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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-QSB/A
[X] AMENDMENT NO. 1 TO QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from __________ to ___________
Commission file number 333-87224
ELECTRONIC SENSOR TECHNOLOGY, INC.
(Exact Name of Small Business Issuer as Specified in Its Charter)
NEVADA 98-0372780
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1077 Business Center Drive
Newbury Park, California 91320
(Address of Principal Executive Offices)
(805) 480-1994
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes [ ] No [X](*)
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(*) We were not required to file reports pursuant to Section 13 or 15(d) of the
Securities Exchange Act during the past 12 months because (i) our registered
common stock was registered under the Securities Act during such period and was
not registered under the Exchange Act, (ii) we did not have any registration
statement that became effective during such period and (iii) we had less than
300 shareholders of record throughout such period. Although we were not required
to do so, we voluntarily filed such reports with the Securities and Exchange
Commission during such period. On March 24, 2006 we filed a registration
statement on Form 10-SB to register our common stock pursuant to the Exchange
Act, which we subsequently withdrew pursuant to the request of the Securities
and Exchange Commission until our registration statement on Form SB-2, for which
an amendment was last filed on May 1, 2006, is declared effective. Once our
registration statement on Form SB-2 is declared effective, we plan to file
another registration statement on Form 10-SB to register our common stock
pursuant to the Exchange Act. Once our registration statement on Form 10-SB is
effective, we will be subject to the filing requirements of the Securities
Exchange Act.
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date. 54,173,745 shares of common
stock as of September 7, 2006
Transitional Small Business Disclosure Format Yes [ ] No [X]
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EXPLANATORY NOTE
We are filing this amended quarterly report on Form 10-QSB/A for the
three months ended March 31, 2006 to restate our unaudited consolidated
financial statements at March 31, 2006 and for the period ended March 31, 2006
in order to properly account for the fair value of derivative liabilities
resulting from the issuance of freestanding warrants and registration rights
granted in connection with the issuance of such warrants (the effect of this
restatement is described further in Note 3 to the Consolidated Financial
Statements included herein). We have also amended the cover page in order to
correct and clarify certain disclosures contained therein.
The following Items of this amended quarterly report on Form 10-QSB/A
for the period ended March 31, 2006 are amended and restated herein:
Cover Page:
o Disclosure relating to the withdrawal of our registration
statement on Form 10-SB.
Part I Financial Information:
o Item 1. Financial Statements--Consolidated Balance Sheet as of
March 31, 2006 (unaudited), Consolidated Statements of Operations
for the Three Months Ended March 31, 2006 and 2005 (unaudited),
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2006 and 2005 (unaudited) and Notes to Consolidated
Financial Statements as of March 31, 2006 (unaudited); and
o Item 2. Management Discussion and Analysis of Operations or Plan
of Operations.
Part II Other Information:
o Item 6. Exhibits--Exhibits 31.1, 31.2, 32.1 and
32.2--currently-dated certifications from our President and Chief
Executive Officer and Treasurer and Vice President of Finance and
Administration, as required by Section 302 and 906 of the
Sarbanes-Oxley Act of 2002.
The remaining Items are unaffected by the correction in classification, have not
been updated from the disclosure originally contained in our quarterly report on
Form 10-QSB for the period ended March 31, 2006 filed with the Securities and
Exchange Commission on May 11, 2006 and are not reproduced in this Form
10-QSB/A. This amended quarterly report on Form 10-QSB/A for the period ended
March 31, 2006 does not reflect events occurring after the filing of the
quarterly report on Form 10-QSB filed with the Commission on May 11, 2006, nor
does it modify or update the disclosures contained in the quarterly report on
Form 10-QSB filed with the Commission on May 11, 2006, other than as described
above and to correct typographical errors contained therein.
