| TELKONET INC ITEM 1A RISK FACTORS The risks and uncertainties described below are those that the Company currently deems to be material and that it believes are specific to the Company and the industry in which it competes |
| In addition to these risks, the Company’s business may be subject to risks currently unknown to the Company |
| The Company has a history of operating losses and an accumulated deficit and expects to continue to incur losses for the foreseeable future |
| Since inception through December 31, 2005, the Company has incurred cumulative losses of dlra42cmam987cmam553 and has never generated enough funds through operations to support its business |
| The Company expects to continue to incur operating losses through 2006 |
| The Company’s losses to date have resulted principally from: · research and development costs relating to the development of the Telkonet iWire System^TM product suite; · costs and expenses associated with manufacturing, distribution and marketing of the Company’s products; · general and administrative costs relating to the Company’s operations; and · interest expense related to the Company’s indebtedness |
| The Company is currently unprofitable and may never become profitable |
| Since inception, the Company has funded its research and development activities primarily from private placements of equity and debt securities, a bank loan and short term loans from certain of its executive officers |
| As a result of its substantial research and development expenditures and limited product revenues, the Company has incurred substantial net losses |
| The Company’s ability to achieve profitability will depend primarily on its ability to successfully commercialize the Telkonet iWire System^TM product suite |
| Potential fluctuations in operating results could have a negative effect on the price of the Company’s common stock |
| The Company’s operating results may fluctuate significantly in the future as a result of a variety of factors, most of which are outside the Company’s control, including: · the level of use of the Internet; · the demand for high-tech goods; · the amount and timing of capital expenditures and other costs relating to the expansion of the Company’s operations; 7 _________________________________________________________________ [46]Table of Contents · price competition or pricing changes in the industry; · technical difficulties or system downtime; · economic conditions specific to the internet and communications industry; and · general economic conditions |
| The Company’s quarterly results may also be significantly impacted by certain accounting treatment of acquisitions, financing transactions or other matters |
| Such accounting treatment could have a material impact on the Company’s results of operations and have a negative impact on the price of the Company’s common stock |
| The Company’s directors and executive officers own a substantial percentage of the Company’s issued and outstanding common stock |
| Their ownership could allow them to exercise significant control over corporate decisions |
| As of March 1, 2006, the Company’s officers and directors owned 26dtta4prca of the Company’s issued and outstanding common stock |
| This means that the Company’s officers and directors, as a group, exercise significant control over matters upon which the Company’s stockholders may vote, including the selection of the Board of Directors, mergers, acquisitions and other significant corporate transactions |
| Further issuances of equity securities may be dilutive to current stockholders |
| Although the funds raised in the Company’s debenture offerings, the note offerings and the private placement of common stock are being used for general working capital purposes, it is likely that the Company will be required to seek additional capital in the future |
| This capital funding could involve one or more types of equity securities, including convertible debt, common or convertible preferred stock and warrants to acquire common or preferred stock |
| Such equity securities could be issued at or below the then-prevailing market price for the Company’s common stock |
| Any issuance of additional shares of the Company’s common stock will be dilutive to existing stockholders and could adversely affect the market price of the Company’s common stock |
| Our significant indebtedness and interest payment obligations may adversely affect our ability to obtain additional financings, service other existing debt, use our operating cash flow in other areas of our business, or otherwise adversely affect our operations |
| In October 2005, the Company completed a dlra20 million convertible senior debt financing to two institutional investors in exchange for dlra20 million, in the aggregate pursuant to which the Company issued senior convertible notes |
| The convertible senior notes accrue interest at 7dtta25prca per annum and call for monthly principal installments beginning March 1, 2006 |
| The convertible senior notes, coupled with our other outstanding indebtedness, could make it difficult for us to obtain additional financing when, and if, needed |
| In addition, the significant interest payment obligations on the convertible senior notes could make it difficult to service our other outstanding indebtedness |
| Both the failure to obtain additional financing and the default on existing indebtedness could have a negative impact on the Companyapstas business and results of operations |
| Our convertible senior debt financing contains loan covenants relating to revenue targets and other restrictions which may reduce our operating cash |
| The documents executed in connection with the dlra20 million convertible senior debt financing, contain certain covenants that require the Company to achieve minimum revenue of dlra3 million for the period October 1, 2005 through March 31, 2006 and dlra2 million for each fiscal quarter thereafter in 2006 |
| The covenant requires that the Company pay an accelerated principal payment of up to dlra1 million on a pro rata basis calculated based upon the percentage shortfall between actual revenues and the quarterly targeted revenues |
