================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2009
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 000-51859
ELECTRONIC SENSOR TECHNOLOGY, INC.
(Exact name of registrant 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
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
(ss.232.405 of this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files).
Yes [ ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of "large accelerated filer," "accelerated filer" and
"smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check Smaller reporting company [X]
if a smaller
reporting company)
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date. 161,918,543 shares of common
stock as of July 30, 2009
================================================================================
Certain statements in this quarterly report on Form 10-Q, including those
relating to the company's plans regarding business and product development;
product sales and distribution; market demands and developments in the homeland
security, analytical instrumentation/quality control and environmental
monitoring markets; and the sufficiency of the company's resources to satisfy
operation cash requirements are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These forward-looking statements
may contain the words "believe," "anticipate," "expect," "predict," "estimate,"
"project," "will be," "will continue," "will likely result," or other similar
words and phrases. Risks and uncertainties exist that may cause results to
differ materially from those set forth in these forward-looking statements.
Factors that could cause the anticipated results to differ from those described
in the forward-looking statements include: risks related to changes in
technology, our dependence on key personnel, our ability to protect our
intellectual property rights, emergence of future competitors, changes in our
largest customer's business and government regulation of homeland security
companies. 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.
PART I.
FINANCIAL INFORMATION
Item 1. Financial Statements.
INDEX TO FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2009 (unaudited)
and December 31, 2008 (audited) F-1
Consolidated Statements of Operations (unaudited) for the
Three and Six Months Ended June 30, 2009 and 2008 F-2
Consolidated Statements of Cash Flows (unaudited) for the
Three and Six Months Ended June 30, 2009 and 2008 F-3
Notes to Consolidated Financial Statements (unaudited) F-4
1
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
June December 31,
30, 2009 2008
------------ ------------
(Unaudited) (Audited)
CURRENT ASSETS:
Cash and cash equivalents $ 709,186 $ 484,028
Certificate of deposit-restricted 15,500 15,500
Accounts receivable, net of allowance for uncollectible
of $4,200 at June 30, 2009 and $0 at December 31, 2008 278,718 284,644
Prepaid expenses 96,457 59,219
Inventories 490,013 557,454
------------ ------------
TOTAL CURRENT ASSETS 1,589,874 1,400,845
------------ ------------
PROPERTY AND EQUIPMENT, net 98,060 114,213
SECURITY DEPOSITS 12,817 12,817
------------ ------------
$ 1,700,751 $ 1,527,875
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 477,375 $ 352,369
Obligation under capital lease due within one year 21,194 20,024
Debenture payable 1,000,000 -
------------ ------------
TOTAL CURRENT LIABILITIES 1,498,569 372,393
------------ ------------
CONVERTIBLE DEBENTURES - long-term portion, net of
unamortized discount 1,956,729 1,951,017
LONG-TERM OBLIGATION UNDER CAPITAL LEASE 5,685 16,583
------------ ------------
TOTAL LIABILITIES 3,460,983 2,339,993
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock, $.001 par value 50,000,000 shares
authorized, none issued and outstanding - -
Common stock, $.001 par value 250,000,000 shares authorized,
161,918,543 and 155,853,385 issued and outstanding at
June 30, 2009 and December 31, 2008, respectively 161,919 155,854
Additional paid-in capital 15,321,544 15,207,301
Accumulated deficit (17,243,695) (16,175,273)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY (1,760,232) (812,118)
------------ ------------
$ 1,700,751 $ 1,527,875
============ ============
See unaudited notes to consolidated financial statements
F-1
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Six Months Ended Three Months Ended
June 30, June 30,
-------------------------------- --------------------------------
2009 2008 2009 2008
-------------- -------------- -------------- --------------
REVENUES $ 583,479 $ 759,642 $ 297,574 $ 366,109
COST OF SALES 328,812 460,644 159,491 232,503
-------------- -------------- -------------- --------------
GROSS PROFIT 254,667 298,998 138,083 133,606
OPERATING EXPENSES:
Research and development 198,073 348,937 88,281 171,614
