As filed with the Securities and Exchange Commission on April 28, 2006
Registration No. 333- 130900
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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PRE-EFFECTIVE AMENDMENT NO. 3 TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
ELECTRONIC SENSOR TECHNOLOGY, INC.
(Name of Small Business Issuer in Its Charter)
Nevada 3679 98-0372780
(State or Other (Primary Standard (I.R.S. Employer
Jurisdiction of Industrial Classification Identification
Incorporation or Code Number) Number)
Organization)
1077 Business Center Circle
Newbury Park, California 91320
(805) 480-1994
(Address and Telephone Number of Principal Executive Offices
and Principal Place of Business)
Francis Chang
Secretary and Vice President of Finance and Administration
1077 Business Center Circle
Newbury Park, California 91320
(805) 480-1994
(Name, Address and Telephone Number of Agent For Service)
With a copy to:
Neil W. Rust, Esq.
White & Case LLP
633 West Fifth Street
Los Angeles, California 90071
(213) 620-7700
Approximate Date of Proposed Sale to the Public: As soon as practicable
after this registration statement becomes effective.
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]_____________________________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]___________________________________________________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]___________________________________________________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
PROPOSED PROPOSED
AMOUNT MAXIMUM MAXIMUM AMOUNT OF
TITLE OF SECURITIES TO BE OFFERING PRICE AGGREGATE REGISTRATION
TO BE REGISTERED REGISTERED PER UNIT OFFERING PRICE FEE
------------------------ -------------- -------------- -------------- ------------
Common stock, par value
$.001 per share 1,925,000(1) $ 1.0000 $ 1,925,000 $ 205.98
Common stock, par value
$.001 per share 1,500,000(2) $ 1.0000 $ 1,500,000 $ 160.50
Common stock, par value
$.001 per share 130,000(3) $ .8145 $ 105,882 $ 11.33
Common stock, par value
$.001 per share 350,000(4) $ 2.4000 $ 840,000 $ 90.00
Common stock, par value
$.001 per share 21,058,770(5) $ .4544 $ 9,569,105 $ 1,023.89
Common stock, par value
$.001 per share 485,213(6) $ .4761 $ 231,010 $ 24.72
------------------------ -------------- -------------- -------------- ------------
Total 25,448,983 $ 14,170,997 $ 1,516.42*
======================== ============== ============== ============== ============
(1) 1,925,000 shares of common stock of Electronic Sensor Technology, Inc., par
value $.001 per share issued on February 1, 2005 at a price of
approximately $1.00 per share (unit price of $1.00, such units including
one share of common stock and a warrant to purchase one share of common
stock at an exercise price of $1.00 per share).
(2) 1,500,000 shares of common stock underlying three-year warrants issued on
February 1, 2005 with an exercise price of $1.00 per share.
(3) 130,000 shares of common stock issued on December 5, 2005 in exchange for
services, the value of which totaled $105,882.
(4) 350,000 shares of common stock underlying a five-year warrant issued on
December 5, 2005 with an exercise price of $2.40 per share.
(5) 21,058,770 shares of common stock underlying 110% of an aggregate principal
amount of $7,000,000 of 8% unsecured convertible debentures Due December 7,
2009 issued on December 7, 2005 with a conversion price of $.4544 per
share, plus interest on the debentures that may be paid in common stock.
(6) 485,213 shares of common stock underlying a five-year warrant issued on
December 7, 2005 with an exercise price of $.4761 per share.
* Previously paid.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
PROSPECTUS
[LOGO OF ELECTRONIC SENSOR TECHNOLOGY]
ELECTRONIC SENSOR TECHNOLOGY, INC.
25,448,983 SHARES OF COMMON STOCK
This prospectus is part of a registration statement on Form SB-2 that we
filed with the Securities and Exchange Commission. Under this registration
statement, the holders of common stock named in this registration statement may,
and the holders of the warrants and the debentures described below may upon
exercise of such warrants and upon conversion of such debentures, offer for
resale up to a total of 25,448,983 shares of common stock at any time at market
prices prevailing at the time of the sale or at privately negotiated prices. The
selling security holders may sell the common stock directly to purchasers or
through underwriters, broker-dealers or agents, who may receive compensation in
the form of discounts, concessions or commissions.
The 25,448,983 shares of common stock that may be sold by selling security
holders pursuant to this registration statement consist of:
o 1,925,000 shares of common stock of Electronic Sensor Technology, Inc.
(formerly Bluestone Ventures Inc.), par value $.001 per share, which
were issued in a private offering on February 1, 2005;
o 1,500,000 shares of common stock underlying three-year warrants to
purchase such common stock at an exercise price of $1.00 per share,
which were issued in the same private offering on February 1, 2005;
o 130,000 shares of common stock, which were issued in a private
offering on December 5, 2005;
o 350,000 shares of common stock underlying a five-year warrant to
purchase such common stock at an exercise price of $2.40 per share,
which was issued in a private offering on December 5, 2005;
o 21,058,770 shares of common stock, which include 110% of shares
underlying 8% unsecured convertible debentures due December 7, 2009,
which were issued in a private offering on December 7, 2005 and shares
that, at our option, may be used to pay interest on the debentures;
and
o 485,213 shares of common stock underlying a five-year warrant to
purchase such common stock at an exercise price of $0.4761 per share,
which was issued in a private offering on December 7, 2005.
We have agreed to register the foregoing shares of common stock in order to
facilitate secondary trading by the holders of the aforementioned common stock,
debentures and warrants.
Our common stock is quoted on the OTC bulletin board under the symbol
"ESNR.OB".
INVESTING IN OUR COMMON STOCK INVOLVES RISK. SEE "RISK FACTORS" BEGINNING
ON PAGE 2 FOR A DISCUSSION OF CERTAIN RISKS THAT YOU SHOULD CONSIDER BEFORE
INVESTING IN OUR COMMON STOCK.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
This prospectus is dated [_________], 2006
In making your investment decision, you should rely only on the information
contained in this prospectus and in each prospectus supplement, if any. We have
not authorized anyone to provide you with any other information. If you receive
any unauthorized information, you must not rely on it. This prospectus is not an
offer to sell these securities and is not soliciting an offer to buy these
securities in any state or jurisdiction where the offer or sale of these
securities is not permitted. You should assume that the information appearing in
this prospectus and any prospectus supplement is accurate only as of the
respective dates thereof. Our business, financial condition, results of
operations and prospects may have changed since those dates.
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TABLE OF CONTENTS
Page
Prospectus Summary.............................................................1
Risk Factors...................................................................2
Use of Proceeds................................................................8
Determination of Offering Price................................................8
Selling Security Holders.......................................................8
Plan of Distribution..........................................................12
Legal Proceedings.............................................................13
Directors, Executive Officers and Control Persons.............................13
Security Ownership of Certain Beneficial Owners and Management................15
Description of Securities.....................................................17
Interest of Named Experts and Counsel.........................................18
Disclosure of Commission Position on Indemnification for
Securities Act Liabilities...................................................18
Description of Business.......................................................19
Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................................26
Description of Property.......................................................31
Certain Relationships and Related Transactions................................32
Market for Common Equity and Related Stockholder Matters......................32
Executive Compensation........................................................35
Financial Statements..........................................................39
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.....................................................40
Where You Can Find More Information...........................................40
Special Note of Caution Regarding Forward-Looking Statements..................41
Legal Matters.................................................................41
Experts.......................................................................41
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(i)
PROSPECTUS SUMMARY
This summary highlights information described more fully elsewhere in this
prospectus. This summary does not contain all of the information that you should
consider before investing in our common stock. You should read the entire
prospectus carefully, including "Risk Factors" and our audited and unaudited
financial statements and the notes to those financial statements, which are
included in this prospectus.
OVERVIEW OF THE COMPANY
Electronic Sensor Technology is engaged in the development, manufacture,
and sale of a patented product called zNose(R), a device designed to detect and
analyze chemical odors and vapors, or, in other words, an electronic "nose." The
zNose(R) identifies the chemical makeup of any fragrance, vapor or odor. The
zNose(R) does this by creating a visual image of the fragrance, vapor or odor
that it detects, so that the user of the zNose(R) may easily identify the
fragrance, vapor or odor. We are involved in ongoing product research and
development efforts in the homeland security and laboratory instrumentation
markets.
Electronic Sensor Technology was originally incorporated under the name
"Bluestone Ventures Inc.", on July 12, 2000. From inception until February 1,
2005, we were engaged in the business of acquiring, exploring and developing
certain mining properties in Canada. On January 26, 2005, a transaction closed
whereby:
(i) Amerasia Acquisition Corp., a wholly-owned subsidiary of Bluestone,
merged with and into Amerasia Technology, Inc., holder of
approximately 55% of the partnership interests of Electronic Sensor
Technology, L.P. (the predecessor business of Electronic Sensor
Technology, Inc.), such that Amerasia Technology became a
wholly-owned subsidiary of Bluestone;
(ii) L&G Acquisition Corp., a wholly owned subsidiary of Bluestone, merged
with and into L&G Sensor Technology, L.P., holder of approximately
45% of the partnership interests of Electronic Sensor Technology,
L.P., such that L&G Sensor Technology became a wholly-owned
subsidiary of Bluestone;
(iii) as a result of the merger of (i) and (ii), Bluestone indirectly
acquired all of the partnership interests of Electronic Sensor
Technology, L.P.; and
(iv) Bluestone issued 20,000,000 shares of its common stock to the
shareholders of Amerasia Technology and L&G Sensor Technology.
Upon the acquisition of Electronic Sensor Technology, L.P., we abandoned
our mining business and adopted Electronic Sensor Technology, L.P.'s business of
developing, manufacturing and selling the vapor analysis device. Prior to the
closing of the aforementioned mergers, we changed our name to "Electronic Sensor
Technology, Inc."
Electronic Sensor Technology's executive offices are located at 1077
Business Center Circle, Newbury Park, California 91320, telephone:
(805) 480-1994.
THE OFFERING
Issuer.................................. Electronic Sensor Technology, Inc.
Securities Offered...................... 25,448,983 shares of common stock,
par value $.001.
Use of Proceeds......................... We will not receive any proceeds from
the resale by the selling security
holders of the common stock
registered pursuant to this
registration statement.
-1-
SUMMARY FINANCIAL DATA
The financial data set forth below under the captions "Results of
Operations Data" and "Balance Sheet Data" for the years ended December 31, 2005
and December 31, 2004 and as of December 31, 2005, respectively, are derived
from our financial statements, included elsewhere in this prospectus, audited by
Sherb & Co., LLP, independent public accountants. The financial data set forth
below should be read in conjunction with the financial statements and notes
thereto included elsewhere in this prospectus and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." All statistical data
set forth herein is unaudited.
RESULTS OF OPERATIONS DATA
Year Ended December 31,
------------------------------
2005 2004
------------- -------------
Revenues $ 2,072,350 $ 1,268,416
Cost of sales 1,302,602 1,039,280
Gross profit 769,748 229,136
Operating expenses 2,902,089 525,585
Net operating loss (2,132,341) (296,449)
Other income and expense (2,046,147) (114,767)
Net loss (4,178,488) (411,216)
Loss per common share, basic and diluted (0.08) (0.01)
Weighted average number of common shares,
basic and diluted 53,636,560 53,525,865
BALANCE SHEET DATA
December 31,
2005
-------------
Working capital $ 6,133,134
Total assets 7,552,255
Total liabilities 13,455,682
Stockholders' deficit (5,903,427)
RISK FACTORS
You should carefully consider each of the following risk factors, as well
as the other information contained elsewhere in this prospectus before deciding
to purchase any of our common stock. We face risks other than those listed here,
but at present consider such risks immaterial. We may also face additional risks
which are unknown to us at this time. Because of the following factors, as well
as other variables affecting our operating results, past financial performance
may not be a reliable indicator of future performance, and historical trends
should not be used to anticipate results or trends in future periods.
RISKS RELATED TO OUR COMPANY
WE HAVE A SIGNIFICANT ACCUMULATED DEFICIT AND WE MAY NEVER ACHIEVE
PROFITABILITY.
We have incurred significant net losses every year since our inception,
including net losses in 2005 and 2004. These losses have resulted principally
from expenses incurred in our research and development programs and general and
administrative expenses. We have also incurred non-cash expenses related to the
recognition of derivative liabilities. To date, we have not generated
significant recurring revenues. Our limited revenues that derive from sales of
the zNose(R) product have not been and may not be sufficient to sustain our
operations. We anticipate that we will continue to incur substantial operating
losses based on projected sales revenues less manufacturing, general and
administrative and other operating costs for the next twelve months. We expect
that our revenues will not be sufficient to sustain our operations for the near
term, notwithstanding any anticipated revenues
-2-
we may receive when our vapor detection products obtain increased visibility in
our markets, due to the significant costs associated with the development and
marketing of our products. No assurances can be given when we will ever be
profitable.
We expect to continue to experience losses until the time, if ever, when we
are able to sell products sufficient to generate revenues adequate to support
our operations. If we fail to become profitable, we may be forced to cease
operations.
OUR LIMITED MANUFACTURING EXPERIENCE AND CAPACITY MAY LIMIT OUR ABILITY TO GROW
OUR REVENUES.
To be successful, we must manufacture our products in compliance with
industry standards and on a timely basis, while maintaining product quality and
acceptable manufacturing costs. We also currently use a limited number of
sources for most of the supplies and services that we use in the manufacturing
of our vapor detection and analysis technology. We do not have agreements with
our suppliers. Our manufacturing strategy presents the following risks:
o delays in the quantities needed for product development could delay
commercialization of our products in development;
o if market demand for our products increases suddenly, our current
suppliers might not be able to fulfill our commercial needs, which
would require us to seek new supply arrangements and may result in
substantial delays in meeting market demand; and
o we may not have intellectual property rights, or may have to share
intellectual property rights, to any improvements in the manufacturing
processes or new manufacturing processes for our products.
Any of these factors could delay commercialization of our products under
development, entail higher costs and result in our being unable to effectively
sell our products.
WE FACE SIGNIFICANT COMPETITION AND OUR BUSINESS AND FINANCIAL RESULTS COULD
SUFFER FROM COMPETITION.
While we are unaware of any competitor that has created a vapor analysis
device similar to the zNose(R), there are companies that offer products and
services that compete with the zNose(R) in our markets. We believe that
manufacturers of X-Rays, Ion Mobility Spectrometers, and other electronic noses
compete with us in the security-related markets. In the markets for instruments
that analyze chemicals, we compete with many manufacturers including
Perkin-Elmer (NYSE: PKI) and Agilent Technologies (NYSE: A). Many of our
existing and potential competitors have longer operating histories, greater
experience, greater name recognition, larger customer bases and significantly
greater financial, technical and marketing resources than we do. Because of
their greater resources, our competitors are able to undertake more extensive
marketing campaigns for their products and services, and make more attractive
offers to potential employees, strategic partners, and others. We may not be
able to compete successfully against our current or future competitors and our
business and financial results could suffer from such competition.
IF OUR PRODUCTS DO NOT ACHIEVE A SIGNIFICANT LEVEL OF MARKET ACCEPTANCE, IT IS
HIGHLY UNLIKELY THAT WE EVER WILL BECOME PROFITABLE.
To our knowledge, electronic nose technology, and our zNose(R) product, has
yet to receive widespread market acceptance in the markets we are focused on.
The commercial success of our current and future products will depend upon the
adoption of our zNose(R) technology by our customers. In order to be successful,
our future products must meet the technical and cost requirements for the
markets we intend to penetrate. Market acceptance will depend on many factors,
including:
o our ability to convince potential customers to adopt our products;
o the willingness and ability of potential customers to adopt our
products;
o our ability to sell and service sufficient quantities of our products;
and
o new, advanced technology offered by other companies which compete with
our products.
-3-
Because of these and other factors, our products may not achieve market
acceptance. If our products do not achieve a significant level of market
acceptance, demand for our future products will not develop as expected and it
is highly unlikely that we ever will become profitable.
OTHER COMPANIES COULD CREATE A TECHNOLOGY WHICH COMPETES EFFECTIVELY WITH OUR
ZNOSE(R) TECHNOLOGY, AND WE MAY BE UNABLE TO MAINTAIN OUR EXISTING, OR CAPTURE
ADDITIONAL, MARKET SHARE IN OUR MARKETS.
Based upon our review of the industry, we are unaware of any company today
that markets a technology which is similar to our zNose(R) technology.
Nonetheless, our intended markets generally are dominated by very large
corporations (or their subsidiaries), which have greater access to capital,
manpower, technical expertise, distribution channels and other elements which
would give them a competitive advantage over us were they to begin to compete
directly against us. It is possible that these and other competitors may
implement new, advanced technologies before we are able to, allowing them to
provide more effective products at more competitive prices. Any number of future
technological developments could:
o adversely impact our competitive position;
o require write-downs of obsolete technology;
o require us to discontinue production of obsolete products before we
can recover any or all of our related research, development and
commercialization expenses; or
o require significant capital expenditures beyond those currently
contemplated.
We cannot assure investors that we will be able to achieve the
technological advances to remain competitive and profitable, that new products
and services will be developed and manufactured on schedule or on a
cost-effective basis, that anticipated markets will exist or develop for new
products or services, or that any marketed product will not become
technologically obsolete.
WE DEPEND ON KEY PERSONNEL IN A COMPETITIVE MARKET FOR SKILLED EMPLOYEES, AND
FAILURE TO RETAIN AND ATTRACT QUALIFIED PERSONNEL COULD SUBSTANTIALLY HARM OUR
BUSINESS.
We believe that our future success will depend in large part on our ability
to attract and retain highly skilled engineering, sales and marketing and
management personnel. If we are unable to hire the necessary personnel, the
development of our business will likely be delayed or prevented. Competition for
these highly skilled employees is intense. As a result, we cannot assure you
that we will be successful in retaining our key personnel or in attracting and
retaining the personnel we require for expansion.
WE ARE DEPENDENT UPON A MAJOR CUSTOMER FOR A LARGE PERCENTAGE OF OUR SALES AND
ANY CHANGES TO THAT CUSTOMER'S BUSINESS OR OUR RELATIONSHIP WITH THAT CUSTOMER
COULD HAVE A SUBSTANTIAL EFFECT ON OUR SALES AND REVENUE.
Our largest customer is Beijing R&D Technology Co., Ltd., which is our
exclusive distributor in China. During the fiscal year ending December 31, 2005,
purchases by Beijing R&D Technology accounted for $601,000, or approximately 29%
of our total sales. We expect that in the upcoming fiscal year, Beijing R&D
Technology will continue to account for a large percentage of our total sales.
If Beijing R&D Technology experiences any changes in its business that affect
its level of purchases from Electronic Sensor Technology, or if there is any
change in the business relationship between Beijing R&D Technology and
Electronic Sensor Technology leading to a decrease in its level of purchases
from Electronic Sensor Technology, our sales and revenues could substantially
decrease.
WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY AND MAY INFRINGE ON THE
INTELLECTUAL PROPERTY RIGHTS OF OTHERS.
The protection of our intellectual property, including our patents and
other proprietary rights, is important to our success and our competitive
position. Accordingly, we devote substantial resources to the maintenance and
protection of intellectual
-4-
property through various methods such as patents and patent applications,
trademarks, copyrights, confidentiality and non-disclosure agreements. We also
rely on trade secrets, proprietary methodologies and continuing technological
innovation to remain competitive. We have taken measures to protect our trade
secrets and know-how, including the use of confidentiality agreements with our
employees. However, it is possible that these agreements may be breached and
that the available remedies for any breach will not be sufficient to compensate
us for damages incurred.
We currently have four patents in the United States and patents in various
foreign countries. There can be no assurance that the patents that we hold will
protect us from competition from third parties with similar technologies or
products, as it is possible that third parties may be able to develop similar
technologies or products without necessarily infringing on the patents that we
currently hold. Moreover, we cannot assure you that others will not assert
rights in, or ownership of, patents and other proprietary rights we may
establish or acquire or that we will be able to successfully resolve such
conflicts. We do not have reason to believe that our current patents are at
great risk of being challenged, however, due to the nature and complexity of our
technology, we cannot assure you that any patents issued to us will not be
challenged, invalidated or circumvented or that the rights granted under these
patents will provide a competitive advantage to us. Moreover, the laws of some
foreign countries do not protect intellectual property rights to the same extent
as the laws of the United States, and we could experience various obstacles and
high costs in protecting our intellectual property rights in foreign countries.
If we are unable to obtain or maintain these protections, we may not be able to
prevent third parties from using our intellectual property.
RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK
OUR STOCK PRICE IS SUBJECT TO EXTREME VOLATILITY.
The trading price of our common stock has been, and is likely to continue
to be, highly volatile and could be subject to wide fluctuations in response to
factors such as actual or anticipated variations in our quarterly operating
results, announcements of technological innovations, announcements of
significant new orders or cancellation of significant orders, or new products by
Electronic Sensor Technology or its competitors, changes in financial estimates
by securities analysts, conditions or trends in the analytic instrumentation
markets, changes in the market valuations of other security-detection oriented
companies, announcements by Electronic Sensor Technology or its competitors of
significant acquisitions, strategic partnerships, joint ventures or capital
commitments, additions or departures of key personnel, sales of common stock or
other securities of Electronic Sensor Technology in the open market and other
events or factors, many of which are beyond our control.
THERE IS NO ESTABLISHED TRADING MARKET FOR OUR SHARES OF COMMON STOCK. THE
LIQUIDITY OF OUR COMMON STOCK WILL BE AFFECTED BY ITS LIMITED TRADING MARKET.
Bid and ask prices for our common stock are quoted on the Over-the-Counter
Bulletin Board under the symbol "ESNR.OB." There is currently no broadly
followed, established trading market for our common stock. An established
trading market for our shares may never develop or be maintained. Active trading
markets generally result in lower price volatility and more efficient execution
of buy and sell orders. The absence of an active trading market reduces the
liquidity of our shares. Prior to the consummation of the merger in February
2005, we had no reported trading volume in our common stock. Since then, we have
had sporadic reported trading in our shares. As a result of this sporadic
trading activity, the quoted price for our common stock on the Over-the-Counter
Bulletin Board is not necessarily a reliable indicator of its fair market value.
Further, if we cease to be quoted, holders would find it more difficult to
dispose of, or to obtain accurate quotations as to the market value of, our
common stock, and the market value of our common stock would likely decline.
IF AND WHEN A TRADING MARKET FOR OUR COMMON STOCK DEVELOPS, BECAUSE WE ARE A
TECHNOLOGY COMPANY, WE EXPECT THAT THE TRADING PRICES WILL BE EXTREMELY
VOLATILE.
The trading prices of technology company stocks in general tend to
experience extreme price fluctuations. The valuations of many technology
companies without consistent product revenues or earnings, if any, are not based
on conventional valuation standards such as price to earnings and price to sales
ratios. Any negative change in the public's perception of the prospects of
technology companies could depress our stock price regardless of our results of
operations if a trading market for our stock develops. In addition, our stock
price could be subject to wide fluctuations in response to factors including,
but not limited to, the following:
o announcements of new technological innovations or new products by us
or our competitors;
-5-
o conditions or trends in the sensor technology industry;
o changes in the market valuations of other technology companies;
o developments in domestic and international governmental policy or
regulations that affect the technology utilized in our products;
o announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
o developments in patent or other proprietary rights held by us or by
others; or
o loss or expiration of our intellectual property rights.
WE MAY RAISE ADDITIONAL CAPITAL THROUGH A SECURITIES OFFERING THAT COULD DILUTE
THE OWNERSHIP INTERESTS OF OUR SHAREHOLDERS.
We require substantial working capital to fund our business. If we raise
additional funds through the issuance of equity, equity-related or convertible
debt securities, these securities may have rights, preferences or privileges
senior to those of the holders of our common stock. The issuance of additional
common stock or securities convertible into common stock by our management will
also have the effect of further diluting the proportionate equity interest and
voting power of holders of our common stock.
In addition, under our articles of incorporation, our Board of Directors is
authorized to issue, without obtaining shareholder approval, shares of preferred
stock having the rights, privileges and designations as determined by the Board
of Directors. Therefore, the Board of Directors could issue shares of preferred
stock that would have preferential liquidation, distribution, voting, dividend
or other rights, which would be superior to the rights of common stockholders.
A SIGNIFICANT NUMBER OF OUR SHARES ARE ELIGIBLE FOR SALE, AND THEIR SALE COULD
DEPRESS THE MARKET PRICE OF OUR COMMON STOCK.
Sales of a significant number of shares of our common stock in the open
market could harm the market price of our common stock. A reduced market price
for our shares could make it more difficult to raise funds through future
offerings of common stock. Approximately 27 million shares are presently
eligible for trading in the open market. As additional shares become available
for resale in the open market, including new shares issued upon conversion of
our debentures issued on December 7, 2005, the exercise of our outstanding
options, warrants, and contractual obligations to issue shares, the number of
our publicly tradable shares will increase, which could decrease their trading
price. In addition, some of our shares may be offered from time to time in the
open market pursuant to Rule 144, and these sales may have a depressive effect
on the market for our shares. In general, a person who has held restricted
shares for a period of one year may, upon satisfying certain conditions to the
application of Rule 144, sell into the market shares up to an amount equal to 1%
of the outstanding shares (and potentially more) of our common stock. These
sales may be repeated once each three months. In addition, an unlimited amount
of restricted shares may be sold by a non-affiliate after they have been held
for two years pursuant to Rule 144(k).
WE ARE NOT REQUIRED TO FILE REPORTS WITH THE SEC ON A CONTINUOUS BASIS BECAUSE
OUR STOCK IS NOT CURRENTLY REGISTERED UNDER THE EXCHANGE ACT.
