge: An Ethernet to Zigbee bridge that serves as the coordinator for all EcoSmart devices connected to the intelligent automation network,
managing approximately 30 - 70 device connections each.
EcoCommander Gateway: EcoSmart’s network-edge gateway server that provides real-time proactive data aggregation, analytics, reporting and management of
the EcoSmart product suite.
EcoSense Occupancy Sensor: A remote occupancy sensor that monitors environments with ultra, high-sensitive sensors designed to detect motion or body heat. All
sensors are programmed to ensure accurate occupancy detection. The EcoSense Occupancy Sensor may be hardwired or programmed to communicate wirelessly
and may be battery operated or utilize external power.
EcoSwitch Light Switch: An EcoSmart energy management product with the appearance of a traditional ‘rocker’ light switch. Turning lights off, even for a short
time, saves energy and extends lamp life. The EcoSwitch can be used to compose and automate dramatic lighting scenes in a room.
EcoGuard Outlet: An 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 Door & Window Sensor: 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.
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[1] Facility Type: Hotels - https://www.energystar.gov/sites/default/files/tools/DataTrends_Hotel_20150129.pdf
[2] Hotels-Energy Star - http://www.energystar.gov/sites/default/files/buildings/tools/SPP Sales Flyer for Hospitality and Hotels.pdf
2
Several of these devices have been recently released in “Plus” models which provide greater functionality and increased capabilities.
EcoCentral
Telkonet’s EcoSmart Platform is 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 derives its name
through its ability to direct user resources to where they add the most value. From monitoring equipment operation and determining where engineering efforts are needed and
notifying staff when performance is degrading, EcoCentral creates a comprehensive tool for providing insights and access for EcoSmart Platform deployments either
individually or across an entire building portfolio.
EcoCare
EcoCare is Telkonet’s professional support services including call, email and chat support, repair and replacement services, periodic reporting, communication with customers’
utility and Internet Service Provider (“ISP”) partners and more. Telkonet provides three 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). Typical EcoCare contracts range from one to five years and have automatic renewal terms built into each individual contract. All support staff are located at Telkonet’s
Waukesha, Wisconsin headquarters.
EcoSmart Mobile
Telkonet’s EcoMobile tools provide iOS and Android applications for use by partners, customers, 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.
Intelligent Energy Management
Telkonet’s EcoSmart energy management platform applies and improves building intelligence to deliver energy and cost savings through controlling lighting, plugload and
HVAC runtimes. Captured 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. EcoSmart achieves this by leveraging our device platform, including occupancy sensors and intelligent programmable thermostats connected with packaged terminal
air conditioner (“PTAC”) controllers or any other terminal equipment HVAC products and 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 of these can be accomplished
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, due to a proprietary technology
named “Recovery Time”.
Recovery Time Technology
EcoSmart’s HVAC controls feature Recovery Time, technology designed to maximize energy efficiency without sacrificing occupant comfort. When a room is occupied, the
temperature selected by the occupant will be maintained by the EcoSmart system. Once an EcoSmart 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.
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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 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 Other Systems Work?
In competing systems the occupant chooses their preferred temperature. When the occupant leaves, the thermostat reverts to a set-point of a fixed number of degrees different
than the preferred set temperature (lower in winter and higher in summer). In some products temperature gap is a fixed temperature selected by the property owner. Because
each occupant room will require different lengths of time to return to the occupant’s desired temperature, based on room size and orientation, whether blinds are open, outdoor
temperature, sun, and wind, the length of time required for the HVAC to return to temperature can vary dramatically and can often be prohibitive. Additionally, a dirty HVAC
filter or coil will reduce heat transfer, increasing that recovery time.
EcoSmart Delivers Room-by-Room Savings
Because each room’s environment is unique, Telkonet’s approach is likewise unique. Rooms are 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 the environmental
characteristics that impact the temperature in the room, including:
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The occupant’s preferred temperature setting
The location of the room within the building
The window placement – facing the sun or shade
If the drapes are open or closed
If the climate is dry or humid
The varying weather conditions throughout the day
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. The technology also significantly improves the guest experience, driving loyalty to the property and brand, and
decreases service calls.
The EcoSmart Platform maximizes energy reductions while at the same time ensuring occupant comfort, maximizing energy savings and extending equipment life expectancy.
The technology is particularly attractive to customers in the hospitality industry, as well as the education, healthcare, public housing and government/military markets, who are
constantly seeking ways to reduce costs and meet federal and state mandates without impacting building occupant comfort.
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Using standard communication protocols, ensuring widespread adoption and a simple interface, EcoSmart technology may also be integrated with utility controls, property
management systems and building automation systems to be used in load shedding initiatives. This feature provides management companies and utilities enhanced opportunities
for cost savings, environmental protections and energy management. Additionally, Telkonet’s energy management systems 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 differentiation against competing products, including:
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Technology that evaluates each room’s environmental conditions results in maximum energy savings;
The ability to reduce HVAC runtimes increases overall equipment life;
Increased occupant control and comfort, driving brand and property loyalty;
· Multiple thermostat options, including wired and wireless, to fit a brand’s image and application;
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Backlight of thermostat improves the experience for the visually impaired;
· Web-based access with extremely powerful and simple dashboard web interface;
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Breadth of HVAC system compatibility;
Adaptive learning and system programming;
Utility-integrated events capabilities;
Remote HVAC control network;
Expert EcoCare support, staffed in the USA;
Plug load, lighting and HVAC controls;
Extensive 3rd-party integrations, including lighting, door locks, and window treatments;
Industry standard software and communication protocols, Linux and ZigBee;
Typical two or three-year ROI; and
· Mobile applications provide installation, remote management and end-user accessibility.
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Our open, scalable and standards-based architecture approach allows for truly custom deployments. The EcoSmart Platform integrates 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.
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 commercial industries. In addition, our relationships with utility-sponsored direct-install and rebate-funded programs provide us with a significant
advantage over our competitors in the commercial space.
Given the population growth in the United States and the increasing demand for energy, we forecast 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 costs.
Target Markets
Rooms with intermittent occupancy are most commonly found in the following market sectors:
· Hospitality: hotels, motels, resorts, timeshares and casinos.
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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.
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Public Housing: apartments and other public living options.
Industry and Market Overview
According to the U.S. Department of Energy, 44% of all the energy consumed by commercial buildings in the United States is employed to cool, heat, or light, 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 2017 report issued by Navigant Research, titled, “Energy Efficient Buildings Global Outlook”, stated that the global market for energy efficient building technologies is
expected to reach nearly $360.6 billion in 2026.[4] The report asserts that the Internet-of-Things (“IoT”) is partly responsible for one of the most dramatic changes to the market
landscape in its history, and that OEMs and providers are adjusting their strategies to address specific market needs. HVAC has been identified as one of nine key categories.
Telkonet’s key industries are all prime candidates for energy management, in part due to their utilizing energy “on-demand” or intermittently. 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] U.S Energy Information Administration - www.eia.gov/energyexplained/images/charts/energy_use_commercial_bldgs.jpg
[4] Energy Efficient Buildings: Global Outlook - https://www.navigantresearch.com/research/energy-efficient-buildings-global-outlook
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Education Industry
Telkonet approaches the education industry with strategic relationships with enterprise energy service companies (“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, bundling solutions with acceptable ROI and which meet state mandated guidelines.
ESCOs also structure self-funding financial transactions called “Performance Contracts” in which the savings are greater than the repayment costs, typically guaranteeing the
financial and operational performance in this type of engagement. This type of approach can remove any capital expense barriers and improve adoption.
In addition to an installed base of University of California, Davis, Massachusetts Institute of Technology, Kansas State University, North Carolina State University, University
of Notre Dame, US Military Academy at West Point, Columbia University, and Texas A&M University-Commerce, we have recently added University of Houston – Victoria.
The opportunities in this market are not limited to higher education institutions. According to an NRG Business Energy Advisor report, schools in the United States spend $8
billion on energy costs annually, with 73% of natural gas use going towards heating and 35% of electricity consumption going towards cooling. While heating and cooling
account for only 2 – 4% of district costs, it is an opportunity for significant impact and gain.
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
There is a constant balancing act for hotel operators between managing guest comfort and operating margins. The EcoSmart platform’s Recovery Time allows operators to
manage operation costs yet still provide for a comfortable and engaging guest experience. In fact, the EcoSmart platform individual brands and properties can create a desired
guest environment, and still allow for energy savings via the Recovery Time algorithm. Telkonet has proven that the EcoSmart platform can deliver a return on investment in
less than three years for hospitality customers.
Government & Military Industry
The Department of Defense (“DOD”) is the single largest energy consumer in the United States, accounting for about 90 percent of the federal government’s energy use and
using over 30,000 giga-watt hours of electricity per year. [5] Thus, we view this market as strategically significant to Telkonet’s interests.
Our energy management platform is already successfully incorporated into the energy initiatives in several military housing sites, military academies and barracks. Telkonet
benefited from 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.
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[5] http://www.brookings.edu/~/media/research/files/papers/2007/8/defense%20lengyel/lengyel20070815.pdf
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Healthcare Industry
Healthcare organizations currently spend over $6.5 billion on energy each year, a cost which continues to rise in an effort to meet patient needs. [6] This is viewed as an
emerging market for energy management systems. Although hospitals have many specific regulatory mandates, Telkonet has 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. 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.
These facilities offer a commercial environment similar to the hospitality or educational housing markets, and the increasing aging population 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 and an aging
population.
Utility Industry
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, 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 Internet-of-Things environment.
Public Housing
Public housing, which are properties owned and managed by the government, is an additional emerging market for energy management solutions. 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. The EcoSmart platform is an ideal solution for conserving
energy, allowing remote monitoring, and improving tenant comfort.
Competition for Markets
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 (“BAS”) or Building Management Systems (“BMS”), static temperature occupancy-
based systems, scheduling/programmable thermostats and high-efficiency HVAC systems.
We participate in a relatively small competitive field within the hospitality industry, with the majority of the energy management sales handled by fewer than seven
manufacturers. The key competitors in the market segment are Inncom by Honeywell and Schneider Electric, with each offering some level of comparable products to our
standalone and/or networked products. Telkonet leverages the above-mentioned competitive advantages to successfully compete in these spaces and win business.
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[6] https://www.energystar.gov/ia/partners/publications/pubdocs/Healthcare.pdf
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The educational space is new to adopt occupancy-based controls. The EcoSmart Platform has been introduced for use within student dormitories, which traditionally had few, if
any, controls. More recently we’ve also been requested to install our products into classrooms, which traditionally have been an environment for BAS/BMS. 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. Again, our key differentiators allow us to compete and win business
in this space.
The healthcare and government/military markets are very similar in scope, relative to energy management systems. A key differentiator in these environments is the specific
implementation being considered. Each market utilizes BAS/BMS for wide scale energy management initiatives. When 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.
Inventory
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, but have experienced gross profit pressure as a result of price increases and the impact of tariffs (discussed below). We
contract the majority of our inventory with ATR Manufacturing, based in China, which provides substantially all the manufacturing requirements for Telkonet’s energy
management platform.
Customers
We are neither limited to, nor reliant upon, a single or narrowly segmented customer base to derive our revenues. Our current primary focus is in the hospitality, commercial,
education, utility, 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, 2018 and 2017, no single customer represented 10% or more of our revenues.
Intellectual Property
Telkonet has acquired certain intellectual properties, 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
As discussed in Part I, Item IA, given we purchase the majority of our inventory from a supplier based in China, we are subject to and have been affected by the tariffs imposed
by the United States Federal Government on imports of industrial sector products from China.
In addition, 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.
9
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, 2018 and 2017, the Company spent $1,879,676 and $1,770,597, respectively, on research and development activities. Telkonet continues
to invest significantly in research & development to maintain and grow our competitive differentiation and customer value. Key initiatives for 2019 include: expanding our
EcoTouch product line with WIFI and Bluetooth wireless capabilities; creation of a new Gateway model with cellular wireless capabilities; expanding Symphony Composer
development for next generation web management Internet of Things dashboard; and expanding data analytics engine integration into Symphony platform for savings algorithm
development.
Additional Information
Employees
As of April 1, 2019, we had 50 full-time employees and 1 part-time employee. 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.
Discontinued Operations
In October of 2016, the Company decided to offer for sale its Ethostream High-Speed Internet Access (“HSIA”) subsidiary. While EthoStream is one of the largest public
HSIA providers in the world, providing services to more than 12.0 million users monthly across a network of approximately 1,800 locations, the Company will focus on its
higher growth potential EcoSmart Platform line. The operating results of Ethostream for the years ended December 31, 2017 have been reclassified as discontinued operations in
the consolidated statements of operations. The Company closed the sale of EthoStream, LLC on March 29, 2017 and the impact on the Company’s liquidity as a result of the
proceeds from the sale is expected to allow for greater strategic investment in marketing and research and development by the Company.
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.
10
Risks Relating to Our Financial Results and Need for Financing
We have a history of operating losses and an accumulated deficit and expect to continue to incur operating losses and negative operating cash flows for one year beyond the
date of these financial statements, and as a result, there is substantial doubt about our ability to continue as a going concern.
Since inception through December 31, 2018, we have incurred cumulative losses of $123,171,406 and have never generated enough funds through operations to support our
business. For the year ended December 31, 2018, we had an operating cash flow deficit of $3,945,742 from continuing operations. The Company’s ability to continue as a going
concern is dependent upon generating profitable operations in the future and obtaining the necessary financing to meet its obligations and repay its liabilities arising from
normal business operations when they come due. We have not identified, and cannot be certain we will be able to identify, a course of action that guarantees the achievement of
profitable operations in the foreseeable future. Further, there can be no assurance that the Company will be able to secure such financing at commercially reasonable terms, if at
all. If cash resources become insufficient to meet the Company’s ongoing obligations, the Company will be required to scale back or discontinue portions of its operations or
discontinue operations entirely, whereby, the Company’s shareholders may lose some or all of their investment. Accordingly, and in light of the Company’s historic and
continuing losses, there is substantial doubt about the Company’s ability to continue as a going concern.
The Company’s Board is working with an investment bank to identify strategic alternatives available in an effort to maximize shareholder value, including but not limited to, a
sale of the Company, a merger or other business combination, a sale of all or substantially all assets, a joint venture or equity and debt refinancing. At April 1, 2019, no
definitive alternatives had been identified.
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 Amended Restated and Articles of Incorporation. As of March 2019, we have issued
134,793,211 shares of common stock and have approximately 8,147,955 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, we may not able to raise
additional equity capital or complete a merger or other business combination unless we increase the number of shares we are authorized to issue. 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 Amended and
Restated Articles of Incorporation to increase the number of shares of common stock we are authorized to issue.
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. There can be no assurance that the Company will be able to secure financing to refinance these
borrowings at commercially reasonable terms, if at all. If we are unable to secure such financing and cash resources become insufficient to meet the Company’s ongoing
obligations, the Company will be required to scale back or discontinue portions of its operations or discontinue operations entirely, whereby, the Company’s shareholders may
lose some or all of their investment.
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, (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 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.
11
If the Company is unable to continue as a going concern, the Company’s shareholders may lose some or all of their investment.
Risks Relating to the Ownership of Our Common Stock
As discussed above, we have a history of operating losses and an accumulated deficit and expect to continue to incur operating losses and negative operating cash flows for one
year beyond the date of these financial statements, and as a result, there is substantial doubt about our ability to continue as a going concern. If cash resources become
insufficient to meet the Company’s ongoing obligations and we are unable to secure financing at commercially reasonable terms, if at all, the Company will be required to scale
back or discontinue portions of its operations or discontinue operations entirely, whereby, the Company’s shareholders may lose some or all of their investment.
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.
The market price of our common stock has been and may continue to be volatile.
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
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 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 Security and Exchange Commission (“SEC”) has adopted regulations which define a “penny stock” to include any equity security that has a market price of less
than $5 per share or an exercise price of less than $5 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require the
delivery to and execution by the retail customer of a written declaration of suitability relating to the penny stock, which must include disclosure of the commissions payable to
both the broker/dealer and the registered representative and current quotations for the securities. Finally, the broker/dealer must send monthly statements disclosing recent price
information for the penny stocks held in the account and information on the limited market in penny stocks. Those requirements could adversely affect the market liquidity of
our common stock. There can be no assurance that the price of our common stock will rise above $5 per share so as to avoid these regulations.
Further issuances of equity securities may be dilutive to current stockholders.
It is possible that we will be required to seek additional capital in the near term. 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.
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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, 2018, we had outstanding employee options to purchase a total of 3,349,793 shares of common stock at exercise prices ranging from $0.14 to $1.00 per
share, with a weighted average exercise price of $0.16. As of December 31, 2018, we had warrants outstanding to purchase a total of 250,000 shares of common stock at an
exercise price of $0.20 per share. The exercise of outstanding options and warrants and the sale in the public market of the shares purchased upon such exercise could be
dilutive to existing stockholders and could adversely affect the market price of our common stock.
New tariffs and evolving trade policy between the United States and China may have a material adverse effect on our business.
Risks Related to Our Business
During 2018, the United States Federal Government imposed significant tariffs on imports from numerous countries, including China. Subsequent to this, the Office of the
United States Trade Representative (“USTR”) announced an initial proposed list of imports from China that could be subject to additional tariffs. The list of imports for which
Customs and Border Protection began collecting additional duties during July 2018, focuses on the industrial sector. The Company’s main supplier, accounting for
approximately 80% of total purchases, is located in China. The products that the Company purchases from the supplier are subject to up to 25% tariffs. As a result of the tariffs,
our cost of sales has increased.
The current administration, along with Congress, has created significant uncertainty about the future relationship between the United States and other countries with respect to
the trade policies, treaties, taxes, government regulations and tariffs that would be applicable. It is unclear what changes might be considered or implemented and what response
to any such changes may be by the governments of other countries. These changes have created significant uncertainty about the future relationship between the United States
and China, as well as other countries, including with respect to the trade policies, treaties, government regulations and tariffs that could apply to trade between the United States
and other nations. If significant tariffs or other restrictions are placed on Chinese imports or any related counter-measures are taken by China, our revenue and results of
operations may be materially harmed. Even in the absence of further tariffs, the related uncertainty and the market's fear of an escalating trade war might create forecasting
difficulties for us and cause our customers and business partners to place fewer orders for our products and services, which could have a material adverse effect on our business,
liquidity, financial condition, and/or results of operations.
These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial
markets, and may significantly reduce global trade and, in particular, trade between these nations and the United States. Any of these factors could depress economic activity
and restrict our access to suppliers or customers and have a material adverse effect on our business, financial condition and results of operations and affect our strategy in China
and elsewhere around the world. Given the relatively fluid regulatory environment in China and the United States and uncertainty how the U.S. Administration or foreign
governments will act with respect to tariffs, international trade agreements and policies, a trade war, further governmental action related to tariffs or international trade policies,
or additional tax or other regulatory changes in the future could directly and adversely impact our financial results and results of operations.
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, with purchases from one supplier
comprising approximately 81% of total purchases for the year ended December 31, 2018. 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.
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The industry within which we operate is intensely competitive and rapidly evolving.
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 developing and 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;
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, 2018 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, 2018, our management has concluded that, as of such date, there were material
weaknesses in our internal control over financial reporting related to a lack of segregation of duties due to the limited size of the Company’s accounting department, a failure to
implement adequate internal control over financial reporting including in our IT general control environment and the need for a stronger internal control environment
particularly in our financial reporting and close process. 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. As
disclosed in Item 9A of Part II of this report, because of the material weaknesses identified by the Company, our consolidated financial statements may contain material
misstatements that would require restatement of the Company’s financial results in this report. 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. At present, the Company does not expect to hire additional personnel to remediate these control deficiencies in the near future. We
are reviewing other potential actions to remediate the identified material weaknesses.
Until and if 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. Material misstatements in our financial
statements could result in litigation or regulatory enforcement actions, which would require additional financial and management resources; loss of investor confidence; and
delays in filing required financial disclosures, one or more of which could have a material adverse effect on our business and financial condition. The Company believes the
consolidated financial statements as of December 31, 2018 and 2017 are free of material misstatements.
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
product suite complies with the FCC technical requirements for Class A and Class B digital devices. No further testing of these devices is required, and the devices may be
manufactured and marketed for commercial and residential use. Additional devices designed by us for commercial and residential use will be subject to the FCC rules for
unlicensed digital devices. Moreover, if in the future, the FCC changes its technical requirements for unlicensed digital devices, further testing and/or modifications of devices
may be necessary. Failure to comply with any FCC technical requirements could impair our ability to sell our products in certain markets and could have a negative impact on
our business and results of operations.