1
PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEET
MARCH 31, 2006
(Restated)
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,216,536
Certificate of deposit-restricted 250,000
Accounts receivable, net of allowance for doubtful accounts 222,081
Prepaid expenses 66,333
Inventories 1,008,098
------------
TOTAL CURRENT ASSETS 5,763,048
DEFERRED FINANCING COSTS, net of amortization of $69,191 659,168
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $925,677 166,804
SECURITY DEPOSITS 12,817
------------
$ 6,601,837
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 531,718
Deferred revenues 129,167
Derivative liabilities 4,550,881
------------
TOTAL CURRENT LIABILITIES 5,211,766
CONVERTIBLE DEBENTURES, net of unamortized discount of $6,222,223 777,777
------------
TOTAL LIABILITIES 5,989,543
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, 53,968,643 issued and outstanding 54,174
Additional paid-in capital 8,516,354
Accumulated deficit (7,958,234)
------------
TOTAL STOCKHOLDERS' DEFICIT 612,294
------------
$ 6,601,837
============
See unaudited notes consolidated to financial statements
2
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
March 31,
-----------------------------
2006 2005
------------- ------------
(Restated) (Restated)
REVENUES $ 532,817 $ 219,511
COST OF SALES 301,592 149,962
------------ ------------
GROSS PROFIT 231,225 69,549
OPERATING EXPENSES:
Research and development 211,799 140,172
Selling, general and administrative 780,092 567,950
------------ ------------
TOTAL OPERATING EXPENSES 991,891 708,122
------------ ------------
LOSS FROM OPERATIONS (760,666) (638,573)
OTHER INCOME AND (EXPENSE):
Other expense (217) (239)
Other income - derivatives 1,220,197 119,550
Other expense - derivatives - (2,205,642)
Gain (loss) on sale of property and equipment - 13,257
Interest expense (730,391) (20,566)
------------ ------------
TOTAL OTHER INCOME AND EXPENSE 489,589 (2,093,640)
------------ ------------
NET (LOSS) $ (271,077) $ (2,732,214)
============ ============
(Loss) per share, basic $ (0.01) $ (0.05)
============ ============
Weighted average number of shares, basic 54,145,922 52,640,310
============ ============
(Loss) per share, diluted $ (0.03) $ (0.05)
============ ============
Weighted average number of shares, diluted 54,145,922 52,640,310
============ ============
See unaudited notes to consolidated financial statements
3
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
-------------------------------
2006 2005
------------- --------------
(Restated) (Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (271,077) $ (2,732,214)
Adjustments to reconcile net income (loss) to net
cash provided by (used in)operating activities:
Depreciation and amortization 8,666 1,845
Fair value of derivatives at date of issuance - 2,205,642
Decrease in fair value of derivative liability (1,220,197) (119,550)
Issuance of shares for services 21,000 -
Amortization of debt discount 583,333 -
Amortization of deferred financing costs 51,894 -
Changes in assets and liabilities:
Accounts receivable 243,695 (106,349)
Inventories (68,476) 7,212
Prepaid expenses 3,603 (7,324)
Security deposits - 140
Accounts payable and accrued expenses 50,919 120,797
Deferred revenues (12,500) (12,500)
Due to related party - (60,000)
Interest payable - (5,544)
Other current liabilities - (1,016)
------------- -------------
Net cash provided by (used in) operating activities (609,140) (708,861)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment - 16,064
Decrease (increase) in restricted security deposit 668,678 (900,651)
Purchase of property and equipment (62,924) (55,044)
------------- -------------
Net cash provided by (used in) investing activities 605,754 (939,631)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in line of credit - (200,000)
Repayment of partners' loans payable - (110,000)
Proceeds from issuance of common stock - 3,811,708
------------- -------------
Net cash provided by financing activities - 3,501,708
------------- -------------
NET INCREASE (DECREASE) IN CASH (3,385) 1,853,217
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,219,921 26,430
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,216,536 $ 1,879,647
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 140,000 $ 21,217
============= =============
NON-CASH FINANCING ACTIVITIES
Fair value of derivative liabilities issued in
connection with issuance of common stock $ - $ 5,897,800
============= =============
See unaudited notes to consolidated financial statements.
4
ELECTRONIC SENSOR TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
MARCH 31, 2006
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles
for interim financial statements and with the instructions to Form
10-QSB and Article 10 of Regulation S-B. Accordingly, they do not
include all the information and disclosures required for annual
financial statements. These financial statements should be read in
conjunction with the consolidated financial statements and related
footnotes for the year ended December 31, 2005, included in the Annual
Report filed on Form 10-KSB/A for the year then ended.
In the opinion of the management of Electronic Sensor Technology, Inc.
(the "Company"), all adjustments (consisting of normal recurring
accruals) necessary to present fairly the Company's financial position
as of March 31, 2006, and the results of operations and cash flows for
the three month period ending March 31, 2006 have been included. The
results of operations for the three-month period ended March 31, 2006
are not necessarily indicative of the results to be expected for the
full year. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's
Annual Report filed on Form 10-KSB/A as filed with the Securities and
Exchange Commission for the year ended December 31, 2005.
(2) 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.
(3) NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) NATURE OF BUSINESS
The Company develops and manufactures electronic devices used for
vapor analysis.
(b) 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 March 31, 2006.
(c) 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.
(d) SHIPPING AND HANDLING
The Company accounts for shipping and handling costs as a
component of "Cost of Sales".