Our registered common stock is registered under the Securities Act and is
not currently registered under the Exchange Act. On March 24, 2006 we filed a
registration statement with the SEC on Form 10-SB to register our common stock
pursuant to the Exchange Act, which will become effective within 60 days of
filing such registration statement, unless the SEC directs otherwise. Once the
registration statement is effective, we will be subject to the filing
requirements of the Exchange Act, including the requirement to file various
reports relating to the ownership of our stock, and compliance with the proxy
rules, which require, among other things, that we send out proxy materials and
annual reports to our shareholders in connection with our annual meetings.
However, until such registration statement is effective, our duty to file
reports with the SEC is automatically suspended for any fiscal year, other than
the fiscal year within which a registration statement that we filed under the
Securities Act became
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effective, and we have less than 300 record holders of our shares at the
beginning of such fiscal year. We presently have substantially below 300 record
holders of our shares. Although we have chosen to continue such reporting with
the SEC on a voluntary basis in the past and intend to continue to do so in the
immediate future, we currently have no legal obligation to file reports with the
SEC and will not have any such legal obligation until our registration statement
on Form 10-SB is effective, provided we continue to have less than 300 record
holders of our shares.
WE ARE SUBJECT TO THE SEC'S PENNY STOCK RULES.
Broker-dealer practices in connection with transactions in "penny stocks"
are regulated by certain rules adopted by the SEC. Penny stocks generally are
equity securities with a price of less than $5.00, other than securities
registered on certain national securities exchanges or quoted on the NASDAQ
Stock Market if current price and volume information with respect to
transactions in such securities is provided by the exchange or system. The rules
require that a broker-dealer, prior to a transaction in a penny stock not
otherwise exempt from the rules, deliver a standardized risk disclosure document
that provides information about penny stocks and the risks in the penny stock
market. The broker-dealer also must provide the customer with current bid and
offer quotations for the penny stock, the compensation of the broker-dealer and
its salesperson in connection with the transaction and monthly account
statements showing the market value of each penny stock held in the customer's
account. In addition, the rules generally require that prior to a transaction in
a penny stock, the broker-dealer must make a special written determination that
the penny stock is a suitable investment for the purchaser and receive the
purchaser's written agreement to the transaction. These disclosure requirements
may have the effect of reducing the liquidity of penny stocks. Our securities
are subject to the penny stock rules. As such, holders of our shares of common
stock may find it more difficult to sell their securities.
WE HAVE NOT PAID DIVIDENDS IN THE PAST AND DO NOT EXPECT TO PAY DIVIDENDS IN THE
FUTURE. ANY RETURN ON INVESTMENT MAY BE LIMITED TO POTENTIAL FUTURE APPRECIATION
IN THE VALUE OF OUR STOCK.
We have never paid cash dividends on our stock and do not anticipate paying
cash dividends on our stock in the foreseeable future. The payment of dividends
on our shares, if ever, will depend on our earnings, financial condition and
other business and economic factors affecting us at such time as the Board of
Directors may consider relevant. If we do not pay dividends, our stock may be
less valuable because a return on investment will only occur if and to the
extent that our stock price appreciates, and if the price of our stock does not
appreciate, then there will be no return on investment.
OUR ANTI-TAKEOVER DEFENSE PROVISIONS MAY DETER POTENTIAL ACQUIRERS AND DEPRESS
OUR STOCK PRICE.
Certain provisions of our articles of incorporation, bylaws and Nevada law
could be used by our incumbent management to make it substantially more
difficult for a third party to acquire control of us. These provisions include
the following:
o we may issue preferred stock with rights senior to those of our common
stock; and
o the Board of Directors may fill casual vacancies occurring in the
Board of Directors and may appoint one or more additional directors
between annual meetings of shareholders to hold office until the next
annual meeting of shareholders.
These provisions may discourage certain types of transactions involving an
actual or potential change in control. These provisions may also limit our
shareholders' ability to approve transactions that they may deem to be in their
best interests and discourage transactions in which our shareholders might
otherwise receive a premium for their shares over the then current market price.
SOME OF OUR EXISTING SHAREHOLDERS CAN EXERT CONTROL OVER US, AND MAY NOT MAKE
DECISIONS THAT ARE IN THE BEST INTERESTS OF ALL SHAREHOLDERS.
Our officers, directors and principal shareholders together control
approximately 43.4% of our outstanding common stock. Land & General Berhad
through its wholly owned subsidiary, L&G Resources (1994), Inc., owns
approximately 18.4% of our outstanding common stock. As a result, these
shareholders, if they act together, will be able to exert a significant degree
of influence over our management and affairs and over matters requiring
shareholder approval, including the election of directors and approval of
significant corporate transactions. In addition, this concentration of ownership
may delay or prevent a change in control of Electronic Sensor Technology and
might affect the market price of our shares, even when a change may be in the
best
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interests of all shareholders. Moreover, the interests of this concentration of
ownership may not always coincide with our interests or the interests of other
shareholders, and, accordingly, they could cause us to enter into transactions
or agreements which we would not otherwise consider.
SHAREHOLDERS REPRESENTING A SMALL NUMBER OF OUR SHARES MAY TAKE SHAREHOLDER
ACTION THAT WOULD AFFECT ALL SHAREHOLDERS.
Our bylaws provide that two persons present and being, or representing by
proxy, shareholders constitutes a quorum for purposes of shareholders' meetings.
In order for action to be approved at a shareholders' meeting, other than the
election of directors, a majority of the votes cast in favor of the action must
exceed the number of votes cast in opposition to the action. Unless elected in
accordance with the foregoing, directors must be elected at the annual meeting
of shareholders by a plurality of the votes cast at the election. Consequently,
if only two shareholders or shareholders' representatives attend a shareholders'
meeting (which may be called by the Board of Directors, or its designee in the
case of special shareholders' meetings), actions to be taken by the company
could potentially be approved and directors could potentially be elected by only
one shareholder. In addition, given our two-person quorum requirement and the
concentration of ownership of our shares in our directors and officers, our
directors and officers who are also shareholders have a considerable ability to
adopt actions at shareholders' meetings without requiring the votes or
attendance of other shareholders.
PAST ACTIVITIES OF THE COMPANY AND ITS AFFILIATES MAY LEAD TO FUTURE LIABILITY
FOR US.
Prior to the acquisition of Electronic Sensor Technology, L.P., we engaged
in the exploitation of mining claims, a business unrelated to Electronic Sensor
Technology's current operations. Although we are unaware of any at this time,
liabilities, if any, of the prior business may have a material adverse effect on
us. These liabilities potentially may include liabilities relating to
Bluestone's operations of its mining business, individuals that Bluestone
employed, contracts to which Bluestone was a party, any personal injury claims
against Bluestone and any other liabilities that may arise as a result of
operating a publicly-traded mining business.
USE OF PROCEEDS
We will not receive any proceeds from the resale by the selling security
holders of the common stock registered pursuant to this registration statement.
DETERMINATION OF OFFERING PRICE
There is currently no broadly followed, established trading market for our
common stock. Each selling security holder and any of their pledgees, assignees
and successors-in-interest may, from time to time, sell any or all of their
shares of common stock on through the OTC Bulletin Board or any stock exchange,
market or trading facility on which the shares are traded (if we ever become
eligible for trading on any stock exchange, market or trading facility and seek
a listing or quotation thereon) or in private transactions. These sales may be
at fixed prices or negotiated prices, as determined by the selling security
holder.
SELLING SECURITY HOLDERS
Each of the selling security holders obtained beneficial ownership of the
common stock being registered for resale pursuant to this registration statement
in one of the following transactions, as set forth below.
o On February 1, 2005, in a private offering, Electronic Sensor
Technology issued 3,985,000 shares of common stock of Electronic
Sensor Technology and three-year warrants to purchase 3,985,000 shares
of our common stock at an exercise price of $1.00 per share (units
consisting of one share of common stock and one warrant were sold for
$1.00 per unit). The following selling security holders obtained
beneficial ownership of our common stock through this private
offering: Mark S. Barbara, Bixbie Financial Corp., John J. and Alicia
C. Caufield, Chase Investments, Inc., Crown Capital Partners SA,
Richard Forte, Jeffrey R. Haines, Highgate House Funds, Ltd.,
Nathaniel Kramer, Memphis Group, Inc., Jeremy Shaffer Roenick, Gene
Salkind, M.D., Brian Patrick Shanahan and Paul Tompkins.
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o Electronic Sensor Technology issued 130,000 shares of common stock to
CEOcast, Inc. on December 5, 2005, in a private offering, in exchange
for investor relations services valued at approximately $105,882.
CEOcast provides us with investor relations services valued at
approximately $17,500 per month. We have entered into three short-term
consulting agreements with CEOcast on each of January 17, 2005,
July 17, 2005 and October 17, 2005, pursuant to which we agreed to
compensate CEOcast with $7,500 per month, paid in cash, and CEOcast is
compensated for the remainder of the value of its services with our
common stock. The 130,000 shares of common stock issued to CEOcast
represented the compensation in our shares due to CEOcast under the
three consulting agreements. The number of shares issued to CEOcast
was calculated by determining for each of the nine months of the
contract between us and CEOcast that number of shares that could be
purchased per month at a 15% discount with $10,000.
o On December 5, 2005, in a private offering, Electronic Sensor
Technology issued to HomelandSecurityStocks, a division of
Protect-A-Life, Inc., a warrant to purchase 350,000 shares of common
stock at an exercise price of $2.40 per share. HomelandSecurityStocks
formerly provided us with investor relations services. The warrant was
issued pursuant to a Settlement Agreement entered into on October 11,
2005 among HomelandSecurityStocks, Protect-A-Life and Electronic
Sensor Technology. The Settlement Agreement settled a dispute between
HomelandSecurityStocks and Electronic Sensor Technology resulting from
the termination by Electronic Sensor Technology of a consulting
agreement dated February 7, 2005, between HomelandSecurityStocks and
Electronic Sensor Technology. Pursuant to the consulting agreement, we
had engaged HomelandSecurityStocks to provide us with investor
relations and public relations services from February 9, 2005 through
February 9, 2006 for a fee of $12,000 per month and warrants to
purchase 500,000 shares of common stock at an exercise price of $2.40
per share, to vest as follows: (i) warrants to purchase 200,000 shares
on February 9, 2005, (ii) warrants to purchase 75,000 shares on May 9,
2005, (iii) warrants to purchase 75,000 shares on August 9, 2005,
(iv) warrants to purchase 75,000 shares on November 9, 2005 and
(v) warrants to purchase 75,000 shares on February 8, 2006. Electronic
Sensor Technology terminated the consulting agreement in July 2005.
o In a private offering on December 7, 2005, we issued to Islandia, L.P.
and Midsummer Investment Ltd. an aggregate principal amount of
$7,000,000 of 8% unsecured convertible debentures due December 7, 2009
that are convertible into 15,404,930 shares of our common stock. The
debentures are convertible into common stock at an exercise price of
$0.4544 per share. This price was calculated based upon 105% of the
volume weighted average price over the 20 trading days preceding the
date of issuance of the debentures. Under certain circumstances, we
have the right, at our option to pay interest on the debentures with
shares of common stock. In connection with the private offering, we
agreed to register 130% of the common stock into which the debentures
are convertible plus 130% of the common stock that we may use to pay
interest on the debentures. On this registration statement, we are
registering 110% of such shares, or 21,058,770 shares, to facilitate
secondary trading by the holders of the debentures.
o In a private offering on December 7, 2005, we issued to Montgomery &
Co., LLC a five-year warrant to purchase 485,213 shares of common
stock at an exercise price of $0.4761 per share. This price was
calculated based upon 110% of the volume weighted average price over
the 20 trading days preceding the date of issuance of the warrant.
Montgomery provided us with financial advisory services in connection
with the issuance of the 8% unsecured convertible debentures issued on
December 7, 2005 and various other securities, for which it received
$490,000 in addition to the warrant.
The table below sets forth the following information, as of the date that
we received such information from the selling security holder (this information
was received by Electronic Sensor Technology between December 6, 2005 and the
date of this prospectus):
o the name of each beneficial owner of the common stock registered
pursuant to this registration statement;
o the number of shares of common stock that each selling security holder
beneficially owns as of such date;
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o the number of shares of common stock that may, assuming the exercise
in full of all of the warrants described above and the conversion in
full of all of the debentures described above, be offered for sale by
each selling security holder from time to time pursuant to this
prospectus;
o the number of shares of common stock to be beneficially owned by each
selling security holder assuming the exercise in full of all of the
warrants described above and the conversion in full of all of the
debentures described above, and the sale of all of the shares of
common stock offered hereby; and
o by footnote, any position or office held or other material
relationship with Electronic Sensor Technology or any of its
predecessors or affiliates within the past three years, other than
that of being a shareholder, and details regarding the transaction in
which each selling security holder acquired beneficial ownership of
its common stock.
Of the selling security holders, we understand that Montgomery & Co. LLC is
registered as a broker-dealer with the NASD, California, Connecticut, Florida,
Massachusetts, Nevada, New York and Washington. Otherwise, to our knowledge,
none of the selling security holders is a broker-dealer or an affiliate of a
broker-dealer.
NUMBER OF
SHARES OF
SHARES OF COMMON STOCK SHARES OF COMMON STOCK
COMMON STOCK TO BE OFFERED FOR BENEFICIALLY OWNED AFTER
BENEFICIALLY THE SELLING COMPLETION OF THE OFFERING
OWNED PRIOR TO SECURITY HOLDER'S ---------------------------
NAME OF SELLING SECURITY HOLDER THE OFFERING ACCOUNT NUMBER PERCENTAGE
----------------------------------- ----------------- ----------------- ---------- --------------
Mark S. Barbara (1) 50,000 50,000 0 *
Bixbie Financial Corp. (2) 250,000 250,000 0 *
John J. and Alicia C. Caufield (3) 130,000 100,000 30,000 *
CEOcast, Inc. (4) 130,000 130,000 0 *
Chase Investments, Inc. (5) 50,000 50,000 0 *
Crown Capital Partners SA (6) 1,000,000 1,000,000 0 *
Richard Forte (7) 50,000 50,000 0 *
Jeffrey R. Haines 50,000 50,000 0 *
Highgate House Funds, Ltd. (8) 1,000,000 1,000,000 0 *
HomelandSecurityStocks.com, a
division of Protect-A-Life, Inc.(9) 350,000 350,000 0 *
Islandia, L.P. (10) 7,520,990 7,520,990 0 *
Nathaniel Kramer (11) 50,000 50,000 0 *
Memphis Group Inc. (12) 500,000 500,000 0 *
Midsummer Investment Ltd. (13) 13,537,780 13,537,780 0 *
Montgomery & Co., LLC (14) 485,213 485,213 0 *
Jeremy Shaffer Roenick (15) 50,000 50,000 0 *
Gene Salkind, M.D. (16) 200,000 200,000 0 *
Brian Patrick Shanahan 212,500 50,000 162,500 *
Paul Tompkins 25,000 25,000 0 *
* Less than 1%.
(1) Mr. Barbara's shares include 25,000 shares of common stock underlying a
warrant exercisable within 60 days of January 31, 2006.
(2) Alan Meiteen is a beneficial owner of Bixbie Financial Corp.'s shares by
virtue of his position as sole control person of Bixbie Financial Corp.
(3) The Caufields' shares include 50,000 shares of common stock underlying a
warrant exercisable within 60 days of January 31, 2006.
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(4) Rachel Glicksman and Kenneth D. Sgro are beneficial owners of CEOcast's
shares by virtue of their positions as principal shareholders of CEOcast,
Inc.
(5) Richard Chase is a beneficial owner of Chase Investment, Inc.'s shares by
virtue of his position as sole control person of Chase Investments, Inc.
(6) Crown Capital Partners SA's shares include 500,000 shares of common stock
underlying a warrant exercisable within 60 days of January 31, 2006. John
Graham Douglas is a beneficial owner of Crown Capital Partners' shares by
virtue of his position as sole control person of Crown Capital Partners
SA.
(7) Mr. Forte's shares include 25,000 shares of common stock underlying a
warrant exercisable within 60 days of January 31, 2006.
(8) Highgate House Funds, Ltd.'s shares include 500,000 shares of common
stock underlying a warrant exercisable within 60 days of January 31,
2006. Mark Angelo is a beneficial owner of Highgate House Funds' shares
by virtue of his position as Portfolio Manager of Highgate House Funds,
Ltd.
(9) HomelandSecurityStocks.com's shares include 350,000 shares of common
stock underlying a warrant exercisable within 60 days of January 31,
2006. Leon Hamerling and J. Robert Paul are both beneficial owners of
HomelandSecurityStocks' shares by virtue of their collective ownership of
100% of the outstanding shares of Protect-A-Life.
(10) Islandia, L.P.'s shares include 110% of 5,501,761 shares of common stock
underlying a debenture convertible within 60 days of January 31, 2006,
plus 110% of 1,335,502 shares of common stock that may be used to pay
interest on the debenture. The general partner of Islandia is John Lang,
Inc., a New York Sub-S corporation formed to manage investments. John
Lang, Inc. has sole dispositive power and sole voting power over all
matters not related to director elections. The individuals that exercise
shared dispositive and voting power for John Lang, Inc. are Richard
Berner, President of John Lang, Inc. and Edgar Berner and Thomas Berner,
both Vice-Presidents of John Lang, Inc. By virtue of these relationships
John Lang, Inc., Richard Berner, Edgar Berner and Thomas Berner may be
deemed to have indirect beneficial ownership of the shares of common
stock beneficially owned by Islandia; however, John Lang, Inc. Richard
Berner, Edgar Berner and Thomas Berner disclaim beneficial ownership of
the shares of common stock beneficially owned by Islandia.
(11) Mr. Kramer's shares include 25,000 shares of common stock underlying a
warrant exercisable within 60 days of January 31, 2006.
(12) Memphis Group, Inc.'s shares include 250,000 shares of common stock
underlying a warrant exercisable within 60 days of January 31, 2006.
Jeffrey Shear is a beneficial owner of Memphis Group's shares by virtue
of his position as sole control person of Memphis Group, Inc.
(13) Midsummer Investment Ltd.'s shares include 110% of 9,903,169 shares of
common stock underlying a debenture convertible within 60 days of January
31, 2006, plus 110% of 2,403,903 shares of common stock that may be used
to pay interest on the debenture. Midsummer Capital, LLC, a New York
limited liability company, serves as investment advisor to Midsummer
Investment Ltd., a Bermuda company. By reason of such relationships,
Midsummer Capital may be deemed to share dispositive power over the
shares of common stock beneficially owned by Midsummer Investment.
Midsummer Capital disclaims beneficial ownership of such shares of common
stock. Michel A. Amsalem and Scott D. Kaufman are members of Midsummer
Capital. By reason of such relationships, Mr. Amsalem and Mr. Kaufman may
be deemed to share dispositive power over the shares of common stock
stated as beneficially owned by Midsummer Investment. Mr. Amsalem and Mr.
Kaufman disclaim beneficial ownership of such shares of common stock.
(14) Montgomery & Co., LLC's shares include 485,213 shares of common stock
underlying a warrant exercisable within 60 days of January 31, 2006.
Montgomery & Associates is a beneficial owner of Montgomery & Co., LLC's
shares by virtue of its position as a controlling entity of Montgomery &
Co., LLC. George Montgomery, Michael Montgomery and Brian Bean are
beneficial owners of Montgomery & Co.'s shares by virtue of their
positions as control persons of Montgomery & Co. Jamie Montgomery is a
beneficial owner of Montgomery & Co.'s shares by virtue of his positions
as both a control person of Montgomery & Co. and sole control person of
Montgomery & Associates.
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(15) Mr. Roenick's shares include 25,000 shares of common stock underlying a
warrant exercisable within 60 days of January 31, 2006.
(16) Dr. Salkind's shares include 100,000 shares of common stock underlying a
warrant exercisable within 60 days of January 31, 2006.
PLAN OF DISTRIBUTION
Each selling security holder and any of their pledgees, assignees and
successors-in-interest may, from time to time, sell any or all of their shares
of common stock on through the OTC Bulletin Board or any other stock exchange,
market or trading facility on which the shares are traded or in private
transactions. These sales may be at fixed or negotiated prices. A selling
security holder may use any one or more of the following methods when selling
shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
o block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block as
principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately negotiated transactions;
o settlement of short sales entered into after the effective date of the
registration statement of which this prospectus is a part;
o broker-dealers may agree with the selling security holders to sell a
specified number of such shares at a stipulated price per share;
o a combination of any such methods of sale;
o through the writing or settlement of options or other hedging
transactions, whether through an options exchange or otherwise; or
o any other method permitted pursuant to applicable law.
The selling security holders may also sell shares under Rule 144 under the
Securities Act of 1933, as amended, if available, rather than under this
prospectus.
Broker-dealers engaged by the selling security holders may arrange for
other brokers-dealers to participate in sales. Broker-dealers may receive
commissions or discounts from the selling security holders (or, if any
broker-dealer acts as agent for the purchaser of shares, from the purchaser) in
amounts to be negotiated, but, except as set forth in a supplement to this
prospectus, in the case of an agency transaction not in excess of a customary
brokerage commission in compliance with NASDR Rule 2440; and in the case of a
principal transaction a markup or markdown in compliance with NASDR IM-2440.
In connection with the sale of the common stock or interests therein, the
selling security holders may enter into hedging transactions with broker-dealers
or other financial institutions, which may in turn engage in short sales of the
common stock in the course of hedging the positions they assume. The selling
security holders may also sell shares of the common stock short and deliver
these securities to close out their short positions, or loan or pledge the
common stock to broker-dealers that in turn may sell these securities. The
selling security holders may also enter into option or other transactions with
broker-dealers or other financial institutions or the creation of one or more
derivative securities which require the delivery to such broker-dealer or other
financial institution of shares offered by this prospectus, which shares such
broker-dealer or other financial institution may resell pursuant to this
prospectus (as supplemented or amended to reflect such transaction).
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The selling security holders and any broker-dealers or agents that are
involved in selling the shares may be deemed to be "underwriters" within the
meaning of the Securities Act in connection with such sales. In such event, any
commissions received by such broker-dealers or agents and any profit on the
resale of the shares purchased by them may be deemed to be underwriting
commissions or discounts under the Securities Act. Each selling security holder
has informed us that it does not have any written or oral agreement or
understanding, directly or indirectly, with any person to distribute the common
stock. In no event shall any broker-dealer receive fees, commissions and markups
which, in the aggregate, would exceed eight percent (8%).
Electronic Sensor Technology is required to pay certain fees and expenses
incurred by Electronic Sensor Technology incident to the registration of the
shares. Electronic Sensor Technology has agreed to indemnify the selling
security holders against certain losses, claims, damages and liabilities,
including liabilities under the Securities Act.
Because selling security holders may be deemed to be "underwriters" within
the meaning of the Securities Act, they will be subject to the prospectus
delivery requirements of the Securities Act. In addition, any securities covered
by this prospectus which qualify for sale pursuant to Rule 144 under the
Securities Act may be sold under Rule 144 rather than under this prospectus.
Each selling security holder has advised us that they have not entered into any
written or oral agreements, understandings or arrangements with any underwriter
or broker-dealer regarding the sale of the resale shares. There is no
underwriter or coordinating broker acting in connection with the proposed sale
of the resale shares by the selling security holders.
We agreed to keep this prospectus effective until the earlier of (i) the
date on which the shares may be resold by the selling security holders without
registration and without regard to any volume limitations by reason of Rule
144(e) under the Securities Act or any other rule of similar effect or (ii) all
of the shares have been sold pursuant to the prospectus or Rule 144 under the
Securities Act or any other rule of similar effect. The resale shares will be
sold only through registered or licensed brokers or dealers if required under
applicable state securities laws. In addition, in certain states, the resale
shares may not be sold unless they have been registered or qualified for sale in
the applicable state or an exemption from the registration or qualification
requirement is available and is complied with.
Under applicable rules and regulations under the Exchange Act, any person
engaged in the distribution of the resale shares may not simultaneously engage
in market making activities with respect to the common stock for the applicable
restricted period, as defined in Regulation M, prior to the commencement of the
distribution. In addition, the selling security holders will be subject to
applicable provisions of the Exchange Act and the rules and regulations
thereunder, including Regulation M, which may limit the timing of purchases and
sales of shares of the common stock by the selling security holders or any other
person. We will make copies of this prospectus available to the selling security
holders and have informed them of the need to deliver a copy of this prospectus
to each purchaser at or prior to the time of the sale.
We will not receive any part of the proceeds from the resale by the selling
security holders of any common stock under this prospectus. We will bear all
expenses other than selling discounts and commissions and fees and expenses of
the selling security holders in connection with the registration of the shares
being reoffered by the selling security holders.
LEGAL PROCEEDINGS
We are not a party to any pending legal proceeding, other than routine
litigation that is incidental to our business, and are not aware of any
proceeding contemplated by a governmental authority against us.
DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS
TEONG C. LIM
Teong C. Lim, age 66, currently serves as interim President and Chief
Executive Officer and a director of Electronic Sensor Technology. Dr. Lim has
served as a director of Electronic Sensor Technology since January 31, 2005 and
served as Vice President of Corporate Development from February 1, 2005 through
January 25, 2006. Dr. Lim was the director of corporate development of
Electronic Sensor Technology, L.P. from March 1995 through August 2000 and was
the Manager of Corporate Development of Electronic Sensor Technology, L.P. from
August 2000 through February 2005. Dr. Lim has been the President of Amerasia
Technology, Inc., a subsidiary of Electronic Sensor Technology, since 1984.
