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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended DECEMBER 31, 2008
[ ] 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.
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(Exact name of registrant as specified in its charter)
NEVADA 98-0372780
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1077 BUSINESS CENTER CIRCLE,
NEWBURY PARK, CALIFORNIA 91320
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (805) 480-1994
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None. N/A
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.001
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(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act.
Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
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 [ ] Smaller reporting company [X]
(Do not check if smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant as of June 30, 2008 was $3,235,226.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. On April 8, 2009,
there were 155,853,385 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the
Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(c) of the Securities Act of 1933. The listed documents should be clearly
described for identification purposes (e.g., annual report to security holders
for fiscal year ended December 24, 1980). N/A
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Certain statements in this annual report on Form 10-K, 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. The company
does 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
Item 1. Business.
In this annual report, references to the "company," "we," "our," or "us"
refers to Electronic Sensor Technology, Inc., a Nevada corporation.
We are engaged in the development, manufacture, and sale of a patented
product we call zNose(R), a device designed to detect and analyze chemical odors
and vapors, or, in another words, an electronic "nose". We believe the zNose(R)
is superior to other electronic "noses" because of its speed, specificity and
sensitivity. The zNose(R) identifies the chemical makeup of any fragrance, vapor
or odor. The zNose(R) does this by creating a visual image of the fragrance,
vapor or odor that it detects, so that the user of the zNose(R) may easily
identify the fragrance, vapor or odor.
We believe that our products have broad applications in the homeland
security, analytical instrumentation/quality control, and environmental
monitoring and detection markets. We are involved in ongoing product research
and development efforts in that regard. We have also concentrated our efforts on
further product development, testing and proving, and continuing to expand our
sales and support organization.
Our executive offices are located at 1077 Business Center Circle, Newbury
Park, California 91320 and our telephone number is (805) 480-1994.
HISTORY AND BACKGROUND
Electronic Sensor Technology, Inc. was originally incorporated under the
laws of the state of Nevada as Bluestone Ventures Inc. on July 12, 2000. From
the date of its incorporation until February 1, 2005, Bluestone Ventures was in
the business of acquiring and exploring potential mineral properties in Ontario,
Canada. The company's name was changed to "Electronic Sensor Technology, Inc."
on January 26, 2005 in connection with the acquisition of two corporations that
had together owned Electronic Sensor Technology, L.P. Since the acquisition of
Electronic Sensor Technology, L.P., our business has been the development,
manufacture and sale of instruments that detect and analyze vapors and odors.
The company has abandoned its mining exploration business.
Overview of Past Operations of Electronic Sensor Technology, L.P.
Electronic Sensor Technology, L.P. was formed in 1995 to develop and
manufacture, the zNose(R), an advanced technology in chemical vapor detection
and analysis. In 1999, Electronic Sensor Technology, L.P. completed beta testing
of its products and commenced commercial sales to the analytical
instrumentation/quality control market as well as the homeland security market.
1
Electronic Sensor Technology, L.P. Acquisition
On February 1, 2005, pursuant to the terms of an Agreement and Plan of
Merger by and among Electronic Sensor Technology, Inc., Amerasia Technology,
Inc., holder of approximately 55% of the partnership interests of Electronic
Sensor Technology, L.P., L&G Sensor Technology, Inc., holder of approximately
45% of the partnership interests of Electronic Sensor Technology, L.P., Amerasia
Acquisition, a wholly-owned subsidiary of Electronic Sensor Technology, Inc.,
and L&G Acquisition, a wholly-owned subsidiary of Electronic Sensor Technology,
Inc., Electronic Sensor Technology, Inc., acquired 100% of the outstanding
equity partnership interest of Electronic Sensor Technology, L.P. Under the
Agreement and Plan of Merger:
(i) Amerasia Technology merged with and into Amerasia Acquisition such
that Amerasia Technology became a wholly-owned subsidiary of
Electronic Sensor Technology, Inc.;
(ii) L&G Sensor Technology merged with and into L&G Acquisition such that
L&G Sensor Technology became a wholly-owned subsidiary of Electronic
Sensor Technology, Inc.;
(iii) as a result of the mergers of (i) and (ii), Electronic Sensor
Technology, Inc. indirectly acquired the partnership interests of
Electronic Sensor Technology, L.P.; and
(iv) Electronic Sensor Technology, Inc. issued 20,000,000 shares of its
common stock to the shareholders of Amerasia Technology and L&G Sensor
Technology.
In November 2004, Electronic Sensor Technology, L.P. sold $200,000 in
limited partnership interests to certain bridge investors. Concurrent with the
mergers, these limited partnership interests were directly exchanged into
200,000 shares of common stock of Electronic Sensor Technology, Inc. and
warrants to purchase 200,000 shares of common stock of Electronic Sensor
Technology, Inc. at $1.00 per share.
In connection with the mergers, Electronic Sensor Technology, Inc. entered
into Subscription Agreements with certain investors on January 31, 2005. Under
these Subscription Agreements, Electronic Sensor Technology issued and sold in a
private placement 3,985,000 shares of its common stock and warrants to purchase
3,985,000 shares of common stock at $1.00 per share to certain investors for
gross proceeds of $3,985,000, which were received on February 1, 2005.
Electronic Sensor Technology received net proceeds of approximately $3,821,000
less fees, including counsel fees for the investors and Electronic Sensor
Technology, L.P. of approximately $164,000.
Immediately following the mergers and the private placement, on February 1,
2005 there were 53,968,471 shares of Electronic Sensor Technology common stock
outstanding, of which (i) shareholders of Bluestone Ventures prior to the
mergers and the private placement held 26,988,279 shares (approximately 50.0% of
our common stock), (ii) the shareholders of Amerasia Technology and L&G Sensor
Technology prior to the mergers and the private placement held 22,783,471 shares
(approximately 42.2% of our common stock) and (iii) investors in the private
placement occurring on February 1, 2005 and the bridge investors as a group held
4,185,000 shares (approximately 7.8% of our common stock). The total outstanding
interests of Electronic Sensor Technology, L.P. were exchanged for 20,000,000
shares of Electronic Sensor Technology, Inc. In addition, 2,783,279 shares of
Electronic Sensor Technology, Inc. were distributed to pre-merger shareholders
of Amerasia Technology and L&G Sensor Technology in exchange for the
cancellation of debt owed to such shareholders, at a conversion rate of $1.00
per share. The conversion rate of $1.00 per share was established immediately
preceding the merger through the private placement of 3,985,000 shares of common
stock at $1.00 per share and the conversion of a $200,000 equity advance to
Electronic Sensor Technology, L.P. for 200,000 shares of Electronic Sensor
Technology common stock. The transaction price of $1.00 per share was
established by arms length negotiation between the former management of
Bluestone Ventures and Electronic Sensor Technology, L.P. (now management of
Electronic Sensor Technology, Inc.) in December 2004. As a condition to the
merger transactions, Bluestone Ventures agreed to raise not less than $3,000,000
of new equity capital in a private placement offering. In determining to proceed
with the merger transactions, management of Electronic Sensor Technology, L.P.
(now management of Electronic Sensor Technology, Inc.) weighed the expected cash
balance of Bluestone Ventures after giving effect to the private placement
offering discussed above and the mergers against the overall equity ownership of
Electronic Sensor Technology, Inc. post-merger that would be held by the former
owners of Electronic Sensor Technology, L.P. (i.e., the former owners of
Electronic Sensor Technology, L.P. were willing to give up 57.8% of Electronic
Sensor Technology, L.P. for not less than $3,000,000 in cash). While management
of Electronic Sensor Technology, L.P. (now management of Electronic Sensor
Technology, Inc.) was not privy to the valuation methodology used by management
of Bluestone Ventures in establishing a transaction price of $1.00 per
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share, management of Electronic Sensor Technology, L.P. (now management of
Electronic Sensor Technology, Inc.) assumes that management of Bluestone
Ventures and its advisors used one or more traditional valuation methodologies.
Following the mergers we assumed as our principal operations the operations
of Electronic Sensor Technology, L.P. and the prior operations of Bluestone
Ventures were terminated.
INDUSTRY OVERVIEW
Although there are a vast number of applications for the zNose(R) product,
we believe that the most significant demands for our product will be in three
general market categories - homeland security, analytical
instrumentation/quality control and environmental monitoring and detection.
Homeland Security. According to published sources, the homeland security
market is a multi-billion dollar market and is projected to remain as such in
the foreseeable future. We believe that detection and analysis of chemical
compounds will aid greatly in various homeland security efforts including:
o Cargo Containers. Over 46.3 million cargo containers arrive in the
U.S. every year and only a fraction of them are being inspected by the
U.S. Customs Department. We believe cargo container security will
become a top priority with the U.S. government.
o Airports. Our zNose(R) products may be used to complement existing
x-ray and bomb detection technologies.
o Drug Interdiction. The zNose(R)has been used to detect contraband,
including illicit controlled substances along U.S. borders.
o Building Security. zNose(R) technology can be applied for continuous
and real-time chemical detection and to monitor the air in buildings
and in confined spaces. Detecting hazardous gases and poisonous
chemical agents such as sarin, VX explosives, and contrabands for
security and environmental safety purposes are the main concerns for
various government and commercial buildings, as well as military
facilities.
Analytical Instrumentation/Quality Control. The zNose(R) has been serving
the chemical vapor analysis needs in various manufacturing industries. We
estimate that the market for products such as zNose(R) will exceed $50 million
during the next few years. The zNose(R) has been used for a host of applications
relating to analysis and quality control such as:
o screening incoming raw materials;
o checking ingredients in processed food and pharmaceutical products;
o inspecting packaging materials and finished goods; and
o detecting hazardous gas leaks in chemical plants.
Environmental Monitoring and Detection. The zNose(R) has been serving rapid
on-location needs in detection and monitoring of toxic chemicals in the water
for environmental protection purposes. The zNose(R) was used by the China
Environmental Protection Agency (China EPA) to detect and monitor toxic flows in
a river caused by a chemical spill after a chemical plant explosion in
northeastern China. This industrial accident contaminated the major water
sources located near the plant. The zNose(R) is also used by the China
Environmental Protection Agency (EPA) to determine the safety of drinkable water
on a near real-time basis.
CONVENTIONAL ELECTRONIC NOSE TECHNOLOGY
Conventional electronic noses are unable to meet the needs of the market
because of their fundamental construction. They are not able to identify
fragrances, vapors and odors with an acceptable degree of specificity and
preciseness. In addition, conventional electronic noses require sophisticated
computer software in order for its chemical analyses to be recognized. This type
of electronic nose is therefore not acceptable for use in scientific
measurement.
3
THE ZNOSE(R) SOLUTION
Speed, precision and versatility are the key characteristics of the
zNose(R) product. The zNose(R) has been developed to replace the conventional
electronic nose. The zNose(R) operates as quickly as a conventional electronic
nose while delivering the precision and accuracy of a much more expensive
instrument. The zNose(R) has advanced chemical analysis technology by performing
vapor analysis within 10 seconds. Early models of the zNose(R) have been tested
by the U.S. Environmental Protection Agency under Environmental Technology
Verification program and by the Office of National Drug Control Policy for drug
interdiction. Tests have also been performed at the Midwest Research Institute's
Surety Laboratory in Kansas City and at the U.S. Army Dugway Proving Ground in
Utah with respect to the effectiveness of the zNose(R) in detecting chemical
agents such as sarin gases.
Our VaporPrint(R) imaging ability is another major advantage of the
zNose(R) product. VaporPrint(R) allows the user of the zNose(R) to see a visual
image of the makeup of a particular fragrance, vapor or odor within 10 seconds.
In addition, VaporPrint(R) can produce high-resolution visual images of odor
intensity. VaporPrint(R) images are displayed on a laptop computer screen and
are recorded on the hard drive of the laptop computer.
OUR PRODUCTS
zNose(R)
The zNose(R) is essentially a vapor detector that uses a sensor based on
Surface Acoustic Wave technology. Basically, the zNose(R) "inhales" a particular
fragrance, vapor or odor. The fragrance, vapor or odor is carried up through a
column and the chemicals making up the fragrance, vapor or odor condense on the
crystal surface of the sensor in the zNose(R). This condensation on the sensor
causes a change in what is called the "fundamental acoustic frequency" of the
crystal surface. It is this change in fundamental acoustic frequency that allows
the zNose(R) to determine the chemical makeup of the fragrance, vapor or odor.
This change is measured by a microprocessor that calculates the change in
frequency which is related to the amount of fragrance, vapor or odor sampled by
the zNose(R). The microprocessor also measures the arrival time (called the
retention time) of the change in the fundamental frequency. Different chemicals
arrive at different times and so, once the microprocessor has determined the
retention time of the unidentified fragrance, vapor or odor, it compares it to
retention times that are stored in a computer library. This allows the zNose(R)
to identify the particular fragrance, vapor or odor.
The zNose(R) analyzes and identifies vapor specimens in a two-step process.
In the first step, typically lasting 10 seconds, the instrument collects a small
sample of the vapor to be analyzed. The sample is then injected in to the gas
chromatography column where the individual chemicals present are separated and
measured. The chemical analysis requires as little as 10 seconds to produce the
vapor's chemical signature, or chromatogram. The vapor's chemical signature can
also be visually displayed in a graphic form called a "VaporPrint". This
chemical signature is then compared against the reference database of chemical
odor profiles. If the chemical compound of the specimen is not in the reference
database, it will not be identified by name; however, the makeup of the
unidentified specimen can be stored in the reference database for future
identification. The reference database of chemical odor profiles that is stored
on the hard drive of the laptop computer is composed of standards of various
chemicals that are available through the National Institute of Standards and
Technology (NIST). The database can be updated when standards of new chemicals
are encountered and input by way of simple software selection, or by way of
sampling unknown chemical compounds and storing the measurements of such
chemical compounds in the database. If the zNose(R) samples a non-specimen
vapor, such as clear ambient air, no signal is generated on the laptop computer
screen and no VaporPrint(R) is created. If the zNose(R) samples a complex
mixture of chemical compounds, each compound and the concentration of such
compound is measured independently of the other compounds contained in the
mixture. Due to the independent measurement of each compound in a complex
mixture, each measurement is free from the influence of the other compounds, and
the accuracy of the zNose(R) is therefore not affected by complex mixtures.
We currently manufacture and sell four zNose(R) models designated as Model
4200 (Handheld Unit), Model 4300 (Portable Unit), Model 7100 (Bench Top Unit),
and Model 8100 (Fixed Installation Unit). Model 4200 is designed for portability
and for applications requiring quick and accurate vapor screening in the field.
Model 4300 is also designed for portability and can operate outdoors with the
same capabilities of Model 4200 without the need for an external power source.
Model 7100 is designed for laboratory testing and is ideal for testing water and
product quality control samples. Model 8100 is designed for indoor ambient air
monitoring and can be used for building security monitoring applications. Both
Model 4200 and Model 7100 weigh approximately 27 pounds, not including a laptop
computer that must be used with each zNose(R). Model 4300 weighs approximately
24 pounds, not including the laptop computer, but also includes a battery
charger that weighs approximately 8
4
pounds. The Model 4200 has two housings (the case and the detector head) and a
laptop computer. The case of the Model 4200 is 10" x 12" x 6" and weighs 20
pounds and the detector head of the Model 4200 is 4.25" x 12" x 7" and weighs 7
pounds. The components and dimensions of the Model 4300 are similar to the Model
4200, but the battery charger of the Model 4300 is 5.5" x 13.5" x 5.5. The Model
7100 is packaged in a single housing and also requires a laptop computer. The
dimensions of the Model 7100 packaging are 14.3" x 14.3" x 7.5". The Model 8100
is designed as a fixed installation unit for indoor ambient air monitoring and
is designed to be operated remotely from a central control station via a
Bluetooth control link. The dimensions of the Model 8100 unit are 15" x 37" x
36". The Models 4200, 7100, and 8100 are powered by a standard AC electrical
outlet, and all models adapt to standard outlets in North America, Asia and
Europe (i.e., the zNose(R) may be operated by a 110 volt or 220 volt power
source). All four models can be produced in one of two basic vapor sensing
configurations: volatile and semi-volatile. The volatile configuration can
detect volatile organic compounds, such as benzene. The semi-volatile
configuration can detect heavier vapors such as those found in explosives and
drugs.
During 2008, we developed the Model 4500. The Model 4500 is a two-piece
portable unit that is similar in configuration to the Model 4300 except for the
laptop computer that is required by the Model 4300 has been replaced by an
embedded processor in the Model 4500.