15
Products sold by our competitors could become more popular than our products or render our products obsolete.
The market for our products and services is highly competitive. Some of our competitors have longer operating histories, greater name recognition and substantially greater
financial, technical, sales, marketing and other resources. These competitors may, among other things, undertake more extensive marketing campaigns, adopt more aggressive
pricing policies, obtain more favorable pricing from suppliers and manufacturers and exert more influence on the sales channel than we can. As a result, we may not be able to
compete successfully with these competitors, and these competitors may develop or market technologies and products that are more widely accepted than those being
developed by us or that would render our products obsolete or noncompetitive. We anticipate that competitors will also intensify their efforts to penetrate our target markets.
These competitors may have more advanced technology, more extensive distribution channels, stronger brand names, bigger promotional budgets and larger customer bases
than we do. These companies could devote more capital resources to develop, manufacture and market competing products than we could. If any of these companies are
successful in competing against us, our sales could decline, our margins could be negatively impacted, and we could lose market share, any of which could seriously harm our
business, results of operations, and prospects.
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.
We may be affected if the United States participates in wars or other military 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.
16
Cyber security risks and cyber incidents could adversely affect our business and disrupt operations.
Cyber incidents can result from deliberate attacks or unintentional events. These incidents can include, but are not limited to, gaining unauthorized access to digital systems for
purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. The result of these incidents could include, but are not limited
to, disrupted operations, misstated financial data, liability for stolen assets or information, increased cyber-security protection costs, litigation and reputational damage adversely
affecting customer or investor confidence. We have implemented systems and processes to focus on identification, prevention, mitigation and resolution. However, these
measures cannot provide absolute security, and our systems may be vulnerable to cyber-security breaches such as viruses, hacking, and similar disruptions from unauthorized
intrusions. In addition, we rely on third party service providers to perform certain services, such as payroll and tax services. Any failure of our systems or third party systems
may compromise our sensitive information and/or personally identifiable information of our employees. While we have secured cyber insurance to potentially cover certain
risks associated with cyber incidents, there can be no assurance the insurance will be sufficient to cover any such liability.
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. This risk is increased given we depend on a limited number of third party suppliers to provide the components and the equipment required to deliver
our solutions, with purchases from one supplier comprising approximately 81% of total purchases for the year ended December 31, 2018. If we encounter such difficulties, we
may not be able to produce our products for our customers in a timely fashion which could have an adverse effect on our results of operations, financial condition and cash
flows.
Changes in the economy and credit markets may adversely affect our future results of operations.
Our operations and performance depend to some degree on general economic conditions and their impact on our customers’ finances and purchase decisions. As a result of
economic events, potential customers may elect to defer purchases of capital equipment items, such as the products we manufacture and supply. Additionally, the credit markets
and the financial services industry are subject to change. While the ultimate outcome of these events cannot be predicted, it may have a material adverse effect on our
customers’ ability to fund their operations thus adversely impacting their ability to purchase our products or to pay for our products on a timely basis, if at all. These and other
economic factors could have a material adverse effect on demand for our products, the collection of payments for our products and on our financial condition and operating
results.
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 federally 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.
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ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
In October 2013, the Company entered into a lease agreement for 6,362 square feet of commercial office space in Waukesha, Wisconsin for its corporate headquarters with a
term expiration of April 30, 2021. On April 7, 2017, the Company executed an amendment to the existing lease to expand another 3,982 square feet, bringing the total leased
space to 10,344 square feet, and extend the lease term from May 1, 2021 to April 30, 2026. The commencement date for this amendment was July 15, 2017.
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 employees. In
September 2018, the Company entered into a third amendment to the lease agreement extending the lease through the end of January 2022.
In May 2017, the Company entered into a lease agreement for 5,838 square feet of floor space in Waukesha, Wisconsin for its inventory warehousing operations. The Waukesha
lease expires in May 2023.
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.
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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 OTC Bulletin Board is not a stock exchange and any over-the-counter market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
PART II
Record Holders
As of March 26, 2019, we had 211 holders of record of our common stock and 134,793,211 shares of our common stock issued and outstanding.
Securities Authorized for Issuance Under Equity Compensation Plans
See Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for information about securities authorized for issuance under
the Company’s equity compensation plans.
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.
Issuer Purchases of Equity Securities
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, recovery of long-lived assets, income tax provisions and related valuation allowance, 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.
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Revenue from Contracts with Customers
Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606, the Standard”) supersedes nearly all legacy revenue recognition guidance.
ASC 606, the Standard outlines a comprehensive five-step revenue recognition model based on the principle that an entity should recognize revenue based on when it satisfies
its performance obligations by transferring control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in
exchange for said goods or services.
Identify the customer contracts
The Company accounts for a customer contract under ASC 606 when the contract is legally enforceable. A contract is legally enforceable when all of the following criteria are
met: (1) the contract has been approved by the Company and the customer and both parties are committed to perform their respective obligations, (2) the Company can identify
each party’s rights regarding goods or services transferred, (3) the Company can identify payment terms for goods or services transferred, (4) the contract has commercial
substance, and (5) collectability of all the consideration to which the Company is entitled in exchange for the goods or services transferred is probable.
A contract does not exist if each party to the contract has the unilateral right to terminate a wholly unperformed contract without compensating the other party (or parties).
Nearly all of the Company’s contracts do not contain such mutual termination rights for convenience. All contracts are in written form.
Identify the performance obligations
The Company will enter into product only contracts that contain a single performance obligation related to the transfer of EcoSmart products to a customer.
The Company will also enter into certain customer contracts that encompass product and installation services, referred to as “turnkey” solutions. These contracts ultimately
provide the customer with a solution that enhances the functionality of the customer’s existing equipment. For this reason, the Company has determined that the product and
installation services are not separately identifiable performance obligations, but in essence represent one, combined performance obligation (“turnkey”).
The Company also offers post-installation support services to customers. Support services are considered a separate performance obligation.
Determine the transaction price
The Company generally enters into contracts containing fixed prices. It is not customary for the Company to include contract terms that would result in variable consideration.
In the rare situation that a contract does include this type of provision, it is not expected to result in a material adjustment to the transaction price. The Company regularly
extends pricing discounts; however, they are negotiated up front and adjust the fixed transaction price set out in the contract.
Customer contracts will typically contain upfront deposits that will be applied against future invoices, as well as customer retainage. The intent of any required deposit or
retainage is to ensure that the obligations of either party are honored and follow customary industry practices. In addition, the Company will typically be paid in advance at the
beginning of any support contracts, consistent with industry practices. None of these payment provisions are intended to represent significant implicit financing. The Company’s
standard payment terms are thirty days from invoice date. Products are fully refundable when returned in their original packaging without damage or defacing less a restocking
fee. Historical returns have shown to be immaterial. The Company offers a standard one-year assurance warranty. However customers can purchase an extended warranty.
Under the new standard, extended warranties are accounted for as a service warranty, requiring the revenue to be recognized over the extended service periods. Contracts
involving an extended warranty are immaterial and will continue to be combined with support revenue and recognized on a straight-line basis over the support revenue term.
20
Allocate the transaction price to the performance obligations
Revenues from customer contracts are allocated to the separate performance obligations based on their relative stand-alone selling price (“SSP”) at contract inception. The SSP
is the price at which the Company would sell a promised good or service separately. The best evidence of an SSP is the observable price of a good or service when the entity
sells that good or service separately in similar circumstances and to similar customers. However, turnkey solutions are sold for a broad range of amounts resulting from, but not
limited to, tiered discounting for value added resellers (“VAR”) based upon committed volumes and other economic factors. Due to the high variability of our pricing, the
Company cannot establish a reliable SSP using observable data. Accordingly, the Company uses the residual approach to allocate the transaction price to performance
obligations related to its turnkey solutions. When support services are not included within the turnkey solution, the residual method is not utilized and no allocation of the
transaction price to the performance obligation is necessary.
All support service agreements, whether single or multi-year terms, automatically renew for one-year terms at a suggested retail price (“SRP”). Support service renewals are
consistently priced and therefore would support the use of SRP as the best estimate of an SSP for such performance obligations.
Revenue Recognition
The Company recognizes revenues from product only sales at a point in time, when control over the product has transferred to the customer. As the Company’s principal terms
of sale are FOB shipping point, the Company primarily transfers control and records revenue for product only sales upon shipment.
A typical turnkey project involves the installation and integration of 200-300 rooms in a customer-controlled facility and usually takes sixty days to complete. Since control
over goods and services transfers to a customer once a room is installed, the Company recognizes revenue for turnkey solutions over time. The Company uses an outputs
measure based on the number of rooms installed to recognize revenues from turnkey solutions.
Revenues from support services are recognized over time, in even daily increments over the term of the contract, and are presented as “Recurring Revenue” in the Statement of
Operations.
Contract liabilities include monthly support service fees, customer deposits, and billings in advance of revenue recognition. The long term portion of these liability balances
represent the amount of revenues that will be recognized after December 31, 2019.
Contract Fulfillment Cost
The Company recognizes related costs of the contract over time in relation to the revenue recognition. Costs included within the projects relate to the cost of material, direct
labor and costs of outside services utilized to complete projects. These are presented as “Contract assets” in the consolidated balance sheets.
Transition
The Company adopted ASC 606 using a modified retrospective approach to all contracts not completed as of January 1, 2018. Results for reporting periods beginning January 1,
2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under
Topic 605, Revenue Recognition. The Company recorded a net decrease to beginning retained earnings of $0.43 million as of January 1, 2018 due to the cumulative impact of
adopting ASC 606. The impact to beginning retained earnings was primarily driven by the deferral of revenue for unfulfilled performance obligations related to the Company’s
turnkey solutions.
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.
21
Inventory Obsolescence
Inventories consist of 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 net realizable value 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.
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, 2018 and 2017, the
Company experienced approximately between 1% and 3% of returns related to product warranties. As of December 31, 2018 and 2017, the Company recorded warranty
liabilities in the amount of $46,103 and $59,892, 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. For the year
ended December 31, 2018, the Company has recorded all known and estimable impacts of the Tax Act that are effective for 2018.
Stock Based Compensation
We account for our stock based awards in accordance with ASC 718, which requires a fair value measurement and recognition of compensation expense for all share-based
payment awards made to our employees and directors, including employee stock options and restricted stock awards.
We estimate the fair value of stock options granted using the Black-Scholes valuation model. This model requires us to make estimates and assumptions including, among other
things, estimates regarding the length of time an employee will retain vested stock options before exercising them and the estimated volatility of our common stock price. The
fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Changes in these estimates and
assumptions can materially affect the determination of the fair value of stock-based compensation and consequently, the related amount recognized in our consolidated
statements of operations.
Recovery of 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.
22
Contingent Liabilities - Sales Tax
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.
Results of Continuing Operations
Year Ended December 31, 2018 Compared to Year Ended December 31, 2017
Revenues
The table below outlines our product versus recurring revenues from continuing operations for comparable periods:
2018
Year Ended December 31,
2017
$
$
7,616,415
815,564
8,431,979
90%
10%
100%
$
$
7,798,680
483,889
8,282,569
94%
6%
100%
$
$
Variance
(182,265)
331,675
149,410
(2%)
69%
2%
Product
Recurring
Total
Product Revenue
Product revenue principally arises from the sale and installation of the EcoSmart Suite of products consists of thermostats, sensors, controllers, wireless networking products
switches, outlets and a control platform.
For the year ended December 31, 2018, product revenue decreased $0.18 million to $7.61 million when compared to the prior year. Product revenue from the hospitality market
increased $0.8 million to $6.4 million for the year ended December 31, 2018 compared to $5.6 million for the prior year. Product revenue from the MDU market remained
relatively unchanged at $0.5 million for the year ended December 31, 2018 compared to the prior year period. Product revenue from the education market decreased $0.8
million to $0.7 million for the year ended December 31, 2018 compared to $1.5 million for the prior year. Product revenue attributed to sales from channel partnerships and
value added resellers increased $1.8 million to $6.3 million for the year ended December 31, 2018 compared to $4.5 million for the prior year period. Product revenue attributed
to sales from channel partnerships and value added resellers as a percentage of total revenue was 75% for the year ended December 31, 2018 compared to 59% for the prior
year. The most significant impact to the changes in revenue with the various markets was related to the timing of revenue recognition of the related contracts.
Recurring Revenue
Recurring revenue is attributed to our technical phone support 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. Recurring revenue consists of Telkonet’s EcoCare service and support program.
For the year end comparison, recurring revenue increased 69% or $0.33 million to $0.82 million for the year ended December 31, 2018 compared to $0.48 million for the year
ended December 31, 2017. The primary reasons for the increase are renewals outpaced cancellations for support services along with organic sales growth.
23
Cost of Sales
2018
Year ended December 31,
2017
Product
Recurring
Total
$
$
4,392,643
269,443
4,662,086
58%
33%
55%
$
$
4,261,100
176,131
4,437,231
55%
36%
54%
$
$
Costs of Product Revenue
Variance
131,543
93,312
224,855
3%
53%
5%
Costs of product revenue include equipment and installation labor related to EcoSmart technology. For the year ended December 31, 2018, product costs increased by 3%
compared to the prior year. Material costs increased $0.38 million due to price increases. Additionally, freight in increased $0.13 million largely due to increased tariffs related
to the Company’s primary supplier. These increases were partially offset by salary and wages decrease of $0.85 million, a decrease in the use of outside services of $0.18
million, a decrease in purchase price variance of $0.03 million, along with other immaterial changes to costs of product revenue.
Costs of Recurring Revenue
Recurring costs are comprised of labor and telecommunication services for our customer service department. For the year ended December 31, 2018, costs of recurring revenue
increased by 53% when compared to the prior year. The increase of $0.09 million was driven by an increase in salaries and benefits due to the Company adding support services
employees during the year ended December 31, 2018.
Gross Profit
2018
Year ended December 31,
2017
Product
Recurring
Total
$
$
3,223,772
546,121
3,769,893
42%
67%
45%
$
$
3,537,580
307,758
3,845,338
45%
64%
46%
$
$
Gross Profit on Product Revenue
Variance
(313,808)
238,363
(75,445)
(9%)
77%
(2%)
Gross profit for the year ended December 31, 2018 decreased by 9% when compared to the prior year. The actual gross profit percentages decreased to 42% for the year ended
December 31, 2018 compared to 45% for the year ended December 31, 2017. Contributing to the 3% decrease in gross profit percentage was an increase in customer discounts
given on product sales, cost of goods sold and freight in, mainly due to the increased tariffs.
Gross Profit on Recurring Revenue
For the year ended December 31, 2018, our gross profit increased by 77% when compared to the prior year driven by unit sales. The actual gross profit percentages increased to
67% for the year ended December 31, 2018 compared to 64% for the year ended December 31, 2017.
24
Operating Expenses
2018
2017
Variance
Year ended December 31,
Total
$
6,790,642 $
7,334,751 $
(544,109)
(7%)
The Company’s operating expenses are comprised of research and development, selling, general and administrative expenses and depreciation and amortization expense. During
the year ended December 31, 2018, operating expenses decreased by 7% when compared to the prior year as outlined below.
Research and Development
2018
2017
Variance
Year ended December 31,
Total
$
1,879,676 $
1,770,597 $
109,079
6%
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, 2018, research and development costs increased 6% when compared to the prior year. The
majority of the variance is due to an approximate $0.27 million increase in expenditures for IT consulting. This increase was partially offset by decreases in salary and wages
($0.08 million) and certification expenses ($0.04 million) when compared to the prior year. Key initiatives for 2019 include: expanding our EcoTouch product line with WIFI
and Bluetooth wireless capabilities; creation of a new Gateway model with cellular wireless capabilities; expanding Symphony Composer development for next generation web
management Internet of Things dashboard; and expanding data analytics engine integration into Symphony platform for savings algorithm development.
Selling, General and Administrative Expenses
2018
2017
Variance
Year ended December 31,
Total
$
4,843,859 $
5,512,925 $
(669,066)
(12%)
Selling, general and administrative expenses decreased for the year ended December 31, 2018 from the prior year by 12%. The decrease was driven by a decrease in salaries and
benefits of $0.2 million, a $0.17 million decrease in consulting fees, and an additional decrease in stock option expense of $0.31 million, primarily related to the prior year’s
sale of Ethostream.
Income from Discontinued Operations, Net of Tax
2018
Year ended December 31,
2017
Variance
Total
$
-
$
612,875 $
(612,875)
-100%
Income from discontinued operations decreased $0.6 million for the year ended December 31, 2018 over the prior year or 100%. On March 29, 2017, pursuant to the terms and
the conditions of the Purchase Agreement, the Company closed on the sale of EthoStream. The income from discontinued operations (net of tax) represents the activity of
EthoStream from January 1, 2017 through the date of the sale on March 29, 2017. After March 29, 2017, certain insignificant liabilities retained by the Company have been
adjusted as these liability balances were paid. The Company realized a gain from the sale of EthoStream of $6,630,244.
25
EBITDA from Continuing Operations
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, amortization and stock-based compensation (“Adjusted EBITDA”) is a
metric used by management and frequently used by the financial community. Adjusted EBITDA from continuing operations provides insight into an organization’s operating
trends and facilitates comparisons between peer companies, since interest, taxes, depreciation, amortization and stock-based compensation can differ greatly between
organizations as a result of differing capital structures and tax strategies. Adjusted EBITDA from continuing operations is one of the measures used for determining our debt
covenant compliance. Adjusted EBITDA from continuing operations 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 from continuing operations 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, 2018 and 2017, the Company excluded items in the following general categories 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.
· Bonuses paid to executives upon sale of discontinued operations: The Company does not consider the bonuses of $87,750 associated with the sale of Ethostream to be
indicative of current or future operating performance. Therefore, the Company does not consider the inclusion of these costs helpful in assessing its current financial
performance compared to the previous year.
RECONCILIATION OF NET LOSS FROM
CONTINUING OPERATIONS TO ADJUSTED EBITDA
FOR THE YEARS ENDED DECEMBER 31,
Net loss from continuing operations
Interest (income) expense, net
Provision for income taxes
Depreciation and amortization
EBITDA – continuing operations
Adjustments:
Stock-based compensation
Bonuses paid to executives upon sale of discontinued operations
Adjusted EBITDA – continuing operations
26
$
$
2018
2017
(3,016,750)
(13,622)
9,623
67,107
(2,953,642)
6,405
–
(2,947,237)
$
$
(3,496,741)
(2,434)
9,762
51,229
(3,438,184)
322,888
87,750
(3,027,546)
Liquidity and Capital Resources
For the year ended December 31, 2018, the Company reported a net loss of $3,016,750 and had cash used in operating activities of $3,945,742, and ended the year with an
accumulated deficit of $123,171,406 and total current assets in excess of current liabilities of $6,206,299. At December 31, 2018, the Company had $4,678,891 of cash and
approximately $500,000 of availability on its credit facility. The credit facility is a $2,000,000 line of credit, which 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. As of December 31, 2018, we had borrowing capacity of $621,790 and an outstanding balance of $121,474, resulting in the approximate availability of $500,000 on
the credit facility.
Since inception, the Company has incurred operating losses and has reported negative cash flows from operating activities. Since 2012, the Company has made significant
investments in the engineering, development and marketing of an intelligent automation platform, including but not limited to, hardware and software enhancements, support
services and applications. The funding for these development efforts has contributed to the ongoing operating losses and use of cash. Operating losses have been financed by
debt and equity transactions, credit facility capacity, the sale of a wholly-owned subsidiary and management of working capital levels. The report from our independent
registered public accounting firm on our consolidated financial statements for the year ended December 31, 2018 stated there is substantial doubt about our ability to continue
as a going concern.
The Company’s ability to continue as a going concern is dependent upon generating profitable operations in the future and/or securing the necessary financing to meet its
obligations and repay its liabilities arising from normal business operations when they come due. There can be no assurance that the Company will be able to secure such
financing at commercially reasonable terms, if at all. If cash resources become insufficient to meet the Company’s ongoing obligations, the Company will be required to scale
back or discontinue portions of its operations or discontinue operations entirely, whereby, the Company’s shareholders may lose some or all of their investment.
We have not identified, and cannot be certain we will be able to identify, a course of action that guarantees the achievement of profitable operations in the foreseeable future. In
June 2018, the Company’s Board engaged an investment bank to identify strategic alternatives to maximize shareholder value, including but not limited to, a sale of the
Company, an investment in the Company, a merger or other business combination, a sale of all or substantially all assets or a strategic joint venture. At April 1, 2019, no
definitive alternatives had been identified.