Since 1997, Dr. Lim has been a director of Crystal Clear Technology, Sdn. Bhd.,
a privately-owned Malaysian company that manufactures and markets a
high-contrast liquid crystal display (LCD) product line. Dr. Lim received a
Ph.D. in Electrical Engineering from McGill
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University in 1968 and an M.B.A. from Pepperdine University in 1982. Dr. Lim
does not serve as a director of any other publicly reporting company.
FRANCIS H. CHANG
Francis H. Chang, age 71, currently serves as Secretary and Vice President
of Finance and Administration and a director of Electronic Sensor Technology.
Mr. Chang has served as a director of Electronic Sensor Technology since January
31, 2005 and has served as Secretary and Vice President of Finance and
Administration since February 1, 2005. Mr. Chang was the Vice President of
Finance and Operations of Electronic Sensor Technology, L.P. from March 1995
through February 2005. Mr. Chang received a B.A. in Economics from National
Taiwan University in Taiwan in 1956 and an M.B.A. from Pepperdine University in
1978. Mr. Chang does not serve as a director of any other publicly reporting
company.
JAMES H. FREY
James H. Frey, age 68, currently serves as Chairman of the Board of
Directors of Electronic Sensor Technology. Mr. Frey has served as Chairman since
February 21, 2005. From June 1999 to March 2003, Mr. Frey served as Chief
Executive Officer of TASC Inc., a subsidiary of Litton/Northrup Grumman. He also
served as the Vice President of Information Technology at Litton from March 2001
to March 2002. Mr. Frey is currently a director of SSG Precision Optronics, a
privately-held optical component manufacturing company. Mr. Frey received a B.S.
in Electrical Engineering from Duke University in 1960. Mr. Frey does not serve
as a director of any other publicly reporting company.
MIKE KRISHNAN
Mike Krishnan, age 66, currently serves as a director of Electronic Sensor
Technology. Mr. Krishnan has served as a director of Electronic Sensor
Technology since February 21, 2005. Mr. Krishnan serves on our audit committee
and compensation committee. Mr. Krishnan has been President of L&G Resources
(1994) Inc. since August 2003. He has served as Managing Director of Land &
General Berhad since September 2001. Land & General Berhad is an investment
holding company with subsidiaries engaging in property development, property
management and education services in Malaysia and Australia. Mr. Krishnan also
served as the executive director of Antah Holdings Berhad from April 1990 to
October 2000. Mr. Krishnan received an A.M.P from Harvard Business School in
1987. Mr. Krishnan does not serve as a director of any other publicly reporting
company in the United States. Mr. Krishnan is a director of Land & General
Berhad, which is listed on the Kuala Lumpur Stock Exchange.
EDWARD J. STAPLES
Edward J. Staples, age 62, currently serves as Chief Scientific Officer and
a director of Electronic Sensor Technology. Dr. Staples has served as a director
of Electronic Sensor Technology since January 31, 2005 and has served as Chief
Scientific Officer of Electronic Sensor Technology since May 26, 2005. From
February 1, 2005 through May 26, 2005, Dr. Staples served as President and Chief
Executive Officer of Electronic Sensor Technology. Dr. Staples was a co-founder
of Electronic Sensor Technology, L.P. and was its managing director from
February 1995 through February 2005. Dr. Staples received a B.S. in Electrical
Engineering from Loyola University in 1966, an M.S. in Electrical Engineering in
1969 and a Ph.D. in Solid State Electronics in 1971 from Southern Methodist
University. Dr. Staples does not serve as a director of any other publicly
reporting company.
JAMES WILBURN
James Wilburn, age 73, currently serves as a director of Electronic Sensor
Technology. Dr. Wilburn has served as a director of Electronic Sensor Technology
since September 8, 2005. Dr. Wilburn serves on our audit committee and
compensation committee. Dr. Wilburn has served as dean of Pepperdine
University's School of Public Policy since September 1996. Dr. Wilburn has also
served Pepperdine as Vice President of University Affairs, and as provost and
Chief Operating Officer. He is also a member of the European Parliament
Industrial Council. Dr. Wilburn has served as a director of several companies in
the United States and Europe, including Signet Scientific, George Fisher
(Switzerland), The Olsen Company, Flowline, Brentwood Square Savings Bank and
First Fidelity Thrift and Loan. Dr. Wilburn received his Ph.D. in economic
history from the University of California at Los Angeles, a masters degree from
Midwestern State University and an MBA from Pepperdine's Presidential/Key
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Executive program. He received his bachelors degree from Abilene Christian
University. Dr. Wilburn currently serves as a director of Virco Manufacturing,
which is a publicly reporting company.
GARY WATSON
Gary Watson, age 56, currently serves as Vice President of Engineering of
Electronic Sensor Technology. Mr. Watson has served as Vice President of
Engineering since September 8, 2005. Mr. Watson is the co-inventor of the
zNose(R). Mr. Watson has over twenty years experience in gas chromatography. Mr.
Watson joined Amerasia Technology in 1988 and directed Amerasia Technology's
research in adapting gas chromatographic techniques with surface acoustic wave
(SAW) detectors. He received his B.S. degree from the University of Southern
California in 1972.
FAMILY RELATIONSHIPS AND INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS
Each of our directors holds office until the next annual meeting of our
shareholders, or until his prior death, resignation or removal. There are no
family relationships among our directors or executive officers. Within the past
five years, there has not been any bankruptcy petition filed by or against any
business of which any of our officers, directors or control persons were a
general partner or executive officer either at the time of the bankruptcy or
within two years prior to that time. None of our officers, directors or control
persons has been convicted in a criminal proceeding in the past five years or is
subject to a pending criminal proceeding (excluding traffic violations and other
minor offenses). None of our officers, directors or control persons is subject
to any order, judgment, or decree, not subsequently reversed, suspended or
vacated, of any court of competent jurisdiction, permanently or temporarily
enjoining, barring, suspending or otherwise limiting his involvement in any type
of business, securities or banking activities. None of our officers, directors
or control persons has been found by a court of competent jurisdiction (in a
civil action), the Securities and Exchange Commission or the Commodity Futures
Trading Commission to have violated a federal or state securities or commodities
law, where the judgment has not been reversed, suspended, or vacated.
AUDIT COMMITTEE FINANCIAL EXPERT
While we believe that certain members of our Board of Directors have some
of the attributes of an audit committee financial expert, no single individual
possesses all of the attributes; therefore, no one on our Board of Directors can
be deemed to be an audit committee financial expert. In forming our Board of
Directors, we sought out individuals who would be able to guide our operations
based on their business experience, both past and present, or their education.
Our business model is not complex and our accounting issues are straightforward.
Responsibility for our operations is centralized within our executive
management, which is comprised of four persons. We recognize that having a
person who possesses all of the attributes of an audit committee financial
expert would be a valuable addition to our Board of Directors, however, we are
not, at this time, able to compensate such a person therefore, we may find it
difficult to attract such a candidate.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information, as of March 1, 2006, concerning
our issued and outstanding stock beneficially owned (i) by each director and
each named executive officer of Electronic Sensor Technology, (ii) by all
directors and executive officers of Electronic Sensor Technology as a group and
(iii) by each stockholder known by Electronic Sensor Technology to be the
beneficial owner of more than 5% of the outstanding common stock.
AMOUNT AND NATURE OF
NAME AND ADDRESS (1) BENEFICIAL OWNERSHIP PERCENTAGE
TITLE OF CLASS OF BENEFICIAL OWNER (SHARES OF STOCK) OF CLASS(2)
----------------------- ---------------------------------------- -------------------- -----------
Common stock Francis Chang*+++ 3,933,160(3) 7.26%
Common stock Teong Lim*+++ 5,247,908(4) 9.69%
Common stock James Frey* 0 0.00%
Common stock Mike Krishnan* 9,948,801(5) 18.36%
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AMOUNT AND NATURE OF
NAME AND ADDRESS (1) BENEFICIAL OWNERSHIP PERCENTAGE
TITLE OF CLASS OF BENEFICIAL OWNER (SHARES OF STOCK) OF CLASS(2)
----------------------- ---------------------------------------- -------------------- -----------
Common stock Edward Staples*+++ 4,212,544(6) 7.78%
Common stock James Wilburn* 0 0.00%
Common stock Gary Watson+ 175,000(7) 0.32%
Common stock Land & General Berhad++
c/o Electronic Sensor Technology, Inc.
1077 Business Center Circle
Newbury Park, California 91320 9,948,801(8) 18.36%
Common stock L&G Resources (1994), Inc.++
c/o Electronic Sensor Technology, Inc.
1077 Business Center Circle
Newbury Park, California 91320 9,948,801(9) 18.36%
Common stock 3 Springs, LLC++
c/o Electronic Sensor Technology, Inc.
1077 Business Center Circle
Newbury Park, California 91320 3,595,913 6.64%
Common stock TC Lim, LLC++
c/o Electronic Sensor Technology, Inc.
1077 Business Center Circle
Newbury Park, California 91320 4,729,112 8.73%
Common stock Midsummer Investment Ltd.++
485 Madison Avenue, 23rd Floor
New York, New York 10022 17,701,228(10) 32.67%
Common stock Islandia L.P.++
485 Madison Avenue, 23rd Floor
New York, New York 10022 11,278,101(11) 20.82%
Common stock All directors and named executive
officers as a group 23,517,413(12) 43.41%
* Director
+ Named executive officer
++ 5% or more beneficial owner
(1) The address of each director and named executive officer is c/o Electronic
Sensor Technology, Inc., 1077 Business Center Circle, Newbury Park, California
91320.
(2) These percentages are calculated based upon the total amount of outstanding
shares of common stock held by any person or group plus any securities that such
person or group has the right to acquire within 60 days of March 1, 2006
pursuant to options warrants, conversion privileges or other rights, divided by
54,173,745, which represents the total number of shares of common stock issued
and outstanding as of March 1, 2006.
(3) Includes 80,000 shares of common stock underlying options exercisable
within 60 days of March 1, 2006 and 257,247
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shares of common stock underlying a warrant exercisable within 60 days of
March 1, 2006 and 3,595,913 shares of common stock held by 3 Springs, LLC and
beneficially owned by Mr. Chang by virtue of his position as sole member of 3
Springs.
(4) Includes 80,000 shares of common stock underlying options exercisable
within 60 days of March 1, 2006 and 438,796 shares of common stock underlying a
warrant exercisable within 60 days of March 1, 2006 and 4,729,112 shares of
common stock held by TC Lim, LLC and beneficially owned by Dr. Lim by virtue of
his position as sole member of TC Lim.
(5) Includes 9,632,534 shares of common stock and 316,267 shares of common stock
underlying a warrant exercisable within 60 days of March 1, 2006 held by L&G
Resources (1994), Inc., of which Mr. Krishnan is a beneficial owner by virtue of
being President of L&G Resources (1994), Inc. and Managing Director of Land &
General Berhad, the parent company of L&G Resources (1994), Inc.
(6) Includes 100,000 shares of common stock underlying options exercisable
within 60 days of March 1, 2006 and 343,708 shares of common stock underlying a
warrant exercisable within 60 days of March 1, 2006.
(7) Includes 175,000 shares of common stock underlying options exercisable
within 60 days of March 1, 2006.
(8) Includes 9,632,534 shares of common stock and 316,267 shares of common
stock underlying a warrant exercisable within 60 days of March 1, 2006 held by
its wholly-owned subsidiary, L&G Resources (1994), Inc., of which Land & General
Berhad is a beneficial owner.
(9) Includes 316,267 shares of common stock underlying a warrant exercisable
within 60 days of March 1, 2006.
(10) Includes 9,903,169 shares of common stock underlying a debenture
convertible within 60 days of March 1, 2006 and 7,798,059 shares of common stock
underlying a warrant exercisable within 60 days of March 1, 2006. Midsummer
Capital, LLC, a New York limited liability company, serves as investment advisor
to Midsummer Investment Ltd., a Bermuda company. By reason of such
relationships, Midsummer Capital may be deemed to share dispositive power over
the shares of common stock beneficially owned by Midsummer Investment. Midsummer
Capital disclaims beneficial ownership of such shares of common stock. Michel A.
Amsalem and Scott D. Kaufman are members of Midsummer Capital. By reason of such
relationships, Mr. Amsalem and Mr. Kaufman may be deemed to share dispositive
power over the shares of common stock stated as beneficially owned by Midsummer
Investment. Mr. Amsalem and Mr. Kaufman disclaim beneficial ownership of such
shares of common stock.
(11) Includes 5,501,761 shares of common stock underlying a debenture
convertible within 60 days of March 1, 2006 and 5,776,340 shares of common stock
underlying a warrant exercisable within 60 days of March 1, 2006. The general
partner of Islandia is John Lang, Inc., a New York Sub-S corporation formed to
manage investments. John Lang, Inc. has sole dispositive power and sole voting
power over all matters not related to director elections. The individuals that
exercise shared dispositive and voting power for John Lang, Inc. are Richard
Berner, President of John Lang, Inc. and Edgar Berner and Thomas Berner, both
Vice-Presidents of John Lang, Inc. By virtue of these relationships John Lang,
Inc., Richard Berner, Edgar Berner and Thomas Berner may be deemed to have
indirect beneficial ownership of the shares of common stock beneficially owned
by Islandia; however, John Lang, Inc. Richard Berner, Edgar Berner and Thomas
Berner disclaim beneficial ownership of the shares of common stock beneficially
owned by Islandia.
(12) Includes 435,000 shares of common stock underlying options exercisable
within 60 days of March 1, 2006 and 1,356,018 shares of common stock underlying
warrants exercisable within 60 days of March 1, 2006, as well as 9,632,534
shares of common stock held by L&G Resources (1994), Inc., 3,595,913 shares of
common stock held by 3 Springs, LLC and 4,729,112 shares of common stock held by
TC Lim, LLC.
DESCRIPTION OF SECURITIES
As of March 1, 2006, Electronic Sensor Technology has 54,173,745 shares of
common stock issued and outstanding and no shares of preferred stock issued and
outstanding. Electronic Sensor Technology is authorized to issue 200,000,000
shares of common stock in the aggregate and 50,000,000 shares of preferred stock
in the aggregate. Each of our shareholders is entitled to one vote for each
share of common stock on all matters submitted to a shareholder vote. Holders of
the common stock do not have cumulative voting rights. Therefore, holders of a
majority of the shares of common stock voting for the election of directors can
elect all of the directors. A quorum is required for any annual or special
meeting of our shareholders in order to transact any business at the meeting,
other than the election of the chairman or the adjournment of the meeting. Two
persons present and being, or representing by proxy, shareholders constitutes a
quorum. A vote by the holders of a majority of our outstanding shares
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of common stock is required to effectuate certain fundamental corporate changes
such as liquidation, merger or an amendment to our articles of incorporation.
Dividends on our common stock may be declared and paid at such times as the
Board of Directors may determine. Holders of common stock are entitled to share
in all dividends that the Board of Directors, in its discretion, declares from
legally available funds. However, we have never paid cash dividends on our
common stock and do not anticipate paying cash dividends on our common stock in
the foreseeable future.
In the event of a liquidation, dissolution or winding up, each outstanding
share of common stock entitles its holder to participate pro rata in all assets
that remain after payment of liabilities and after providing for each class of
stock, if any, having preference over the common stock. Holders of our common
stock have no pre-emptive rights, no conversion rights and there are no
redemption provisions applicable to our common stock.
Certain provisions of our articles of incorporation, bylaws and Nevada law,
as well as certain agreements we have with our executives, could be used by our
incumbent management to make it substantially more difficult for a third party
to acquire control of us. These provisions include the following:
o we may issue preferred stock with rights senior to those of our common
stock; and
o the Board may fill casual vacancies occurring in the Board and may
appoint one or more additional directors between annual meetings of
shareholders to hold office until the next annual meeting of
shareholders.
These provisions may discourage certain types of transactions involving an
actual or potential change in control. These provisions may also limit our
shareholders' ability to approve transactions that they may deem to be in their
best interests and discourage transactions in which our shareholders might
otherwise receive a premium for their shares over the then current market price.
INTEREST OF NAMED EXPERTS AND COUNSEL
No expert preparing or certifying all or part of this registration
statement or a report or valuation for use in connection with the registration
statement or counsel named in this prospectus as having given an opinion on the
validity of the securities being registered or upon other legal matters
concerning the registration or offering of the securities was hired on a
contingent basis, will receive a direct or indirect interest in Electronic
Sensor Technology, or was a promoter, underwriter, voting trustee, director,
officer, or employee of Electronic Sensor Technology.
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION
FOR SECURITIES ACT LIABILITIES
Under our bylaws, directors are generally indemnified for all costs,
charges and expenses incurred in connections with a proceeding to which a
director is made a party by reasons of his being or having been a director and
officers, employees and agents may be, at the discretion of the Board of
Directors, indemnified for all costs, charges and expenses incurred that result
from acting as an officer of the corporation. Nevada Revised Statute 78.7502
provides that Electronic Sensor Technology may indemnify directors, officers,
employees and agents of Electronic Sensor Technology for expenses reasonably
incurred in connection with and to the extent that such director, officer,
employee or agent of Electronic Sensor Technology has been successful on the
merits or otherwise in defense of any action, suit or proceeding or any claim,
issue or matter wherein such person "acted in good faith and in a manner which
he reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful," subject to certain
limitations.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of Electronic
Sensor Technology pursuant to the foregoing provisions, or otherwise, Electronic
Sensor Technology has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable.
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DESCRIPTION OF BUSINESS
We are engaged in the development, manufacture, and sale of a patented
product we call zNose(R), a device designed to detect and analyze chemical odors
and vapors, or, in another words, an electronic "nose". We believe the zNose(R)
is superior to other electronic "noses" because of its speed, specificity and
sensitivity. The zNose(R) identifies the chemical makeup of any fragrance, vapor
or odor. The zNose(R) does this by creating a visual image of the fragrance,
vapor or odor that it detects, so that the user of the zNose(R) may easily
identify the fragrance, vapor or odor.
We believe that our products will have broad applications in the homeland
security, environmental monitoring and detection and laboratory instrument
markets. We are involved in ongoing product research and development efforts in
that regard. We have also concentrated our efforts on further product
development, testing and proving, and assembling our sales and support
organization.
Our executive offices are located at 1077 Business Center Circle, Newbury
Park, California 91320 and our telephone number is (805) 480-1994.
HISTORY AND BACKGROUND
We were incorporated under the laws of the state of Nevada as Bluestone
Ventures Inc. on July 12, 2000. From the date of our incorporation until
February 1, 2005, we were in the business of acquiring and exploring potential
mineral properties in Ontario, Canada. We changed our name to Electronic Sensor
Technology, Inc. on January 26, 2005 in connection with the acquisition of two
corporations that had together owned Electronic Sensor Technology, L.P. Since
the acquisition of Electronic Sensor Technology, L.P., our business has been the
development, manufacture and sale of instruments that detect and analyze vapors
and odors. We have abandoned our mining exploration business.
ELECTRONIC SENSOR TECHNOLOGY, L.P. ACQUISITION
On February 1, 2005, pursuant to the terms of an Agreement and Plan of
Merger by and among Electronic Sensor Technology, Amerasia Technology, holder of
approximately 55% of the partnership interests of Electronic Sensor Technology,
L.P., L&G Sensor Technology, holder of approximately 45% of the partnership
interests of Electronic Sensor Technology, L.P., Amerasia Acquisition, a
wholly-owned subsidiary of Electronic Sensor Technology, and L&G Acquisition, a
wholly-owned subsidiary of Electronic Sensor Technology, Electronic Sensor
Technology acquired 100% of the outstanding equity partnership interest of
Electronic Sensor Technology, L.P. Under the Agreement and Plan of Merger:
(i) Amerasia Technology merged with and into Amerasia Acquisition such
that it became a wholly-owned subsidiary of Electronic Sensor
Technology;
(ii) L&G Sensor Technology merged with and into L&G Acquisition such that
L&G Sensor Technology became a wholly-owned subsidiary of Electronic
Sensor Technology;
(iii) as a result of the mergers of (i) and (ii), Electronic Sensor
Technology indirectly acquired the partnership interests of
Electronic Sensor Technology, L.P.; and
(iv) Electronic Sensor Technology issued 20,000,000 shares of its common
stock to the shareholders of Amerasia Technology and L&G Sensor
Technology.
In November 2004, Electronic Sensor Technology, L.P. sold $200,000 in
limited partnership interests to certain bridge investors. Concurrent with the
mergers, these limited partnership interests were directly exchanged into
200,000 shares of common stock of Electronic Sensor Technology and warrants to
purchase 200,000 shares of common stock of Electronic Sensor Technology at $1.00
per share to certain investors.
In connection with the mergers, Electronic Sensor Technology entered into
Subscription Agreements with certain investors on January 31, 2005. Under these
Subscription Agreements, Electronic Sensor Technology issued and sold in a
private placement 3,985,000 shares of its common stock and warrants to purchase
3,985,000 shares of common stock at $1.00 per share to certain investors for
gross proceeds of $3,985,000. Electronic Sensor Technology received the gross
proceeds of the sale of these
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shares on February 1, 2005. Electronic Sensor Technology received net proceeds
of approximately $3,821,000 less fees, including counsel fees for the investors
and Electronic Sensor Technology, L.P. of approximately $164,000.
Immediately following the mergers and the private placement, on February 1,
2005 there were 53,968,471 shares of Electronic Sensor Technology common stock
outstanding, of which (i) shareholders of Bluestone prior to the mergers and the
private placement held 26,988,279 shares (approximately 50.0% of our common
stock), (ii) the shareholders of Amerasia Technology and L&G Sensor Technology
prior to the mergers and the private placement held 22,783,471 shares
(approximately 42.2% of our common stock) and (iii) investors in the private
placement occurring on February 1, 2005 as a group held 4,185,000 shares
(approximately 7.8% of our common stock). The total outstanding interests of
Electronic Sensor Technology, L.P. were exchanged for 20,000,000 shares of
Electronic Sensor Technology, Inc. In addition, 2,783,279 shares of Electronic
Sensor Technology, Inc. were distributed to pre-merger shareholders of Amerasia
Technology and L&G Sensor Technology in exchange for the cancellation of debt
owed to such shareholders, at a conversion rate of $1.00 per share. The
conversion rate of $1.00 per share was established immediately preceding the
merger through the private placement of 3,985,000 shares of common stock at
$1.00 per share and the conversion of a $200,000 equity advance to Electronic
Sensor Technology, L.P. for 200,000 shares of Electronic Sensor Technology
stock. The transaction price of $1.00 per share was established by arms length
negotiation between the former management of Bluestone Ventures and Electronic
Sensor Technology, L.P. (now management of Electronic Sensor Technology, Inc.)
in December 2004. As a condition to the merger transactions, Bluestone Ventures
agreed to raise not less than $3,000,000 of new equity capital in a private
placement offering. In determining to proceed with the merger transactions,
management of Electronic Sensor Technology, L.P. (now management of Electronic
Sensor Technology, Inc.) weighed the expected cash balance of Bluestone Ventures
after giving effect to the private placement offering discussed above and the
mergers against the overall equity ownership of Electronic Sensor Technology,
Inc. post-merger that would be held by the former owners of Electronic Sensor
Technology, L.P. (i.e., the former owners of Electronic Sensor Technology, L.P.
were willing to give up 57.8% of Electronic Sensor Technology, L.P. for not less
than $3,000,000 in cash). While management of Electronic Sensor Technology, L.P.
(now management of Electronic Sensor Technology, Inc.) was not privy to the
valuation methodology used by management of Bluestone Ventures in establishing a
transaction price of $1.00 per share, management of Electronic Sensor
Technology, L.P. (now management of Electronic Sensor Technology, Inc.) assumes
that management of Bluestone Ventures and its advisors used one or more
traditional valuation methodologies.
In conjunction with the mergers, all of the officers and directors of
Bluestone resigned and Dr. Edward Staples was appointed President of Bluestone.
Dr. Staples, along with Mr. Francis Chang and Dr. Teong Lim were named directors
of Bluestone and the prior operations of Bluestone were terminated.
Following the mergers we assumed as our principal operations, the
operations of Electronic Sensor Technology, L.P. and we appointed additional
officers. In May 2005, we expanded our Board of Directors from 5 to 7 directors
and appointed additional directors to fill the new directorships.
OVERVIEW OF PAST OPERATIONS OF ELECTRONIC SENSOR TECHNOLOGY, L.P.
Following the mergers, our operations are a continuation of operations
originally conducted by Electronic Sensor Technology, L.P. Electronic Sensor
Technology, L.P. was formed in 1995 to develop and manufacture, the zNose(R), an
advanced technology in chemical vapor detection and analysis. The zNose(R) has
been developed with over $10 million in funding, primarily from equity funding
from existing equity holders. In 1999, Electronic Sensor Technology, L.P.
completed beta testing of its products and commenced commercial sales to the
analytical instrumentation/quality control market as well as the homeland
security market.
In order to finance its operations, Electronic Sensor Technology, L.P.
obtained a 4% loan of $1.975 million from East West Bank in September 2003.
This loan was guaranteed by three officers of Electronic Sensor Technology, L.P.
In connection with the mergers, we assumed the then outstanding balance of
$1.8 million on the East West Bank loan from Electronic Sensor Technology, L.P.,
and the guarantees were released. In addition, we agreed to pledge a $900,000
certificate of deposit as collateral for repayment under the loan.
