<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB

              Annual Report Pursuant to Section 13 or 15(d) of the
                        Securities Exchange Act of 1934

                   For the fiscal year ended December 31, 2002


                        Commission file number: 0-27305

                                 TELKONET, INC.
        (Exact name of small business issuer as specified in its charter)

             Utah                                         87-0627421
(State or other jurisdiction of                (IRS Employee Identification No.)
 incorporation or organization)

                        435 Devon Park Drive Building 500
                            Wayne, Pennsylvania 19087
                    (Address of principal executive offices)

                                 (610)- 971-1717
                           (Issuer's telephone number)

Securities Registered pursuant to section 12(g) of the Act:   None

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.

Yes      X                 No
    -----------               -----------

Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
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-KSB or any amendment to
this Form 10-KSB.

         X
    -----------               -----------

State issuer's revenues for its most recent fiscal year:      none

Aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 26, 2003: $6,115,841

Number of outstanding shares of the registrant's par value $0.001 common stock
as of March 26, 2003: 15,721,131



<PAGE>

<TABLE>
                                                TELKONET, INC.
                                                 FORM 10-KSB
                                                    INDEX
<CAPTION>

                                                                                                         Page
                                                                                                         ----
                                                    Part I

<S>           <C>                                                                                         <C>
Item 1.       Business....................................................................................3

Item 2.       Properties..................................................................................9

Item 3.       Legal Proceedings...........................................................................9

Item 4.       Submission of Matters of a Vote of Security Holders.........................................9


                                                   Part II

Item 5.       Market for Registrant's Common Equity and Related Stockholder Matters.......................10

Item 6.       Management's Discussion and Analysis of Financial
              Condition and Results of Operation..........................................................10

Item 7.       Financial Statements and Supplementary Data.................................................19

Item 8.       Changes in and Disagreements with Accountants on
              Accounting and Financial Disclosure.........................................................19


                                                   Part III

Item 9.       Directors and Executive Officers of the Registrant..........................................19

Item 10.      Executive Compensation......................................................................22

Item 11.      Security Ownership of Certain Beneficial Owners and Management..............................24

Item 12.      Certain Relationships and Related Transactions..............................................25


                                                   Part IV

Item 13.      Exhibits, Financial Statement Schedule and Reports on Form 8-K..............................26

Item 14.      Controls and Procedures.....................................................................26

Signatures    ............................................................................................27

                                                      2
</TABLE>
<PAGE>

                                     PART I

PART I

ITEM 1.  BUSINESS

When used in this Form 10-KSB, the words "expects," "anticipates," "estimates"
and similar expressions are intended to identify forward-looking statements.
Such statements are subject to risks and uncertainties, including those set
forth below under "Risks and Uncertainties," that could cause actual results to
differ materially from those projected. These forward-looking statements speak
only as of the date hereof. The Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any forward-looking
statements contained herein to reflect any change in the Company's expectations
with regard thereto or any change in events, conditions or circumstances on
which any statement is based. This discussion should be read together with the
financial statements and other financial information included in this Form
10-KSB.

GENERAL
-------

Telkonet, Inc. is an innovative creator of Powerline Communications (PLC)
solutions for the commercial and industrial markets. Telkonet's PLC solutions
utilize their patent-pending technology for the transmission of high-speed data,
communications and Internet access over the existing electrical wiring in the
buildings. With the Telkonet solution there is no need for costly additional
wiring, and there is no disruption to business activity during the installation
process. In many situations the Telkonet solution can be implemented more
quickly and less expensively than adding dedicated wiring or installing wireless
systems offering a viable and cost effective alternative to the challenges of
wired and wireless LANs.

Telkonet, Inc. (hereinafter "The Company", "Telkonet" and "TCI"), a development
stage company, was incorporated on November 1999 under the laws of the State of
Utah. Its Articles of Incorporation provided for authorized capital of One
hundred million (100,000,000) shares of Common Stock, par value $0.001. The
Company has authorized 15,000,000 shares of preferred stock, with a par value of
$.001 per share.

In 1999, Telkonet Communications, Inc. was formed to develop applications for
the emerging power line carrier technologies. On August 30th, 2000, a Utah
Corporation formerly known as Comstock Coal Company, Inc. was merged into
Telkonet, Inc., NASDAQ - (OTCBB:"TLKO"), which as of December 31, 2002 has
15,721,131 million shares of common stock outstanding. Telkonet Communications,
Inc. is a wholly owned subsidiary of Telkonet, Inc. As of March 26, 2003 there
were 15,721,131 outstanding shares as referenced in Item# 12.

There has been no bankruptcy, receiverships, or similar proceedings by or
against the Company. There has been no material reclassification, merger,
consolidation, or purchase or sale of any significant asset(s).

The Company's principal executive offices are located at: 435 Devon Park Drive,
Building 500 Wayne, Pennsylvania 19087

BUSINESS HISTORY
----------------

The Company was formed to design and develop high technology applications with a
primary focus on high-speed Internet distribution over the existing electrical
wiring in buildings. Telkonet believes that utilizing the electrical wiring to
deliver Internet and telephony connectivity for the commercial and the
multi-dwelling markets creates a significant and definitive niche market
opportunity for the Company.

                                       3


<PAGE>

Telkonet's solutions overcome many of the difficulties associated with powerline
communications that historically have prevented the achievement of high-speed
data transmission rates. Because the existing electrical wiring is the most
ubiquitous wired network in the home, or business, service providers and
consumers can now avoid the expense, time and inconvenience of installing new
wiring for LAN service. Consumers can achieve reliable, secure communications
simply by plugging Telkonet's PlugPlusInternet devices into their existing
standard electrical outlets.

In July 2001, the Company announced that it has completed the initial product
development phase of their proprietary communications system, which utilizes the
existing electrical wiring infrastructure in residential and commercial
buildings for Internet connectivity.

In August 2001, the Company announced that successful system tests were recently
performed in the Washington D.C. metropolitan area, where Telkonet's
PlugPlusInternet connectivity solution was demonstrated in a 28-unit residential
apartment building and a 5-story commercial office building. High-speed data
connectivity was successfully achieved from the basements to the farthest
receptacles on the top floors.

In January 2002, the Company announced that it had shifted its management
emphasis from R&D to product sales and marketing in order to move their initial
proprietary products into the commercial market. Extensive research and product
testing conducted over the previous three years, demonstrated the product's
robust capacity and aroused industry demand for the Company's initial
proprietary products.

The Board of Directors, Founders and Executive Management reassessed Telkonet's
initial capital structure. Agreements were reached on a realignment of the
initial Founders' share distribution in order to attract additional management
and marketing expertise, and to raise the necessary capital for manufacturing,
sales, and marketing. The Founders agreed to surrender 8.9 million shares of
their current stock and 560,000 option positions in the capital realignment.
This re-allocation of Founders stock and option positions retain the Founders
core competence in the Company, provides each with fair and equitable stock
positions, an orderly method of liquidity, and reduces the dilution factor for
shareholders thus helping to attract perspective management talent and potential
investors. The net effect of the recapitalization reduced the number of shares
outstanding from approximately 22.1 to 13.9 million shares.

In May 2002 the Company announced that it had successfully concluded an offering
of 8%, three year, convertible debentures raising approximately $1.7 million
dollars for working capital purposes. In November 2002, the Company announced
the successful installation of its PlugPlusInternet solution at the historic
Partridge Inn in Augusta, Georgia. The installation provided high-speed Internet
connectivity to guest rooms, meeting rooms and a lobby kiosk.

In July 2002 at the Annual Meeting of Stockholders of Telkonet, Inc. the
Company's shareholders ratified the Telkonet Stock Option Plan, which on April
24, 2002, the Board of Directors adopted, subject to stockholder approval. The
plan provides for the grant of stock options to employees, officers,
consultants, independent contractors and non-employee directors providing
services to Telkonet, as determined by the Board of Directors or by a committee
of directors designated by the Board of Directors to administer the plan. The
plan provides for the issuance of up to 7,000,000 shares of Telkonet common
stock, subject to adjustment in the event of stock dividends, recapitalization,
stock splits, reorganizations, mergers, consolidations or other similar changes
in the corporate or capital structure of Telkonet. have been reacquired by
Telkonet. The types of awards that may be granted under the plan are stock
options, restricted stock and stock appreciation rights. Options granted
pursuant to the plan will not be transferable without the approval of the Board

                                       4

<PAGE>

of Directors, other than by will or by the laws of descent and distribution.
During the lifetime of a participant, an award may be exercised only by the
participant to whom such award is granted. The full text of the plan is attached
as exit 10.1.

In December 2002, the Company announced the installation of a product field
trial at the Marriott Residence Inn-Landfall in Wilmington, NC. Telkonet
implemented a hotel wide PLC system based on the use of its PlugPlusInternet
Gateway for providing connectivity to the hotels 90 guest rooms, meeting rooms,
common areas and a lobby kiosk.

The Company announced that the Board of Directors unanimously elected Mr. Ronald
W. Pickett as Chairman of Board, President and interim CEO. Mr. Pickett had
fostered the development of Telkonet since 1999 as the Company's principle
investor and stepped forward in December 2002 to take an active leadership role
in the Company.

The Company announced that, Company Founders David Grimes and Stephen Sadle
retired 1,805,400 shares of the Company's common stock in exchange for the
cancellation of a note reducing the total outstanding number of shares of common
stock in the Company by approximately 9% from 17,526,531 shares to 15,721,131
shares.

In January 2002, the Company announced that they had satisfactorily complied
with Parts 2 and 15 of Title 47 of the Code of Federal Regulations of the
Federal Communications Commission ("FCC") to market their Powerline
Communications. The rules of the Federal Communications Commission ("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. An independent, FCC-certified testing lab has verified that
Telkonet's gateway PLC device complies with the FCC technical requirements for
Class A digital devices. No further testing of this device is required; the
device may be manufactured and marketed for commercial use. Additional devices
designed by Telkonet for commercial and residential use are subject to the FCC
rules for unlicensed digital devices. Unlicensed digital devices for sale to the
general public, without restriction, must meet the FCC's technical requirements
for Class B devices, and must be verified for compliance by an independent
FCC-certified testing lab.

The Company announced that the Board of Directors unanimously elected Warren V.
"Pete" Musser as Chairman of Board. Mr. Musser is the Managing Director of The
Musser Group and Chairman Emeritus of Safeguard Scientifics, Inc. - (NYSE: SFE).

The Company announced that the Board of Directors unanimously elected Howard
Lubert as Chief Executive Officer. Mr. Lubert brings to Telkonet over three
decades of diversified expertise, which includes: Technical due diligence and
business acceleration services for Safeguard Scientifics in Infrastructure,
Internet/e-Business and Telecommunications. Internet, Intranet, Extranet and
e-Commerce strategy and implementation expertise as an e. Business service line
leader with Deloitte & Touche. PC, Local and Wide Area Networking experience as
the founder/president of HEL INC. (Integration, Networking & Connectivity).
General Systems Division of IBM, marketing mid-range computer systems in the
manufacturing, distribution, hospitality and not-for-profit vertical markets.
Mr. Lubert is a nationally recognized speaker who has lectured on e. Business
technologies, Web Content Management and Community Solutions, e. Business
integration, The Financial and Human Capital Issues of e. Business.

In February 2003 the Company announced that they had successfully concluded an
offering of 8%, three year, convertible debentures raising $2.5 million dollars
for working capital purposes.

                                       5


<PAGE>

In March 2003 the Company announced that it had entered into a strategic
alliance agreement with Choice Hotels International (NYSE:CHH), one of the
largest hotel franchise companies in the world with more than 3,500 hotels,
inns, all-suite hotels and resorts open and under development in 46 countries
under the Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Rodeway Inn,
EconoLodge and MainStay Suites brand names. The Choice Hotels-Telkonet agreement
is an initial two-year contract, wherein Telkonet will become a Choice Endorsed
Vendor offering Telkonet's "PlugPlusInternet" high-speed Internet access service
to Choice Hotels U.S. franchisees. Telkonet and Choice Hotels will undertake
cooperative efforts for the marketing, advertising and promotion of Telkonet's
Internet access solution to their franchisees prior to and through the Choice
Hotels national convention, May 7-9 in Orlando, Florida. Choice Hotel
franchisees that take advantage of Telkonet's "Early Adopter Program" will
receive a discount by scheduling prior to or at the national convention.

Telkonet Communications, Inc. is now at a point in the Company's business
development cycle where the system requirements and hardware have been
developed, customer feedback is highly positive, markets and marketing
strategies have been identified and management has put in place a sales and
marketing organization to leverage its core strengths for maximum impact.
Products for the hospitality market are scheduled for installation in May 2003.
The Company has applied for patents that cover its unique technology, and has
utilized the recently announced advancements in transmission speeds to build its
next generation of products that will be launched into the hospitality market.
The Company continues to identify, design and develop enhancements to its core
technologies that will provide additional functionality, diversification of
application and desirability for current and future users. It is the intent of
the Company to protect this Intellectual Property by filing additional Patent
applications.

The majority of data network systems in place today are comprised of wired
network connections requiring high construction costs and disruption of the
workplace, or complex wireless networks, which have coverage and security
issues. As the Internet becomes more and more critical to business operations,
newly manufactured PC's and laptop computers are configured with high-speed
Internet connections and the consumer demand for higher access speeds will fuel
the need for more effective broadband solutions.

In many situations the Telkonet PlugPlusInternet family of Internet access
products can be implemented more quickly and less expensively than installing
dedicated wiring or wireless systems offering a viable and cost effective
alternative to the challenges of wired and wireless LANs.

The Telkonet solution consists of two parts-the PlugPlusInternet Gateway and the
PlugPlusInternet Modem. The Gateway is a modular, self-contained unit that
accepts data from an existing network on one port and distributes it via the
second. The most common configuration of the gateway is 10BaseT Ethernet (ETH)
on one side and power line carrier (PLC) on the other. The intelligent backbone
of the Gateway is a fast communications processor running a series of
proprietary applications under Linux. Other useful configurations of the Gateway
are PLC-PLC to bridge data around a physical block to the signal (e.g. from old
to new sections of a building that do not share common wiring). Another useful
configuration is PLC to wireless access point (WAP) to provide immediate
line-of-sight wireless access in a large office. The PLC signal generated by the
Gateway can be directly coupled into low voltage wiring via the power cord of
the Gateway itself.

In addition, the PLC signal may be routed to a remote injection point via an
inexpensive coaxial cable. This allows the Telkonet solution to couple into the
medium voltage and multi-phase environments found in commercial buildings. A
suite of software applications running on the Gateway can be roughly classified
as performing communications functions or system management functions. As an
example of the supported management functions, the gateway provides for remote
management of the network via a Telnet (command line) interface and remote
updating of its own firmware. The gateway is optimized to network with dozens of

                                       6


<PAGE>

PlugPlusInternet Modems and provides scalable, robust solution for the
commercial market. The PlugPlusInternet Modem is a small, self-contained unit
with a standard 110V plug on one side and an Ethernet RJ-45 connector on the
other. This intelligent Modem in conjunction with the gateway provides the
enhanced communications and management functions required by enterprise
customers.

The current generation of the Telkonet PlugPlusInternet system delivers data at
speeds in excess of 7 Mega bits per second (Mbps), with burst speeds of 12.6
Mbps. The Telkonet PlugPlusInternet system is installed by connecting the
incoming broadband signal (DSL, TL, Satellite, and Cable Modem) into the Gateway
and then connecting the Gateway to the to the buildings electrical panel, which
distributes the high-speed Internet signal throughout the entire existing
network of electrical wires within the building. The user accesses the
high-speed Internet signal by plugging the PlugPlusInternet Modem into any
electrical outlet and then plugging their computer Ethernet connection into the
Modem. Many PCs, each equipped with one Telkonet PlugPlusInternet Modem, can
communicate with one another and can share a single broadband resource via the
Telkonet PlugPlusInternet Gateway.

The Telkonet solution interfaces to the backbone of the Internet by taking the
signal from any of these broadband sources and, through the Telkonet
PlugPlusInternet Gateway, distributes access to the Internet to the ultimate
user over the existing electrical wiring in the building. With the Gateway in
place, access is achieved by plugging the user's Telkonet PlugPlusInternet Modem
into the nearest standard electrical outlet. Any existing electrical outlet in
the structure can provide immediate access to the Internet via a Telkonet
PlugPlusInternet Modem. Moving the location of a PC, server, or printer is
accomplished by simply moving the PlugPlusInternet Modem to another electrical
outlet. No additional wiring is required and changes can be made quickly and
easily.