The Company expects to draw on its’ cash reserves and utilize the credit facility to the extent availability exists to finance its near term working capital needs. We expect to
continue to incur operating losses and negative operating cash flows for one year beyond the date of these financial statements. Accordingly, and in light of the Company’s
historic and continuing losses, there is substantial doubt about the Company’s ability to continue as a going concern.
Working Capital
Our working capital (current assets in excess of current liabilities) from continuing operations decreased by $3,274,266 during the year ended December 31, 2018 from a
working capital of $9,480,565 at December 31, 2017, to $6,206,299 at December 31, 2018. The majority of the decrease was due to the operating losses for 2018.
27
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 “Heritage Bank 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”). Following the sale of EthoStream in March of 2017, it was removed as a co-borrower.
Availability of borrowings under the Credit Facility 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 Heritage Bank Loan Agreement is available for
working capital and other general business purposes. The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 8.50% at
December 31, 2018 and 7.50% at December 31, 2017. On October 9, 2014, as part of the Heritage Bank 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 13, 2019, the tenth amendment to the Credit
Facility was executed extending the maturity date to September 30, 2020, unless earlier accelerated under the terms of the Heritage Bank Loan Agreement.
The Heritage Bank 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 Heritage Bank Loan Agreement also contains financial covenants, including a maximum EBITDA loss covenant, measured quarterly, a minimum asset coverage ratio,
measured monthly, and a minimum unrestricted cash balance of $2 million. During the year ended December 31, 2018, the Company and Heritage Bank entered into several
amendments to the Credit Facility to adjust these covenant levels. As long as the Company maintains the minimum unrestricted cash balance of $2 million, a violation of the
minimum EBITDA level will not trigger an event of default. A violation of any of these covenants could result in an event of default under the Heritage Bank 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 Heritage Bank Loan Agreement may be terminated. The Heritage Bank Loan Agreement contains other
representations and warranties, covenants, and other provisions customary to transactions of this nature.
The outstanding balance on the Credit Facility was $121,474 and $682,211 at December 31, 2018 and 2017 and the remaining available borrowing capacity was approximately
$499,000 and $202,000, respectively. As of December 31, 2018, the Company was in compliance with all financial covenants.
Cash Flow from Continuing Operations Analysis
Cash used in operating activities of continuing operations was $3,945,742 and $3,594,906 during the years ended December 31, 2018 and 2017, respectively. As of December
31, 2018, our primary capital needs included costs incurred to increase energy management sales, inventory procurement, and managing current liabilities. The working capital
changes during the year ended December 31, 2018 were primarily related to an approximate $570,000 decrease in accounts payable, a $512,000 decrease in deferred revenues,
a $434,000 increase in prepaid expenses, a $401,000 increase in inventories and a $124,000 decrease in customer deposits. The cash outlays were partially offset by an
approximate $144,000 expense related to stock compensation, a $454,000 increase in contract liabilities and a $474,000 decrease in accounts receivable. The primary working
capital change during the year ended December 31, 2017 were primarily related to an approximate $594,000 increase in inventory, a $242,000 increase in accounts receivable, a
$213,000 increase in accounts payable, a $207,000 increase in deferred revenue, a $41,000 decrease in customer deposits, a $97,000 decrease in related party payable and
a $257,000 decrease in accrued liabilities and expenses. 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.
Cash used by investing activities was $10,225 and cash provided by investing activities was $11,861,319 during the years ended December 31, 2018 and 2017, respectively.
During the year ended December 31, 2018, the cash used by investing activities reflects the purchases of property and equipment. During the year ended December 31, 2017,
the cash provided by investing activities reflects the proceeds less adjustments of $12,072,811 associated with the sale of the assets and certain liabilities assumed of the
Company’s wholly-owned subsidiary, EthoStream. A decrease of $211,492 was associated with the purchase of computer equipment and furniture, fixtures and equipment. Due
to the sale of EthoStream, the Company extended the Waukesha lease in 2017, as discussed in Note M, and refurbished the corporate office to accommodate employee’s
previously working at the Milwaukee operations office.
28
Cash used by financing activities was $560,737 and $379,918 during the years ended December 31, 2018 and 2017, respectively. During the year ended December 31, 2018,
$3,720,000 was drawn from the line of credit and $4,280,737 was paid on the line of credit. During the year ended December 31, 2017, the Heritage Bank Loan Agreement for
the Company’s line of credit included the Company and EthoStream as co borrowers. Upon closing the EthoStream sale transaction on March 29, 2017, the entire balance
outstanding on the Credit Facility, $1,062,129, was repaid and a net balance of $379,918 was subsequently paid during the year ended December 31, 2017.
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 2019; therefore working capital management will continue to be a high priority for 2019. 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 continuing 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.
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 Exchange
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.
29
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 Exchange Act. 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, 2018 based on the framework in Internal Control—Integrated Framework (2013) 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, 2018 based on the COSO framework criteria.
Management did not properly design or maintain effective controls over the control environment and monitoring components of COSO. We did not have a sufficient
complement of accounting and financial personnel with an appropriate level of knowledge to address technical accounting and financial reporting matters in accordance with
generally accepted accounting principles and the Company’s overall financial reporting requirements. We also lack sufficient information technology resources to address our
IT general control environment requirements. The failures within the control environment and monitoring components contributed to the following control activity level material
weaknesses:
·
·
·
·
Revenues – We did not properly design or maintain effective controls over the recording of revenue recognition for contracts whose performance obligations are fulfilled
over time.
Financial Statement Close and Reporting – We did not properly design or maintain effective controls over the period end financial close and reporting process.
Specifically, we lacked control over the review of account reconciliations, journal entries, identification of related party transactions, and reporting of our financial
results and disclosures.
Information Technology – We did not properly design or maintain effective controls to prevent unauthorized access to certain systems, programs and data, and provide
for periodic review and monitoring of access and changes in programs, including review of security logs and analysis of segregation of duties conflicts.
Segregation of Duties – We did not maintain adequate segregation of duties within the Company’s business processes, financial applications, and IT systems.
Specifically, we did not have appropriate controls in place to adequately assess the segregation of job responsibilities and system user access for initiating, authorizing,
and recording transactions.
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.
We are reviewing actions to remediate the identified material weaknesses. As we continue to evaluate and work to improve our internal controls over financial reporting, our
senior management may determine to take additional measures to address deficiencies or modify the remediation efforts. Until the remediation efforts that our senior
management identifies as necessary, are completed, tested and determined effective, the material weaknesses described above will continue to exist. At present, the Company
does not expect to hire additional personnel to remediate these control deficiencies in the near future.
In light of these material weaknesses, we performed additional analyses and procedures in order to conclude that our consolidated financial statements as of and for the year
ended December 31, 2018 and 2017 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, 2018 and 2017 are fairly stated, in all material respects, in accordance with GAAP.
Under applicable Securities Law, the Company is not required to obtain an attestation report from the Company's independent registered public accounting firm regarding
internal control over financial reporting, and accordingly, such an attestation has not been obtained or included in this Annual Report.
Changes in Internal Controls
Other than the material weaknesses discussed above, during the year ended December 31, 2018, 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.
30
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 May 23, 2019.
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 May 23, 2019.
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 May 23, 2019.
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, 2018.
Number of
securities to be
issued upon
exercise of
outstanding
options, warrants
and rights
(a)
3,599,793
–
3,599,793
Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)
$
$
0.16
–
0.16
Number of
securities
remaining available
for future issuance
under equity
compensation plans
(excluding
securities reflected
in column (a))
(c)
1,606,549
–
1,606,549
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Total
31
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.
Pursuant to General Instruction G(3), information on certain relationships and related transactions and director independence is incorporated by reference from our definitive
proxy statement for the annual shareholder meeting to be held on May 23, 2019.
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 May 23, 2019.
32
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, 2018 and 2017
Consolidated Balance Sheets as of December 31, 2018 and 2017
Consolidated Statements of Operations for the Years ended December 31, 2018 and 2017
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2018 and 2017
Consolidated Statements of Cash Flows for Years ended December 31, 2018 and 2017
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
33
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
4.1
4.2
4.3
10.1
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
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 (File No. 001-31972) 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 (File No. 001-31972) filed on March 19, 2007)
Asset Purchase Agreement by and among EthoStream, LLC, Telkonet, Inc., and DCI-Design Communications, dated as of March 28, 2017 (incorporated by
reference to our Form 8-K (File No. 001-31972) filed on March 31, 2017)
Amended and Restated Articles of Incorporation of the Company (incorporated by reference to our Form S-8 (File No. 333-47986), filed on October 16, 2000)
Bylaws of the Company (incorporated by reference to our Registration Statement on Form S-1(File No. 333-108307), filed on August 28, 2003
Amendment to Amended and Restated Articles of Incorporation of the Company (incorporated by reference to our Form 8-K (File No. 001-31972), filed
November 18, 2009)
Amendment to Amended and Restated Articles of Incorporation (incorporated by reference to our Form 8-K (File No. 001-31972) filed on August 9, 2010)
Amendment to Amended and Restated Articles of Incorporation of the Company, (incorporated by reference to our Form 8-K (File No. 001-31972) filed on April
13, 2011)
Form of Warrant to Purchase Common Stock (incorporated by reference to our Form 8-K (File No. 001-31972) filed on November 18, 2009)
Form of Warrant to Purchase Common Stock (incorporated by reference to our Form 8-K (File No. 001-31972) filed on August 9, 2010)
Form of Warrant to Purchase Common Stock (incorporated by reference to our Form 8-K (File No. 001-31972) filed on April 13, 2011)
Amended and Restated Stock Option Plan (incorporated by reference to our Registration Statement on Form S-8 (File No. 333-161909), filed on September 14,
2009)
Series A Convertible Redeemable Preferred Stock Securities Purchase Agreement, dated November 16, 2009 (incorporated by reference to our Form 8-K (File
No. 001-31972) 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 (File
No. 001-31972) filed on November 18, 2009)
Form of Executive Officer Reimbursement Agreement (incorporated by reference to our Form 8-K (File No. 001-31972) filed on November 18, 2009)
Form of Director and Officer Indemnification Agreement (incorporated by reference to our Form 10-K (File No. 001-31972) filed on March 31, 2010)
Series B Convertible Redeemable Preferred Stock Securities Purchase Agreement, dated August 4, 2010 (incorporated by reference to our Form 8-K (File No.
001-31972) filed on August 9, 2010)
Series B Convertible Redeemable Preferred Stock Registration Rights Agreement, dated August 4, 2010 (incorporated by reference to our Form 8-K (File No.
001-31972) filed on August 9, 2010)
Form of Director Reimbursement Agreement (incorporated by reference to our Form 8-K (File No. 001-31972) filed on August 9, 2010)
Form of Transition Agreement and Release (incorporated by reference to our Form 8-K (File No. 001-31972) filed on August 9, 2010)
2010 Stock Option and Incentive Plan (incorporated by reference to our Registration Statement filed on Form S-8 (File No. 333-175737) filed July 22, 2011)
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 (File
No. 001-31972) filed on April 13, 2011)
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 (File
No. 001-31972) filed on April 13, 2011)
*10.15
*10.16
Employment Agreement by and between Telkonet, Inc. and Jason L. Tienor, dated as October 1, 2018
Employment Agreement by and between Telkonet, Inc. and Jeffrey J. Sobieski, dated as of October 1, 2018
34
*10.17
10.18
Employment Agreement by and between Telkonet, Inc. and Richard E. Mushrush, dated as of October 1, 2018
Loan and Security Agreement, dated September 30, 2014, by and between Telkonet, Inc. and Heritage Bank of Commerce (incorporated by reference to our Form
10.19
10.20
10.21
10.22
10.23
10.24
10.25
10.26
14
21
23
31.1
31.2
32.1
8-K (File No. 001-31972) filed October 2, 2014)
First 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 (File No. 001-31972) filed February 23, 2016)
Second Amendment to Loan and Security Agreement, dated October 27, 2016, by and between Telkonet, Inc. and Heritage Bank of Commerce (incorporated by
reference to our Form 8-K (File No. 001-31972) filed October 28, 2016)
2010 Amended and Restated Stock Option and Incentive Plan (amended and restated effective as of November 17, 2016, incorporated by reference as an exhibit
to Form 10-K (File No. 001-31972) filed April 3, 2017)
Sixth Amendment to Loan and Security Agreement, dated October 23, 2017, by and between Telkonet, Inc. and Heritage Bank of Commerce (incorporated by
reference to our Form 8-K (File No. 001-31972) filed October 26, 2017)
Seventh Amendment to Loan and Security Agreement entered into as of February 2, 2018, by and among Telkonet, Inc. and Heritage Bank of Commerce
(incorporated by reference to our Form 10-Q (File No. 001-31972) filed November 14, 2018)
Eighth Amendment to Loan and Security Agreement entered into as of April 5, 2018, by and among Telkonet, Inc. and Heritage Bank of Commerce (incorporated
by reference to our Form 10-Q (File No. 001-31972) filed November 14, 2018)
Ninth Amendment to Loan and Security Agreement entered into as of November 7, 2018, by and among Telkonet, Inc. and Heritage Bank of Commerce
(incorporated by reference to our Form 10-Q (File No. 001-31972) filed November 14, 2018)
Tenth Amendment to Loan and Security Agreement entered into as of February 12, 2019, by and among Telkonet, Inc. and Heritage Bank of Commerce
(incorporated by reference to our Form 8-K (File No. 001-31972) filed February 14, 2019
Code of Ethics (incorporated by reference to our Form 10-KSB (File No. 001-31972), filed on March 30, 2004)
Telkonet, Inc. Subsidiaries (incorporated by reference to our Form 10-K (File No. 001-31972) filed March 16, 2007)
Consent of BDO USA, LLP, Independent Registered Public Accounting Firm
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Jason L. Tienor
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Richard E. Mushrush
Certification of Jason L. Tienor pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
101.INS
101.SCH
Certification of Richard E. Mushrush pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
XBRL Instance Document
XBRL Schema Document
* Indicates management contract or compensatory plan or arrangement.
ITEM 16. FORM 10-K SUMMARY.
None.
35
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: April 1, 2019
TELKONET, INC.
/s/ Jason L. Tienor
Jason L. Tienor
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
Name
Position
/s/ Jason L. Tienor
Jason Tienor
/s/ Richard E. Mushrush
/s/Arthur E. Byrnes
Arthur E. Byrnes
/s/ Tim S. Ledwick
Tim S. Ledwick
/s/ Peter T. Kross
Peter T. Kross
/s/ Leland D. Blatt
Leland D. Blatt
Chief Executive Officer and Director
(principal executive officer)
Chief Financial Officer
(principal financial officer)
Chairman of the Board
Director
Director
Director
36
Date
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
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, 2018 and 2017
Consolidated Statements of Operations for the Years ended December 31, 2018 and 2017
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2018 and 2017
Consolidated Statements of Cash Flows for the Years ended December 31, 2018 and 2017
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
Shareholders and Board of Directors
Telkonet, Inc.
Waukesha, Wisconsin
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Telkonet, Inc. (the “Company”) and subsidiaries as of December 31, 2018 and 2017, the related consolidated
statements of operations, stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”).
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2018 and
2017, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of
America.
Going Concern Uncertainty
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note A to the
consolidated financial statements, the Company has suffered recurring losses from operations, has negative operating cash flow and is dependent upon its ability to generate
profitable operations in the future and/or obtain additional financing to meet its obligations and repay its liabilities arising from normal business operations when they come due
that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note A. The consolidated
financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Change in Accounting Principles – Related to Revenue Recognition
As discussed in Notes A, B and C to the consolidated financial statements, the Company has changed its method of accounting for revenue from contracts with customers in the
year 2018 due to the adoption of Accounting Standards Codification Topic 606, Revenue from Contracts with Customers.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated
financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are
required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and
Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to
perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting 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.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing
procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of
the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
We have served as the Company's auditor since 2013.
Milwaukee, Wisconsin
April 1, 2019
F-3
TELKONET, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2018 AND 2017
December 31,
2018
December 31,
2017
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash on deposit
Accounts receivable, net
Inventories
Contract assets
Prepaid expenses
Income taxes receivable
Total current assets
Property and equipment, net
Other assets:
Deposits
Total other assets
Total Assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Accrued liabilities
Line of credit
Contract liabilities – current
Deferred revenue – current
Customer deposits
Total current liabilities
Long-term liabilities:
Contract liabilities – long term
Deferred revenue - long term
Deferred lease liability - long term
Total long-term liabilities
Total Liabilities
Commitments and contingencies
Stockholders’ Equity
Series A, par value $.001 per share; 215 shares issued, 185 shares outstanding at December 31, 2018 and 2017,
preference in liquidation of $1,600,168 and $1,526,141 as of December 31, 2018 and 2017, respectively
Series B, par value $.001 per share; 538 shares issued, 52 shares outstanding at December 31, 2018 and 2017,
preference in liquidation of $435,081 and $414,258 as of December 31, 2018 and 2017, respectively
Common stock, par value $.001 per share; 190,000,000 shares authorized; 134,793,211 and 133,695,111 shares
issued and outstanding at December 31, 2018 and 2017, respectively
Additional paid-in-capital
Accumulated deficit
Total stockholders’ equity
$
$
$
$
$
4,678,891
–
1,081,291
1,790,919
314,749
577,386
19,695
8,462,931
247,289
17,130
17,130
8,385,595
810,000
1,610,286
1,259,536
–
143,566
17,300
12,226,283
304,170
17,130
17,130
8,727,350
$
12,547,583
408,045
656,611
121,474
1,070,502
–
–
2,256,632
162,121
–
71,877
233,998
2,490,630
$
$
1,340,566
362,059
134,792
127,570,709
(123,171,406)
6,236,720
978,207
668,814
682,211
–
292,106
124,380
2,745,718
–
219,960
48,839
268,799
3,014,517
1,340,566
362,059
133,695
127,421,402
(119,724,656)
9,533,066
Total Liabilities and Stockholders’ Equity
$
8,727,350
$
12,547,583
See accompanying notes to consolidated financial statements
F-4
TELKONET, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
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
Operating Loss
Other Income:
Interest income, net
Total Other Income
Loss from Continuing Operations before Provision for Income Taxes
Provision for Income Taxes
Net loss from continuing operations
Discontinued Operations:
Gain from sale of discontinued operations (net of tax)
Income from Discontinued Operations (net of tax)
Net income (loss) attributable to common stockholders
Net income (loss) per common share:
Basic - continuing operations
Basic - discontinued operations
Basic - net income (loss) attributable to common stockholders
Diluted - continuing operations
Diluted - discontinued operations
Diluted - net income (loss) attributable to common stockholders
2018
2017
$
7,616,415
815,564
8,431,979
4,392,643
269,443
4,662,086
3,769,893
1,879,676
4,843,859
67,107
6,790,642
7,798,680
483,889
8,282,569
4,261,100
176,131
4,437,231
3,845,338
1,770,597
5,512,925
51,229
7,334,751
(3,020,749)
(3,489,413)
13,622
13,622
(3,007,127)
9,623
(3,016,750)
–
–
(3,016,750)
(0.02)
0.00
(0.02)
(0.02)
0.00
(0.02)
$
$
$
$
$
$
$
2,434
2,434
(3,486,979)
9,762
(3,496,741)
6,630,244
612,875
3,746,378
(0.03)
0.05
0.03
(0.03)
0.05
0.03
$
$
$
$
$
$
$
$
Weighted Average Common Shares Outstanding used in computing basic net loss per share
Weighted Average Common Shares Outstanding used in computing diluted net loss per share
134,055,098
134,055,098
133,116,491
133,116,491
See accompanying notes to consolidated financial statements
F-5
TELKONET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
Balance at January
1, 2017
Shares issued to
directors at $0.15
per share
Stock-based
compensation
expense related to
employee stock
options
Net income
attributable to
common
stockholders
Balance at
December 31,
2017
Series A
Preferred
Stock
Shares
Series A
Preferred Stock
Amount
Series B
Preferred
Stock
Shares
Series B
Preferred
Stock
Amount
Common
Shares
Common
Stock
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Total
Stockholders’
Equity
185
$
1,340,566
52
$
362,059
132,744,475
$
132,774
$
126,955,435
$ (123,471,034)
$
5,319,800
–
–
–
–
–
–
–
–
–
–
–
–
920,636
921
143,079
–
144,000
–
–
–
–
322,888
–
322,888
–
3,746,378
3,746,378
185
$
1,340,566
52
$
362,059
133,695,111
$
133,695
$
127,421,402
$ (119,724,656)
$
9,533,066
See accompanying notes to the consolidated financial statements
F-6
TELKONET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
Series A
Preferred
Stock
Shares
Series A
Preferred
Stock
Amount
Series B
Preferred
Stock
Shares
Series B
Preferred
Stock
Amount
Balance at January 1, 2018
185
$
1,340,566
52
$
362,059
Common
Shares
133,695,111
Common
Stock
Amount
$
133,695
$
Additional
Paid-in
Capital
127,421,402
Accumulated
Deficit
(119,724,656) $
$
Total
Stockholders’
Equity
9,533,066
January 1, 2018, Cumulative
effect of a change in
accounting principle related
to ASC 606, net of tax
Shares issued to directors
Stock-based compensation
expense related to employee
stock options
Net loss attributable to
common stockholders
Balance at December 31,
2018
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
1,098,100
–
1,097
–
142,903
(430,000)
–
–
(430,000)
144,000
6,404
–
–
–
–
6,404
–
(3,016,750)
(3,016,750)
185
$
1,340,566
52
$
362,059
134,793,211
$
134,792
$
127,570,709
$
(123,171,406) $
6,236,720
See accompanying notes to the consolidated financial statements
F-7
TELKONET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
2018
2017
Cash Flows from Operating Activities:
Net income (loss)
Less: Net income from discontinued operations
Gain on sale of discontinued operations
Net loss from continuing operations
Adjustments to reconcile net (loss) from continuing operations to cash used in operating activities of
continuing operations:
Stock-based compensation expense
Stock issued to directors as compensation
Depreciation and amortization
Provision for doubtful accounts, net of recoveries
Reserve for inventory obsolescence
Changes in operating assets and liabilities:
Accounts receivable
Inventories
Prepaid expenses and other current assets
Deposits and other long term assets
Accounts payable
Accrued liabilities and expenses
Contract liability
Deferred revenue
Related party payable
Customer deposits
Contract assets
Income taxes receivable
Deferred lease liability
Net Cash Used In Operating Activities of Continuing Operations
Net Cash Provided By Operating Activities of Discontinued Operations
Net Cash Used In Operating Activities
Cash Flows From Investing Activities:
Purchase of property and equipment
Net proceeds from sale of subsidiary
Net Cash (Used In) Provided By Investing Activities of Continuing Operations
Cash Flows From Financing Activities:
Proceeds from line of credit
Payments on line of credit
Net Cash Used In Financing Activities of Continuing Operations
Net (decrease) increase in cash and cash equivalents
Cash, cash equivalents and restricted cash at the beginning of the period
Cash, cash equivalents and restricted cash at the end of the period
Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets:
Cash and cash equivalents
Restricted cash
Total cash, cash equivalents, and restricted cash
See accompanying notes to consolidated financial statements
F-8
$
$
$
$
$
(3,016,750)
–
–
(3,016,750)
6,404
144,000
67,107
55,152
(130,749)
473,845
(400,637)
(433,820)
–
(570,162)
(12,203)
453,623
(512,066)
–
(124,380)
34,251
(2,395)
23,038
(3,945,742)
–
(3,945,742)
(10,225)
–
(10,225)
3,720,000
(4,280,737)
(560,737)
(4,516,704)
9,195,595
4,678,891
4,678,891
–
4,678,891
$
$
$
3,746,378
(612,875)
(6,630,244)
(3,496,741)
322,888
144,000
51,229
35,187
111,400
(241,701)
(593,734)
61,762
(17,130)
212,590
(256,767)
–
206,852
(97,127)
(41,450)
–
(17,300)
21,136
(3,594,906)
517,242
(3,077,664)
(211,492)
12,072,811
11,861,319
4,373,600
(4,753,518)
(379,918)
8,403,737
791,858
9,195,595
8,385,595
810,000
9,195,595
TELKONET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
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:
Issuance of stock to directors
2018
2017
$
$
32,662
12,410
$
144,000
$
17,173
139,823
144,000
See accompanying notes to consolidated financial statements
F-9
TELKONET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
NOTE A – BASIS OF PRESENTATION AND SIGNIFICANT 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 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”).