| Failure to meet these revenue targets could reduce our operating cash and have a negative impact on the Companyapstas business and results of operations |
| If we acquire any companies or technologies in the future, they could provide difficult to integrate, disrupt our business, dilute stockholder value and adversely affect our operating results |
| In January 2006, the Company acquired a 90prca interest in Microwave Satellite Technologies (MST), a communications technology company that offers complete sales, installation, and service of VSAT and business television networks, and is a full-service national Internet Service Provider (ISP) |
| The failure of the Company to successfully integrate MST, or any Company acquired by Telkonet in the future, to Telkonetapstas business, could have a negative impact on the Companyapstas results of operations |
| 8 _________________________________________________________________ [47]Table of Contents Recent accounting pronouncements may impact our future financial position and results of operations |
| There have been new accounting pronouncements or regulatory rulings that will have an impact on our future financial position and results of operations |
| For instance, on December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement Nodtta 123 (revised 2004), "e Share-Based Payment "e , which is a revision of FASB Statement Nodtta 123, "e Accounting for Stock-Based Compensation "e |
| SFAS 123(R) supersedes APB Opinion Nodtta 25, "e Accounting for Stock Issued to Employees "e , and amends FASB Statement Nodtta 95, "e Statement of Cash Flows "e |
| Generally, the approach in SFAS 123(R) is similar to the approach described in Statement 123 |
| However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values |
| Pro forma disclosure is no longer an alternative |
| We expect to adopt SFAS 123(R) effective January 1, 2006 under the modified-prospective method |
| The adoption of SFAS 123(R)apstas fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position |
| With the adoption of SFAS 123(R), we expect to record stock-based compensation of approximately dlra2 million in 2006 |
| Our estimate of stock-based compensation expense is affected by our stock price, the number of stock-based awards we may grant in 2006, as well as a number of complex and subjective valuation assumptions including, but not limited to, the volatility of our stock price, interest rates and employee stock option exercise behaviors |
| The exercise of options and warrants outstanding and available for issuance may adversely affect the market price of the Company’s common stock |
| As of December 31, 2005, the Company had outstanding employee options to purchase a total of 10cmam151cmam078 shares of common stock at exercise prices ranging from dlra1dtta00 to dlra5dtta97 per share, with a weighted average exercise price of dlra1dtta85 |
| As of December 31, 2005, the Company had outstanding non-employee options to purchase a total of 1cmam841cmam774 shares of common stock at an exercise price of dlra1dtta00 per share |
| As of December 31, 2005, the Company had warrants outstanding to purchase a total of 1cmam230cmam000 shares of common stock at exercise prices ranging from dlra1dtta00 to dlra5dtta00 per share, with a weighted average exercise price of dlra4dtta31 |
| The exercise of outstanding options and warrants and the sale in the public market of the shares purchased upon such exercise will be dilutive to existing stockholders and could adversely affect the market price of the Company’s common stock |
| The powerline communications industry is intensely competitive and rapidly evolving |
| The Company operates in a highly competitive, quickly changing environment, and the Company’s future success will depend on its ability to develop and introduce new products and product enhancements that achieve broad market acceptance in commercial and governmental sectors |
| The Company will also need to respond effectively to new product announcements by its competitors by quickly introducing competitive products |
| Delays in product development and introduction could result in: · loss of or delay in revenue and loss of market share; · negative publicity and damage to the Company’s reputation and brand; and · decline in the average selling price of the Company’s products |
| Government regulation of the Company’s products could impair the Company’s ability to sell such products in certain markets |
| 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 |
| 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 Telkonet’s iWire System^TM 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 |
| In addition, the Companyapstas products are subject to safety and RF emissions regulations adopted by the European Union (EU) for Information Technology Equipment |
| In March 2005, the Company received final Conformite Europeane (CE) certification, which is required for the Company to freely market and sell its products in the EU Additional devices designed by the Company for commercial and residential use may be subject to FCC and EU rules |
| Moreover, if in the future, the FCC, EU or any other regulatory body changes its technical requirements for our products, further testing and/or modifications of the Companyapstas products may be necessary to comply with such changes |
| Failure to comply with any existing or future applicable technical requirements could impair the Company’s ability to sell its products in certain markets and could have a negative impact on its business and results of operations |
| 9 _________________________________________________________________ [48]Table of Contents Products sold by the Company’s competitors could become more popular than the Company’s products or render the Company’s products obsolete |
| The market for powerline communications products is highly competitive |
| The Company believes it has the only commercial integrated three phase solution for “in-building” distribution of broadband utilizing the electrical wiring infrastructure |
| Certain HomePlug^(TM) Powerline Alliance members offer similar PLC solutions for the residential market |