Accessories
We offer several lines of accessory products such as calibration devices,
sample desorbers, MicroSense Software(C), and GPS receivers. An example is our
Model 3100 which provides a calibrated vapor source as well as a tool for
extracting vapors from solid and liquid samples.
SALES AND DISTRIBUTION
We sell our zNose(R) product through distribution channels including
equipment distributors and sales representatives both in the U.S. and in over 20
foreign countries, e-commerce, customer referrals, and GSA contracted suppliers.
We entered into an agreement with eScreen Sensor Solutions to be a distributor
in Israel, the Caribbean, the State of Florida, and Central and South America on
October 16, 2003. As part of the agreement, eScreen paid us an up-front fee of
$250,000 in 2004. We entered into an agreement with TechMondial, Ltd. to be a
distributor in the countries of the European Community, Romania, Bulgaria,
Turkey, Croatia and Switzerland on October 21, 2005. In 2005, we selected
Beijing R&D Technology Co., Ltd. to be our exclusive distributor in China. We
entered into an agreement with Macrochem JSC to be a distributor in the
countries of Germany, Russia, and Ukraine on March 27, 2006. We entered into an
agreement with Analytical Solutions and Product B.V. to be a distributor in the
Benelux countries on January 15, 2007. Also, on December 3, 2007, we entered
into an agreement with Breckbuhler, AG to be a distributor in the countries of
Switzerland, France, Austria, and Italy.
All sales representatives and distributors are required to attend a
three-day training course conducted at our headquarters in Newbury Park,
California. We advertise in selected industry trade journals and trade
conventions. We are continuing to work on building a dedicated marketing and
sales team. We historically generated sales from both domestic and international
customers, with international customers accounting for approximately 66% and 62%
of our sales for the fiscal years ending December 31, 2007 and December 31,
2008, respectively. We expect future sales to domestic and international
customers to be more balanced. All of our customers pay us in U.S. dollars.
Major domestic customers include Security Pro USA, Proctor & Gamble, Rubbermaid
Home Products, and S.C. Johnson. Major international customers include Beijing
R&D Technology Company Ltd. in China, Petroleum Services Co. in Kuwait, Dynex
Technologies in the Czech Republic and Brechbuhler, AG in Switzerland.
COMPETITION
We are unaware of any direct competitor to the zNose(R) product on the
market today. In the homeland security markets, we face competition from
manufacturers of x-ray machines, ion-mobility spectrometers and chemical coated
sensors. X-ray machines have been widely used for security purposes in detecting
metal objects but not for chemical compounds. Ion-mobility spectrometer
equipment is a vapor detector and is designed to detect certain compounds but is
blind to other compounds. Hence, it can only see a small dot in a space but
cannot see the total picture. It employs a different sample collection technique
by wiping the surfaces of the object placed for screening. The ion-mobility
spectrometer also uses materials in its construction which may be offensive to
users in certain countries.
5
Chemical coated sensors are the conventional electronic noses. They use an
array of chemical sensors each reacting to certain specific compounds. As
mentioned earlier, electronic noses cannot be calibrated with chemical standards
and therefore cannot be used effectively for scientific measurement.
We have another set of competitors manufacturing portable vapor and odor
analysis products for the instrumentation market from major corporations such as
Agilent Technologies, Inc. (NYSE: A), Perkin-Elmer, Inc. (NYSE: PKI) and Varian,
Inc. (NASDAQ: VARI). We believe that our zNose(R)product is competitive with
these companies' products based on speed and cost.
Many of our current and potential competitors, including the aforementioned
competitors, have larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do and
may enter into strategic or commercial relationships with larger, more
established companies. Some of our competitors may be able to secure alliances
with customers and affiliates on more favorable terms, devote greater resources
to marketing, advertising and promotional campaigns and devote substantially
more resources to research and development than we do. In addition, new
technologies and the expansion of existing technologies may increase the
competitive pressures on us.
We cannot assure you that we will be able to compete successfully against
current or future competitors, and competitive pressures faced by us could harm
our business, operating results and financial condition. We do not currently
represent a significant competitive presence in the homeland security or
analytic instrumentation markets.
MANUFACTURING AND RAW MATERIALS
We design, prototype and manufacture our products at our headquarters. Our
manufacturing facilities adhere to ISO9001 manufacturing methods (quality
standards developed by the International Organization for Standardization, which
have been adopted by many countries around the world). We contract out the
manufacturing and assembling of certain components to subcontractors. Our
current annual manufacturing capacity is approximately 300 zNose(R) units. The
principal components to our products are computer chips, circuit boards,
transformers and sensory devices. The prices for these components are subject to
market forces largely beyond our control, including energy costs, market demand,
and freight costs. The prices for these components have varied significantly in
the past and may vary significantly in the future. Our principal suppliers of
components and raw materials include: Sigma Aldrich Co. of Bellefonte,
Pennsylvania, American Precision of Chatsworth, California, Machine Works LLC of
Santa Paula California, Clayton Controls of Costa Mesa, California, and Syncor
Industries, Inc. of Ventura, California.
CUSTOMERS
In 2008, we had approximately 61 customers. Our largest customer in 2008,
Beijing R&D Technology Company Ltd. (which is our exclusive distributor in
China), purchased 22 of the total 56 zNose(R) units sold by us in 2008,
constituting approximately 39% of the zNose(R) units sold in 2008. Our largest
customers are (1) Beijing R&D Technology Company Ltd. of China, (2) Petroleum
Services Co. and (3) Security Pro USA.
PATENTS, TRADEMARKS AND OTHER PROPRIETARY RIGHTS
We regard our patents, trademarks, trade names and similar intellectual
property as critical to our success. We rely on patent and trademark laws, trade
secret protection and confidentiality agreements with employees, distributors,
customers, partners and others to protect our proprietary rights.
We own four United States patents covering our zNose(R) product, including:
o No. 5,289,715, "Vapor Detection Apparatus and Method Using an Acoustic
Interferometer" issued March 1, 1994;
o No. 5,970,803, "Method and Apparatus for Identifying and Analyzing
Vapor Elements", issued October 26, 1999;
o No. 6,212,938, "Method of Detecting Smell of a Vapor and Producing a
Unique Visual Representation thereof," issued April 10, 2001;
o No. 6,354,160, "Method and Apparatus for Identifying and Analyzing
Vapor Elements," issued December 3, 2002.
6
We may not be able to obtain patent protection for any derivative uses of
zNose(R), or for any other products we may later acquire or develop. We also
cannot assure you that we will be able to obtain other foreign patents to
protect our products.
We have copyrighted our MicroSense Windows software and Xilinx gate array
firmware, which controls the operation of the zNose(R) and produces visual
images. These images, trademarked as VaporPrint(R) images, make it possible to
display vapor analysis data from any vapor analysis system, as unique visual
images and facilitate pattern recognition of complex odors and fragrances.
We currently hold registered trademarks for zNose(R) and VaporPrint(R). We
intend to evaluate the possible application for new patents and trademarks as
needed to cover current and future applications of our technology and product
developments. We intend to undertake all steps necessary to preserve and protect
our patents, trademarks and intellectual property generally.
We are not aware that our products, trademarks or other proprietary rights
infringe the rights of third parties, nor are we aware of any infringements of
our proprietary rights. We continually evaluate potential infringements of our
proprietary rights and intend to take such legal and other actions as may be
necessary to protect those rights. However, there can be no assurance that third
parties will not assert infringement claims against us in the future with
respect to current or future products or that any such assertion may not require
us to enter into royalty arrangements or result in costly litigation.
GOVERNMENT REGULATION
Government agencies, in particular, the Department of Defense, are
principal customers for our products. As a result, we are required to comply
with the Federal Acquisition Regulations, a comprehensive set of regulations
governing how vendors do business with the U.S. federal government, to the
extent we contract with departments or agencies of the U.S. government, as well
as similar regulations to the extent we contract with state or local
governments. Sales to or grants from foreign governments or organizations
generally have their own regulatory framework, which may or may not be similar
to present U.S. standards or requirements.
RESEARCH AND DEVELOPMENT
Our research and development program consists of developing technologies
related to enhancing our electronic nose product and making it more portable.
Fees related to research and development include consulting fees, technical
fees, and research, development and testing of our zNose(R) product. We spent
approximately $745,000 in 2007 and $658,000 in 2008 on research and development
activities, none of which was borne directly by customers.
EMPLOYEES
As of December 31, 2008 we had a total of 15 full-time employees and 3
consultants. In addition to management, we employ sales people, administrative
staff, and development and technical personnel. From time to time, we may employ
independent consultants or contractors to support our research and development,
marketing, sales and support, and administrative organizations. No collective
bargaining units represent our employees and Electronic Sensor Technology is not
party to any labor contracts.
7
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 2008.
The figures in the table are derived from our audited financial statements and
should be read in conjunction with our consolidated financial statements and
related notes included elsewhere in this annual report. All information below
excludes any securities issued subsequent to December 31, 2008.
December 31, 2008
Long-term debt .......................................... $ 1,951,017
Stockholders' deficit:
Common stock; $0.001 par value; 200,000,000 Shares
authorized; 155,853,385 shares issued and outstanding. $ 155,854
Additional paid-in capital ............................ $ 15,207,301
Accumulated deficit ................................... $ (16,175,273)
---------------
Total Stockholders' deficit ............................. $ (812,118)
---------------
Total capitalization .................................... $ 1,138,899
===============
Item 1A. Risk Factors.
This item is not applicable to smaller reporting companies.
Item 1B. Unresolved Staff Comments.
This item is not applicable to smaller reporting companies.
Item 2. Properties.
We lease approximately 12,700 square feet of office space and production
facilities at 1077 Business Center Circle, Newbury Park, California. Our current
lease expires on September 30, 2010. The lease payments are currently $12,127
per month, and increase by 3% per annum on October 1, 2009. The facility serves
as our headquarters and research and development and manufacturing facility.
This property is in good condition and is suitable and adequate for our uses. We
do not believe this property is subject to any material competitive conditions.
Our management is of the opinion that this property is adequately covered by
insurance.
INVESTMENT POLICIES
We do not invest, nor do we plan to invest in the foreseeable future in
real estate, interests in real estate, real estate mortgages or securities of or
interests in persons primarily engaged in real estate activities. This policy
may be changed without a vote of security holders.
Item 3. Legal Proceedings.
We are not a party to any pending legal proceeding, other than routine
litigation that is incidental to our business, and are not aware of any
proceeding contemplated by a governmental authority against us.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2008.
8
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
MARKET FOR COMMON EQUITY
Our common stock has been quoted on the Over-the-Counter Bulletin Board
since February 1, 2005 under the symbol "ESNR.OB". Prior to February 1, 2005
Bluestone Ventures's common stock was quoted on the Over-the-Counter Bulletin
Board under the symbol "BLUV.OB". There is currently no broadly followed,
established public trading market for our common stock. The quarterly range of
high and low Over-the-Counter Bulletin Board quotation information for our
common stock for the last two fiscal years is set forth below. These quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission,
and may not represent actual transactions.
QUARTERLY COMMON STOCK PRICE RANGES
2008
--------------
QUARTER ENDED HIGH LOW
------------------- ----- ------
December 31 $ .05 $ .003
September 30 .05 .02
June 30 .06 .02
March 31 .09 .04
2007
--------------
QUARTER ENDED HIGH LOW
------------------- ----- ------
December 31 $ .19 $ .04
September 30 .22 .06
June 30 .26 .18
March 31 .29 .13
Source: AOL Money & Finance.
There were 46 record holders of our common stock as of April 8, 2009. This
number does not include an indeterminate number of shareholders whose shares are
held by brokers in street name.
We have not paid dividends on our common stock since our inception. The
decision to pay dividends on common stock is within the discretion of our Board
of Directors. It is our current policy to retain any future earnings to finance
the operations and growth of our business. Accordingly, we do not anticipate
paying any dividends on common stock in the foreseeable future.
9
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table illustrates, as of December 31, 2008, information
relating to all of our equity compensation plans:
EQUITY COMPENSATION PLAN INFORMATION
Number of securities
Number of securities to be Weighted average remaining available
issued upon exercise of exercise price of for future issuance
outstanding options, outstanding options, under the equity
Plan Category warrants and rights warrants and rights compensation plan
----------------------------- -------------------------- -------------------- --------------------
Equity compensation plans
approved by security holders 0 N/A 0
Equity compensation plans not
approved by security holders 3,146,900 $.19 1,853,100 (1)
Total 3,146,900 $.19 1,853,100
(1) This amount represents the remainder of the 5,000,000 shares of our common
stock authorized for issuance under the Electronic Sensor Technology, Inc. 2005
Stock Incentive Plan, less 3,146,900, the number of shares of common stock
underlying outstanding options granted pursuant to the Stock Incentive Plan as
of December 31, 2008.
ELECTRONIC SENSOR TECHNOLOGY, INC. 2005 STOCK INCENTIVE PLAN
A description of the Electronic Sensor Technology, Inc. 2005 Stock
Incentive Plan is set forth in Note 5 to the company's consolidated financial
statements under the heading "Options" included in this annual report and is
incorporated herein by reference.
RECENT SALES OF UNREGISTERED SECURITIES
All recent sales of unregistered equity securities during the period
covered by this annual report have previously been included on our current
report on Form 8-K filed January 16, 2008, our current report on Form 8-K filed
April 3, 2008, our amended current report on Form 8-K/A filed January 2, 2009
and our amended current report on Form 8-K/A filed January 5, 2009.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER
We did not repurchase any of our equity securities during the three months
ended December 31, 2008.
Item 6. Selected Financial Data.
This item is not applicable to smaller reporting companies.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
You should read the following discussion and analysis of our financial
condition and results of operations together with the financial statements and
the related notes appearing in this annual report.
CRITICAL ACCOUNTING POLICIES
Electronic Sensor Technology records revenue from direct sales of products
to end-users when the products are shipped, collection of the purchase price is
probable and Electronic Sensor Technology has no significant further obligations
to the customer. Costs of remaining insignificant obligations of Electronic
Sensor Technology, if any, are accrued as costs of revenue at
10
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.
Electronic Sensor Technology reviews long-lived assets, such as property
and equipment, to be held and used or disposed of, for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. If the sum of the expected cash flows, undiscounted and
without interest, is less than the carrying amount of the asset, an impairment
loss is recognized as the amount by which the carrying amount of the asset
exceeds its fair value. At December 31, 2008 no assets were impaired.
The company accounts for its liquidated damages pursuant to FASB Staff
Position No. EITF 00-19-2 "Accounting for Registration Payment Arrangements"
("FSP 00-19-2"). FSP 00-19-2 provides that the contingent obligation to make
future payments or otherwise transfer consideration under a registration payment
arrangement, should be separately recognized and measured in accordance with
FASB Statement No.5, "Accounting for Contingencies". The registration statement
payment arrangement should be recognized and measured as a separate unit of
account from the financial instrument(s) subject to that arrangement. If the
transfer of consideration under a registration payment arrangement is probable
and can be reasonably estimated at inception, such contingent liability is
included in the allocation of proceeds from the related financing instrument.
The company had registered all shares underlying the 8% convertible debentures
as well as all shares underlying the warrants related to the 8% convertible
debentures, but no longer maintains such registration, in light of the partial
conversion and partial cancellation of the debentures and a portion of the
warrants.
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. The recognition of derivative liabilities related to the issuance of
convertible debt is applied first to the proceeds of such issuance as a debt
discount, at the date of issuance, and the excess of derivative liabilities over
the proceeds is recognized as other expense in the accompanying consolidated
financial statements. Any subsequent increase or decrease in the fair value of
the derivative liabilities, which are measured at the balance sheet date, are
recognized as other expense or other income, respectively.
Accounts receivable are reported at net realizable value. We have
established an allowance for doubtful accounts based upon factors pertaining to
the credit risk of specific customers, historical trends, and other information.
Delinquent accounts are written-off when it is determined that the amounts are
uncollectible.
Inventories are stated at the lower of cost or market, cost determined by
the first-in, first-out (FIFO) method. The company writes down its inventory for
estimated obsolescence or unmarketable inventory using the difference between
the cost of inventory and the estimated market value based upon assumptions
about future demand and market conditions.