5
(e) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is computed using the straight-line
method over the estimated useful lives of five years.
(f) 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.
(g) 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.
(h) 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.
(i) 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 September 30, 2005 no assets
were impaired.
(j) DERIVATIVE LIABILITIES
In June 2005, the Financial Accounting Standard Board issued EITF
05-04. EITF 05-04 addresses the question as to whether liquidated
damages pursuant to a registration rights agreement should be
combined as a unit with the underlying financial instruments and
be evaluated as a single instrument. EITF 05-04 does not reach a
consensus on this matter and allows for the treatment as a
combined unit (Views A and B) as well as separate freestanding
financial instruments (View C). On September 15, 2005, the FASB
staff postponed further discussion of EITF 05-04. As of May 31,
2006, the FASB still has not rescheduled EITF 05-04 for further
discussion.
In connection with the issuance of a convertible debentures and
related warrants, we granted liquidated damages pursuant to a
separate registration right agreement. The Company adopted View C
of EITF 05-04. Accordingly, the liquidated damages pursuant to
this registration right agreement were evaluated as a stand alone
financial instrument. This treatment did not have a significant
different effect than if the Company would have adopted View A or
B, because the classification of the warrants and certain
embedded features of the convertible debentures were classified
as derivative liabilities. The Company believes that should the
FASB staff reach a consensus on EITF 05-04 and select combined
treatment (View A or B), the embedded conversion features and the
warrants will have to be evaluated as a combined unit with the
liquidated damages pursuant to the registration rights agreement,
and accordingly, be evaluated as derivative liabilities. The
Company does not believe that its measurement of the derivative
liabilities under View A or View B would significantly differ
from its measurement of the derivative liabilities under View C
in these circumstances.
6
The Company accounts for liquidated damages granted pursuant to
registration rights which are not included in a separate
registration right agreement as a combined unit with the warrants
which are contemporaneously issued with the registration rights
pursuant to SFAS 133 "Accounting for Derivative and Hedging
Activities" and EITF 00-19.
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 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. Any
subsequent increase or decrease in the fair value of the
derivative liabilities, which are measured at the balance sheet
date, are recognized as other expense or other income,
respectively.
(k) BASIC AND DILUTED EARNINGS PER SHARE
Basic earnings per share are calculated by dividing income
available to stockholders by the weighted-average number of
common shares outstanding during each period. Diluted earnings
per share are computed using the weighted average number of
common and dilutive common share equivalents outstanding during
the period. Dilutive common share equivalents consist of shares
issuable upon the exercise of stock options and warrants embedded
conversion features (calculated using the reverse treasury stock
method). The outstanding options, warrants and shares equivalent
issuable pursuant to embedded conversion features amounted to
58,558,501 and 5,576,871at March 31, 2006 and 2005, respectively.
The outstanding options, warrants and shares equivalent issuable
pursuant to embedded conversion features and warrants at March
31, 2006 and 2005, respectively, are excluded from the loss per
share computation for that period due to their anti-dilutive
effect. The Company adjusted the numerator for any changes in
income or loss that would result if the contract had been
recorded as an equity instrument for accounting purposes during
the period. However, the Company did not adjust the numerator for
interest charges during the period on the convertible debentures
because it would have been anti-dilutive.
The following sets forth the computation of basic and diluted
earnings per share at March 31:
2006 2005
---------- ----------
(Restated) (Restated)
Numerator:
Net income (loss) $ (271,077) $ (2,732,214)
Net other income (expense)associated with
derivative contracts 1,220,197 (2,086,092)
------------ -----------
Net income (loss) for diluted earnings per
share purposes (1,491,274) $ (646,122)
=========== ============
Denominator:
Denominator for basic earnings per share-
Weighted average shares outstanding 54,145,922 52,640,310
Effect of dilutive warrants, embedded
conversion features and liquidated damages - -
------------ ------------
Denominator for diluted earnings per share-
Weighted average shares outstanding 54,145,922 52,640,310
============ =============
Basic earnings (loss) per share $ (0.01) $ (0.05)
============ =============
Diluted earnings (loss) per share $ (0.03) $ (0.05)
============ =============
7
(4) CONVERTIBLE DEBENTURES
During December 2005, we issued in a private offering $7,000,000
aggregate principal amount of convertible debentures due December 7,
2009. The convertible debentures are convertible at a variable
conversion price, which is the lesser of $0.4544 or 90% of the average
of the volume weighted average price for the 20 consecutive trading
days immediately prior to the conversion date. The convertible
debentures are convertible at any time on or prior to the maturity
date at the option of the debenture holder. We received $7,000,000 in
cash as consideration. The convertible debentures bear interest at 8%,
payable in cash or stock, at the Company's options, and are required
to be redeemed in 9 equal quarterly payments commencing January 1,
2008.