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 recognized as a
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.
On March 28, 2017, the Company sold substantially all of the assets of its wholly-owned subsidiary, EthoStream, LLC. Refer to Note P for further details.
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Telkonet Communications, Inc., and EthoStream, LLC. The
accounts of EthoStream, LLC have been classified as discontinued operations on the consolidated statement of operations and the consolidated statement of cash flows for the
year ended December 31, 2017. The Company deconsolidated EthoStream, LLC on March 29, 2017, when the Company had sold its controlling financial interest in this
subsidiary, refer to Note P for further discussion on discontinued operations and the sale of EthoStream, LLC. All significant intercompany balances and transactions have been
eliminated in consolidation. We currently operate in a single reportable business segment.
Unless otherwise noted, all financial information in the consolidated financial statement footnotes reflect the Company’s results from continuing operations.
Going Concern and Management’s Plan
The accompanying financial statements have been prepared on a going concern basis which assumes the Company will be able to realize its assets and discharge its liabilities in
the normal course of business for the foreseeable future and, thus, do not include any adjustments relating to the recoverability and classification of assets and liabilities that
may be necessary if the Company is unable to continue as a going concern.
Since inception through December 31, 2018, we have incurred cumulative losses of $123,171,406 and have never generated enough funds through operations to support our
business. For the year ended December 31, 2018, we had an operating cash flow deficit of $3,945,742 from continuing operations. The Company’s ability to continue as a going
concern is dependent upon generating profitable operations in the future and obtaining the necessary financing to meet its obligations and repay its liabilities arising from
normal business operations when they come due. There can be no assurance that the Company will be able to secure such financing at commercially reasonable terms, if at all.
If cash resources become insufficient to meet the Company’s ongoing obligations, the Company will be required to scale back or discontinue portions of its operations or
discontinue operations entirely, whereby, the Company’s shareholders may lose some or all of their investment.
F-10
We have not identified, and cannot be certain we will be able to identify, a course of action that guarantees the achievement of profitable operations in the foreseeable future. In
June 2018, the Company’s Board engaged an investment bank to strategic alternatives to maximize shareholder value, including but not limited to, a sale of the Company, an
investment in the Company, a merger or other business combination, a sale of all or substantially all assets or a strategic joint venture. At April 1, 2019, no definitive alternatives
had been identified.
At December 31, 2018, the Company had approximately $4,678,891 of cash and approximately $500,000 of availability on its credit facility. The Company currently expects to
draw on these cash reserves and utilize the credit facility to finance its near term working capital needs. It expects to continue to incur operating losses and negative operating
cash flows for one year beyond the date of these financial statements. Accordingly, and in light of the Company’s historic and continuing losses, there is substantial doubt about
the Company’s ability to continue as a going concern.
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.
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 $65,542 and $22,173 at December 31, 2018 and 2017, 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.
The allowance for doubtful accounts for the years ended December 31 are as follows:
Beginning balance
Provision charged to expense
Deductions
Ending balance
$
$
2018
2017
22,173
55,152
(11,783)
65,542
$
$
34,573
35,187
(47,587)
22,173
F-11
Inventories
Inventories consist of 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 net realizable value 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 reserve for inventory obsolescence balance was approximately $114,000 and $245,000 for the years ended December 31, 2018, and 2017,
respectively.
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 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.
The Company’s financial instruments include cash and cash equivalents, restricted cash on deposit, accounts receivable, accounts payable, line of credit, 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. The carrying amount of the line of credit approximates fair value due to the interest rate and terms approximating those available to the Company for similar obligations
(Level 2 instruments).
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 assessment for impairment performed during 2018 and 2017, no impairment was recorded.
F-12
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 weighted average
shares outstanding. Diluted 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, 2018 and 2017, there were
3,599,793 and 4,626,474 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”) requires 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 assets, 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 de-recognition, classification, treatment of interest and penalties, and disclosure
of such positions. The Securities and Exchange Commission issued Staff Accounting Bulletin 118 to address uncertainty regarding the application of ASC 740 to the income tax
effects of the Tax Cuts and Jobs Act, signed into law on December 22, 2017. The bulletin provides a measurement period (not to exceed one year from the Tax Act enactment
date) for companies to complete the accounting under ASC 740. To the extent that a company’s accounting for certain income tax effects is incomplete, but is able to determine
a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate in the financial statements, it
should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act. The company was able to
make reasonable estimates of certain effects and, therefore, recorded non-material provisional adjustments.
The revaluation of the net deferred tax assets resulted in an increase to tax expense of $12.72 million. This was offset by the revaluation of the valuation allowance of $13.71
million. The sale of EthoStream generated income, resulting in an increase to tax expense of $1.067 million. Tax credits generated during the year resulted in a tax benefit of
$.07 million.
The provision for income taxes was $.001 million for the year ended December 31, 2018, relatively unchanged from the prior year amount of $.001 million. The effective
income tax rate was 0.3% for the year ended December 31, 2018 similarly to 0.3% for the prior year. On December 22, 2017, the U.S. government enacted comprehensive tax
legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”), which effectively lower the federal tax rate from 35% to 21%. For the year ended December 31,
2018, the Company has recorded all known and estimable impacts of the Tax Act that are effective for 2018.
F-13
Revenue from Contracts with Customers
Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606, the Standard”) supersedes nearly all legacy revenue recognition guidance.
ASC 606, the Standard outlines a comprehensive five-step revenue recognition model based on the principle that an entity should recognize revenue based on when it satisfies
its performance obligations by transferring control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in
exchange for said goods or services.
Identify the customer contracts
The Company accounts for a customer contract under ASC 606 when the contract is legally enforceable. A contract is legally enforceable when all of the following criteria are
met: (1) the contract has been approved by the Company and the customer and both parties are committed to perform their respective obligations, (2) the Company can identify
each party’s rights regarding goods or services transferred, (3) the Company can identify payment terms for goods or services transferred, (4) the contract has commercial
substance, and (5) collectability of all the consideration to which the Company is entitled in exchange for the goods or services transferred is probable.
A contract does not exist if each party to the contract has the unilateral right to terminate a wholly unperformed contract without compensating the other party (or parties).
Nearly all of the Company’s contracts do not contain such mutual termination rights for convenience. All contracts are in written form.
Identify the performance obligations
The Company will enter into product only contracts that contain a single performance obligation related to the transfer of EcoSmart products to a customer.
The Company will also enter into certain customer contracts that encompass product and installation services, referred to as “turnkey” solutions. These contracts ultimately
provide the customer with a solution that enhances the functionality of the customer’s existing equipment. For this reason, the Company has determined that the product and
installation services are not separately identifiable performance obligations, but in essence represent one, combined performance obligation (“turnkey”).
The Company also offers technical phone support services to customers. This service is considered a separate performance obligation.
Determine the transaction price
The Company generally enters into contracts containing fixed prices. It is not customary for the Company to include contract terms that would result in variable consideration.
In the rare situation that a contract does include this type of provision, it is not expected to result in a material adjustment to the transaction price. The Company regularly
extends pricing discounts; however, they are negotiated up front and adjust the fixed transaction price set out in the contract.
Customer contracts will typically contain upfront deposits that will be applied against future invoices, as well as customer retainage. The intent of any required deposit or
retainage is to ensure that the obligations of either party are honored and follow customary industry practices. In addition, the Company will typically be paid in advance at the
beginning of any support contracts, consistent with industry practices. None of these payment provisions are intended to represent significant implicit financing. The Company’s
standard payment terms are thirty days from invoice date. Products are fully refundable when returned in their original packaging without damage or defacing less a restocking
fee. Historical returns have shown to be immaterial. The Company offers a standard one-year assurance warranty. However customers can purchase an extended warranty.
Under the new standard, extended warranties are accounted for as a service warranty, requiring the revenue to be recognized over the extended service periods. Contracts
involving an extended warranty are immaterial and will continue to be combined with support revenue and recognized on a straight-line basis over the support revenue term.
F-14
Allocate the transaction price to the performance obligations
Revenues from customer contracts are allocated to the separate performance obligations based on their relative stand-alone selling price (“SSP”) at contract inception. The SSP
is the price at which the Company would sell a promised good or service separately. The best evidence of an SSP is the observable price of a good or service when the entity
sells that good or service separately in similar circumstances and to similar customers. However, turnkey solutions are sold for a broad range of amounts resulting from, but not
limited to, tiered discounting for value added resellers (“VAR”) based upon committed volumes and other economic factors. Due to the high variability of our pricing, the
Company cannot establish a reliable SSP using observable data. Accordingly, the Company uses the residual approach to allocate the transaction price to performance
obligations related to its turnkey solutions. When support services are not included within the turnkey solution, the residual method is not utilized and no allocation of the
transaction price to the performance obligation is necessary.
All support service agreements, whether single or multi-year terms, automatically renew for one-year terms at a suggested retail price (“SRP”). Support service renewals are
consistently priced and therefore would support the use of SRP as the best estimate of an SSP for such performance obligations.
Revenue Recognition
The Company recognizes revenues from product only sales at a point in time, when control over the product has transferred to the customer. As the Company’s principal terms
of sale are FOB shipping point, the Company primarily transfers control and records revenue for product only sales upon shipment.
A typical turnkey project involves the installation and integration of 200-300 rooms in a customer-controlled facility and usually takes sixty days to complete. Since control
over goods and services transfers to a customer once a room is installed, the Company recognizes revenue for turnkey solutions over time. The Company uses an outputs
measure based on the number of rooms installed to recognize revenues from turnkey solutions.
Revenues from support services are recognized over time, in even daily increments over the term of the contract, and are presented as “Recurring Revenue” in the Statement of
Operations.
Contract liabilities include deferrals for the monthly support service fees. Long-term contract liabilities represent support service fees that will be recognized as revenue after
December 31, 2019.
Contract Fulfillment Cost
The Company recognizes related costs of the contract over time in relation to the revenue recognition. Costs included within the projects relate to the cost of material, direct
labor and costs of outside services utilized to complete projects. . These are presented as “Contract assets” in the consolidated balance sheets.
Transition
The Company adopted ASC 606 using a modified retrospective approach to all contracts not completed as of January 1, 2018. Results for reporting periods beginning January 1,
2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under
Topic 605, Revenue Recognition. The Company recorded a net decrease to beginning retained earnings of $0.43 million as of January 1, 2018 due to the cumulative impact of
adopting ASC 606. The impact to beginning retained earnings was primarily driven by the deferral of revenue for unfulfilled performance obligations related to the Company’s
turnkey solutions.
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, 2018 and 2017, the Company experienced returns of
approximately 1% to 3% of material’s included in cost of sales. As of December 31, 2018 and 2017, the Company recorded warranty liabilities in the amount of $46,103 and
$59,892, respectively, using this experience factor range.
F-15
Product warranties for the years ended December 31 is as follows:
Beginning balance
Warranty claims incurred
Provision charged to expense
Ending balance
Advertising
$
$
2018
2017
59,892
(28,000)
14,211
46,103
$
$
95,540
(84,087)
48,439
59,892
The Company follows the policy of charging the costs of advertising to expenses as incurred. The Company incurred $108,632 and $33,520 in advertising costs during the years
ended December 31, 2018 and 2017, respectively.
Research and Development
The Company accounts for research and development costs in accordance with the ASC 730-10, “Research and Development”. Under ASC 730-10, all research and
development costs must be charged to expense as incurred. Accordingly, internal research and development costs are expensed as incurred. Third-party research and
development costs are expensed when the contracted work has been performed or as milestone results have been achieved. Company-sponsored research and development costs
related to both present and future products are expensed in the period incurred. Total expenditures on research and product development for 2018 and 2017 were $1,879,676 and
$1,770,597, 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 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 2018 and prior years, expected stock price volatility is based on the historical volatility
of the Company’s stock for the related expected term.
Stock-based compensation expense in connection with options granted to employees for the years ended December 31, 2018 and 2017 was $6,405 and $322,888, 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.
Reclassification
Certain prior year amounts have been reclassified to conform to the current year presentation in the consolidated financial statements and accompanying notes to the
consolidated financial statements.
F-16
NOTE B – NEW ACCOUNTING PRONOUNCEMENTS
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13
provides guidance for estimating credit losses on certain types of financial instruments, including trade receivables, by introducing an approach based on expected losses. The
expected loss approach will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. ASU 2016-13
also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The guidance is effective for fiscal
years beginning after December 15, 2019, including interim periods within those fiscal years. The guidance requires a modified retrospective transition method and early
adoption is permitted. The Company does not expect the adoption of ASU 2016-13 to have a material impact on its consolidated financial statements.
In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02, Leases (“ASU 2016-02”), subsequently amended in 2018 by ASU 2018-10, ASU
2018-11 and ASU 2018-20 and codified in ASC 842, Leases (“ASC 842”). ASC 842 is effective for annual periods beginning after December 15, 2018 and interim periods
thereafter. Earlier application is permitted, however the Company will not do so. ASC 842 supersedes current lease guidance in ASC 840 and requires a lessee to recognize a
right-of-use asset and a corresponding lease liability for substantially all leases. The lease liability will be equal to the present value of the remaining lease payments while the
right-of-use asset will be similarly calculated and then adjusted for initial direct costs. In addition, ASC 842 expands the disclosure requirements to increase the transparency
and comparability of the amount, timing and uncertainty of cash flows arising from leases.
We will elect available practical expedients permitted under the guidance, which among other items, allow the Company to carry forward its historical lease classification and
not reassess leases for the definition of lease under the new standard. Upon the adoption of ASC 842, we do not expect to record a right-of-use asset and related lease liability
for leases with an initial term of 12 months or less and we plan to account for lease and non-lease components as a single lease component.
ASU 2016-02 may be applied using either an optional alternative approach, under which all years included in the financial statements will be presented under the revised
guidance, a modified retrospective approach, under which financial statements will be prepared under the revised guidance for the year of adoption, but not for prior years, or a
new transition alternative approach, under which the standard is adopted and measured from the first date of the fiscal year under adoption, in this case January 1, 2019. We
adopted the new transition alternative approach, where entities will measure current leases from date of adoption, January 1, 2019. Initial direct costs are to be recognized as a
cumulative catch-up adjustment to the opening balance of retained earnings on January 1, 2019. The Company did not incur any initial direct costs upon the initial assessment
of leases and thus will not be require a cumulative catch-up adjustment.
We expect to recognize additional lease assets and liabilities of approximately $1.0 million and $1.1 million, respectively, to reflect the present value of remaining lease
payments under existing leasing arrangements. The cumulative impact of adopting ASC 842 is based on the Company’s best estimates at the time of the preparation of the
consolidated financial statements. Our conclusions are preliminary and subject to change as we finalize our analysis. Changes in our lease population or changes in incremental
borrowing rates may alter these estimates. We will expand our consolidated financial statement disclosure upon adoption of the new standard. We do not expect significant
changes to our business processes, systems, or internal controls as a result of implementing the standard.
Accounting Standards Recently Adopted
Effective January 1, 2018, the Company has adopted Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606, the Standard”),
which supersedes nearly all legacy revenue recognition guidance. ASC 606 outlines a comprehensive five-step revenue recognition model based on the principle that an entity
should recognize revenue based on when an it satisfies its performance obligations by transferring control of promised goods or services in an amount that reflects the
consideration to which the entity expects to be entitled in exchange for said goods or services. Refer to Note C for further consideration of the recently adopted standard.
F-17
In November 2016, the Financial Accounting Standards Board issued ASU No. 2016-18, Statement of Cash Flows: Restricted Cash, (“Update 2016-18”). Update 2016-18
provides guidance on the classification of restricted cash in the statement of cash flows. The amendments are effective for interim and annual periods beginning after December
15, 2017. The amendments in Update 2016-18 should be adopted on a retrospective basis. The adoption of this amendment increased the beginning cash balance by $810,000 as
of January 1, 2018 in our statement of cash flows, due to the reclassification of $810,000 of restricted cash into the cash and cash equivalents category.
Management has evaluated other recently issued accounting pronouncements and does not believe any will have a significant impact on our consolidated financial statements
and related disclosures.
NOTE C– REVENUE
The following table presents the Company’s product and recurring revenues disaggregated by industry for the year ended December 31, 2018.