BUSINESS DEVELOPMENT
--------------------

Telkonet's focus is on high-speed Internet distribution over the existing
electrical wiring for the commercial, hospitality and multi-dwelling markets.
Telkonet has designed and constructed their powerline communication products to
provide high-speed Internet access to office buildings, hotels, schools,
shopping malls, commercial buildings, and multi-dwelling units. The Company
believes that through extensive research and development, it has refined a
business model that will provide marketable Internet services across a wide
spectrum of commercial and business end users.

The demand for broadband Internet access from the business traveler and
multi-dwelling market continues to grow. There are an ever-increasing number of
consumers and small businesses with multiple PC's. These factors continue to
create a very strong need for residential and in-building networks. According to
industry analysts, the market for home and building networks will represent a
$26 Billion market worldwide for the next 4 years.

MARKETING STRATEGY
------------------

Management has focused on the commercial sector, initially targeting the
hospitality markets with a direct Sales effort (at the regional and national
level). The multi-unit dwelling, government, and international markets will
follow, accessed through network administrator and systems administrator
partners (incorporating the system as a high value added offering to existing
customers). These markets have rapidly growing demand for broadband and are now
primarily served by wired and wireless technologies, which are costly to install
and have significant ongoing costs.

Target markets for Telkonet include office buildings, hotels, schools, shopping
malls, commercial buildings, and multi-dwelling units, government facilities,
and any other commercial facilities that have a need for Internet access and

                                       7


<PAGE>

network connectivity. Telkonet will continue to examine, select and approach
entities with existing distribution channels that will be enhanced by the
Company's offerings. Several DSL, fiber and satellite access providers have
indicated interest in Telkonet's solutions. Our products will allow them to
reach whole new classes of users, enhance their product offerings, and
ultimately provide a vehicle for incremental revenue.

Additional marketing opportunities exist in Europe, South America, Asia and Pac
Rim where the Internet is available. Access to the Internet is restricted in
some developing countries by the limitation of the infrastructure of the basic
Public Service Telephone Network and the pricing methodology of charging the
user for every minute that the user is on line. The Telkonet solution would
allow economical access to the Internet by simply bypassing the per-minute
charge to the user when implemented in conjunction with a 2-way satellite link,
dedicated landline or fixed wireless access.

KEY TELKONET ADVANTAGES:
------------------------

No special cabling or expensive wiring required for hotels, office buildings or
multi-dwelling residential complexes to provide Internet connection. The
Telkonet PlugPlusInternet family of commercial products provides excellent
connectivity over the existing electrical wiring and does not require the costly
installation of additional wiring, or major disruption of business activity. In
many situations the PlugPlusInternet system can be implemented quicker and less
expensively than adding dedicated wiring or installing a wireless system
offering a viable and cost effective alternative to the challenges of wired
and wireless LANs.

Competition
-----------

Several established networking vendors, including Linksys and Netgear, have
planned and/or announced Powerline Communications products that are compliant
with the HomePlug Alliance. Both Linksys and Netgear are focused on products for
the home and residential marketplace. Telkonet finds potential competitors to
actually be complementary in nature and a validation of the viability of the
powerline communications market overall. While these companies may choose to
move into the commercial market at a future date, at this time they do not
represent a direct threat to Telkonet. Telkonet is specifically focused on the
needs of the commercial customer where issues like security, support for greater
distances, a larger number of users, and enhanced network management preclude
the use of a product developed to suit the home market.

Employees
---------

Currently, the Company has 14 full time employees. Additional key staff is
planned in the areas of business development, sales and marketing, and
engineering.

Government Regulations
----------------------

The rules of the Federal Communications Commission ("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. An
independent, FCC-certified testing lab has verified that Telkonet's gateway PLC
device complies with the FCC technical requirements for Class A digital devices.
No further testing of this device is required; the device may be manufactured
and marketed for commercial use. Additional devices designed by Telkonet for
commercial and residential use are subject to the FCC rules for unlicensed
digital devices. Unlicensed digital devices for sale to the general public,
without restriction, must meet the FCC's technical requirements for Class B
devices, and must be verified for compliance by an independent FCC-certified
testing lab.

                                       8


<PAGE>

Raw Materials
-------------

The Company does not rely on any one or more raw materials or raw material
suppliers for the normal course of business. The Company has developed
relationships with a cross-section of qualified and quality providers of
components and parts necessary for the Company's product line, and uses multiple
vendors for certain items dependent on internal purchasing criteria, inclusive
of price, delivery schedule and specification evaluation.

Intellectual Property
---------------------

From the Company's inception, Telkonet has continued to pursue the perfection of
its technology and enhance its core technological values. The company believes
they have developed certain Intellectual Property and have filed both
provisional and standard patent applications with the United States Patent and
Trademark Office. There can be no assurance that any of the Company's current or
future patent applications will be granted, or will provide necessary protection
for the Company's technology or their product offerings, or be of commercial
benefit to the Company, or that these patent applications will not be
challenged.

Customers
---------

The Company is neither limited to nor reliant upon a single or narrowly
segmented consumer base from which to derive its revenues. As a result of the
Company's market research, customers will be developed from within four
strategic markets, which includes: hospitality, multi-dwelling, Government, and
International markets.

ITEM 2.  PROPERTIES

The Company currently leases office space at 902A Commerce Drive, Annapolis, MD
21401, which occupies approximately 3,000 square feet of designated office
space, designed to provide short term/temporary accommodation solution to
emerging and growing businesses. The facility allows businesses to lease spaces
on a short-term or project basis. These office quarters are adequate for the
immediate short term. The Company anticipates the need for additional office
space in conjunction with the projected personnel requirements in the business
plan. The Company's principal executive offices are located at: 435 Devon Park
Drive, Building 500 Wayne, Pennsylvania 19087.

         (a)      Real Estate- None

         (b)      Computer and Office Equipment- $75,000

ITEM 3.  LEGAL PROCEEDINGS

The Company is not a party to any legal proceedings.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Matters submitted during the fiscal year covered by this report to a vote of
security holders of the Company, through the solicitation of proxies consisted
of the annual election of Directors and the appointment of independent
accountants at the annual shareholders meeting held on Friday July 29, 2002.

                                       9


<PAGE>

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
         MATTERS

(a)      The Company's Common Shares are currently quoted on NASDAQ -Over The
         Counter Bulletin Board market under the ticker symbol (OTCBB:"TLKO").

(b)      As of December 31, 2002, the Company had approximately 208 shareholders
         of record of the common stock.

(c)      No dividends on outstanding common stock have been paid within the last
         two fiscal years, and interim periods. The Company does not anticipate
         or intend upon paying dividends for the foreseeable future.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATION

The following discussion contains forward-looking statements that are subject to
significant risks and uncertainties. There are several important factors that
could cause actual results to differ materially from historical results and
percentages and results anticipated by the forward-looking statements. The
Company has sought to identify the most significant risks to its business, but
cannot predict whether or to what extent any of such risks may be realized nor
can there be any assurance that the Company has identified all possible risks
that might arise. Investors should carefully consider all of such risks before
making an investment decision with respect to the Company's stock. In
particular, investors should refer to the section entitled, "Factors that May
Affect Future Results and Market Price of Stock".

Plan of Operation
-----------------

The Company is still in the development stage and is yet to generate revenues
from operations. The Company may experience fluctuations in operating results in
future periods due to a variety of factors including, but not limited to, market
acceptance of the Internet and power line communication technologies as a medium
for customers requiring high-speed Internet access utilizing the Company's
products, the Company's ability to acquire and deliver high quality products at
a price lower than currently available to consumers, the Company's ability to
obtain additional financing in a timely manner and on terms favorable to the
Company, the Company's ability to successfully attract customers at a steady
rate and maintain customer satisfaction, Company promotions, branding and sales
programs, the amount and timing of operating costs and capital expenditures
relating to the expansion of the Company's business, operations and
infrastructure and the implementation of marketing programs, key agreements and
strategic alliances, the number of products offered by the Company, the number
of returns experienced by the Company, and general economic conditions specific
to the Internet, power-line communications, and the communications industry.

Revenues
--------

Telkonet is transitioning from a development stage company to that of an active
growth and acquisition stage company. Initial hospitality market revenues are
projected to commence in the second quarter 2003 primarily driven by the recent
Strategic Alliance Agreement with Choice Hotels International wherein Telkonet
became a Choice Endorsed Vendor thereby offering its high-speed Internet access
solution to Choices 3,500 U.S. hotel franchisees.

                                       10


<PAGE>

Costs and expenses
------------------

From its inception on November 3, 1999 through December 31, 2002, the Company
has not generated any revenues. The Company has incurred total costs and
expenses of $6,458,676 during this period. These expenses were associated
principally with compensation to employees, product development costs,
amortization of debt discount costs related to the Company's convertible
debentures, and issuance of equity-based compensation to non-employees in
exchange for consulting services and financing.

Liquidity and Capital Resources
-------------------------------

As of December 31, 2002, the Registrant had a deficiency in working capital of
$894,403. To date the Company has no operating revenues, has incurred expenses,
and has sustained losses from operating activities. As a result of the Company's
operating losses from its inception through December 31, 2002, the Registrant
generated a cash flow deficit of $4,100,225 from operating activities. Cash
flows used in investing activities was $112,502 during the period November 3,
1999 through December 31, 2002. The Company met its cash requirements during
this period through the private placement of $1,751,224 of the Company's common
stock, loan proceeds (net of repayments) of $440,330 from banks and
shareholders, and $2,040,000 proceeds (net of financing fess) from issuance of
convertible debentures.

While the Company has raised capital to meet its working capital and financing
needs in the past, additional financing is required in order to meet the
Company's current and projected cash flow deficits from operations and
development. Such financing may be upon terms that are dilutive or potentially
dilutive to our shareholders. The Company is presently seeking financing in the
form of debt or equity in order to provide the necessary working capital. The
Company currently has no commitments for financing. There are no assurances the
Company will be successful in raising the funds required.

By adjusting its operations and development to the level of capitalization,
management believes it has sufficient capital resources to meet projected cash
flow deficits through the next twelve months. However, if thereafter, we are not
successful in generating sufficient liquidity from operations or in raising
sufficient capital resources on terms acceptable to us, this could have a
material adverse affect on our business, results of operations, liquidity and
financial condition.

The independent auditors report on the Company's December 31, 2002 financial
statements included in this Form states that the Company's recurring losses
raise substantial doubt about the Company's ability to continue as a going
concern.

Product Research and Development
--------------------------------

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 the period November 3, 1999 (date of
inception) through December 31, 2002 were $520,278.We anticipate continuing to
incur approximately $500,000 in research and development expenditures in
connection with the development of Telkonet PlugPlusInternet system the Telkonet
PlugPlusInternet Gateway and the Telkonet PlugPlusInternet Modem.

These projected expenditures are dependent upon our generating revenues and
obtaining sources of financing in excess of our existing capital resources.
There is no guarantee that we will be successful in raising the funds required
or generating revenues sufficient to fund the projected costs of research and
development during the next twelve months.

                                       11
<PAGE>

Acquisition or Disposition of Plant and Equipment
-------------------------------------------------

We do not anticipate the sale of any significant property, plant or equipment
during the next twelve months The Company does not anticipate the acquisition of
any significant property, plant or equipment during the next 12 months, other
than computer equipment and peripherals used in the day-to-day operations. We
believe we have sufficient resources available to meet these acquisition needs.

Number of Employees
-------------------

As of March 26, 2003, the Company had fourteen (14) full time employees. In
order for the Company to attract and retain quality personnel, the Company
anticipates it will continue to offer competitive salaries to current and future
employees. The Company anticipates increasing its employment base to meet the
needs outlined in the business plan.

As the Company continues to expand, the Company will incur additional costs for
personnel. This projected increase in personnel is dependent upon the Company
generating revenues and obtaining sources of financing in excess of our existing
capital resources. There are no assurances the Company will be successful in
raising the funds required or generating revenues sufficient to fund the
projected increase in the number of employees.

Trends, Risks and Uncertainties
-------------------------------

The Company has sought to identify what it believes to be the most significant
risks to its business, but cannot predict whether or to what extent any of such
risks may be realized nor can there be any assurances that the Company has
identified all possible risks that might arise. Investors should carefully
consider all of such risk factors before making an investment decision with
respect to the Company's stock.

Limited Operating History; Anticipated Losses; Uncertainly of Future Results.
-----------------------------------------------------------------------------

Telkonet has only a limited operating history upon which an evaluation of the
Company and its prospects can be based. The Company's prospects must be
evaluated with a view to the risks encountered by a company in an early stage of
development, particularly in light of the uncertainties relating to the new and
evolving distribution methods with which the Company intends to operate and the
acceptance of the Company's business model. The Company will continue to incur
costs to develop, introduce and enhance its interactive website, to establish
marketing relationships, to acquire and develop products that will compliment
each other and to build an administrative organization. To the extent that such
expenses are not subsequently followed by commensurate revenues, the Company's
business, results of operations and financial condition will be materially
adversely affected. There can be no assurance that the Company will be able to
generate sufficient revenues from the sale of their first product suite, and
other product candidates. The Company expects negative cash flow from operations
to continue for the next 12 months as it continues to develop and market its
business. If cash generated by operations is insufficient to satisfy the
Company's liquidity requirements, the Company may be required to sell additional
equity or debt securities. The sale of additional equity or convertible debt
securities would result in additional dilution to the Company's stockholders.

                                       12

<PAGE>

Potential Fluctuations in Quarterly Operating Results
-----------------------------------------------------

The Company's quarterly 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; seasonal trends in both Internet use, the amount and timing of
capital expenditures and other costs relating to the expansion of the Company's
operations; price competition or pricing changes in the industry; technical
difficulties or system downtime; general economic conditions, and economic
conditions specific to the Internet and Communications Industry. The Company's
quarterly results may also be significantly impacted by the impact of the
accounting treatment of acquisitions, financing transactions or other matters.
Particularly at the Company's early stage of development, such accounting
treatment can have a material impact on the results for any quarter. Due to the
foregoing factors, among others, it is likely that the Company's operating
results will fall below the expectations of the Company or investors in some
future quarter.

Limited Public Market, Possible Volatility of Share Price
---------------------------------------------------------

The Company's Common Stock is currently quoted on the NASDAQ - (OTCBB: "TLKO")
As of December 31, 2002, there were 15,721,131 shares of Common Stock
outstanding. As of March 26, 2003 there were 15,721,131 outstanding shares as
referenced in Item# 12.

Telkonet Communications, Inc. is a wholly owned subsidiary of Telkonet. There
can be no assurance that a trading market will be sustained in the future.
Factors such as, but not limited to, technological innovations, new products,
acquisitions or strategic alliances entered into by the Company or its
competitors, failure to meet security analysts' expectations, government
regulatory action, patent or proprietary rights developments, and market
conditions for technology stocks in general could have a material adverse effect
on the volatility of the Company's stock price.

New Accounting Pronouncements
-----------------------------

In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" (SFAS No.
141), and Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" (SFAS No. 142). The FASB also issued Statement of
Financial Accounting Standards No. 143, "Accounting for Obligations Associated
with the Retirement of Long-Lived Assets" (SFAS No. 143), and Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144) in August and October 2001,
respectively.

SFAS No. 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interest method. The adoption of SFAS No. 141 had no material impact
on the Company's consolidated financial statements.

Effective January 1, 2002, the Company adopted SFAS No. 142. Under the new
rules, the Company will no longer amortize goodwill and other intangible assets
with indefinite lives, but such assets will be subject to periodic testing for
impairment. On an annual basis, and when there is reason to suspect that their
values have been diminished or impaired, these assets must be tested for
impairment, and write-downs to be included in results from operations may be
necessary. SFAS No. 142 also requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption.

Any goodwill impairment loss recognized as a result of the transitional goodwill
impairment test will be recorded as a cumulative effect of a change in
accounting principle no later than the end of fiscal year 2002. The adoption of
SFAS No. 142 had no material impact on the Company's consolidated financial
statements.

                                       13


<PAGE>

SFAS No. 143 establishes accounting standards for the recognition and
measurement of an asset retirement obligation and its associated asset
retirement cost. It also provides accounting guidance for legal obligations
associated with the retirement of tangible long-lived assets. SFAS No. 143 is
effective in fiscal years beginning after June 15, 2002, with early adoption
permitted. The Company expects that the provisions of SFAS No. 143 will not have
a material impact on its consolidated results of operations and financial
position upon adoption. The Company plans to adopt SFAS No. 143 effective
January 1, 2003.