In connection with the issuance of the convertible debentures, the
Company issued five-year warrants to purchase 12,130,314 shares of
common stock at an exercise price of $0.4761 per share. Furthermore,
the Company granted liquidated damages pursuant to a registration
rights agreement.
The convertible debentures and related agreements provide, among other
things, for:
1) Liquidated damages amounting to 2% per month of the outstanding
principal amount, payable in cash or stock, 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.
The liquidated damages are payable in cash monthly or in unpaid,
bear interest at 18% per annum. If unpaid by January 1, 2008 and
thereafter, they may be converted in shares of common stock at
the same prevailing rate as the remaining principal amount of the
convertible debentures;
2) Default interest rate of 18% and a default premium of 30% of the
principal amount of the debentures, payable in cash or stock.
Events of default include, among other things, if a payment,
whether cash or stock is not paid on time and cured within three
days, if the Company's common stock is not quoted for trading for
at least five trading days, if a registration is not effective
within 180 days after December 5, 2005. The default interest rate
and the default premium may be converted in shares of common
stock at the same prevailing rate as the remaining principal
amount of the convertible debentures;
3) 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, whereby the
aforementioned variable conversion price of the convertible
debentures is adjusted to the new lower effective price of the
subsequent equity or convertible financing;
4) A prepayment premium amounting to 30% of the principal balance of
the convertible debentures in the event that the Company, at its
sole option, prepays the convertible debentures before its due
date. The prepayment is payable in cash only; and
5) 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. The warrants have the same terms as
those granted to the debenture holders. The fair value of the
warrants (at the time of their issuance) and related professional
fees pertaining to the issuance of the convertible debentures
have been recorded as deferred financing costs.
8
The deferred financing costs are amortized over the term of the
convertible debentures. See Note 6 - Derivative Liabilities for
further information on the accounting and measurement of the
derivative liabilities associated with the issuance of the convertible
debentures and related agreements.
(5) OPTIONS
Company adopted a Stock Incentive Option Plan in April 2005. No
options have been granted through March 31, 2006.
(6) DERIVATIVE LIABILITIES
FEBRUARY 2005 TRANSACTION
During February 2005, we recognized derivative liabilities of
approximately $6.0 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.
There are no liquidated damages provided for untimely effectiveness of
the registration of shares pursuant to piggy-back registration rights.
The Company intends to register all shares and warrants pursuant to
the subscriber piggy-back registration rights.
The agreement pursuant to which the warrants were issued and the
registration rights were granted provided for liquidated damages
pursuant to demand registration rights in the event of a failure to
timely register the shares after demand is made by the holders of a
majority of the warrants and shares of common stock issued pursuant to
such agreement. The demand 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 amounts 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%. The Company believes that the
likelihood that it will incur any liabilities resulting from the
liquidated damages pursuant to the demand registration rights is
remote considering that it will register the shares and the shares
underlying the warrants pursuant to piggy-back registration rights,
which do not contain liquidated damages.
Because the registration rights were not granted under a separate
registration rights agreement, we considered those features in
evaluating whether the associated warrants should be classified as
derivative liabilities. Considering that the amount of the maximum
penalty is 49%, the Company cannot conclude that that this discount
represents a reasonable approximation of the difference between
registered and unregistered shares under paragraph 16 of EITF 00-19.
Accordingly, the warrants issued in connection with the February 2005
transaction are considered derivative liabilities.
The fair value of the warrants issued in connection with the February
2005 transaction at the date of issuance of the warrants and the
granting of registration rights and at March 31, 2006 is as follows:
At issuance At March 31, 2006
Freestanding warrants ------------- --------------------
$6,017,350 $ 0
9
The Company used the following assumptions, using the Black Scholes
Model to measure the identified derivatives as follows:
Freestanding warrants
At issuance At March 31, 2006
-------------- --------------------
Market price: $ 2.40 $ 0.23
Exercise price: $ 1.00 $ 1.00
Term: 3 years 2.08 years
Volatility: 39% 39%
Risk-free interest rate: 2.78% 4.82%
Number of warrants: 3,985,000 3,985,000
DECEMBER 2005 TRANSACTION
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. Because there is no explicit number of
shares that are to be delivered upon satisfaction of the convertible
debentures and that there is no cap on the number of shares to be
delivered upon expiration of the contract to a fixed number, the
Company is unable to assert that it had sufficient authorized and
unissued shares to settle its obligations under the convertible
debentures and therefore, net-share settlement is not within the
control of the Company. 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.