We are required to estimate our income taxes in each of the jurisdictions
in which we operate as part of the process of preparing our consolidated
financial statements. SFAS No. 109, "Accounting for Income Taxes", requires a
valuation allowance to reduce the deferred tax assets reported if, based on the
weight of the evidence, it is not more likely than not that some portion or all
of the deferred tax assets will be realized. Management reviews deferred tax
assets periodically for recoverability and makes estimates and judgments
regarding the expected geographic sources of taxable income, gains from
investments, as well as tax planning strategies in assessing the need for a
valuation allowance. We determined that a valuation allowance of approximately
$3,700,000 relating to net operating loss carryovers was necessary to reduce our
deferred tax assets to the amount that will more likely than not be realized. As
a result, at December 31, 2008 the company has no net deferred tax assets. If
the estimates and assumptions used in our determination change in the future, we
could be required to revise our estimates of the valuation allowances against
our deferred tax assets and adjust our provisions for additional income taxes.
In the ordinary course of global business, there are transactions for which the
ultimate tax outcome is uncertain, thus judgment is required in determining the
worldwide provision for income taxes. We provide for income taxes on
transactions based on our estimate of the probable liability. We adjust our
provision as appropriate for changes that impact our underlying judgments.
Changes that impact provision
11
estimates include such items as jurisdictional interpretations on tax filing
positions based on the results of tax audits and general tax authority rulings.
PLAN OF OPERATIONS
Over the course of the next 12 months, we intend to execute our business
plan and focus our business development efforts in the following key areas:
o By diversifying our product offerings to enhance the usefulness of our
solutions for customers who will have already adopted one or more
products;
o By enhancing our product lines and developing new products to attract
new customers; and
o By developing partnering relationships with wide-ranging sales and
distribution channel leaders already serving our vertical market space
in a way that assists them in developing new revenue streams and
opportunities through improved technical and sales support and
customer services.
RESULTS OF OPERATIONS
Fiscal Year Ended December 31, 2008 Compared to Fiscal Year Ended December 31,
2007
The following table sets forth certain items included in our Income
Statements (see Financial Statements and Notes) for the periods indicated:
Year Ended
December 31, Variation $ Variation %
---------------------------- 2008 vs 2008 vs
2008 2007 2007 2007
------------ ------------ ------------ ------------
In $
REVENUES $ 1,724,897 $ 2,198,204 (473,307) (21.5%)
COST OF SALES 1,042,825 1,356,719 (313,894) (23.1%)
------------ ------------ ------------
GROSS PROFIT 682,072 841,485 (159,413) (18.9%)
OPERATING EXPENSES:
Research and development 658,111 744,646 (86,535) (11.6%)
Selling 472,310 664,838 (192,528) (29.0%)
Compensation 632,009 787,114 (155,105) (19.7%)
General and administrative 913,967 1,078,651 (164,684) (15.3%)
------------ ------------ ------------
TOTAL OPERATING EXPENSES 2,676,397 3,275,249 (598,852) (18.3%)
------------ ------------ ------------
LOSS FROM OPERATIONS (1,994,325) (2,433,764) 439,439 18.1%
OTHER INCOME AND EXPENSE:
Other income - derivative liabilities 323,210 987,805 (664,595) (67.3%)
Other income - 1,854 (1,854) (100.0%)
Gain from extinguishment of debt 1,261,864 - 1,261,864 -
Loss on sale of property and equipment (5,357) (6,051) 694 11.5%
Interest expense (886,876) (2,924,486) 2,037,610 69.7%
------------ ------------ ------------
TOTAL OTHER INCOME (EXPENSE) 692,841 (1,940,878) 2,633,719 135.7%
------------ ------------ ------------
12
Year Ended
December 31, Variation $ Variation %
---------------------------- 2008 vs 2008 vs
2008 2007 2007 2007
------------ ------------ ------------ ------------
NET LOSS $ (1,301,484) $ (4,374,642) 3,073,158 70.2%
============= ============ ============
The following table sets forth, as a percentage of revenues, certain items
included in our Income Statements (see Financial Statements and Notes) for the
periods indicated:
Year Ended
December 31,
---------------------
2008 2007
-------- --------
As a % of revenues
REVENUES 100% 100%
COST OF SALES 60% 62%
GROSS PROFIT 40% 38%
OPERATING EXPENSES 155% 149%
LOSS FROM OPERATIONS (115%) (111%)
OTHER INCOME AND EXPENSE 40% (88%)
NET LOSS (75%) (199%)
Revenues are derived from sales and support services on our zNose product
line. Revenues for 2008 were approximately $473,000 or 22% below 2007. The
decrease in revenues was due to a significant drop in business from our Chinese
distributor in the first two quarters of the year. Even though business from
this customer recovered in the second half of the year, it was not enough to
offset the first half drop in business. Shipments picked up in the second half
of the year, its impact on revenues; however, was somewhat offset by aggressive
pricing on the Model 4200 which is being discontinued in its current
configuration at the end of the production run. The aggressive pricing also
prompted several customers to "buy down" from our higher priced model to the
Model 4200. As in the prior year, over 60% of our revenues were from
international customers who generate very little training and after-sales
support revenues. This is because most training and all after-sales support
needs for international customers are performed by the respective sales
representative or distributor servicing their respective accounts. Training and
after-sales support functions for domestic customers are performed by the
company.
Cost of Sales consist of product costs and expenses associated with product
support services. Consistent with the decrease in revenues, cost of sales was
approximately $314,000 or 23% lower in 2008 than in 2007. As a percentage of
revenues, cost of sales were 60% and 62% for 2008 and 2007, respectively. Cost
of sales continue to be negatively impacted by manufacturing variances resulting
from a slow down in production to reflect lower sales activities and to work-off
existing inventory. Excluding the impact of the variances and other adjustments,
cost of sales would be 49% of revenues, 1% worse than in 2007.
Research and development expenses primarily consist of salaries and related
benefits, material and supplies associated with our efforts in developing and
enhancing our products. In 2008, research and development expenses decreased
approximately $86,000 or 12% from 2007. The decrease is attributable to a
reduction of personnel expenses due to a reduction of census ($100,000),
reduction in patent attorney fees and consultants' expenses ($15,000), offset by
expenses associated with the development of the Model 4500.
Selling expenses primarily consist of salaries, commissions and related
benefits associated with our selling and marketing efforts. Selling expenses
were approximately $193,000 lower in 2008 than in 2007. The decrease in selling
expenses resulted from savings through reduction of commission and consulting
expenses ($103,000), selective attendance at trade shows ($40,000), reduction in
personnel costs ($88,000), offset by an increase in promotional ($29,000) and
facility ($9,000) expenses.
13
Compensation expenses primarily consist of salaries and related benefits of
our general and administrative personnel. The decrease in compensation expenses
of approximately $155,000 during 2008 when compared to 2007 is attributable to a
decrease in stock based compensation expense ($18,000), decrease in personnel
expenses through census reduction ($58,000), decrease in severance paid to
departed company officers ($53,000), and lower employee benefits expenses
($26,000).
General and administrative expenses for 2008 were approximately 15% less
than 2007. The improvement of approximately $165,000 resulted from reductions of
legal and professional expenses ($32,000), deferred financing fees ($111,000),
Board of Directors meeting expenses ($92,000), travel and lodging ($17,000),
offset by increases in operating expenses ($6,000) and facilities cost
($81,000).
Other income - derivative liabilities primarily consists of the decrease in
the fair value of derivative liabilities between the measurement dates which are
balance sheet dates. On March 31, 2008, we satisfied our obligations under the
8% convertible debentures and as a result, the company can assert 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.
Other income - gain from extinguishment of debt resulted from the early
retirement of the 8% convertible debentures on March 31, 2008 (see Item 8).
Interest expense primarily consists of debt discount amortization and
interest on certain debt. The $2,037,000 reduction in interest expense is due to
retirement of the $7.0 million 8% convertible debentures, and related debt
discount, on March 31, 2008. Previously, interest expense included both interest
accrued on the 8% convertible debentures as well as amortization of the related
debt discount. Since the beginning of the second quarter, interest expense
pertains mostly to the interest accrued on the $2.0 million 9% convertible
debenture, which was issued on March 28, 2008.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents amounted to approximately $484,000 at
December 31, 2008.
During 2008, we used approximately $1.755 million in our operating
activities which is the result of the following:
o A net loss of approximately $1.301 million adjusted for:
o depreciation and amortization of approximately $48,000,
increase in the reserve for obsolescence of approximately
$7,000, amortization of debt discount of approximately
$592,000, amortization of deferred financing costs of
approximately $45,000, issuance of shares for payment of
interest of $160,000, and stock based compensation of
approximately $96,000; and
o decreases in the fair value of the derivative liabilities of
approximately $323,000, allowance for doubtful accounts of
$1,500 and gain on extinguishment of debt of approximately
$1.262 million.
o Decreases in inventories of approximately $254,000, prepaid
expenses of approximately $22,000, deferred revenues of
approximately $42,000, accounts payable and accrued expenses of
approximately $48,000 due to better management of cash
expenditures, and increases in accounts receivable of
approximately $2,000.
During 2008, investing activities provided approximately $12,000 from
proceeds received from the sale of property and equipment, less property and
equipment purchased.
During 2008, we generated approximately $1.979 million from financing
activities. The company received $5.5 million from an investor, $3.5 million for
the purchase of common stock of the company (at $0.0405 per share), and $2.0
million for a 9% convertible debenture. The 9% convertible debenture has a five
(5)-year term, and the conversion rate of the debenture is at $0.0486. A
condition of the new investment required the company to use $3.5 million to
extinguish the company's 8% convertible debentures. A Conversion and Termination
Agreement with the 8% convertible debenture holders on February 26, 2008,
provided that in exchange for $3.5 million, the debenture holders would convert
$3.5 million of the principal amount of their 8% convertible debentures,
together with interest thereon, at a conversion price of $0.35 per share of
Common Stock. Additionally, the agreement
14
provided that upon receipt of the foregoing sum and the conversion shares of
Common Stock, the debenture holders would cancel the remainder of their 8%
convertible debenture and 50% of the shares of Common Stock underlying warrants.
On March 31, 2008, upon payment of $3.5 million and remittance of the conversion
shares to the 8% convertible debenture holders, the entire $7.0 million 8%
convertible debentures was extinguished.
Certificates of deposits, aggregating $15,500 at December 31, 2008, are
used to secure and collateralize the company's credit card liability and to
provide a performance guarantee for a sale to an oversea customer.
During 2007, we used approximately $1.807 million in our operating
activities which is the result of the following:
o A net loss of approximately $4.375 million adjusted for:
o the amortization of debt discount of approximately $2.333
million, amortization of deferred financing costs of
approximately $182,000, issuance of shares for payment of
interest of $311,000, and stock based compensation of
$115,000, and a decrease in the fair value of the derivative
liabilities of approximately $980,000.
o A decrease in inventories of approximately $410,000 due to an
extended slow down of production to work-off on-hand materials,
and an increase in accounts payable and accrued expenses of
approximately $117,000 due to better management of cash
expenditures.
During 2007, investing activities provided approximately $22,000 from
proceeds received from the sale of property and equipment.
During 2007, we generated approximately $940,000 from financing activities
by liquidating a certificate of deposit that was used to satisfy collateral
requirement of our line of credit which we cancelled.
There can be no assurance that any required or desired financing will be
available through any other bank borrowings, debt, or equity offerings, or
otherwise, on acceptable terms. If future financing requirements are satisfied
through the issuance of equity securities, investors may experience significant
dilution in the net book value per share of common stock. There is no guarantee
that a market will exist for the sale of our shares.
Our primary capital needs are to fund our growth strategy, which includes
expanding our sales and marketing staff for the marketing, advertising and
selling of the zNose(R) family of chemical detection products, increasing
distribution channels both in the U.S. and foreign countries, introducing new
products, improving existing product lines and development of a strong corporate
infrastructure. We do not believe that we will have to incur significant capital
expenditures in the near future in order to meet our growth strategy goals.
As of December 31, 2008, our cash balance and working capital were $484,000
and $1,028,000, respectively. The cash balance and working deficit as December
31, 2007 were $249,000 and $3,848,000.
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.
15
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
This item is not applicable to smaller reporting companies.
16
Item 8. Financial Statements and Supplementary Date.
FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheet as of December 31, 2008 and December 31, 2007 F-2
Consolidated Statements of Operations for the Years Ended December
31, 2008 and December 31, 2007 F-3
Consolidated Statement of Changes in Stockholders' Deficit for the
Period from January 1, 2007 to December 31, 2008 F-4
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2008 and December 31, 2007 F-5
Notes to Consolidated Financial Statements F-6
17
805 Third Avenue
21st Floor
New York, NY 10022
Tel: 212-838-5100
Fax: 212-838-2676
e-mail: info@sherbcpa.com
[GRAPHIC OMITTED] SHERB & CO., LLP Offices in New York and Florida
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Electronic Sensor Technology, Inc.
We have audited the accompanying balance sheets of Electronic Sensor
Technology, Inc. as of December 31, 2008 and 2007 and the related consolidated
statements of operations, changes in stockholders' deficit and cash flows for
the years ended December 31, 2008 and 2007. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
the consolidated financial position of Electronic Sensor Technology, Inc., as of
December 31, 2008 and 2007 and the consolidated results of its operations and
its cash flows for the years ended December 31, 2008 and 2007 in conformity with
accounting principles generally accepted in the United States of America.
/s/ Sherb & Co., LLP
----------------------------
Sherb & Co., LLP
Certified Public Accountants
New York, New York
April 14, 2009
F-1
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEET
December 31, December 31,
2008 2007
-------------- --------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 484,028 $ 248,587
Certificate of deposit-restricted 15,500 12,384
Accounts receivable, net of allowance for uncollectible
of $0 at December 31, 2008 and $1,500 at December 31, 2007 284,644 281,400
Prepaid expenses 59,219 80,761
Inventories 557,454 818,989
-------------- --------------
TOTAL CURRENT ASSETS 1,400,845 1,442,121
-------------- --------------
DEFERRED FINANCING COSTS, net - 347,967
PROPERTY AND EQUIPMENT, net 114,213 174,111
SECURITY DEPOSITS 12,817 12,817
-------------- --------------
$ 1,527,875 $ 1,977,016
============== ==============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 352,369 $ 520,685
Deferred revenues - 41,667
Derivative liabilities - 2,376,543
Convertible debentures - current portion - 2,333,333
Obligation under capital lease due within one year 20,024 17,875
-------------- --------------
TOTAL CURRENT LIABILITIES 372,393 5,290,103
-------------- --------------
CONVERTIBLE DEBENTURES - long-term portion, net of
unamortized discount 1,951,017 2,527,777
LONG-TERM OBLIGATION UNDER CAPITAL LEASE 16,583 36,607
-------------- --------------
TOTAL LIABILITIES 2,339,993 7,854,487
-------------- --------------
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, 155,853,385 issued and outstanding at
December 31, 2008 and 56,756,098 issued and outstanding
at December 31, 2007 155,854 56,756
Additional paid-in capital 15,207,301 8,939,562
Accumulated deficit (16,175,273) (14,873,789)
-------------- --------------
TOTAL STOCKHOLDERS' DEFICIT (812,118) (5,877,471)
-------------- --------------
$ 1,527,875 $ 1,977,016
============== ==============
See notes to consolidated financial statements
F-2
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended
December 31,
--------------------------------
2008 2007
-------------- --------------
REVENUES $ 1,724,897 $ 2,198,204
COST OF SALES 1,042,825 1,356,719
-------------- --------------
GROSS PROFIT 682,072 841,485
-------------- --------------
OPERATING EXPENSES:
Research and development 658,111 744,646
Selling 472,310 664,838
Compensation 632,009 787,114
General and administrative 913,967 1,078,651
-------------- --------------
TOTAL OPERATING EXPENSES 2,676,397 3,275,249
-------------- --------------
LOSS FROM OPERATIONS (1,994,325) (2,433,764)
-------------- --------------
OTHER INCOME AND EXPENSE:
Other income - derivative liabilities 323,210 987,805
Other income - 1,854
Gain from extinguishment of debt 1,261,864 -
Loss on sale of property and equipment (5,357) (6,051)
Interest expense (886,876) (2,924,486)
-------------- --------------
TOTAL OTHER INCOME (EXPENSE) 692,841 (1,940,878)
-------------- --------------
NET LOSS $ (1,301,484) $ (4,374,642)
============== ==============
Loss per share, basic $ (0.01) $ (0.08)
============== ==============
Weighted average number of shares, basic 132,900,656 54,884,012
============== ==============
Loss per share, diluted $ (0.01) $ (0.10)
============== ==============
Weighted average number of shares, diluted 132,900,656 54,884,012
============== ==============
See notes to consolidated financial statements
F-3
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT
Common Stock Preferred Stock Additional Total
--------------------------- --------------- Paid-In Accumulated Stockholders'
Shares Amount Shares Amount Capital Deficit Deficit
------------ ------------ ------ ------ -------------- -------------- --------------
BALANCE - January 1, 2007 54,173,745 $ 54,174 - $ - $ 8,516,354 $ (10,499,147) $ (1,928,619)
Shares issued for interest 2,582,353 2,582 - - 308,529 - 311,111
Stock based compensation - - - - 114,679 - 114,679
Net (loss) - - - - - (4,374,642) (4,374,642)
------------ ------------ ------ ------ -------------- -------------- --------------
BALANCE - December 31, 2007 56,756,098 56,756 - - 8,939,562 (14,873,789) (5,877,471)
Shares issued for interest 2,677,534 2,678 - - 157,322 - 160,000
Shares issued for
conversion of 8%
debentures 10,000,000 10,000 - - 490,000 - 500,000
Sales of common stock 86,419,753 86,420 - - 3,413,580 - 3,500,000
Reclassification of
derivative liability in
connection with
retirement and
conversion of 8%
debentures - - - - 2,053,333 - 2,053,333
Beneficial feature
pertaining to the
convertible shares on
the 9% debentures - - - - 57,613 - 57,613
Stock based compensation - - - - 95,891 - 95,891
Net (loss) - - - - - (1,301,484) (1,301,484)
------------ ------------ ------ ------ -------------- -------------- --------------
BALANCE - December 31, 2008 155,853,385 $ 155,854 - $ - $ 15,207,301 $ (16,175,273) $ (812,118)
============ ============ ====== ====== ============== ============== ==============
See notes to consolidated financial statements.