Selling, general and administrative 1,005,441 1,140,705 565,821 652,943
-------------- -------------- -------------- --------------
TOTAL OPERATING EXPENSES 1,203,514 1,489,642 654,102 824,557
-------------- -------------- -------------- --------------
LOSS FROM OPERATIONS (948,847) (1,190,644) (516,019) (690,951)
-------------- -------------- -------------- --------------
OTHER INCOME (EXPENSE)
Other income - derivative - 323,210 - -
Loss on disposal of fixed assets (1,121) - -
Gain from extinguishment of debt - 1,261,864 - -
Other income 13 - 13 -
Interest (expense) (118,470) (786,466) (69,413) (52,197)
-------------- -------------- -------------- --------------
TOTAL OTHER INCOME (EXPENSE) (119,578) 798,608 (69,400) (52,197)
-------------- -------------- -------------- --------------
NET (LOSS) $ (1,068,425) $ (392,036) $ (585,419) $ (743,148)
============== ============== ============== ==============
Loss per share, basic $ (0.01) $ (0.00) $ (0.00) $ (0.00)
============== ============== ============== ==============
Weighted average number of shares, basic 155,952,005 109,764,305 156,045,930 155,690,885
============== ============== ============== ==============
Loss per share, diluted $ (0.01) $ (0.01) $ (0.00) $ (0.00)
============== ============== ============== ==============
Weighted average number of shares, diluted 155,952,005 109,764,305 156,045,930 155,690,885
============== ============== ============== ==============
See unaudited notes to consolidated financial statements
F-2
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
----------------------------
2009 2008
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) $ (1,068,425) $ (392,036)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 21,140 24,167
Increase in allowance for doubtful accounts 4,200 -
Issuance of shares for payment of interest - 280,000
Issuance of shares for services 109,173 -
Stock based compensation 11,135 21,931
Amortization of debt discount 5,712 586,269
Amortization of deferred financing costs - 45,387
Gain on extinguishment of debt - (1,261,864)
Decrease in fair value of derivative liability - (323,210)
Changes in assets and liabilities:
Accounts receivable 1,726 92,163
Inventories 67,441 (60,032)
Prepaid expenses (37,239) (114,857)
Accounts payable and accrued expenses 125,010 226,970
Deferred revenues - (25,000)
------------ ------------
Net cash provided by (used in) operating activities (760,127) (900,112)
------------ ------------
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 4,772 9,884
Purchase of property and equipment (9,759) (2,389)
------------ ------------
Net cash provided by (used in) investing activities (4,987) 7,495
------------ ------------
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in capital lease obligation (9,728) (8,684)
Proceeds from 9% debenture payable 1,000,000 -
Proceeds from issuance of 9% convertible debentures - 2,000,000
Proceeds from issuance of equity - 3,500,000
Repayment of 8% convertible debentures - (3,500,000)
------------ ------------
------------ ------------
Net cash provided by (used in) financing activities 990,272 1,991,316
------------ ------------
------------ ------------
NET INCREASE IN CASH 225,158 1,098,699
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 484,028 248,587
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 709,186 $ 1,347,286
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 47,101 $ 4,482
============ ============
NONCASH FINANCING AND INVESTING ACTIVITY:
Reclassification of derivative liability to paid-in-capital $ - $ 2,053,333
============ ============
Conversion of 8% convertible debentures into equity $ - $ 500,000
============ ============
Debt discount related to 9% convertible debentures $ - $ 54,678
============ ============
See unaudited notes to consolidated financial statements.
F-3
ELECTRONIC SENSOR TECHNOLOGY, INC.
Notes to Consolidated Financial Statements
(Unaudited)
June 30, 2009
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-Q and
Item 10 of Regulation S-K. 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,
2008, included in the Annual Report filed on Form 10-K 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 June 30,
2009, and the results of operations and cash flows for the six month period
ending June 30, 2009 have been included. The results of operations for the
six month period ended June 30, 2009 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-K as filed with the Securities and
Exchange Commission for the year ended December 31, 2008.
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. It markets its products through distribution channels
in over 20 countries.
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.
c) Certificate of Deposit - Restricted
The Company had two certificates of deposit in place at June 30, 2009.