The embedded conversion features are as follows:
Default Interest Rate and Premium: The default interest rate is 18%
while the stated rate of the convertible debentures is 8%.
Additionally, the Company is liable to pay for a premium amounting to
30% of the principal amount of the convertible debentures in the event
of default. This embedded derivative could at least double the
investor's initial rate of return on the host contract and could also
result in a rate of return that is at least twice what otherwise would
be the market return for a contract that has the same terms as the
host contract and that involves a debtor with similar credit quality.
Furthermore, the default interest rate may be triggered by certain
events of defaults which are not related to credit-risk-related
covenants or the Company's creditworthiness (e.g., if a registration
statement is not effective within 180 days after December 7, 2005).
The default provisions are effective, at the holders' option, upon an
event of default. Although a registration statement covering the
shares underlying the convertible debentures has not been declared
effective as of June 30, 2006, the debenture holders have not notified
the Company of an election to accelerate the debentures, nor have any
claims for liquidated damages been received.
Reset Feature Following Subsequent Financing: The debenture provides
for 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, whereby the aforementioned
variable conversion price of the convertible debentures is adjusted to
the new lower effective price of the subsequent equity or convertible
financing , which amounts to 10% of the shares issuable pursuant to
the convertible debentures, which is the effective discount to market
value we would offer in the event we provide for a subsequent private
placement financing. This reset does not constitute a standard
anti-dilution provision and is indexed to an underlying other than an
interest rate or credit risk.
Conversion Rate: The convertible debentures are convertible at a
variable conversion price, which is the lesser of $0.4544 or 90% of
the average of the volume weighted average price for the 20
consecutive trading days immediately prior to the conversion date. The
convertible debentures are convertible at any
10
time on or prior to the maturity date at the option of the debenture
holder. The implied conversion embedded feature amounts to a
conversion discount of 10% to market.
The Company believes that the aforementioned embedded derivatives meet
the criteria of SFAS 133, including Implementation issue No. B16 and
EITF 00-19, when appropriate, and should be accounted for as
derivatives with a corresponding value recorded as a liability.
In connection with the issuance of the convertible debentures, the
Company issued warrants to the debenture holders. 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.
Accordingly, we have accounted for such warrants as derivatives.
In connection with the issuance of the convertible debentures, the
Company granted liquidated damages pursuant to a registration rights
agreement. The liquidated damages amount to 2% per month of the
outstanding principal amount, payable in cash or stock, 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. The
liquidated damages are payable in cash monthly or if unpaid, bear
interest at 18% per annum. If unpaid by January 1, 2008 and
thereafter, they may be converted in shares of common stock at the
same prevailing rate as the remaining principal amount of the
convertible debentures. Pursuant to View C of EITF 05-04 the
liquidated damages are accounted for as a separate derivative. While
the liquidated damages may be settled in stock if unpaid by January 1,
2008, the Company determined that it was more likely that they would
be paid in cash shortly after their occurrence and has used such
assumption in measuring the fair value of the derivative liability
associated with the liquidated damages. The maximum liability
associated with the liquidated damages amount to 38% of the gross
proceeds associated with the issuance of the convertible debentures,
which amounts to $2,660,000.
Additionally, because there is no explicit number of shares that are
to be delivered upon satisfaction of the convertible debentures, the
Company is unable to assert that it had sufficient amount of
authorized and unissued shares to settle its obligations under the
convertible debentures. Accordingly, all of the Company's previously
issued and outstanding instruments, such as warrants, as well as those
issued in the future, would be classified as liabilities as well,
effective with the issuance of the convertible debentures and until
the Company is able to assert that it has a sufficient amount of
authorized and unissued shares to settle its obligations under all
outstanding instruments. At the date of the issuance of the
convertible debentures, the Company had 1,941,871 warrants outstanding
which were classified as derivatives.
The fair value of the derivative liabilities at the date of issuance
of the convertible debentures and at March 31, 2006 are as follows:
At issuance At March 31, 2006
------------- -----------------
(Restated) (Restated)
Freestanding warrants $ 3,532,348 $ 756,932
Embedded conversion features 3,463,542 3,601,449
Liquidated damages 192,500 192,500
Other outstanding warrants 143,268 0
The Company used the following methodology to value the embedded
conversion features and liquidated damages:
It estimated the discounted cash flows payable by the Company, using
probabilities and likely scenarios, for event of defaults triggering
the 30% penalty premium and 18% interest accrual, subsequent financing
reset, and liquidated damages, such as the untimely effectiveness of a
registration statement. If the additional cash
11
consideration was payable in cash or stock, it determined the amount
of additional shares that would be issuable pursuant to its
assumptions. The Company will revisit the weight of probabilities and
the likelihood of scenarios at each of the measurement dates of the
derivative liabilities, which are the balance sheet dates.