F-4
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
December 31,
-------------------------------
2008 2007
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (1,301,484) $ (4,374,642)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 48,276 56,511
Decrease in allowance for doubtful accounts (1,500) (22,862)
Increase in reserve for obsolescence 7,197 56,320
Issuance of shares for payment of interest 160,000 311,111
Amortization of stock based compensation 95,891 114,679
Amortization of debt discount 591,963 2,333,334
Amortization of deferred financing costs 45,387 181,548
Decrease in fair value of derivative liability (323,210) (979,930)
Gain on extinguishment of debt (1,261,864) -
Changes in assets and liabilities:
Accounts receivable (1,744) 41,875
Inventories 254,338 410,381
Prepaid expenses 21,542 (1,991)
Accounts payable and accrued expenses (48,315) 116,767
Deferred revenues (41,667) (50,000)
-------------- --------------
Net cash provided by (used in) operating activities (1,755,190) (1,806,899)
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 15,242 21,647
Purchase of property and equipment (3,620) -
-------------- --------------
Net cash provided by (used in) investing activities 11,622 21,647
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease (increase) in certificate of deposit - restricted (3,116) 939,698
Decrease in capital lease obligation (17,875) -
Proceeds from issuance of 9% convertible debentures 2,000,000 -
Proceeds from issuance of common stock 3,500,000 -
Repayment of 8% convertible debentures (3,500,000) -
-------------- --------------
Net cash provided by (used in) financing activities 1,979,009 939,698
-------------- --------------
NET INCREASE (DECREASE) IN CASH 235,441 (845,554)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 248,587 1,094,141
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 484,028 $ 248,587
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 102,153 $ 147,888
-------------- --------------
Cash paid for taxes $ - $ -
============== ==============
NON-CASH INVESTING AND FINANCING ACTIVITIES
Reclassification of derivative liability to paid-in-capital $ 2,053,333 $ -
============== ==============
Conversion of 8% convertible debenture into equity $ 500,000 $ -
============== ==============
Debt discount related to 9% convertible debentures $ 57,613 $ -
============== ==============
Purchase of property and equipment under capital lease $ - $ 54,482
============== ==============
See notes to consolidated financial statements.
F-5
ELECTRONIC SENSOR TECHNOLOGY, INC.
Notes to Financial Statements
December 31, 2008 and 2007
(1) Nature of Business and Summary of Significant Accounting Policies
Nature of Business
Electronic Sensor Technology, Inc. develops and manufactures electronic
devices used for vapor analysis. It markets its products through
distribution channels in over 20 countries.
Basis of Consolidation
The accompanying financial statements include the accounts of the Company
and its wholly owned subsidiaries. All intercompany balances and
transactions have been eliminated in consolidation.
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 had cash and cash equivalents amounting to $484,028 and $248,587 at
December 31, 2008 and 2007, respectively.
Certificate of Deposit - Restricted
The Company had two certificates of deposit in place at December 31, 2008.
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.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is based on the Company's assessment of
the collectability 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 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 collectability of amounts and at which time the
Company may need to provide additional allowances in excess of that
currently provided.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, certificate of deposit,
accounts receivables, accounts payable and accrued expenses approximate
their fair value due to their short-term maturities. The fair value of the
9% convertible debentures issued by the Company on March 28, 2008 amounts
to $2,000,000, based on the Company's incremental borrowing rate.
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
F-6
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.
a. Concentration of Credit
The Company is subject to concentrations of credit risk primarily from
cash and cash equivalents and accounts receivable. 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 $100,000 at December 31, 2008. For the years ended December 31,
2008 and 2007, 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. The Company's accounts
receivables are due from distributors in all other countries in which
it markets its products. The Company does not require collateral to
secure its accounts receivables.
b. Product Concentration
Substantially all of the Company's revenues were derived from the sale
of electronic devices and related accessories used for vapor analysis.
c. Customer Concentration
The Company's largest customer accounted for approximately 33% and 47%
of its revenues during 2008 and 2007, respectively. This same customer
and another customer accounted for approximately 96% and 86% of the
gross accounts receivable balance at December 31, 2008 and 2007,
respectively. No other customers accounted for more than 10% of its
revenues or more than 10% of its net accounts receivable.
d. Geographic Concentration
The Company sells its products internationally in 20 countries. Sales
to these countries were approximately 63% and 66% for the years ended
December 31, 2008 and 2007, respectively.
Inventories
Inventories are comprised of raw materials, work-in-process, and finished
goods. Inventories are stated at the lower of cost or market, cost
determined by the first-in, first-out (FIFO) method. The Company writes
down its inventory for estimated obsolescence or unmarketable inventory
using the difference between the cost of inventory and the estimated market
value based upon assumptions about future demand and market conditions.
Property and Equipment
Property and equipment are recorded at cost and are depreciated on a
straight-line basis over their estimated useful lives of five years.
Leasehold improvements are recorded at cost and are amortized on a
straight-line basis over the lesser of five years or the remaining
lease-life. Maintenance and repairs are charged to expense as incurred.
Significant renewals and betterments are capitalized.
Property and equipment consist of the following as of December 31, 2008:
Machinery and equipment $ 260,500
Leasehold improvements 39,500
Office furniture and equipment 125,900
----------
425,900
Accumulated depreciation (311,700)
----------
$ 114,200
==========
Machinery and equipment includes a capital lease for $74,000. Depreciation
expense amounted to approximately $48,300 and $56,500 during 2008 and 2007,
respectively.
F-7
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 lease
expires in September 2010. 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 $36,600 at December
31, 2008, of which approximately $20,000 is included in the current portion
of capital lease obligations in the accompanying consolidated balance
sheet. As of December 31, 2008, the total future minimum lease payments on
this lease is approximately $36,600 (if stated by year, the minimum lease
payments are approximately: 2009 - $20,000, and 2010 - $16,600).
Deferred Financing Costs
Deferred financing costs consist of direct costs incurred by the Company in
connection with the issuance of its 8% convertible debentures. The direct
costs include cash payments and fair value of warrants issued to the
placement agent, which secured the financing. Deferred financing costs are
amortized over 48 months using the effective interest rate method. On March
31, 2008, $3.5 million of the $7.0 million 8% convertible debentures was
retired and the remaining $3.5 million was converted into equity. As such,
the unamortized deferred financing costs related to the 8% convertible
debentures were fully amortized as of March 31, 2008.
Income Taxes
Income taxes are accounted for in accordance with SFAS No. 109, Accounting
for Income Taxes. SFAS No. 109 requires the recognition of deferred tax
assets and liabilities to reflect the future tax consequences of events
that have been recognized in the Company's financial statements or tax
returns. Measurement of the deferred items is based on enacted tax laws. In
the event the future consequences of differences between financial
reporting bases and tax bases of the Company's assets and liabilities
result in a deferred tax asset, SFAS No. 109 requires an evaluation of the
probability of being able to realize the future benefits indicated by such
assets. A valuation allowance related to a deferred tax asset is recorded
when it is more likely than not that some or the entire deferred tax asset
will not be realized.
Use of Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Significant estimates made by
management include, but are not limited to, the realization of receivables,
recognition of stock based compensation and the valuation of the derivative
liability. Actual results may differ from these estimates.
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 December 31, 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 December 31:
2008 2007
-------------- --------------
Numerator:
Net (loss) $ (1,301,484) $ (4,374,642)
F-8
2008 2007
-------------- --------------
Net other (income) expense associated with derivative contracts (323,210) (987,805)
-------------- --------------
Net (loss) for diluted earnings per share purposes $ (1,624,694) $ (5,362,447)
============== ==============
Denominator:
Denominator for basic earnings per share - Weighted average
shares outstanding 132,900,656 54,884,012
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 132,900,656 54,884,012
============== ==============
Basic earnings (loss) per share $ (0.01) $ (0.08)
============== ==============
Diluted earnings (loss) per share $ (0.01) $ (0.10)
============== ==============
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.
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 $95,900 in additional
compensation expense during the year ended December 31, 2008. Such amount
is included in general and administrative expenses on the statement of
operations.
Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses at December 31, 2008 consist
primarily of vendor payables.
Deferred Revenues
Deferred revenues consist of a one-time licensing fee received by the
Company during 2004 and is recognized over the term of the agreement which
is five years. The Company recognized revenues of $41,667 and $50,000
pursuant to this agreement during 2008 and 2007, respectively.
Derivative Liabilities
The Company accounts for its liquidated damages pursuant to FASB Staff
Position No. EITF 00-19-2 "Accounting for Registration Payment
Arrangements" ("FSP 00-19-2"). FSP 00-19-2 provides that the contingent
obligation to make future payments or otherwise transfer consideration
under a registration payment arrangement, should be separately recognized
and measured in accordance with FASB Statement No.5, "Accounting for
Contingencies". The registration statement payment arrangement should be
recognized and measured as a separate unit of account from the financial
instrument(s) subject to that arrangement. If the transfer of consideration
under a registration payment arrangement is probable and can be reasonably
estimated at inception, such contingent liability is included in the
allocation of proceeds from the related financing instrument. The Company
had registered all shares underlying the 8% convertible debentures as well
as all shares underlying the warrants related to the 8% convertible
debentures, but no longer maintains such registration, in light of the
partial conversion and partial cancellation of the debentures and a portion
of the warrants (see Notes 3 and 4).
F-9
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. The recognition of derivative
liabilities related to the issuance of convertible debt is applied first to
the proceeds of such issuance as a debt discount, at the date of issuance,
and the excess of derivative liabilities over the proceeds is recognized as
other expense in the accompanying consolidated financial statements. Any
subsequent increase or decrease in the fair value of the derivative
liabilities, which are measured at the balance sheet date, are recognized
as other expense or other income, respectively.
Research and Development
Research and development costs are charged to operations as incurred and
consists primarily of salaries and related benefits, raw materials and
supplies.
Segment reporting
The Company operates in one segment, manufacturing of electronic devices
used for vapor analysis. The Company's chief operating decision-maker
evaluates the performance of the Company based upon revenues and expenses
by functional areas as disclosed in the Company's statements of operations.
Revenue Recognition
The Company records revenue from direct sales of products to end-users when
the products are shipped, collection of the purchase price is probable and
the Company has no significant further obligations to the customer. Costs
of remaining insignificant Company obligations, if any, are accrued as
costs of revenue at the time of revenue recognition. Cash payments received
in advance of product or service revenue are recorded as deferred revenue.
Shipping and Handling
The Company accounts for shipping and handling costs as a component of
"Cost of Sales".
Long-lived Assets
The Company reviews long-lived assets, such as property and equipment, to
be held and used or disposed of, for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. If the sum of the expected cash flows, undiscounted and
without interest, is less than the carrying amount of the asset, an
impairment loss is recognized as the amount by which the carrying amount of
the asset exceeds its fair value. At December 31, 2008 no assets were
impaired.
Recently Issued Accounting Pronouncements
FASB Statement Number 160
In December 2007, the FASB issued FASB Statement No. 160 - Noncontrolling
Interests in Consolidated Financial Statements - an amendment of ARB No.
51. This Statement applies to all entities that prepare consolidated
financial statements, except not-for-profit organizations, but will affect
only those entities that have an outstanding noncontrolling interest in one
or more subsidiaries or that deconsolidate a subsidiary. Not-for-profit
organizations should continue to apply the guidance in Accounting Research
Bulletin No. 51, Consolidated Financial Statements, before the amendments
made by this Statement, and any other applicable standards, until the Board
issues interpretative guidance.
This Statement amends ARB 51 to establish accounting and reporting
standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. It clarifies that a noncontrolling
interest in a subsidiary is an ownership interest in the consolidated
entity that should be reported as equity in the consolidated financial
statements. Before this Statement was issued, limited guidance existed for
reporting noncontrolling interests. As a result, considerable diversity in
practice existed. So-called minority interests were reported in the
consolidated statement of financial position as liabilities or in the
mezzanine section between liabilities and equity. This Statement improves
comparability by eliminating that diversity.
F-10
A noncontrolling interest, sometimes called a minority interest, is the
portion of equity in a subsidiary not attributable, directly or indirectly,
to a parent. The objective of this Statement is to improve the relevance,
comparability, and transparency of the financial information that a
reporting entity provides in its consolidated financial statements by
establishing accounting and reporting standards that require: (a) The
ownership interests in subsidiaries held by parties other than the parent
be clearly identified, labeled, and presented in the consolidated statement
of financial position within equity, but separate from the parent's equity,
(b) The amount of consolidated net income attributable to the parent and to
the noncontrolling interest be clearly identified and presented on the face
of the consolidated statement of income, (c) Changes in a parent's
ownership interest while the parent retains its controlling financial
interest in its subsidiary be accounted for consistently. A parent's
ownership interest in a subsidiary changes if the parent purchases
additional ownership interests in its subsidiary or if the parent sells
some of its ownership interests in its subsidiary. It also changes if the
subsidiary reacquires some of its ownership interests or the subsidiary
issues additional ownership interests. All of those transactions are
economically similar, and this Statement requires that they be accounted
for similarly, as equity transactions, (d) When a subsidiary is
deconsolidated, any retained noncontrolling equity investment in the former
subsidiary be initially measured at fair value. The gain or loss on the
deconsolidation of the subsidiary is measured using the fair value of any
noncontrolling equity investment rather than the carrying amount of that
retained investment, (e) Entities provide sufficient disclosures that
clearly identify and distinguish between the interests of the parent and
the interests of the noncontrolling owners.
This Statement is effective for fiscal years, and interim periods within
those fiscal years, beginning on or after December 15, 2008 (that is,
January 1, 2009, for entities with calendar year-ends). Earlier adoption is
prohibited. This Statement shall be applied prospectively as of the
beginning of the fiscal year in which this Statement is initially applied,
except for the presentation and disclosure requirements. The presentation
and disclosure requirements shall be applied retrospectively for all
periods presented. Management believes this Statement will have no impact
on the financial statements of the Company once adopted.
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.
(2) Inventory
Inventory consists of the following:
December 31, 2008 December 31, 2007
----------------- -----------------
Finished goods $ 341,530 $ 475,091
Work-in-process 4,816 360,671
Raw materials 311,108 76,030
Reserve for obsolescence (100,000) (92,803)
---------- ----------
$ 557,454 $ 818,989
========== ==========
Inventories are stated at the lower of cost or market, cost determined by
the first-in, first-out (FIFO) method. The Company writes down its
inventory for estimated obsolescence or unmarketable inventory equal to the
difference between the cost of inventory and the estimated market value
based upon assumptions about future demand and market conditions. The
Company writes down inventory during the period in which such products are
no longer marketable in any of their markets due to governmental
regulations as well as inventory which matures within the next three months
of the measurement date.