One, in the amount of $12,000, was used to secure and collateralize
the Company's credit card liability. The other certificate of deposit
in the amount of $3,500 was used to provide a performance guarantee
for a sale to an oversea customer.
d) Allowance for Doubtful Accounts
The allowance for doubtful accounts is based on the Company's
assessment of the collectibility of customer accounts and the aging of
the accounts receivable. If there is a deterioration of a major
customer's credit worthiness or actual defaults are higher than the
Company's historical experience, the Company's estimates of the
recoverability of amounts due it could be adversely affected. The
Company regularly reviews the adequacy of the Company's allowance for
doubtful accounts through identification of specific receivables where
it is expected that payments will not be received. The Company also
establishes an unallocated reserve that is applied to all amounts that
are not specifically identified. In determining specific receivables
where collections may not
F-4
be received, the Company reviews past due receivables and gives
consideration to prior collection history and changes in the
customer's overall business condition. The allowance for doubtful
accounts reflects the Company's best estimate as of the reporting
dates. Changes may occur in the future, which may require the Company
to reassess the collectibility of amounts and at which time the
Company may need to provide additional allowances in excess of that
currently provided.
e) 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 shipment or
service revenue are recorded as deferred revenue.
f) Shipping and Handling
The Company accounts for shipping and handling costs as a component of
"Cost of Sales".
g) 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.
h) 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.
i) 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.
j) 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.
k) Fair Value of Financial Instruments
The fair value of certain financial instruments, including accounts
receivable, accounts payable and accrued liabilities, approximate
their carrying values due to the short maturity of these instruments.
The fair value as of June 30, 2009 of the 9% convertible debentures
issued by the Company on March 28, 2008 and the 9% note payable issued
by the Company on April 10, 2009 amounts to $2,000,000 and $1,000,000,
respectively, based on the Company's incremental borrowing rate.
l) 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,
F-5
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 June 30, 2009
no assets were impaired.
m) Capital Lease
On June 28, 2007, the Company entered into a capital lease under which
the present value of the minimum lease payments amounted to $59,200.
The present value of the minimum lease payments was calculated using a
discount rate of 11.41%. The principal balance of the capital lease
obligation amounted to approximately $26,900 at June 30, 2009,
including approximately $21,200 in the current portion of capital
lease obligations in the accompanying consolidated balance sheet.
n) 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 by dividing income available to stockholders, adjusted for
interest savings on the convertible debenture and changes in income or
loss associated with the derivative contract that would result if the
contract had been recorded as an equity instrument for accounting
purposes during the period, by the weighted average number of common
shares outstanding during the period plus the net effect of stock
options and warrants, effect of the convertible debentures, and
embedded conversion features.
The outstanding options, warrants and shares equivalent issuable
pursuant to embedded conversion features and warrants at June 30, 2009
and 2008 are excluded from the loss per share computation for that
period due to their antidilutive effect.
The following sets forth the computation of basic and diluted earnings
per share at June 30:
2009 2008
-------------- --------------
Numerator:
Net (loss) $ (1,068,425) $ (392,036)
Net other (income)/expense associated with
derivative contracts - (323,210)
-------------- --------------
Net (loss) for diluted earnings per share purposes $ (1,068,425) $ (715,246)
============== ==============
Denominator:
Denominator for basic earnings per share-
Weighted average shares outstanding 155,952,005 109,764,305
Effect of dilutive stock options and warrants,
determined under the treasury stock method - -
Assume issued common shares for convertible
debentures, determined under the if-converted
method - -
-------------- --------------
Denominator for diluted earnings per share-
Weighted average shares outstanding 155,952,005 109,764,305
============== ==============
Basic earnings (loss) per share $ (0.01) $ 0.00
============== ==============
Diluted earnings (loss) per share $ (0.01) $ (0.01)
============== ==============
o) Stock Based Compensation
The Company adopted SFAS No. 123R, "Share Based Payments." SFAS No.
123R requires companies to expense the value of employee stock options
and similar awards and applies to all outstanding and vested
stock-based awards.
F-6
In computing the impact, the fair value of each option is estimated on
the date of grant based on the Black-Scholes options-pricing model
utilizing certain assumptions for a risk free interest rate;
volatility; and expected remaining lives of the awards. The
assumptions used in calculating the fair value of share-based payment
awards represent management's best estimates, but these estimates
involve inherent uncertainties and the application of management
judgment. As a result, if factors change and the Company uses
different assumptions, the Company's stock-based compensation expense
could be materially different in the future. In addition, the Company
is required to estimate the expected forfeiture rate and only
recognize expense for those shares expected to vest. In estimating the
Company's forfeiture rate, the Company analyzed its historical
forfeiture rate, the remaining lives of unvested options, and the
amount of vested options as a percentage of total options outstanding.
