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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 June 30, 2005
[ ] 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 June 30, 2005 to restate our unaudited consolidated financial
statements at June 30, 2005 and for the period ended June 30, 2005 in order to:
(i) 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), (ii) correct the classification of a certificate of deposit maintained
by us with East West Bank as unrestricted and properly classify such certificate
of deposit as a restricted asset, and (iii) properly account for the receipt of
a one-time licensing fee for which the amount received is classified as deferred
revenue and amortized to earned revenue over the five (5) year life of the
agreement (the effect of this restatement is described further in Note 7 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
three months ended June 30, 2005 are amended and restated herein:
Cover Page:
o Disclosure relating to the registration of our common stock under the
Securities Exchange Act has been removed and corrected to reflect that
we did not have any equity securities registered under the Exchange
Act as of June 30, 2005, nor were we subject to the filing
requirements of Section 13 or 15(d) of the Securities Exchange Act as
of such date.
Part I Financial Information:
o Item 1. Financial Statements--Consolidated Balance Sheet as of June
30, 2005 (unaudited), Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 2005 and June 30, 2004
(unaudited), Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2005 and June 30, 2004 (unaudited) and Notes to
Consolidated Financial Statements as of June 30, 2005 (unaudited);
o Item 2. Management Discussion and Analysis of Operations or Plan of
Operations (excluding Risk Factors); and
o Item 3. Controls and Procedures.
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 three months ended June 30, 2005 filed with the Securities
and Exchange Commission on August 12, 2005 and are not reproduced in this Form
10-QSB/A. This amended quarterly report on Form 10-QSB/A for the three months
ended June 30, 2005 does not reflect events occurring after the filing of the
quarterly report on Form 10-QSB filed with the Commission on August 12, 2005,
nor does it modify or update the disclosures contained in the quarterly report
on Form 10-QSB filed with the Commission on August 12, 2005, 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
JUNE 30, 2005
(Restated)
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,209,424
Certificate of deposit-restricted 906,599
Accounts receivable, net of allowance for doubtful accounts 128,707
Prepaid expenses 23,618
Inventories 493,150
--------------
TOTAL CURRENT ASSETS 2,761,498
PROPERTY AND EQUIPMENT, net of accumulated depreciation
of $ 901,317 93,093
SECURITY DEPOSITS 12,817
--------------
$ 2,867,408
==============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Line of credit borrowings $ 1,769,137
Accounts payable and accrued expenses 259,644
Derivative liabilities 1,753,400
Deferred revenues 166,667
Other current liabilities 33,039
--------------
TOTAL CURRENT LIABILITIES 3,981,887
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 53,969
Additional paid-in capital 8,422,109
Accumulated deficit (9,590,557)
--------------
TOTAL STOCKHOLDERS' DEFICIT (1,114,479)
--------------
$ 2,867,408
==============
See unaudited notes consolidated to financial statements
2
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Six Months Ended Three Months Ended
June 30, June 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(Restated) (Restated) (Restated) (Restated)
REVENUES $ 651,652 $ 565,943 $ 432,141 $ 239,860
COST OF SALES 706,046 489,117 415,912 244,777
------------ ------------ ------------ ------------
GROSS PROFIT (54,394) 76,826 16,229 (4,917)
OPERATING EXPENSES:
Compensation 175,798 124,327 116,705 18,822
Selling 117,514 19,906 78,304 50,503
General and administration 810,125 168,373 340,478 85,023
------------ ------------ ------------ ------------
TOTAL OPERATING EXPENSES 1,103,437 312,606 535,487 154,348
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (1,157,831) (235,780) (519,258) (159,265)
OTHER INCOME AND EXPENSE:
Other income (expense) 83 (70,156) 322 (45,323)