SFAS No. 144 establishes a single accounting model for the impairment or
disposal of long-lived assets, including discontinued operations. SFAS No. 144
superseded Statement of Financial Accounting Standards No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
(SFAS No. 121), and APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions". The Company adopted
SFAS No. 144 effective January 1, 2002. The adoption of SFAS No. 144 had no
material impact on Company's consolidated financial statements.

In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This Statement rescinds FASB Statement No. 4, "Reporting Gains and
Losses from Extinguishment of Debt", and an amendment of that Statement, FASB
Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements" and FASB Statement No. 44, "Accounting for Intangible Assets of
Motor Carriers". This Statement amends FASB Statement No. 13, "Accounting for
Leases", to eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. The Company does not expect the adoption to have a material impact
to the Company's financial position or results of operations.

In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. The
Company does not expect the adoption to have a material impact to the Company's
financial position or results of operations.

In October 2002, the FASB issued Statement No. 147, "Acquisitions of Certain
Financial Institutions-an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9", which removes acquisitions of financial institutions from
the scope of both Statement 72 and Interpretation 9 and requires that those
transactions be accounted for in accordance with Statements No. 141, Business
Combinations, and No. 142, Goodwill and Other Intangible Assets. In addition,
this Statement amends SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, to include in its scope long-term customer-relationship
intangible assets of financial institutions such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
The requirements relating to acquisitions of financial institutions is effective
for acquisitions for which the date of acquisition is on or after October 1,
2002. The provisions related to accounting for the impairment or disposal of
certain long-term customer-relationship intangible assets are effective on
October 1, 2002. The adoption of this Statement did not have a material impact
to the Company's financial position or results of operations as the Company has
not engaged in either of these activities.

                                       14


<PAGE>

In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure", which amends FASB Statement No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The transition guidance and annual disclosure provisions of Statement
148 are effective for fiscal years ending after December 15, 2002, with earlier
application permitted in certain circumstances. The interim disclosure
provisions are effective for financial reports containing financial statements
for interim periods beginning after December 15, 2002. The adoption of this
statement did not have a material impact on the Company's financial position or
results of operations as the Company has not elected to change to the fair value
based method of accounting for stock-based employee compensation.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation 46 changes the criteria by which one
company includes another entity in its consolidated financial statements.
Previously, the criteria were based on control through voting interest.
Interpretation 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. A company that consolidates a variable
interest entity is called the primary beneficiary of that entity. The
consolidation requirements of Interpretation 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation requirements
apply to older entities in the first fiscal year or interim period beginning
after June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company does not expect the
adoption to have a material impact to the Company's financial position or
results of operations.

Risk Factors that may affect future results and market price of stock
---------------------------------------------------------------------

The business of the Company involves a number of risks and uncertainties that
could cause actual results to differ materially from results projected in any
forward-looking statement, or statements, made in this report. These risks and
uncertainties include, but are not necessarily limited to the risks set forth
below. The Company's securities are speculative and investment in the Company's
securities involves a high degree of risk and the possibility that the investor
will suffer the loss of the entire amount invested.

LIMITED OPERATING HISTORY; ANTICIPATED LOSSES; UNCERTAINLY OF FUTURE RESULTS

The Company was organized in 1999, and has no operating history upon which an
evaluation of its business and prospects can be based. The Company's prospects
must be evaluated with a view to the risks encountered by a company in an early
stage of development, particularly in light of the uncertainties relating the
acceptance of the Company's business model.

The Company will be incurring additional costs to further develop and market its
powerline communications solutions, and to build an administrative organization.
There can be no assurance that the Company will be profitable on a quarterly or
annual basis. In addition, as the Company expands its business network and
marketing operations it will likely need to increase its operating expenses,
broaden its sales and customer support capabilities, and increase its
administrative resources. To the extent that such expenses are not subsequently
followed by commensurate revenues, the Company's business, results of operations
and financial condition will be materially adversely affected.

                                       15


<PAGE>

It is possible that revenues from the Company's operations may not be sufficient
to finance its initial operating cost to reach breakeven. If this were to occur,
the Company would need to raise or find additional capital. While the Company
has raised capital to meet its working capital and financing needs in the past,
additional financing is required in order to meet the Company's current and
projected cash flow deficits from operations and development. Such financing may
be upon terms that are dilutive or potentially dilutive to our shareholders. The
Company is presently seeking financing in the form of debt or equity in order to
provide the necessary working capital. The Company currently has no commitments
for financing. There are no assurances the Company will be successful in raising
the funds required. While the Company expects to be able to meet its financial
obligations for approximately the next twelve months, there is no assurance
that, after such period, the Company will be operating profitably. If they are
not, there can be no assurance that any required capital would be obtained on
terms favorable to the Company. Failure to obtain adequate additional capital on
favorable terms could result in significant delays in the expansion of new
services and market share and could even result in the substantial curtailment
of existing operations and services to clients, and have a material adverse
affect on our business, results of operations, liquidity and financial
condition.

UNPREDICTABILITY OF FUTURE REVENUES: POTENTIAL FLUCTUATIONS IN QUARTERLY
RESULTS.

As a result of the Company's lack of operating history and the emerging
nature of the commercial powerline communications market in which it competes,
the Company is unable to accurately forecast its revenues. The Company's current
and future expense levels are based largely on its investment/operating plans
and estimates of future revenue and are to a large extent based on the Company's
own estimates. Sales and operating results generally depend on the volume of,
timing of, and ability to obtain customers, orders for services received, and
revenues there from generated. These are, by their nature, difficult at best to
forecast.

The Company may be unable to adjust spending in a timely manner to compensate
for any unexpected revenue shortfall or delay. Accordingly, any significant
shortfall or delay in revenue in relation to the Company's planned expenditures
would have an immediate adverse affect on the Company's business, financial
condition, and results of operations. Further, in response to changes in the
competitive environment, the Company may from time to time make certain pricing,
service, or marketing decisions that could have a material adverse effect on the
Company's business, financial condition, operating results, and cash flows.

DEVELOPING MARKET: ACCEPTANCE OF THE INTERNET AS A MEDIUM FOR COMMERCE JUST NOW
BEING PROVEN.

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,
in terms of the sales of both products and services to businesses and
individuals. The use of the Internet as a means of business sales and commerce
is has only recently reached a point where many companies are making reasonable
profits from their endeavors therein, and there can be no assurance that this
trend will continue.

The Internet has experienced, and is expected to continue to experience,
significant growth in the number of users and amount of traffic. 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.

                                       16


<PAGE>

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 material adverse effect on the Company's
business, financial condition, operating results, and cash flows.

UNPROVEN ACCEPTANCE OF THE COMPANY'S SERVICES AND/OR PRODUCTS

The Company is still in its development stage. As a result, it does not know
with any certainty whether its services and/or products will be accepted within
the business marketplace. If the Company's services and/or products prove to be
unsuccessful within the marketplace, or if the Company fails to attain market
acceptance, it could materially adversely affect the Company's financial
condition, operating results, and cash flows.

DEPENDENCE ON KEY PERSONNEL

The Company's performance and operating results are substantially dependent on
the continued service and performance of its officer and directors. The Company
intends to hire additional technical, sales, and other personnel as they move
forward with their business model. Competition for such personnel is intense,
and there can be no assurance that the Company can retain its key technical
employees, or that it will be able to attract or retain highly qualified
technical and managerial personnel in the future. The loss of the services of
any of the Company's key employees or the inability to attract and retain the
necessary technical, sales, and other personnel could have a material adverse
effect upon the Company's business, financial condition, operating results, and
cash flows. The Company does not currently maintain "key man" insurance for any
of its key employees.

DEPENDENCE ON THE INTERNET

Online companies have experienced interruptions in their services as a result of
outages and other delays occurring due to problems with the Internet network
infrastructure, disruptions in Internet access provided by third-party providers
or failure of third party providers to handle higher volumes of user traffic. If
Internet usage grows, the Internet infrastructure or third-party service
providers may be unable to support the increased demands which may result in a
decline of performance, reliability or ability to access the Internet. If
outages or delays frequently occur in the future, Internet usage, as well as
usage of the Company's Internet Web-sites, could grow more slowly or decline.

COMPETITION

The powerline communications solutions market in which the Company will operate
is very competitive. Many competitors have substantially greater, financial,
technical, marketing, and distribution resources than the Company.

In all its markets, the Company competes against a large number of companies of
varying sizes and resources. There are an increasing number of competitive
services and products offered by a growing number of companies. Increased
competition in any service or product area may result in a loss of a client,
reduction in sales revenue, or additional price competition, any of which could
have a material adverse effect on the Company's operating results. In addition,
existing competitors may continue to broaden their service and/or product lines
and other potential competitors may enter or increase their presence in the
powerline communications solutions market, resulting in greater competition for
the Company.

Most of the Company's current and potential competitors have substantially
longer operating histories, larger customer bases, greater name and service
recognition, and significantly greater financial, marketing, and other resources

                                       17


<PAGE>

than the Company. In addition, competitors may be acquired by, receive
investments from or enter into other commercial relationships with larger,
well-established and well-financed companies as the use of the Internet and
other online services increases. Many of the Company's competitors may be able
to respond more quickly to changes in customer preferences/needs, devote greater
resources to marketing and promotional campaigns, adopt more aggressive pricing
policies and devote substantially more resources to Internet site and systems
development than the Company.

It is possible that new competitors or alliances among competitors may emerge
and rapidly acquire market share. Increased competition may result in reduced
operating margins and/or loss of market share, either of which could materially
adversely affect the Company's business, results of operations and financial
condition. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or alliances of such
competitors, or that competitive pressures faced by the Company will not
materially adversely affect its business, financial condition, operating results
and cash flows.

INTELLECTUAL PROPERTY RIGHTS

As part of its confidentiality procedures, the Company expects to enter into
nondisclosure and confidentiality agreements with its key employees, and any
consultants and/or business partners and will limit access to and distribution
of its technology, documentation, and other proprietary information.

Despite the Company's efforts to protect any intellectual property rights it may
have, unauthorized third parties, including competitors, may from time to time
copy or reverse-engineer certain portions of the Company's technology and use
such information to create competitive services and/or products.

It is possible that the scope, validity, and/or enforceability of the Company's
intellectual property rights could be challenged by other parties, including
competitors. The results of such challenges before administrative bodies or
courts depend on many factors, which cannot be accurately assessed at this time.
Unfavorable decisions by such administrative bodies or courts could have a
negative impact on the Company's intellectual property rights. Any such
challenges, whether with or without merit, could be time consuming, result in
costly litigation and diversion of resources, and cause service or product
delays. If such events should occur, the Company's business, operating results
and financial condition could be materially adversely affected.

RISKS OF TECHNOLOGY TRENDS AND EVOLVING IINDUSTRY STANDARDS

The Company's success will depend on its ability to develop Information
Technology solutions that will meet customers' changing requirements. The
powerline communications solutions industry is characterized by rapidly changing
technology, evolving industry standards, and changes in customer need and
frequent new service and product introductions. The Company's future success
will depend, in part, on its ability to effectively use leading edge
technologies, to continue to develop its technological expertise, to enhance its
current service, to develop new products that meet changing customer preferences
and to influence and respond to merging industry standards and other
technological changes on a timely and cost-effective basis.

DEPENDENCE OF LICENSED TECHNOLOGY

The Company may rely on certain technology licensed from third parties, and
there can be no assurance that these third party technology licenses will be
available to the Company on acceptable commercial terms or at all.

                                       18


<PAGE>

ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The financial statements attached to this Report on Form 10-KSB as
pages F-1 to F-30 are incorporated herein by reference.


ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         None

                                    PART III

ITEM 9.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

(a)   Directors and Officers

The following table furnishes the information concerning the Company's directors
and officers as of March 26, 2003. The directors of the Company are elected
every year and serve until their successors are elected and qualify.

           Name              Age                   Title                   Term
           ----              ---                   -----                   ----
     Ronald W. Pickett        55           President & Director           1 year
     Howard Lubert            54           CEO                            1 year
     Robert P. Crabb          55           Secretary                      1 year
     E. Barry Smith           52           CFO                            1 year
     Stephen Sadle            56           COO & Director                 1 year
     James Landry             49           VP Engineering                 1 year
     Ben Tuorto               47           VP US Sales                    1 year
     Warren V. Musser         76           Chairman of the Board          1 year
     Hugo DeCesaris           43           Director                       1 year
     David Grimes             63           Director                       1 year

The following table sets forth the portion of their time the Officers and
Directors devote to the Company:

           Name                        Title                         Time
           ----                        -----                         ----
     Ronald W. Pickett            President & Director               100%
     Howard Lubert                CEO                                100%
     Robert P. Crabb              Secretary                          100%
     E. Barry Smith               CFO                                100%
     Stephen Sadle                COO & Director                     100%
     James Landry                 VP Engineering                     100%
     Ben Tuorto                   VP US Sales                        100%
     Warren V. Musser             Chairman of the Board              Director
     Hugo DeCesaris               Director                           Director
     David Grimes                 Director                           Director

                                       19


<PAGE>

The term of office for each director is one (1) year, or until his/her successor
is elected at the Company's annual meeting and is qualified. The term of office
for each officer of the Company is at the pleasure of the board of directors.

The board of directors does not have a nominating committee. Therefore, the
selection of persons or election to the board of directors was neither
independently made nor negotiated at arm's length.

(b)   Identification of Certain Significant Employees- The directors and
      executive officers of the Company handle strategic matters and critical
      decisions.

(c)   Family Relationships- None

(d)   Business Experience

EXECUTIVE MANAGEMENT TEAM

Telkonet's management team consists of successful individuals with diverse
backgrounds in both the public and private sectors encompassing over a century
of experience with such well-known public companies and governmental agencies as
General Dynamics, Data General, 3Com, US Robotics, Penril Datacomm, CompuCom
Systems, Inc, Nortel Networks, Fujitsu, Digital Equipment Corporation, Deloitte
and Touche, Textron, Safeguard Scientifics, IBM and NASA. These seasoned
professionals possess significant industry and customer knowledge with an
extensive network of contacts within the powerline and data networking industry
and a proven record of success in start-up ventures that required developing and
selling networking solutions into the commercial market.

RONALD W. PICKETT-PRESIDENT & DIRECTOR

Mr. Pickett fostered the development of Telkonet since 1999 as the Company's
principle investor and Co-Founder of the Company. He was the Founder, Chairman
of the Board and President of Medical Advisory Systems, Inc., which is now the
Digital Angel Corporation- AMEX: "DOC". A graduate of Gordon College, Mr.
Pickett has engaged in various entrepreneurial activities for 35 years.

HOWARD LUBERT - CHIEF EXECUTIVE OFFICER

Mr. Lubert brings to Telkonet over three decades of diversified expertise, which
includes technical due diligence and business acceleration services for
Safeguard Scientifics in Infrastructure, Internet/e-Business and
Telecommunications. Internet, Intranet, Extranet and e-Commerce strategy and
implementation expertise as an e. Business service line leader with Deloitte and
Touche. PC, Local and Wide Area Networking experience as the founder/president
of HEL INC. (Integration, Networking & Connectivity), General Systems Division
of IBM marketing mid-range computer systems in the manufacturing, distribution,
hospitality and not-for-profit vertical markets. Mr. Lubert is a nationally
recognized speaker who has lectured on e. Business technologies, Web Content
Management and Community Solutions, e. Business integration, The Financial and
Human Capital Issues of e. Business

                                       20


<PAGE>

E. BARRY SMITH - CHIEF FINANCIAL OFFICER

Mr. Smith is a CPA and senior financial executive with diversified experience in
both public and private companies. Mr. Smith's background includes big-four
Public accounting experience with the firm of Deloitte & Touche. Senior
Financial Partner and over 15 years executive management experience with
Safeguard Scientifics, Inc. and their partner companies including: ThinAirApps,
Inc.-(Wireless Application Provider-sold to Palm, Inc.), Interactive Marketing
Venture -(Database Marketing) and Tangram Enterprise Solutions-
(Software/Hardware for PC/LAN Mainframe Connectivity and Enterprise Software
Management). Mr. Smith's experience also includes, Vice President of Finance &
Administration for US Golf Management- (Public/Private Golf Course & Restaurant
Management, Vice President of Finance for International Communications Research-
(Market Research & Database Services) and Treasurer for The Chilton Company-
(Publishing).