F-11
(3) Convertible debentures
8% Convertible Debentures
During December 2005, we issued in a private offering, $7,000,000 aggregate
principal amount of 8% convertible debentures due December 7, 2009. The
convertible debentures were convertible at any time on or prior to the
maturity date at the option of the debenture holder at a conversion price
of $0.4544, which was subsequently reduced to $0.4000 as per a Forbearance
and Amendment Agreement, dated September 7, 2006, with the holders of the
convertible debentures and can be redeemed at the lesser of $0.4000 or 90%
of the average of the volume weighted average price for the 20 consecutive
trading days immediately prior to the conversion date. Interest on the
convertible debentures was payable in cash or stock, at the Company's
option.
In connection with the issuance of the convertible debentures, the Company
issued five-year warrants to purchase 12,130,314 shares of common stock at
an exercise price of $0.4761 per share, which was subsequently reduced to
$0.4300 per share as per a Forbearance and Amendment Agreement, dated
September 7, 2006, with the holders of the warrants.
We paid professional fees of approximately $592,000 and issued 485,213
warrants with a fair value of approximately $136,000 relating to the
issuance of the convertible debentures and warrants. The payments of
professional fees and the fair value of the warrants, aggregating
approximately $729,000, were recorded as deferred financing costs.
A Conversion and Termination Agreement was entered into with the debenture
holders on February 26, 2008. Pursuant to the agreement, the convertible
debenture holders agreed that in exchange for $3,500,000, the debenture
holders would convert $3,500,000 of the principal amount of their 8%
convertible debentures, together with accrued interest thereon, at a
conversion price of $0.35 per share of Common Stock. Upon receipt of the
foregoing sum and the conversion shares of Common Stock, the debenture
holders agreed to cancel the remainder of their 8% convertible debentures
and 50% of the shares of Common Stock underlying warrants. With respect to
the remaining 6,065,157 shares of Common Stock underlying the warrants,
they will otherwise continue in full force and effect in accordance with
their terms. On March 31, 2008, we remitted $3,500,000 in cash and
transferred 10,400,000 shares of common stock to the debenture holders to
completely retire the 8% convertible debentures.
The extinguishment of the convertible debentures resulted in a gain of
approximately $1,261,900, which included the write off of related
unamortized deferred financing costs of approximately $302,600.
9% Convertible Debentures
On March 28, 2008, we received $5,500,000 from an investor, $3,500,000 of
which was for Common Stock of the Company, and $2,000,000 for a convertible
debenture bearing an interest rate of 9%, payable semi-annually in cash.
The common stock shares were issued at a price of $0.0405 per share. The 9%
convertible debenture has a five (5)-year term, and the conversion rate of
the debenture is $0.0486 (equaled 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. The unamortized balance at
December 31, 2008 was approximately $49,000.
A condition of the new investment required the Company to use $3,500,000 to
extinguish the 8% convertible debentures and this event occurred on March
31, 2008.
(4) Derivative Liabilities
In connection with the issuance of the 8% convertible debentures in
December 2005, the Company determined that the conversion feature of the
convertible debentures represents an embedded derivative since the
debentures are convertible into a variable number of shares upon
conversion. Because there is no explicit number of shares that are to be
delivered upon satisfaction of the convertible debentures and that there is
no cap on the number of shares to be delivered upon expiration of the
contract to a fixed number, the Company is unable to assert that it had
sufficient authorized and unissued shares to settle its obligations under
the convertible debentures and therefore, net-share settlement is not
within the control of the Company. Accordingly, the convertible debentures
are not considered to be conventional debt under EITF 00-19 and the
embedded conversion feature must be bifurcated from the debt host and
accounted for as a derivative liability.
F-12
A Conversion and Termination Agreement was entered into with the 8%
convertible debenture holders on February 26, 2008. Pursuant to the
agreement, the convertible debenture holders agreed that in exchange for
$3,500,000, the debenture holders would convert $3,500,000 of the principal
amount of their 8% convertible debentures, together with accrued interest
thereon, at a conversion price of $0.35 per share of Common Stock. Upon
receipt of the foregoing sum and the conversion shares of Common Stock, the
debenture holders agreed to cancel the remainder of their 8% convertible
debentures and 50% of the shares of Common Stock underlying warrants. With
respect to the remaining shares of Common Stock underlying the warrants,
they will otherwise continue in full force and effect in accordance with
their terms. On March 31, 2008, we remitted $3,500,000 in cash and
transferred 10,400,000 shares of Common Stock to the debenture holders.
As a result of the satisfaction of the Company's obligations under its 8%
convertible debentures, the Company reclassified the derivative liabilities
balance outstanding at March 31, 2008 from liability to equity. The amount
of derivative liabilities that was reclassified to equity approximated
$2,053,000.
(5) Stockholders' Deficit
Common Stock
Shares issued for payment of interest
During 2008, the Company elected interest accrued on the 8% convertible
debentures in shares of the Company's common stock, rather than in cash.
The Company issued 2,677,534 shares of the Company's common stock to the
holders of the 8% convertible debentures.
Shares issued to private investor
On March 28, 2008, we received $5,500,000 from an investor, $3,500,000 of
which was for Common Stock of the Company, and $2,000,000 for a convertible
debenture bearing an interest rate of 9%, payable semi-annually in cash
(see Note 3). The common stock shares were issued at a price of $0.0405 per
share. The number of common shares issued to this investor was 86,419,753.
Shares issued for conversion of 8% convertible debentures
A Conversion and Termination Agreement was entered into with the debenture
holders on February 26, 2008. Pursuant to the agreement, the convertible
debenture holders agreed that in exchange for $3,500,000, the debenture
holders would convert $3,500,000 of the principal amount of their 8%
convertible debentures, together with accrued interest thereon, at a
conversion price of $0.35 per share of Common Stock (see Note 3). On March
31, 2008, we remitted $3,500,000 in cash and transferred 10,400,000 (of
which 400,000 common shares pertained to accrued interest) shares of common
stock to the debenture holders to retire $3,500,000 of the 8% convertible
debentures.
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
F-13
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.
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.
2008 2007
---- ----
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
$258,000 or $0.06 per share. Approximately $96,000 was charged to
compensation expense in 2008. 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 $36,000 and
$112,000 at December 31, 2008 and 2007, respectively. 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 December 31, 2008:
Weighted
Average
Number of Exercise
Stock Options Options Price
---------------------------------------- ------------ ------------
Balance at December 31, 2006 1,219,500 $ 0.93
Granted 2,657,950 $ 0.22
Exercised - $ -
F-14
Weighted
Average
Number of Exercise
Stock Options Options Price
---------------------------------------- ------------ ------------
Forfeited (439,500) $ 0.73
------------ ------------
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
============ ============
Options exercisable at December 31, 2008 898,850 $ 0.53
============ ============
Weighted average fair value of options
granted during 2008 2,000,000 $ 0.03
============ ============
A summary of the status of the Company's nonvested shares as of December
31, 2008, and changes during the fiscal year then ended as presented below.
Weighted
Average
Grant Date
Nonvested Shares Shares Fair Value
---------------------------------------- ------------ ------------
Nonvested at December 31, 2006 - -
Granted 2,657,950 $ 0.22
Vested (898,250) $ 0.09
Cancelled (161,500) $ 0.09
------------ ------------
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 $ 0.05
============ ============
Options Outstanding Options Exercisable
------------------------------------------------------- --------------------------
Number Weighted
Outstanding Average Weighted Number Weighted
as of Remaining Average Exercisable Average
Exercise December 31, Contractual Exercise at December Exercise
Price 2008 Years Price 31, 2008 Price
------------ ------------ ------------ ---------- ------------- ----------
$ 0.02 1,000,000 9.90 $ 0.02 - $ 0.02
$ 0.03 1,000,000 9.56 $ 0.03 - $ 0.03
$ 0.19 161,500 8.18 $ 0.19 161,500 $ 0.19
$ 0.24 632,400 8.04 $ 0.24 384,350 $ 0.24
$ 1.00 353,000 7.62 $ 1.00 353,000 $ 1.00
------------ ------------ ---------- ------------- ----------
3,146,900 7.82 $ 0.19 898,850 $ 0.53
============ ============ ========== ============= ==========
Warrants
The following table summarizes the warrants outstanding at December 31,
2008:
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
F-15
Number of
Expiration Shares of
Issue Date Date Common Stock Price Basis for Warrant Issuance
---------- ---------- ------------- ------- --------------------------
12/07/05 12/06/10 485,213 0.4761 Investment advisor
12/07/05 12/06/10 2,166,128 0.43 Convertible debenture
12/07/05 12/06/10 3,899,030 0.43 Convertible debenture
-------------
6,900,371 Outstanding at December 31, 2008
=============
(6) Commitments and Contingencies
Leases
The Company rents office space and production facilities in Newbury Park,
California. The lease expires in September 2011. The rental expense
associated with this lease was approximately $182,800 and $180,000 in 2008
and 2007, respectively. As of December 31, 2008, the total future minimum
rental payments on this lease is approximately $259,000 (if stated by year,
the minimum rental payments are: 2009 - 146,600, and 2010 - 112,400).
During 2007, the Company entered into a lease for equipment used in
administration. Lease payments totaled approximately $2,400 and $2,200 for
2008 and 2007, respectively. As of December 31, 2008, the total future
minimum lease payments on this lease is approximately $7,400 (if stated by
year, the minimum lease payments are: 2009 - $2,400, 2010 - $2,400, 2011 -
$2,400, and 2012 - $200).
(7) Retirement savings plan
The Company sponsors a safe harbor 401(k) retirement savings plan (the
plan) which covers most of its full-time employees. The Company contributes
3% of compensation for each payroll period to all eligible employees.
Eligible employees may also elect to contribute a percentage of their
compensation to the Plan. During 2008 and 2007, the Company contributed
approximately $33,300 and $32,300, respectively, to the Plan.
(8) Income Taxes
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Significant components of the net deferred taxes are as follows:
2008 2007
---- ----
Deferred tax assets:
Net operating loss carryforward $ 3,700,000 $ 3,300,000
Less valuation allowance (3,700,000) (3,300,000)
------------ ------------
Total net deferred tax assets: $ - $ -
============ ============
The Company's net operating losses totaled approximately $9.1 million at
December 31, 2008, and will expire in 2028.
SFAS No. 109 requires a valuation allowance to reduce the deferred tax
assets reported, if any, based on the weight of the evidence, it is more
likely than not that some portion or all of the deferred tax assets will
not be realized. Management has determined that a valuation allowance of
$3,700,000 at December 31, 2008 is necessary to reduce the deferred tax
assets to the amount that will more likely than not be realized. The change
in the valuation allowance during 2008 and 2007 was an increase of
approximately $400,000 and $1,300,000 respectively.
The federal statutory tax rate reconciled to the effective tax rate during
2008 and 2007, respectively, is as follows:
2008 2007
-------- --------
Tax at U.S. Statutory Rate: 35.0% 35.0%
State tax rate, net of federal benefits 5.7 5.7
Change in valuation allowance (40.7) (40.7)
-------- --------
Effective tax rate 0.0% 0.0%
======== ========
(9) Subsequent Events
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.
F-16
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
Item 9A(T). Controls and Procedures.
EVALUATION OF DISCLOSURE 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 annual report on Form 10-K,
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.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the company is responsible for establishing and
maintaining adequate internal control over financial reporting. Internal control
over financial reporting is defined in Rule 13a-15(f) and Rule 15d-15(f)
promulgated under the Securities Exchange Act of 1934, as amended, as a process
designed by, or under the supervision of, the company's principal executive and
principal financial officers and effected by the company's Board of Directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles. The company's internal control over financial reporting includes
those policies and procedures that:
o pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the
assets of the company;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and
o provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
The company's management assessed the effectiveness of the company's internal
control over financial reporting as of December 31, 2008. In making this
assessment, it used the criteria set forth in the Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Based on its assessment, the company's management has
concluded that, as of December 31, 2008, the company's internal control over
financial reporting is effective based on those criteria. This report does not
include an attestation report of our registered public accounting firm regarding
internal control over financial reporting. Management's report was not subject
to attestation by our registered public accounting firm pursuant to temporary
rules of the Securities and Exchange Commission that permit us to provide only
management's report in this annual report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the quarter ended December 31, 2008, there were no changes in our
internal control over financial reporting that materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
18
Item 9B. Other Information.
None.
PART III
Item 10. Directors, Executive Officers, Officers and Corporate Governance.
Teong C. Lim
Teong C. Lim, age 69, currently serves as President, Chief Executive
Officer and interim Chief Scientist of Electronic Sensor Technology and as
Chairman of the Board of Directors of Electronic Sensor Technology. Dr. Lim has
served as President and Chief Executive Officer of Electronic Sensor Technology
since July 25, 2008, as interim Chief Scientist of Electronic Sensor Technology
since February 11, 2009 and as a director of Electronic Sensor Technology since
January 31, 2005. Dr. Lim also served as President and Chief Executive Officer
of Electronic Sensor Technology from January 26, 2006 through July 16, 2007, and
served as Vice President of Corporate Development of Electronic Sensor
Technology from February 1, 2005 through January 25, 2006. Dr. Lim was the
Director of Corporate Development of Electronic Sensor Technology, L.P. from
March 1995 through August 2000 and was the Manager of Corporate Development of
Electronic Sensor Technology, L.P. from August 2000 through February 2005. Dr.
Lim has been the President of Amerasia Technology, Inc., a subsidiary of
Electronic Sensor Technology, since 1984. Since 1997, Dr. Lim has been a
director of Crystal Clear Technology, Sdn. Bhd., a privately-owned Malaysian
company that manufactures and markets a high-contrast liquid crystal display
(LCD) product line. Dr. Lim also serves as a director of Chatsworth Data
Solutions, Inc., which is a public reporting company. Dr. Lim received a Ph.D.
in Electrical Engineering from McGill University in 1968 and an M.B.A. from
Pepperdine University in 1982.
Thomas J. Dudley
Thomas J. Dudley, age 77, currently serves as a director of Electronic
Sensor Technology. Dr. Dudley serves as the chairman of our audit committee and
compensation committee. Dr. Dudley has served as a director of Electronic Sensor
Technology since November 24, 2008. Dr. Dudley is currently an Emeritus
Professor of Decision Sciences at the Pepperdine University, Graziadio School of
Business and Management, and has been with Pepperdine's School of Business and
Management for 40 years. Dr. Dudley's field of expertise is the application of
quantitative methods to business and management problems. Dr. Dudley has
consulted in major industries such as aerospace, health care, automotive, food
products, computers and non-profit organizations as well as Indian Tribes in
Montana and Arizona. He has been involved with a number of start-up companies as
participant and advisor. Prior to beginning his Pepperdine tenure, Dr. Dudley
was assistant to the president of Channing Financial Corporation, the first
director of the computer facility, Graduate School of Business, University of
Southern California, operations analyst at Capitol Records, Inc., and a
management engineer at Convair Division of General Dynamics Corporation. Dr.
Dudley served for 10 years on the board of SpaceLabs Medical, Inc., where he was
chairman of the audit committee and a member of the compensation and executive
committees. Dr. Dudley currently serves as a director of Auto Graphics, Inc.,
VantageILM, Inc. and is the chairman of the board of Liberty Building
Maintenance and Services, Inc. He also served on the boards of Recording for the
Blind and Dyslexic, Los Angeles unit, America-China Association for Science, and
Technology Exchange. Dr. Dudley received a B.A. and an MBA from the University
of Michigan. Dr. Dudley received his Doctorate in business from the University
of Southern California.
Low Gay Teck
Low Gay Teck, age 44, currently serves as a director of Electronic Sensor
Technology. Mr. Low has served as a director of Electronic Sensor Technology
since September 1, 2008. Mr. Low has served as Managing Director of Land &
General Berhad since January 1, 2008, after serving as a non-executive director
of Land & General Berhad from October 15, 2007. Prior to joining Land & General
Berhad, Mr. Low was the Managing Director of the Mayland Group from 2005-2007,
after serving as a Director of the Mayland Group from 2002 and a Project Manager
with the Mayland Group from 1996. Mr. Low holds a Bachelor of Civil Engineering
from Footscray Institute of Technology, Australia (now known as Victoria
University, Australia).
19
Maggie Tham
Maggie Tham, age 58, currently serves as a director of Electronic Sensor
Technology. Ms. Tham serves on our audit committee and compensation committee.
Ms. Tham has served as a director of Electronic Sensor Technology since May 1,
2008. Ms. Tham has over 25 years of experience in management and strategy
consulting. Ms. Tham is the Co-Founder, Chief Executive Officer and Executive
Director of eXS Network Technologies Sdn. Bhd., which provides innovative
communication solutions to service providers in South East Asia. In 2004, Ms.