Other income - derivatives 4,263,950 - 4,144,400 -
Other expense - derivatives (2,205,642) - - -
Gain (loss) on sale of property and equipment 9,287 (7,711) (3,970) -
Interest expense (34,271) (37,599) (13,705) (21,229)
------------ ------------ ------------ ------------
TOTAL OTHER INCOME AND EXPENSE 2,033,407 (115,466) 4,127,047 (66,552)
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ 875,576 $ (351,246) $ 3,607,789 $ (225,817)
============ ============ ============ ============
Earnings (loss) per share, basic $ 0.02 $ (0.01) $ 0.07 $ 0.00
============ ============ ============ ============
Weighted average number of shares, basic 53,304,475 49,983,643 53,968,643 49,983,643
============ ============ ============ ============
Earnings (loss) per share, diluted $ (0.02) $ (0.01) $ (0.01) $ 0.00
============ ============ ============ ============
Weighted average number of shares, diluted 56,865,166 49,983,643 57,986,853 49,983,643
============ ============ ============ ============
See unaudited notes to consolidated financial statements
3
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
--------------------------
2005 2004
----------- -----------
(Restated) (Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 875,576 $ (351,246)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 5,605 2,641
Fair value of derivatives at date of issuance 2,205,642 -
Decrease in fair value of derivative liability (4,263,950) -
Donated services - 6,000
Changes in assets and liabilities:
Accounts receivable (98,020) 343,546
Inventories (12,502) (23,713)
Prepaid expenses (9,361) (2,277)
Security deposits 140 (2)
Accounts payable and accrued expenses 46,841 (45,333)
Deferred revenues (25,000) 216,667
Due to related party (60,000) (48,500)
Interest payable (26,961) (4,450)
Other current liabilities (2,626) (3,064)
----------- -----------
Net cash provided by (used in) operating activities (1,364,616) 90,269
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 30,280 9,973
Investment in restricted security deposit (906,599) -
Purchase of property and equipment (77,780) -
----------- -----------
Net cash provided by (used in) investing activities (954,099) 9,973
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in line of credit (200,000) (15,000)
Repayment of partners' loans payable (110,000) (230,000)
Proceeds from issuance of common stock 3,811,708 68,500
----------- -----------
Net cash provided by financing activities 3,501,708 (176,500)
----------- -----------
NET INCREASE (DECREASE) IN CASH 1,182,994 (76,258)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 26,430 121,069
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,209,424 $ 44,811
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest
$ 40,870 $ 37,641
=========== ===========
NON-CASH FINANCING ACTIVITIES
Fair value of derivative liabilities issued in
connection with issuance of shares of common stock $ 1,753,400 $ -
=========== ===========
See unaudited notes to consolidated financial statements.
4
ELECTRONIC SENSOR TECHNOLOGY, INC.
Notes to Financial Statements
(Unaudited)
June 30, 2005
(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,
2004, included in the current report filed on Form 8-K with the Securities
and Exchange Commission on April 19, 2005.
In the opinion of the management of Electronic Sensor Technology, Inc.
(formerly Bluestone Ventures Inc.) (the "Company"), all adjustments
(consisting of normal recurring accruals) necessary to present fairly the
Company's financial position as of June 30, 2005, and the results of
operations and cash flows for the six month period ending June 30, 2005
have been included. The results of operations for the six month period
ended June 30, 2005 are not necessarily indicative of the results to be
expected for the full year. For further information, refer to the
consolidated financial statements and related footnotes thereto for the
year ended December 31, 2004, included in the current report filed on Form
8-K with the Securities and Exchange Commission on April 19, 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 June 30,
2005.
(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".
(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.
5
(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 June 30, 2005
no assets were impaired.