STEPHEN L. SADLE - CHIEF OPERATING OFFICER AND DIRECTOR & CO-FOUNDER

Mr. Sadle was previously employed as Senior Vice President and General Sales
Manager of Internos; a provider of Web based vertical extranet applications and
has developed operating extranets in the construction and transportation
industries. For 15 years prior, Sadle was Vice President of Business Development
and Sales for the Driggs Corporation, a major heavy and infrastructure
contracting firm interfacing with government and the private sectors. Also, he
was president and founder of a successful construction company and was awarded
Small Businessman of the Year Award for the Washington Metropolitan Area. Mr.
Sadle brings significant management, contracting and entrepreneurial skills to
the company.

JAMES F. LANDRY - VICE PRESIDENT OF ENGINEERING

Mr. Landry has over 18 years experience in developing communications hardware
for the enterprise/carrier market with 3Com, US Robotics, Penril Datacomm and
Data General. While at 3Com/US Robotics, he was singularly responsible for the
development of the entire xDSL product line as well as a number of modems and
interface cards. At Penril, he served as the product development leader for the
Series 1544 multiplexer/channel bank and at Data General he was technical leader
of system integration for ISDN WAN. Mr. Landry brings a wealth of practical
design leadership and a solid history of delivering products to the marketplace.
He holds four US patents.

ROBERT P. CRABB - SECRETARY

Mr. Crabb has over 35 years of sales, marketing and corporate management
experience including 15 years with the Metropolitan Life Insurance Company. His
entrepreneurial expertise also includes public company administration, financial
consulting and commercial/residential real estate development. Mr. Crabb
oversees the Company's public company administration and corporate governance,
is a former Director of Telkonet and has been involved with the Company since
1999.

BEN TUORTO - VICE PRESIDENT OF CHANNEL SALES

Mr. Tuorto has over 26 years of industry experience in sales with industry lead
networking manufacturers for systems integration, networking, business
development and customer service. Mr. Tuorto has developed and implemented
numerous successful sales programs and his varied background provides him with a
solid understanding of the different channel distribution models that Telkonet
will deploy as the company grows. Mr. Tuorto has held strategic sales positions
with industry leaders including Nortel Networks, Fujitsu, Digital Equipment

                                       21


<PAGE>

Corporation and has participated in several high tech startups. Mr. Tuorto will
be responsible for building upon and establishing relationships with business
partners and distribution channels, including systems integrators and value
added resellers.

JOHN I. VASILJ - VICE PRESIDENT OF US GOVT. & INTERNATIONAL BUSINESS DEVELOPMENT

Mr. Vasilj is a Partner with the Lloyd Group, an international
business-consulting firm offering commercial and government client's strategic
guidance and support with the growing U.S. state, federal, and military
marketplaces. In this role, Mr. Vasilj is responsible for helping clients create
and manage business relationships between U.S. and international firms and their
respective government and military counterparts. Mr. Vasilj served the Foreign
Service of the Republic of Croatia. As a founding member of Croatia's first
diplomatic mission to the U.S, expanding bilateral commercial, diplomatic, and
political relations. He also served as Chief of Staff and Press Secretary at the
Croatian Embassy in Washington, D.C., where he developed and implemented
initiatives aimed at supporting the country's international policy objectives
relative to the U.S. Administration, Congress, and the armed services. Mr.
Vasilj worked closely with the international community to implement policies
dedicated to securing peace and prosperity in Croatia. Mr. Vasilj had
represented the Government at the local, national and international levels,
including a number of U.S. Presidential Trade and Development Missions to Bosnia
and Herzegovina and Croatia, the Dayton Peace Accords, and the United Nations
General Assembly.

DAVID W. GRIMES, Director is a co-founder of the company. From 1963-1982 Grimes
was the Senior Executive with NASA for the Delta Program, heading the $200
Million per annum program. From 1982-1989 he was Founder and CEO of Transpace
Carriers Inc., a venture to commercialize the delta launch vehicle. From
1989-1992 he was the Engineering Division Director at EER Inc., of Seabrook
Maryland with responsibility for over 100 engineers and technicians on
electrical mechanical and thermal tasks for Goddard Space Flight Center. From
1992-1999, Chief Engineer for Final Analysis, Inc. and led the design and
development of the Low Earth Orbit constellation of 38 satellites for use in
global store and forward communications. Grimes is a recognized expert in space
and ground communications systems and brings this expertise to bear on the
implementation of the hybrid telephony and high speed Internet technology. David
Grimes is retired from daily business of the Company; however he maintains an
active interest in the Company through a consulting relationship.

ITEM 10. EXECUTIVE COMPENSATION

Section 16(a) of the Securities Exchange Act of 1934, as amended (The "Exchange
Act"), requires the Registrant's officers and directors, and persons who own
more than 10% of a registered class of the Registrant's equity securities, to
file reports of ownership and changes in ownership of equity securities of the
Registrant with the Securities and Exchange Commission and NASDAQ. Officers,
directors and greater-than 10% shareholders are required by the Securities and
Exchange Commission regulation to furnish to Registrant with copies of all
Section 16(a) that they file.

Some of the officers and directors of the Company will not devote more than a
portion of their time to the affairs of the Company. There will be occasions
when the time requirements of the Company's business conflict with the demands
of their other business and investment activities. Such conflict may require
that the company attempt to employ additional personnel. There is no assurance
that the services of such persons will be available or that they can be obtained
upon terms favorable to the Company.

(a) Compensation.

                                       22


<PAGE>

The following table sets forth all compensation actually paid or accrued by the
Company for services rendered to the Company for the years ended December 31,
2000, 2001 and 2002 to the Company's Chief Executive Officer or others who
earned a salary greater than $100,000 annually for any of the periods:

<TABLE>
                                              SUMMARY COMPENSATION TABLE OF EXECUTIVES
<CAPTION>
                                                     Annual Compensation                             Long Term Compensation
                                                     -------------------                             ----------------------
                  (a)                      (b)         (c)           (d)          (e)          (f)            (g)            (h)
<S>                                      <C>          <C>                <C>          <C>    <C>           <C>                   <C>
      Name and Principal Position          Year       Salary        Bonus        Other      Restricted     Underlying       LTIP or
                                                       ($)         Annual        Awards       Stock          /Option         other
                                                                 Compensation                               Securities
                                                                     ($)
L. Peter Larson                          2000          76,747            -            -      1,505,285       200,000             -
                                         2001         160,484            -            -      1,505,285       200,000             -
                                         2002           4,000            -            -      1,505,285     1,000,000             -
David Grimes                             2000          60,918            -            -      4,971,918       200,000             -
                                         2001          57,041            -            -      4,971,918       200,000             -
                                         2002               -            -            -      1,298,000             -             -
Robert Crabb                             2000               -            -            -              -             -             -
                                         2001               -            -            -              -             -             -
                                         2002           8,500            -            -              -             -             -
Stephen L. Sadle                         2000          78,270            -            -      5,722,695       200,000             -
                                         2001         160,484            -            -      5,722,695       200,000             -
                                         2002         130,000            -            -      3,721,600             -             -
Greg Fowler                              2002         114,000            -            -              -       200,000             -
Jim Landry                               2001          29,000            -            -              -       125,000             -
                                         2002         116,000            -            -              -       225,000             -
Ben Tuorto                               2002          49,327            -            -              -       225,000             -
</TABLE>

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   a)    BENEFICIAL OWNERS OF FIVE PERCENT (5%) OR GREATER, OF THE COMPANY'S
         COMMON STOCK: No preferred stock is outstanding at the date of this
         offering. The following sets forth information with respect to
         ownership by holders of more than five percent (5%) of the Registrant's
         common stock known by the Registrant based upon 15,721,131 shares
         outstanding at December 31, 2002.

  ALL 5% OWNERS SUPPLEMENTAL BENEFICIAL OWNERSHIP TABLE AS OF DECEMBER 31, 2002
  -----------------------------------------------------------------------------

<TABLE>
<CAPTION>
                       Name and Address of             Amount of
  Title of Class        Beneficial Owner           Beneficial Interest     Percent of Class
  --------------        ----------------           -------------------     ----------------
<S>                     <C>                            <C>                       <C>
Common                  David Grimes,                  1,298,000                  7.6 %
                        Crownsville MD
Common                  Stephen Sadle,                 3,721,600                 21.9 %
                        Crownsville, MD
Common                  L. Peter Larson,               2,505,285                 14.7 %
                        Annapolis, MD

                                       23


<PAGE>

Common                  Ron Pickett,                   2,658,964                 15.7 %
                        Wilmington, NC
Common                  Jenson and Associates          1,980,000                 11.7 %
                        Salt Lake City, Utah
Common                  Hugo DeCesaris                 1,375,000                  8.1 %
                        Annapolis, MD
</TABLE>

   ALL 5% OWNERS SUPPLEMENTAL BENEFICIAL OWNERSHIP TABLE AS OF MARCH 26, 2002
   --------------------------------------------------------------------------

Beneficial owners of five percent (5%) or greater, of the Company's common
stock: No preferred stock is outstanding at the date of this offering. The
following sets forth information with respect to ownership by holders of more
than five percent (5%) of the Registrant's common stock known by the Registrant
based upon 15,721,131

<TABLE>
<CAPTION>
                       Name and Address of             Amount of
  Title of Class        Beneficial Owner           Beneficial Interest     Percent of Class
  --------------        ----------------           -------------------     ----------------
<S>                     <C>                            <C>                       <C>
Common                  David Grimes,                  2,198,000                  9.7 %
                        Crownsville MD
Common                  Stephen Sadle,                 4,621,600                 20.3 %
                        Crownsville, MD
Common                  L. Peter Larson,               2,505,285                 11.0 %
                        Annapolis, MD
                        Warren V. Musser               2,000,000                  8.8 %
Common                  Ron Pickett,                   2,658,964                 11.7 %
                        Wilmington, NC
Common                  Jenson and Associates,         1,980,000                  8.7 %
                        Salt Lake City , Utah
Common                  Hugo DeCesaris                 1,375,000                  6.0 %
                        Annapolis, MD
</TABLE>

b) The following sets forth information with respect to the Company's common
stock beneficially owned by each Officer and Director, and by all Directors and
Officers as a group.

<TABLE>
   OFFICERS AND DIRECTORS SUPPLEMENTAL BENEFICIAL OWNERSHIP TABLE AS OF DECEMBER 31, 2002
   --------------------------------------------------------------------------------------
<CAPTION>
                       Name and Address of             Amount of
  Title of Class        Beneficial Owner           Beneficial Interest     Percent of Class
  --------------        ----------------           -------------------     ----------------
<S>                     <C>                            <C>                       <C>
Common                  Ron Pickett, President         2,658,964                 15.7 %
                        Wilmington, NC
Common                  Howard Lubert, CEO                     0                    0
                        West Chester, PA
Common                  E. Barry Smith, CFO                    0                    0
                        West Chester, PA
Common                  Stephen Sadle, COO             3,721,600                 21.9 %
                        Crownsville, MD
Common                  Robert Crabb, Secy.                    0                    0
                        Rising Sun, MD
Common                  James Landry, VP Eng.            225,000                  1.3 %
                        Germantown, MD.
Common                  Ben Tuorto, VP Sales             225,000                  1.3 %
                        Cary, NC

                                             24


<PAGE>

Common                  David Grimes, Director         1,298,000                  7.6 %
                        Crownsville, MD
Common                  Hugo DeCesaris- Director                                  8.1 %
                        Annapolis, MD                  1,375,000

Common                  Warren V. Musser, Chairman             0                    0
                        Villanova, PA
All directors and
executive officers as
a group (6 persons in group)                          9,503,564                  55.9 %
</TABLE>

<TABLE>
    OFFICERS AND DIRECTORS SUPPLEMENTAL BENEFICIAL OWNERSHIP TABLE AS OF MARCH 26, 2002
    -----------------------------------------------------------------------------------
<CAPTION>
                       Name and Address of             Amount of
  Title of Class        Beneficial Owner           Beneficial Interest     Percent of Class
  --------------        ----------------           -------------------     ----------------
<S>                     <C>                            <C>                      <C>
Common                  Ron Pickett, President          2,658,964               11.7 %
                        Wilmington, NC
Common                  Howard Lubert, CEO              1,000,000                4.4 %
                        West Chester, PA
Common                  E. Barry Smith, CFO               350,000                1.5 %
                        West Chester, PA
Common                  Stephen Sadle, COO              4,621,600               20.3 %
                        Crownsville, MD
Common                  Robert Crabb, Secy.               500,000                2.2 %
                        Rising Sun, MD
Common                  James Landry, VP Eng.             350,000                1.5 %
                        Germantown, MD.
Common                  Ben Tuorto, VP Sales              225,000                1.0 %
                        Cary, NC
Common                  David Grimes, Director          2,198,000                9.7 %
                        Crownsville, MD
Common                  Hugo DeCesaris- Director        1,375,000                6.0 %
                        Annapolis, MD
Common                  Warren V. Musser, Chairman      2,000,000                8.8 %
                        Villanova, PA
All directors and
executive officers as
a group (10 persons in group)                          15,278,564               63.5 %
</TABLE>

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

A company officer has advanced funds to the Company for working capital
purposes. No formal repayment terms or arrangements exist. The net amount of
advances due the officer at December 31, 2002 was $4,830.

Significant shareholders of the Company have advanced funds to the Company for
working capital purposes. The amount of the advances at December 31, 2002 and
2001 is $125,500 and $7,500, respectively. No formal repayment terms or
arrangements exist.

For the year ended December 31, 2002 and 2001, the Company entered into several
convertible debentures with sophisticated investors in the aggregate principal
amount of $2,162,000, of which $340,000 was with members of the board directors,
officers, and shareholders.

                                       25


<PAGE>

                                     PART IV

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

         (A) Exhibits

         The exhibits listed below are required by Item 601 of Regulation S-K.
Each management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-K has been identified.

Exhibit
Number            Description of Document
------            -----------------------

3.1 (a)           Articles of Incorporation of the Registrant
3.2 (a)           By-laws of the Registrant
4.1               Agreement of Convertible Debenture and Warrants
4.2               Agreement of Series B Convertible Debenture and Warrants
10.1              Telkonet, Inc. Stock Option Plan (filed herewith)
10.2              2001 Debenture and Warrant (filed herewith)
10.3              2002 Debenture and Warrant (filed herewith)
23.1              Consent of Independent Accounts (file herewith)
99.1              Certification of Ronald W. Pickett Pursuant to Section 906 of
                  the Sarbanes-Oxley Act of 2002 (filed herewith).
99.2              Certification of Stephen Sadle Pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002 (filed herewith).

_________________

(a) Incorporated by reference herein from Exhibits to the Registrant's Form 8-K
dated August 30, 2000

(b) The Company filed the following reports on Form 8-K during the reporting
period.

January 16, 2002 -   Telkonet Founders Re-align Capital.
December 20, 2002 -  Board of Directors elect Mr. Ronald W. Pickett as Chairman
                     of Board, President and interim CEO. J. Gregory Fowler re
                     Telkonet finds potential competitors to actually be
                     complementary in nature and a validation of the viability
                     of the powerline communications market overall. resigned as
                     the President & CEO and from the Board of Directors.

ITEM 14.  CONTROLS AND PROCEDURES

The Company has established and maintains disclosure controls and procedures
that are designed to ensure that material information required to be disclosed
by Telkonet, Inc. in the reports that it files under the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, and that
such information is accumulated and communicated to the Company's management,
including the Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.

                                       26


<PAGE>

Within the 90 days prior to the date of this annual report, under the
supervision and with the participation of Telkonet, Inc.'s Chief Executive
Officer and Chief Financial Officer, the Company carried out an evaluation of
the effectiveness of the design and operation of disclosure controls and
procedures. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective as of the date of such evaluation in timely alerting them to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in Telkonet, Inc.'s periodic SEC filings.

There have been no significant changes to the Company's internal controls or in
other factors that could significantly affect internal controls subsequent to
the date the Company carried out its evaluation.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

Date:  March 26, 2003                          Telkonet, Inc.


                                               /s/ Ronald W. Pickett, President
                                               --------------------------------
                                               Ronald W. Pickett, President

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.