If the Company's actual forfeiture rate is materially different from
its estimate, or if the Company reevaluates the forfeiture rate in the
future, the stock-based compensation expense could be significantly
different from what we have recorded in the current period. The impact
of applying SFAS No. 123R approximated $11,100 in additional
compensation expense during for the six month period ended June 30,
2009. Such amount is included in general and administrative expenses
on the statement of operations.
p) Risk Factors
Recently, the credit markets and the financial services industry have
been experiencing a period of unprecedented turmoil and upheaval
characterized by the bankruptcy, failure, collapse or sale of various
financial institutions and an unprecedented level of intervention from
the United States federal government. While the ultimate outcome of
these events cannot be predicted, they may have a material adverse
effect on the Company's liquidity and financial condition if its
ability to borrow money to finance its operations from its existing
lenders or from other sources, or obtain credit from trade creditors
were to be impaired. In addition, the recent economic crisis could
also adversely impact our customers' ability to finance the purchase
of electronic instruments from us or our suppliers' ability to provide
us with product, either of which may negatively impact the Company's
business and results of operations.
Concentration of Credit Risks
The Company is subject to concentrations of credit risk primarily from
cash and cash equivalents. The Company's cash and cash equivalents
accounts are held at financial institutions and are insured by the
Federal Deposit Insurance Corporation ("FDIC") up to $250,000 at June
30, 2009. During the six-month periods ended June 30, 2009 and 2008,
the Company has reached bank balances exceeding the FDIC insurance
limit. While the Company periodically evaluates the credit quality of
the financial institutions in which it holds deposits, it cannot
reasonably alleviate the risk associated with the sudden failure of
such financial institutions.
Customer Concentration
The Company's largest customer accounted for approximately 20% and 23%
of its revenues during the six-month periods ended June 30, 2009 and
2008, respectively. The customer accounted for approximately 41% and
69% of the gross accounts receivable balance at June 30, 2009 and
2008, respectively.
Product Concentration
All of the Company's revenues were derived from the sale of electronic
devices and related accessories used for vapor analysis.
Geographic Concentration
The Company sells its products internationally in 20 countries. Sales
to these countries were approximately 44% and 56% of net revenues
during the six-month periods ended June 30, 2009 and 2008,
respectively.
F-7
q) Recently Issued Accounting Pronouncements
FASB 161 - Disclosures about Derivative Instruments and Hedging
Activities
In March 2008, the FASB issued FASB Statement No. 161, which amends
and expands the disclosure requirements of FASB Statement No. 133 with
the intent to provide users of financial statements with an enhanced
understanding of; how and why an entity uses derivative instruments,
how the derivative instruments and the related hedged items are
accounted for and how the related hedged items affect an entity's
financial position, performance and cash flows. This Statement is
effective for financial statements for fiscal years and interim
periods beginning after November 15, 2008. Management believes this
Statement will have no impact on the financial statements of the
Company once adopted.
FASB 161 - The Hierarchy of Generally Accepted Accounting Principles
In May 2008, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 162, "The
Hierarchy of Generally Accepted Accounting Principles." The new
standard is intended to improve financial reporting by identifying a
consistent framework, or hierarchy, for selecting accounting
principles to be used in preparing financial statements that are
presented in conformity with U.S. generally accepted accounting
principles (GAAP) for non-governmental entities. We are currently
evaluating the effects, if any, that SFAS No. 162 may have on our
financial reporting.
4) Convertible debentures
9% Debenture Payable
On April 10, 2009, the Company received $1 million from an investor in
exchange for a debenture bearing an interest rate of 9% with a maturity of
one year. The debenture grants the investor a security interest in all of
the intellectual property of the Company.
9% Convertible Debentures
On March 28, 2008, we received $2,000,000 from an investor in exchange for
a convertible debenture bearing an interest rate of 9%, payable
semi-annually in cash. The convertible debenture has a five (5)-year term,
and the conversion rate of the debenture is $0.0486 (equal to 41,152,263
common shares). The difference between the conversion rate of the debenture
and the closing price of the Company's common stock on the date of issuance
resulted in a note discount of approximately $58,000. The note discount
will be amortized over the term of the convertible debenture.