INDUSTRY OVERVIEW
Although there are a vast number of applications for the zNose(R) product,
we believe that the most significant demands for our product will be in three
general market categories - homeland security, analytical
instrumentation/quality control and environmental monitoring and detection.
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Homeland Security. According to published sources, the overall homeland
security market was projected to be $98-114 billion in 2004. We believe that
detection and analysis of chemical compounds will aid greatly in various
homeland security efforts including:
o Building Security. There is a need for a continuous and real-time
chemical detection systems to monitor the air in buildings and in
confined spaces. Detecting hazardous gases and poisonous chemical
agents such as sarin, VX explosives, and contrabands for security and
environmental safety purposes are the main concerns. We believe that
the addressable commercial building security market segment may be as
high as $1.2 billion based on the top 4% of the high-end commercial
buildings that would seek protection from a chemical detection system.
o Marine Smart Containers. Over seven million sea cargo containers
arrive in the U.S. every year and only 4% of them are being inspected
by the U.S. Customs Department. Cargo container security is a top
priority with the U.S. government. We seek to incorporate the
zNose(R) product into the smart container program.
o Airports. Our zNose(R) products may be used to complement existing
X-Ray and bomb detection technologies.
o Drug Interdiction. The zNose(R)has been used to detect contrabands,
including illicit controlled substances along U.S. borders.
Analytical Instrumentation/Quality Control. The zNose(R) has been serving
the chemical vapor analysis needs in various manufacturing industries. We
estimate that the market for products such as zNose(R) may reach as much as $50
million during the next few years. The zNose(R) has been used for a host of
applications relating to analysis and quality control such as:
o screening incoming raw materials;
o checking ingredients in processed food and pharmaceutical products;
o inspecting packaging materials and finished goods; and
o detecting hazardous gas leaks in chemical plants.
Environmental Monitoring and Detection. The zNose(R) has been serving rapid
on-location needs in detection and monitoring of toxic chemicals in the water
for environmental protection purposes. In a recent toxic chemical spill caused
by a chemical plant explosion in northeastern China which contaminated major
water sources, the zNose(R) was deployed by local authorities to detect and
monitor toxic flows in a river and to determine the safety of the water on a
near real-time basis.
CONVENTIONAL ELECTRONIC NOSE TECHNOLOGY
Conventional electronic noses are unable to meet the needs of the market
because of their fundamental construction. They are not able to identify
fragrances, vapors and odors with an acceptable degree of specificity and
preciseness. In addition, conventional electronic noses require sophisticated
computer software in order for its chemical analyses to be recognized. This type
of electronic nose is therefore not acceptable for use in scientific
measurement.
THE ZNOSE(R) SOLUTION
Speed, precision and versatility are the key characteristics of the
zNose(R) product. The zNose(R) has been developed to replace the conventional
electronic nose. The zNose(R) operates as quickly as a conventional electronic
nose while delivering the precision and accuracy of a much more expensive
instrument. The zNose(R) has advanced chemical analysis technology by performing
vapor analysis within 10 seconds. Early models of the zNose(R) have been tested
by the U.S. Environmental Protection Agency under Environmental Technology
Verification program and by the Office of National Drug Control Policy for drug
interdiction. Tests have also been performed at the Midwest Research Institute's
Surety Laboratory in Kansas City and at the U.S. Army Dugway Proving Ground in
Utah with respect to the effectiveness of the zNose(R) in detecting chemical
agents such as sarin gases. We believe that the zNose(R) is currently the only
electronic nose approved for purchase through the General Services
Administration pre-approved procurement program.
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Our VaporPrint(TM) imaging ability is another major advantage of the
zNose(R) product. VaporPrint(TM) allows the user of the zNose(R) to see a visual
image of the makeup of a particular fragrance, vapor or odor within 10 seconds.
In addition, VaporPrint(TM) can produce high-resolution visual images of odor
intensity. VaporPrint(TM) images are displayed on a laptop computer screen and
are recorded on the hard drive of the laptop computer.
OUR PRODUCTS
ZNOSE(R)
The zNose(R) is essentially a vapor detector that uses a sensor based on
Surface Acoustic Wave technology. Basically, the zNose(R) "inhales" a particular
fragrance, vapor or odor. The fragrance, vapor or odor is carried up through a
column and the chemicals making up the fragrance, vapor or odor condense on the
crystal surface of the sensor in the zNose(R). This condensation on the sensor
causes a change in what is called the "fundamental acoustic frequency" of the
crystal surface. It is this change in fundamental acoustic frequency that allows
the zNose(R) to determine the chemical makeup of the fragrance, vapor or odor.
This change is measured by a microprocessor that calculates the change in
frequency which is related to the amount of fragrance, vapor or odor sampled by
the zNose(R). The microprocessor also measures the arrival time (called the
retention time) of the change in the fundamental frequency. Different chemicals
arrive at different times and so, once the microprocessor has determined the
retention time of the unidentified fragrance, vapor or odor, it compares it to
retention times that are stored in a computer library. This allows the zNose(R)
to identify the particular fragrance, vapor or odor.
The zNose(R) analyzes and identifies vapor specimens in a two-step process.
In the first step, typically lasting 10 seconds, the instrument collects a small
sample of the vapor to be analyzed. The sample is then injected in to the gas
chromatography column where the individual chemicals present are separated and
measured. The chemical analysis requires as little as 10 seconds to produce the
vapor's chemical signature, or chromatogram. The vapor's chemical signature can
also be visually displayed in a graphic form called a "VaporPrint". This
chemical signature is then compared against the reference database of chemical
odor profiles. If the chemical compound of the specimen is not in the reference
database, it will not be identified by name; however, the makeup of the
unidentified specimen can be stored in the reference database for future
identification. The reference database of chemical odor profiles that is stored
on the hard drive of the laptop computer is composed of standards of various
chemicals that are available through the National Institute of Standards and
Technology (NIST). The database can be updated when standards of new chemicals
are encountered and input by way of simple software selection, or by way of
sampling unknown chemical compounds and storing the measurements of such
chemical compounds in the database. If the zNose(R) samples a non-specimen
vapor, such as clear ambient air, no signal is generated on the laptop computer
screen and no VaporPrint(TM) is created. If the zNose(R) samples a complex
mixture of chemical compounds, each compound and the concentration of such
compound is measured independently of the other compounds contained in the
mixture. Due to the independent measurement of each compound in a complex
mixture, each measurement is free from the influence of the other compounds, and
the accuracy of the zNose(R) is therefore not affected by complex mixtures.
We currently manufacture and sell two zNose(R) models designated as Model
4200 (Handheld Unit) and Model 7100 (Bench Top Unit). Model 4200 is designed for
portability and for applications requiring quick and accurate vapor screening in
the field. Model 7100 is designed for laboratory testing and is ideal for
testing water and product quality control samples. Both Model 4200 and Model
7100 weigh approximately 27 pounds, not including a laptop computer that must be
used with each zNose(R). The Model 4200 has two housings (the case and the
detector head) and a laptop computer. The case of the Model 4200 is 10" x 12" x
6" and weighs 20 pounds and the detector head of the Model 4200 is 4 1/4" x 12"
x 7" and weighs 7 pounds. The Model 7100 is packaged in a single housing and
also requires a laptop computer. The dimensions of the Model 7100 packaging are
14.3" x 14.3" x 7.5". Both the Model 4200 and Model 7100 are powered by a
standard AC electrical outlet, and both models adapt to standard outlets in
North America, Asia and Europe (i.e., the zNose(R) may be operated by a 110 volt
or 220 volt power source). In addition, both the Model 4200 and 7100 may be
powered by connecting the unit to a car battery with an appropriate adaptor.
Either model can be produced in one of two basic vapor sensing configurations:
volatile and semi-volatile. The volatile configuration can detect volatile
organic compounds, such as benzene. The semi-volatile configuration can detect
heavier vapors such as those found in explosives and drugs.
We are also developing Models 7100B and 7100C. Model 7100B is designed as a
fixed installation unit for both indoor and outdoor ambient air monitoring
instrument. It can be used for building security as well as outdoor
environmental monitoring applications. It is designed to be operated remotely
from a central control station via a radio frequency (RF) control link. Model
7100C is designed to be used for shipping containers and truck monitoring for
both commercial and homeland security
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applications. It is designed to be used with a remote sampling kit which enables
multiple samples to be collected then taken to the zNose(R) to be analyzed.
We have designs to produce a hand-held zNose(R) that is smaller than the
Model 4200 for commercial market. This model is designed to meet the needs of
law enforcement, manufacturing process monitoring, and environmental monitoring.
We plan to develop a separate version of the mini-zNose(R) to be used as a
personal nerve agents detector for the military and security markets.
ACCESSORIES
We offer several lines of accessory products such as calibration devices,
sample desorbers, MicroSense Software(C), and GPS receivers. An example is our
Model 3100 which provides a calibrated vapor source as well as a tool for
extracting vapors from solid and liquid samples.
TECHNICAL SUPPORT
All zNose(R) instruments sold are equipped with a software package called
PCAnywhere. PCAnywhere allows a technical support person at EST to operate an
instrument anywhere in the world through the internet. This better enables an
EST technician to be available to address any customer problem.
SALES AND DISTRIBUTION
We sell our zNose(R) product through distribution channels including
equipment distributors and sales representatives in over 20 foreign countries,
e-commerce and customer referrals. We entered into an agreement with
TechMondial, Ltd. to be our exclusive distributor for a seven-year period in the
countries of the European Community, Romania, Bulgaria, Turkey, Croatia and
Switzerland on October 21, 2005. We entered into an agreement with eScreen
Sensor Solutions to be our exclusive distributor for a five-year period in
Israel, the Caribbean, the State of Florida, and Central and South America on
October 16, 2003. As part of this latter agreement, eScreen paid us an up-front
fee of $250,000 in 2004.
All sales representatives and distributors are required to attend a
three-day training course conducted at our headquarters in Newbury Park,
California. We advertise in selected industry trade journals and trade
conventions. In the future, we intend to build a dedicated marketing and sales
team. We have historically generated sales from both U.S. and international
customers, each of which have accounted for approximately 50% of our sales in
the past. However, in the fiscal year ending December 31, 2005, international
customers accounted for approximately two-thirds of our total sales. We expect a
similar split among U.S. and international sales to continue. All of our
customers pay us in U.S. dollars. Major domestic customers include the U.S.
Armed Forces, Lockheed Corporation and NASA. Major international customers
include Beijing R&D Technology Company Ltd. in China, TechMondial Limited of
England, Hitachi Corporation in Japan and Max Planck Institute in Germany.
COMPETITION
We are unaware of any direct competitor to the zNose(R) product on the
market today. In the homeland security markets, we face competition from
manufacturers of X-Ray machines, Ion-Mobility Spectrometers and chemical coated
sensors. X-Ray machines have been widely used for security purposes in detecting
metal objects but not for chemical compounds. Ion-Mobility Spectrometer
equipment is a vapor detector and is designed to detect certain compounds but is
blind to other compounds. Hence, it can only see a small dot in a space but
cannot see the total picture. It employs a different sample collection technique
by wiping the surfaces of the object placed for screening. Ion-Mobility
Spectrometer also uses materials in its construction which may be offensive to
users in certain countries.
Chemical coated sensors are the conventional electronic noses. They use an
array of chemical sensors each reacting to certain specific compounds. As
mentioned earlier, electronic noses cannot be calibrated with chemical standards
and therefore cannot be used for scientific measurement.
We have another set of competitors manufacturing portable vapor and odor
analysis products for the instrumentation market from major corporations such as
Agilent Technologies, Inc. (NYSE: A), Perkin-Elmer, Inc. (NYSE: PKI) and Varian,
Inc. (NASDAQ: VARI). We believe that our zNose(R)product is competitive with
these companies' products based on speed and cost.
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Many of our current and potential competitors have larger customer bases,
including the previously listed competitors, greater brand recognition and
significantly greater financial, marketing and other resources than we do and
may enter into strategic or commercial relationships with larger, more
established companies. Some of our competitors may be able to secure alliances
with customers and affiliates on more favorable terms, devote greater resources
to marketing, advertising and promotional campaigns and devote substantially
more resources to research and development than we do. In addition, new
technologies and the expansion of existing technologies may increase the
competitive pressures on us.
We cannot assure you that we will be able to compete successfully against
current or future competitors, and competitive pressures faced by us could harm
our business, operating results and financial condition. We do not currently
represent a significant competitive presence in the homeland security or
analytic instrumentation markets.
MANUFACTURING AND RAW MATERIALS
We design, prototype and manufacture our products at our headquarters. Our
manufacturing facilities adhere to ISO9000 manufacturing methods (quality
standards developed by the International Organization for Standardization, which
have been adopted by many countries around the world). We contract out the
manufacturing and assembling of certain components to subcontractors. Our
current annual manufacturing capacity is approximately 1,000 zNose(R) units. The
principal components to our products are computer chips, circuit boards,
transformers and sensory devices. The prices for these components are subject to
market forces largely beyond our control, including energy costs, market demand,
and freight costs. The prices for these components have varied significantly in
the past and may vary significantly in the future. Our principal suppliers of
components and raw materials include: Sigma Co. of Bellefonte, Pennsylvania,
Ventura Fluid System Technologies of Camarillo, California and Valco Instruments
Co., Inc. of Houston, Texas.
CUSTOMERS
In 2005, we had approximately 35 customers. Our largest customer in 2005,
Beijing R&D Technology Company Ltd., purchased 15 of the total 56 zNose(R) units
sold by us in 2005, constituting approximately 27% of the zNose(R) units sold in
2005. In 2005, we selected Beijing R&D Technology Co., Ltd. to be our exclusive
distributor in China and TechMondial, Ltd. to be our exclusive distributor in
the countries of the European Community, Romania, Bulgaria, Turkey, Croatia and
Switzerland for a seven-year term. Our largest customers are (1) Beijing R&D
Technology Company Ltd. of China, (2) TechMondial Limited of England and
(3) Agency for Defense Development of the Republic of South Korea.
PATENTS, TRADEMARKS AND OTHER PROPRIETARY RIGHTS
We regard our patents, trademarks, trade names and similar intellectual
property as critical to our success. We rely on patent and trademark laws, trade
secret protection and confidentiality agreements with employees, distributors,
customers, partners and others to protect our proprietary rights.
We own four United States patents covering our zNose(R) product, including:
o No. 5,289,715, "Vapor Detection Apparatus and Method Using an Acoustic
Interferometer" issued March 1, 1994;
o No. 5,970,803, "Method and Apparatus for Identifying and Analyzing
Vapor Elements", issued October 26, 1999;
o No. 6,212,938, "Method of Detecting Smell of a Vapor and Producing a
Unique Visual Representation thereof," issued April 10, 2001;
o No. 6,354,160, "Method and Apparatus for Identifying and Analyzing
Vapor Elements," issued December 3, 2002.
We may not be able to obtain patent protection for any derivative uses of
zNose(R), or for any other products we may later acquire or develop. We also
cannot assure you that we will be able to obtain other foreign patents to
protect our products.
-24-
We have copyrighted our MicroSense Windows software and Xilinx gate array
firmware, which controls the operation of the zNose(R) and produces visual
images. These images, trademarked as VaporPrints(TM), make it possible to
display vapor analysis data from any vapor analysis system, as unique visual
images and facilitate pattern recognition of complex odors and fragrances.
At March 1, 2006, we held registered trademarks for zNose(R) and
VaporPrints(TM). We intend to evaluate the possible application for new patents
and trademarks as needed to cover current and future applications of our
technology and product developments. We intend to undertake all steps necessary
to preserve and protect our patents, trademarks and intellectual property
generally.
We are not aware that our products, trademarks or other proprietary rights
infringe the rights of third parties, nor are we aware of any infringements of
our proprietary rights. We continually evaluate potential infringements of our
proprietary rights and intend to take such legal and other actions as may be
necessary to protect those rights. However, there can be no assurance that third
parties will not assert infringement claims against us in the future with
respect to current or future products or that any such assertion may not require
us to enter into royalty arrangements or result in costly litigation.
GOVERNMENT REGULATION
Government agencies, in particular, the Department of Defense, are
principal customers for our products. We are required to comply with the Federal
Acquisition Regulations, a comprehensive set of regulations governing how
vendors do business with the U.S. federal government, to the extent we contract
with departments or agencies of the U.S. government, as well as similar
regulations to the extent we contract with state or local governments. Sales to
or grants from foreign governments or organizations will have their own
regulatory framework, which may or may not be similar to present U.S. standards
or requirements.
RESEARCH AND DEVELOPMENT
Our research and development program consists of developing technologies
related to enhancing our electronic nose product and making it more portable.
Fees related to research and development, include consulting fees, technical
fees, and research, development and testing of our zNose(R) product. We spent
approximately $600,000 in each of 2005 and 2004 on research and development
activities, none of which was borne directly by customers.
EMPLOYEES
As of December 31, 2005 we had a total of 23 staff persons, including 21
full time staff and 2 consultants. In addition to management, we employ sales
people, administrative staff, and development and technical personnel. From time
to time, we may employ independent consultants or contractors to support our
research and development, marketing, sales and support, and administrative
organizations. No collective bargaining units represent our employees and
Electronic Sensor Technology is not party to any labor contracts.
REPORTS TO SECURITY HOLDERS
Electronic Sensor Technology is not currently required to and does not
currently deliver an annual report to security holders. We are not currently
required to deliver an annual report to security holders because our registered
common stock is registered under the Securities Act and is not currently
registered under the Exchange Act. On March 24, 2006 we filed a registration
statement with the SEC on Form 10-SB to register our common stock pursuant to
the Exchange Act, which will become effective within 60 days of filing such
registration statement, unless the SEC directs otherwise. Once the registration
statement is effective, we will be subject to the reporting requirements of the
Exchange Act, including the requirement to deliver an annual report to security
holders when we deliver proxy solicitation materials to security holders in
connection with an annual meeting. However, until such registration statement is
effective, we are under no obligation to do so.
Electronic Sensor Technology is a voluntary reporting company and files
with the Securities and Exchange Commission annual reports on Form 10-KSB,
quarterly reports on Form 10-QSB and current reports on Form 8-K. The public may
read and copy any materials that Electronic Sensor Technology files with the SEC
at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549. The public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an
Internet site that contains reports, proxy and information statements, and other
-25-
information regarding issuers that file electronically with the SEC at:
http://www.sec.gov. More information regarding Electronic Sensor Technology is
available at our website: http://www.znose.com. The information on or that can
be accessed through our website is not part of this prospectus.
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 2005.
The figures in the table are derived from our audited financial statements and
should be read in conjunction with our consolidated financial statements and
related notes included elsewhere in this prospectus. All information below
excludes any securities issued subsequent to December 31, 2005.
December 31, 2005
Long-term debt.................................................. $ 194,444
Stockholders' deficit:
Common stock; $0.001 par value; 200,000,000
Shares authorized; 54,098,745 shares issued
and outstanding.............................................. $ 54,099
Additional paid-in capital.................................... $ (1,779,037)
Accumulated deficit........................................... $ (4,178,489)
Total Stockholders' deficit..................................... $ (5,903,427)
Total capitalization............................................ $ (5,708,983)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial
condition and results of operations together with the financial statements and
the related notes appearing at the end of this prospectus. The following
discussion and other parts of this prospectus contain forward-looking statements
that involve risks and uncertainties. Forward-looking statements can be
identified by words such as "anticipates," "expects," "believes," "plans," and
similar terms. Our actual results could differ materially from any future
performance suggested in this prospectus as a result of factors, including those
discussed in "Risk Factors" beginning on page 2 and elsewhere in this
prospectus. All forward-looking statements are based on information currently
available to us and we assume no obligation to update such forward-looking
statements, except as required by law. Service marks, trademarks and trade names
referred to in this prospectus are the property of their respective owners.
As a result of the mergers whereby Electronic Sensor Technology, L.P.
became a wholly-owned indirect subsidiary of Electronic Sensor Technology and
the subsequent termination of Bluestone's prior operations, our business plan
has been altered to focus on the product operations previously conducted by
Electronic Sensor Technology, L.P. Following the mergers, our revenues were
expected to be, and have been, derived principally from the sale of the zNose(R)
products.
CRITICAL ACCOUNTING POLICIES
Electronic Sensor Technology records revenue from direct sales of products
to end-users when the products are shipped, collection of the purchase price is
probable and Electronic Sensor Technology has no significant further obligations
to the customer. Costs of remaining insignificant obligations of Electronic
Sensor Technology, if any, are accrued as costs of revenue at the time of
revenue recognition. Cash payments received in advance of product or service
revenue are recorded as deferred revenue.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the recorded amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Electronic Sensor Technology reviews long-lived assets, such as property
and equipment, to be held and used or disposed of, for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be
-26-
recoverable. If the sum of the expected cash flows, undiscounted and
without interest, is less than the carrying amount of the asset, an impairment
loss is recognized as the amount by which the carrying amount of the asset
exceeds its fair value. At December 31, 2005 no assets were impaired.
We account for liquidated damages pursuant to Emerging Issue Task Force
("EITF") 05-04, View C, "The Effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument", subject to EITF Issue No. 00-19, "Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock". Pursuant to EITF 05-04, View C, liquidated damages payable
in cash or stock are accounted for as a separate derivative, which requires a
periodical valuation of its fair value and a corresponding recognition of
liabilities associated with such derivative. We also account for our embedded
conversion features and freestanding warrants pursuant to SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which requires a
periodic valuation of their fair value and a corresponding recognition of
liabilities associated with such derivatives. The recognition of derivative
liabilities related to the issuance of shares of common stock is applied first
to the proceeds of such issuance, at the date of issuance, and the excess of
derivative liabilities over the proceeds is recognized as other expense in the
accompanying consolidated financial statements. The recognition of derivative
liabilities related to the issuance of convertible debt is applied first to the
proceeds of such issuance as a debt discount, at the date of issuance, and the
excess of derivative liabilities over the proceeds is recognized as other
expense in the accompanying consolidated financial statements. Any subsequent
increase or decrease in the fair value of the derivative liabilities is
recognized as other expense or other income, respectively. The valuation of such
derivatives requires significant judgment. We exercise our judgment in
determining the maximum liabilities associated with such derivatives as well as
the expected volatility related to their fair value. We base our estimate of the
maximum liabilities on our interpretation of the agreements related the
derivatives.
Accounts receivable are reported at net realizable value. We have
established an allowance for doubtful accounts based upon factors pertaining to
the credit risk of specific customers, historical trends, and other information.
Delinquent accounts are written-off when it is determined that the amounts are
uncollectible.
Inventories are stated at the lower of cost or market, cost determined by
the first-in, first-out (FIFO) method. The Company writes down its inventory for
estimated obsolescence or unmarketable inventory using the difference between
the cost of inventory and the estimated market value based upon assumptions
about future demand and market conditions.
We are required to estimate our income taxes in each of the jurisdictions
in which we operate as part of the process of preparing our consolidated
financial statements. SFAS No. 109, "Accounting for Income Taxes", requires a
valuation allowance to reduce the deferred tax assets reported if, based on the
weight of the evidence, it is not more likely than not that some portion or all
of the deferred tax assets will be realized. Management reviews deferred tax
assets periodically for recoverability and makes estimates and judgments
regarding the expected geographic sources of taxable income, gains from
investments, as well as tax planning strategies in assessing the need for a
valuation allowance. We determined that a valuation allowance of approximately
$900,000 relating to net operating loss carryovers was necessary to reduce our
deferred tax assets to the amount that will more likely than not be realized. As
a result, at December 31, 2005, the Company has no net deferred tax assets. If
the estimates and assumptions used in our determination change in the future, we
could be required to revise our estimates of the valuation allowances against
our deferred tax assets and adjust our provisions for additional income taxes.
In the ordinary course of global business, there are transactions for which the
ultimate tax outcome is uncertain, thus judgment is required in determining the
worldwide provision for income taxes. We provide for income taxes on
transactions based on our estimate of the probable liability. We adjust our
provision as appropriate for changes that impact our underlying judgments.
Changes that impact provision estimates include such items as jurisdictional
interpretations on tax filing positions based on the results of tax audits and
general tax authority rulings.
PLAN OF OPERATIONS
Over the course of the next 12 months, we intend to execute our business
plan and focus our business development efforts in the following key areas:
o By diversifying our product offerings to enhance the usefulness of our
solutions for customers who will have already adopted one or more
products;
o By enhancing our product lines and developing new products to attract
new customers; and
-27-
o By developing partnering relationships with wide-ranging sales and
distribution channel leaders already serving our vertical market space
in a way that assists them in developing new revenue streams and
opportunities through improved technical and sales support and
customer services.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED DECEMBER 31, 2005 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
2004
The following table sets forth certain items included in our Income
Statements (see Financial Statements and Notes) for the periods indicated:
Year Ended
December 31, Variation $ Variation %
---------------------------- 2005 vs 2005 vs
2005 2004 2004 2004*
------------ ------------ ------------ ------------
In $
REVENUES $ 2,122,349 $ 1,076,749 1,045,600 97
COST OF SALES 1,302,602 1,039,280 263,322 25
------------ ------------ ------------ ------------
GROSS PROFIT 819,747 37,469 782,278 NM**
OPERATING EXPENSES:
Research and development 260,125 0 260,125 NM
Compensation 466,421 81,734 384,687 471
Selling 653,092 161,546 491,546 304
General and administrative 1,522,451 282,305 1,240,146 439
------------ ------------ ------------ ------------
TOTAL OPERATING EXPENSES 2,902,089 525,585 2,376,504 452
LOSS FROM OPERATIONS (2,082,342) (488,116) 1,594,226 (619)
OTHER INCOME AND EXPENSE:
Other income derivative 9,915,026 0 9,915,026 NM
Extinguishment of debt 0 57,076 (57,076) NM
Other expense (11,645,920) 0 11,645,920 NM
Gain (loss) on sale of property and equipment 9,287 (7,710) 16,997 NM
Interest expense (324,540) (164,133) 160,407 98
------------ ------------ ------------ ------------
TOTAL OTHER INCOME AND EXPENSE (2,046,147) (114,767) 1,931,380 NM
NET LOSS $ (4,128,489) $ (602,883) 3,525,606 585
============ ============ ============ ============
* Expressed as a decimal.