Product
Recurring
Hospitality
Education
$
$
6,410,615 $
668,039
7,078,654 $
652,019 $
128,872
780,891 $
Multiple Dwelling
Units
Government
Total
472,462 $
18,653
491,115 $
81,319 $
–
81,319 $
7,616,415
815,564
8,431,979
Sales taxes and other usage-based taxes are excluded from revenues.
Contract assets
Contracts are billed in accordance with the terms and conditions, either at periodic intervals or upon substantial completion. This can result in billing occurring subsequent to
revenue recognition, resulting in contract assets. Contract assets are presented as current assets in the Condensed Consolidated Balance Sheet. The balance of contract assets as
of December 31, 2018 and at the date of adoption of ASC 606 was $0.31 million and $0.35 million, respectively. There were approximately $0.03 million of costs incurred to
fulfill a contract in the closing balance of contract assets.
Contract liabilities
Contracts are billed in accordance with the terms and conditions, either at periodic intervals or upon substantial completion. Often, the Company will require customers to pay a
deposit upon contract signing that will be applied against work performed or products shipped. In addition, the Company will often invoice the full term of support at the start
of the support period. Billings that occur prior to revenue recognition result in contract liabilities. As of December 31, 2018 and at the date of adoption of ASC 606, contract
liabilities were $1.23 million and $0.78 million, respectively. The change in the contract liability balance during the 12 month period ended December 31, 2018 is the result of
cash payments received and billing in advance of satisfying performance obligations, previously unrecognized cost of goods sold proportionate with the related percentage of
completion, and customer deposits.
Contract costs
Costs to fulfill a turnkey contract primarily relate to the materials cost and direct labor and are recognized proportionately as the performance obligation is satisfied. The
Company will defer cost to fulfill a contract when materials have shipped (and control over the materials has transferred to the customer), but an insignificant amount of rooms
have been installed. The Company will recognize any deferred costs in proportion to revenues recognized from the related turnkey contract. The Company does not expect
deferred contract costs to be long-lived since a typical turnkey project takes sixty days to complete. Deferred contract costs are generally presented as other current assets in the
condensed consolidated balance sheets.
F-18
The Company incurs incremental costs to obtain a contract in the form of sales commissions. These costs, whether related to performance obligations that extend beyond twelve
months or not, are immaterial and will continue to be recognized in the period incurred within selling, general and administrative expenses.
The tables below present the impacts of our adoption of the new revenue standard on our income statement and balance sheet.
Income Statement:
Sales
Cost of Goods Sold
Net loss
Balance Sheet:
Assets
Contract Assets
Inventories
Liabilities
Contract Liabilities - ST
Contract Liabilities - LT
Customer Deposits
Deferred Revenue - Current
Deferred Revenue – Long Term
Equity
Accumulated Deficit
For the 12 Months Ended
December 31, 2018
Pro-Forma as if
Previous
Accounting
Guidance was in
Effect
(Unaudited)
Effect of
Change
Higher/(Lower)
(Unaudited)
As Reported
8,431,979
4,662,086
(3,016,750)
$
$
9,254,508
4,878,490
(2,410,624)
$
$
(822,529)
(216,403)
606,126
As of December 31, 2018
Pro-Forma as if
Previous
Accounting
Guidance was in
Effect
(Unaudited)
Effect of
Change
Higher/(Lower)
(Unaudited)
As Reported
314,749
1,790,992
1,070,502
162,121
–
–
–
–
1,585,124
$
–
–
751,801
233,122
162,121
314,749
205,798
1,070,502
162,121
(751,801)
(233,122)
(162,121)
$
$
$
$
(123,171,406)
(122,565,280)
$
606,126
The table below presents the cumulative effect of the changes made to our consolidated balance sheet as of January 1, 2018 after the adoption of ASU 2014-09, Revenue from
Contracts with Customers (Topic 606).
Balance Sheet:
Assets
Contract Assets
Liabilities
Contract Liabilities
Customer Deposit
Deferred Revenue – Current
Deferred Revenue – Long Term
Equity
Accumulated Deficit
December 31, 2017
Transition
Adjustments
January 1,
2018
$
–
349,000
$
349,000
–
124,380
292,106
219,960
1,415,446
(124,380)
(292,106)
(219,960)
1,415,446
–
–
–
$
(119,724,656)
(430,000)
$
(120,154,656)
F-19
Remaining performance obligations
As of December 31, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was approximately $1.68 million. Except for support
services, the Company expects to recognize 100% of the remaining performance obligations over the next six months.
NOTE D – ACCOUNTS RECEIVABLE
Components of accounts receivable as of December 31, 2018 and 2017 are as follows:
Accounts receivable
Allowance for doubtful accounts
Accounts receivable, net
NOTE E – PROPERTY AND EQUIPMENT
The Company’s property and equipment as of December 31, 2018 and 2017 consists of the following:
Development test equipment
Computer software
Office equipment
Office fixtures and furniture
Leasehold improvements
Total
Accumulated depreciation and amortization
Total property and equipment
$
$
$
$
2018
2017
1,146,832
(65,542)
1,081,291
2018
19,110
76,134
61,367
330,568
18,016
505,195
(257,907)
247,289
$
$
$
$
1,632,459
(22,173)
1,610,286
2017
19,110
76,134
51,142
330,568
18,016
494,970
(190,800)
304,170
Depreciation and amortization expense included as a charge to income was $67,107 and $51,229 for the years ended December 31, 2018 and 2017, respectively.
NOTE F – ACCRUED LIABILITIES AND EXPENSES
Accrued liabilities and expenses as of December 31, 2018 and 2017 are as follows:
Accrued liabilities and expenses
Accrued payroll and payroll taxes
Accrued sales taxes, penalties, and interest
Product warranties
Total accrued liabilities and expenses
F-20
$
$
2018
2017
325,855
241,253
43,400
46,103
656,611
$
$
294,709
230,931
83,282
59,892
668,814
NOTE G – DEBT
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 “Heritage Bank 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”). Following the sale of EthoStream in March of 2017, it was removed as a co-borrower.
Availability of borrowings under the Credit Facility 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 Heritage Bank Loan Agreement is available for
working capital and other general business purposes. The outstanding principal balance of the Credit Facility bears interest at the Prime Rate plus 3.00%, which was 8.50% at
December 31, 2018 and 7.50% at December 31, 2017. On October 9, 2014, as part of the Heritage Bank Loan Agreement, Heritage Bank was granted a warrant to purchase
250,000 shares of Telkonet common stock, for further information on the accounting for warrants, refer to Note J. The warrant has an exercise price of $0.20 and expires
October 9, 2021. On February 13, 2019, the tenth amendment to the Credit Facility was executed extending the maturity date to September 30, 2020, unless earlier accelerated
under the terms of the Heritage Bank Loan Agreement.
The Heritage Bank 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 Heritage Bank Loan Agreement also contains financial covenants, including a maximum EBITDA loss covenant, measured quarterly, a minimum asset coverage ratio,
measured monthly, and a minimum unrestricted cash balance of $2 million. During the year ended December 31, 2018, the Company and Heritage Bank entered into several
amendments to the Credit Facility to adjust these covenant levels. As long as the Company maintains the minimum unrestricted cash balance of $2 million, a violation of the
minimum EBITDA level will not trigger an event of default. A violation of any of these covenants could result in an event of default under the Heritage Bank 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 Heritage Bank Loan Agreement may be terminated. The Heritage Bank Loan Agreement contains other
representations and warranties, covenants, and other provisions customary to transactions of this nature.
The outstanding balance on the Credit Facility was $121,474 and $682,211 at December 31, 2018 and 2017 and the remaining available borrowing capacity was approximately
$499,000 and $202,000, respectively. As of December 31, 2018, the Company was in compliance with all financial covenants.
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 the Company’s common stock at a conversion price of $0.363 per share. 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. In prior years, 30 of the preferred shares issued on November 16, 2009 were converted to shares of the Company’s common stock. In a prior
year, the redemption feature available to the Series A holders expired.
F-21
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. 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 on August 4, 2010. 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 on April 8,
2011. In prior years, 486 of the preferred shares issued on August 4, 2010 and April 8, 2011 were converted to shares of the Company’s common stock. In a prior year, the
redemption feature available to the Series B holders expired.
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. As of December 31, 2018, the liquidation preference of the preferred stock is based
on the following order: first, Series B with a preference value of $435,081, which includes cumulative accrued unpaid dividends of $175,081, and second, Series A with a
preference value of $1,600,168, which includes cumulative accrued unpaid dividends of $675,168. As of December 31, 2017, the liquidation preference of the preferred stock
is based on the following order: first, Series B with a preference value of $414,258, which includes cumulative accrued unpaid dividends of $154,258, and second, Series A
with a preference value of $1,526,141, which includes cumulative accrued unpaid dividends of $601,141.
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, 2018 and 2017, there were 185 shares of Series A and 52 shares of Series B
outstanding, respectively.
The Company has authorized 190,000,000 shares of common stock with a par value of $.001 per share. As of December 31, 2018 and 2017, the Company had 134,793,211 and
133,695,111 common shares issued and outstanding, respectively.
During the years ended December 31, 2018 and 2017, the Company issued 1,098,100 and 920,636 shares of common stock, respectively to directors for services performed
during 2018 and 2017. These shares were valued at $144,000 and $144,000, respectively, which approximated the fair value of the shares when they were issued.
During the years ended December 31, 2018 and 2017, no warrants were exercised. These warrants were originally granted to shareholders of the April 8, 2011 Series B
preferred stock issuance.
During the years ended December 31, 2018 and 2017, no shares of Series A or B preferred stock were converted to shares of common stock.
F-22
NOTE J – STOCK OPTIONS AND WARRANTS
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 Directors 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, 2018, there were approximately 1,606,549 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, 2018.
Exercise Prices
$ 0.01 - $0.15
$ 0.16 - $1.00
Options Outstanding
Options Exercisable
Weighted
Average
Remaining
Contractual Life
(Years)
8.01
4.84
6.73
Number
Outstanding
2,000,000
1,349,793
3,349,793
Weighted
Average
Exercise Price
0.14
0.18
0.16
$
$
Number
Exercisable
2,000,000
1,134,950
3,134,950
Weighted
Average
Exercise Price
0.14
0.18
0.16
$
$
Transactions involving stock options issued to employees are summarized as follows:
Outstanding at January 1, 2017
Granted
Exercised
Cancelled or expired
Outstanding at December 31, 2017
Granted
Exercised
Cancelled or expired
Outstanding at December 31, 2018
F-23
Number of
Shares
Weighted Average
Exercise
Price Per Share
2,832,725
3,000,000
–
(1,456,251)
4,376,474
67,394
–
(1,094,075)
3,349,793
$
$
$
0.18
0.14
–
0.17
0.16
0.17
–
0.14
0.16
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 share price data for the trailing
period equal to the expected term 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 records share-based compensation for
those awards that are expected to vest. In accordance with ASC 718-10, the Company calculates 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 2018 and 2017, using the Black-Scholes
option-pricing model:
Expected life of option (years)
Risk-free interest rate
Assumed volatility
Expected dividend rate
Expected forfeiture rate
2018
10
2.80%
87%
0
65%
2017
7
1.22%
81%
0
10%
The total estimated fair value of the options granted during the years ended December 31, 2018 and 2017 was $244 and $360,000. The total fair value of underlying shares
related to options that vested during the years ended December 31, 2018 and 2017 was $6,811 and $368,544. Future compensation expense related to non-vested options at
December 31, 2018 was $18,724 and will be recognized over the next 3.0 years. The aggregate intrinsic value of the vested options was zero as of December 31, 2018 and
2017. Total stock-based compensation expense recognized in the consolidated statements of operations for the years ended December 31, 2018 and 2017 was $6,404 and
$322,888, respectively.
Warrants
The following table summarizes the changes in warrants outstanding and the related exercise prices for the warrants issued to the debt holder in relation to the revolving credit
facility, see Note G.
Exercise Prices
0.20
$
Number
Outstanding
250,000
Warrants Outstanding
Weighted Average
Remaining
Contractual Life
(Years)
Warrants Exercisable
Weighted Average
Exercise Price
Number
Exercisable
Weighted Average
Exercise Price
3.02
$
0.20
250,000
0.20
F-24
Transactions involving warrants are summarized as follows:
Outstanding at January 1, 2017
Issued
Exercised
Cancelled or expired
Outstanding at December 31, 2017
Issued
Exercised
Cancelled or expired
Outstanding at December 31, 2018
Number of
Shares
Weighted Average
Exercise
Price Per Share
300,000
–
–
(50,000)
250,000
–
–
–
250,000
$
$
0.20
–
–
0.18
0.20
–
–
–
0.20
There were no warrants granted, exercised, cancelled or forfeited during the year ended December 31, 2018. There were no warrants granted or exercised and 50,000 cancelled
or forfeited during the year ended December 31, 2017.
NOTE K – RELATED PARTY TRANSACTIONS
During the years ended December 31, 2018 and 2017, the Company agreed to issue common stock in the amount of $144,000 and $144,000 to the Company’s non-employee
directors as compensation for their attendance and participation in the Company’s Board of Director and committee meetings.
NOTE L – INCOME TAXES
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes
broad and complex changes to the Internal Revenue Code. The Tax Act is generally applicable for tax years beginning after December 31, 2017, but certain provisions of the
Tax Act have an impact upon the Company’s financial statements for 2017, such as the reduction of the U.S. federal corporate tax rate from 35% to 21%.
The Securities and Exchange Commission issued Staff Accounting Bulletin 118 to address uncertainty regarding the application of ASC 740 to the income tax effects of the Tax
Cuts and Jobs Act, signed into law on December 22, 2017. The bulletin provides a measurement period (not to exceed one year from the Tax Act enactment date) for companies
to complete the accounting under ASC 740. To the extent that a company’s accounting for certain income tax effects is incomplete, but is able to determine a reasonable
estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate in the financial statements, it should continue to
apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
Such measurement period is deemed to end when all necessary information has been obtained, prepared and analyzed such that a final accounting determination can be
concluded, but in no event should the period extend beyond one year. If a company does not have the necessary information available, prepared or analyzed for certain income
tax effects of the Tax Act, SAB 118 allows a company to report provisional numbers and adjust those amounts during the measurement period not to extend beyond one year.
For the year ended December 31, 2018, the Company has recorded all known and estimable impacts of the Tax Act that are effective for 2018.
F-25
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
Tax credits
Book expenses not deductible for tax purposes
Tax Cut and Jobs Act impact
Sale of subsidiary
Other(prior period adjustments)
Change in valuation allowance for deferred tax assets
Income tax expense
$
$
2018
2017
(631,497)
6,874
–
2,882
–
–
(27,286)
(649,027)
658,650
9,623
$
$
1,000,507
8,419
(67,357)
6,782
12,721,278
45,327
5,750
13,720,706
(13,710,944)
9,762
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
Credits
Other
Total deferred tax assets
Deferred Tax Liabilities:
Intangibles
Total deferred tax liabilities
Valuation allowance
Net deferred tax liabilities
2018
2017
$
$
20,342,559
318,178
112,086
613,202
21,386,025
–
–
(21,386,025)
–
21,077,944
422,955
67,357
512,796
22,081,052
–
–
(22,081,052)
–
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, 2018 and December 31, 2017, the Company’s valuation allowance, established for the tax benefit that may not be realized, totaled approximately $21,390,000
and $22,080,000, respectively. The overall decrease in the valuation allowance is related to insignificant fluctuations in the temporary differences and federal and state net
operating losses.
F-26
At December 31, 2018 the Company had net operating loss carryforwards of approximately $90,100,000 and $46,500,000 for federal and state income tax purposes which will
expire at various dates from 2019 through 2038.
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 2014 and various states before 2014. 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, 2018 or 2017 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, 2018 or
2017. 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 would have expired in April 2021, but was subsequently amended and extended through April 2026. On April 7, 2017 the Company executed an amendment to
its’ existing lease in Waukesha, Wisconsin to expand another 3,982 square feet, bringing the total leased space to 10,344 square feet. In addition, the lease term was extended
from May 1, 2021 to April 30, 2026. The commencement date for this amendment was July 15, 2017.
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 employees. The
Germantown lease as amended was set to expire at the end of January 2018. In November 2017, the Company entered into a second amendment to the lease agreement
extending the lease through the end of January 2019. In November 2018, the Company entered into a third amendment to the lease agreement extending the lease through the
end of January 2022.
In May 2017, the Company entered into a lease agreement for 5,838 square feet of floor space in Waukesha, Wisconsin for its inventory warehousing operations. The Waukesha
lease expires in May 2024.
F-27
Commitments for minimum rentals under non-cancelable leases as of December 31, 2018 are as follows:
Years ending December 31,
2019
2020
2021
2022
2023
2024 and thereafter
Total
$
$
211,448
223,417
242,785
195,176
193,169
380,714
1,446,708
Rental expenses charged to operations for the years ended December 31, 2018 and 2017 was $342,975 and $284,714, 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 October 1, 2018. Mr. Tienor’s employment agreement
has a term of two (2) years, which will automatically renew for a period of an additional twelve (12) months, and provides for a base salary of $222,800 per year and bonuses
and benefits based upon the Company’s internal policies and participation in the Company’s incentive and benefit plans. The agreement also calls for a bonus to be paid upon
the sale of the Company. The bonus will be equal to $20,000 if The Company’s shares are valued at minimum $0.20 per share, $35,000 if shares are valued at minimum $0.225
per share, or $50,000 if shares are valued at minimum $0.25 per share. If sale price exceeds $0.25 per share, Mr. Tienor is eligible to receive an additional $6,000 for every
$0.01 above a share price of $0.25.
Jeffrey J. Sobieski, Chief Technology Officer, is employed pursuant to an employment agreement with us dated October 1, 2018. Mr. Sobieski’s employment agreement has a
term of two (2) years, which will automatically renew for a period of an additional twelve (12) months, and provides for a base salary of $211,625 per year and bonuses and
benefits based upon the Company’s internal policies and participation in the Company’s incentive and benefit plans. The agreement also calls for a bonus to be paid upon the
sale of the Company. The bonus will be equal to $20,000 if the Company’s shares are valued at minimum $0.20 per share, $35,000 if shares are valued at minimum $0.225 per
share, or $50,000 if shares are valued at minimum $0.25 per share. If sale price exceeds $0.25 per share, Mr. Sobieski is eligible to receive an additional $6,000 for every $0.01
above a share price of $0.25.
Richard E. Mushrush, Chief Financial Officer, is employed pursuant to an employment agreement with us dated October 1, 2018. Mr. Mushrush’s employment agreement has a
term of two (2) years, which will automatically renew for a period of an additional twelve (12) months, and provides for a base salary of $122,000 per year and bonuses and
benefits based upon the Company’s internal policies and participation in the Company’s incentive and benefit plans. The agreement also calls for a bonus to be paid upon the
sale of the Company. The bonus will be equal to $20,000 if the Company’s shares are valued at minimum $0.20 per share, $35,000 if shares are valued at minimum $0.225 per
share, or $50,000 if shares are valued at minimum $0.25 per share. If sale price exceeds $0.25 per share, Mr. Mushrush is eligible to receive an additional $6,000 for every
$0.01 above a share price of $0.25.
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.
F-28
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 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 July 1, 2016, the Company entered
into Indemnification Agreements with director’s Arthur E. Byrnes, Peter T. Kross and Leland D. Blatt. On January 1, 2017, the Company entered into an Indemnification
Agreement with Chief Financial Officer Richard E. Mushrush.
The Indemnification Agreements provide that the Company will indemnify the Company's officers and directors, to the fullest extent permitted by law, relating to, resulting
from or arising out of any threatened, pending or completed action, suit or proceeding, or any inquiry or investigation by reason of the fact that such officer or director (i) is or
was a director, officer, employee or agent of the Company or (ii) is or was serving at the request of the Company as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company,
and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. In addition, the Indemnification Agreements provide
that the Company will make an advance payment of expenses to any officer or director who has entered into an Indemnification Agreement, in order to cover a claim relating to
any fact or occurrence arising from or relating to events or occurrences specified in this paragraph, subject to receipt of an undertaking by or on behalf of such officer or director
to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Company as authorized under the Indemnification Agreement.
Sales Taxes
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.
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 (reversals)
Interest and penalties
Payments
Balance, end of year
$
$
2018
2017
83,282
101,144
30,465
–
(171,492)
43,400
$
$
274,869
297,673
(33,000)
(5,890)
(450,370)
83,282
F-29
NOTE N – BUSINESS CONCENTRATION
For the years ended December 31, 2018 and 2017, no single customer represented 10% or more of the Company’s total net revenues.