(j) DERIVATIVE LIABILITIES
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
6
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 5,576,871 and 0 at June
30, 2005 and 2004, respectively. The outstanding options, warrants and
shares equivalent issuable pursuant to embedded conversion features
and warrants at June 30, 2004 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 June 30:
2005 2004
(Restated) (Restated)
------------ ------------
Numerator:
Net income (loss) $ 875,576 $ (351,246)
Net other income/expense associated with
derivative contracts 2,058,308 -
------------ ------------
Net income (loss) for diluted earnings per share
purposes $ (1,182,732) $ (351,246)
============ ============
Denominator:
Denominator for basic earnings per share-
Weighted average shares outstanding 53,304,475 49,983,643
Effect of dilutive warrants, embedded
conversion features and liquidated damages - -
------------ ------------
Denominator for diluted earnings per share-
Weighted average shares outstanding 53,304,475 49,983,643
============ ============
Basic earnings (loss) per share $ 0.02 $ (0.01)
============ ============
Diluted earnings (loss) per share $ (0.02) $ (0.01)
============ ============
(4) MERGERS AND ACQUISITIONS
Bluestone Ventures, Inc. ("Bluestone") executed an Agreement and Plan of
Merger ("Merger Agreement") by and among Bluestone, Amerasia Technology,
Inc., ("Amerasia"), holder of approximately 55% of the partnership
interests of Electronic Sensor Technology, L.P., ("EST"), L & G Sensor
Technology, L.P., ("L&G"), holder of approximately 45% of the partnership
interests of EST, Amerasia Acquisition Corp., ("AAC") a wholly-owned
subsidiary of Bluestone, and L & G Acquisition Corp., ("LAC") a wholly
owned subsidiary of Bluestone on January 31, 2005. Under the Merger
Agreement (i) AAC merged with and into Amerasia such that Amerasia became a
wholly-owned subsidiary of Bluestone, (ii) LAC merged with and into L&G
such that L&G became a wholly-owned subsidiary of Bluestone, (iii) as a
result of the merger of (i) and (ii), Bluestone indirectly acquired all of
the partnership interests of EST and (iv) Bluestone issued 20,000,000
shares of its common stock to the shareholders of Amerasia and L&G. This
merger has been treated as a purchase only of the partnership interests of
Electronic Sensor Technology L.P.
For accounting purposes, the transaction will be treated as a
recapitalization of EST and accounted for as a reverse acquisition.
Bluestone also entered into various Subscription Agreements with certain
investors on January 31, 2005. Under these Subscription Agreements,
Bluestone issued 3,985,000 shares of its common stock ("shares") and
warrants to purchase 3,985,000 shares at $1.00 per share to certain
investors for gross proceeds of $3,985,000. Bluestone
7
received the gross proceeds of the sale of these shares on February 1,
2005. Bluestone received net proceeds of approximately $3,822,000. This
amount was net of legal fees, including counsel fees for the investors and
EST of approximately $163,000.
By virtue of the Mergers, all shares of common stock of Amerasia were
converted into the right to receive shares of common stock of Bluestone at
an exchange ratio of 4.6223537 shares of Bluestone common stock for each
share of Amerasia common stock and all shares of common stock L&G were
converted into the right to receive shares of common stock of Bluestone at
an exchange ratio of 90 shares of Bluestone common stock for each share of
L&G common stock. In addition, all 200,000 Class C limited partnership
units of Electronic Sensor Technology L.P. were automatically converted
into 200,000 shares of Bluestone common stock.
The purchase price for the Mergers was 20,000,000 shares of Bluestone
common stock. The closing of the mergers occurred on February 1, 2005 (the
"Closing Date").
In January 2005 the loans payable to three partners of Electronic Sensor
Technology L.P., totaling $1,198,630 were converted into 1,198,630 shares
of common stock of Bluestone.
In January 2005 the notes payable to related parties of $1,272,000 plus
accrued interest were converted into 1,585,111 shares of common stock of
Bluestone. Bluestone has changed its name to Electronic Sensor Technology,
Inc. as of February 2005.
The Company adopted a Stock Incentive Option Plan in April 2005. No options
have been granted through June 30, 2005.
(5) DERIVATIVE LIABILITIES
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
8
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 June 30, 2005 is as follows:
At issuance At June 30, 2005
-------------------- ---------------------
Freestanding warrants $6,017,350 $1,753,400
The Company used the following assumptions, using the Black Scholes Model
to measure the identified derivatives as follows:
Freestanding warrants
At issuance At June 30, 2005
-------------------- ---------------------
Market price: $2.40 $1.20
Exercise price: $1.00 $1.00
Term: 3 years 2.66 years
Volatility: 39% 39%
Risk-free interest rate: 2.78% 3.91%
Number of warrants: 3,985,000 3,985,000
(6) 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.
(7) 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, September
30, 2005, and March 31, 2006 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. 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, 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
9
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.
Furthermore, the Company failed to indicate that its certificate of deposit
was restricted as it is used as collateral to secure its line of credit.