** NM = not meaningful.
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The following table sets forth, as a percentage of revenues, certain items
included in our Income Statements (see Financial Statements and Notes) for the
periods indicated:
Year Ended
December 31,
----------------------------
2005 2004
------------ ------------
As a % of revenues
REVENUES 100% 100%
COST OF SALES 61% 97%
GROSS PROFIT 39% 3%
OPERATING EXPENSES 140% 33%
LOSS FROM OPERATIONS 98% 45%
OTHER INCOME AND EXPENSE 96% 6%
NET LOSS (195)% (56)%
Revenues primarily consists of the sale of our zNose products. Our increase
in revenues during 2005, when compared to 2004, is primarily attributable to an
increase of volume of shipments of zNose units from 28 units during 2004 to 56
units during 2005.
Cost of Sales primarily consists of manufacturing costs and licensing fees.
The increase in cost of sales during 2005 when compared to 2004 is primarily
attributable to an increase in our number of units shipped, offset by a decrease
in idle labor hours during 2005 when compared to 2004. We believe that our per
unit manufacturing costs will continue to decline as we increase the number of
units sold per quarter, due to economies of scale.
Research and development expenses primarily consists of salaries and
related benefits, material and supplies associated with our efforts in
developing and enhancing our products. The increase in our research and
development expenses during 2005 is primarily attributable to an increase in
salaries and related benefits resulting from the hiring of personnel whose time
is devoted to the development and enhancement of our products.
Compensation expenses primarily consists of salaries and related benefits
of our general and administrative personnel. The increase in compensation
expenses during 2005 when compared to 2004 is primarily attributable to an
increase in personnel to support the growth of our operations.
Selling expenses primarily consists of salaries, commissions and related
benefits associated with our selling and marketing efforts The increase in
selling expenses during 2005 when compared to 2004 is primarily attributable to
an increase in employees associated with sales efforts as well expanded sales
activities.
General and administrative expenses primarily consists of costs incurred in
connection with the reverse merger as well professional fees associated with
being a publicly-traded company. Our increase in general and administrative
expenses during 2005 when compared to 2004 results from professional fees
associated with the reverse merger, which occurred during 2005, as well as an
increase of professional fees related to being publicly-traded, which also began
in 2005. The costs incurred in connection with the reverse merger totaled
approximately $635,000, which consisted of approximately $310,000 in legal fees,
$143,000 in investment banking and consultant fees and $182,000 in public
relations firm fees.
Other income-derivatives primarily consists of the decrease in the fair
value of derivative liabilities between the date of issuance of such derivatives
and our year-end. The increase in other income during 2005 when compared to 2004
is primarily attributable to a decrease in derivative liabilities recognized
during 2004. No such derivatives were issued during 2004. Please refer to Note 4
of our accompanying financial statements for further explanation of the origin
and nature of such income. We are unable to determine whether we will record
further decreases in the fair value of derivative liabilities in the foreseeable
future, which would be recorded as other income-derivatives. Such decreases
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would be generally triggered by a decrease in the fair value of our stock price,
upon satisfaction of liquidated damages pursuant to registration rights, or,
possibly, upon satisfaction of our convertible debentures.
Extinguishment of debt primarily consists of the extinguishment of debt
which lapsed pursuant to the applicable statute of limitations during 2004. No
such transactions occurred during 2005.
Other expense-derivatives primarily consists of the recognition of
derivative liabilities we issued during 2005. No such derivatives were issued
during 2004. Please refer to Note 4 of our accompanying financial statements for
further explanation of the origin and nature of such expense. We believe that we
will incur additional expenses associated with the fair value at issuance of
financial instruments which will be recorded pursuant to derivative accounting.
However, we are unable to determine the expected amount we would recognize
pursuant to such issuances since their fair value is computed based on a number
of assumptions, including, among others, the fair value of our stock price,
expected term and exercise price of the financial instrument and expected
volatility of our stock price, which will only be known at the date of issuance.
Interest expense primarily consists of debt discount amortization and
interest on certain debt. The increase in interest discount during 2005 when
compared to 2004 is primarily attributable to the recognition of debt discount
associated with the issuance of convertible debentures in December 2005, offset
by a decrease on certain loans payable which were satisfied in February 2005.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents amounted to approximately $4.2 million at
December 31, 2005.
During 2005, we used approximately $3.0 million in our operating activities
which is the result of the following:
o A net loss of approximately $3.8 million adjusted for:
o the recognition of derivative liabilities of $13.4 million
resulting from the issuance of such derivatives (convertible
debentures and warrants) and a decrease in the fair value of the
derivative liabilities of approximately $11.4 million.
o An increase in accounts receivables, inventories, and accounts payable
and accrued expenses of approximately $435,000, $459,000, and
$266,000, respectively, resulting from increased revenues, increased
production to meet the increased demand of our products and a general
increase in of our expenses associated with our growth.
During 2005, we used approximately $1.0 million in investing activities by
purchasing a certificate of deposit of approximately $919,000 to satisfy the
collateral requirement of our line of credit and by incurring capital
expenditures of approximately $127,000.
During 2005, we generated approximately $8.1 million in financing
activities by generating proceeds of approximately $7,000,000 and $3.8 million
from the issuance of our convertible debentures and our shares of common stock,
respectively, offset by the repayment of our line of credit of approximately
$2.0 million and by paying financing costs of approximately $582,000.
As a result of the mergers, as of February 1, 2005, we assumed certain
liabilities and obligations of Electronic Sensor Technology, L.P. Total
liabilities assumed pursuant to the mergers were approximately $2.2 million,
including approximately (1) $1.8 million owed under a revolving line of credit
with East West Bank, (2) $212,000 of accounts payable and accrued expenses and
(3) $35,000 of other current liabilities. The outstanding loan for $1.8 million
with East West Bank accrued interest at the prime rate as reported in the Wall
Street Journal plus one-half point (0.5%) and was paid off on December 9, 2005.
The original maturity date of the East West Bank line of credit was December 31,
2005, which was extended to February 28, 2006 in order to provide additional
time for processing a pending renewal of the line of credit. East West Bank has
extended a reduced line of credit of $500,000 (based on projected cash flow
requirements for the coming year) with a maturity date of March 31, 2007 and
with an annual interest rate of 7.75%. The loan will be collateralized by all
assets of Electronic Sensor Technology. As part of such collateral, we will also
pledge a certificate of deposit of $250,000 to East West Bank. The loan
documents are currently being processed and we expect to execute them as soon as
they are approved by our Board of Directors.
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During 2004, we used approximately $167,000 in our operating activities
which is the result of the following:
Our net loss of approximately $411,000 adjusted for:
o a decrease in our accounts receivable and accounts payable amounting
to approximately $363,000 and $66,000, respectively, resulting from a
shorter average collection time on accounts receivable and more timely
payments on accounts payable as well as an increase in our inventory
of approximately $88,000 to meet the increased demand of our product.
During 2004, we incurred capital expenditures of approximately $35,000.
During 2004, we financed our operations and capital expenditures by issuing
shares of our common stock generating proceeds of $200,000 and repaying
partners' loan of $120,000.
Although Electronic Sensor Technology possesses a bank operating line of
credit, there can be no assurance that these proceeds together with the net
proceeds of the debentures issued in December 2005 will be adequate for our
capital needs. There can be no assurance that any required or desired financing
will be available through any other bank borrowings, debt, or equity offerings,
or otherwise, on acceptable terms. If future financing requirements are
satisfied through the issuance of equity securities, investors may experience
significant dilution in the net book value per share of common stock. There is
no guarantee that a market will exist for the sale of our shares.
Our primary capital needs are to fund our growth strategy, which includes
creating a sales and marketing staff for the marketing, advertising and selling
of the zNose(R) family of chemical detection products, increasing distribution
channels both in the U.S. and foreign countries, introducing new products,
improving existing product lines and development of a strong corporate
infrastructure. We do not believe that we will have to incur significant capital
expenditures in the near future in order to meet our growth strategy goals.
As of December 31, 2005, our cash balance and working capital were
$5,138,597 and $6,133,134, respectively. Our current monthly cash burn rate is
approximately $250,000 and we do not anticipate any extraordinary cash payments
that we will have to make in the near future until the first principal payment
of approximately $780,000 is due on the convertible debentures that we issued on
December 7, 2005, which such payment is to be made on January 1, 2008. Based on
our current monthly cash burn rate, we believe that we will not require any
financing until the second half of 2007, at the earliest. Accordingly, we
believe that we will be able to continue as a going concern for at least the
next twelve months.
SEASONALITY AND QUARTERLY RESULTS
We do not foresee any seasonality to our revenues or our results of
operations.
INFLATION
Although we currently use a limited number of sources for most of the
supplies and services that we use in the manufacturing of our vapor detection
and analysis technology, our raw materials and finished products are sourced
from cost-competitive industries. While prices for our raw materials may vary
significantly based on market trends, we do not foresee any material
inflationary trends for our product sources.
OFF BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements.
DESCRIPTION OF PROPERTY
We lease approximately 13,500 square feet of office space at 1077 Business
Center Circle, Newbury Park, California. Our current lease expires on September
30, 2006. The lease payments are $15,826 per month. The facility serves as the
company's headquarters and R&D and manufacturing facility.
-31-
INVESTMENT POLICIES
We do not invest, nor do we plan to invest in the foreseeable future in
real estate, interests in real estate, real estate mortgages, securities of or
interests in persons primarily engaged in real estate activities.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Electronic Sensor Technology, L.P., prior to becoming an indirect
subsidiary of Electronic Sensor Technology, Inc., was a party to the following
transactions with the following then executive officers and directors of
Electronic Sensor Technology, L.P. during the past two years:
o On January 22, 2005, Electronic Sensor Technology, L.P. converted
$399,643 in debt of Electronic Sensor Technology, L.P. held by Edward
Staples, then Managing Director of Electronic Sensor Technology, L.P.,
into the right to receive, upon completion of the acquisition of
Electronic Sensor Technology, L.P. by Bluestone Ventures Inc.
(predecessor to Electronic Sensor Technology, Inc.), 399,643 shares of
common stock of Bluestone and warrants to purchase 199,821.5 shares of
common stock of Bluestone at $1.00 per share, exercisable only if the
trading price of such stock is at least $1.50 per share. In addition,
Electronic Sensor Technology, L.P. converted $952,577 in debt owed to
Amerasia Technology into the right to receive shares of common stock
of Bluestone and warrants to purchase shares of common stock of
Bluestone. By virtue of his 30.21% ownership of Amerasia Technology,
Dr. Staples obtained the right to receive, upon the acquisition of
Electronic Sensor Technology, L.P. by Bluestone, 287,773 shares of
Bluestone common stock and warrants to purchase 143,866.5 shares of
Bluestone common stock at $1.00 per share, exercisable only if the
trading price of such stock is at least $1.50 per share.
o On January 22, 2005, on the same terms as those described above,
Electronic Sensor Technology, L.P. converted $226,720 in debt of
Electronic Sensor Technology, L.P. held by 3 Springs, LLC (of which
Francis Chang, then Chief Financial Officer of Electronic Sensor
Technology, L.P. is the sole member), into the right to receive,
226,720 shares of Bluestone common stock and warrants to purchase
113,360 shares of Bluestone common stock. In addition, 3 Springs, LLC
obtained the right to receive 287,773 shares of Bluestone common stock
and warrants to purchase 143,886.5 shares of Bluestone common stock by
virtue of its 30.21% ownership of Amerasia Technology.
o On January 22, 2005, on the same terms as those described above,
Electronic Sensor Technology, L.P. converted $517,899 in debt of
Electronic Sensor Technology, L.P. held by TC Lim, LLC (of which Teong
Lim, then Manager of Corporate Development of Electronic Sensor
Technology, L.P. is the sole member), into the right to receive,
517,899 shares of Bluestone common stock and warrants to purchase
258,949.5 shares of Bluestone common stock. In addition, TC Lim, LLC
obtained the right to receive 359,693 shares of Bluestone common stock
and warrants to purchase 179,846.5 shares of Bluestone common stock by
virtue of its 37.76% ownership of Amerasia Technology.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been quoted on the Over-the-Counter Bulletin Board
since February 1, 2005 under the symbol "ESNR.OB". Prior to February 1, 2005 our
common stock was quoted on the Over-the-Counter Bulletin Board under the symbol
"BLUV.OB". There is currently no broadly followed, established public trading
market for our common stock. The quarterly range of high and low
Over-the-Counter Bulletin Board quotation information for our common stock for
the last two fiscal years is set forth below. These quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not represent actual transactions.
QUARTERLY COMMON STOCK PRICE RANGES
QUARTER ENDED 2005
----------------------------------------------- ----------------------------
HIGH LOW
------------ ------------
December 31 $ .62 $ .27
-32-
September 30 1.19 .42
June 30 2.50 1.07
February 1-March 31 2.51 1.90
QUARTER ENDED 2004
----------------------------------------------- ----------------------------
HIGH LOW
------------ ------------
December 31 $ .01 $ .01
September 30 .01 .01
June 30 .01 .01
March 31 .01 .01
37,110,913 of our shares of common stock are subject to outstanding options
or warrants to purchase, or securities convertible into common stock.
As of February 1, 2006, 26,968,741 shares of our common stock may be sold
pursuant to Rule 144 under the Securities Act. In addition to the shares of
common stock registered herein, we have agreed to register 21,475,584 shares of
common stock under the Securities Act for sale by security holders.
There were approximately 66 record holders of our common stock as of March
1, 2006. This number does not include an indeterminate number of shareholders
whose shares are held by brokers in street name.
We have not paid dividends on our common stock since our inception. The
decision to pay dividends on common stock is within the discretion of the Board
of Directors. It is our current policy to retain any future earnings to finance
the operations and growth of our business. Accordingly, we do not anticipate
paying any dividends on common stock in the foreseeable future.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table illustrates, as of December 31, 2005, information
relating to all of our equity compensation plans:
EQUITY COMPENSATION PLAN INFORMATION
NUMBER OF SECURITIES
NUMBER OF SECURITIES TO WEIGHTED AVERAGE REMAINING AVAILABLE
BE ISSUED UPON EXERCISE EXERCISE PRICE OF FOR FUTURE ISSUANCE
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS UNDER THE EQITY
WARRANTS AND RIGHTS WARRANTS AND RIGHTS COMPENSATION PLAN
----------------------- -------------------- --------------------
Equity Compensation Plans approved by
security holders 0 N/A 0
Equity compensation plans not
approved by security holders 1,794,500 $ .89 3,205,500
Total 1,794,500 $ .89 3,205,500
-33-
ELECTRONIC SENSOR TECHNOLOGY, INC. 2005 STOCK INCENTIVE PLAN
In 2005, the Board of Directors adopted the Electronic Sensor Technology,
Inc. 2005 Stock Incentive Plan. The purpose of the Stock Incentive Plan is to
attract and retain the services of experienced and knowledgeable individuals to
serve as our employees, consultants and directors. On the date the Stock
Incentive Plan was adopted, the total number of shares of common stock subject
to it was 5,000,000. The Stock Incentive Plan is currently administered by the
Board of Directors, and may be administered by any Committee authorized by the
Board of Directors, so long as any such Committee is made up of Non-Employee
Directors, as that term is defined in Rule 16(b)-3(b) of the Securities Exchange
Act of 1934.
The Stock Incentive Plan is divided into two separate equity programs: the
Discretionary Option Grant Program and the Stock Issuance Program. Under the
Discretionary Option Grant Program, eligible persons may, at the discretion of
the administrator, be granted options to purchase shares of common stock and
stock appreciation rights. Under the Stock Issuance Program, eligible persons
may, at the discretion of the administrator, be issued shares of common stock
directly, either through the immediate purchase of such shares or as a bonus for
services rendered for Electronic Sensor Technology (or a parent or subsidiary of
Electronic Sensor Technology).
Pursuant to the terms of the Discretionary Option Grant Program, the
exercise price per share is fixed by the administrator, but may not be less than
85% of the fair market value of the common stock on the date of grant, unless
the recipient of a grant owns 10% or more of Electronic Sensor Technology's
common stock, in which case the exercise price of the option must not be less
than 110% of the fair market value. An option grant may be subject to vesting
conditions. Options may be exercised in cash, with shares of the common stock of
Electronic Sensor Technology already owned by the person or through a special
sale and remittance procedure, provided that all applicable laws relating to the
regulation and sale of securities have been complied with. This special sale and
remittance procedure involves the optionee concurrently providing irrevocable
written instructions to: (i) a designated brokerage firm to effect the immediate
sale of the purchased shares and remit to Electronic Sensor Technology, out of
the sale proceeds available on the settlement date, sufficient funds to cover
the aggregate exercise price payable for the purchased shares plus all
applicable federal, state and local income and employment taxes required to be
withheld by Electronic Sensor Technology by reason of such exercise and (ii)
Electronic Sensor Technology to deliver the certificates for the purchased
shares directly to such brokerage firm in order to complete the sale. The term
of an option granted pursuant to the Discretionary Option Grant Program may not
be more than 10 years.
The Discretionary Option Grant Program also allows for the granting of
Incentive Options to purchase common stock, which may only be granted to
employees, and are subject to certain dollar limitations. Any options granted
under the Discretionary Option Grant Program that are not Incentive Options are
considered Non-Statutory Options and are governed by the aforementioned terms.
The exercise price of an Incentive Option must be no less than 100% of the fair
market value of the common stock on the date of grant, unless the recipient of
an award owns 10% or more of Electronic Sensor Technology's common stock, in
which case the exercise price of an incentive stock option must not be less than
110% of the fair market value. The term of an Incentive Option granted may not
be more than five years if the option is granted to a recipient who owns 10% or
more of Electronic Sensor Technology's common stock, or 10 years for all other
recipients of Incentive Options. Incentive Options are otherwise governed by the
general terms of the Discretionary Option Grant Program.
Pursuant to the terms of the Stock Issuance Program, the purchase price per
share of common stock issued is fixed by the administrator, but may not be less
than 85% of the fair market value of the common stock on the issuance date,
unless the recipient of a such common stock owns 10% or more of Electronic
Sensor Technology's common stock, in which case the purchase price must not be
less than 100% of the fair market value. Common stock may be issued in exchange
for cash or past services rendered to Electronic Sensor Technology (or any
parent or subsidiary of Electronic Sensor Technology). Common stock issued may
be fully and immediately vested upon issuance or may vest in one or more
installments, at the discretion of the administrator.
-34-
EXECUTIVE COMPENSATION
For the fiscal years ended December 31, 2003 and December 31, 2004 and for
the period from January 1, 2005 through January 31, 2005, no salary or any other
compensation was paid to any named executive officer of Bluestone for services
provided to us. The table below outlines the compensation of the named executive
officers of Electronic Sensor Technology for the fiscal year ended December 31,
2005, beginning on February 1, 2005, the date upon which Electronic Sensor
Technology, Inc. acquired Electronic Sensor Technology, L.P.:
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
ANNUAL
COMPENSATION AWARDS
SECURITIES
RESTRICTED STOCK UNDERLYING
SALARY AWARD(S) OPTIONS/SARS
NAME AND PRINCIPAL POSITION YEAR ($) ($)(6) (#)
-------------------------------------------------- ------ -------------- ------------------ ------------------
Matthew Collier, President and Chief
Executive Officer (May 26, 2005-January 25, 2006) 2005 135,384 24,750(1) 500,000
Edward Staples, President and Chief
Executive Officer (February 1, 2005-
May 26, 2005), Chief Scientific Officer
(May 26, 2005-present) 2005 132,411 0 100,000(2)
Francis Chang, Secretary and Vice
President of Finance and Administration 2005 123,888 0 80,000(3)
Teong Lim, Vice President of Corporate
Development 2005 111,316 0 80,000(4)
Gary Watson, Vice President of
Engineering 2005 120,898 0 175,000(5)
(1) Matthew Collier was granted, on May 26, 2005, the right to receive
75,000 shares of restricted common stock, subject to approval by the Board of
Directors, pursuant to a letter agreement of employment entered into with
Electronic Sensor Technology. On January 25, 2006, Mr. Collier was granted
75,000 shares of restricted common stock, subject to a right of first refusal on
the part of Electronic Sensor Technology in the event Mr. Collier decides to
sell such shares. Such shares have been valued, for purposes of the Summary
Compensation Table, at $0.33 per share, the closing quotation on the
Over-the-Counter Bulletin Board on January 25, 2006.
(2) Edward Staples was granted options to purchase 100,000 limited
partnership interests of Electronic Sensor Technology, L.P. at $1.00 per limited
partnership interest on December 31, 2003. Such options were terminated in
connection with the merger whereby Electronic Sensor Technology, L.P. became an
indirect subsidiary of Electronic Sensor Technology, Inc., and were replaced
with options to purchase 100,000 shares of common stock at $1.00 per share.
(3) Francis Chang was granted options to purchase 80,000 limited
partnership interests of Electronic Sensor Technology, L.P. at $1.00 per limited
partnership interest on December 31, 2003. Such options were terminated in
connection with the merger whereby Electronic Sensor Technology, L.P. became an
indirect subsidiary of Electronic Sensor Technology, Inc., and were replaced
with options to purchase 80,000 shares of common stock at $1.00 per share.
(4) Teong Lim was granted options to purchase 80,000 limited partnership
interests of Electronic Sensor Technology, L.P. at $1.00 per limited partnership
interest on December 31, 2003. Such options were terminated in connection with
the merger
-35-
whereby Electronic Sensor Technology, L.P. became an indirect subsidiary of
Electronic Sensor Technology, Inc., and were replaced with options to purchase
80,000 shares of common stock at $1.00 per share.
(5) Gary Watson was granted options to purchase (i) 50,000 limited
partnership interests of Electronic Sensor Technology, L.P. at $1.00 per limited
partnership interest on March 15, 1999, (ii) 50,000 limited partnership
interests of Electronic Sensor Technology, L.P. at $1.05 per limited partnership
interest on July 1, 2000, (iii) 50,000 limited partnership interests of
Electronic Sensor Technology, L.P. at $1.05 per limited partnership interest on
May 15, 2001 and (iv) 25,000 limited partnership interests of Electronic Sensor
Technology, L.P. at $1.05 per limited partnership interest on September 15,
2002. Such options were terminated in connection with the merger whereby
Electronic Sensor Technology, L.P. became an indirect subsidiary of Electronic
Sensor Technology, Inc., and were replaced with options to purchase 50,000
shares of common stock at $1.00 per share and options to purchase 125,000 shares
of common stock at $1.05 per share.
(6) As of December 31, 2005, there were no shares of restricted common
stock of Electronic Sensor Technology outstanding. Only a right to receive
75,000 shares of restricted common stock, subject to approval by the Board of
Directors, was held by Matthew Collier as of December 31, 2005. On January 25,
2006, the 75,000 shares of restricted common stock were issued to Mr. Collier,
valued at $24,750, in the aggregate, for purposes of the Summary Compensation
Table. Such shares of restricted common stock have been valued, for purposes of
the Summary Compensation Table, at $0.33 per share, the closing quotation on the
Over-the-Counter Bulletin Board on January 25, 2006, the date of the grant of
restricted common stock. The 75,000 shares were all fully vested on the date of
the grant, but are restricted by a right of first refusal on the part of
Electronic Sensor Technology in the event Mr. Collier decides to sell such
shares. Aside from the right of first refusal on our part, the shares of
restricted common stock carry the same rights and privileges as our unrestricted
shares of common stock, including the right to receive dividends, if any.
Individual grants of stock options (whether or not in tandem with stock
appreciation rights (SARs)), and freestanding SARs made during the fiscal year
ended December 31, 2005 to each of the named executed officers are outlined in
the table below:
OPTION/SAR GRANTS IN LAST FISCAL YEAR
(Individual Grants)
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS/SARS
UNDERLYING GRANTED TO EXERCISE OF
OPTIONS/SARS EMPLOYEES IN BASE PRICE
NAME GRANTED (#) FISCAL YEAR ($/SH) EXPIRATION DATE
--------------- ------------ ------------- ----------- ---------------
Matthew Collier 500,000 100% .64 May 26, 2015
Edward Staples (1)
Francis Chang (2)
Teong Lim (3)
Gary Watson (4)
(1) Edward Staples was granted options to purchase 100,000 limited
partnership interests of Electronic Sensor Technology, L.P. at $1.00 per limited
partnership interest on December 31, 2003. Such options were terminated in
connection with the merger whereby Electronic Sensor Technology, L.P. became an
indirect subsidiary of Electronic Sensor Technology, Inc., and were replaced
with options to purchase 100,000 shares of common stock at $1.00 per share. In
connection with such merger, Dr. Staples also received a warrant to purchase
343,708 shares of common stock at $1.00 per share in exchange for the
cancellation of debt owed by Electronic Sensor Technology, L.P. The warrant was
issued to Dr. Staples solely in exchange for the cancellation of such debt, and
not as compensation.