Tham co-founded, with William Wittmeyer, eXS Inc., a wireless access company
developing innovative and cost effective products for developing countries.
Prior to founding eXS Network Technologies and eXS, Inc., Ms. Tham raised
early-stage financing for companies and worked as a management consultant in the
United States and Malaysia for companies including Peat, Marwick, Mitchell & Co.
Ms. Tham received a B.Sc. (Economics) from the London School of Economics and an
M.B.A. from Columbia University Graduate School of Business Administration. Ms.
Tham was recommended to the Board of Directors by Halfmoon Bay, pursuant to the
Securities Purchase Agreement dated March 28, 2008 between Electronic Sensor
Technology and Halfmoon Bay.
William Wittmeyer
William Wittmeyer, age 59, currently serves as Chief Operating Officer of
Electronic Sensor Technology and as a director of Electronic Sensor Technology.
Mr. Wittmeyer also serves on our audit committee and compensation committee. Mr.
Wittmeyer has served as Chief Operating Officer of Electronic Sensor Technology
since November 24, 2008 and as a director of Electronic Sensor Technology since
May 1, 2008. Mr. Wittmeyer has over 25 years of experience in high-technology
business and investment management. In 1997, Mr. Wittmeyer co-founded, with
Maggie Tham, eXS Network Technologies Sdn. Bhd. Mr. Wittmeyer is the co-founder,
along with Ms. Tham, and Chief Executive Officer of eXS Inc., a wireless access
company developing innovative and cost effective products for developing
countries. Prior to founding eXS Network Technologies and eXS, Inc., Mr.
Wittmeyer was active in technology investing in telecommunications and
semi-conductor companies. Mr. Wittmeyer was employed by W.R. Grace and Exxon
Enterprises. Mr. Wittmeyer received a B.Sc. (E.E.) from the Coast Guard Academy
and an M.B.A. from Columbia University Graduate School of Business
Administration. Mr. Wittmeyer was recommended to the Board of Directors by
Halfmoon Bay, pursuant to the Securities Purchase Agreement dated March 28, 2008
between Electronic Sensor Technology and Halfmoon Bay.
Philip Yee
Philip Yee, age 59, currently serves as Secretary, Treasurer and Chief
Financial Officer of Electronic Sensor Technology. Mr. Yee has served as
Secretary, Treasurer and Chief Financial Officer of Electronic Sensor Technology
since November 1, 2006. From April 2006 through November 1, 2006, Mr. Yee served
as Controller of Electronic Sensor Technology. From February 2005 through April
2006, Mr. Yee was Corporate Controller of Sleepwell Laboratories, Inc., a
regional healthcare provider, and its related companies. From 2001 through
February 2005, Mr. Yee was Corporate Controller of BLT Enterprises, Inc., a
regional recycling company and real estate developer, and its related companies.
Mr. Yee received a B.A. and an M.B.A. from the University of Michigan.
FAMILY RELATIONSHIPS AND INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS
Each of our directors holds office until the next annual meeting of our
shareholders, or until his prior death, resignation or removal. Two of our
directors, Maggie Tham and William Wittmeyer, are married to each other. Other
than the marriage of such directors, there are no family relationships among our
directors or executive officers. Within the past five years, there has not been
any bankruptcy petition filed by or against any business of which any of our
officers, directors or control persons were a general partner or executive
officer either at the time of the bankruptcy or within two years prior to that
time. None of our officers, directors or control persons has been convicted in a
criminal proceeding in the past five years or is subject to a pending criminal
proceeding (excluding traffic violations and other minor offenses). None of our
officers, directors or control persons is subject to any order, judgment, or
decree, not subsequently reversed, suspended or vacated, of any court of
competent jurisdiction, permanently or temporarily enjoining, barring,
suspending or otherwise limiting his involvement in any type of business,
securities or banking activities. None of our officers, directors or control
persons has been found by a court of competent jurisdiction (in a civil action),
the Securities and Exchange Commission or the Commodity Futures Trading
Commission to have violated a federal or state securities or commodities law,
where the judgment has not been reversed, suspended, or vacated.
20
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires that the
company's officers, directors and persons who beneficially own more than ten
percent (10%) of the company's outstanding common stock, file reports of
ownership and changes in ownership with the Securities and Exchange Commission.
Such persons are required by the Securities and Exchange Commission to furnish
the company with copies of all Section 16(a) reports they file.
To the best of our knowledge, based solely on review of copies of such
reports, including Forms 3, 4 and 5 and amendments thereto, we are aware of the
following persons who, during the period ended December 31, 2008, did not file
on a timely basis reports required by Section 16(a) of the Securities Exchange
Act of 1934:
o Halfmoon Bay Capital Ltd did not timely file an initial statement of
beneficial ownership on Form 3 reporting ownership of more than ten
percent (10%) of the company's outstanding common stock.
o Maggie Tham did not timely file one Form 3 reporting her appointment
as a director of the company and one Form 4 reporting the grant of an
option to purchase 500,000 shares of the company's common stock.
o William Wittmeyer did not timely file one Form 3 reporting his
appointment as a director of the company and one Form 4 reporting the
grant of an option to purchase 500,000 shares of the company's common
stock.
o Low Gay Teck did not timely file one Form 3 reporting his appointment
as a director of the company.
o Thomas Dudley did not timely file one Form 3 reporting his appointment
as a director of the company.
CODE OF ETHICS
We have adopted a code of ethics that applies to our principal executive
officer, principal financial officer and principal accounting officer or
controller, or persons performing similar functions. A copy of our code of
ethics is attached as Exhibit 14 to our annual report on Form 10-KSB for the
fiscal year ended December 31, 2004. Our code of ethics will be provided to any
person without charge, upon request. Requests should be addressed to: Electronic
Sensor Technology, Inc., Attn: Investor Relations Department, 1077 Business
Center Circle, Newbury Park, California 91320.
NOMINATING COMMITTEE
There have been no material changes to the procedures by which security
holders may recommend nominees to the company's Board of Directors.
AUDIT COMMITTEE
We have a separately designated standing audit committee, which is
comprised of William Wittmeyer, Maggie Tham and Thomas Dudley, who is the
chairman of the audit committee. Our Board of Directors has determined that at
least one person on the audit committee, Thomas Dudley, qualifies as a financial
expert. Although there are no standards applicable to us regarding the
independence of our audit committee members, Dr. Dudley would be considered
independent using the standards contained in the NASDAQ Marketplace Rules, as
described further below under "Item 13. Certain Relationships and Related
Transactions, and Director Independence."
Item 11. Executive Compensation.
SUMMARY COMPENSATION
The table below outlines the total compensation of the named executive
officers of Electronic Sensor Technology for the fiscal years ended December 31,
2007 and December 31, 2008.
21
SUMMARY COMPENSATION TABLE (1)
Stock Option All Other
Name and Salary Bonus Awards Awards Compensation Total
Pincipal Position Year ($)(2) ($) ($) ($)(3) ($)(4) ($)
----------------------- ---- --------- ------- -------- ---------- ------------ ----------
Teong C. Lim, 2007 100,532 - - 10,000(6) 74,049(7) 184,581
President and Chief
Executive Officer
(July 25, 2008 -
Present) 2008 40,502(8) - - - 111,618(9) 152,120
Interim Chief
Scientist (February
11, 2009 - Present)
Former President and
Chief Executive
Officer (January 26,
2006 - July 15, 2007)
Former Vice President
of Corporate
Development (February
1, 2005 - January 25,
2006)
Director (January 31,
2005 - Present)
Chairman (May 1, 2008
- Present)(5)
Barry S. Howe, 2007 116,923 - - 80,000(10) - 196,923
Former President and
Chief Executive
Officer (July 16, 2007
- July 25, 2008) 2008 122,647(11) - - - 85,850(12) 208,497
Former Chief Operating
Officer (April 11,
2007 - July 15, 2007)
Former Director (July
16, 2007 - July 25,
2008)(5)
Gary Watson, 2007 142,773 _ _ 10,000(13) 4,283(14) 157,056
Former Vice President
of Engineering (May
26, 2005 - February
11, 2009) 2008 133,987 _ _ _ 4,020(14) 138,007
Former Interim
Chief Scientist
22
Stock Option All Other
Name and Salary Bonus Awards Awards Compensation Total
Pincipal Position Year ($)(2) ($) ($) ($)(3) ($)(4) ($)
----------------------- ---- --------- ------- -------- ---------- ------------ ----------
(March 8,
2007 - February 11,
2009)
Philip Yee, 2007 120,961 - - 10,000(15) 3,629(14) 134,590
Secretary, Treasurer
and Chief Financial
Officer (November 1,
2006 - Present) 2008 121,156 - - - 3,635(14) 124,791
William Wittmeyer 2007 - - - - - -
Chief Operating
Officer (November 24, 2008 - - - 5,750(16) 28,167(17) 33,917
2008 - Present)
Director (May 1, 2008
- Present)
(1) The columns entitled "Non-Equity Incentive Plan Compensation" and
"Nonqualified Deferred Compensation Earnings" have been omitted from the Summary
Compensation Table because there has been no compensation awarded to, earned by,
or paid to any of the named executive officers required to be reported in such
columns.
(2) Amounts represent all pre-tax salaries and include any amounts earned but
deferred under the company's 401(k) plan.
(3) The manner in which the company values stock and option awards is outlined
in Note 1 to the company's consolidated financial statements under the heading
"Stock-Based Compensation" as well as Note 5 under the heading "Stockholders'
Deficit" included in this annual report. We did not grant any stock awards to
the named executive officers during our 2007 fiscal year or our 2008 fiscal
year.
(4) All named executive officers are covered by the company's health insurance
plan, which does not discriminate in scope, terms or operation, in favor of
named executive officers or directors and is generally available to all salaried
employees. As a result, the information regarding health insurance premiums paid
to the named executive officers has been omitted from the Summary Compensation
Table.
(5) Barry Howe and Teong Lim did not receive any compensation for their
services as directors of the company in either 2007 or 2008.
(6) On January 16, 2007, Teong Lim was granted an option under our 2005 Stock
Incentive Plan to acquire 100,000 shares of our common stock, par value $0.001
per share, at an exercise price of $0.24 per share. The option shares will vest
as follows: one quarter vested on January 16, 2008, one quarter vested on
January 16, 2009, one quarter will vest on January 16, 2010 and one quarter will
vest on January 16, 2011. On March 5, 2007, Dr. Lim was granted an option under
our 2005 Stock Incentive Plan to acquire 40,000 shares of our common stock, par
value $0.001 per share, at an exercise price of $0.19 per share. The option
shares were fully vested upon grant. The manner in which the company values the
option awards is outlined in Note 1 to the company's consolidated financial
statements under the heading "Stock-Based Compensation" as well as Note 5 under
the heading "Stockholders' Deficit" included in this annual report.
(7) Amount represents (i) $67,185 paid to Dr. Lim in exchange for consulting
services, (ii) $3,016 in 401(k) contributions by the company and (iii) $3,848
paid to Dr. Lim as reimbursement for health insurance premiums.
(8) Amount represents salary paid to Dr. Lim in his capacity as President and
Chief Executive Officer of the company for the period of July 25, 2008 through
December 31, 2008.
23
(9) Amount represents (i) $100,261 paid to Dr. Lim in exchange for consulting
services, (ii) $1,215 in 401(k) contributions by the company and (iii) $10,142
paid to Dr. Lim as reimbursement for health insurance premiums.
(10) On July 16, 2007, Barry Howe was granted an option to acquire 1,000,000
shares of our common stock, the option to acquire 500,000 of which were granted
under our 2005 Stock Incentive Plan, par value $0.001 per share, at an exercise
price of $0.20 per share, which is the average of the quoted closing price of
our common stock over the five trading days ending on July 16, 2007. The option
grant was evidenced by a Notice of Grant of Stock Option and Option Agreement
substantially in the form attached as Exhibit 10.2 to our annual report on Form
10-KSB for the fiscal year ended December 31, 2004 filed with the Commission on
April 15, 2005. 100,000 of the option shares were fully vested upon grant and
225,000 vested on April 11, 2008. The remaining option shares would have vested
22.5% annually, provided that Mr. Howe was still employed by Electronic Sensor
Technology at the end of each annual period. On July 25, 2008, Mr. Howe resigned
from his position as President and Chief Executive Officer and as a director of
Electronic Sensor Technology, and is no longer employed by Electronic Sensor
Technology. In accordance with the terms of the Option Agreement, Mr. Howe's
resignation resulted in the forfeiture of the unvested option to purchase
675,000 shares of common stock, and Mr. Howe had three months from July 25, 2008
in which to exercise the vested option to purchase 325,000 shares of common
stock. Mr. Howe did not exercise the vested option within three months of July
25, 2008 and the option expired.
(11) Amount represents salary paid to Mr. Howe in his capacity as President and
Chief Executive Officer of the company for the period of January 1, 2008 through
July 25, 2008.
(12) Amount represents (i) $82,171 received as severance pursuant to the
Severance Agreement and Mutual Release, as more fully described under the
heading "Severance and Termination Agreements" below and (ii) $3,679 in 401(k)
contributions by the company.
(13) On January 16, 2007, Gary Watson was granted an option under our 2005 Stock
Incentive Plan to acquire 100,000 shares of our common stock, par value $0.001
per share, at an exercise price of $0.24 per share. 12,500 of the option shares
vested on each of January 16, 2008 and January 16, 2009 and 12,500 of the option
shares vested on each of September 8, 2007 and September 8, 2008. The remaining
options shares would have vested as follows: 12,500 on January 16, 2010, 12,500
January 16, 2011, 12,500 on September 8, 2009 and 12,500 on September 8, 2010,
provided that Mr. Watson was still employed by Electronic Sensor Technology at
the end of each period. On March 5, 2007, Mr. Watson was granted an option under
our 2005 Stock Incentive Plan to acquire 87,500 shares of our common stock, par
value $0.001 per share, at an exercise price of $0.19 per share. The option
shares were fully vested upon grant. Each of the option grants was evidenced by
a Notice of Grant of Stock Option and Option Agreement substantially in the form
attached as Exhibit 10.2 to our annual report on Form 10-KSB for the fiscal year
ended December 31, 2004 filed with the Commission on April 15, 2005. On February
11, 2009, Mr. Watson was terminated from his position as Vice President of
Engineering and interim Chief Scientist of Electronic Sensor Technology, and is
no longer employed by Electronic Sensor Technology. In accordance with the terms
of the Option Agreements, Mr. Watson's termination resulted in the forfeiture of
the unvested options to purchase 50,000 shares of common stock, and Mr. Watson
has three months from February 11, 2008 in which to exercise vested options to
purchase 50,000 shares of common stock and 87,500 shares of common stock. The
manner in which the company values the option awards is outlined in Note 1 to
the company's consolidated financial statements under the heading "Stock-Based
Compensation" as well as Note 5 under the heading "Stockholders' Deficit"
included in this annual report.
(14) Amounts represent 401(k) contributions by the company, as described under
the heading "401(k) Plan" below.
(15) On January 16, 2007, Philip Yee was granted an option under our 2005 Stock
Incentive Plan to acquire 100,000 shares of our common stock, par value $0.001
per share, at an exercise price of $0.24 per share. The option shares granted to
Mr. Yee will vest as follows: 15,000 of the option shares were fully vested upon
grant of the options, 6,250 vested on January 16, 2008, 6,250 vested on January
16, 2009, 6,250 will vest on January 16, 2010, 6,250 will vest on January 16,
2011, 15,000 vested on April 3, 2007, 15,000 vested on April 3, 2008, 15,000
will vest on April 3, 2009 and 15,000 will vest on April 3, 2010. The manner in
which the company values the option awards is outlined in Note 1 to the
company's consolidated financial statements under the heading "Stock-Based
Compensation" as well as Note 5 under the heading "Stockholders' Deficit"
included in this annual report.
(16) On July 25, 2008, William Wittmeyer was granted an option under our 2005
Stock Incentive Plan to acquire 500,000 shares of our common stock, par value
$0.001 per share, at an exercise price of $0.03 per share (which was the closing
price of the common stock on July 25, 2008). The option shares will vest as
follows: 125,000 will vest on July 25, 2009, 125,000 will vest on July 25, 2010,
125,000 will vest on July 25, 2011 and 125,000 will vest on July 25, 2012. The
manner in which the company
24
values the option awards is outlined in Note 1 to the company's consolidated
financial statements under the heading "Stock-Based Compensation" as well as
Note 5 under the heading "Stockholders' Deficit" included in this annual report.