The Company had accounted for its restricted certificate of deposit as part
of cash and cash equivalents in its statement of cash flows while it should
have accounted for its purchase of the certificate of deposit as an
investing activity.
Additionally, the Company did not properly account for a prior year
one-time advance from a customer related to a five (5) year licensing
agreement with this customer. The Company had accounted for the entire
amount as revenue at the time the funds were received. The funds, at the
time of its receipt, should have, instead, been accounted for as deferred
revenue and then amortized to earned revenue over the five (5) year life of
the agreement.
The proper accounting for such liquidated damages provision, the restricted
certificate of deposit, and the advancement of funds from a customer for
licensing rights affects the following figures in our quarterly financial
statements at and for the six-month period ended June 30, 2005:
Increase in certificate of deposit - restricted ($906,599) derivative
liabilities ($1,753,400), deferred revenues ($166,667), revenues ($25,000),
other income - derivatives ($4,263,950), other expense - derivatives
($2,205,642), net income ($2,083,308), earnings per share-basic ($.04), and
cash used in investing activities ($906,599) on the statement of cash
flows.
Decrease in additional paid-in capital ($3,811,707) and accumulated deficit
($1,891,640).
10
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, 2004 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
filed with the Securities and Exchange Commission on April 15, 2005 and the
consolidated financial statements and related footnotes thereto for the year
ended December 31, 2004, included in the current report filed on Form 8-K with
the Securities and Exchange Commission on April 19, 2005.
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 those discussed in "Factors That May Affect Future Operating
Results" and elsewhere in this report and in our Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2004 and our Current Report on Form 8-K
filed with the Securities and Exchange Commission on February 7, 2005. All
forward-looking statements are based on information currently available to EST
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
EST 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 and laboratory instrumentation markets. EST is involved in ongoing
product research and development efforts in that regard. EST has also
concentrated its efforts on further product development, testing and proving and
assembling a sales and support organization.
Electronic Sensor Technology, Inc. ("EST") was originally incorporated under the
name "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 Canada. Upon the acquisition of Electronic Sensor
Technology, LP ("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, on January 26, 2005, we changed our name to
"Electronic Sensor Technology, Inc."
EST's executive offices are located at 1077 Business Center Circle, Newbury
Park, California 91320. The company's telephone number is (805) 480-1994.
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:
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SIX MONTHS ENDED JUNE 30,
-------------------------------
2005 2004
(Restated) (Restated)
-------------- --------------
STATEMENTS OF OPERATIONS DATA:
Revenues................................ 100% 100%
Cost of sales........................... 108% 86%
Gross profit (loss) .................... (8%) 14%
Operating expenses...................... 169% 55%
(Loss) from operations.................. (177%) (41%)
Other income (expense).................. 312% (20%)
Net income (loss)....................... 135% (61%)
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
Revenues for the six months ended June 30, 2005 were $651,700 compared to
$565,900 in 2004. The 15% increase in revenues result from a 36% increase in the
number of zNose(R) units shipped in the first six months of 2005 over that in
2004.
Gross loss was $54,400 for the six months ending June 30, 2005, compared to a
gross profit of $76,800 for the six months period ending June 30, 2004. This
decrease of $131,200 resulted from increased manufacturing overhead due to
additional personnel.
Compensation expenses in the six months of 2005 were $175,800, as compared to
$124,300 in 2004. As a percentage of sales, total compensation expenses
increased from 22% of sales, to 27% of sales. The increase of $51,500 was due to
the increase of personnel costs.
Selling expenses in the first six months of 2005 were $117,500, as compared to
$19,900 in 2004. As a percentage of sales, total selling expenses increased from
4% of sales to 18% of sales. This increase of $97,600 was due to an increase of
personnel costs and expanded sales activities.
General and administrative expenses for the first six months of 2005 were
$810,100, as compared to $168,400 in 2004. As a percentage of sales, general and
administration expenses increased from 30% of sales to 124% of sales. This
increase of $641,800 was primarily due to costs incurred in connection with the
reverse merger and the added costs involved in a publicly traded company.