(2) Francis Chang was granted options to purchase 80,000 limited partnership
interests of Electronic Sensor Technology, L.P. at $1.00 per limited partnership
interest on December 31, 2003. Such options were terminated in connection with
the merger
-36-
whereby Electronic Sensor Technology, L.P. became an indirect subsidiary of
Electronic Sensor Technology, Inc., and were replaced with options to purchase
80,000 shares of common stock at $1.00 per share. In connection with such
merger, Mr. Chang also received a warrant to purchase 257,247 shares of common
stock at $1.00 per share in exchange for the cancellation of debt owed by
Electronic Sensor Technology, L.P. The warrant was issued to Mr. Chang solely in
exchange for the cancellation of such debt, and not as compensation.
(3) Teong Lim was granted options to purchase 80,000 limited partnership
interests of Electronic Sensor Technology, L.P. at $1.00 per limited partnership
interest on December 31, 2003. Such options were terminated in connection with
the merger whereby Electronic Sensor Technology, L.P. became an indirect
subsidiary of Electronic Sensor Technology, Inc., and were replaced with options
to purchase 80,000 shares of common stock at $1.00 per share. In connection with
such merger, Dr. Lim also received a warrant to purchase 438,796 shares of
common stock at $1.00 per share in exchange for the cancellation of debt owed by
Electronic Sensor Technology, L.P. The warrant was issued to Dr. Lim solely in
exchange for the cancellation of such debt, and not as compensation.
(4) Gary Watson was granted options to purchase (i) 50,000 limited
partnership interests of Electronic Sensor Technology, L.P. at $1.00 per limited
partnership interest on March 15, 1999, (ii) 50,000 limited partnership
interests of Electronic Sensor Technology, L.P. at $1.05 per limited partnership
interest on July 1, 2000, (iii) 50,000 limited partnership interests of
Electronic Sensor Technology, L.P. at $1.05 per limited partnership interest on
May 15, 2001 and (iv) 25,000 limited partnership interests of Electronic Sensor
Technology, L.P. at $1.05 per limited partnership interest on September 15,
2002. Such options were terminated in connection with the merger whereby
Electronic Sensor Technology, L.P. became an indirect subsidiary of Electronic
Sensor Technology, Inc., and were replaced with options to purchase 50,000
shares of common stock at $1.00 per share and options to purchase 125,000 shares
of common stock at $1.05 per share.
AGGREGATED OPTION/SAR EXERCISES IN THE LAST FISCAL YEAR AND FY-END
OPTION/SAR VALUES
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
SHARES UNEXERCISED IN-THE-MONEY
ACQUIRED OPTIONS/SARS OPTIONS/SARS
ON VALUE AT FY-END (#) AT FY-END ($)
EXERCISE REALIZED EXERCISABLE/ EXERCISABLE/
NAME (#) ($) UNEXERCISABLE UNEXERCISABLE
--------------- ---------- ---------- --------------- --------------
Matthew Collier N/A N/A 0/500,000 N/A
Edward Staples N/A N/A 100,000/0 N/A
Francis Chang N/A N/A 80,000/0 N/A
Teong Lim N/A N/A 80,000/0 N/A
Gary Watson N/A N/A 175,000/0 N/A
COMPENSATION OF DIRECTORS
Commencing April 2005, each director who is not an employee is paid $2,500
per meeting. Mr. Frey, as the Chairman of the Board of Directors, is also
provided with a business class airline ticket for meetings requiring more than
two hours travel, and out-of-pocket expenses. On October 7, 2005, Mr. Frey was
granted 250,000 non-qualified stock options to acquire common stock at an
exercise price of $0.64 per share, under our 2005 Stock Incentive Plan. Mr.
Frey's stock options will vest as follows: one quarter of the options will vest
on March 8, 2006, one quarter on September 8, 2006, one quarter on March 8, 2007
and one quarter on September 8, 2007, provided he is still participating as a
member of our Board of Directors at the end of each such six-month period.
-37-
EMPLOYMENT CONTRACTS
On May 16, 2005, Electronic Sensor Technology entered into a letter
agreement with Matthew Collier, who was appointed President and Chief Executive
Officer on May 26, 2005. Pursuant to the letter agreement, Mr. Collier agreed to
serve as President and Chief Executive Officer of Electronic Sensor Technology
for at an annual salary of $220,000 per year and a potential target bonus of 25%
of such annual salary, to be paid at the discretion of the Board of Directors.
The letter agreement also provides for a grant of 75,000 shares of restricted
common stock that may be traded one year from Mr. Collier's date of employment
and an additional 75,000 shares of restricted common stock to be granted one
year from Mr. Collier's date of employment, if Mr. Collier remains an employee
of Electronic Sensor Technology, tradable on the first anniversary of such
grant. The letter agreement also provides for a grant of 500,000 options to
purchase common stock, 33% of which will vest on each of the first and second
anniversaries of Mr. Collier's date of employment and the remaining 34% of which
will vest on the third anniversary of Mr. Collier's date of employment. On
January 25, 2006, the letter agreement with Mr. Collier was mutually terminated
by Mr. Collier and Electronic Sensor Technology (other than that portion of the
letter agreement relating to indemnification of Mr. Collier for liability
incurred within the scope of his employment with the Registrant, embodied in
Section 7 of the letter agreement), by way of a Settlement Agreement, Mutual
Release and Amendment of Option Agreement entered into between Mr. Collier and
Electronic Sensor Technology in connection with the resignation of Mr. Collier
as President and Chief Executive Officer and a director of Electronic Sensor
Technology, effective January 25, 2006.
The terms of the Settlement Agreement, Mutual Release and Amendment of
Option Agreement in large part carried out the terms of the letter agreement
dated May 16, 2005 with Mr. Collier. Specifically, the Settlement Agreement,
Mutual Release and Amendment of Option Agreement provided for (i) the payment of
six months' base salary to Mr. Collier, totaling $110,000, over the course of 13
biweekly payroll periods, (ii) the payment of a bonus in the sum of $18,334
earned through the date of Mr. Collier's resignation, (iii) the acceleration by
six months of the vesting schedule of Mr. Collier's options to purchase 500,000
shares of common stock, each of (i) through (iii) as provided for in the letter
agreement in the event of a termination without cause and (iv) the issuance of
75,000 shares of restricted common stock, as contemplated in the letter
agreement. The Settlement Agreement, Mutual Release and Amendment of Option
Agreement also provided for the vesting of options to purchase 200,000 shares of
common stock in the first vesting period of the vesting schedule of Mr.
Collier's options to purchase 500,000 shares of common stock, described above.
As a result of the six-month acceleration of the vesting schedule, such vesting
of options to purchase 200,000 shares of common stock was deemed to occur on
November 26, 2005. In accordance with the terms of Mr. Collier's Option
Agreement, Mr. Collier's resignation will result in the forfeiture of the
remaining unvested options to purchase 300,000 shares of common stock, and Mr.
Collier will have three months from January 25, 2006 in which to exercise the
vested options to purchase 200,000 shares of common stock.
Other than the terminated letter agreement with Mr. Collier, we have no
employment agreements with any of our named executive officers, nor do we have
any compensatory plans or arrangements with respect to any named executive
officers that results or will result from the resignation, retirement or any
other termination of such executive officer's employment with Electronic Sensor
Technology or from a change-in-control of Electronic Sensor Technology or a
change in the named executive officer's responsibilities following a
change-in-control wherein the amount involved, including all periodic payments
or installments, exceeds $100,000.
REPORT ON REPRICING OF OPTIONS/SARs
On May 26, 2005, Matthew Collier, former President and Chief Executive
Officer of Electronic Sensor Technology, entered into a letter agreement of
employment with Electronic Sensor Technology pursuant to which we agreed to
grant Mr. Collier options to purchase 500,000 shares of common stock at an
exercise price of $1.50 per share, subject to approval by the Board of
Directors. On September 8, 2005, the Board of Directors approved the granting of
such options and also approved a repricing of the options from the $1.50 per
share exercise price stated in the May 26, 2005 letter agreement to $0.64 per
share, the closing price of the common stock on September 8, 2005. On October 7,
2005, Electronic Sensor Technology entered into an Option Agreement with Mr.
Collier, substantially in the form attached as Exhibit 10.2 to our annual report
on Form 10-KSB for the fiscal year ended December 31, 2004 filed with the
Commission on April 15, 2005 for the granting of options to purchase 500,000
shares of common stock at an exercise price of $0.64 per share.
-38-
FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheet as of December 31, 2005 F-2
Consolidated Statements of Operations for the Year
Ended December 31, 2005 F-3
Consolidated Statement of Changes in Stockholders' Deficit for the
Period from January 1, 2004 to December 31, 2005 F-4
Consolidated Statements of Cash Flows for the Year Ended
December 31, 2005 F-5
Notes to Financial Statements F-6
-39-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Electronic Sensor Technology, Inc.
We have audited the accompanying balance sheet of Electronic Sensor
Technology, Inc. as of December 31, 2005 and the related consolidated statements
of operations, changes in stockholders' deficit and cash flows for the years
ended December 31, 2005 and 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. 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 that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
the consolidated financial position of Electronic Sensor Technology, Inc., as of
December 31, 2005 and the consolidated results of its operations and its cash
flows for the years ended December 31, 2005 and 2004 in conformity with
accounting principles generally accepted in the United States of America.
/s/ Sherb & Co., LLP
Sherb & Co., LLP
Certified Public Accountants
New York, New York
February 20, 2006
F-1
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2005
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,219,921
Certificate of deposit-restricted 918,678
Accounts receivable, net of allowance for doubtful accounts of $20,577 465,776
Prepaid expenses 69,936
Inventories 939,622
--------------
TOTAL CURRENT ASSETS 6,613,933
--------------
DEFERRED FINANCING COSTS, net of amortization of $17,297 812,957
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $917,010 112,548
SECURITY DEPOSITS 12,817
--------------
$ 7,552,255
--------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable and accrued expenses 480,799
Deferred revenues 141,667
Derivative liabilities 12,780,439
--------------
TOTAL CURRENT LIABILITIES 13,402,905
--------------
CONVERTIBLE DEBENTURES, net of unamortized discount of $6,805,556 194,444
--------------
TOTAL LIABILITIES 13,597,349
--------------
STOCKHOLDERS' DEFICIT:
Preferred stock, $.001 par value 50,000,000 shares authorized,
none issued and outstanding -
Common stock, $.001 par value, 200,000,000
shares authorized, 54,098,745 issued and outstanding 54,099
Additional paid-in capital (1,970,704)
Accumulated deficit (4,128,489)
--------------
TOTAL STOCKHOLDERS' DEFICIT (6,045,094)
--------------
$ 7,552,255
==============
See notes consolidated to financial statements
F-2
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended
December 31,
---------------------------------
2005 2004
-------------- ---------------
REVENUES $ 2,122,349 $ 1,076,749
COST OF SALES 1,302,602 1,039,280
-------------- --------------
GROSS PROFIT 819,747 37,469
-------------- --------------
OPERATING EXPENSES:
Research and development 260,125 -
Compensation 466,421 81,734
Selling 653,092 161,546
General and administrative 1,522,451 282,305
-------------- --------------
TOTAL OPERATING EXPENSES 2,902,089 525,585
-------------- --------------
LOSS FROM OPERATIONS (2,082,342) (488,116)
-------------- --------------
OTHER INCOME AND EXPENSE:
Other income 9,915,026 -
Extinguishment of debt - 57,076
Other expense (11,645,920) -
Gain (loss) on sale of property and equipment 9,287 (7,710)
Interest expense (324,540) (164,133)
-------------- --------------
TOTAL OTHER INCOME AND EXPENSE (2,046,147) (114,767)
-------------- --------------
NET LOSS $ (4,128,489) $ (602,883)
============== ==============
Loss per share, basic and diluted $ (0.08) $ (0.01)
============== ==============
Weighted average number of shares, basic and diluted 53,636,560 53,525,865
============== ==============
See notes to consolidated financial statements
F-3
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT
Common Stock Preferred Stock Additional Total
------------------------- ------------------- Paid-In Accumulated Stockholders'
Shares Amount Shares Amount Capital Deficit Deficit
------------- -------- -------- -------- ------------ ------------ -------------
BALANCE - January 1, 2004 81,279,000 $ 81,279 - $ - $ 4,500,000 $ (9,863,250) $ (5,281,971)
Sale of Partnership interest
- Class C - - - - 200,000 - 200,000
Note payable related party -
interest waived - - - - 63,774 - 63,774
Net loss - - - - - (602,883) (602,883)
------------- -------- -------- -------- ------------ ------------ -------------
BALANCE - December 31, 2004 81,279,000 81,279 - - 4,763,774 (10,466,133) (5,621,080)
Reclassification of
Partners' deficit to
additional paid-in capital - - - - (10,466,133) 10,466,133 -
Cancellation of common stock (54,279,147) (54,279) - - 54,279 - -
Notes payable converted to
common stock 1,272,000 1,272 - - 1,270,728 - 1,272,000
Sale of common stock 3,985,000 3,985 - - (3,985) - -
Deferred compensation
contributed to capital - - - - 934,957 - 934,957
Officers loans converted to
common stock 1,198,630 1,199 - - 1,197,431 - 1,198,630
Issuance of shares for
services 130,000 130 - - 74,820 - 74,950
Accrued interest converted
to common stock 313,262 313 - - 312,949 - 313,262
Common stock issued for
acquisition of EST 20,200,000 20,200 - - (109,525) - -
Net loss - - - - - (4,128,489) (4,128,489)
------------- -------- -------- -------- ------------ ------------ -------------
BALANCE - December 31, 2005 54,098,745 $ 54,099 - $ - $ (1,970,704) $ (4,128,489) $ (6,045,093)
============= ======== ======== ======== ============ ============ =============
See notes to consolidated financial statements.
F-4
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
December 31,
---------------------------------
2005 2004
--------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) $ (4,126,489) $ (602,883)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization 21,300 11,223
Issuance of shares for services 74,950 -
Recognition of derivative liabilities 13,135,000 -
Amortization of debt discount 194,444 -
Amortization of deferred financing costs 17,297 -
Notes payable related party - interest waived - 63,774
Decrease in fair value of derivative liability (11,404,023) -
Changes in assets and liabilities:
Accounts receivable (435,088) 363,042
Inventories (458,974) (87,544)
Prepaid expenses (55,679) 2,312
Security deposits 140 -
Accounts payable and accrued expenses 266,494 (66,120)
Due to related party (60,000) (40,910)
Interest payable (26,961) 4,364
Deferred revenues (50,000) 191,667
-------------- --------------
Other current liabilities (35,665) (6,773)
-------------- --------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (2,945,254) (167,848)
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 43,933 12,198
Purchase of certificate deposit (918,678)
Purchase of property and equipment (126,582) (35,113)
-------------- --------------
NET CASH (USED IN) INVESTING ACTIVITIES (1,001,327) (22,915)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in line of credit (1,969,137) 17,000
Repayment of partners' loans payable (110,000) (120,000)
Proceeds from issuance of common stock 3,811,708 200,000
Proceeds from convertible debenture 7,000,000 -
Payment of deferred financing costs (592,500) -
-------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 8,140,071 97,000
-------------- --------------
NET INCREASE (DECREASE) IN CASH 4,193,491 (93,763)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 26,430 119,968
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 4,219,921 $ 26,205
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 102,928 $ 87,284
============== ==============
Taxes $ - $ -
============== ==============
NON-CASH INVESTING AND FINANCING ACTIVITIES
Notes payable, loans payable and accrued expenses converted into
Common stock and additional paid-in capital $ 3,718,849 $ -
============== ==============
Fair value of derivative liability recorded as debt discount on convertible
debentures $ 7,000,000 $ -
============== ==============
Fair value of derivative liability recorded as deferred financing costs $ 237,754 -
============== ==============
See notes to consolidated financial statements.
F-5
ELECTRONIC SENSOR TECHNOLOGY, INC.
Notes to Financial Statements
December 31, 2005
(1) NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Electronic Sensor Technology, Inc. (the "Company") (formerly Bluestone Ventures,
Inc.) develops and manufactures electronic devices used for vapor analysis.
It markets its products through distribution channels in over 20 countries.
BASIS OF CONSOLIDATION
The accompanying financial statements include the accounts of the Company and
its wholly owned subsidiaries. All intercompany balances and transactions have
been eliminated in consolidation. Bluestone Ventures, Inc. ("Bluestone")
executed an Agreement and Plan of Merger ("Merger Agreement") by and among
Bluestone, Amerasia Technology, Inc., ("Amerasia"), holder of approximately
55% of the partnership interests of Electronic Sensor Technology, L.P., ("EST"),
L & G Sensor Technology, L.P., ("L&G"), holder of approximately 45% of the
partnership interests of EST, Amerasia Acquisition Corp., ("AAC") a wholly-owned
subsidiary of Bluestone, and L & G Acquisition Corp., ("LAC") a wholly owned
subsidiary of Bluestone on January 31, 2005. Under the Merger Agreement (i) AAC
merged with and into Amerasia such that Amerasia became a wholly-owned
subsidiary of Bluestone, (ii) LAC merged with and into L&G such that L&G became
a wholly-owned subsidiary of Bluestone, (iii) as a result of the merger of (i)
and (ii), Bluestone indirectly acquired all of the partnership interests of EST
and (iv) Bluestone issued 20,000,000 shares of its common stock to the
shareholders of Amerasia and L&G. This merger has been treated as a purchase
only of the partnership interests of Electronic Sensor Technology L.P.
For accounting purposes, the transaction was treated as a recapitalization of
EST and accounted for as a reverse acquisition. Accordingly, the accompanying
financial statements include the accounts of EST for the period from January 1,
2004 to December 31, 2005 and the accounts of Bluestone from February 1, 2005 to
December 31, 2005.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid financial instruments with maturities of
three months or less at the time of purchase to be cash equivalents. The Company
did not have any cash equivalents at December 31, 2005.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, certificate of deposit,
accounts receivables, accounts payable and accrued expenses approximate their
fair value due to their short-term maturities. The fair value of the convertible
debentures amounts to $7,000,000, based on the Company's incremental borrowing
rate. The carrying value of the derivative liability associated with the
convertible debentures approximates its fair value based on assumptions using
the Black Scholes model.
CONCENTRATION OF CREDIT RISKS
The Company is subject to concentrations of credit risk primarily from cash and
cash equivalents and accounts receivable. The Company maintains accounts with
financial institutions, which at times exceeds the insured limit of
approximately $100,000. The Company minimizes its credit risks associated with
cash by periodically evaluating the credit quality of its primary financial
institutions. The Company's accounts receivables are due from distributors in
all other countries in which it markets its products. The Company does not
require collateral to secure its accounts receivables. Three of the Company's
customers accounted for approximately 36%, 16% and 16%,
F-6
respectively, of its net accounts receivable at December 31, 2005. No other
customers accounted for more than 10% of its net accounts receivables.
PRODUCT CONCENTRATION RISK
Substantially all of the Company's revenues derive from the sale of electronic
devices used for vapor analysis.
CUSTOMER CONCENTRATION RISK
One of the Company's customers accounted for 29% of its revenues during 2005 and
two of the Company's customers accounted for 20% and 10%, respectively of its
revenues during 2004. No other customers accounted for more than 10% of its
revenues.
INVENTORIES
Inventories are stated at the lower of cost or market, cost determined by the
first-in, first-out (FIFO) method. The Company writes down its inventory for
estimated obsolescence or unmarketable inventory using the difference between
the cost of inventory and the estimated market value based upon assumptions
about future demand and market conditions. The Company writes down inventory
during the period in which such products are no longer marketable in any of
their markets due to governmental regulations as well as inventory which matures
within the next three months.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and are depreciated on a
straight-line basis over their estimated useful lives of five years. Maintenance
and repairs are charged to expense as incurred. Significant renewals and
betterments are capitalized.
Property and equipment consist of the following as of December 31, 2005:
Machinery and equipment $ 777,017
Leasehold improvements 39,500
Office furniture and equipment 213,041
----------
1,029,558
Accumulated depreciation (917,010)
----------
$ 112,548
==========
Depreciation expense amounted to approximately $21,000 and $11,000 during 2005
and 2004, respectively.
DEFERRED FINANCING COSTS
Deferred financing costs consists of direct costs incurred by the Company in
connection with the issuance of its convertible debentures. The direct costs
include cash payments and fair value of warrants issued to the placement agent
which secured the financing. Deferred financing costs are amortized over the
term of the related convertible debentures using the effective interest rate
method.
INCOME TAXES
Income taxes are accounted for in accordance with SFAS No. 109, Accounting for
Income Taxes. SFAS No. 109 requires the recognition of deferred tax assets and
liabilities to reflect the future tax consequences of events that have been
recognized in the Company's financial statements or tax returns. Measurement of
the deferred items is based on enacted tax laws. In the event the future
consequences of differences between financial reporting bases and tax bases of
the Company's assets and liabilities result in a deferred tax asset, SFAS No.
109 requires an evaluation of the probability of being able to realize the
future benefits indicated by such assets. A valuation
F-7
allowance related to a deferred tax asset is recorded when it is more likely
than not that some or the entire deferred tax asset will not be realized.
USE OF ESTIMATES
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Significant estimates made by management include, but are not
limited to, the realization of receivables and the valuation of the derivative
liability. Actual results may differ from these estimates.
BASIC AND DILUTED EARNINGS PER SHARE
Basic and diluted earnings per share are calculated by dividing income available
to stockholders by the weighted-average number of common shares outstanding
during each period. The outstanding options and rights amounted to 1,794,500 and
0 at December 31, 2005 and 2004, respectively. The outstanding warrants amounted
to 16,603,966 and 0 at December 31, 2005 and 2004, respectively. The outstanding
options and warrants at December 31, 2005 and 2004 are excluded from the loss
per share computation for the respective periods due to their antidilutive
effect.
STOCK-BASED COMPENSATION
The Company accounts for stock options issued to employees in accordance with
the provisions of Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations. As
such, compensation cost is measured on the date of grant as the excess of the
current market price of the underlying stock over the exercise price. Such
compensation amounts, if any, are amortized over the respective vesting periods
of the option grant. The Company adopted the disclosure provisions of SFAS No.
123, "Accounting for Stock-Based Compensation" and SFAS 148, "Accounting for
Stock-Based Compensation -Transition and Disclosure", which permits entities to
provide pro forma net income and pro forma earnings per share disclosures for
employee stock option grants as if the fair-valued based method defined in SFAS
No. 123 had been applied. The Company accounts for stock options and stock
issued to non-employees for goods or services in accordance with the fair value
method of SFAS 123.
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 2005 consist primarily of
vendor payables.
DEFERRED REVENUES
Deferred revenues at December 31, 2005 amount to $141,667. The deferred revenues
consist of a one-time licensing fee received by the Company during 2004 and is
recognized over the terms of the agreement which is five years. The Company
recognized revenues of $50,000 and $58,333 pursuant to this agreement during
2005 and 2004, respectively.
DERIVATIVE LIABILITIES
The Company accounts for its liquidated damages pursuant to Emerging Issue Task
Force ("EITF") 05-04, View C, "The Effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument", subject to EITF Issue No. 00-19, "Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock". Pursuant to EITF 05-04, View C, liquidated damages payable
in cash or stock are accounted for as a separate derivative, which requires a
periodical valuation of its fair value and a corresponding recognition of
liabilities associated with such derivative. The Company accounts for its
embedded conversion features and freestanding warrants pursuant to SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which requires a
periodic valuation of their fair value and a corresponding recognition of
liabilities associated with such derivatives. The recognition of derivative
liabilities related to the issuance of shares of common stock is
F-8
applied first to the proceeds of such issuance, at the date of issuance, and the
excess of derivative liabilities over the proceeds is recognized as other
expense in the accompanying consolidated financial statements. The recognition
of derivative liabilities related to the issuance of convertible debt is applied
first to the proceeds of such issuance as a debt discount, at the date of
issuance, and the excess of derivative liabilities over the proceeds is
recognized as other expense in the accompanying consolidated financial
statements. Any subsequent increase or decrease in the fair value of the
derivative liabilities is recognized as other expense or other income,
respectively.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as incurred and
consists primarily of salaries and related benefits, raw materials and supplies.
SEGMENT REPORTING
The Company operates in one segment, manufacturing of electronic devices used
for vapor analysis. The Company's chief operating decision-maker evaluates the
performance of the Company based upon revenues and expenses by functional areas
as disclosed in the Company's statements of operations.
RECENT PRONOUNCEMENTS
In December 2004, the FASB issued SFAS 123 (revised 2004) "Share-Based Payment".
This Statement requires that the cost resulting from all share-based
transactions be recorded in the financial statements. The Statement establishes
fair value as the measurement objective in accounting for share-based payment
arrangements and requires all entities to apply a fair-value-based measurement
in accounting for share-based payment transactions with employees. The Statement
also establishes fair value as the measurement objective for transactions in
which an entity acquires goods or services from non-employees in share-based
payment transactions. The Statement replaces SFAS 123 "Accounting for
Stock-Based Compensation" and supersedes APB Opinion No. 25 "Accounting for
Stock Issued to Employees". The provisions of this Statement will be effective
for the Company beginning in the first quarter of 2006. The Company is currently
evaluating the impact this new Standard will have on its financial position,
results of operations or cash flows.
REVENUE RECOGNITION
The Company records revenue from direct sales of products to end-users when the
products are shipped, collection of the purchase price is probable and the
Company has no significant further obligations to the customer. Costs of
remaining insignificant Company obligations, if any, are accrued as costs of
revenue at the time of revenue recognition. Cash payments received in advance of
product or service revenue are recorded as deferred revenue.