The Company used the following assumptions to measure the identified
derivatives, using the Lattice valuation model, as follows:
Embedded conversion features
At issuance At March 31, 2006
-------------- ------------------
(Restated) (Restated)
Market price: $ 0.4880 $ 0.23
Conversion price: $ 0.4544 $ 0.21
Term: 4 years 3.67 years
Volatility: 39% 39%
Risk-free interest rate: 4.39% 4.82%
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 March 31, 2006
-------------- ------------------
(Restated) (Restated)
Market price: $ 0.488 $ 0.23
Exercise price: $ 0.4761 $ 0.34
Term: 5 years 4.67 years
Volatility: 39% 39%
Risk-free interest rate: 4.39% 4.82%
We adjusted the effective exercise price to reflect the contractual
adjustment assuming that the warrants will most likely be registered
during the fourth quarter of 2006.
Liquidated damages
The liquidated damages, payable in cash, are valued using the
weighting probabilities and likely scenarios to estimate the amount of
liquidated damages and were valued at approximately $192,500 at the
date of the grant of the registration rights and at March 31, 2006.
The aggregate fair value of the derivative liabilities associated with
the warrants, embedded conversion features, and liquidated damages in
connection with the issuance of the convertible debentures and related
agreements amounted to approximately $7.05 million at the date of
issuance which exceeded the principal amount of the convertible
debentures by approximately $50,000. The Company recognized $7,000,000
as debt discount and the excess amount has been recorded as other
expenses. Additionally, approximately $136,000 of the fair value of
the warrants was recorded as deferred financing costs.
The aggregate fair value of all derivative liabilities upon issuance
of the various debt and equity instruments amounted to $13.3 million,
of which $10.7 million was allocated to the net proceeds of the
issuance of common stock and convertible debentures, $2.4 million was
allocated to other expenses and approximately $136,000 was allocated
to deferred financing costs.
12
The decrease in fair value of the derivative liabilities between
measurement dates, which are the date of issuance of the various debt
and equity instruments and the balance sheet date, which is March 31,
2006 amounted to approximately $1.2 million and has been recorded as
other income. In 2005, approximately $7.6 million was recorded as
other income.
(7) 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. 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.
(8) RESTATEMENT OF INTERIM FINANCIAL STATEMENTS
In connection with the filing of an amendment to our registration
statement on Form SB-2/A with the Securities and Exchange Commission,
and after reviewing certain accounting principles we had applied in
our financial statements for the periods ended March 31, 2005, June
30, 2005 and September 30, 2005 previously filed with the Commission,
management has determined that those financial statements should no
longer be relied upon as they did not properly account for certain
liquidated damages associated with a $3.985 million private placement
of warrants and shares of our common stock that occurred in February
2005; and with a $7,000,000 private offering of convertible debentures
and warrants that occurred in December 2005 . Previously, the Company
had not reflected the liquidated damages at their fair value nor their
effect on other outstanding convertible instruments. Pursuant to the
terms of the warrants that the Company issued and the registration
rights granted in such private placement and offering, the warrant
holders are entitled to liquidated damages pursuant to demand
registration rights in the event of a failure to timely register the
shares after demand is made by the holders of a majority of the
warrants and shares of common stock issued pursuant to such agreement.
The demand 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 amounts 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%. The Company believes that the likelihood that it will
incur any liabilities resulting from the liquidated damages pursuant
to the demand registration rights is remote considering that it will
register the shares and the shares underlying the warrants pursuant to
piggy-back registration rights, which do not contain liquidated
damages. Because the registration rights were not granted under a
separate registration rights agreement, we considered those features
in evaluating whether the associated warrants should be classified as
derivative liabilities. Considering that the amount of the maximum
penalty is 49%, the Company cannot conclude that that this discount
represents a reasonable approximation of the difference between
registered and unregistered shares under paragraph 16 of EITF 00-19.
Accordingly, the warrants issued in connection with the February 2005
transaction are considered derivative liabilities.