| Although the HomePlug^(TM) Powerline Alliance members do not presently compete with the Company in the commercial market, there can be no assurance that the HomePlug^(TM) Powerline Alliance members or any other company will not develop PLC products that compete with the Company’s products in the future |
| Some of these potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other resources |
| These potential competitors may, among other things, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, may obtain more favorable pricing from suppliers and manufacturers and exert more influence on the sales channel than the Company can |
| As a result, the Company may not be able to compete successfully with these potential competitors and these potential competitors may develop or market technologies and products that are more widely accepted than those being developed by the Company or that would render the Company’s products obsolete or noncompetitive |
| The Company anticipates that potential competitors will also intensify their efforts to penetrate the Company’s target markets |
| These potential competitors may have more advanced technology, more extensive distribution channels, stronger brand names, bigger promotional budgets and larger customer bases than the Company does |
| These companies could devote more capital resources to develop, manufacture and market competing products than the Company could |
| If any of these companies are successful in competing against the Company, its sales could decline, its margins could be negatively impacted, and the Company could lose market share, any of which could seriously harm the Company’s business and results of operations |
| The failure of the Internet to continue as an accepted medium for business commerce could have a negative impact on the Company’s results of operations |
| The Company’s long-term viability is substantially dependent upon the continued widespread acceptance and use of the Internet as a medium for business commerce |
| The Internet has experienced, and is expected to continue to experience, significant growth in the number of users |
| There can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on it by this continued growth |
| In addition, delays in the development or adoption of new standards and protocols to handle increased levels of Internet activity or increased governmental regulation could slow or stop the growth of the Internet as a viable medium for business commerce |
| Moreover, critical issues concerning the commercial use of the Internet (including security, reliability, accessibility and quality of service) remain unresolved and may adversely affect the growth of Internet use or the attractiveness of its use for business commerce |
| The failure of the necessary infrastructure to further develop in a timely manner or the failure of the Internet to continue to develop rapidly as a valid medium for business would have a negative impact on the Company’s results of operations |
| The Company may not be able to obtain patents, which could have a material adverse effect on its business |
| The Company’s ability to compete effectively in the powerline technology industry will depend on its success in acquiring suitable patent protection |
| The Company currently has several patents pending |
| The Company also intends to file additional patent applications that it deems to be economically beneficial |
| If the Company is not successful in obtaining patents, it will have limited protection against those who might copy its technology |
| As a result, the failure to obtain patents could negatively impact the Company’s business and results of operations |
| Infringement by third parties on the Company’s proprietary technology and development of substantially equivalent proprietary technology by the Company’s competitors could negatively impact the Company’s business |
| The Company’s success depends partly on its ability to maintain patent and trade secret protection, to obtain future patents and licenses, and to operate without infringing on the proprietary rights of third parties |
| There can be no assurance that the measures the Company has taken to protect its intellectual property, including those integrated to its Telkonet iWire System^TM product suite, will prevent misappropriation or circumvention |
| In addition, there can be no assurance that any patent application, when filed, will result in an issued patent, or that the Company’s existing patents, or any patents that may be issued in the future, will provide the Company with significant protection against competitors |
| Moreover, there can be no assurance that any patents issued to, or licensed by, the Company will not be infringed upon or circumvented by others |
| Infringement by third parties on the Company’s proprietary technology could negatively impact its business |
| Moreover, litigation to establish the validity of patents, to assert infringement claims against others, and to defend against patent infringement claims can be expensive and time-consuming, even if the outcome is in the Company’s favor |
| The Company also relies to a lesser extent on unpatented proprietary technology, and no assurance can be given that others will not independently develop substantially equivalent proprietary information, techniques or processes or that the Company can meaningfully protect its rights to such unpatented proprietary technology |
| Development of substantially equivalent technology by the Company’s competitors could negatively impact its business |
| 10 _________________________________________________________________ [49]Table of Contents The Company depends on a small team of senior management, and it may have difficulty attracting and retaining additional personnel |
| The Company’s future success will depend in large part upon the continued services and performance of senior management and other key personnel |
| If the Company loses the services of any member of its senior management team, its overall operations could be materially and adversely affected |
| In addition, the Company’s future success will depend on its 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 |
| The Company cannot ensure that it 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 the Company’s financial condition and results of operations |