5) Stockholders' Equity
Common Stock
On June 12, 2009, the Company filed Amended and Restated Articles of
Incorporation with the Nevada Secretary of State. The Articles of
Incorporation of the Company were amended and restated to give effect to
the following amendments: (i) to increase the number of authorized shares
of common stock from 200,000,000 shares to 250,000,000 shares, (ii) to vest
authority in the Board of Directors to prescribe the classes, series and
the number of each class or series of preferred stock and the voting
powers, designations, preferences, limitations, restrictions and relative
rights granted to or imposed upon any wholly unissued series of preferred
stock and (iii) to clarify and restate that the purpose of the business of
the Company is to engage in any lawful act or activity for which
corporations may be organized under the General Corporation Law of the
State of Nevada.
F-8
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.
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.
F-9
Management used Black Scholes methodology to determine the fair value of
the options on the date of issue based on the following assumptions. The
expected volatility was based on the average historical volatility of
comparable publicly-traded companies.
2009 2008
------------- -------------
Exercise price $0.02 - $0.24 $0.19 - $0.24
Market value $0.02 - $0.24 $0.19 - $0.24
Expected dividend yield 0% 0%
Expected volatility 36% - 47% 36% - 39%
Risk free interest rate 3.81% - 4.54% 4.03% - 4.54%
Expected life of option 5 years 5 years
The fair value of the granted stock options shares was approximately $0.02
per share. Approximately $22,000 and $11,100 were charged to compensation
expense for the six month period ended June 30, 2008 and 2009,
respectively. The remaining amount will be amortized to compensation
expense over future periods based on the vesting schedule of the respective
stock option shares. The total compensation cost related to nonvested
awards not yet recognized amounted to approximately $25,300 at June 30,
2009. This compensation cost will be recognized over the weighted average
period of the remaining terms of the stock options, unless the options are
terminated sooner.
The following tables summarize all stock option grants to employees and
non-employees as of June 30, 2009:
Weighted
Number of Average
Stock Options Options Exercise Price
---------------------------------------------------------- ------------ --------------
Balance at December 31, 2007 3,437,950 $ 0.41
Granted 2,000,000 $ 0.03
Exercised - $ -
Forfeited (2,291,050) $ 0.37
------------ --------------
Balance at December 31, 2008 3,146,900 $ 0.19
Granted - $ -
Exercised - $ -
Forfeited (612,500) $ 0.45
------------ --------------
Balance at June 30, 2009 2,534,400 $ 0.12
============ ==============
Options exercisable at June 30, 2009 415,700 $ 0.56
============ ==============
Weighted average fair value of options granted during 2009 - $ -
============ ==============
A summary of the status of the Company's nonvested shares as of June 30,
2009, and changes during the fiscal period then ended as presented below.
F-10
Weighted
Average
Grant Date
Nonvested Shares Shares Fair Value
------------------------------ ------------ -----------
Nonvested at December 31, 2007 1,598,200 $ 0.09
Granted 2,000,000 $ 0.03
Vested (191,850) $ 0.24
Cancelled (1,158,300) $ 0.21
------------ -----------
Nonvested at December 31, 2008 2,248,050 $ 0.09
Granted - $ -
Vested (66,850) $ 0.24
Cancelled (62,500) $ 0.24
------------ -----------
Nonvested at June 30, 2009 2,118,700 $ 0.04
============ ===========
Options Outstanding Options Exercisable
-------------------------------------------------------------------------- ----------------------------------
Exercise Number Weighted Weighted Number Weighted
Average
Outstanding Remaining Average Exercisable Average
as of June Contractual Exercise at June 30, Exercise
Price 30, 2009 Years Price 2009 Price
----- ----------- --------------- -------------- --- ------------ -------------- --- ------------
$ 0.02 1,000,000 9.40 $ 0.02 - $ -
$ 0.03 1,000,000 9.07 $ 0.03 - $ -
$ 0.19 74,000 7.68 $ 0.19 74,000 $ 0.19
$ 0.24 282,400 7.55 $ 0.24 163,700 $ 0.24
$ 1.00 178,000 5.59 $ 1.00 178,000 $ 1.00
-------------- ------------ ------------
--------------- -------------- ------------ -------------- ------------
2,534,400 8.75 $ 0.12 415,700 $ 0.56
=============== ============== === ============ ============== === ============
Warrants
On May 29, 2009, the Company entered into an agreement with Montgomery
2006-1 Partnership ("Montgomery"), pursuant to which Montgomery agreed to
terminate and cancel the warrant issued by the Company to Montgomery on
December 7, 2005, which entitled Montgomery to purchase up to 485,213
shares of common stock of the Company. In consideration for the
termination and cancellation of the warrant, the Company paid to
Montgomery a total amount of $2,500.