The proper accounting for such liquidated damages provision affects
the following figures in our quarterly financial statements:
Increases in additional paid-in capital ($10,466,134), and accumulated
deficit ($4,025,518). Decreases in deferred financing costs
($101,898), derivative liabilities ($6,542,512), other
income-derivatives ($466,849), net income ($466,850), loss per
share-basic ($0.01), and loss per share-diluted ($0.03). Additionally,
on the statement of cash flows, there was a decrease in net income
($466,850) and an increase in the fair value of derivative liabilities
($466,850).
13
ITEM 2. 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 our interim financial statements and the
related notes appearing at the beginning of this report. The interim financial
statements and this Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 2005 and the
related Management's Discussion and Analysis of Financial Condition and Results
of Operations, both of which are contained in our Annual Report on Form 10-KSB/A
filed with the Securities and Exchange Commission.
The following discussion and other parts of this Form 10-QSB 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 report as a result of
factors, including the risk factors discussed in Exhibit 99.1 hereto, which is
incorporated herein by reference, and factors discussed elsewhere in this report
and in our Annual Report on Form 10-KSB/A for the fiscal year ended December 31,
2005. All forward-looking statements are based on information currently
available to the Company 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 Form 10-QSB are the property of their
respective owners.
--------------------------------------------------------------------------------
OVERVIEW
The Company is engaged in the development, manufacturing, and sales 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." We believe
the zNose(R) is superior to other electronic "noses" because of its speed,
specificity and sensitivity. The zNose(R) is capable of measuring and
quantifying the chemistry of any compound, fragrance, vapor or odor with parts
per trillion sensitivity in 10 seconds. We also believe the zNose(R) has the
unique ability to quantify and speciate the subject chemical vapor by creating
visual olfactory images. This enables the measured odor or vapor to be easily
identified by the user.
We believe that our products will have broad applications in the homeland
security, environmental and laboratory instrumentation markets. The Company is
involved in ongoing product research and development efforts in that regard. The
Company has also concentrated its efforts on further product development,
testing and proving and assembling a sales and support organization.
The Company was originally incorporated under the laws of the state of Nevada as
"Bluestone Ventures, Inc." on July 12, 2000. From inception until February 1,
2005, we engaged in the business of acquiring, exploring and developing certain
mining properties in Ontario, Canada. Upon acquisition of Electronic Sensor
Technology, L.P. ("ELP"), we abandoned our mining business and adopted ELP's
business of developing, manufacturing and selling the vapor analysis device.
Prior to the closing of the mergers, as discussed in the footnotes to the
financial statements, on January 26, 2005, we changed our name to "Electronic
Sensor Technology, Inc."
Our executive offices are located at 1077 Business Center Circle, Newbury Park,
California 91320 and our telephone number is (805) 480-1994.
CRITICAL ACCOUNTING POLICIES
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.
14
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.
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 March 31, 2006 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.
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
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.
15
RESULTS OF OPERATIONS
The following tables sets forth, in $ and as a percentage of revenues, certain
items included in the Company's Income Statements (see Financial Statements and
Notes) for the periods indicated:
THREE MONTHS ENDED MARCH 31
---------------------------------
2006 2005
------------- --------------
STATEMENT OF OPERATIONS DATA: (Restated) (Restated)
-----------------------------
Revenues ..................... 100% 100%
Cost of Sales ................ 57% 68%
Gross Profit ................. 43% 32%
Operating Expenses ........... 186% 323%
Loss From Operations ......... (143%) (291%)
Other Income (Expense) ....... 92% (954%)
Net Income (Loss) ............ (51%) (1,245%)
THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THREE MONTHS ENDED MARCH 31, 2005
Revenues are derived from product sales and product support services. For the
three months ended March 31, 2006 revenues were $532,817, compared to $219,511
in 2005. The 143% increase in revenues results from an increase in the number of
zNose(R) units shipped from 6 units in 2005 to 12 units in 2006 for the three
month period. Also contributing to the increase in revenues was a corresponding
increase in sales from product support services.
Cost of Sales consist of product costs and expenses associated with product
support services. For the first quarter period cost of sales was $301,592 for
2006 as compared to $149,962 in 2005. The improvement in cost of sales from 68%
of 2005 revenues to 57% of 2006 revenues is attributed to production
efficiencies and production economies of scales resulting in overhead being
spread over a greater volume of production.
Gross profit was $231,225 for the three months ending March 31, 2006, compared
to $69,549 for the same period in 2005. The increase of 2006 gross profit from
32% in 2005 to 43% of revenues is attributed to increased sales volume offset by
higher product support costs.
Research and Development costs for first quarter 2006 were $211,799 versus
$140,172 for 2005. The increase of $71,627 over 2005 R&D expenditures were
mainly for increased personnel related expenses with additional research and
development staff dedicated in the enhancements of existing products and new
product development.