SHIPPING AND HANDLING
The Company accounts for shipping and handling costs as a component of "Cost of
Sales".
INVENTORIES
Inventories are comprised of raw materials, work in process, and finished goods.
Inventories are stated at the lower of cost or market and are determined using
the first-in, first-out method.
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the recorded amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-9
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of certain financial instruments, including accounts receivable,
accounts payable and accrued liabilities, approximates their carrying value due
to the short maturity of these instruments.
LONG-LIVED ASSETS
The Company reviews long-lived assets, such as property and equipment, to be
held and used or disposed of, for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If the sum of the expected cash flows, undiscounted and without
interest, is less than the carrying amount of the asset, an impairment loss is
recognized as the amount by which the carrying amount of the asset exceeds its
fair value. At December 31, 2005 no assets were impaired.
EXTINGUISHMENT OF DEBT
During 2004, the Company recognized a gain on extinguishment of debt which
lapsed pursuant to statute of limitations. The gain amounted to approximately
$57,000.
(2) INVENTORY
Inventory at December 31, 2005 consist of the following:
Finished goods $260,517
Work-in-process 464,610
Raw materials 214,495
----------
$939,622
==========
(3) CONVERTIBLE DEBENTURES
During December 2005, we issued in a private offering, (i) $7,000,000 aggregate
principal amount of convertible debentures due December 7, 2009, convertible
into 15,404,930 shares of common stock, with a conversion price of $0.4544 per
share and (ii) five-year warrants to purchase 12,130,314 shares of common stock
at an exercise price of $0.4761 per share. We received $7,000,000 in cash as
consideration. The convertible debentures bear interest at 8% and are required
to be redeemed in 9 equal quarterly payments commencing January 1, 2008. The
convertible debentures and related agreements provide, among other things, for
(a) liquidated damages amounting to 2% per month of the outstanding principal
amount, in cash to the debenture holders in the event that a registration
statement covering the shares underlying the convertible debentures is not
declared effective within 150 days of the date the debentures were issued,
(b) default interest rate of 18% and a default premium of not less than 30%, and
(c) a reset feature of the conversion price in the event of a subsequent equity
or convertible financing with an effective price lower than the debenture
conversion price. Additionally, the warrants require that the Company reimburse
any holder of a warrant in respect of any trading loss resulting from the
failure of the Company to timely deliver shares issued pursuant to the exercise
of warrants. This compensation may be paid in shares of common stock or cash.
The exercise price of the warrants, which is $0.4761 per share at the date of
the agreement, may be reduced to $0.001 per share, at a monthly rate $0.03 per
share if the registration statement we are required to file at the request of
the warrant holders with respect to the common stock underlying the warrants is
not declared effective within six months of the date of issuance of the
warrants.
In connection with the issuance of the convertible debentures, we issued 485,213
warrants to a company in partial consideration for financial advisory services,
as well as paid $490,000 to this company. The warrants have the same terms as
those granted to the debenture holders. The fair value of the warrants at the
date of issuance amounted to approximately $238,000. We also incurred
approximately $102,500 in additional professional fees relating to the issuance
of the convertible debentures and warrants. The payments of professional fees
and the fair value of the warrants, aggregating approximately $830,000 has been
recorded as deferred financing costs. The deferred financing costs are amortized
over the term of the convertible debentures. The amortization of deferred
financing costs amounted to $17,000 during 2005.
F-10
The aggregate fair value of the warrants and embedded conversion features
associated with the convertible debentures amounted to approximately $12.8
million at the date of issuance which exceeded the principal amount of the
convertible debentures by $5.8 million. We recognized a debt discount of
$7,000,000 at the date of issuance of the convertible debentures and the excess
amount has been recorded as liability and a corresponding increase to other
expense. The debt discount is recognized over the term of the convertible
debentures.
The interest expense, including the amortization of debt discount but excluding
charges related to the recognition of derivative liability amounted to
approximately $238,000 during 2005.
(4) DERIVATIVE LIABILITIES
During February 2005, we recognized derivative liabilities of approximately $6.6
million pursuant to the issuance of 3,985,000 freestanding warrants and granting
certain registration rights which provided for liquidated damages in the event
of failure to timely register the shares in connection with the issuance of
shares of common stock and the related warrants.
The registration rights of these investors are such that if the Company fails to
register the investors shares, including the shares underlying the warrants, the
Company will pay a cash penalty amounting to 1% of the amount invested per
month, $39,850, if the registration statement is not filed within 60 days of
demand or is not declared effective within 150 days from the date of initial
filing. The maximum liability associated with the liquidated damages amount to
49% of the gross proceeds associated with the issuance of shares of common
stock, which amounts to $1,952,650. The percentage of liquidated damages amounts
to the difference between 60 months, which is the inherent time limitation under
which the underlying shares would be free-trading (three year term and two year
holding period) and 11 months, which is the grace period for registering the
shares (no demand permitted for four months, two-month period to file and
five-month period to become effective), times the penalty percentage, which is
1%.
Additionally, because there is no explicit number of shares that are to be
delivered upon satisfaction of the liquidated damages, the Company is unable to
assert that it had sufficient authorized and unissued shares to settle the
liquidated damages. Accordingly, all of the Company's previously issued and
outstanding instruments, such as warrants and options as well as those issued in
the future, would be classified as liabilities as well, effective with the
granting of the registration rights. The fair value of the derivative
liabilities at the date of issuance of the warrants and the granting of
registration rights and at December 31, 2005 is as follows:
At issuance At December 31, 2005
------------ ---------------------
Freestanding warrants $ 6,017,350 $ -
Liquidated damages $ 577,659 $ 631,740
Other outstanding Options and warrants $ 2,506,994 $ 35,980
The Company used the following assumptions to measure the identified derivatives
as follows:
At the date of issuance of the shares of common stock, related warrants, and
registration rights
Freestanding warrants
At issuance At December 31, 2005
------------ ---------------------
Market price: $ 2.40 $ 0.34
Exercise price: $ 1.00 $ 1.00
Term: 3 years 2.08 years
Volatility: 39% 39%
Risk-free interest rate: 2.78% 4.39%
Number of warrants: 3,985,000 3,985,000
F-11
Liquidated damages
At issuance At December 31, 2005
------------ ---------------------
Market price: $ 2.40 $ 0.34
Exercise price: $ 2.40 $ 0.34
Term: 4.08 years 3.17 years
Volatility: 39% 39%
Risk-free interest rate: 2.78% 4.39%
Maximum liability: $ 1,952,650 $ 1,952,650
Other options and warrants
At issuance At December 31, 2005
------------ ---------------------
Market price: $ 2.40 $ 0.34
Exercise price: $ 1.00 $ 1.00
Term: 3-4 years 3-4 years
Volatility: 39% 39%
Risk-free interest rate: 2.78% 4.39%
Outstanding other options and 1,591,871 1,591,871
warrants:
During December 2005, in connection with the issuance of the convertible
debentures, the Company determined that the conversion feature of the
convertible debentures represents an embedded derivative since the debentures
are convertible into a variable number of shares upon conversion and, among
other things, a liquidated damage clause contained in the registration rights
agreement requires the Company to pay 2% per month of the outstanding principal
amount of the debentures, in cash to the debenture holders in the event that a
registration statement covering the shares underlying the convertible debentures
and warrants is not declared effective within 150 days of the date the
debentures were issued. Accordingly, the convertible debentures are not
considered to be conventional debt under EITF 00-19 and the embedded conversion
feature must be bifurcated from the debt host and accounted for as a derivative
liability. Furthermore, the related warrants require that the Company reimburse
any holder of a warrant in respect of any trading loss resulting from the
failure of the Company to timely deliver shares issued pursuant to the exercise
of warrants. This compensation may be paid in shares of common stock or cash.
The Company believes that the aforementioned embedded derivatives and
freestanding warrants meet the criteria of SFAS 133 and EITF 00-19, when
appropriate, and should be accounted for as separate derivatives with a
corresponding value recorded as liability.
The embedded conversion features are as follows:
Default Interest Rate: 10%, which is the difference between the default rate and
the contractual rate.
Reset Feature Following Subsequent Financing: 10%, which is the effective
discount to market value we would offer in the event we provide for a subsequent
private placement financing
Liquidated Damage Clause: 38%, which is the difference, in months between the
time the underlying shares are free-trading and the grace period to obtain a
registration statement, multiplied by the liquidated damage rate of 2% per
month.
Mandatory Premium Upon Default: 30%
The fair value of the derivative liabilities at the date of issuance of the
convertible debentures and at December 31, 2005 are as follows:
F-12
At issuance At December 31, 2005
------------ ---------------------
Freestanding warrants $ 6,181,608 $ 4,289,279
Embedded Conversion Features $ 7,375,880 $ 7,823,529
The Company used the following assumptions to measure the identified derivatives
as follows:
Embedded conversion features
At issuance At December 31, 2005
------------ ---------------------
Market price: $ 0.488 $ 0.34
Conversion price: $ 0.4544 $ 0.306
Term: 5 years 4.92 years
Volatility: 39% 39%
Risk-free interest rate: 4.39% 4.39%
Maximum liability:
Principal debentures: $ 7,000,000 $ 7,000,000
Default interest rate: $ 3,500,000 $ 3,500,000
Reset feature: $ 700,000 $ 700,000
Liquidated damages: $ 2,660,000 $ 2,660,000
Default premium: $ 2,100,000 $ 2,100,000
Freestanding warrants
The derivative liability amounts to the fair value of the warrants issuable upon
exercise, assuming that the underlying shares will not be timely registered. We
computed the fair value of this embedded derivative using the Black Scholes
valuation model with the following assumptions:
At issuance At December 31, 2005
------------ ---------------------
Market price: $ 0.488 $ 0.34
Exercise price: $ 0.001 $ 0.001
Term: 5 years 4.92 years
Volatility: 39% 39%
Risk-free interest rate: 4.39% 4.39%
The aggregate fair value of the warrants and embedded conversion features
amounted to approximately $13.6 million at the date of issuance which exceeded
the principal amount of the convertible debentures by $6.6 million.
Additionally, approximately $238,000 of the fair value of the warrants was
recorded as deferred financing costs. The excess amount of approximately $6.3
million has been recorded as liability and a corresponding increase to other
expense.
The aggregate fair value of all derivative liabilities upon issuance of the
various debt and equity instruments, less amounts allocated to the net proceeds
of the issuance of common stock and convertible debentures, amounted to
approximately $11.6 million at December 31, 2005. The decrease in fair value
between the date of issuance of the various debt and equity instruments and
December 31, 2005 amounted to approximately $11.4 million and has been recorded
as other income.
(5) LINE OF CREDIT
In September 2004, the Company's subsidiary renewed its revolving line of credit
agreement for borrowings up to $1,800,000. The line of credit was assumed and
renewed by the Company. The line of credit matured in February 2006. Borrowings
under this agreement bear interest at prime, are guaranteed by certain related
parties and are collateralized with the assets of the Company and by the
certificate of deposit. No amounts were due under this line of credit at
December 31, 2005.
F-13
(6) NOTES PAYABLE - RELATED PARTIES
On September 12, 1999, the Company's subsidiary issued convertible promissory
notes to its general and limited partners' in consideration of $1,000,000. The
convertible promissory notes were due September 12, 2005 and were convertible at
the election of the holder into Class A Units or Class A Equivalents at a
conversion price of $2, on or after the maturity date. The notes bore interest
at a rate of 5% per annum. At December 31, 2004 interest due under these notes
was $265,000.
During 2004, the Company's subsidiary entered into notes payable to the general
partner amounting to $272,000. The notes bore interest at 5% per annum.
In January 2005 the notes payable to related parties of $1,272,000 plus accrued
interest of $313,262 were converted into 1,585,262 shares of common stock of the
Company.
(7) PARTNERS' LOANS PAYABLE
The Company entered into short-term loans with three partners' of its subsidiary
prior to the merger. The notes were non-interest bearing and due on demand. The
loans were due upon successful closure of a private placement of new ownership
interests. In January 2005 the loans payable to three partners of Electronic
Sensor Technology L.P., totaling $1,198,630 were converted into 1,198,630 shares
of common stock of the Company.
In September 2004, three partners' of its subsidiary lent additional funds to
the Partnership. The agreements were for borrowings up to $100,000, from each
partner, payable on March 31, 2005. Borrowings under these agreements bore
interest at prime and were guaranteed by the officers. At December 31, 2004 the
total amount outstanding for these loans was $110,000. The loans were paid off
in March 2005.
(8) DUE TO RELATED PARTY
The Company's subsidiary received funds from Amerasia Technology, Inc., a
related party, for various purposes during the normal course of business. The
amount due to Amerasia as of December 31, 2004 was $60,000 and was fully repaid
during 2005. The due to related party was non-interest bearing and payable on
demand.
(9) ACCRUED COMPENSATION DUE TO OFFICERS
Three officers employed by the Company's subsidiary agreed to defer a portion of
their salaries until such time as it is financially able to meet these financial
obligations. During January 2005 the officers forfeited their accrued
compensation amounting to $934,957 which was recorded as additional paid-in
capital.
(10) STOCKHOLDERS' DEFICIT
COMMON STOCK
Shares issued pursuant to private placement
The Company entered into various Subscription Agreements with certain investors
on January 31, 2005. Under these Subscription Agreements, the Company issued
3,985,000 shares of its common stock ("shares") and warrants to purchase
3,985,000 shares at $1.00 per share to certain investors for gross proceeds of
$3,985,000. The Company received the gross proceeds of the sale of these shares
on February 1, 2005. The Company received proceeds, net of financing costs, of
approximately $3,822,000.
Shares issued pursuant to the Mergers
By virtue of the Mergers, all shares of common stock of Amerasia were converted
into the right to receive shares of common stock of Bluestone at an exchange
ratio of 4.6223537 shares of Bluestone common stock for each share of Amerasia
common stock and all shares of common stock L&G were converted into the right to
receive shares of
F-14
common stock of Bluestone at an exchange ratio of 90 shares of Bluestone common
stock for each share of L&G common stock. In addition, all 200,000 Class C
limited partnership units of Electronic Sensor Technology L.P. were
automatically converted into 200,000 shares of Bluestone common stock. The
combined effect of the adjustment of the shares pursuant to the Mergers was to
cancel 54,279,147 share of common stock held by certain of the pre-merger
stockholders of the Company and the issuance of 20,200,000 shares of common
stock to the pre-merger partners of EST.
Conversion of shares for pre-merger liabilities
In connection with the Mergers, the Company issued, in aggregate, 2,783,892
shares of common stock in satisfaction of liabilities incurred pursuant to notes
payable, loan payable, and related accrued interest to related parties.
Shares issued pursuant to services
The purchase price for the Mergers was 20,000,000 shares of Bluestone common
stock. The closing of the mergers occurred on February 1, 2005 (the "Closing
Date").
During December 2005, the Company issued 130,000 shares of common stock to a
consultant for services rendered. The fair value of such shares amounted to
approximately $75,000 based on the quoted price of the Company's shares at the
date of issuance.
OPTIONS
In 2005, the Board of Directors adopted the Electronic Sensor Technology, Inc.
2005 Stock Incentive Plan. The purpose of the Stock Incentive Plan is to attract
and retain the services of experienced and knowledgeable individuals to serve as
our employees, consultants and directors. On the date the Stock Incentive Plan
was adopted, the total number of shares of common stock subject to it was
5,000,000. The Stock Incentive Plan is currently administered by the Board of
Directors, and may be administered by any Committee authorized by the Board of
Directors, so long as any such Committee is made up of Non-Employee Directors,
as that term is defined in Rule 16(b)-3(b) of the Securities Exchange Act of
1934.
The Stock Incentive Plan is divided into two separate equity programs: the
Discretionary Option Grant Program and the Stock Issuance Program. Under the
Discretionary Option Grant Program, eligible persons may, at the discretion of
the administrator, be granted options to purchase shares of common stock and
stock appreciation rights. Under the Stock Issuance Program, eligible persons
may, at the discretion of the administrator, be issued shares of common stock
directly, either through the immediate purchase of such shares or as a bonus for
services rendered for Electronic Sensor Technology (or a parent or subsidiary of
Electronic Sensor Technology).
Pursuant to the terms of the Discretionary Option Grant Program, the exercise
price per share is fixed by the administrator, but may not be less than 85% of
the fair market value of the common stock on the date of grant, unless the
recipient of a grant owns 10% or more of Electronic Sensor Technology's common
stock, in which case the exercise price of the option must not be less than 110%
of the fair market value. An option grant may be subject to vesting conditions.
Options may be exercised in cash, with shares of the common stock of Electronic
Sensor Technology already owned by the person or through a special sale and
remittance procedure, provided that all applicable laws relating to the
regulation and sale of securities have been complied with. This special sale and
remittance procedure involves the optionee concurrently providing irrevocable
written instructions to: (i) a designated brokerage firm to effect the immediate
sale of the purchased shares and remit to Electronic Sensor Technology, out of
the sale proceeds available on the settlement date, sufficient funds to cover
the aggregate exercise price payable for the purchased shares plus all
applicable federal, state and local income and employment taxes required to be
withheld by Electronic Sensor Technology by reason of such exercise and
(ii) Electronic Sensor Technology to deliver the certificates for the purchased
shares directly to such brokerage firm in order to complete the sale. The term
of an option granted pursuant to the Discretionary Option Grant Program may not
be more than 10 years.
F-15
The Discretionary Option Grant Program also allows for the granting of Incentive
Options to purchase common stock, which may only be granted to employees, and
are subject to certain dollar limitations. Any options granted under the
Discretionary Option Grant Program that are not Incentive Options are considered
Non-Statutory Options and are governed by the aforementioned terms. The exercise
price of an Incentive Option must be no less than 100% of the fair market value
of the common stock on the date of grant, unless the recipient of an award owns
10% or more of Electronic Sensor Technology's common stock, in which case the
exercise price of an incentive stock option must not be less than 110% of the
fair market value. The term of an Incentive Option granted may not be more than
five years if the option is granted to a recipient who owns 10% or more of
Electronic Sensor Technology's common stock, or 10 years for all other
recipients of Incentive Options. Incentive Options are otherwise governed by the
general terms of the Discretionary Option Grant Program.
Pursuant to the terms of the Stock Issuance Program, the purchase price per
share of common stock issued is fixed by the administrator, but may not be less
than 85% of the fair market value of the common stock on the issuance date,
unless the recipient of a such common stock owns 10% or more of Electronic
Sensor Technology's common stock, in which case the purchase price must not be
less than 100% of the fair market value. Common stock may be issued in exchange
for cash or past services rendered to Electronic Sensor Technology (or any
parent or subsidiary of Electronic Sensor Technology). Common stock issued may
be fully and immediately vested upon issuance or may vest in one or more
installments, at the discretion of the administrator.
The following pro forma information regarding stock-based compensation has been
determined as if the Company had accounted for its employee stock options under
the fair value method pursuant to SFAS 123. For purposes of the proforma
calculations, the fair value of each option granted in 2005 and 2004 was
estimated at the date of grant using the Black-Scholes model with the following
assumptions used: risk-free interest rate: 4.39%, respectively; dividend yield:
none; volatility: 39% (at the date of grant); expected lives: 3 years.
No stock-based employee compensation cost is reflected in net income, as all
options granted under the Company's plans had an exercise price equal to or
above market value of the underlying common stock on the date of grant. However,
the Company has recognized another expense in connection with the recognition of
derivative liability associated with the outstanding options at the date of
issuance of certain derivatives and freestanding warrants. Furthermore, the
Company has recognized income from the decrease in fair value of the derivative
liabilities associated with the options. Had compensation cost for the Company's
stock-based compensation plans been determined based on the fair value at the
grant dates for grants under those plans consistent with the method of SFAS No.
123, the Company's cash flows would have remained unchanged; however net loss
and loss per share would have been reduced to the pro forma amounts indicated
below:
2005 2004
------------- -------------
Net loss as reported: $ (4,178,488) $ (411,216)
Deduct: Total stock-base employee compensation expense
determined under fair value based method for all awards, net
of related tax effects (12,500) (-)
------------- -------------
Net loss pro forma $ (4,165,988) $ (411,216)
============= =============
A summary of the activity during 2005 and 2004 of the Company's stock option
plan and options and rights granted prior to the adoption, or otherwise outside,
of the 2005 Stock Incentive Plan is presented below:
Options Weighted Average
and Rights Exercise Price
----------- -----------------
Outstanding at January 1, 2004 - $ -
Granted - -
Exercised - -
Expired or cancelled - -
----------- -----------------
Outstanding at December 31, 2004 - -
Granted 1,794,500 0.89
Exercised - -
F-16
Options Weighted Average
and Rights Exercise Price
------------ -----------------
Expired or cancelled - -
------------ -----------------
Outstanding at December 31, 2005 1,794,500 $ 0.89
============ =================
Exercisable at December 31, 2004 - $ -
============ =================
Exercisable at December 31, 2005 969,500 $ 1.03
============ =================
The weighted average remaining contractual life and weighted average exercise
price of options and rights outstanding at December 31, 2005, for selected
exercise price ranges, is as follows:
Options outstanding:
Weighted average remaining Weighted average
Range of exercise prices Number of options contractual life exercise price
------------------------ ----------------------- -------------------------- -----------------
$ 0.64 750,000 9.5 $ 0.64
1.00-1.05 969,500 9.91 1.03
1.57 75,000 9.91 1.57
WARRANTS
During February 2005, the Company issued 3,985,000 warrants in connection with
the Subscription Agreements. These warrants have an exercise price of $1.00 per
share. These warrants expire in 2008. The fair value of the warrants has been
accounted as a derivative liability at the date of issuance and at December 31,
2005.
During February 2005, the Company issued 1,591,871 warrants in connection with
its merger. These warrants have an exercise price of $1.00 per share. These
warrants expire in 2010. The fair value of the warrants has been accounted as a
derivative liability at the date of issuance and at December 31, 2005.
During December 2005, the Company issued 12,615,527 warrants in connection with
the issuance of its convertible debentures. These warrants have an exercise
price of $0.4761 per share. The exercise price per share may be reduced to
$0.001 per share in the event the Company fails to timely register the
underlying shares. Furthermore, the warrants could be converted in cash if
certain events occur, such as a provision which require compensation for buy-in
on failure to timely deliver shares issued pursuant to the exercise of warrants,
whereas we reimburse the warrantholders for shares they purchase on the market
at the market price for shares issued pursuant to the exercise of warrants we
fail to issue in a timely manner. This compensation may be paid in shares of
common stock or cash. These warrants expire in 2010. The fair value of the
warrants has been accounted as a derivative liability at the date of issuance
and at December 31, 2005.
During December 2005, the Company issued 350,000 warrants to an investor
relations firm in partial satisfaction of amounts due to the firm. The warrants
have an exercise price of $2.40 and expire in 2010. No value was attributed to
the issuance of such warrants based on the Black Scholes model using the
following assumptions: volatility: 39%; dividend rate: 0%, term: 5 years,
risk-free interest rate: 4.39%.
A summary of the activity during 2005 and 2004 of the Company's warrants is
presented below:
Weighted Average
Warrants Exercise Price
------------ ----------------
Outstanding at January 1, 2004 - $ -
Granted - -
Exercised - -
Expired or cancelled - -
Outstanding at December 31, 2004 - -
Granted 18,542,398 0.67
F-17
Weighted Average
Warrants Exercise Price
------------ ----------------
Exercised - -
Expired or cancelled - -
------------ ----------------
Outstanding at December 31, 2005 18,542,398 $ 0.67
============ ================
Exercisable at December 31, 2004 - -
============ ================
Exercisable at December 31, 2005 18,542,398 $ 0.67
============ ================
The weighted average remaining contractual life and weighted average exercise
price of warrants outstanding at December 31, 2005, for selected exercise price
ranges, is as follows:
Weighted average remaining Weighted average
Range of exercise prices Number of warrants contractual life exercise price
------------------------ ------------------ -------------------------- -----------------
$ 0.48 12,615,527 4.91 years $ 0.48
1.00 5,576,871 4.09 years 1.00
2.40 350,000 4.91 years 2.40
(11) COMMITMENTS AND CONTINGENCIES
LEASES
The Company rents office space in Newbury Park, California. The lease expires in
September 2006 with an optional extension through September 2007.
Rental expense associated with this lease amounted to $155,581 and $155,581
during 2005 and 2004, respectively.
(12) RETIREMENT SAVINGS PLAN
The Company sponsors a 401(k) retirement savings plan (the plan) which covers
most of its full-time employees. Eligible employees may elect to contribute a
percentage of their compensation to the Plan. Matching contributions by the
Company equal 50% of the eligible participant's tax-deferred contribution
percentage for each payroll period of up to a maximum election of 3% and 6% per
payroll period, during 2005 and 2004, respectively. During 2005 and 2004, the
Company contributed approximately $27,000 and $10,000, respectively, to the
Plan.
(13) Income Taxes
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the net deferred taxes, as of December 31, 2005, are as follows:
Deferred tax assets:
Net operating loss carryforward $ 900,000
Less valuation allowance (900,000)
---------
Total net deferred tax assets: $ -
=========
The Company's net operating losses amounts to approximately $2.1 million at
December 31, 2005 and expire in 2025.
SFAS No. 109 requires a valuation allowance to reduce the deferred tax assets
reported, if any, based on the weight of the evidence, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
Management has determined that a valuation allowance of $ 900,000 at December
31, 2005 is necessary to reduce the deferred tax assets to the amount that will
more likely than not be realized. The change in the valuation allowance during
2005 and 2004 was a decrease of approximately $900,000 and $0, respectively.