On June 29, 2009, the Company entered into an agreement with Midsummer
Investment, Ltd. ("Midsummer") and Islandia, L.P. ("Islandia"),
pursuant to which, the Company agreed to issue 3,899,030 shares of
common stock of the Company to Midsummer and 2,166,128 shares of common
stock of the Company to Islandia in exchange for the termination and
cancellation of the warrants issued by the Company to each of Midsummer
and Islandia on December 7, 2005. The agreement also provided for the
termination of all existing agreements among the Company, Midsummer and
Islandia. This transaction resulted in a charge of approximately
$109,000 to general and administrative expenses. The amount was
calculated by multiplying the number of shares issued by the closing
price of the Company's common stock on June 29, 2009.
The following table summarizes the warrants outstanding at June 30, 2009:
Number of
Expiration Shares of
Issue Date Date Common Stock Price Basis for Warrant Issuance
---------- ---------- ------------ ----- --------------------------
03/09/05 03/08/10 200,000 $2.40 Media consulting services
05/09/05 05/08/10 75,000 $2.40 Media consulting services
08/09/05 08/08/10 75,000 $2.40 Media consulting services
------------
350,000 Outstanding at June 30, 2009
============
F-11
Item 2. Management's Discussion and Analysis or Plan of Operation.
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, 2008 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-K
filed with the Securities and Exchange Commission.
--------------------------------------------------------------------------------
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, analytical instrumentation/quality control, and environmental
monitoring and detection 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
continuing to expand our 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. 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 shipment 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.
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 June 30, 2009 no assets were impaired.
2
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.
Results of Operations
The following table sets forth, as a percentage of revenues, certain items
included in the company's Income Statements (see Financial Statements and Notes)
for the periods indicated:
Six Months
Ended June 30
---------------
Statement of Operations Data: 2009 2008
---------------------------------------- ------ ------
Revenues............................ 100% 100%
Cost of Sales....................... 56% 61%
Gross Profit........................ 44% 39%
Operating Expenses.................. 206% 196%
(Loss) From Operations.............. (162%) (157%)
Other Income (Expense).............. (20%) 105%
Net (Loss).......................... (182%) (52%)
Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008
Revenues are derived from product sales and product support services. For the
six months ending June 30, 2009, revenues were $583,500 which was $176,200 less
than for the same period in 2008. Current global economic conditions have caused
the durable equipment market to be very sluggish and, as such, have
significantly impacted revenues performance. Shipments for the quarter were 40%
below that in 2008, despite an averaged 24% across-the-board price reduction on
all of our instruments instituted at the beginning of the year. The decrease in
shipments has also impacted product support revenues which for the six months
ending June 30, 2009 were 61% less than for the same period in 2008. Also
impacting revenues was the company's license agreement with a customer which
ended in October 2008 and was not renewed. The license agreement provided
$12,500 in quarterly royalty income for the company.
The company anticipates the stresses of current global economic conditions on
the commercial durable equipment market to continue. These conditions have
caused many of our customers to postpone their purchases of capital equipment.
Until global economic conditions improve, we expect the commercial durable
equipment market to remain depressed.
During the first quarter, we introduced our latest product, the Model 4500, to
select customers in the homeland security market. The introduction has been
hampered by the swine flu health epidemic which affected and commanded the
attention of several of our customers. As a consequence, these affected
customers were forced to redirect their homeland security efforts from
traditional security concerns to managing the swine flu situation. Until the
swine flu situation is under control, it will remain a priority for our affected
homeland security customers. For the upcoming quarter, we will continue our
strategy for a global rollout of the Model 4500. It should be noted, however,
that the homeland security market is characterized by its long sales cycle where
the time between product introduction to product sale may be considerable. For
this reason as well as the continuing impact of the swine flu
3
health epidemic, we are anticipating only modest sales performance for the
Model 4500 for the remainder of the year.
Cost of Sales consist of product costs and expenses associated with product
support services. For the three and six month periods ending June 30, 2009, cost
of sales were $159,500 and $328,800, compared to $232,500 and $460,600 in 2008.
For the same periods, cost of sales, as a percentage of revenues, were 54% and
56%, respectively, versus 64% and 61%, in 2008. The improvement in cost of sales
is due primarily to favorable price economics on purchased materials. These cost
savings were offset by production variances resulting from under-absorption of
overhead expenses.