<TABLE>
<CAPTION>
          Name                                  Position                                 Date
          ----                                  --------                                 ----
<S>                                      <C>                                    <C>
/s/ Warren V. Musser                     Chairman of the Board                  Supplemental Beneficial
------------------------------                                                   Ownership Table as of
Warren V. Musser                                                                    March 26, 2002
                                                                                    --------------
/s/ Ronald W. Pickett
------------------------------
Ronald W.  Pickett                       President                              March 26, 2003

/s/ Stephen Sadle
------------------------------
Stephen Sadle                            Chief Operating Officer                March 26, 2003

/s/ Hugo DeCesaris
------------------------------
Hugo DeCesaris                           Director                               March 26, 2003

/s/ David Grimes
------------------------------
David Grimes                             Director                               March 26, 2003 Telkonet finds
                                                                                potential competitors to actually be
                                                                                complementary in nature and a
                                                                                validation of the viability of the
                                                                                powerline communications market
                                                                                overall.
</TABLE>

                                                       27


<PAGE>

                                 CERTIFICATIONS

I, Ronald W. Pickett, certify that:

1.   I have reviewed this quarterly report on Form 10-KSB of Telkonet, Inc.

2.   Based on my knowledge, this quarterly 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 quarterly report;

3.   Based on my knowledge, the financial statements and other financial
     information included in this quarterly 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
     quarterly report;

4.   The registrant's other certifying officers and I are responsible for
     establishing and maintaining disclosure controls and procedures (as defined
     in Exchange Act Rules 13a-14 and 15d-14 for the registrant and have:

     a)   designed such disclosure controls and procedures 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 quarterly
          report is being prepared;

     b)   evaluated the effectiveness of the registrant's disclosure controls
          and procedures as of a date within 90 days prior to the filing date of
          this quarterly report (the "Evaluation Date"); and

     c)   presented in this quarterly report our conclusions about the
          effectiveness of the disclosure controls and procedures based on our
          evaluation as of the Evaluation Date;

5.   The registrant's other certifying officers and I have disclosed, based on
     our most recent evaluation, 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 in the design or operation of internal
          controls which could adversely affect the registrant's ability to
          record, process, summarize, and report financial data and have
          identified for the registrant's auditors any material weaknesses in
          internal controls; and

                                       28


<PAGE>

     b)   any fraud, whether or not material, that involves management or other
          employees who have a significant role in the registrant's internal
          controls; and

6.   The registrant's other certifying officers and I have indicated in this
     quarterly report whether or not there were significant changes in internal
     controls or in other factors that could significantly affect internal
     controls subsequent to the date of our most recent evaluation, including
     any corrective actions, with regard to significant deficiencies and
     material weaknesses.


Date: March 26, 2003


                                        /s/ Ronald W. Pickett
                                        ------------------------------
                                            Ronald W. Pickett
                                               President


                                 CERTIFICATIONS

I, Steve Sadle, certify that:

1.   I have reviewed this quarterly report on Form 10-KSB of Telkonet, Inc.

2.   Based on my knowledge, this quarterly 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 quarterly report;

3.   Based on my knowledge, the financial statements and other financial
     information included in this quarterly 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
     quarterly report;

4.   The registrant's other certifying officers and I are responsible for
     establishing and maintaining disclosure controls and procedures (as defined
     in Exchange Act Rules 13a-14 and 15d-14 for the registrant and have:

     a)   designed such disclosure controls and procedures 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 quarterly
          report is being prepared;

     b)   evaluated the effectiveness of the registrant's disclosure controls
          and procedures as of a date within 90 days prior to the filing date of
          this quarterly report (the "Evaluation Date"); and

                                       29


<PAGE>

     c)   presented in this quarterly report our conclusions about the
          effectiveness of the disclosure controls and procedures based on our
          evaluation as of the Evaluation Date;

5.   The registrant's other certifying officers and I have disclosed, based on
     our most recent evaluation, 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 in the design or operation of internal
          controls which could adversely affect the registrant's ability to
          record, process, summarize, and report financial data and have
          identified for the registrant's auditors any material weaknesses in
          internal controls; and

     b)   any fraud, whether or not material, that involves management or other
          employees who have a significant role in the registrant's internal
          controls; and

6.   The registrant's other certifying officers and I have indicated in this
     quarterly report whether or not there were significant changes in internal
     controls or in other factors that could significantly affect internal
     controls subsequent to the date of our most recent evaluation, including
     any corrective actions, with regard to significant deficiencies and
     material weaknesses.


Date: March 26, 2003


                                        /s/ Steve Sadle
                                        ------------------------------
                                            Steve Sadle
                                            Chief Operating Officer

                                       30


<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549



                       FINANCIAL STATEMENTS AND SCHEDULES

                           DECEMBER 31, 2002 AND 2001



                         FORMING A PART OF ANNUAL REPORT
                 PURSUANT TO THE SECURITIES EXCHANGE ACT OF 1934


                                 TELKONET, INC.


                                      F-1


<PAGE>

<TABLE>
                                                   TELKONET, INC.

                                           INDEX TO FINANCIAL STATEMENTS
<CAPTION>
-------------------------------------------------------------------------------------------------------------------

<S>                                                                                                    <C>
Report of Independent Certified Public Accountants                                                             F-3
Consolidated Balance Sheets at December 31, 2002 and 2001                                                      F-4
Consolidated Statements of Losses for the Years ended December 31, 2002 and 2001 and for
  the Period November 3, 1999 (Date of Inception) Through December 31, 2002                                    F-5
Consolidated Statements of Deficiency in Stockholders' Equity for the Period November 3,
  1999 (Date of Inception) Through December 31, 2002                                                     F-6 - F-8
Consolidated Statements of Cash Flows for the Years ended December 31, 2002 and 2001 and
  for the Period November 3, 1999 (Date of Inception) through December 31, 2002                          F-9 - F10
Notes to Consolidated Financial Statements                                                             F-11 - F-30


                                                        F-2
</TABLE>


<PAGE>

                    RUSSELL BEDFORD STEFANOU MIRCHANDANI LLP
                          CERTIFIED PUBLIC ACCOUNTANTS

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
               --------------------------------------------------

Board of Directors
Telkonet, Inc.
Annapolis, MD

         We have audited the accompanying consolidated balance sheets of
Telkonet, Inc. and its wholly-owned subsidiary (the "Company"), a development
stage company, as of December 31, 2002 and 2001 and the related consolidated
statements of losses, deficiency in stockholders' equity, and cash flows for the
years ended December 31, 2002 and 2001 and for the period November 3, 1999 (date
of inception) to December 31, 2002. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based upon our audit.

         We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatements. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe our audits
provide a reasonable basis for our opinion.

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Telkonet, Inc. and
its wholly-owned subsidiary as of December 31, 2002 and 2001, and the results of
its operations and its cash flows for the two years then ended, and from
November 3, 1999 (date of inception), to December 31, 2002, in conformity with
accounting principles generally accepted in the United States of America.

         The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As shown in the financial
statements, the Company has incurred net losses since its inception. This raises
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to this matter are described in Note K. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.

         As discussed in Note L, the Company restated its Consolidated Balance
Sheet as of December 31, 2001 , and the related Statements of Losses, Deficiency
in Stockholders' Equity and Cash Flows for the year ended December 31, 2001 and
the period November 3, 1999 (date of Inception) to December 31, 2001.

                                    /s/ RUSSELL BEDFORD STEFANOU MIRCHANDANI LLP
                                    --------------------------------------------
                                        Russell Bedford Stefanou Mirchandani LLP
                                        Certified Public Accountants
McLean, Virginia
February 27, 2003

                                       F-3


<PAGE>

<TABLE>
                                               TELKONET, INC.
                                       (A DEVELOPMENT STAGE COMPANY)
                                        CONSOLIDATED BALANCE SHEETS
                                         DECEMBER 31, 2002 AND 2001
<CAPTION>

                                                                                          (As Restated - Note L)
                                                                            2002                   2001
                                                                       -------------          -------------
<S>                                                                    <C>                    <C>
ASSETS
 CURRENT ASSETS:
 Cash and equivalents                                                  $     18,827           $     21,885

 Inventory, net (Note A)                                                     39,790                     --

 Other receivable                                                             1,550                     --

 Prepaid expenses and deposits                                                4,625                     --
                                                                       -------------          -------------
 Total current assets                                                        64,792                 21,885

 PROPERTY AND EQUIPMENT (Note B):

 Furniture and equipment, at cost                                            73,215                 54,950

 Less:  accumulated depreciation                                             35,252                 28,108
                                                                       -------------          -------------
                                                                             37,963                 26,842

 OTHER ASSETS:
 Financing costs, less accumulated amortization of $76,923
and $24,769 at December 31, 2002 and 2001, respectively                     192,600                183,049

 Prepaid expenses and deposits                                                   --                  4,625
                                                                       -------------          -------------
                                                                            192,600                187,674

                                                                       $    295,355           $    236,401
                                                                       =============          =============
 LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY

 CURRENT LIABILITIES:
 Accounts payable and accrued expenses                                 $    518,865           $    116,741

 Notes payable (Note D)                                                     310,000                400,000

 Due to Shareholders (Note C)                                               130,330                  7,500
                                                                       -------------          -------------
 Total current liabilities                                                  959,195                524,241

 Convertible debentures, net of discounts - including
related
 parties (Note E)                                                           862,682                126,200


 COMMITMENTS AND CONTINGENCIES (Note I)                                          --                     --

 DEFICIENCY IN STOCKHOLDERS' EQUITY (Note F)

 Preferred stock,
 par value $.001 per share; 15,000,000 shares authorized;
 none issued and outstanding at December 31, 2002 and 2001                       --                     --
 Common stock, par value $.001 per share; 100,000,000 shares
 authorized; 15,721,131 and 22,115,371 shares issued and
 outstanding at December 31, 2002 and 2001, respectively                     15,721                 22,115

 Additional paid-in-capital                                               4,916,433              2,244,033

 Accumulated deficit during development stage                            (6,458,676)            (2,680,188)
                                                                       -------------          -------------
 Deficiency in stockholders' equity                                      (1,526,522)              (414,040)
                                                                       -------------          -------------
                                                                       $    295,355           $    236,401
                                                                       =============          =============

                        See accompanying notes to consolidated financial statements

                                                    F-4
</TABLE>


<PAGE>

<TABLE>
                                              TELKONET, INC.
                                      (A DEVELOPMENT STAGE COMPANY)
                                    CONSOLIDATED STATEMENTS OF LOSSES
<CAPTION>

                                                                                        For the period from
                                                                                          November 3, 1999
                                                                                        (date of inception)
                                                                                              through
                                                 For the year ended December 31,            December 31,
                                                  2002                   2001                   2002
                                              -------------          -------------          -------------
                                                                (As Restated - Note L)  (As Restated - Note L)
<S>                                           <C>                    <C>                    <C>
Costs and Expenses:
Research and Development                      $    280,450           $    120,828           $    520,278

Selling, General and Administrative              2,790,819              1,386,222              4,984,078
Impairment of Property and Equipment
(Note B)                                                --                 39,287                 39,287

Depreciation and Amortization                       84,067                 30,797                136,944
                                              -------------          -------------          -------------
Total Operating Expense                          3,155,336              1,577,134              5,680,587


Loss from Operations                            (3,155,336)            (1,577,134)            (5,680,587)


Other Income                                         3,322                  1,257                  4,579

Interest Income (Expense)                         (626,474)              (140,618)              (782,668)

Provision for Income Tax                                --                     --                     --
                                              -------------          -------------          -------------
                                                  (623,152)              (139,361)              (778,089)

Net Loss                                      $ (3,778,488)          $ (1,716,495)          $ (6,458,676)
                                              =============          =============          =============
Loss per common share (basic and
assuming dilution) (Note J)                   $      (0.22)          $      (0.08)          $      (0.40)
                                              =============          =============          =============


Weighted average common shares
outstanding                                     17,119,639             21,974,439             16,050,030


                       See accompanying notes to consolidated financial statements

                                                   F-5
</TABLE>


<PAGE>

<TABLE>
                                                           TELKONET, INC.
                                                    (A DEVELOPMENT STAGE COMPANY)
                                    CONSOLIDATED STATEMENTS OF DEFICIENCY IN STOCKHOLDERS' EQUITY
                              FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2002
<CAPTION>

                                                                                                              Deficit
                                                                                                             Accumulated
                                              Preferred                    Common    Additional    Common      During
                                    Preferred   Stock                      Stock      Paid in      Stock     Development
                                     Shares     Amount   Common Shares     Amount     Capital   Subscription    Stage       Total
<S>                                      <C>   <C>        <C>            <C>          <C>         <C>       <C>           <C>

Net Loss                                 --    $   --             --     $     --     $     --    $   --    $ (33,973)    $ (33,973)
                                    --------   -------    -----------    ---------    ---------   -------   ----------    ----------

Balance at December 31, 1999             --        --             --           --           --        --      (33,973)      (33,973)

Shares issued to founders
January 2000, in exchange
for services and costs
valued at $ 0.60 per share               --        --         19,300          193       11,387        --           --        11,580

Shares issued in June 2000,
for cash in connection with
private placement at $375
per share, net of costs                  --        --          1,735           17      644,219        --           --       644,236

Shares issued in July 2000,
for warrants exercised at a
price of $375 per share                  --        --            190           --       71,250        --           --        71,250

Shares issued in August 2000,
in connection with the merger
of Comstock Coal and Telkonet
Communications, Inc                      --        --     21,775,335       21,775           --        --           --        21,775

August 2000, retirement of
Telkonet Communications, Inc
shares                                   --        --        (21,225)        (210)          --        --           --          (210)
Shares issued in October 2000,
in exchange for warrants
exercised at a price of $1
per share                                --        --         29,145           29       29,115        --           --        29,144

Shares issued in October 2000,
in exchange for warrants
exercised at a price of $0.40
per share                                --        --         10,891           11        4,345        --           --         4,356

Net loss                                 --        --             --           --           --        --     (929,720)     (929,720)
                                    --------   -------    -----------    ---------    ---------   -------   ----------    ----------
 BALANCE AT DECEMBER 31, 2000            --    $   --     21,815,371     $ 21,815     $760,316    $   --    $(963,693)    $(181,562)
                                    ========   =======    ===========    =========    =========   =======   ==========    ==========

                                     See accompanying notes to consolidated financial statements

                                                                F-6
</TABLE>


<PAGE>

<TABLE>
                                                           TELKONET, INC.
                                                    (A DEVELOPMENT STAGE COMPANY)
                                    CONSOLIDATED STATEMENTS OF DEFICIENCY IN STOCKHOLDERS' EQUITY
                              FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2002
<CAPTION>

                                                                                                          Deficit
                                                                                                        Accumulated
                                                Preferred              Common    Additional    Common      During
                                      Preferred   Stock     Common     Stock      Paid in      Stock     Development
                                       Shares     Amount    Shares     Amount     Capital   Subscription    Stage        Total
<S>                                         <C>  <C>      <C>          <C>       <C>          <C>      <C>            <C>
Balance Forward                             --   $   --   21,815,371   $21,815   $  760,316   $   --   $  (963,693)   $  (181,562)

Shares issued in June 2001,
for cash in connection with
a private placement, shares
issued at $.50 a share,
net of costs                                --       --      260,000       260      129,740       --            --        130,000

1,839,378 warrants issued in
June 2001, valued at $0.13 per
warrant, in exchange for services           --       --           --        --      237,035       --            --        237,035

72,668 stock options issued in
June 2001, valued at $ 0.09 per
stock option, in exchange for
services                                    --       --           --        --        6,375       --            --          6,375

245,287 warrants issued in July
2001, valued at $0.08 per warrant,
in exchange for services                    --       --           --        --       18,568       --            --         18,568

36,917 stock options issued in
July 2001, valued at $ 0.08 per
warrant, in exchange for services           --       --           --        --        2,795       --            --          2,795

Shares issued in August 2001, for
cash in connection with a private
placement, shares issued at $.50
a share, net of costs                       --       --       40,000        40       19,960       --            --         20,000

241,000 warrants issued in August
2001, valued at $ 0.39 per warrant
in exchange for financing costs             --       --           --        --       85,818       --            --         85,818

150,000 warrants issued in August
2001, valued at $ 0.16 per warrant,
in exchange for services                    --       --           --        --       23,340       --            --         23,340

36,917 stock options issued in
August 2001, valued at $ 0.06 per
stock option, in exchange for services      --       --           --        --        2,422       --            --          2,422

25,000 warrants issued in September
2001, valued at $0.30 per warrant in
exchange for services                       --       --           --        --        7,380       --            --          7,380

95,000 warrants issued in October
2001, valued at $ 0.21 per warrant,
in exchange for services                    --       --           --        --       19,558       --            --         19,558

25,000 warrants issued in November
2001, valued at $ 0.33 per warrant,
in exchange for services                    --       --           --        --        8,218       --            --          8,218

25,000 warrants issued in December
2001, valued at $ 0.30 per warrant,
in exchange for services                    --       --           --        --        7,380       --            --          7,380

Beneficial conversion feature of
convertible debentures (Note E)             --       --           --        --      837,874       --            --        837,874