F-18
The federal statutory tax rate reconciled to the effective tax rate during 2005
and 2004, respectively, is as follows:
2005 2004
------ ------
Tax at U.S. Statutory Rate: 35.0% 35.0%
State tax rate, net of federal benefits 5.7 5.7
Change in valuation allowance (40.7) (40.7)
------ ------
Effective tax rate 0.0% 0.0%
====== ======
F-19
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On April 18, 2005, Electronic Sensor Technology engaged Sherb & Co. LLP as
our independent registered public accounting firm.
Manning Elliott Chartered Accountants resigned as Electronic Sensor
Technology's auditors effective from April 18, 2005. Manning Elliott served as
Bluestone's (now Electronic Sensor Technology) independent auditors for fiscal
years ended December 31, 2004 and December 31, 2003. Manning Elliott's report on
Bluestone's (now Electronic Sensor Technology) consolidated financial statements
for the audit reports fiscal years ended December 31, 2004 and December 31, 2003
did not contain any adverse opinion or disclaimer of opinion and were not
qualified or modified as to uncertainty, audit scope or accounting principles
except as follows: In Manning Elliott's audit reports dated April 7, 2005 and
March 25, 2004 for Bluestone's (now Electronic Sensor Technology) fiscal years
ended December 31, 2004 and December 31, 2003, respectively, Manning Elliott
indicated that: "The accompanying financial statements have been prepared
assuming the Company will continue as a going concern. As discussed in Note 1 to
the financial statements, the Company has not generated any revenue since
inception and will need additional financing to sustain operations. These
factors raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also discussed
in Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty."
The decision to change accountants was approved and recommended by the
Board of Directors.
During the fiscal years ended December 31, 2004 and December 30, 2003 and
until Manning Elliott's resignation, there were no disagreements with Manning
Elliott within the meaning of item 304 of regulation S-B or any matter of
accounting principles or practices, financial disclosure, or auditing scope or
procedure, which disagreements if not resolved to Manning Elliott's
satisfaction, would have caused Manning Elliott to make reference to the subject
matter of the disagreements in connection with its reports. During the fiscal
years ended December 31, 2004 and December 31, 2003, until Manning Elliott's
resignation, there were no "reportable events" (as such term is defined in item
304(a)(1)(v) of regulation S-K).
During Electronic Sensor Technology's two most recent fiscal years and any
subsequent interim period prior to the engagement of Sherb & Co. LLP, neither
Electronic Sensor Technology nor anyone on Electronic Sensor Technology's behalf
consulted with Sherb & Co. LLP, regarding either (i) the application of
accounting principles to a specified transaction, either contemplated or
proposed, or the type of audit opinion that might be rendered on Electronic
Sensor Technology's financial statements or (ii) any matter that was either the
subject of a "disagreement" or a "reportable event."
Electronic Sensor Technology requested that Manning Elliott review the
disclosure contained in Electronic Sensor Technology's current report filed on
Form 8-K on April 19, 2005, which is reproduced herein, and Manning Elliott
furnished Electronic Sensor Technology with a letter addressed to the Commission
containing any new information, clarification of Electronic Sensor Technology's
expression of Manning Elliott's views, or the respects in which Manning Elliott
did not agree with the statements contained in Electronic Sensor Technology's
current report filed on Form 8-K on April 19, 2005. A copy of Manning Elliott's
letter is included as an Exhibit to this prospectus.
WHERE YOU CAN FIND MORE INFORMATION
We file annual reports on Form 10-KSB, quarterly reports on Form 10-QSB and
current reports on Form 8-K with the SEC. You may read and copy any materials
that Electronic Sensor Technology files with the SEC at the SEC's Public
Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain
information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy
and information statements, and other information regarding issuers that file
electronically with the SEC at: http://www.sec.gov. More information regarding
Electronic Sensor Technology is available at our website: http://www.znose.com.
The information on or that can be accessed through our website is not part of
this prospectus.
-40-
This prospectus is part of a registration statement on Form SB-2 that we
filed with the SEC. As allowed by SEC rules, this prospectus does not contain
all of the information that is in the registration statement and the exhibits to
the registration statement. For further information about Electronic Sensor
Technology, investors should refer to the registration statement and its
exhibits. A copy of the registration statement and its exhibits may be
inspected, without charge, at the SEC's Public Reference Room or on the SEC's
web site.
It is important for you to analyze the information in this prospectus, the
registration statement and the exhibits to the registration statement before you
make your investment decision.
SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This prospectus and the documents incorporated by reference herein contain
"forward-looking statements" within the meaning of the federal securities laws.
These forward-looking statements are based on our management's estimates and
assumptions and take into account only the information available at the time the
forward-looking statements are made. Although we believe these estimates and
assumptions are and will be reasonable, forward-looking statements involve
risks, uncertainties and other factors that could cause our actual results to
differ materially from those suggested in the forward-looking statements.
Forward-looking statements include the information concerning future financial
performance, business strategy, projected plans and objectives of Electronic
Sensor Technology set forth in this prospectus. The words "anticipates,"
"estimates," "projects," "forecasts," "goals," "believes," "expects," "intends,"
and similar expressions are intended to identify such forward-looking
statements. Forward-looking statements are subject to numerous risks and
uncertainties.
Our actual results, performance or achievement could differ materially from
those expressed in, or implied by, forward-looking statements and, accordingly,
no assurances can be given that any of the events anticipated by the
forward-looking statements will transpire or occur, or if any of them do so,
what impact they will have on the results of operations and financial condition
of Electronic Sensor Technology. The forward-looking statements speak only as of
the date they are made. We do not undertake to update forward-looking statements
to reflect circumstances or events that occur after the date the forward-looking
statements are made.
LEGAL MATTERS
The validity of the common stock offered hereunder will be passed upon by
Snell & Wilmer LLP.
EXPERTS
The financial statements of Electronic Sensor Technology for the fiscal
years ended December 31, 2005 and 2004 included in this prospectus have been so
included in reliance on the report of Sherb & Co., LLP, an independent
registered public accounting firm, given on the authority of said firm as
experts in auditing and accounting.
* * *
-41-
[LOGO OF ELECTRONIC SENSOR TECHNOLOGY]
ELECTRONIC SENSOR TECHNOLOGY, INC.
25,448,983 SHARES OF COMMON STOCK
----------
PROSPECTUS
----------
We have not authorized anyone to give you any information that differs from
the information in this prospectus. If you receive any different information,
you should not rely on it.
The delivery of this prospectus shall not, under any circumstances, create
an implication that Electronic Sensor Technology, Inc. is operating under the
same conditions that it was operating under on the date of this prospectus. Do
not assume that the information contained in this prospectus is correct at any
time past the date indicated.
This prospectus does not constitute an offer to sell, or the solicitation
of an offer to buy, any securities other than the securities to which it
relates.
This prospectus does not constitute an offer to sell, or the solicitation
of an offer to buy, the securities to which it relates in any circumstances in
which such offer or solicitation is unlawful.
Dated [_________], 2006
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Subject to certain limitations, Nevada Revised Statute 78.7502 provides
that "[a] corporation may indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative or investigative,
except an action by or in the right of the corporation, by reason of the fact
that he is or was a director, officer, employee or agent of the corporation, or
is or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, against expenses, including attorneys' fees, judgments, fines
and amounts paid in settlement actually and reasonably incurred by him in
connection with the action, suit or proceeding if he . . . [a]cted in good faith
and in a manner which he reasonably believed to be in or not opposed to the best
interests of the corporation, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his conduct was unlawful."
Our bylaws provide in pertinent part, with respect to indemnification of
our directors that "[t]he Directors shall cause the Corporation to indemnify a
Director or former Director of the Corporation . . . against all costs, charges
and expenses, including an amount paid to settle an action or satisfy a judgment
.. . . in an action or proceeding to which he is or they are made a party by
reason of his or her being or having been a Director of the Corporation . . .
including an action brought by the Corporation . . . ."
With respect to indemnification of officers of Electronic Sensor
Technology, the bylaws provide, in pertinent part, that "[t]he Directors may
cause the Corporation to indemnify an officer, employee or agent of the
Corporation . . . (notwithstanding that he is also a Director) . . . against all
costs, charges and expenses incurred by him or them and resulting from his or
her acting as an officer, employee or agent of the Corporation . . . . In
addition the Corporation shall indemnify the Secretary or an Assistance [sic]
Secretary of the Corporation (if he is not a full time employee of the
Corporation and notwithstanding that he is also a Director) . . . against all
costs, charges and expenses incurred by him or them and arising out of the
functions assigned to the Secretary by the Corporation Act or these Articles . .
.. ."
Our bylaws also allow our directors to cause Electronic Sensor Technology
to "purchase and maintain insurance for the benefit of a person who is or was
serving as a Director, officer, employee or agent of the Corporation . . .
against liability incurred by him as a Director, officer, employee or agent." We
maintain a policy of liability insurance that insures its directors and officers
against the cost of defense, settlement or payment of a judgment under certain
circumstances.
Anyone serving on a committee appointed by the Board of Directors to
administer Electronic Sensor Technology's 2005 Stock Incentive Plan is entitled
to the full indemnification and reimbursement to which members of the Board of
Directors are entitled under the Stock Incentive Plan. Under the terms of the
Stock Incentive Plan, no member of the Board of Directors is liable for any act
or omission made in good faith with respect to the Stock Incentive Plan or any
option grants or stock issuances under the Stock Incentive Plan.
II-1
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses in connection with the issuance and distribution of the
securities being registered, other than underwriting discounts and commissions,
are estimated to be as follows:
SEC registration fee.................................$ 1,516.42
Printing fees*.......................................$ 0.00
Legal fees and expenses*.............................$ 90,000.00
Accounting fees and expenses*........................$ 20,000.00
Miscellaneous*.......................................$ 1,500.00
Total..............................................$ 113,016.42
----------
* Estimated
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
We relied upon Section 4(2) of the Securities Act in claiming exemption
from registration of the securities described below due to the knowledge and
experience in financial and business matters of the investors involved, there
was no public offering of such securities, there was no general solicitation or
advertising involved in the offers or sales of the securities and the issuances
otherwise met the requirements for exemption from registration pursuant to
Section 4(2). We have provided below the facts relied upon in order to make the
Section 4(2) exemption available for each transaction.
On December 7, 2005, we issued to Midsummer and Islandia, in a private
offering, (i) $7,000,000 aggregate principal amount of convertible debentures
due December 7, 2009, convertible into 15,404,930 shares of common stock, with a
conversion price of $0.4544 per share and (ii) five-year warrants to purchase
13,574,399 shares of common stock at an exercise price of $0.4761 per share. We
received $4,500,000 in cash from Midsummer and $2,500,000 in cash from Islandia
in exchange for the debentures and warrants. There were a total of 2 investors
in this transaction (Midsummer and Islandia), and each investor represented and
warranted to us, among other things, the following:
(i) that the debentures and warrants were being acquired for its own
account and not with a view to distribute such debentures and
warrants;
(ii) that such investor is an "accredited investor" as defined in
Rule 501(a)(1), (a)(2), (a)(3), (a)(7) or (a)(8) under the Securities
act or a "qualified institutional buyer" as defined in Rule 144A(a)
under the Securities Act;
(iii) that such investor has such knowledge, sophistication and experience
in business and financial matters so as to be capable of evaluating
the merits and risks of such investment; and
(iv) that such investor was not purchasing the debentures and warrants as
a result of any advertisement, article, notice or other communication
regarding the securities.
On December 7, 2005, we also issued, in a private offering, a five-year
warrant to purchase 485,213 shares of common stock at an exercise price of
$0.4761 per share to Montgomery in partial consideration for financial advisory
services performed by Montgomery in connection with the foregoing private
offering. Montgomery was the only investor in this transaction, and Montgomery
provided us with similar representations and warranties as those given by
Midsummer and Islandia, described above.
On December 5, 2005, we issued to CEOcast, in a private offering, 130,000
shares of common stock in partial consideration of investor relations services
provided to Electronic Sensor Technology by CEOcast. CEOcast was the only
investor in this transaction, and CEOcast provided us with similar
representations and warranties as those given by Midsummer and Islandia,
described above.
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On December 5, 2005, we issued to HomelandSecurityStocks, in a separate
private offering, a five-year warrant to purchase 350,000 shares of common stock
at an exercise price of $2.40 per share in partial settlement of litigation
between Electronic Sensor Technology and HomelandSecurityStocks.
HomelandSecurityStocks was the only investor in this transaction, and
HomelandSecurityStocks provided us with similar representations and warranties
as those given by Midsummer and Islandia, described above.
On October 7, 2005, we granted to James Frey, Chairman of the Board of
Directors, non-qualified options to purchase 250,000 shares of common stock at
an exercise price of $0.64 per share under our 2005 Stock Incentive Plan. Mr.
Frey's stock options will vest as follows: one quarter of the options will vest
on March 8, 2006, one quarter on September 8, 2006, one quarter on March 8, 2007
and one quarter on September 8, 2007, provided Mr. Frey is still participating
as a member of our Board of Directors at the end of each such six-month period.
Such options were granted to Mr. Frey as compensation for his service as
Chairman of the Board of Directors. Mr. Frey was the only investor in this
transaction, and this transaction qualified for exemption from registration by
virtue of Mr. Frey's position as Chairman of the Board of Electronic Sensor
Technology and Mr. Frey's representation to us that he was acquiring such
securities for his own account and not with a view toward distribution.
On October 7, 2005, we granted to Matthew Collier, former President and
Chief Executive Officer of Electronic Sensor Technology, non-qualified options
to purchase 500,000 shares of common stock at an exercise price of $0.64 per
share. Mr. Collier's options would have vested, 33% annually (and 34% in the
third year), provided Mr. Collier was still employed by Electronic Sensor
Technology at the end of each such annual period. On January 25, 2006, Mr.
Collier resigned from his position as President and Chief Executive Officer of
Electronic Sensor Technology, and is no longer employed by Electronic Sensor
Technology. Pursuant to the terms of Mr. Collier's employment agreement, upon
Mr. Collier's resignation, the vesting schedule of his options was accelerated
by six months. In addition, pursuant to the terms of the Settlement Agreement,
Mutual Release and Amendment of Option Agreement entered into between Electronic
Sensor Technology and Mr. Collier on January 25, 2006, options to purchase
200,000 shares of common stock at an exercise price of $0.64 per share will vest
in the first vesting period, which, as a result of the six-month acceleration of
the vesting of the options, was deemed to occur on November 26, 2005. In
accordance with the terms of the Option Agreement, Mr. Collier's resignation
will result in the forfeiture of the unvested options to purchase 300,000 shares
of common stock, and Mr. Collier will have three months from January 25, 2006 in
which to exercise the vested options to purchase 200,000 shares of common stock.
Mr. Collier also was granted 75,000 shares of restricted common stock on January
25, 2006, subject to a right of first refusal by Electronic Sensor Technology in
the event Mr. Collier wishes to sell such shares. Such shares and options were
granted to Mr. Collier as compensation for his service as President and Chief
Executive Officer. Mr. Collier was the only investor in these transactions, and
these transactions qualified for exemption from registration by virtue of Mr.
Collier's position as Chairman of the Board of Electronic Sensor Technology and
Mr. Collier's representation to us that he was acquiring such securities for his
own account and not with a view toward distribution.
On February 1, 2005, in connection with various mergers whereby Electronic
Sensor Technology, Inc. acquired Electronic Sensor Technology, L.P., we issued,
in a private offering, 3,985,000 shares of common stock and three-year warrants
to purchase 3,985,000 shares of common stock at an exercise price of $1.00 per
share. In exchange for such common stock and warrants, we received $3,985,000 in
cash from investors. There were 38 investors in this transaction, and each
investor provided us with similar representations and warranties as those given
by Midsummer and Islandia, described above.
On the same date, certain bridge investors of Electronic Sensor Technology,
L.P. exchanged Class C Partnership Interests in Electronic Sensor Technology,
L.P. for 200,000 shares of common stock and warrants to purchase 200,000 shares
of common stock at $1.00 per share. There were 7 investors in this transaction,
and each investor provided us with similar representations and warranties as
those given by Midsummer and Islandia, described above.
On the same date, we issued 20,000,000 shares of common stock to
shareholders of Amerasia Technology, Inc. and L&G Sensor Technology, L.P.,
holders of the partnership interests of Electronic Sensor Technology, L.P. On
the same date, we also issued 2,783,741 shares of common stock and warrants to
purchase 1,391,871 shares of common stock at an exercise price of $1.00 per
share, so long as the trading price of the common stock is at least $1.50 per
share, in exchange for the cancellation of certain debt by Electronic Sensor
Technology, L.P. debtholders.
II-3
On the same date, in connection with the mergers, options to purchase 969,500
limited partnership interests of Electronic Sensor Technology, L.P. were
terminated and replaced by options to purchase 969,500 shares of common stock of
Electronic Sensor Technology, Inc. The replacement options of Electronic Sensor
Technology, Inc. carried over the same exercise prices and vesting provisions as
the options to purchase limited partnership interests of Electronic Sensor
Technology, L.P. There were 20 investors, in the aggregate, in the foregoing 3
related transactions, and each investor provided us with similar representations
and warranties as those given by Midsummer and Islandia, described above.
On March 1, 2004, Bluestone issued, in a private offering, 260,000 shares
of common stock at $0.25 per share. In exchange for such common stock, Bluestone
received $65,000 in cash from investors. We are not aware of the factual
circumstances surrounding Bluestone's reliance on an exemption from registration
of such securities.
ITEM 27. EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
------- ----------------------------------------------------------------------
See Exhibit Index.
ITEM 28. UNDERTAKINGS.
(a) Electronic Sensor Technology hereby undertakes and will:
(1) File, during any period in which it offers or sells securities,
a post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the information
in the registration statement. Notwithstanding the foregoing, any increase
or decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement; and
(iii) Include any additional or changed material information on the
plan of distribution.
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering.
(3) File a post-effective amendment to remove from registration any
of the securities that remain unsold at the end of the offering.
(4) For determining liability of the undersigned company under the
Securities Act to any purchaser in the initial distribution of the securities,
the undersigned company undertakes that in a primary offering of securities of
the undersigned company pursuant to this registration statement, regardless of
the underwriting method used to sell the securities to the purchaser, if the
securities are offered or sold to such purchaser by means of any of the
following communications, the undersigned company will be a seller to the
purchaser and will be considered to offer or sell such securities to such
purchaser:
(i) Any preliminary prospectus or prospectus of the undersigned
company relating to the offering required to be filed pursuant to Rule 424
(Section 230.424 of this chapter);
II-4
(ii) Any free writing prospectus relating to the offering prepared by
or on behalf of the undersigned company or used or referred to by the
undersigned company;
(iii) The portion of any other free writing prospectus relating to the
offering containing material information about the undersigned company or
its securities provided by or on behalf of the undersigned company; and
(iv) Any other communication that is an offer in the offering made by
the undersigned company to the purchaser.
(b) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of Electronic Sensor Technology pursuant to the foregoing provisions, or
otherwise, Electronic Sensor Technology has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by Electronic Sensor Technology of expenses incurred or paid by a
director, officer or controlling person of Electronic Sensor Technology in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, Electronic Sensor Technology will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
* * *
II-5
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorized this Pre-Effective
Amendment No. 3 to registration statement on Form SB-2 to be signed on its
behalf by the undersigned, in the city of Newbury Park, state of California on
April 28, 2006.
ELECTRONIC SENSOR TECHNOLOGY, INC.
By: /s/ Teong Lim
-------------------------------------
Teong Lim
President and Chief Executive Officer
(Principal Executive Officer)
In accordance with the requirements of the Securities Act of 1933, this
Pre-Effective Amendment No. 3 to registration statement on Form SB-2 has been
signed by the following persons in the capacities and on the dates stated.
Date: April 28, 2006 By: /s/ Teong Lim
-------------------------------------
Teong Lim
President and Chief Executive Officer
(Principal Executive Officer)
Date: April 28, 2006 By: /s/ Francis Chang
-------------------------------------
Francis Chang
Secretary and Vice President of
Finance and Administration
(Principal Financial Officer and
Principal Accounting Officer)
Pursuant to the requirements of the Securities Act of 1933, this
Pre-Effective Amendment No. 3 to registration statement on Form SB-2 has been
signed below by the following persons in the capacities and on the dates
indicated.
Date: April 28, 2006 By: *
-------------------------------------
James Frey, Chairman
Date: April 28, 2006 By: *
-------------------------------------
Francis Chang, Director
Date: April 28, 2006 By: *
-------------------------------------
Teong Lim, Director
By:
-------------------------------------
Edward Staples, Director
By:
-------------------------------------
Mike Krishnan, Director
Date: April 28, 2006 By: *
-------------------------------------
James Wilburn, Director
*By: /s/ Francis Chang
------------------
Francis Chang
Attorney-in-Fact
II-6
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------------------------------------------------------------------
3.1 Articles of Incorporation of Electronic Sensor Technology, as amended.*
4.1 Description of our common stock in Article Fourth of the Amendment to
Electronic Sensor Technology's Articles of Incorporation dated
January 25, 2005 (incorporated by reference from Exhibit 3.1 hereto).
4.2 Description of rights of shareholders of Electronic Sensor Technology
in Article I and Article VI of Electronic Sensor Technology's Bylaws
(incorporated by reference from Exhibit 3.2 of the amended registration
statement on Form SB-2/A filed on June 16, 2003).
5.1 Opinion of Snell & Wilmer LLP regarding validity of the common stock.*
10.1 Term Sheet dated December 2, 2004 between Bluestone Ventures Inc. and
Electronic Sensor Technology, L.P. (incorporated by reference from
Exhibit 10.1 of the current report on Form 8-K filed on January 10,
2005).
10.2 Agreement and Plan of Merger dated as of January 31, 2005, by and among
Bluestone Ventures Inc., Amerasia Technology, Inc., L&G Sensor
Technology, Inc., Amerasia Acquisition Corp. and L&G Acquisition Corp.
(incorporated by reference from Exhibit 10.1 of the current report on
Form 8-K filed on February 7, 2005).
10.3 Form of Subscription Agreement between Bluestone Ventures Inc. and each
investor on the signature page thereto (incorporated by reference from
Exhibit 10.2 of the current report on Form 8-K filed on February 7,
2005).
10.4 Electronic Sensor Technology, Inc. 2005 Stock Incentive Plan
(incorporated by reference from Exhibit 10.1 of the annual report on
Form 10-KSB filed on April 15, 2005).
10.5 Form of Stock Option Agreement (incorporated by reference from
Exhibit 10.2 of the annual report on Form 10-KSB filed on April 15,
2005).
10.6 Business Loan Agreement dated March 11, 2005, between Electronic Sensor
Technology, Inc. and East West Bank (incorporated by reference from
Exhibit 10.4 of the annual report on Form 10-KSB filed on April 15,
2005).
10.7 Commercial Security Agreement dated March 11, 2005, between Electronic
Sensor Technology, Inc. and East West Bank (incorporated by reference
from Exhibit 10.5 of the annual report on Form 10-KSB filed on
April 15, 2005).
10.8 Letter agreement dated as of May 16, 2005, by and between Electronic
Sensor Technology, Inc. and Matthew Collier (incorporated by reference
from Exhibit 10.1 of the current report on Form 8-K/A filed on
October 6, 2005).
10.9 Letter agreement dated as of October 3, 2005, between Electronic Sensor
Technology, Inc. and James Frey (incorporated by reference from
Exhibit 10.1 of the current report on Form 8-K filed on October 7,
2005).
10.10 Letter agreement dated as of February 21, 2005, between Electronic
Sensor Technology, Inc. and James Frey (incorporated by reference from
Exhibit 10.2 of the current report on Form 8-K filed on October 7,
2005).
II-7
10.11 Addendum dated as of April 1, 2005 to the letter agreement dated
February 21, 2005, between Electronic Sensor Technology, Inc. and
James Frey (incorporated by reference from Exhibit 10.3 of the current
report on Form 8-K filed on October 7, 2005).
10.12 International Distributorship Agreement dated August 2005, between
Electronic Sensor Technology, Inc. and Beijing R&D Technology Co.,
Ltd.*
10.13 International Distributorship Agreement dated October 21, 2005, between
Electronic Sensor Technology, Inc. and TechMondial, Ltd.*
10.14 Form of Securities Purchase Agreement dated as of December 7, 2005,
among Electronic Sensor Technology, Inc., Midsummer Investment, Ltd.
and Islandia, L.P. (incorporated by reference from Exhibit 10.1 of the
current report on Form 8-K filed on December 8, 2005).
10.15 Form of Registration Rights Agreement dated as of December 7, 2005,
among Electronic Sensor Technology, Inc., Midsummer Investment, Ltd.
and Islandia, L.P. (incorporated by reference from Exhibit 10.2 of the
current report on Form 8-K filed on December 8, 2005).
10.16 Settlement Agreement, Mutual Release and Amendment of Option Agreement,
effective as of January 25, 2006, between Electronic Sensor Technology,
Inc. and Matthew S. Collier (incorporated by reference from
Exhibit 10.1 of the current report on Form 8-K filed on January 31,
2006).
16.1 Letter from Manning Elliott Chartered Accountants (incorporated by
reference from Exhibit 16.1 of the current report on Form 8-K filed on
April 19, 2005).
21.1 Subsidiaries of Electronic Sensor Technology.*
23.1 Consent of Sherb & Co., LLP, Certified Public Accountants.
23.3 Consent of Snell & Wilmer LLP (contained in Exhibit 5.1).*
24.1 Power of Attorney.*
----------
* Previously filed.
II-8