(17) Amount represents (i) $26,667 paid to Mr. Wittmeyer in exchange for
consulting services and (ii) $1,500 as an attendance fee for attending a meeting
of the Board of Directors. Mr. Wittmeyer was appointed Chief Operating Officer
of the company on November 24, 2008 and he no longer receives compensation for
attending Board meetings.
NARRATIVE DISCLOSURE TO SUMMARY COMPENSATION TABLE AND ADDITIONAL NARRATIVE
DISCLOSURE
Employment and Consulting Agreements
Philip Yee. On March 16, 2006, Philip Yee accepted an offer letter extended
by Electronic Sensor Technology regarding his employment with Electronic Sensor
Technology as Controller, which is attached as Exhibit 10.2 to our amended
current report on Form 8-K/A filed February 14, 2007 and is incorporated herein
by reference. The offer letter set Mr. Yee's salary at $75,000 per year, to be
adjusted to $80,000 per year after completion of a three-month trial period, and
included an agreement by Electronic Sensor Technology to grant to Mr. Yee an
option to purchase 75,000 shares of common stock, subject to approval by the
Board of Directors (an option to purchase 100,000 shares of common stock of the
company, was approved by the Board of Directors and granted to Mr. Yee on
January 16, 2007). On October 16, 2006, the Board of Directors appointed Mr. Yee
to become Secretary, Treasurer and Chief Financial Officer of the company,
effective November 1, 2006. In connection with the appointment of Mr. Yee as
Secretary, Treasurer and Chief Financial Officer of Electronic Sensor
Technology, Electronic Sensor Technology and Mr. Yee entered into an oral
agreement to increase Mr. Yee's annual salary to $110,000 through April 1, 2007,
at which point Electronic Sensor Technology and Mr. Yee have orally agreed to
increase Mr. Yee's annual salary to $125,000. On September 1, 2008, Mr. Yee
agreed to reduce his annual salary to $112,507.
Barry Howe. On March 28, 2007, Barry Howe accepted an offer letter extended
by Electronic Sensor Technology regarding his employment with Electronic Sensor
Technology as Chief Operating Officer, which is attached as Exhibit 10.1 to our
current report on Form 8-K filed April 3, 2007 and is incorporated herein by
reference. The offer letter provides that Mr. Howe will serve as Chief Operating
Officer of Electronic Sensor Technology for a trial period of three months, at
the end of which the Board of Directors will evaluate Mr. Howe and consider him
for the position of Chief Executive Officer. The letter also contemplates
nominating Mr. Howe to serve as a director of the Electronic Sensor Technology
at such time. The offer letter sets Mr. Howe's salary at $150,000 per year, to
be reviewed after the three-month trial period, and provides for an option to
purchase 1 million shares of the company's common stock to be granted to Mr.
Howe at the end of such trial period if Mr. Howe is appointed Chief Executive
Officer at such time, of which 100,000 of the option shares will be vested on
the date of the grant and 900,000 of the option shares will vest in installments
of 25% per year on each anniversary of Mr. Howe's employment. On July 16, 2007,
the Board of Directors appointed Mr. Howe to become President and Chief
Executive Officer of the company. In connection with his appointment, Mr. Howe's
annual salary was increased from $150,000 to $185,000. In addition, the Board of
Directors approved the grant of an option to acquire 1 million shares of common
stock of the company.
Teong C. Lim. On July 16, 2007, Teong C. Lim announced his retirement as
President and Chief Executive Officer to the Board of Directors of the company,
effective as of such date. Following such date, Dr. Lim continued to serve as a
director of and a consultant to the company. On July 17, 2007, Dr. Lim and the
company entered into a letter agreement regarding the company's engagement of
Dr. Lim as a consultant through January 17, 2008 for a monthly fee of $13,437,
as more fully described in Exhibit 10.1 to our current report on Form 8-K filed
July 18, 2007 and is incorporated herein by reference. The consulting agreement
with Dr. Lim was extended on January 17, 2008 on a month-to-month basis at the
same retainer fee, and was subsequently terminated on July 25, 2008, when Dr.
Lim resumed his position as President and Chief Executive Officer of the
company. On September 1, 2008, Dr. Lim agreed to reduce his annual salary from
$161,244 to $81,244.
William Wittmeyer. On November 24, 2008, the registrant, William Wittmeyer
and Wittham, a California corporation wholly owned by Mr. Wittmeyer and
employing Mr. Wittmeyer, entered into an Independent Contractor Agreement, which
is attached as Exhibit 10.1 to our amended current report on Form 8-K/A filed
January 5, 2009 and is incorporated herein by reference. Pursuant to the
Independent Contractor Agreement, the registrant engaged Wittham to have Mr.
Wittmeyer serve as an independent contractor to act as Chief Operating Officer
and Wittham will be paid $6,666.67 per month in consideration of the services of
Mr. Wittmeyer as Chief Operating Officer of the registrant.
Severance and Termination Agreements
25
Barry S. Howe. On July 25, 2008, the Board of Directors of Electronic
Sensor Technology accepted Barry S. Howe's resignation as President and Chief
Executive Officer and a director of the company. In connection and concurrently
with such resignation, the company and Mr. Howe entered into a Severance
Agreement and Mutual Release, which is attached as Exhibit 10.1 to our current
report on Form 8-K filed on July 29, 2008 and is incorporated herein by
reference. The Severance Agreement and Mutual Release provides for payment of
five and one-third months' salary as severance to Mr. Howe (totaling $82,170.83)
by the company.
Gary Watson. On February 11, 2009, Gary Watson's employment with Electronic
Sensor Technology as Vice President of Engineering and interim Chief Scientist
was terminated. In connection with Mr. Watson's departure, he received (i)
payment of two weeks' salary (totaling $4,392.96) and (ii) payment for accrued
but unused vacation time as of the Effective Date (totaling $13,254.62).
Electronic Sensor Technology will also continue to provide Mr. Watson with
medical benefits through April 30, 2009.
Retirement Agreements
The company has an agreement with Teong Lim under which, so long as he
continues to be employed by the company until retirement age, which is currently
65 years of age, the company shall provide Medigap insurance, also known as
Medicare supplemental insurance, to Dr. Lim after retirement until his death.
401(k) Plan
The company sponsors a 401(k) retirement savings plan which covers its
full-time employees who have been employed by the company for at least one (1)
year. Eligible employees may elect to contribute a percentage of their
compensation to the 401(k) plan, subject to the maximum amount established
annually under Section 401(k) of the Internal Revenue Code. In each of 2007 and
2008, the company contributed an amount equal to three percent (3%) of each
employee's respective compensation to the 401(k) plan account of each eligible
employee.
Other than the agreements mentioned herein, we have no employment
agreements with any of our named executive officers, nor do we have any
compensatory plans or arrangements with respect to any named executive officers
that results or will result from the resignation, retirement or any other
termination of such executive officer's employment with Electronic Sensor
Technology or from a change-in-control of Electronic Sensor Technology or a
change in the named executive officer's responsibilities following a
change-in-control wherein the amount involved, including all periodic payments
or installments, exceeds $100,000.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table outlines all outstanding equity awards held by named
executive officers as of the fiscal year ended December 31, 2008.
26
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END(1)
Option Awards
---------------------------------------------------------------------------------------------
Equity
Incentive Plan
Number of Number of Awards: Number
Securities Securities of Securities
Underlying Underlying Underlying Option
Unexercised Unexercised Unexercised Exercise Option
Options Options (#) Unearned Price Expiration
Name (#) Exercisable Unexercisable Options (#) ($) Date
-------------------- ----------------- --------------- ---------------- ------------ ------------------
Teong C. Lim 80,000(2) - - $ 1.00 February 1, 2015
50,000(3) 50,000 50,000 $ 0.24 January 16, 2017
40,000(3) - - $ 0.19 March 5, 2017
Barry S. Howe -(4) - - - -
Gary Watson 175,000(5) - - $ 1.00 February 1, 2015
50,000(3) 50,000 50,000 $ 0.24 January 16, 2017
87,500(3) $ 0.19 March 5, 2017
Philip Yee 72,500(3) 27,500 27,500 $ 0.24 January 16, 2017
William Wittmeyer -(3) 500,000 500,000 $ 0.03 July 25, 2018
(1) The columns related to stock awards have been omitted because there were no
outstanding unvested stock awards as of the fiscal year ended December 31, 2008.
(2) Teong Lim was granted an option to purchase 80,000 limited partnership
interests of Electronic Sensor Technology, L.P. at $1.00 per limited partnership
interest on December 31, 2003. Such option was terminated in connection with the
merger whereby Electronic Sensor Technology, L.P. became an indirect subsidiary
of Electronic Sensor Technology, Inc. and was replaced with an option to
purchase 80,000 shares of common stock of Electronic Sensor Technology, Inc. at
$1.00 per share. Such option was accounted for at the time of the original grant
of Electronic Sensor Technology, L.P. options and no dollar amount was
recognized in connection therewith for financial statement reporting purposes
with respect to the 2005 fiscal year.
(3) For the vesting dates of such options, see the footnotes to the Summary
Compensation Table.
(4) See footnote 10 to the Summary Compensation Table.
(5) Gary Watson was granted options to purchase (i) 50,000 limited partnership
interests of Electronic Sensor Technology, L.P. at $1.00 per limited partnership
interest on March 15, 1999, (ii) 50,000 limited partnership interests of
Electronic Sensor Technology, L.P. at $1.05 per limited partnership interest on
July 1, 2000, (iii) 50,000 limited partnership interests of Electronic Sensor
Technology, L.P. at $1.05 per limited partnership interest on May 15, 2001 and
(iv) 25,000 limited partnership interests of Electronic Sensor Technology, L.P.
at $1.05 per limited partnership interest on September 15, 2002. Such options
were terminated in connection with the merger whereby Electronic Sensor
Technology, L.P. became an indirect subsidiary of Electronic Sensor
27
Technology, Inc., and were replaced with an option to purchase 175,000 shares of
common stock at $1.00 per share. Such option was accounted for at the time of
the original grants of Electronic Sensor Technology, L.P. options and no dollar
amount was recognized in connection therewith for financial statement reporting
purposes with respect to the 2005 fiscal year.
DIRECTOR COMPENSATION
The following table sets forth the compensation paid by Electronic Sensor
Technology to all non-employee directors for the fiscal year ended December 31,
2008.
DIRECTOR COMPENSATION (1)
Fees Earned or All Other
Paid in Cash Option Awards Compensation Total
Name (2) ($) ($)(3) ($)(4) ($)
---------------------------------------- -------------- ---------------- -------------- ----------
Thomas Dudley - 4,600(5) - 4,600
(November 24, 2008 - Present)
Low Gay Teck - 4,600(6) - 4,600
(September 1, 2008 - Present)
Maggie Tham 1,500(7) 5,750(8) - 7,250
(May 1, 2008 - Present)
Lewis E. Larson 2,000(9) - - 2,000
(September 7, 2006 - February 19, 2009)
James Wilburn 14,000(10) - - 14,000
(September 2005 - November 24, 2008)
Rita Benoy Bushon 5,000(11) - - 5,000
(October 26, 2007 - September 1, 2008)
James Frey 10,000(12) - - 10,000
(February 21, 2005 - May 1, 2008)
Francis Chang 1,500(13) - 5,206(14) 6,706
(January 31, 2005 - May 1, 2008)
(1) The columns entitled "Stock Awards," "Non-Equity Incentive Plan
Compensation" and "Nonqualified Deferred Compensation Earnings" have been
omitted from the Director Compensation Table because there has been no
compensation awarded to, earned by, or paid to any of the directors required to
be reported in such columns.
(2) Barry Howe, Teong Lim and William Wittmeyer are not included in the
Director Compensation Table because any compensation received by Mr. Howe, Dr.
Lim and Mr. Wittmeyer as directors of Electronic Sensor Technology for the
fiscal year ended December 31, 2008 is reflected in the Summary Compensation
Table above.
(3) The manner in which the company values stock and option awards is outlined
in Note 1 to the company's consolidated financial statements under the heading
"Stock-Based Compensation" as well as Note 5 under the heading "Stockholders'
Deficit" included in this annual report. We did not grant any stock awards to
the directors during our 2007 fiscal year or our 2008 fiscal year.
28
(4) The company reimburses each director who is not an officer or employee of
the company for reasonable out-of-pocket expenses for attending board meetings.
In 2008, with respect to each director, the aggregate amount of such expenses
amounted to less than $10,000.
(5) On November 24, 2008, Thomas Dudley was granted an option under our 2005
Stock Incentive Plan to acquire 500,000 shares of our common stock, par value
$0.001, at an exercise price of $0.02 per share. The option shares will vest as
follows: 125,000 will vest on November 24, 2009, 125,000 will vest on November
24, 2010, 125,000 will vest on November 24, 2011 and 125,000 will vest on
November 24, 2012. The manner in which the company values the option awards is
outlined in Note 1 to the company's consolidated financial statements under the
heading "Stock-Based Compensation" as well as Note 5 under the heading
"Stockholders' Deficit" included in this annual report.
(6) On November 24, 2008, Low Gay Teck was granted an option under our 2005
Stock Incentive Plan to acquire 500,000 shares of our common stock, par value
$0.001, at an exercise price of $0.02 per share. The option shares will vest as
follows: 125,000 will vest on November 24, 2009, 125,000 will vest on November
24, 2010, 125,000 will vest on November 24, 2011 and 125,000 will vest on
November 24, 2012. The manner in which the company values the option awards is
outlined in Note 1 to the company's consolidated financial statements under the
heading "Stock-Based Compensation" as well as Note 5 under the heading
"Stockholders' Deficit" included in this annual report.
(7) In 2008, Maggie Tham received an attendance fee of $1,500 per meeting.
(8) On July 25, 2008, Maggie Tham was granted an option under our 2005 Stock
Incentive Plan to acquire 500,000 shares of our common stock, par value $0.001
per share, at an exercise price of $0.03 per share (which was the closing price
of the common stock on July 25, 2008). The option shares will vest as follows:
125,000 will vest on July 25, 2009, 125,000 will vest on July 25, 2010, 125,000
will vest on July 25, 2011 and 125,000 will vest on July 25, 2012. The manner in
which the company values the option awards is outlined in Note 1 to the
company's consolidated financial statements under the heading "Stock-Based
Compensation" as well as Note 5 under the heading "Stockholders' Deficit"
included in this annual report.
(9) In 2008, Lewis Larson received an attendance fee of $2,000 per meeting.
(10) In 2008, James Wilburn received an attendance fee of $1,500 per meeting and
a monthly retainer fee of $1,000, which was paid quarterly.
(11) In 2008, Rita Benoy Bushon received an attendance fee of $2,500 per
meeting.
(12) James Frey received an attendance fee of $2,000 per meeting and a monthly
retainer fee of $2,000, which was paid quarterly.
(13) In 2008, Francis Chang received an attendance fee of $1,500 per meeting.
(14) Amount represents $5,206 in health insurance premiums paid by the company
on behalf of Francis Chang.
NARRATIVE TO DIRECTOR COMPENSATION
Agreements with Directors
The company has agreements with each of the directors listed in the
Director Compensation Table to continue to pay the meeting attendance fees set
forth in such table, as well as to reimburse such directors for reasonable
out-of-pocket expenses for attending board meetings.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The following table sets forth information, as of the date of this annual
report, concerning our issued and outstanding stock beneficially owned (i) by
each director and each named executive officer of Electronic Sensor Technology,
(ii) by all directors and executive officers of Electronic Sensor Technology as
a group and (iii) by each shareholder known by Electronic Sensor Technology to
be the beneficial owner of more than 5% of the outstanding common stock. The
information regarding beneficial owners of 5% or more of our common stock was
gathered by us from the filings made by such owners with the SEC or
29
from other sources. Shares that may be acquired within 60 days are treated as
outstanding for purposes of determining the amount and percentage beneficially
owned.