Interest expense for the first six months of 2005 was $34,300, as compared to
$37,600 in 2004. This slight decrease is due to small reductions of the average
balance under our line of credit over the six month period last year.
Net income for the six month period ended June 30, 2005 was $875,576 as compared
to a net loss of $351,246 for the six month period ended June 30, 2004. The
increase in net income was primarily due to a decrease in the fair value of
derivative liabilities, as described further below, and was offset by increased
operating expenses, including expenses related to our February 2005 merger,
increased sales activities, increased personnel costs and an expanded new
product development effort.
Other income-derivatives primarily consist of the decrease in the fair value of
derivative liabilities between the date of issuance of such derivatives and the
end of the second quarter of 2005. The increase in other income-derivative
during the first six months of 2005 when compared to the same period in 2004 is
primarily attributable to a decrease in the quoted price of our common stock. 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. No such derivatives were issued
during the first six months of 2004.
Other expense-derivatives primarily consist of the recognition of derivative
liabilities we issued during the six- month period ended June 30, 2005. No such
derivatives were issued during the first six months of 2004.
LIQUIDITY AND CAPITAL RESOURCES
In the first six months of 2005, net cash used by the Company for operating
activities was $1,364,600. In the first six months of 2004, the cash provided by
Company's operations was $90,300. Cash used in the first six months of 2005 was
comprised of the net income for the six month period of $875,600, less net
non-cash income (including depreciation and amortization of $5,600, the fair
value of issued derivatives of $2,205,600, less decrease in fair
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value of derivative liability of $4,264,000) of $2,052,800, less the net change
in operating assets and liabilities of $187,400. Cash provided in operations in
the first six months of 2004 was comprised of the net loss of $351,200, plus net
non-cash expenses of $8,600, plus the net change in operating assets and
liabilities of $432,900.
Investing activities used cash of $954,100 in the first six months of 2005 and
provided $10,000 during the same period in 2004. In 2005 the cash was used to
purchase a restricted certificate of deposit of $906,600 and equipment of
$77,800, offset by the proceeds from the sale of equipment of approximately
$30,300. 2004 investing activities provided $9,700 primarily from the sale of
property and equipment.
Financing activities provided cash of $3.5 million, primarily from the issuance
of common stock, and used cash of $176,000 during the first six months ending
June 30, 2005 and 2004, respectively.
On June 30, 2005 the Company retained cash on hand of $1.2 million, compared to
$33,000 on June 30, 2004. On June 30, 2005 the Company had working deficit of
$1.2 million, as compared to a working deficit of $5.6 million on June 30, 2004.
The Company, at present, has a credit facility in place with East West Bank for
$1.8 million.
Although EST possesses a bank operating line of credit, there can be no
assurance that these proceeds will be adequate for our capital needs. There can
be no assurance that any required or desired financing will be available through
any other bank borrowings, debt, or equity offerings, or otherwise, on
acceptable terms. If future financing requirements are satisfied through the
issuance of equity securities, investors may experience significant dilution in
the net book value per share of common stock 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.
INFLATION
Our raw materials and finished products are sourced from cost-competitive
industries. As such, we do not foresee any material inflationary trends for our
product sources.
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ITEM 3. CONTROLS AND PROCEDURES
Within 90 days prior to the date of this Form 10-QSB, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's President and Chief Executive Officer along
with the Company's Chief Financial Officer, of the effectiveness of the design
and operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15(b). Based upon that evaluation, the Company's President
and Chief Executive Officer along with the Company's Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective in
timely alerting them to material information relating to the Company required to
be included in this Form 10-QSB.
There have been no changes in the Company's internal controls or in other
factors, which could significantly affect the internal controls subsequent to
the date the Company carried out its evaluation.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS
A. 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.
14
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.
/s/ Teong C. Lim
Dated September 25, 2006 By: -----------------------------
Name: Teong C. Lim
Title: President and Chief Executive
Officer
(Principal Executive Officer)
/s/ Francis Chang
Dated September 25, 2006 By: -------------------------------
Name: Francis Chang
Title: Secretary, Treasurer and Vice
President of Finance and
Administration
(Principal Accounting Officer)
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