Value of warrants attached to
convertible debentures (Note E)             --       --           --        --       77,254       --            --         77,254

Net loss                                    --       --           --        --           --       --    (1,716,495)    (1,716,495)
                                       --------  -------  -----------  --------  -----------  -------  ------------   ------------
BALANCE AT DECEMBER 31, 2001
(AS RESTATED- NOTE L)                       --   $   --   22,115,371   $22,115   $2,244,033   $   --   $(2,680,188)   $  (414,040)
                                       ========  =======  ===========  ========  ===========  =======  ============   ============

                                     See accompanying notes to consolidated financial statements

                                                                F-7
</TABLE>


<PAGE>

<TABLE>
                                                           TELKONET, INC.
                                                    (A DEVELOPMENT STAGE COMPANY)
                                    CONSOLIDATED STATEMENTS OF DEFICIENCY IN STOCKHOLDERS' EQUITY
                              FOR THE PERIOD NOVEMBER 3, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 2002
<CAPTION>

                                                                                                          Deficit
                                                                                                         Accumulated
                                              Preferred             Common    Additional     Common        During
                                    Preferred   Stock    Common     Stock      Paid in        Stock      Development
                                     Shares     Amount   Shares     Amount     Capital     Subscription     Stage          Total
<S>                                      <C> <C>      <C>          <C>        <C>           <C>           <C>           <C>

 Balance Forward                         --  $   --   22,115,371   $ 22,115   $ 2,244,033   $        --   $(2,680,188)  $  (414,040)

Shares issued in February 2002,
in exchange for convertible
debentures interest, at $.50
per share                                --      --       43,586         44        21,749            --            --        21,793

Shares issued in March 2002,
to a founder in exchange for
shares canceled                          --      --    5,250,000      5,250        (5,250)           --            --            --


Shares canceled in March 2002
in connection with capital
restructure                              --      --  (13,480,961)   (13,481)       13,481            --            --            --

Shares issued in June 2002,
for warrants exercised at $1.00
per share for services rendered          --      --       47,906         48        47,857            --            --        47,906

Shares issued in June 2002, for
warrants exercised at $.40 per
share for services rendered              --      --       26,443         26        10,551            --            --        10,577

Shares issued in June 2002 to
founders, for options exercised
at $1.00 per share                       --      --    1,000,000      1,000       999,000            --            --     1,000,000

Shares issued in June 2002, for
warrants exercised at $1.0025
per share, for services rendered         --      --       80,039         80        80,158            --            --        80,238

Shares issued in June 2002, for
warrants exercised at $.41, in
connection with original private
placement                                --      --      189,327        189        77,720            --            --        77,910

Shares issued in July 2002, for
warrants exercised at $.40, in
connection with original private
placement                                --      --       41,970         42        16,830            --            --        16,872

Shares issued in July 2002 to
founders, for options exercised
at $1.00 per share                       --      --    1,000,000      1,000       999,000            --            --     1,000,000

Shares issued in August 2002,
for warrants exercised at $.43,
in connection with original
private placement                        --      --      542,500        543       232,459            --            --       233,001

Shares issued in August 2002,
for warrants exercised at $.40,
in connection with original
private placement                        --      --      193,302        193        77,127            --            --        77,320

Shares issued in October 2002,
for warrants exercised at $.40,
in connection with original
private placement                        --      --       77,048         77        30,896            --            --        30,973

Shares issued in October 2002,
for warrants exercised at $0.50
per share in connection with
original private placement               --      --      400,000        400       199,600            --            --       200,000

Common stock subscription                --      --           --         --            --    (1,805,400)           --    (1,805,400)

Return of founders shares in
connection with stock subscription       --      --   (1,805,400)    (1,805)   (1,803,595)    1,805,400            --            --

Stock based compensation for the
issuance of stock options to
consultants in exchange for
services (Note G)                        --      --           --         --       452,459            --            --       452,459

Stock based compensation for the
issuance of warrants to consultants
in exchange for services (Note G)        --      --           --         --       170,330            --            --       170,330

Stock based compensation for the
issuance of warrants to consultants
in exchange for financing costs
(Note G)                                 --      --           --         --        86,474            --            --        86,474

Beneficial conversion feature of
convertible debentures (Note E)          --      --           --         --       840,877            --            --       840,877

Value of warrants attached to
convertible debentures (Note E)          --      --           --         --       124,677            --            --       124,677

Net Loss                                 --      --           --         --            --            --    (3,778,488)   (3,778,488)
                                     ------- -------  -----------  ---------  ------------  ------------  ------------  ------------
 BALANCE AT DECEMBER 31, 2002            --  $   --   15,721,131   $ 15,721   $ 4,916,433   $        --   $(6,458,676)  $(1,526,522)
                                     ======= =======  ===========  =========  ============  ============  ============  ============

                                     See accompanying notes to consolidated financial statements

                                                                F-8
</TABLE>


<PAGE>

<TABLE>
                                                      TELKONET, INC.
                                               (A DEVELOPMENT STAGE COMPANY)
                                           CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>

                                                                                                          For the period from
                                                                                                           November 3, 1999
                                                                   For the year Ended December 31,        (date of inception)
                                                                  ---------------------------------       through December 31,
                                                                     2002                  2001                   2002
                                                                     ----                  ----                   ----
                                                                                 (As Restated - Note L)  (As Restated - Note L)
<S>                                                               <C>                   <C>                   <C>
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:

Net loss from development stage operations                        $(3,778,488)          $(1,716,495)          $(6,458,676)

Adjustments to reconcile net loss from development
stage operations to cash used for operating activities                     --                    --                    --

Amortization of debt discount - beneficial conversion
feature of convertible debentures (Note E)                            440,646                92,776               533,422

Amortization of debt discount - value of warrants
attached to convertible debentures (Note E)                            39,390                 8,552                47,942

Stock options and warrants issued in exchange for
services (Note G)                                                     622,790               333,072               955,862

Common stock issued in exchange for services rendered
(Note F)                                                              138,722                    --               150,302

Common stock issued in exchange for debenture interest
(Note F)                                                               21,793                    --                21,793

Impairment of property and equipment, net (Note B)                         --                39,287                39,287

Depreciation and amortization                                          84,067                30,797               136,944

Increase (decrease) in:

Other receivable                                                       (1,550)                   --                (1,550)

Inventory                                                             (39,790)                   --               (39,790)

Deposits                                                                   --                    --                (4,625)

Accounts payable and accrued expenses, net                            402,124              (136,846)              518,864
                                                                  ------------          ------------          ------------
NET CASH USED IN OPERATING ACTIVITIES                              (2,070,296)           (1,348,857)           (4,100,225)

CASH FLOWS FROM INVESTING ACTIVITIES:

Capital expenditures, net                                             (18,265)               (5,208)             (112,502)
                                                                  ------------          ------------          ------------
NET CASH USED IN INVESTING ACTIVITIES                                 (18,265)               (5,208)             (112,502)

CASH FLOWS FROM FINANCING ACTIVITIES:

Proceeds from sale of common stock, net of costs                      830,673               150,000             1,751,224

Proceeds from (repayments to) stockholder advances                    122,830                (2,500)              130,330

Proceeds from issuance of convertible debentures, net
of costs                                                            1,222,000               818,000             2,040,000

Repayment of loans                                                    (90,000)                   --               (90,000)

Proceeds from loans                                                        --               400,000               400,000
                                                                  ------------          ------------          ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES                           2,085,503             1,365,500             4,231,554

NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS                        (3,058)               11,435                18,827

Cash and cash equivalents at the beginning of the period               21,885                10,450                    --
                                                                  ------------          ------------          ------------
Cash and cash equivalents at the end of the period                $    18,827           $    21,885           $    18,827
                                                                  ============          ============          ============

                                See accompanying notes to consolidated financial statements

                                                           F-9
</TABLE>


<PAGE>

<TABLE>
                                                     TELKONET, INC.
                                             (A DEVELOPMENT STAGE COMPANY)
                                         CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>

                                                                                                        For the period from
                                                                                                         November 3, 1999
                                                                 For the year Ended December 31,        (date of inception)
                                                                ---------------------------------       through December 31,
                                                                   2002                  2001                   2002
                                                                   ----                  ----                   ----
                                                                               (As Restated - Note L)  (As Restated - Note L)
<S>                                                              <C>                  <C>                  <C>

Supplemental Disclosures of Cash Flow Information:

Cash transactions:

Cash paid during the period for interest                         $    30,885          $    24,965          $    55,850

Income taxes paid                                                         --                   --                   --

Non-cash transactions:

Issuance of warrants and options for services rendered               622,790              333,072              955,862

Common stock issued in exchange for services rendered                138,722                   --              150,302

Common stock issued in exchange for debenture interest                21,793                   --               21,793

Beneficial conversion feature on convertible debentures              840,877              837,874            1,678,751

Value of warrants attached to convertible debentures                 124,677               77,254              201,931

Acquisition:

   Assets acquired                                                        --                   --                    1

   Accumulated deficit                                                    --                   --                2,643

   Liabilities assumed                                                    --                   --               (2,642)
                                                                 ------------         ------------         ------------
                                                                 $        --          $        --          $         1
                                                                 ------------         ------------         ------------

                              See accompanying notes to consolidated financial statements

                                                         F-10
</TABLE>


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE A-SUMMARY OF ACCOUNTING POLICIES

A summary of the significant accounting policies applied in the preparation of
the accompanying consolidated financial statements follows.

Business and Basis of Presentation
----------------------------------

Telkonet, Inc. (the "Company"), formerly Comstock Coal Company, Inc., was formed
on November 3, 1999 under the laws of the state of Utah. The Company is a
development stage enterprise, as defined by Statement of Financial Accounting
Standards No. 7 ("SFAS 7") and is seeking to develop, produce and market
proprietary equipment enabling the transmission of voice and data over electric
utility lines. From its inception through the date of these financial
statements, the Company has recognized no revenues and has incurred significant
operating expenses.

The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Telkonet Communications, Inc. Significant
intercompany transactions have been eliminated in consolidation.

Cash and Cash Equivalents
-------------------------

For purposes of the Statements of Cash Flows, the Company considers all highly
liquid debt instruments purchased with a maturity date of three months or less
to be cash equivalents.

Property and Equipment
----------------------

Property and equipment is stated at cost. Depreciation is calculated using the
straight-line method over the estimated useful lives of the assets.

Long-Lived Assets
-----------------

The Company has adopted Statement of Financial Accounting Standards No. 144
(SFAS 144). The Statement requires that long-lived assets and certain
identifiable intangibles held and used by the Company be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Events relating to recoverability may include
significant unfavorable changes in business conditions, recurring losses, or a
forecasted inability to achieve break-even operating results over an extended
period. The Company evaluates the recoverability of long-lived assets based upon
forecasted undercounted cash flows. Should an impairment in value be indicated,
the carrying value of intangible assets will be adjusted, based on estimates of
future discounted cash flows resulting from the use and ultimate disposition of
the asset. SFAS No. 144 also requires assets to be disposed of be reported at
the lower of the carrying amount or the fair value less costs to sell.

                                      F-11


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE A-SUMMARY OF ACCOUNTING POLICIES (CONTINUED)

Inventories
-----------

Inventories are stated at the lower of cost or market determined by the
first-in, first-out (FIFO) method. Inventories consist of Internet applications,
routers and related products available for sale to distributors and retailers.
Components of inventories as of December 31, 2002 and 2001 are as follows:

                                                       2002               2001
                                                       ----               ----
         Finished Goods                              $ 39,790            $   -

Income Taxes
------------

The Company has implemented the provisions on Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires
that income tax accounts be computed using the liability method. Deferred taxes
are determined based upon the estimated future tax effects of differences
between the financial reporting and tax reporting bases of assets and
liabilities given the provisions of currently enacted tax laws.

Net Loss Per Common Share
-------------------------

The Company computes earnings per share under Financial Accounting Standard No.
128, "Earnings Per Share" (SFAS 128). Net loss per common share is computed by
dividing net loss by the weighted average number of shares of common stock and
dilutive common stock equivalents outstanding during the year. Dilutive common
stock equivalents consist of shares issuable upon conversion of convertible
preferred shares and the exercise of the Company's stock options and warrants
(calculated using the treasury stock method). During 2002 and 2001, common stock
equivalents are not considered in the calculation of the weighted average number
of common shares outstanding because they would be anti-dilutive, thereby
decreasing the net loss per common share.

Use of Estimates
----------------

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. Accordingly, actual results
could differ from those estimates.

Revenue Recognition
-------------------

The Company follows a policy of recognizing revenues as services are rendered or
at the time the product is shipped to or picked up by customers.

                                      F-12


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE A-SUMMARY OF ACCOUNTING POLICIES (CONTINUED)

Advertising
-----------

The Company follows the policy of charging the costs of advertising to expenses
incurred. The Company incurred no advertising costs during the years ended
December 31, 2002 and 2001, and for the period from November 3, 1999 (date of
inception) to December 31, 2002.

Research and Development
------------------------

The Company accounts for research and development costs in accordance with the
Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 2 ("SFAS 2"), "Accounting for Research and Development Costs.
Under SFAS 2, 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 developments 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 2002, 2001, and the period from November 3,
1999 (date of inception) to December 31, 2002 were $280,450, $ 120,828, and
$520,278, respectively.

Liquidity
---------

As shown in the accompanying financial statements, the Company has incurred a
net loss of $6,458,676 from its inception through December 31, 2002. The
Company's current liabilities exceeded its current assets by $894,403 as of
December 31, 2002.

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 related party 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 periodically reviews its
trade receivables in determining its allowance for doubtful accounts. The
allowance for doubtful accounts was $0 at December 31, 2002 and 2001.

Comprehensive Income
--------------------

Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting
Comprehensive Income," establishes standards for reporting and displaying of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. Among other disclosures, SFAS
130 requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. The Company does not have any items of comprehensive
income in any of the periods presented.

                                      F-13


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE A-SUMMARY OF ACCOUNTING POLICIES (CONTINUED)

Stock Based Compensation
------------------------

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS 123." This statement
amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary charge to the fair value based
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in APB
Opinion No. 25 and related interpretations. Accordingly, compensation expense
for stock options is measured as the excess, if any, of the fair market value of
the Company's stock at the date of the grant over the exercise price of the
related option. The Company has adopted the annual disclosure provisions of SFAS
No. 148 in its financial reports for the year ended December 31, 2002 and will
adopt the interim disclosure provisions for its financial reports for the
quarter ended March 31, 2003.

Had compensation costs for the Company's stock options been determined based on
the fair value at the grant dates for the awards, the Company's net loss and
losses per share would have been as follows (transactions involving stock
options issued to employees and Black-Scholes model assumptions are presented in
Note G):

<TABLE>
<CAPTION>
                                                                                      2002                2001
                                                                                      ----                ----
<S>                                                                               <C>                 <C>
Net loss - as reported                                                            $ (3,778,488)       $ (1,716,495)
Add: Total stock based employee compensation expense as reported under
intrinsic value method (APB. No. 25)                                                         -                   -
Deduct: Total stock based employee compensation expense as reported under
fair value based method (SFAS No. 123)                                                (210,833)            (81,852)
                                                                                  -------------       -------------
Net loss - Pro Forma                                                              $ (3,989,321)       $ (1,798,347)
Net loss attributable to common stockholders - Pro forma                          $ (3,989,321)       $ (1,798,347)
Basic (and assuming dilution) loss per share - as reported                          $    (0.22)          $   (0.08)
Basic (and assuming dilution) loss per share - Pro forma                            $    (0.23)          $   (0.08)
</TABLE>

Segment Information
-------------------

Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131") establishes standards for
reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS 131 also establishes
standards for related disclosures about products and services and geographic
areas. Operating segments are identified as components of an enterprise about
which separate discrete financial information is available for evaluation by the
chief operating decision maker, or decision-making group, in making decisions
how to allocate resources and assess performance. The information disclosed
herein materially represents all of the financial information related to the
Company's principal operating segment.

                                      F-14


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE A-SUMMARY OF ACCOUNTING POLICIES (CONTINUED)

Reclassifications
-----------------

Certain reclassifications have been made in prior year's financial statements to
conform to classifications used in the current year (see Note L).

New Accounting Pronouncements
-----------------------------

In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" (SFAS No.
141), and Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" (SFAS No. 142). The FASB also issued Statement of
Financial Accounting Standards No. 143, "Accounting for Obligations Associated
with the Retirement of Long-Lived Assets" (SFAS No. 143), and Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144) in August and October 2001,
respectively.