As of December 31, 2018, three customers accounted for 47% of the Company’s net accounts receivable. As of December 31, 2017, three customers accounted for 54% of the
Company’s net accounts receivable.
Purchases from one supplier approximated $3,622,000, or 81%, of total purchases for the year ended December 31, 2018 and approximately $2,796,000, or 79%, of total
purchases for the year ended December 31, 2017. Deposits paid to this vendor were in excess of total accounts payable due to this supplier in the amount of $320,352 as of
December 31, 2018 and total due to this supplier, net of deposits, was $202,258 as of December 31, 2017.
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 3 months of service. 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 $116,000 and $123,000 for the
years ended December 31, 2018 and 2017, respectively.
NOTE P – DISCONTINUED OPERATIONS
In October of 2016, the Company, under the direction and authority of the Board of Directors, committed to a plan to offer for sale EthoStream, the Company’s wholly–owned
High-Speed Internet Access (“HSIA”) subsidiary. As a result of this decision to sell EthoStream, the operating results of EthoStream as of and for the year ended December 31,
2016 were reclassified as discontinued operations and as assets and liabilities held for sale in the consolidated financial statements as detailed in the table below. During the year
ended December 31, 2017, the Company, and EthoStream, entered into an Asset Purchase Agreement (the “Purchase Agreement”) with DCI-Design Communications LLC
(“DCI”), a Delaware limited liability company, whereby DCI acquired all of the assets and certain liabilities of EthoStream for a base purchase price of $12,750,000. The
Purchase Agreement includes that proceeds of $900,000 are to be withheld from the $12,750,000 base purchase price and placed into an escrow account to support potential
indemnification obligations of up to $800,000 and net working capital adjustments of up to $100,000. The escrow amount, net of potential claims, would be fully released after
an escrow period not to exceed 12 months after closing. The assets included, among other items, certain inventory, contracts and intellectual property. DCI acquired only the
liabilities provided for in the Purchase Agreement.
On March 29, 2017, pursuant to the terms and the conditions of the Purchase Agreement, the Company closed on the sale.
On September 27, 2017, the Company reached a final settlement with DCI on net working capital as set forth in the Purchase Agreement and subsequently received $100,000
from the escrow account for the portion of the escrow account set aside for net working capital adjustments and cash proceeds of $311,000 from DCI in the settlement of net
working capital adjustments. During the year ended December 31, 2017, the Company recorded a gain from the sale of EthoStream (net of tax) of $6,630,244.
For the years ended December 31, 2018 and 2017, there were no balance sheet balances from discontinued operations.
F-30
The following table summarizes the statements of operations information for discontinued operations for the years ended December 31, 2018 and 2017.
2018
2017
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 Discontinued Operations before Provision for Income Taxes
Provision for Income Taxes
Income from Discontinued Operations (net of tax)
$
$
–
–
–
–
–
–
–
–
–
–
–
–
–
–
$
$
653,839
925,837
1,579,676
393,804
209,868
603,672
976,004
–
252,378
60,420
312,798
663,206
50,331
612,875
The consolidated statements of cash flows do not present the cash flows from discontinued operations for investing activities or financing activities because there were no
investing or financing activities associated with the discontinued operations in the years ended December 31, 2018 and 2017.
F-31
Exhibit 10.15
EMPLOYMENT AGREEMENT
THIS AGREEMENT is dated October 1, 2018 by and between Telkonet, Inc, a Utah corporation ("Telkonet" or "Company") and Jason L. Tienor ("Executive").
WHEREAS, Telkonet desires to employ Executive and to secure for itself the experience, abilities and services of Executive in the capacity of Chief Executive Officer (CEO) of
Telkonet upon the terms and conditions specified herein; and
WHEREAS, Executive desires to so provide his services to Telkonet, upon the terms and conditions specified herein.
NOW, THEREFORE, in consideration of the mutual covenants contained herein, and for such other good and valuable consideration, the receipt and sufficiency of which are
hereby conclusively acknowledged, the parties, intending to be legally bound, agree as follows:
1. Duties and Scope of Employment.
(a) Positions and Duties. Telkonet hereby employs Executive in the capacity of Chief Executive Officer (CEO) of Telkonet to perform such executive, management and
administrative services and other customary duties consistent with Executive's position as a senior executive officer within the Company as set forth in the Telkonet by-laws
and as Telkonet, by action of its Board of Directors ("Board"), may request from time to time.
(b) Location. Executive's place of work shall be 20800 Swenson Dr., Suite 175, Waukesha, WI 53186. The Company shall be entitled to require the Executive to travel to
work at such other places as business needs require.
2. Term. The term of this Agreement (the "Term") shall commence as of October 1, 2018 and shall expire on October 1, 2020. Upon expiration this term will automatically
renew for an additional twelve (12) months unless mutually agreed to otherwise or is terminated pursuant to Section 6. Automatic renewal cannot occur in two or more
consecutive years.
3. Extent of Services. During the Term and any extension thereof, Executive shall devote his full time, ability, attention and efforts to the performance, to the best of his
abilities, of such duties and responsibilities, as described in Section 1 above, and as the Board of Directors shall determine, consistent therewith.
4. Compensation.
(a) Salary. Executive shall be paid $222,800 on an annualized basis in accordance with Telkonet's normal payroll practices, and be subject to all lawfully required
withholdings. The base salary may be increased, at any time, as determined by the Board.
(b) Sale Bonus. In recognition of Executive's service to the Company, Executive shall be eligible to receive a bonus in the event the Company is sold, subject to the terms set
forth herein (the "Sale Bonus"). This Sale Bonus shall be determined based on the share price of the Company upon such sale, as follows: (i) if the shares are valued at least
$0.20 per share, Executive shall receive a Sale Bonus of $20,000, (ii) if the shares are valued at $0.225 per share, a Sale Bonus of $35,000; or (iii) if the shares are valued at
$0.25 per share, a Sale Bonus of $50,000. If in the event sale price exceeds $0.25 per share, Executive shall be eligible to receive the aforementioned $50,000 bonus, plus an
additional $6,000 for every $0.01 above a share price of $0.25.
1
(c) Executive Participation in Telkonet Staff Benefits Plans. During the Term, Executive shall be entitled to participate in any group health programs and other benefit
plans, which may be instituted from time-to-time for Telkonet employees, and for which Executive qualifies under the terms of such plans. All such benefits shall be
provided on the same terms and conditions as generally apply to all other Telkonet employees under these plans and may be modified by Telkonet from time-to-time.
(d) Expenses. Executive shall be reimbursed by Telkonet for all ordinary, reasonable, customary and necessary expenses incurred by him in the performance of his duties and
responsibilities. Executive agrees to prepare documentation for such expenses as may be necessary for Telkonet to comply with the applicable rules and regulations of the
Internal Revenue Service and Telkonet's existing policy. Telkonet will provide a stipend equal to $323 per pay period to Executive for the purpose of obtaining an auto for
the Executive’s busines use.
(e) Equity. Executive is eligible to participate in the Company's Employee Stock Option Plan, in accordance with the terms of such plan and awards as granted by the
Compensation Committee of the Company's Board.
5. Vacation. At full pay and without any adverse effect to his compensation, provided that all other terms and conditions of this Agreement are satisfied, Executive shall be
entitled to five (5) weeks of vacation for each full calendar year during the term of this Agreement. Executive agrees to schedule his vacation leave in advance upon written
notice to Board or other designated individuals. Carryover of vacation days shall be consistent with Company's existing policy.
6. Termination. This Agreement shall terminate in accordance with Section 2 of this Agreement, or upon the first to occur of any of the following events:
(a) The death of Executive.
(b) The mutual consent of Executive and Telkonet. Executive shall then receive (i) an amount equal to Executive's base salary for the period starting on the first day after
the termination and ending upon the twelve (12) month anniversary date of the termination in accordance with the Company's payroll schedule applicable to all employees
and (ii) if the Executive elects to participate, in a timely manner, in the Company's group health insurance plan in accordance with the mandates of the Consolidated
Omnibus Reconciliation Act of 1985, as amended ("COBRA"), the Company will, pay for any applicable health insurance premiums for such COBRA coverage, for a
period starting on the first day after the termination and ending upon the twelve (12) month anniversary date of the termination. If the Executive becomes eligible for similar
benefits from another employer, Telkonet will reimburse Executive for the Employee's share of current employer's health insurance premium ending upon the twelve (12)
month anniversary date of the termination; Should the Executive wish to continue COBRA coverage after the period of time during which the Company has agreed to pay
the normal employer's share of COBRA coverage, the Executive agrees and acknowledges that he will be solely responsible for payment of any amounts required by the
Company to continue health insurance coverage in accordance with COBRA. The Executive agrees to notify the Company in the event he obtains other health insurance
coverage within ten (10) business days of becoming eligible for such coverage.
(c) "Cause" exists for termination. For purposes of this Agreement, "cause" shall mean the occurrence of any of the following: (1) theft, fraud, embezzlement, or any other
act of intentional dishonesty by Executive; (2) any material breach by Executive of any provision of this Agreement which breach is not cured within a reasonable time (but
not to exceed fourteen (14) days) after written notification thereof to Executive by Telkonet; (3) any habitual neglect of duty or misconduct of Executive in discharging any
of his duties and responsibilities under this Agreement after a written demand for performance was delivered to Executive that specifically identified the manner in which
the Board believed the Executive had failed to discharge his duties and responsibilities, and the Executive failed to resume substantial performance of such duties and
responsibilities on a continual basis immediately following such demand; (4) commission by Executive of a felony or any offense involving moral turpitude; or (5) any
default of Executive's obligations hereunder, or any failure or refusal of Executive to comply with the policies, rules and regulations of Telkonet generally applicable to
Telkonet employees, which default, failure or refusal is not cured within a reasonable time (but not to exceed fourteen (14) days) after written notification thereof to
Executive by Telkonet. If cause exists for termination, Executive shall be entitled to no further compensation, except for accrued leave and vacation and except as may be
required by applicable law.
2
(d) "Good reason" exists for Executive to terminate his employment with Telkonet. For purposes of this Agreement, "good reason" shall mean the occurrence of any of the
following: (1) any material adverse reduction in the scope of Executive's authority or responsibilities; (2) any reduction in the amount of Executive's compensation or
participation in any employee benefits; or (3) Executive's principal place of employment is actually or constructively moved to any office or other location 75 miles or more
outside of the address referenced in Section 1(b). If Executive terminates his employment with Telkonet for "good reason," then, upon notice to Telkonet by Executive of
such termination, Telkonet shall continue to pay Executives base salary and provide Executive with continued participation in each employee benefit plan, in accordance
with the mandates of COBRA (see Section 6.(b)(ii), in which Executive participated immediately prior to the termination date for the period starting on the first day after the
termination date and ending upon expiration of the Term, or if such period is less than twelve (12) months, for a period of twelve (12) months from notice.
(e) If Executive is terminated by Telkonet for any reason other than for "cause," if Telkonet fails to renew the executive's employment agreement and the 12 month
autorenewal period has expired, or in the event of a Change in Control (as defined below), then Executive shall receive: (i) an amount equal to Executive's base salary for
the period starting on the first day after the termination or Change in Control and ending upon the twelve (12) month anniversary date of the termination or Change in
Control in accordance with the Company's payroll schedule applicable to all employees and (ii) pay for any applicable health insurance premiums, in accordance with the
mandates of COBRA (see Section 6.(b)(ii), for a period starting on the first day after the termination or Change in Control and ending upon the twelve (12) month
anniversary date of the termination or Change in Control. If the Executive becomes eligible for similar benefits from another employer, Telkonet will reimburse Executive
for the Executive's share of current employer's health insurance premium ending upon the twelve (12) month anniversary date of the termination. For purposes of this
section, "Change in Control" is defined as a sale of all or substantially all of the stock or assets of the Company.
(f) In the event of a termination under (a), (b), (c), (d) or (e) of this paragraph 6, within thirty (30) days of the separation date, Telkonet shall make a lump sum payment of
any back pay, Executive loans or deferments then due and owing. Notwithstanding anything to the contrary herein, this Agreement shall not terminate or expire under (e) of
this paragraph six unless and until (iii) Executive is reimbursed for any back pay, Executive loans or deferments then due and owing.
(g) Notwithstanding anything to the contrary herein, Telkonet may not terminate the Executive under (b), (c), (d), (e) or (f) of this paragraph 6 until Executive has been
successfully released from any personal guarantee's without loss to the Executive or projects for which Executive has provided a personal guarantee have been successfully
completed and the affiliated bond has been released at no loss to the Executive.
(h) If Executive's employment terminates by reason of death or disability, then (i) Executive will be entitled to receive benefits only in accordance with the Company's then
applicable plans, policies, and arrangements.
(i) Separation Agreement and Release of Claims. The receipt of any severance pursuant to this Agreement will be subject to Executive signing and not revoking a separation
agreement and release of claims (the "Release") in a form reasonably acceptable to the Company, which becomes effective within thirty (30) days following Executive's
separation from service. The Release will provide (among other things) that Executive will not disparage the Company, its directors, or its executive officers for 12 months
following the date of termination and the Company will instruct its officers and directors not to disparage the Executive. No severance pursuant to this Agreement will be
paid or provided until the Release becomes effective.
(j) No Duty to Mitigate. Executive will not be required to mitigate the amount of any payment contemplated by this Agreement, nor will any earnings that Executive may
receive from any other source reduce any such payment.
3
(k) No-Inducement. In the event of a termination of Executive's employment that otherwise would entitle Executive to the receipt of severance and other benefits pursuant
to this Agreement, Executive agrees that as a condition to receipt of such severance, during the 12 month period following termination of employment, Executive, directly or
indirectly, whether as employee, owner, sole proprietor, partner, director, founder or otherwise, will not, solicit, induce, or influence any person to modify their employment
or consulting relationship with the Company (the "No-Inducement"). If Executive breaches the No-Inducement, all payments and benefits to which Executive otherwise
may be entitled pursuant to this Section 6 will cease immediately.
7. Surrender of Books and Papers. Upon termination of this Agreement (irrespective of the time, manner, or cause of termination, be it for cause or otherwise), Executive
shall immediately surrender to Telkonet all books, records, or other written papers or documents entrusted to him or which he has otherwise acquired pertaining to Telkonet
and all other Telkonet property in Executive's possession, custody or control.
8. Inventions and Patents. Executive agrees that Executive will promptly, from time-to time, fully inform and disclose to Telkonet any and all ideas, concepts, copyrights,
copyrightable material, developments, inventions, designs, improvements and discoveries of whatever nature that Executive may have or produced during the term of
Executive's employment under this Agreement that pertain or relate to the then current business of Telkonet (the "Creations"), whether conceived by Executive alone or with
others and whether or not conceived during regular working hours. All Creations shall be the exclusive property of Telkonet and shall be "works made for hire" as defined in 17
U.S.C. §101, and Telkonet shall own all rights in and to the Creations throughout the world, without payment of royalty or other consideration to Executive or anyone claiming
through Executive. Executive hereby transfers and assigns to Telkonet (or its designee) all right, title and interest in and to every Creation. Executive shall assist Telkonet in
obtaining patents or copyrights on all such inventions, designs, improvements and discoveries being patentable or copyrightable by Executive or Telkonet and shall execute all
documents and do all things reasonably necessary (at Telkonet's sole cost and expense) to obtain letters of patent or copyright, vest Telkonet with full and exclusive title thereto,
and protect the same against infringement by third parties, and such assistance shall be given by Executive, if needed, after termination of this Agreement for whatever cause or
reason. Executive hereby represents and warrants that Executive has no current or future obligation with respect to the assignment or disclosure of any or all developments,
inventions, designs, improvements and discoveries of whatever nature to any previous Employer, entity or other person and that Executive does not claim any rights or interest
in or to any previous unpatented or uncopyrighted developments, inventions, designs, improvements or discoveries.
9. Trade Secrets, Non-Competition and Non-Solicitation.
(a) Trade Secrets. Contemporaneous with the execution of this Agreement and during the term of employment under this Agreement, Telkonet shall deliver to Executive or
permit Executive to have access to and become familiar with various confidential information and trade secrets of Telkonet, including without limitation, data, production
methods, customer lists, product format or developments, other information concerning the business of Telkonet and other unique processes, procedures, services and
products of Telkonet, which are regularly used in the operation of the business of Telkonet (collectively, the "Confidential Information"). For purposes of the preceding
sentence, information is not treated as being Confidential Information if it: (i) is or becomes generally available to the public other than by Executive in violation of this
Agreement; (ii) is obtained by Executive in good faith from a third party who discloses such information to Executive on a non-confidential basis without violating any
obligation of confidentiality or secrecy relating to the information disclosed; (iii) is independently developed by Executive outside the scope of his employment without use
of Confidential Information; or (iv) is Executive's personnel information. Executive shall not disclose any of the Confidential Information that he receives from Telkonet or
their clients and customers in the course of his employment with Telkonet, directly or indirectly, nor use it in any way, either during the term of this Agreement or for a period
of five (5) years thereafter, except as required in the course of employment with Telkonet. Executive further acknowledges and agrees that Executive owes Telkonet, a
fiduciary duty to preserve and protect all Confidential Information from unauthorized disclosure or unauthorized use. All files, records, documents, drawings, graphics,
processes, specifications, equipment and similar items relating to the business of Telkonet, whether prepared by Executive or otherwise coming into Executive's possession in
the course of his employment with Telkonet, shall remain the exclusive property of Telkonet and shall not be removed from the premises of Telkonet without the prior
written consent of Telkonet unless removed in relation to the performance of Executive's duties under this Agreement. Any such files, records, documents, drawings,
graphics, specifications, equipment and similar items, and any and all copies of such materials which have been removed from the premises of Telkonet, shall be returned by
Executive to Telkonet. For purposes of this Section 9, "Telkonet" means Telkonet, Inc., including its subsidiaries and affiliates and all successors and predecessors in interest
to Telkonet.
4
(b) Non-Competition. Executive acknowledges that he will be provided with and have access to the Confidential Information, the unauthorized use or disclosure of which
would cause irreparable injury to Telkonet, that Telkonet's willingness to enter into this Agreement is based in material part on Executive's agreement to the provisions of
this Section 9(b) and that Executive's breach of the provisions of this Section would materially and irreparably damage Telkonet. In consideration for Telkonet’s disclosure
of Confidential Information to Executive, Executive's access to the Confidential Information, and the salary paid to executive hereunder, Executive agrees that during the
term of Executive's employment under this Agreement and for one (1) year after the termination of Executive's employment and regardless whether such termination is with
or without cause, Executive shall not, directly or indirectly, either as an executive, employee, employer, consultant, agent, principal, partner, stockholder, corporate officer,
director, advisor or in any other individual or representative capacity, engage or participate in any business that is in competition in any manner whatsoever with the
Restricted Business (as defined herein) in North America. "Restricted Business" means any business conducted by Telkonet at the time of separation of the Executive from
Telkonet.
(c) Reasonableness of Restrictions. Executive acknowledges that the restrictions set forth in Section 9(b) of this Agreement are reasonable in scope and necessary for the
protection of the business and goodwill of Telkonet. Executive agrees that should any portion of the covenants in Section 9 be unenforceable because of the scope thereof or
the period covered thereby or otherwise, the covenant shall be deemed to be reduced and limited to enable it to be enforced to the maximum extent permissible under the
laws and public policies applied in the jurisdiction in which enforcement is sought.
(d) Injunctive Relief; Extension of Restrictive Period. In the event of a breach of any of the covenants by Executive or Telkonet contained in this Agreement, it is
understood that damages will be difficult to ascertain, and either party may petition a court of law or equity for injunctive relief in addition to any other relief which
Executive or Telkonet may have under the law, including but not limited to reasonable attorneys' fees.
10. Indemnification and Insurance. Executive will be covered under the Company's insurance policies and, subject to applicable law, will be provided indemnification to
the maximum extent permitted by the Company's bylaws, Certificate of Incorporation, and standard form of Indemnification Agreement, with such insurance coverage and
indemnification to be in accordance with the Company's standard practices for senior executive officers but on terms no less favorable than provided to any other Company
senior executive officer or director.
11. Miscellaneous.
(a) This Agreement shall be binding upon the parties and their respective heirs, executors, administrators, successors and assigns. Executive shall not assign any part of
his rights under this Agreement without the prior written consent of Telkonet.
(b) This Agreement contains the entire agreement and understanding between the parties and supersedes any and all prior understandings and agreements between the
parties regarding Executive's employment.