Gross profit was $254,700 or 44% of sales for the six months ending June 30,
2009, compared to $299,000 or 39% of sales for the same period in 2008. Gross
margins was aided by cost improvements, primarily on price economics achieved on
purchased materials, on our products which offset an averaged 24%
across-the-board price reduction on our entire instrument product line
instituted at the beginning of the year.
Research and Development costs for the six months ending June 30, 2009 were
$198,100 versus $348,900 for the same period in 2008. The improvement of
$150,800 or 43% over 2008 is attributed to lower personnel expenses due to
reduction of census ($146,700), lower operating expenses ($27,500), offset by
increases in the use of outside services ($9,300) and higher facilities expenses
($14,100).
Selling, General and Administrative expenses for the six months ending June 30,
2009 were $1,005,400, compared to $1,140,700 for the same period in 2008. The
$135,300 improvement in spending resulted from a decrease in personnel expenses
due to a reduction in census ($173,400), reduction in operating expenses
($125,800), offset by increases in the use of outside services ($56,100), and
facilities expenses ($107,800).
Interest expense for the six months ending June 30, 2009 was $118,500, as
compared to $786,500 for the same period in 2008. Interest expense for the first
six months of 2009 pertains to the interest accrued on the $2.0 million 9%
convertible debenture issued on March 28, 2008, and to the interest accrued on
the $1.0 million 9% debenture payable issued on April 10, 2009. Interest expense
for the same period in 2008 consisted of: (1) interest accrued on the $7.0
million 8% convertible debentures which was retired on March 28, 2008; (2)
amortization of the debt discount on the same 8% convertible debentures, and (3)
interest accrued on the $2.0 million 9% convertible debenture issued on March
28, 2008.
Other income-derivatives. There was no income from derivatives in 2009. Such
income from derivatives in 2008 resulted primarily from the decrease in the fair
value of derivative liabilities between the measurement dates which are the
balance sheet dates. On March 31, 2008, we satisfied our obligations under the
8% convertible debentures and as a result, the company asserted that it has a
sufficient amount of authorized and unissued shares to settle its obligations
which can be settled in shares. Accordingly, the company reclassified all
contracts, warrants, and other convertible instruments outstanding at March 31,
2008 from liability to equity.
Gain on extinguishment of debt. In 2008, a gain was realized from the early
retirement of the 8% convertible debentures on March 31, 2008. There were no
debt retirements in the first six months of 2009.
Liquidity and Capital Resources
For the six months ending June 30, net cash used by the company for operating
activities were $760,100 and $900,100 for 2009 and 2008 respectively. Cash used
for the six months ending June 30, 2009 was comprised of the net loss for the
period of $1,068,400, plus net non-cash items (including depreciation and
amortization expenses of $21,100, increase in allowance for doubtful accounts of
$4,200, stock based compensation of $11,100, issuance of common shares for
services of $109,200 and amortization of debt discount of $5,700) of $151,300,
and plus the net change in operating assets and liabilities of $157,000. Cash
used in operations during the same six months of 2008 was comprised of the net
loss for the period of $392,000, less net non-cash expenses (including
depreciation and amortization expenses of $24,200, stock based compensation of
$21,900, issuance of common shares for payment of interest of $280,000,
amortization of debt discount of $586,300, amortization of deferred financing
costs of $45,400, less decrease in fair value of derivative liability of
$323,200, and gain on early retirement of debt of $1,261,800) of $627,200, and
plus the net change in operating assets and liabilities of $119,100.
4
Investing activities used cash of $5,000 in the first six months of 2009 and
provided cash of $7,500 during the same period in 2008. For the period, cash of
$4,800 was provided from the sale of property and equipment, and $9,800 was used
to purchase capital equipment. In 2008, cash of $9,900 was provided from the
sales of property and equipment and $2,400 was used to purchase capital
equipment.
Financing activities for the first six months of 2009 provided cash of $990,300
which resulted from the issuance of a 9% debenture payable to an investor for
$1,000,000 and a decrease in capital lease obligation of $9,700. For the same
period in 2008, financing activities provided cash of $1,991,300 which included
$2,000,000 received from the issuance of 9% convertible debentures to an
investor, $3,500,000 from the issuance of equity to the same investor, less
$3,500,000 used to retire the 8% convertible debentures and a decrease in
capital lease obligation of $8,700.