SFAS No. 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interest method. The adoption of SFAS No. 141 had no material impact
on the Company's consolidated financial statements.

Effective January 1, 2002, the Company adopted SFAS No. 142. Under the new
rules, the Company will no longer amortize goodwill and other intangible assets
with indefinite lives, but such assets will be subject to periodic testing for
impairment. On an annual basis, and when there is reason to suspect that their
values have been diminished or impaired, these assets must be tested for
impairment, and write-downs to be included in results from operations may be
necessary. SFAS No. 142 also requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption.

Any goodwill impairment loss recognized as a result of the transitional goodwill
impairment test will be recorded as a cumulative effect of a change in
accounting principle no later than the end of fiscal year 2002. The adoption of
SFAS No. 142 had no material impact on the Company's consolidated financial
statements

SFAS No. 143 establishes accounting standards for the recognition and
measurement of an asset retirement obligation and its associated asset
retirement cost. It also provides accounting guidance for legal obligations
associated with the retirement of tangible long-lived assets. SFAS No. 143 is
effective in fiscal years beginning after June 15, 2002, with early adoption
permitted. The Company expects that the provisions of SFAS No. 143 will not have
a material impact on its consolidated results of operations and financial
position upon adoption. The Company plans to adopt SFAS No. 143 effective
January 1, 2003.

SFAS No. 144 establishes a single accounting model for the impairment or
disposal of long-lived assets, including discontinued operations. SFAS No. 144
superseded Statement of Financial Accounting Standards No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
(SFAS No. 121), and APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions". The Company adopted
SFAS No. 144 effective January 1, 2002. The adoption of SFAS No. 144 had no
material impact on Company's consolidated financial statements.

                                      F-15


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE A-SUMMARY OF ACCOUNTING POLICIES (CONTINUED)

New Accounting Pronouncements (Continued)
-----------------------------------------

In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This Statement rescinds FASB Statement No. 4, "Reporting Gains and
Losses from Extinguishment of Debt", and an amendment of that Statement, FASB
Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements" and FASB Statement No. 44, "Accounting for Intangible Assets of
Motor Carriers". This Statement amends FASB Statement No. 13, "Accounting for
Leases", to eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. The Company does not expect the adoption to have a material impact
to the Company's financial position or results of operations.

In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. The
Company does not expect the adoption to have a material impact to the Company's
financial position or results of operations.

In October 2002, the FASB issued Statement No. 147, "Acquisitions of Certain
Financial Institutions-an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9", which removes acquisitions of financial institutions from
the scope of both Statement 72 and Interpretation 9 and requires that those
transactions be accounted for in accordance with Statements No. 141, Business
Combinations, and No. 142, Goodwill and Other Intangible Assets. In addition,
this Statement amends SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, to include in its scope long-term customer-relationship
intangible assets of financial institutions such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
The requirements relating to acquisitions of financial institutions is effective
for acquisitions for which the date of acquisition is on or after October 1,
2002. The provisions related to accounting for the impairment or disposal of
certain long-term customer-relationship intangible assets are effective on
October 1, 2002. The adoption of this Statement did not have a material impact
to the Company's financial position or results of operations as the Company has
not engaged in either of these activities.

                                      F-16


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE A-SUMMARY OF ACCOUNTING POLICIES (CONTINUED)

New Accounting Pronouncements (Continued)
-----------------------------------------

In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure", which amends FASB Statement No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The transition guidance and annual disclosure provisions of Statement
148 are effective for fiscal years ending after December 15, 2002, with earlier
application permitted in certain circumstances. The interim disclosure
provisions are effective for financial reports containing financial statements
for interim periods beginning after December 15, 2002. The adoption of this
statement did not have a material impact on the Company's financial position or
results of operations as the Company has not elected to change to the fair value
based method of accounting for stock-based employee compensation.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation 46 changes the criteria by which one
company includes another entity in its consolidated financial statements.
Previously, the criteria were based on control through voting interest.
Interpretation 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. A company that consolidates a variable
interest entity is called the primary beneficiary of that entity. The
consolidation requirements of Interpretation 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation requirements
apply to older entities in the first fiscal year or interim period beginning
after June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company does not expect the
adoption to have a material impact to the Company's financial position or
results of operations.

NOTE B - PROPERTY, PLANT AND EQUIPMENT

The Company's property and equipment at December 31, 2002 and 2001 consists of
the following:

                                                     2002            2001
                                                     ----            ----
     Office Equipment                             $ 58,514        $ 42,005
     Office Fixtures and Furniture                  14,701          12,945
                                                  ---------       ---------
        Total                                       73,215          54,950
     Accumulated Depreciation                      (35,252)        (28,108)
                                                  ---------       ---------
                                                  $ 37,963        $ 26,842
                                                  =========       =========

Depreciation expense included as a charge to income amounted to $7,144, $6,028,
and $35,252 for the year ended December 31, 2002, 2001, and from inception to
December 31, 2002, respectively.

                                      F-17


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE B - PROPERTY, PLANT AND EQUIPMENT (CONTINUED)

Impairment of Property and Equipment
------------------------------------

During the year ended December 31, 2001, the Company recorded a charge for
for the impairment of certain property and equipment held and used by the
Company because the estimated fair value of the assets was less than the
carrying value.  Considerable management judgment is necessary to estimate
fair value. Accordingly, actual results could vary significantly from
managements' estimates. Based upon the evaluation, the Company recognized
an asset impairment loss of $ 39,287 or $ (.00) per share during the year
ended  December 31, 2001.









NOTE C - RELATED PARTY TRANSACTIONS

A company officer has advanced funds to the Company for working capital
purposes. No formal repayment terms or arrangements exist. The net amount of
advances due the officer at December 31, 2002 was $4,830.

Significant shareholders of the Company have advanced funds to the Company for
working capital purposes. The amount of the advances at December 31, 2002 and
2001 is $125,500 and $7,500, respectively. No formal repayment terms or
arrangements exist.

NOTE D - NOTES PAYABLE

Notes payable at December 31, 2002 and 2001 consists of the following:

<TABLE>
<CAPTION>
                                                                                             2002            2001
                                                                                             ----            ----
<S>                                                                                        <C>            <C>
     Note payable in monthly installments of interest only at 7.5% per annum,
     unsecured and guaranteed by a Company shareholder. Maturity date is in September
     2002; the Company paid the debt in full in February 2003                              $  60,000      $ 150,000

     Note payable in monthly installments of interest only at the prime lending rate
     plus 1%, unsecured and guaranteed by a Company shareholder. The original maturity
     date of the loan was extended from March 2002 to March 2003                             250,000        250,000

                                                                                             310,000        400,000
     Less: current portion                                                                  (310,000)      (400,000)
                                                                                           ----------     ----------
                                                                                           $      --      $      --
                                                                                           ==========     ==========

                                      F-18
</TABLE>


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001


NOTE E - CONVERTIBLE PROMISSORY NOTES PAYABLE

A summary of convertible promissory notes payable at December 31, 2002 and 2001
is as follows:

<TABLE>
<CAPTION>
                                                                  2002              2001
                                                                  ----              ----
<S>                                                            <C>              <C>
     Convertible notes payable ("Debenture-1"), in
     quarterly installments of interest only at 8% per
     annum, unsecured and due three years from the date of
     the note with the latest maturity May 2005;
     Noteholder has the option to convert unpaid note
     principal together with accrued and unpaid interest
     to the Company's common stock at a rate of $.50 per
     share six months after issuance                           $ 1,689,100      $   940,000

     Debt Discount - beneficial conversion feature, net of
     amortization of $439,082 in 2002 and $92,776 in 2001         (999,034)        (745,098)

     Debt Discount - value attributable to warrants
     attached to notes, net of amortization of $38,664
     in 2002 and $8,552 in 2001                                    (86,120)         (68,702)
                                                               ------------     ------------
                                                                   603,946          126,200

     Convertible notes payable ("Series B Debenture"), in
     quarterly installments of interest only at 8% per
     annum, unsecured and due three years from the date of
     the note with the latest maturity December 2005;
     Noteholder has the option to convert unpaid note
     principal together with accrued and unpaid interest
     to the Company's common stock at a rate of $.55 per
     share six months after issuance                               472,900               --

     Debt Discount - beneficial conversion feature, net
     of amortization of $1,564 in 2002                            (146,295)              --

     Debt Discount - value attributable to warrants
     attached to notes, net of amortization of $726 in
     2002                                                         (67,869)              --
                                                               -----------      -----------
                                                                  258,736               --
                                                               -----------      -----------
       Total                                                   $  862,682       $   126,200
                                                               -----------      -----------
       Less: current portion                                           --                --
                                                               -----------      -----------
                                                               $  862,682       $   126,200
                                                               ============     ============
</TABLE>

                                      F-19


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE E - CONVERTIBLE PROMISSORY NOTES PAYABLE (CONTINUED)

Convertible Debentures
----------------------

During the year ended December 31, 2001, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $940,000, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of
November 2004. Noteholder has the option to convert any unpaid note principal
together with accrued and unpaid interest to the Company's common stock at a
rate of $.50 per share six months after issuance. In accordance with Emerging
Issues Task Force Issue 98-5, Accounting for Convertible Securities with a
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios
("EITF 98-5"), the Company recognized an imbedded beneficial conversion feature
present in the Debenture-1 note. The Company allocated a portion of the proceeds
equal to the intrinsic value of that feature to additional paid in capital. The
Company recognized and measured an aggregate of $837,874 of the proceeds, which
is equal to the intrinsic value of the imbedded beneficial conversion feature,
to additional paid in capital and a discount against the Debenture-1. The debt
discount attributed to the beneficial conversion feature is amortized over the
Debenture-1's maturity period (three years) as interest expense.

In connection with the placement of the Debenture-1 notes, the Company issued
non-detachable warrants granting the holders the right to acquire 940,000 shares
of the Company's common stock at $1.00 per share. In accordance with Emerging
Issues Task Force Issue 00-27, Application of Issue No. 98-5 to Certain
Convertible Instruments ("EITF - 0027"), the Company recognized the value
attributable to the warrants in the amount of $77,254 to additional paid in
capital and a discount against the Debenture-1. The Company valued the warrants
in accordance with EITF 00-27 using the Black-Scholes pricing model and the
following assumptions: contractual terms of 3 years, an average risk free
interest rate of 4.25%, a dividend yield of 0%, and volatility of 21%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.

During the year ended December 31, 2002, the Company issued convertible
promissory notes (the "Debenture-1") to Company officers, shareholders, and
sophisticated investors in exchange for $749,100, exclusive of placement costs
and fees. The Debenture-1 accrues interest at 8% per annum and is payable and
due three years from the date of the note with the latest maturity date of May
2005. Noteholders have the option to convert any unpaid note principal together
with accrued and unpaid interest to the Company's common stock at a rate of $.50
per share six months after issuance.

In accordance with Emerging Issues Task Force Issue 98-5, Accounting for
Convertible Securities with a Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Debenture-1 note. The Company
allocated a portion of the proceeds equal to the intrinsic value of that feature
to additional paid in capital. The Company recognized and measured an aggregate
of $693,018 of the proceeds, which is equal to the intrinsic value of the
imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Debenture-1. The debt discount attributed to the beneficial
conversion feature is amortized over the Debenture-1's maturity period (three
years) as interest expense.

                                      F-20


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE E - CONVERTIBLE PROMISSORY NOTES PAYABLE

Convertible Debentures (Continued)
----------------------------------

In connection with the placement of the Debenture-1 notes in 2002, the Company
issued non-detachable warrants granting the holders the right to acquire 749,100
shares of the Company's common stock at $1.00 per share. In accordance with
Emerging Issues Task Force Issue 00-27, Application of Issue No. 98-5 to Certain
Convertible Instruments ("EITF -0027"), the Company recognized the value
attributable to the warrants in the amount of $56,082 to additional paid in
capital and a discount against the Debenture-1. The Company valued the warrants
in accordance with EITF 00-27 using the Black-Scholes pricing model and the
following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.67%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Debenture-1's maturity period (three years) as interest expense.

Series B Debentures
-------------------

In October and December 2002, the Company issued convertible promissory notes
(the "Series B Debenture") to Company officers, shareholders, and sophisticated
investors in exchange for $472,900 , exclusive of placement costs and fees .The
Series B Debenture accrues interest at 8% per annum and is payable and due three
years from the date of the note with the latest maturity date of December 2005.
Noteholders have the option to convert any unpaid note principal together with
accrued and unpaid interest to the Company's common stock at a rate of $.55 per
share six months after issuance.

In accordance with Emerging Issues Task Force Issue 98-5, Accounting for
Convertible Securities with a Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the Series B Debenture note. The
Company allocated a portion of the proceeds equal to the intrinsic value of that
feature to additional paid in capital. The Company recognized and measured an
aggregate of $147,859 of the proceeds, which is equal to the intrinsic value of
the imbedded beneficial conversion feature, to additional paid in capital and a
discount against the Series B Debenture. The debt discount attributed to the
beneficial conversion feature is amortized over the Series B Debenture's
maturity period (three years) as interest expense.

In connection with the placement of the Series B Debenture notes in 2002, the
Company issued non-detachable warrants granting the holders the right to acquire
472,900 shares of the Company's common stock at $1.00 per share. In accordance
with Emerging Issues Task Force Issue 00-27, Application of Issue no. 98-5 to
Certain Convertible Instruments ("EITF -0027"), the Company recognized the value
attributable to the warrants in the amount of $68,595 to additional paid in
capital and a discount against the Series B Debenture. The Company valued the
warrants in accordance with EITF 00-27 using the Black-Scholes pricing model and
the following assumptions: contractual terms of 3 years, an average risk free
interest rate of 1.67%, a dividend yield of 0%, and volatility of 26%. The debt
discount attributed to the value of the warrants issued is amortized over the
Series B Debenture's maturity period (three years) as interest expense.

The Company amortized the Debenture 1 and the Series B Debenture debt discount
attributed to the beneficial conversion feature and the value of the attached
warrants and recorded non-cash interest expense of $480,036 and $101,328 for the
years ended December 31, 2002 and 2001, respectively.

                                      F-21


<PAGE>
                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE F - CAPITAL STOCK

The Company has authorized 15,000,000 shares of preferred stock, with a par
value of $.001 per share. As of December 31, 2002, the Company has no preferred
stock issued and outstanding. The company has authorized 100,000,000 shares of
common stock, with a par value of $.001 per share. As of December 31, 2002, the
Company has 15,721,131 shares of common stock issued and outstanding.

In January 2000, the Company issued 19,300 shares to its founders, in exchange
for costs and services, valued at $11,580.

In June 2000, the Company issued a total of 1,735 shares of common stock in a
private placement to sophisticated investors, primarily in the United States in
exchange for $ 644,236 net of costs and fees. In July 2000 the Predecessor
issued 190 shares of common stock in exchange for exercised warrants at $375 per
share, totaling $71,250

In August 2000, the Company issued 21,775,345 shares of common stock in
conjunction with the merger of Comstock Coal Company, Inc. In connection with
the transaction, the Company retired 21,225 shares of previously issued Telkonet
Communications, Inc common stock.

In October 2000, the Company issued 29,145 and 10,881 shares of common stock in
exchange for exercised warrants with exercise prices of $1.00 and $0.40 per
share, respectively.

In June 2001 and August 2001, the Company issued 260,000 and 40,000 shares of
its common stock, respectively, in a private placement to sophisticated
investors in exchange for $150,000, net of costs and fees.

In January 2002, the Company re-organized its capital structure, whereby the
Company agreed to purchase 8,936,244 shares of the Company's common stock held
by the Founders and cancel certain vested options held by the Founders to
purchase the Company's common stock, in exchange for the issuance of newly
issued options to purchase 3,500,000 shares of the Company's common stock. The
new stock options expire in January 2012, and have an exercise price of $1.00
per share, which is in excess of the weighted average fair value of the
Company's common stock at the grant dates. The canceled options had no intrinsic
value at the award date and as a result, the Company did not incur a
compensation cost in connection with the cancellation of the options. In
connection with this transaction, the Company issued 5,250,000 shares of common
stock to founders and canceled 13,480,961 shares of previously issued common
stock.

In June and July 2002, two of the Founders exercised the stock options to
purchase 2,000,000 shares of the Company's common stock. The Company entered
into four promissory notes with principal amounts of $250,000 each and two
promissory notes with principal amounts of $500,000 each with the two Founders
to ensure payments for issued stock. The notes are due one year from the date of
issuance. Interest will begin to accrue from and after the maturity dates on any
unpaid principal balance at an interest rate of 6% per annum. During the year
2002, the Company received $194,600 proceeds from the stock subscription. In
December 2002, the Founders returned a total of 1,805,400 shares of common stock
to the Company and the unpaid principal amount of the promissory notes was
canceled accordingly.