(c) No modification hereof shall be binding unless made in writing and signed by the party against whom enforcement is sought. No waiver of any provisions of this
Agreement shall be valid unless the same is in writing and signed by the party against whom it is sought to be enforced, unless it can be shown through custom, usage
or course of action.
(d) This Agreement is executed in, and it is the intention of the parties hereto that it shall be governed by, the laws of the State of Wisconsin without giving effect to
applicable conflict of laws provisions.
5
(e) The provisions of this Agreement shall be deemed to be severable, and the invalidity or unenforceability of any provision shall not affect the validity or
enforceability of the other provisions hereof.
(f) Any notice or communication permitted or required by this Agreement shall be in writing and shall become effective upon personal service, or service by wire
transmission, which has been acknowledged by the other party as being received, or two (2) days after its mailing by certified mail, return receipt requested, postage
prepaid addressed as follows:
(1) If to Telkonet: Attn: General Counsel Telkonet, Inc. 20800, Suite 175, Swenson Dr. Waukesha, WI 53186.
(2) If to Executive, to: Jason L. Tienor at the last residential address known by the Company as provided by Executive in writing.
(g) Acknowledgment. Executive acknowledges that he has had the opportunity to discuss this matter with and obtain advice from his private attorney, has had sufficient
time to, and has carefully read and fully understands all the provisions of this Agreement, and is knowingly and voluntarily entering into this Agreement.
(h) Counterparts. This Agreement may be executed in counterparts, and each counterpart will have the same force and effect as an original and will constitute an effective,
binding agreement on the part of each of the undersigned.
IN WITNESS WHEREOF, Telkonet and Executive have executed this Agreement as of the date first set forth above.
/s/ signature
Compensation Committee
10.8.18
Date
/s/ Jason L. Tienor
Jason L. Tienor
10/1/18
Date
6
Exhibit 10.16
EMPLOYMENT AGREEMENT
THIS AGREEMENT is dated October 1, 2018 by and between Telkonet, Inc, a Utah corporation ("Telkonet" or "Company") and Jeffrey J. Sobieski ("Executive").
WHEREAS, Telkonet desires to employ Executive and to secure for itself the experience, abilities and services of Executive in the capacity of Chief Technology Officer (CTO)
of Telkonet upon the terms and conditions specified herein; and
WHEREAS, Executive desires to so provide his services to Telkonet, upon the terms and conditions specified herein.
NOW, THEREFORE, in consideration of the mutual covenants contained herein, and for such other good and valuable consideration, the receipt and sufficiency of which are
hereby conclusively acknowledged, the parties, intending to be legally bound, agree as follows:
1. Duties and Scope of Employment.
(a) Positions and Duties. Telkonet hereby employs Executive in the capacity of Chief Technology Officer (CTO) of Telkonet to perform such executive, management and
administrative services and other customary duties consistent with Executive's position as a senior executive officer within the Company as set forth in the Telkonet by-laws
and as Telkonet, by action of its Chief Executive Officer (CEO) and Board of Directors ("Board"), may request from time to time.
(b) Location. Executive's place of work shall be 20800 Swenson Dr., Suite 175, Waukesha, WI 53186. The Company shall be entitled to require the Executive to travel to
work at such other places as business needs require.
2. Term. The term of this Agreement (the "Term") shall commence as of October 1, 2018 and shall expire on October 1, 2020. Upon expiration this term will automatically
renew for an additional twelve (12) months unless mutually agreed to otherwise or is terminated pursuant to Section 6. Automatic renewal cannot occur in two or more
consecutive years.
3. Extent of Services. During the Term and any extension thereof, Executive shall devote his full time, ability, attention and efforts to the performance, to the best of his
abilities, of such duties and responsibilities, as described in Section 1 above, and as the CEO shall determine, consistent therewith.
4. Compensation.
(a) Salary. Executive shall be paid $211,625 on an annualized basis in accordance with Telkonet's normal payroll practices, and be subject to all lawfully required
withholdings. The base salary may be increased, at any time, as determined by the CEO and the Board.
(b) Sale Bonus. In recognition of Executive's service to the Company, Executive shall be eligible to receive a bonus in the event the Company is sold, subject to the terms set
forth herein (the "Sale Bonus"). This Sale Bonus shall be determined based on the share price of the Company upon such sale, as follows: (i) if the shares are valued at least
$0.20 per share, Executive shall receive a Sale Bonus of $20,000, (ii) if the shares are valued at $0.225 per share, a Sale Bonus of $35,000; or (iii) if the shares are valued at
$0.25 per share, a Sale Bonus of $50,000. If in the event sale price exceeds $0.25 per share, Executive shall be eligible to receive the aforementioned $50,000 bonus, plus an
additional $6,000 for every $0.01 above a share price of $0.25.
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(c) Executive Participation in Telkonet Staff Benefits Plans. During the Term, Executive shall be entitled to participate in any group health programs and other benefit
plans, which may be instituted from time-to-time for Telkonet employees, and for which Executive qualifies under the terms of such plans. All such benefits shall be
provided on the same terms and conditions as generally apply to all other Telkonet employees under these plans and may be modified by Telkonet from time-to-time.
(d) Expenses. Executive shall be reimbursed by Telkonet for all ordinary, reasonable, customary and necessary expenses incurred by him in the performance of his duties and
responsibilities. Executive agrees to prepare documentation for such expenses as may be necessary for Telkonet to comply with the applicable rules and regulations of the
Internal Revenue Service and Telkonet's existing policy. Telkonet will provide a stipend equal to $323 per pay period to Executive for the purpose of obtaining an auto for
the Executive’s business use.
(e) Equity. Executive is eligible to participate in the Company's Employee Stock Option Plan, in accordance with the terms of such plan and awards as granted by the
Compensation Committee of the Company's Board.
5. Vacation. At full pay and without any adverse effect to his compensation, provided that all other terms and conditions of this Agreement are satisfied, Executive shall be
entitled to five (5) weeks of vacation for each full calendar year during the term of this Agreement. Executive agrees to schedule his vacation leave in advance upon written
notice to CEO or other designated individuals. Carryover of vacation days shall be consistent with Company's existing policy.
6. Termination. This Agreement shall terminate in accordance with Section 2 of this Agreement, or upon the first to occur of any of the following events:
(a) The death of Executive.
(b) The mutual consent of Executive and Telkonet. Executive shall then receive (i) an amount equal to Executive's base salary for the period starting on the first day after
the termination and ending upon the twelve (12) month anniversary date of the termination in accordance with the Company's payroll schedule applicable to all employees
and (ii) if the Executive elects to participate, in a timely manner, in the Company's group health insurance plan in accordance with the mandates of the Consolidated
Omnibus Reconciliation Act of 1985, as amended ("COBRA"), the Company will, pay for any applicable health insurance premiums for such COBRA coverage, for a
period starting on the first day after the termination and ending upon the twelve (12) month anniversary date of the termination. If the Executive becomes eligible for similar
benefits from another employer, Telkonet will reimburse Executive for the Employee's share of current employer's health insurance premium ending upon the twelve (12)
month anniversary date of the termination; Should the Executive wish to continue COBRA coverage after the period of time during which the Company has agreed to pay
the normal employer's share of COBRA coverage, the Executive agrees and acknowledges that he will be solely responsible for payment of any amounts required by the
Company to continue health insurance coverage in accordance with COBRA. The Executive agrees to notify the Company in the event he obtains other health insurance
coverage within ten (10) business days of becoming eligible for such coverage.
(c) "Cause" exists for termination. For purposes of this Agreement, "cause" shall mean the occurrence of any of the following: (1) theft, fraud, embezzlement, or any other
act of intentional dishonesty by Executive; (2) any material breach by Executive of any provision of this Agreement which breach is not cured within a reasonable time (but
not to exceed fourteen (14) days) after written notification thereof to Executive by Telkonet; (3) any habitual neglect of duty or misconduct of Executive in discharging any
of his duties and responsibilities under this Agreement after a written demand for performance was delivered to Executive that specifically identified the manner in which
the Board believed the Executive had failed to discharge his duties and responsibilities, and the Executive failed to resume substantial performance of such duties and
responsibilities on a continual basis immediately following such demand; (4) commission by Executive of a felony or any offense involving moral turpitude; or (5) any
default of Executive's obligations hereunder, or any failure or refusal of Executive to comply with the policies, rules and regulations of Telkonet generally applicable to
Telkonet employees, which default, failure or refusal is not cured within a reasonable time (but not to exceed fourteen (14) days) after written notification thereof to
Executive by Telkonet. If cause exists for termination, Executive shall be entitled to no further compensation, except for accrued leave and vacation and except as may be
required by applicable law.
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(d) "Good reason" exists for Executive to terminate his employment with Telkonet. For purposes of this Agreement, "good reason" shall mean the occurrence of any of the
following: (1) any material adverse reduction in the scope of Executive's authority or responsibilities; (2) any reduction in the amount of Executive's compensation or
participation in any employee benefits; or (3) Executive's principal place of employment is actually or constructively moved to any office or other location 75 miles or more
outside of the address referenced in Section 1(b). If Executive terminates his employment with Telkonet for "good reason," then, upon notice to Telkonet by Executive of
such termination, Telkonet shall continue to pay Executives base salary and provide Executive with continued participation in each employee benefit plan, in accordance
with the mandates of COBRA (see Section 6.(b)(ii), in which Executive participated immediately prior to the termination date for the period starting on the first day after the
termination date and ending upon expiration of the Term, or if such period is less than twelve (12) months, for a period of twelve (12) months from notice.
(e) If Executive is terminated by Telkonet for any reason other than for "cause," if Telkonet fails to renew the executive's employment agreement and the 12 month
autorenewal period has expired, or in the event of a Change in Control (as defined below), then Executive shall receive: (i) an amount equal to Executive's base salary for
the period starting on the first day after the termination or Change in Control and ending upon the twelve (12) month anniversary date of the termination or Change in
Control in accordance with the Company's payroll schedule applicable to all employees and (ii) pay for any applicable health insurance premiums, in accordance with the
mandates of COBRA (see Section 6.(b)(ii), for a period starting on the first day after the termination or Change in Control and ending upon the twelve (12) month
anniversary date of the termination or Change in Control. If the Executive becomes eligible for similar benefits from another employer, Telkonet will reimburse Executive
for the Executive's share of current employer's health insurance premium ending upon the twelve (12) month anniversary date of the termination. For purposes of this
section, "Change in Control" is defined as a sale of all or substantially all of the stock or assets of the Company.
(f) In the event of a termination under (a), (b), (c), (d) or (e) of this paragraph 6, within thirty (30) days of the separation date, Telkonet shall make a lump sum payment of
any back pay, Executive loans or deferments then due and owing. Notwithstanding anything to the contrary herein, this Agreement shall not terminate or expire under (e) of
this paragraph six unless and until (iii) Executive is reimbursed for any back pay, Executive loans or deferments then due and owing.
(g) Notwithstanding anything to the contrary herein, Telkonet may not terminate the Executive under (b), (c), (d), (e) or (f) of this paragraph 6 until Executive has been
successfully released from any personal guarantee's without loss to the Executive or projects for which Executive has provided a personal guarantee have been successfully
completed and the affiliated bond has been released at no loss to the Executive.
(h) If Executive's employment terminates by reason of death or disability, then (i) Executive will be entitled to receive benefits only in accordance with the Company's then
applicable plans, policies, and arrangements.
(i) Separation Agreement and Release of Claims. The receipt of any severance pursuant to this Agreement will be subject to Executive signing and not revoking a separation
agreement and release of claims (the "Release") in a form reasonably acceptable to the Company, which becomes effective within thirty (30) days following Executive's
separation from service. The Release will provide (among other things) that Executive will not disparage the Company, its directors, or its executive officers for 12 months
following the date of termination and the Company will instruct its officers and directors not to disparage the Executive. No severance pursuant to this Agreement will be
paid or provided until the Release becomes effective.
(j) No Duty to Mitigate. Executive will not be required to mitigate the amount of any payment contemplated by this Agreement, nor will any earnings that Executive may
receive from any other source reduce any such payment.
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(k) No-Inducement. In the event of a termination of Executive's employment that otherwise would entitle Executive to the receipt of severance and other benefits pursuant
to this Agreement, Executive agrees that as a condition to receipt of such severance, during the 12 month period following termination of employment, Executive, directly or
indirectly, whether as employee, owner, sole proprietor, partner, director, founder or otherwise, will not, solicit, induce, or influence any person to modify their employment
or consulting relationship with the Company (the "No-Inducement"). If Executive breaches the No-Inducement, all payments and benefits to which Executive otherwise
may be entitled pursuant to this Section 6 will cease immediately.
7. Surrender of Books and Papers. Upon termination of this Agreement (irrespective of the time, manner, or cause of termination, be it for cause or otherwise), Executive
shall immediately surrender to Telkonet all books, records, or other written papers or documents entrusted to him or which he has otherwise acquired pertaining to Telkonet
and all other Telkonet property in Executive's possession, custody or control.
8. Inventions and Patents. Executive agrees that Executive will promptly, from time-to time, fully inform and disclose to Telkonet any and all ideas, concepts, copyrights,
copyrightable material, developments, inventions, designs, improvements and discoveries of whatever nature that Executive may have or produced during the term of
Executive's employment under this Agreement that pertain or relate to the then current business of Telkonet (the "Creations"), whether conceived by Executive alone or with
others and whether or not conceived during regular working hours. All Creations shall be the exclusive property of Telkonet and shall be "works made for hire" as defined in 17
U.S.C. §101, and Telkonet shall own all rights in and to the Creations throughout the world, without payment of royalty or other consideration to Executive or anyone claiming
through Executive. Executive hereby transfers and assigns to Telkonet (or its designee) all right, title and interest in and to every Creation. Executive shall assist Telkonet in
obtaining patents or copyrights on all such inventions, designs, improvements and discoveries being patentable or copyrightable by Executive or Telkonet and shall execute all
documents and do all things reasonably necessary (at Telkonet's sole cost and expense) to obtain letters of patent or copyright, vest Telkonet with full and exclusive title thereto,
and protect the same against infringement by third parties, and such assistance shall be given by Executive, if needed, after termination of this Agreement for whatever cause or
reason. Executive hereby represents and warrants that Executive has no current or future obligation with respect to the assignment or disclosure of any or all developments,
inventions, designs, improvements and discoveries of whatever nature to any previous Employer, entity or other person and that Executive does not claim any rights or interest
in or to any previous unpatented or uncopyrighted developments, inventions, designs, improvements or discoveries.
9. Trade Secrets, Non-Competition and Non-Solicitation.
(a) Trade Secrets. Contemporaneous with the execution of this Agreement and during the term of employment under this Agreement, Telkonet shall deliver to Executive or
permit Executive to have access to and become familiar with various confidential information and trade secrets of Telkonet, including without limitation, data, production
methods, customer lists, product format or developments, other information concerning the business of Telkonet and other unique processes, procedures, services and
products of Telkonet, which are regularly used in the operation of the business of Telkonet (collectively, the "Confidential Information"). For purposes of the preceding
sentence, information is not treated as being Confidential Information if it: (i) is or becomes generally available to the public other than by Executive in violation of this
Agreement; (ii) is obtained by Executive in good faith from a third party who discloses such information to Executive on a non-confidential basis without violating any
obligation of confidentiality or secrecy relating to the information disclosed; (iii) is independently developed by Executive outside the scope of his employment without use
of Confidential Information; or (iv) is Executive's personnel information. Executive shall not disclose any of the Confidential Information that he receives from Telkonet or
their clients and customers in the course of his employment with Telkonet, directly or indirectly, nor use it in any way, either during the term of this Agreement or for a period
of five (5) years thereafter, except as required in the course of employment with Telkonet. Executive further acknowledges and agrees that Executive owes Telkonet, a
fiduciary duty to preserve and protect all Confidential Information from unauthorized disclosure or unauthorized use. All files, records, documents, drawings, graphics,
processes, specifications, equipment and similar items relating to the business of Telkonet, whether prepared by Executive or otherwise coming into Executive's possession in
the course of his employment with Telkonet, shall remain the exclusive property of Telkonet and shall not be removed from the premises of Telkonet without the prior
written consent of Telkonet unless removed in relation to the performance of Executive's duties under this Agreement. Any such files, records, documents, drawings,
graphics, specifications, equipment and similar items, and any and all copies of such materials which have been removed from the premises of Telkonet, shall be returned by
Executive to Telkonet. For purposes of this Section 9, "Telkonet" means Telkonet, Inc., including its subsidiaries and affiliates and all successors and predecessors in interest
to Telkonet.
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(b) Non-Competition. Executive acknowledges that he will be provided with and have access to the Confidential Information, the unauthorized use or disclosure of which
would cause irreparable injury to Telkonet, that Telkonet's willingness to enter into this Agreement is based in material part on Executive's agreement to the provisions of
this Section 9(b) and that Executive's breach of the provisions of this Section would materially and irreparably damage Telkonet. In consideration for Telkonet’s disclosure
of Confidential Information to Executive, Executive's access to the Confidential Information, and the salary paid to executive hereunder, Executive agrees that during the
term of Executive's employment under this Agreement and for one (1) year after the termination of Executive's employment and regardless whether such termination is with
or without cause, Executive shall not, directly or indirectly, either as an executive, employee, employer, consultant, agent, principal, partner, stockholder, corporate officer,
director, advisor or in any other individual or representative capacity, engage or participate in any business that is in competition in any manner whatsoever with the
Restricted Business (as defined herein) in North America. "Restricted Business" means any business conducted by Telkonet at the time of separation of the Executive from
Telkonet.
(c) Reasonableness of Restrictions. Executive acknowledges that the restrictions set forth in Section 9(b) of this Agreement are reasonable in scope and necessary for the
protection of the business and goodwill of Telkonet. Executive agrees that should any portion of the covenants in Section 9 be unenforceable because of the scope thereof or
the period covered thereby or otherwise, the covenant shall be deemed to be reduced and limited to enable it to be enforced to the maximum extent permissible under the
laws and public policies applied in the jurisdiction in which enforcement is sought.
(d) Injunctive Relief; Extension of Restrictive Period. In the event of a breach of any of the covenants by Executive or Telkonet contained in this Agreement, it is
understood that damages will be difficult to ascertain, and either party may petition a court of law or equity for injunctive relief in addition to any other relief which
Executive or Telkonet may have under the law, including but not limited to reasonable attorneys' fees.
10. Indemnification and Insurance. Executive will be covered under the Company's insurance policies and, subject to applicable law, will be provided indemnification to
the maximum extent permitted by the Company's bylaws, Certificate of Incorporation, and standard form of Indemnification Agreement, with such insurance coverage and
indemnification to be in accordance with the Company's standard practices for senior executive officers but on terms no less favorable than provided to any other Company
senior executive officer or director.
11. Miscellaneous.
(a) This Agreement shall be binding upon the parties and their respective heirs, executors, administrators, successors and assigns. Executive shall not assign any part of
his rights under this Agreement without the prior written consent of Telkonet.
(b) This Agreement contains the entire agreement and understanding between the parties and supersedes any and all prior understandings and agreements between the
parties regarding Executive's employment.
(c) No modification hereof shall be binding unless made in writing and signed by the party against whom enforcement is sought. No waiver of any provisions of this
Agreement shall be valid unless the same is in writing and signed by the party against whom it is sought to be enforced, unless it can be shown through custom, usage
or course of action.
(d) This Agreement is executed in, and it is the intention of the parties hereto that it shall be governed by, the laws of the State of Wisconsin without giving effect to
applicable conflict of laws provisions.
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(e) The provisions of this Agreement shall be deemed to be severable, and the invalidity or unenforceability of any provision shall not affect the validity or
enforceability of the other provisions hereof.
(f) Any notice or communication permitted or required by this Agreement shall be in writing and shall become effective upon personal service, or service by wire
transmission, which has been acknowledged by the other party as being received, or two (2) days after its mailing by certified mail, return receipt requested, postage
prepaid addressed as follows:
(1) If to Telkonet: Attn: General Counsel Telkonet, Inc. 20800, Suite 175, Swenson Dr. Waukesha, WI 53186.
(2) If to Executive, to: Jeffrrey J. Sobieski at the last residential address known by the Company as provided by Executive in writing.
(g) Acknowledgment. Executive acknowledges that he has had the opportunity to discuss this matter with and obtain advice from his private attorney, has had sufficient
time to, and has carefully read and fully understands all the provisions of this Agreement, and is knowingly and voluntarily entering into this Agreement.