Selling, General and Administrative expenses for the three months ending March
31, 2006 were $780,092, compared to $567,950 for 2005. The $212,142 increase was
due to the hiring of new employees necessitated by the growth of the business,
expanded marketing activities, offset by a reduction in legal and related
expenses incurred in connection with the company's reverse merger in 2005.
Interest expense for the first three months of 2006 was $730,391, as compared to
$20,566 in 2005. The increase in interest expense is primarily due to the
amortization of debt discount and stated interest associated with our
convertible debentures, which were issued in December 2005.
Other income-derivatives primarily consist of the decrease in the fair value of
derivative liabilities between the measurement dates. The increase in other
income-derivatives during the-three-month period ended March 31, 2006 when
compared to prior period is primarily attributable to a decrease in the quoted
price of our common stock. Please refer to Note 6 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 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.
16
Other expense-derivatives primarily consist of the recognition of derivative
liabilities we issued during the three-month period ended March 31, 2005. No
derivatives were issued during the three-month period ended March 31, 2006.
Please refer to Note 6 of our accompanying financial statements for further
explanation of the origin and nature of such expenses. 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.
LIQUIDITY AND CAPITAL RESOURCES
In the first three months of 2006, net cash used by the Company for operating
activities was $609,140. In the first three months of 2005, cash used by Company
operations was $708,861. Cash used in the first three months of 2006 was
comprised of the net loss for the three-month period of $271,077, less net
non-cash items of $555,304, plus the net change in operating assets and
liabilities of $217,241. Cash used in operations in the three months of 2005 was
comprised of the net loss of $2,732,214, plus net non-cash expenses of
$2,087,937, less the net change in operating assets and liabilities of $64,584.
Investing activities provided cash of $605,754 in the first three months of 2006
and used $939,631 during the same period in 2005. Cash of $62,924 and $55,044
was used in 2006 and 2005, respectively, to purchase of equipment. In 2005,
$900,651 was used to purchase a certificate of deposit as collateral for the
company's line of credit. Whereas in 2006, $668,678 was provided due to a
reduction in the amount of collateral required for the company's line of credit.
There were no financing activities for the first three months of 2006. In first
quarter 2005, financing activities provided cash of $3,501,708 from the issuance
of common stock ($3,811,708), offset by a reduction in the company's line of
credit ($200,000) and repayment of loans from the company's partners ($110,000).
On March 31, 2006 the Company's cash (including cash equivalents) was
$4,216,536, compared to $1,879,647 on March 31, 2005. The Company had a working
capital on March 31, 2006 of $551,282. The working deficit includes $4,550,881
for derivative liabilities - excluding this amount from current liabilities; the
Company's working capital would be $5,102,163. The Company's working deficit at
March 31, 2005 was $4,824,920 - excluding derivative liabilities, working
capital would be $1,072,880.
The Company has a credit facility in place with East West Bank for $500,000. The
entire credit line was available at March 31, 2006.
Although the Company possesses a bank operating line of credit, there can be no
assurance that these proceeds will be adequate for our future 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 and there is no
guarantee that a market will exist for the sale of the Company's shares.
The Company's primary capital needs are to fund its 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 U.S. and foreign countries, introducing new
products, improving existing product lines and development of a strong corporate
infrastructure.
SEASONALITY AND QUARTERLY RESULTS
We do not foresee any seasonality to our revenues or our results of operations.
17
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.
18
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS
Exhibit
No. Description
------- -------------------------------------------------------------------
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act.
31.2 Certification of Principal Financial and Accounting Officer
Pursuant to Rule 13a-14(a)/15d-14(a) of the Exchange Act.
32.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(b)
or 15d-14(b) of the Exchange Act and 18 U.S.C. 1350.
32.2 Certification of Principal Financial and Accounting Officer
Pursuant to Rule 13a-14(b) or 15d-14(b) of the Exchange Act and 18
U.S.C. 1350.
99.1 Risk Factors (previously filed).
--------------------------------------------------------------------------------
19
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this amended report to be signed on its behalf by the undersigned, thereunto
duly authorized.
ELECTRONIC SENSOR TECHNOLOGY, INC.
Dated September 26, 2006 By: /s/ Teong C. Lim
---------------------------------------
Name: Teong C. Lim
Title: President and Chief Executive Officer
(Principal Executive Officer)
Dated September 26, 2006 By: /s/ Francis Chang
---------------------------------------
Name: Francis Chang
Title: Secretary, Treasurer and Vice President
of Finance and Administration
(Principal Accounting Officer)