                                      F-22


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE F - CAPITAL STOCK (CONTINUED)

In February 2002, the Company issued 43,586 shares of common stock to its
convertible debenture holders in exchange for interest of $21,793.

In June 2002, the Company issued 154,388 shares of common stock to consultants
for warrants exercised at prices ranging from $.40 to $1.00 per share in
exchange for services, totaling $138,722., which approximated the fair value of
the shares issued during the period the services were completed and rendered.
Compensation costs of $ 138,722 were charged to income during the year ended
December 31, 2002. In 2002, the Company issued 1,444,147 shares of common stock,
or $636,076 to sophisticated investors for warrants exercised at prices ranging
from $.40 to $.50 per share.

Share amounts presented in the consolidated balance sheets and consolidated
statements of stockholders' equity reflect the actual share amounts outstanding
for each period presented.

NOTE G - STOCK OPTIONS AND WARRANTS

Employee Stock Options

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 a non-qualified employee stock option plan.

<TABLE>
<CAPTION>
                                Options Outstanding                                     Options Exercisable
                                -------------------                                     -------------------
                                            Weighted Average         Weighted                        Weighted
                           Number        Remaining Contractual        Average         Number         Average
    Exercise Prices     Outstanding           Life (Years)        Exercise Price    Exercisable   Exercise Price
    ---------------     -----------           ------------        --------------    -----------   --------------
<S>    <C>               <C>                    <C>                <C>               <C>             <C>
       $  1.00           1,450,000              9.08               $ 1.00            649,935         $  1.00
</TABLE>

Transactions involving stock options issued to employees are summarized as
follows:

                                                                Weighted Average
                                            Number of Shares    Price Per Share
                                            ----------------    ---------------
       Outstanding at January 1, 2001            840,000                  -
          Granted                                215,000            $  1.00
          Exercised                                    -                  -
          Canceled or expired                          -                  -
                                              -----------           --------
       Outstanding at December 31, 2001        1,055,000               1.00
          Granted                              2,835,000               1.00
          Exercised                           (1,000,000)              1.00
          Canceled or expired                 (1,440,000)              1.00
                                              -----------           --------
       Outstanding at December 31, 2002        1,450,000            $  1.00
                                              ===========           ========

                                      F-23


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE G - STOCK OPTIONS AND WARRANTS (CONTINUED)

Employee Stock Options (Continued)
----------------------------------

The weighted-average fair value of stock options granted to employees during the
years ended December 31, 2002 and 2001 and the weighted-average significant
assumptions used to determine those fair values, using a Black-Scholes option
pricing model are as follows:

                                                              2002        2001
                                                              ----        ----
       Significant assumptions (weighted-average):
           Risk-free interest rate at grant date             1.67%        4.25%
           Expected stock price   volatility                   26%          21%
           Expected dividend payout                             -            -
           Expected option life-years (a)                      10           10
         (a)The expected option life is based on contractual expiration dates.

If the Company recognized compensation cost for the non-qualified employee stock
option plan in accordance with SFAS No. 123, the Company's pro forma net loss
and net loss per share would have been $(3,989,321) and $(0.23) in 2002 and
$(1,798,347) and $(0.08) in 2001, respectively.

Non-Employee Stock Options
--------------------------

The following table summarizes the changes in options outstanding and the
related prices for the shares of the Company's common stock issued to the
Company consultants. These options were granted in lieu of cash compensation for
services performed.

<TABLE>
<CAPTION>
                                Options Outstanding                                     Options Exercisable
                                -------------------                                     -------------------
                                            Weighted Average          Weighed                        Weighted
                           Number        Remaining Contractual        Average         Number         Average
    Exercise Prices     Outstanding           Life (Years)        Exercise Price    Exercisable   Exercise Price
    ---------------     -----------           ------------        --------------    -----------   --------------
<S>      <C>             <C>                      <C>                 <C>            <C>              <C>
         $1.00           1,555,000                8.93                $ 1.00         1,298,829        $  1.00
</TABLE>

Transactions involving options issued to non-employees are summarized as
follows:

                                                               Weighted Average
                                            Number of Shares    Price Per Share
                                            ----------------    ---------------
       Outstanding at January 1, 2001
          Granted                                  246,502          $  0.70
          Exercised                                      -                -
          Canceled or expired                            -                -
                                               ------------         --------
       Outstanding at December 31, 2001            246,502             0.70
          Granted                                2,455,000             1.00
          Exercised                             (1,146,502)            0.96
          Canceled or expired                            -                -
                                               ------------         --------
       Outstanding at December 31, 2002          1,555,000          $  1.00
                                               ============         ========

                                      F-24


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE G - STOCK OPTIONS AND WARRANTS (CONTINUED)

Non-Employee Stock Options (Continued)
--------------------------------------

The estimated value of the options granted to consultants was determined using
the Black-Scholes option pricing model and the following assumptions:
contractual term of 10 years, a risk free interest rate of 1.67%, a dividend
yield of 0% and volatility of 26%. The amount of the expense charged to
operations in connection with granting the options was $452,459 and $11,592
during 2002 and 2001, respectively.

Warrants
--------

The following table summarizes the changes in warrants outstanding and the
related prices for the shares of the Company's common stock issued to
non-employees of the Company. These warrants were granted in lieu of cash
compensation for services performed or financing expenses and in connection with
placement of convertible debentures.

<TABLE>
<CAPTION>
                                Warrants Outstanding                                   Warrants Exercisable
                                --------------------                                   --------------------
                                            Weighted Average          Weighed                        Weighted
                           Number        Remaining Contractual        Average         Number         Average
    Exercise Prices     Outstanding           Life (Years)        Exercise Price    Exercisable   Exercise Price
    ---------------     -----------           ------------        --------------    -----------   --------------
<S>       <C>            <C>                      <C>                <C>             <C>             <C>
          $ .50            815,000                8.00               $  .50            815,000       $  .50
          $ .53            354,460                3.00               $  .53            354,460       $  .53
          $1.00          2,362,000                3.00               $ 1.00          2,362,000       $ 1.00
                        ===========                                                  ==========
                         3,531,460                                                   3,531,460
                        ===========                                                  ==========
</TABLE>
Transactions involving warrants are summarized as follows:

                                                           Weighted Average
                                        Number of Shares   Price Per Share
                                        ----------------   ---------------

     Outstanding at January 1, 2001        1,210,572      $           1.00
        Granted                            3,528,665                  0.67
        Exercised                                 --                    --
        Canceled or expired               (1,210,572)                 1.00
                                          -----------     -----------------
     Outstanding at December 31, 2001      3,528,665      $           0.67
        Granted                            1,667,460                  0.87
        Exercised                         (1,650,675)                 0.51
        Canceled or expired                  (13,990)                 1.00
                                          -----------     -----------------
     Outstanding at December 31, 2002      3,531,460      $           0.84
                                          ===========     =================

The estimated value of the compensatory warrants granted to non-employees in
exchange for services and financing expenses was determined using the
Black-Scholes pricing model and the following assumptions: contractual term of 3
to 8 years, a risk free interest rate of 1.67%, a dividend yield of 0% and
volatility of 26%. The amount of the expense charged to operations for
compensatory warrants granted in exchange for services and services was $170,330
and $321,479 during 2002 and 2001, respectively. The Company also capitalized
financing costs of $86,474 and $85,818 for compensatory warrants granted in
connection with placement of convertible debentures for the year ended December
31, 2002 and 2001, respectively. The financing cost was amortized over the life
(three years) of the convertible debenture.

                                      F-25


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE H - INCOME TAXES

The Company has adopted Financial Accounting Standard No. 109 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. Temporary differences between taxable
income reported for financial reporting purposes and income tax purposes are
insignificant.

For income tax reporting purposes, the Company's aggregate unused net operating
losses approximate $6,450,000 which expire through 2022, subject to limitations
of Section 382 of the Internal Revenue Code, as amended. The deferred tax asset
related to the carryforward is approximately $2,193,000. The Company has
provided a valuation reserve against the full amount of the net operating loss
benefit, because in the opinion of management based upon the earning history of
the Company, it is more likely than not that the benefits will not be realized.

Components of deferred tax assets as of December 31, 2002 are as follows:

          Non Current:
                 Net operating loss carryforward                   $ 2,193,000
                 Valuation allowance                                (2,193,000)
                                                                   ------------
                 Net deferred tax asset                            $        --
                                                                   ============
NOTE I - COMMITMENTS AND CONTINGENCIES

Lease Commitments
-----------------

The Company leases office space on a year to year basis in Annapolis, Maryland
for its corporate offices. Commitments for minimum rentals under non cancelable
leases at December 31, 2002 are as follows:

                          2003                                  $ 44,746
                                                                ---------
                                                                $ 44,746
                                                                =========

Employment and Consulting Agreements
------------------------------------

The Company has employment agreements with the Company's employees. In addition
to salary and benefit provisions, the agreements include defined commitments
should the employer terminate the employment with or without cause.

The Company has consulting agreements with outside contractors to provide
marketing and financial advisory services. The Agreements are generally for a
term of 12 months from inception and renewable automatically from year to year
unless either the Company or Consultant terminates such engagement by written
notice.

                                      F-26


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE I - COMMITMENTS AND CONTINGENCIES (CONTINUED)

Litigation
----------

The Company is subject to other 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.

NOTE J - LOSSES PER COMMON SHARE

The following table presents the computations of basic and dilutive loss per
share:

<TABLE>
<CAPTION>
                                                                                          For the period from November
                                                                                           3, 1999 (date of inception)
                                                         2002                   2001        through December 31, 2002
                                                         ----                   ----        -------------------------
<S>                                                 <C>                    <C>                    <C>
Net loss available to common shareholders           $ (3,778,488)          $ (1,716,495)          $ (6,458,676)
Basic and fully diluted loss per share              $      (0.22)          $      (0.08)          $      (0.40)
Weighted average common shares outstanding            17,119,639             21,974,439             16,050,030
</TABLE>

NOTE K - GOING CONCERN MATTERS

The accompanying statements have been prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. As shown in the financial statements from
November 3, 1999 (date of inception of Company), the Company incurred loses from
operations of $6,458,676. This factor among others may indicate that the Company
will be unable to continue as a going concern for a reasonable period of time.

The Company's existence is dependent upon management's ability to develop
profitable operations and resolve it's liquidity problems. Management
anticipates the Company will attain profitable status and improve it liquidity
through the continued developing of its products, establishing a profitable
market for the Company's products and additional equity investment in the
Company. The accompanying consolidated financial statements do not include any
adjustments that might result should the Company be unable to continue as a
going concern.

In order to improve the Company's liquidity, the Company is actively pursing
additional equity financing through discussions with investment bankers and
private investors. There can be no assurance the Company will be successful in
its effort to secure additional equity financing.

If operations and cash flows continue to improve through these efforts,
management believes that the Company can continue to operate. However, no
assurance can be given that management's actions will result in profitable
operations or the resolution of its liquidity problems.

                                      F-27


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE L - RESTATEMENT OF FINANCIAL STATEMENTS

The Company has restated its financial statements for the year ended December
31, 2001 to correct the following errors in the financial statements previously
filed:

         o        The Company erroneously recorded the Black-Scholes value of
                  the 940,000 warrants attached to its convertible debentures as
                  an asset (financing cost), and amortized over the maturity
                  period (three year) of the note.

         o        The Company erroneously recorded the beneficial conversion
                  feature of its convertible debentures as an asset (financing
                  cost) and the beneficial conversion feature was erroneously
                  amortized over six-months (from the issuance of the note to
                  the earliest conversion date).

         o        The Company erroneously recorded impairment of property and
                  equipment as research and development expense.

     The net effect of the correction of these errors was to:

         o        Decrease the Company's reported net loss for the year ended
                  December 31, 2001 by $289,645 from $(2,006,140) to
                  $(1,716,495).

         o        Decrease the loss per share by $.01 from $(.09) to $(.08) per
                  share.

         o        Decrease the deficiency accumulated during the development
                  stage by $289,645 from $(2,969,833) to $(2,680,188).

         o        Decrease other assets by $501,276 from $688,950 to $187,674.

         o        Increase debt discount by $813,800 from $0 to $813,800 (Note
                  E).

         o        Increase additional paid in capital by $22,879 from $2,221,154
                  to $2,244,033.

Following are reconciliations of the Company's restatement of the Consolidated
Balance Sheet as of December 31, 2001 and Consolidated Statement of Losses for
the year ended 2001.

                                      F-28


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE L - RESTATEMENT OF FINANCIAL STATEMENTS (CONTINUED)

<TABLE>
                                               TELKONET, INC.
                                       (A DEVELOPMENT STAGE COMPANY)
                                         CONSOLIDATED BALANCE SHEET
                                             DECEMBER 31, 2001
<CAPTION>

                                                           As Reported        Adjustment        Restated
                                                          -------------     -------------     -------------
<S>                                                       <C>               <C>               <C>
ASSETS
 CURRENT ASSETS:
 Cash and equivalents                                     $     21,885                        $     21,885
                                                          -------------                       -------------
 Total current assets                                           21,885                              21,885

 PROPERTY AND EQUIPMENT:

 Furniture and equipment, at cost                               54,950                              54,950

 Less:  accumulated depreciation                                28,108                              28,108
                                                          -------------                       -------------
                                                                26,842                              26,842
 OTHER ASSETS:
 Financing costs, net of amortization                          684,325      $   (501,276)          183,049

 Prepaid expenses and deposits                                   4,625                               4,625
                                                          -------------                       -------------
                                                               688,950                             187,674

                                                          $    737,677      $   (501,276)     $    236,401
                                                          =============     =============     =============
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
 CURRENT LIABILITIES:
 Accounts payable and accrued expenses                    $    116,741                        $    116,741

 Notes payable                                                 400,000                             400,000

 Due to Shareholders                                             7,500                               7,500
                                                          -------------                       -------------
 Total current liabilities                                     524,241                             524,241

 Convertible debentures, net of discounts - including
  Related parties                                              940,000      $   (813,800)          126,200

 COMMITMENTS AND CONTINGENCIES                                      --                                  --

 DEFICIENCY IN STOCKHOLDERS' EQUITY
 Common stock, par value $.001 per share;
  100,000,000 shares authorized; 21,115,371 shares
  issued and outstanding at December 31, 2001                   22,115                              22,115

 Additional paid-in-capital                                  2,221,154            22,879         2,244,033

 Accumulated deficit during development stage               (2,969,833)          289,645        (2,680,188)
                                                          -------------     -------------     -------------
 Deficiency in stockholders' equity                           (726,564)          312,524          (414,040)
                                                          -------------     -------------     -------------
                                                          $    737,677      $   (501,276)     $    236,401
                                                          =============     =============     =============

                                                   F-29
</TABLE>


<PAGE>

                                 TELKONET, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2002 AND 2001

NOTE L - RESTATEMENT OF FINANCIAL STATEMENTS (CONTINUED)

<TABLE>
                                              TELKONET, INC.
                                      (A DEVELOPMENT STAGE COMPANY)
                                     CONSOLIDATED STATEMENT OF LOSSES
                                   FOR THE YEAR ENDED DECEMBER 31, 2001
<CAPTION>

                                                         As Reported       Adjustments        Restated
                                                        -------------     -------------     -------------
<S>                                                     <C>               <C>               <C>
Costs and Expenses:
Research & Development                                  $    160,115      $    (39,287)     $    120,828

Selling, General and Administrative                        1,386,222                           1,386,222
Impairment of Property and Equipment                              --            39,287            39,287

Depreciation and Amortization                                 43,557           (12,760)           30,797
                                                        -------------                       -------------
Total Operating Expense                                    1,589,894                           1,577,134


Loss from Operations                                      (1,589,894)                         (1,577,134)


Other Income                                                   1,257                               1,257

Interest Income (Expense)                                   (417,503)          276,885          (140,618)

Provision for Income Tax                                          --                                  --
                                                        -------------                       -------------
                                                            (416,246)                           (139,361)


Net Loss                                                $ (2,006,140)          289,645      $ (1,716,495)
                                                        =============     =============     =============

Loss per common share (basic and assuming dilution)     $      (0.09)     $       0.01      $      (0.08)
                                                        =============     =============     =============
Weighted average common shares outstanding                21,974,439        21,974,439        21,974,439

                                                  F-30
</TABLE>