(h) Counterparts. This Agreement may be executed in counterparts, and each counterpart will have the same force and effect as an original and will constitute an effective,
binding agreement on the part of each of the undersigned.
IN WITNESS WHEREOF, Telkonet and Executive have executed this Agreement as of the date first set forth above.
/s/ signature
Compensation Committee
10.8.18
Date
/s/ Jeffrey J. Sobieski
Jeffrey J. Sobieski
10/1/18
Date
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Exhibit 10.17
EMPLOYMENT AGREEMENT
THIS AGREEMENT is dated October 1, 2018 by and between Telkonet, Inc, a Utah corporation ("Telkonet" or "Company") and Richard E. Mushrush ("Executive").
WHEREAS, Telkonet desires to employ Executive and to secure for itself the experience, abilities and services of Executive in the capacity of Chief Financial Officer (CFO) of
Telkonet upon the terms and conditions specified herein; and
WHEREAS, Executive desires to so provide his services to Telkonet, upon the terms and conditions specified herein.
NOW, THEREFORE, in consideration of the mutual covenants contained herein, and for such other good and valuable consideration, the receipt and sufficiency of which are
hereby conclusively acknowledged, the parties, intending to be legally bound, agree as follows:
1. Duties and Scope of Employment.
(a) Positions and Duties. Telkonet hereby employs Executive in the capacity of Chief Financial Officer (CFO) of Telkonet to perform such executive, management and
administrative services and other customary duties consistent with Executive's position as a senior executive officer within the Company as set forth in the Telkonet by-laws
and as Telkonet, by action of its Chief Executive Officer (CEO) and Board of Directors ("Board"), may request from time to time.
(b) Location. Executive's place of work shall be 20800 Swenson Dr., Suite 175, Waukesha, WI 53186. The Company shall be entitled to require the Executive to travel to
work at such other places as business needs require.
2. Term. The term of this Agreement (the "Term") shall commence as of October 1, 2018 and shall expire on October 1, 2020. Upon expiration this term will automatically
renew for an additional twelve (12) months unless mutually agreed to otherwise or is terminated pursuant to Section 6. Automatic renewal cannot occur in two or more
consecutive years.
3. Extent of Services. During the Term and any extension thereof, Executive shall devote his full time, ability, attention and efforts to the performance, to the best of his
abilities, of such duties and responsibilities, as described in Section 1 above, and as the CEO shall determine, consistent therewith.
4. Compensation.
(a) Salary. Executive shall be paid $122,000 on an annualized basis in accordance with Telkonet's normal payroll practices, and be subject to all lawfully required
withholdings. The base salary may be increased, at any time, as determined by the CEO and the Board.
(b) Sale Bonus. In recognition of Executive's service to the Company, Executive shall be eligible to receive a bonus in the event the Company is sold, subject to the terms set
forth herein (the "Sale Bonus"). This Sale Bonus shall be determined based on the share price of the Company upon such sale, as follows: (i) if the shares are valued at least
$0.20 per share, Executive shall receive a Sale Bonus of $20,000, (ii) if the shares are valued at $0.225 per share, a Sale Bonus of $35,000; or (iii) if the shares are valued at
$0.25 per share, a Sale Bonus of $50,000. If in the event sale price exceeds $0.25 per share, Executive shall be eligible to receive the aforementioned $50,000 bonus, plus an
additional $6,000 for every $0.01 above a share price of $0.25.
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(c) Executive Participation in Telkonet Staff Benefits Plans. During the Term, Executive shall be entitled to participate in any group health programs and other benefit
plans, which may be instituted from time-to-time for Telkonet employees, and for which Executive qualifies under the terms of such plans. All such benefits shall be
provided on the same terms and conditions as generally apply to all other Telkonet employees under these plans and may be modified by Telkonet from time-to-time.
(d) Expenses. Executive shall be reimbursed by Telkonet for all ordinary, reasonable, customary and necessary expenses incurred by him in the performance of his duties and
responsibilities. Executive agrees to prepare documentation for such expenses as may be necessary for Telkonet to comply with the applicable rules and regulations of the
Internal Revenue Service and Telkonet's existing policy.
(e) Equity. Executive is eligible to participate in the Company's Employee Stock Option Plan, in accordance with the terms of such plan and awards as granted by the
Compensation Committee of the Company's Board.
5. Vacation. At full pay and without any adverse effect to his compensation, provided that all other terms and conditions of this Agreement are satisfied, Executive shall be
entitled to four (4) weeks of vacation for each full calendar year during the term of this Agreement. Executive agrees to schedule his vacation leave in advance upon written
notice to CEO or other designated individuals. Carryover of vacation days shall be consistent with Company's existing policy.
6. Termination. This Agreement shall terminate in accordance with Section 2 of this Agreement, or upon the first to occur of any of the following events:
(a) The death of Executive.
(b) The mutual consent of Executive and Telkonet. Executive shall then receive (i) an amount equal to Executive's base salary for the period starting on the first day after
the termination and ending upon the twelve (12) month anniversary date of the termination in accordance with the Company's payroll schedule applicable to all employees
and (ii) if the Executive elects to participate, in a timely manner, in the Company's group health insurance plan in accordance with the mandates of the Consolidated
Omnibus Reconciliation Act of 1985, as amended ("COBRA"), the Company will, pay for any applicable health insurance premiums for such COBRA coverage, for a
period starting on the first day after the termination and ending upon the twelve (12) month anniversary date of the termination. If the Executive becomes eligible for similar
benefits from another employer, Telkonet will reimburse Executive for the Employee's share of current employer's health insurance premium ending upon the twelve (12)
month anniversary date of the termination; Should the Executive wish to continue COBRA coverage after the period of time during which the Company has agreed to pay
the normal employer's share of COBRA coverage, the Executive agrees and acknowledges that he will be solely responsible for payment of any amounts required by the
Company to continue health insurance coverage in accordance with COBRA. The Executive agrees to notify the Company in the event he obtains other health insurance
coverage within ten (10) business days of becoming eligible for such coverage.
(c) "Cause" exists for termination. For purposes of this Agreement, "cause" shall mean the occurrence of any of the following: (1) theft, fraud, embezzlement, or any other
act of intentional dishonesty by Executive; (2) any material breach by Executive of any provision of this Agreement which breach is not cured within a reasonable time (but
not to exceed fourteen (14) days) after written notification thereof to Executive by Telkonet; (3) any habitual neglect of duty or misconduct of Executive in discharging any
of his duties and responsibilities under this Agreement after a written demand for performance was delivered to Executive that specifically identified the manner in which
the Board believed the Executive had failed to discharge his duties and responsibilities, and the Executive failed to resume substantial performance of such duties and
responsibilities on a continual basis immediately following such demand; (4) commission by Executive of a felony or any offense involving moral turpitude; or (5) any
default of Executive's obligations hereunder, or any failure or refusal of Executive to comply with the policies, rules and regulations of Telkonet generally applicable to
Telkonet employees, which default, failure or refusal is not cured within a reasonable time (but not to exceed fourteen (14) days) after written notification thereof to
Executive by Telkonet. If cause exists for termination, Executive shall be entitled to no further compensation, except for accrued leave and vacation and except as may be
required by applicable law.
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(d) "Good reason" exists for Executive to terminate his employment with Telkonet. For purposes of this Agreement, "good reason" shall mean the occurrence of any of the
following: (1) any material adverse reduction in the scope of Executive's authority or responsibilities; (2) any reduction in the amount of Executive's compensation or
participation in any employee benefits; or (3) Executive's principal place of employment is actually or constructively moved to any office or other location 75 miles or more
outside of the address referenced in Section 1(b). If Executive terminates his employment with Telkonet for "good reason," then, upon notice to Telkonet by Executive of
such termination, Telkonet shall continue to pay Executives base salary and provide Executive with continued participation in each employee benefit plan, in accordance
with the mandates of COBRA (see Section 6.(b)(ii), in which Executive participated immediately prior to the termination date for the period starting on the first day after the
termination date and ending upon expiration of the Term, or if such period is less than twelve (12) months, for a period of twelve (12) months from notice.
(e) If Executive is terminated by Telkonet for any reason other than for "cause," if Telkonet fails to renew the executive's employment agreement and the 12 month
autorenewal period has expired, or in the event of a Change in Control (as defined below), then Executive shall receive: (i) an amount equal to Executive's base salary for
the period starting on the first day after the termination or Change in Control and ending upon the twelve (12) month anniversary date of the termination or Change in
Control in accordance with the Company's payroll schedule applicable to all employees and (ii) pay for any applicable health insurance premiums, in accordance with the
mandates of COBRA (see Section 6.(b)(ii), for a period starting on the first day after the termination or Change in Control and ending upon the twelve (12) month
anniversary date of the termination or Change in Control. If the Executive becomes eligible for similar benefits from another employer, Telkonet will reimburse Executive
for the Executive's share of current employer's health insurance premium ending upon the twelve (12) month anniversary date of the termination. For purposes of this
section, "Change in Control" is defined as a sale of all or substantially all of the stock or assets of the Company.
(f) In the event of a termination under (a), (b), (c), (d) or (e) of this paragraph 6, within thirty (30) days of the separation date, Telkonet shall make a lump sum payment of
any back pay, Executive loans or deferments then due and owing. Notwithstanding anything to the contrary herein, this Agreement shall not terminate or expire under (e) of
this paragraph six unless and until (iii) Executive is reimbursed for any back pay, Executive loans or deferments then due and owing.
(g) Notwithstanding anything to the contrary herein, Telkonet may not terminate the Executive under (b), (c), (d), (e) or (f) of this paragraph 6 until Executive has been
successfully released from any personal guarantee's without loss to the Executive or projects for which Executive has provided a personal guarantee have been successfully
completed and the affiliated bond has been released at no loss to the Executive.
(h) If Executive's employment terminates by reason of death or disability, then (i) Executive will be entitled to receive benefits only in accordance with the Company's then
applicable plans, policies, and arrangements.
(i) Separation Agreement and Release of Claims. The receipt of any severance pursuant to this Agreement will be subject to Executive signing and not revoking a separation
agreement and release of claims (the "Release") in a form reasonably acceptable to the Company, which becomes effective within thirty (30) days following Executive's
separation from service. The Release will provide (among other things) that Executive will not disparage the Company, its directors, or its executive officers for 12 months
following the date of termination and the Company will instruct its officers and directors not to disparage the Executive. No severance pursuant to this Agreement will be
paid or provided until the Release becomes effective.
(j) No Duty to Mitigate. Executive will not be required to mitigate the amount of any payment contemplated by this Agreement, nor will any earnings that Executive may
receive from any other source reduce any such payment.
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(k) No-Inducement. In the event of a termination of Executive's employment that otherwise would entitle Executive to the receipt of severance and other benefits pursuant
to this Agreement, Executive agrees that as a condition to receipt of such severance, during the 12 month period following termination of employment, Executive, directly or
indirectly, whether as employee, owner, sole proprietor, partner, director, founder or otherwise, will not, solicit, induce, or influence any person to modify their employment
or consulting relationship with the Company (the "No-Inducement"). If Executive breaches the No-Inducement, all payments and benefits to which Executive otherwise
may be entitled pursuant to this Section 6 will cease immediately.
7. Surrender of Books and Papers. Upon termination of this Agreement (irrespective of the time, manner, or cause of termination, be it for cause or otherwise), Executive
shall immediately surrender to Telkonet all books, records, or other written papers or documents entrusted to him or which he has otherwise acquired pertaining to Telkonet
and all other Telkonet property in Executive's possession, custody or control.
8. Inventions and Patents. Executive agrees that Executive will promptly, from time-to time, fully inform and disclose to Telkonet any and all ideas, concepts, copyrights,
copyrightable material, developments, inventions, designs, improvements and discoveries of whatever nature that Executive may have or produced during the term of
Executive's employment under this Agreement that pertain or relate to the then current business of Telkonet (the "Creations"), whether conceived by Executive alone or with
others and whether or not conceived during regular working hours. All Creations shall be the exclusive property of Telkonet and shall be "works made for hire" as defined in 17
U.S.C. §101, and Telkonet shall own all rights in and to the Creations throughout the world, without payment of royalty or other consideration to Executive or anyone claiming
through Executive. Executive hereby transfers and assigns to Telkonet (or its designee) all right, title and interest in and to every Creation. Executive shall assist Telkonet in
obtaining patents or copyrights on all such inventions, designs, improvements and discoveries being patentable or copyrightable by Executive or Telkonet and shall execute all
documents and do all things reasonably necessary (at Telkonet's sole cost and expense) to obtain letters of patent or copyright, vest Telkonet with full and exclusive title thereto,
and protect the same against infringement by third parties, and such assistance shall be given by Executive, if needed, after termination of this Agreement for whatever cause or
reason. Executive hereby represents and warrants that Executive has no current or future obligation with respect to the assignment or disclosure of any or all developments,
inventions, designs, improvements and discoveries of whatever nature to any previous Employer, entity or other person and that Executive does not claim any rights or interest
in or to any previous unpatented or uncopyrighted developments, inventions, designs, improvements or discoveries.
9. Trade Secrets, Non-Competition and Non-Solicitation.
(a) Trade Secrets. Contemporaneous with the execution of this Agreement and during the term of employment under this Agreement, Telkonet shall deliver to Executive or
permit Executive to have access to and become familiar with various confidential information and trade secrets of Telkonet, including without limitation, data, production
methods, customer lists, product format or developments, other information concerning the business of Telkonet and other unique processes, procedures, services and
products of Telkonet, which are regularly used in the operation of the business of Telkonet (collectively, the "Confidential Information"). For purposes of the preceding
sentence, information is not treated as being Confidential Information if it: (i) is or becomes generally available to the public other than by Executive in violation of this
Agreement; (ii) is obtained by Executive in good faith from a third party who discloses such information to Executive on a non-confidential basis without violating any
obligation of confidentiality or secrecy relating to the information disclosed; (iii) is independently developed by Executive outside the scope of his employment without use
of Confidential Information; or (iv) is Executive's personnel information. Executive shall not disclose any of the Confidential Information that he receives from Telkonet or
their clients and customers in the course of his employment with Telkonet, directly or indirectly, nor use it in any way, either during the term of this Agreement or for a period
of five (5) years thereafter, except as required in the course of employment with Telkonet. Executive further acknowledges and agrees that Executive owes Telkonet, a
fiduciary duty to preserve and protect all Confidential Information from unauthorized disclosure or unauthorized use. All files, records, documents, drawings, graphics,
processes, specifications, equipment and similar items relating to the business of Telkonet, whether prepared by Executive or otherwise coming into Executive's possession in
the course of his employment with Telkonet, shall remain the exclusive property of Telkonet and shall not be removed from the premises of Telkonet without the prior
written consent of Telkonet unless removed in relation to the performance of Executive's duties under this Agreement. Any such files, records, documents, drawings,
graphics, specifications, equipment and similar items, and any and all copies of such materials which have been removed from the premises of Telkonet, shall be returned by
Executive to Telkonet. For purposes of this Section 9, "Telkonet" means Telkonet, Inc., including its subsidiaries and affiliates and all successors and predecessors in interest
to Telkonet.
4
(b) Non-Competition. Executive acknowledges that he will be provided with and have access to the Confidential Information, the unauthorized use or disclosure of which
would cause irreparable injury to Telkonet, that Telkonet's willingness to enter into this Agreement is based in material part on Executive's agreement to the provisions of
this Section 9(b) and that Executive's breach of the provisions of this Section would materially and irreparably damage Telkonet. In consideration for Telkonet’s disclosure
of Confidential Information to Executive, Executive's access to the Confidential Information, and the salary paid to executive hereunder, Executive agrees that during the
term of Executive's employment under this Agreement and for one (1) year after the termination of Executive's employment and regardless whether such termination is with
or without cause, Executive shall not, directly or indirectly, either as an executive, employee, employer, consultant, agent, principal, partner, stockholder, corporate officer,
director, advisor or in any other individual or representative capacity, engage or participate in any business that is in competition in any manner whatsoever with the
Restricted Business (as defined herein) in North America. "Restricted Business" means any business conducted by Telkonet at the time of separation of the Executive from
Telkonet.
(c) Reasonableness of Restrictions. Executive acknowledges that the restrictions set forth in Section 9(b) of this Agreement are reasonable in scope and necessary for the
protection of the business and goodwill of Telkonet. Executive agrees that should any portion of the covenants in Section 9 be unenforceable because of the scope thereof or
the period covered thereby or otherwise, the covenant shall be deemed to be reduced and limited to enable it to be enforced to the maximum extent permissible under the
laws and public policies applied in the jurisdiction in which enforcement is sought.
(d) Injunctive Relief; Extension of Restrictive Period. In the event of a breach of any of the covenants by Executive or Telkonet contained in this Agreement, it is
understood that damages will be difficult to ascertain, and either party may petition a court of law or equity for injunctive relief in addition to any other relief which
Executive or Telkonet may have under the law, including but not limited to reasonable attorneys' fees.
10. Indemnification and Insurance. Executive will be covered under the Company's insurance policies and, subject to applicable law, will be provided indemnification to
the maximum extent permitted by the Company's bylaws, Certificate of Incorporation, and standard form of Indemnification Agreement, with such insurance coverage and
indemnification to be in accordance with the Company's standard practices for senior executive officers but on terms no less favorable than provided to any other Company
senior executive officer or director.
11. Miscellaneous.
(a) This Agreement shall be binding upon the parties and their respective heirs, executors, administrators, successors and assigns. Executive shall not assign any part of
his rights under this Agreement without the prior written consent of Telkonet.
(b) This Agreement contains the entire agreement and understanding between the parties and supersedes any and all prior understandings and agreements between the
parties regarding Executive's employment.
(c) No modification hereof shall be binding unless made in writing and signed by the party against whom enforcement is sought. No waiver of any provisions of this
Agreement shall be valid unless the same is in writing and signed by the party against whom it is sought to be enforced, unless it can be shown through custom, usage
or course of action.
(d) This Agreement is executed in, and it is the intention of the parties hereto that it shall be governed by, the laws of the State of Wisconsin without giving effect to
applicable conflict of laws provisions.
5
(e) The provisions of this Agreement shall be deemed to be severable, and the invalidity or unenforceability of any provision shall not affect the validity or
enforceability of the other provisions hereof.
(f) Any notice or communication permitted or required by this Agreement shall be in writing and shall become effective upon personal service, or service by wire
transmission, which has been acknowledged by the other party as being received, or two (2) days after its mailing by certified mail, return receipt requested, postage
prepaid addressed as follows:
(1) If to Telkonet: Attn: General Counsel Telkonet, Inc. 20800, Suite 175, Swenson Dr. Waukesha, WI 53186.
(2) If to Executive, to: Richard E. Mushrush at the last residential address known by the Company as provided by Executive in writing.
(g) Acknowledgment. Executive acknowledges that he has had the opportunity to discuss this matter with and obtain advice from his private attorney, has had sufficient
time to, and has carefully read and fully understands all the provisions of this Agreement, and is knowingly and voluntarily entering into this Agreement.
(h) Counterparts. This Agreement may be executed in counterparts, and each counterpart will have the same force and effect as an original and will constitute an effective,
binding agreement on the part of each of the undersigned.
IN WITNESS WHEREOF, Telkonet and Executive have executed this Agreement as of the date first set forth above.
/s/ signature
Compensation Committee
10.8.18
Date
/s/ Richard E. Mushrush
Richard E. Mushrush
10/1/18
Date
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EXHIBIT 23
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 April
1, 2019, relating to the consolidated financial statements, which appear in this Form 10-K. Our report contains an explanatory paragraph regarding the Company’s ability to
continue as a going concern.
/s/ BDO USA, LLP
Milwaukee, Wisconsin
April 1, 2019
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’s other certifying officer 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
(the registrant’s fourth fiscal quarter in the case of an annual report) 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 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: April 1, 2019
By: /s/ Jason L. Tienor
Jason L. Tienor
Chief Executive Officer
EXHIBIT 31.2
I, Gene Mushrush, 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’s other certifying officer 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
(the registrant’s fourth fiscal quarter in the case of an annual report) 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 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: April 1, 2019
By: /s/ Gene Mushrush
Gene Mushrush
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, 2018 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
April 1, 2019
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 year ended December 31, 2018 as filed with the Securities and Exchange
Commission on the date hereof (the “Report”), I, Gene Mushrush, 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/ Gene Mushrush
Gene Mushrush
Chief Financial Officer
April 1, 2019