On June 30, 2009 the company's cash (including cash equivalents) was $709,200,
compared to $1,347,300 on June 30, 2008. The company had working capital of
$91,300 and $1,840,300 on June 30, 2009 and 2008, respectively.
Seasonality and Quarterly Results
We have not experienced and 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 have not experienced and do not foresee
any material inflationary trends for our product sources.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
This Item is not applicable to smaller reporting companies.
Item 4T. Controls and Procedures.
The company's Chief Executive Officer and Chief Financial Officer, after
evaluating the effectiveness of the company's disclosure controls and procedures
(as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as
amended) as of the end of the period covered by this quarterly report on Form
10-Q, have concluded that, based on such evaluation, the company's disclosure
controls and procedures were effective to ensure that material information
relating to the company is recorded, processed, summarized, and reported in a
timely matter. In designing and evaluating the disclosure controls and
procedures, the company's management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and the
company's management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
There were no changes in the company's internal control over financial reporting
that occurred during the period covered by this quarterly report that have
materially affected, or are reasonably likely to materially affect, the
company's internal control over financial reporting.
5
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings.
We are not a party to any pending material legal proceedings and are not aware
of any threatened or contemplated proceeding by any governmental authority
against us.
Item 1A. Risk Factors.
This Item is not applicable to smaller reporting companies.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
We did not sell any unregistered equity securities or repurchase any of our
equity securities during the three months ended June 30, 2009.
On June 29, 2009, the company issued 3,899,030 shares of common stock to
Midsummer Investment, Ltd. and 2,166,128 shares of common stock to Islandia,
L.P. in exchange for the termination and cancellation of the warrants issued by
the company to each of Midsummer and Islandia on December 7, 2005. The issuances
of the shares of common stock to Midsummer and Islandia were unregistered. Such
issuances were made in reliance upon the exemption set forth in Section 3(a)(9)
of the Securities Act of 1933, as amended, on the basis that the exchange offer
constituted an exchange with the company's existing shareholders and no
commission or other remuneration was paid or given directly or indirectly to any
party for soliciting such exchange. Details regarding the issuances are included
in the Current Report on Form 8-K that we filed on July 2, 2009, which is
incorporated herein by reference.
Item 3. Defaults Upon Senior Securities.
During the three months ended June 30, 2009, there were no material defaults
upon senior securities.
Item 4. Submission of Matters to a Vote of Security Holders.
On April 30, 2009, the company received a written consent in lieu of an annual
meeting of shareholders from the holders of a majority of the outstanding shares
of common stock of the company entitled to vote as of such date and as of the
record date, in connection with the following actions:
(1) election of directors;
(2) approval of an amendment to the company's Articles of Incorporation to
increase the number of authorized shares of common stock of the company
from 200,000,000 shares to 250,000,000 shares;
(3) approval of an amendment to the company's Articles of Incorporation to
vest authority in the board of directors of the company to prescribe
the classes, series and the number of each class or series of preferred
stock and the voting powers, designations, preferences, limitations,
restrictions and relative rights granted to or imposed upon any wholly
unissued series of preferred stock; and
(4) approval of an amendment to the company's Articles of Incorporation to
clarify and restate that the purpose of the company is to engage in any
lawful act or activity for which corporations may be organized under
the General Corporation Law of the State of Nevada.
The following directors were elected pursuant to such written consent: Teong C.
Lim, William Wittmeyer, Maggie Tham, Thomas Dudley and Low Gay Teck. The holders
of 104,377,312 shares of our common stock (approximately 67% of our outstanding
common stock) executed the written consent.
6
Item 5. Other Information.
None.
Item 6. Exhibits.
Exhibit
No. Description
-------- ---------------------------------------------------------------------
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act.
31.2 Certification of Principal Financial and Accounting Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1 Certification of Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act.
32.2 Certification of Principal Financial and Accounting Officer Pursuant
to Section 906 of the Sarbanes-Oxley Act.
7
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ELECTRONIC SENSOR TECHNOLOGY, INC.
Dated: August 7, 2009 By: /s/ Teong Lim
---------------------------------
Name: Teong Lim
Title: President and Chief Executive
Officer
(Principal Executive Officer)
Dated: August 7, 2009 By: /s/ Philip Yee
---------------------------------
Name: Philip Yee
Title: Secretary, Treasurer and Chief
Financial Officer
(Principal Financial and
Accounting Officer)