Amount and Nature of
Name and Address Beneficial Ownership Percentage
Title of Class of Beneficial Owner (1) (Shares of Stock) of Class (2)
-------------- ----------------------------------- -------------------- ------------
Common stock Teong Lim*+++ 8,495,025(3) 5.44%
Common stock Philip Yee+ 72,500(4) 0.05%
Common stock Thomas Dudley* 0 0.00%
Common stock Low Gay Teck* 0(5) 0.00%
Common stock Maggie Tham* 0 0.00%
Common stock William Wittmeyer+* 0 0.00%
Common stock L&G Resources (1994), Inc. (wholly
owned by Land & General Berhad)++ 9,632,534(6) 6.18%
Common stock Midsummer Investment Ltd.++ 13,708,957(7) 8.58%
Common stock Halfmoon Bay Capital Ltd++ 127,572,016(8) 64.76%
Common stock Fairwind LLC++ 8,325,025(9) 5.34%
Common stock All directors and named executive
officers as a group 8,567,525(10) 5.64%
* Director
+ Named executive officer
++5% or more beneficial owner
(1) The address of each director and named executive officer and Fairwind LLC
is c/o Electronic Sensor Technology, Inc., 1077 Business Center Circle, Newbury
Park, California 91320. The address of Midsummer Investment Ltd. is 295 Madison
Avenue, 38th Floor, New York, New York 10017. The address of each of L&G
Resources (1994), Inc. and Land & General Berhad is 7 Persiaran Dagang, Bandar
Sri Damansara, Kuala Lumpur, Malaysia 52200. The address of Halfmoon Bay Capital
Ltd is Trident Chambers, P.O. Box 146, Road Town Tortola, British Virgin
Islands.
(2) These percentages are calculated based upon the total amount of outstanding
shares of common stock beneficially owned by each person or group, including
shares of common stock that person or group has the right to acquire within 60
days pursuant to options, warrants, conversion privileges or other rights,
divided by 155,853,385, which represents the total number of shares of common
stock issued and outstanding as of the date of this annual report, plus, for
each person or group, any shares of common stock that person or group has the
right to acquire within 60 days pursuant to options, warrants, conversion
privileges or other rights.
(3) Includes 170,000 shares of common stock underlying options exercisable
within 60 days of the date of this annual report held by Teong Lim and 4,729,112
shares of common stock held by TC Lim, LLC and 3,595,913 shares of common stock
held by 3 Springs, LLC. Fairwind LLC is the sole member of each of TC Lim, LLC
and 3 Springs, LLC and by virtue of such relationships, beneficially owns the
shares of common stock held by TC Lim, LLC and 3 Springs, LLC. Teong Lim and
Francis Chang are the
30
sole members of Fairwind LLC. By virtue of Dr. Lim's position as a member of
Fairwind LLC, he shares ultimate beneficial ownership of the shares of common
stock held by TC Lim, LLC and 3 Springs, LLC.
(4) Includes 72,500 shares of common stock underlying an option exercisable
within 60 days of the date of this annual report.
(5) Mr. Low is the Managing Director of Land & General Berhad and President of
L&G Resources (1994), Inc., a wholly owned subsidiary of Land & General Berhad.
By virtue of his position, Mr. Low may be deemed to share dispositive power over
the 9,632,534 shares of common stock beneficially owned by Land & General Berhad
and L&G Resources (1994), Inc. Mr. Low is one of ten directors on the Board of
Directors of Land & General Berhad and the Board of Directors of Land & General
Berhad makes the ultimate voting and investment decisions with respect to the
9,632,534 shares of common stock. Mr. Low disclaims beneficial ownership of such
shares of common stock.
(6) Includes 9,632,534 shares of common stock held by L&G Resources (1994),
Inc., a wholly-owned subsidiary of Land & General Berhad, of which Land &
General Berhad is a beneficial owner. Low Gay Teck is President of L&G Resources
(1994), Inc. and Managing Director of Land & General Berhad. By reason of such
relationships, Mr. Low may be deemed to share dispositive power over the shares
of common stock beneficially owned by L&G Resources (1994), Inc. Mr. Low
expressly disclaims beneficial ownership as Mr. Low is one of ten directors on
the Board of Directors of Land & General Berhad and the Board of Directors of
Land & General Berhad makes the ultimate voting and investment decisions with
respect to the 9,632,534 shares of common stock.
(7) Includes 3,899,030 shares of common stock underlying a warrant exercisable
within 60 days of this annual report. The exercise of the warrant is
contractually capped such that such exercise shall not cause Midsummer's
beneficial ownership to exceed 4.99%, unless waived by Midsummer, and in no
event to exceed 9.99% (without giving effect to shares of common stock
underlying any unexercised portion of the warrant). Midsummer Capital, LLC, a
New York limited liability company, serves as investment advisor to Midsummer
Investment Ltd., a Bermuda company. By reason of such relationships, Midsummer
Capital may be deemed to share dispositive power over the shares of common stock
beneficially owned by Midsummer Investment. Midsummer Capital disclaims
beneficial ownership of such shares of common stock. Michel A. Amsalem and Scott
D. Kaufman are members of Midsummer Capital. By reason of such relationships,
Mr. Amsalem and Mr. Kaufman may be deemed to share dispositive power over the
shares of common stock stated as beneficially owned by Midsummer Investment. Mr.
Amsalem and Mr. Kaufman disclaim beneficial ownership of such shares of common
stock.
(8) Includes 41,152,263 shares of common stock underlying a debenture
convertible within 60 days of this annual report, held by Halfmoon Bay Capital
Ltd and beneficially owned by each of Wan Azmi Wan Hamzah and Nik Anida Bte Nik
Manshor by virtue of their positions as shareholders and directors of Halfmoon
Bay Capital Ltd. Halfmoon Bay Capital Ltd has three shareholders, who are Wan
Azmi Wan Hamzah, Nik Anida Bte Nik Manshor and Wan Afzal Bin Wan Azmi and two
directors, who are Wan Azmi Wan Hamzah and Nik Anida Bte Nik Manshor. Wan Afzal
Bin Wan Azmi may be deemed to share dispositive power over the shares of common
stock beneficially owned by Halfmoon Bay Capital Ltd. Wan Afzal Bin Wan Azmi
expressly disclaims beneficial ownership as Wan Afzal Bin Wan Azmi is not a
director of Halfmoon Bay Capital Ltd and the Board of Directors of Halfmoon Bay
Capital Ltd makes the ultimate voting and investment decisions with respect to
the 127,572,016 shares of common stock.
(9) Includes 4,729,112 shares of common stock held by TC Lim, LLC and 3,595,913
shares of common stock held by 3 Springs, LLC, which are beneficially owned by
Fairwind LLC by virtue of its position as the sole member of each of TC Lim, LLC
and 3 Springs, LLC. Francis Chang and Teong Lim, Chairman of the Board of
Directors of the company, are the sole members of Fairwind LLC. By virtue of
such relationships, Francis Chang and Teong Lim share ultimate beneficial
ownership of the shares of common stock beneficially owned by Fairwind LLC.
(10) Includes 242,500 shares of common stock underlying options exercisable
within 60 days of this annual report, as well as 4,729,112 shares of common
stock held by TC Lim, LLC and 3,595,913 shares of common stock held by 3
Springs, LLC.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
See disclosure under Item 5 of this annual report with respect to
information regarding securities authorized for issuance under equity
compensation plans.
31
Item 13. Certain Relationships and Related Transactions, and Director
Independence.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Halfmoon Bay Capital Ltd Debenture
On April 10, 2009, Electronic Sensor Technology received $1 million from
Halfmoon Bay in exchange for a debenture bearing an interest rate of 9% with a
maturity of one year. The debenture grants Halfmoon Bay a security interest in
all of the intellectual property of the company. Halfmoon Bay owns approximately
55% of the outstanding common stock of the company and beneficially owns an
additional 10% of the outstanding common stock of the company by virtue of the
shares underlying a 9% convertible debenture issued by Electronic Sensor
Technology to Halfmoon Bay on March 28, 2008, as described further below under
the heading "Securities Purchase Agreement with Halfmoon Bay Capital Ltd." The
9% debenture issued to Halfmoon Bay on April 10, 2009 is attached as Exhibit 4.1
to, and is more fully described in, our current report on Form 8-K filed on
April 15, 2009, which description is incorporated herein by reference.
Securities Purchase Agreement with Halfmoon Bay Capital Ltd
On March 28, 2008, Electronic Sensor Technology issued $2 million aggregate
principal amount of 9% convertible debentures with a conversion price of $0.0486
to Halfmoon Bay and 86,419,753 shares of the company's common stock in exchange
for $5.5 million from Halfmoon Bay, pursuant to a Securities Purchase Agreement
dated March 28, 2008 between the company and Halfmoon Bay, pursuant to which,
Halfmoon Bay acquired ownership of approximately 55% of the outstanding common
stock of the company, and beneficial ownership of an additional 10% of the
outstanding common stock of the company by virtue of the shares underlying its
9% convertible debenture. The Securities Purchase Agreement is attached as
Exhibit 10.1 to, and is more fully described in, our current report on Form 8-K
filed on April 3, 2008, which description is incorporated herein by reference.
Midsummer Investment, Ltd. and Islandia, L.P.
On September 7, 2006, Electronic Sensor Technology entered into a
Forbearance and Amendment Agreement with Midsummer Investment, Ltd. and
Islandia, L.P., which, at such time, each held an 8% convertible debenture and a
warrant, the common stock underlying which represented more than 5% of the
beneficial ownership of our outstanding shares of common stock. The Forbearance
and Amendment Agreement is attached as Exhibit 10.1 to, and is more fully
described in, our current report on Form 8-K filed September 8, 2006, which
description is incorporated herein by reference. On December 27, 2007,
Electronic Sensor Technology entered into a First Amendment Agreement with
Midsummer and Islandia, which is attached as Exhibit 10.1 to, and is more fully
described in, our amended current report on Form 8-K/A filed January 14, 2008,
which description is incorporated herein by reference.
On February 26, 2008, the company entered into a Conversion and Termination
Agreement with Midsummer and Islandia, which is attached as Exhibit 10.2 to, and
is more fully described in, our current report on Form 8-K filed February 27,
2008, which description is incorporated herein by reference. Pursuant to the
Conversion and Termination Agreement, on March 31, 2008, the company paid to
Midsummer and Islandia an aggregate amount of $3.5 million of the $7 million
outstanding principal amount of the convertible debentures. Further, pursuant to
the Conversion and Termination Agreement, Midsummer and Islandia converted the
remaining $3.5 million of the principal amount of their 8% convertible
debentures, together with interest thereon, at a conversion price of $0.35 per
share of common stock, and the remaining shares of common stock underlying the
warrants held by Midsummer and Islandia were reduced by 50%.
DIRECTOR INDEPENDENCE
Although we are not required to have independent directors on our Board of
Directors because our securities are not listed on a national securities
exchange or an inter-dealer quotation system that has director independence
requirements, two of the five directors on our Board are independent using the
definition of "independent director" contained in Rule 5605(a)(2) of the NASDAQ
Marketplace Rules. Our independent directors are Low Gay Teck and Thomas Dudley.
Under Rule 5605(a)(2) of the NASDAQ Marketplace Rules, an "independent director"
is generally defined as a person other than an executive officer or employee of
the company or another individual having a relationship which, in the opinion of
the company's Board of Directors, would interfere with the exercise of
independent judgment in carrying out the responsibilities of a director.
The members of our audit committee and our compensation committee include
Thomas Dudley, who is also the chairman of both committees, Maggie Tham and
William Wittmeyer. In addition to being an independent director under Rule
5605(a)(2), the NASDAQ audit committee independence standards (which are also
not applicable to us) contain NASDAQ Marketplace Rule 5605(c), which requires
that audit committee members meet certain additional independence requirements.
Thomas Dudley is independent under the NASDAQ audit committee independence
standards.
32
Item 14. Principal Accountant Fees and Services.
AUDIT FEES
The aggregate fees billed for the 2007 and 2008 fiscal years for
professional services rendered by our principal accountant, Sherb & Co., LLP,
for the audit of our annual financial statements and review of financial
statements included in our periodic reports on Form 10-Q and other services
provided in connection with statutory and regulatory filings were $53,000 and
$58,000 respectively.
AUDIT-RELATED FEES
No assurance or related services that are reasonably related to the
performance of the audit or review of our financial statements were rendered by
our principal accountants during the 2007 or 2008 fiscal year.
TAX FEES
The aggregate fees to be billed for professional services rendered by our
current principal accountant, Sherb & Co., LLP, for tax compliance and tax
advice were $7,500 and $5,000 for 2007 and 2008 fiscal years, respectively.
ALL OTHER FEES
No other products or services were provided by our principal accountants
during the 2007 or 2008 fiscal year, other than the services outlined in the
foregoing sections.
AUDIT COMMITTEE
Our audit committee has not to date adopted any pre-approval policies or
procedures.
33
Exhibit Index
Exhibit
Number Description
------- ----------------------------------------------------------------------
3.1 Articles of Incorporation of Electronic Sensor Technology, as amended
(incorporated by reference from Exhibit 3.1 of the registration
statement on Form SB-2 filed on January 6, 2006).
3.2 Bylaws of Electronic Sensor Technology, as amended (incorporated by
reference from Exhibit 3.1 of the current report on Form 8-K filed on
June 12, 2008).
4.1 Description of our common stock in Article Fourth of the Amendment to
Electronic Sensor Technology's Articles of Incorporation dated January
25, 2005 (incorporated by reference from Exhibit 3.1 of the
registration statement on Form SB-2 filed on January 6, 2006).
4.2 Description of rights of shareholders of Electronic Sensor Technology
in Article I and Article IX of Electronic Sensor Technology's Amended
and Restated Bylaws (incorporated by reference from Exhibit 3.1 of the
current report on Form 8-K filed on June 12, 2008).
4.3 Form of 9% Debenture dated April 10, 2009 issued by Electronic Sensor
Technology in favor of Halfmoon Bay Capital Ltd (incorporated by
reference from Exhibit 4.1 of the current report on Form 8-K filed on
April 15, 2009).
10.1 Electronic Sensor Technology, Inc. 2005 Stock Incentive Plan
(incorporated by reference from Exhibit 10.1 of the annual report on
Form 10-KSB filed on April 15, 2005).
10.2 Form of Stock Option Agreement (incorporated by reference from Exhibit
10.2 of the annual report on Form 10-KSB filed on April 15, 2005).
10.3 International Distributorship Agreement dated August 2005, between
Electronic Sensor Technology, Inc. and Beijing R&D Technology Co.,
Ltd. (incorporated by reference from Exhibit 10.12 of the amended
registration statement on Form SB-2/A filed on February 15, 2006).
10.4 International Distributorship Agreement dated October 21, 2005,
between Electronic Sensor Technology, Inc. and TechMondial, Ltd.
(incorporated by reference from Exhibit 10.13 of the amended
registration statement on Form SB-2/A filed on February 15, 2006).
10.5 Form of Securities Purchase Agreement dated as of December 7, 2005,
among Electronic Sensor Technology, Inc., Midsummer Investment, Ltd.
and Islandia, L.P. (incorporated by reference from Exhibit 10.1 of the
current report on Form 8-K filed on December 8, 2005).
10.6 Form of Registration Rights Agreement dated as of December 7, 2005,
among Electronic Sensor Technology, Inc., Midsummer Investment, Ltd.
and Islandia, L.P. (incorporated by reference from Exhibit 10.2 of the
current report on Form 8-K filed on December 8, 2005).
10.7 Form of Forbearance and Amendment Agreement dated as of September 7,
2006, among Electronic Sensor Technology, Inc., Midsummer Investment,
Ltd. and Islandia L.P. (incorporated by reference from Exhibit 10.1 of
the current report on Form 8-K filed on September 8, 2006).
10.8 Offer letter dated March 15, 2006 between Electronic Sensor
Technology, Inc. and Philip Yee (incorporated by reference from
Exhibit 10.2 of the amended current report on Form 8-K/A filed on
February 14, 2007).
10.9 Severance Agreement, Mutual Release and Promotion Agreement effective
as of March 8, 2007 between Electronic Sensor Technology, Inc. and
Edward Staples (incorporated by reference from Exhibit 10.1 of the
current report on Form 8-K filed on March 13, 2007).
10.10 Offer letter dated March 28, 2007 between Electronic Sensor
Technology, Inc. and Barry S. Howe (incorporated by reference from
Exhibit 10.1 of the current report on Form 8-K filed on April 3,
2007).
34
Exhibit
Number Description
------- ----------------------------------------------------------------------
10.11 Offer letter dated July 17, 2007 between Electronic Sensor Technology,
Inc. and Teong C. Lim (incorporated by reference from Exhibit 10.1 of
the current report on Form 8-K filed on July 18, 2007).
10.12 First Amendment Agreement dated as of December 27, 2007, among
Electronic Sensor Technology, Inc., Midsummer Investment, Ltd. and
Islandia L.P. (incorporated by reference from Exhibit 10.1 of the
amended current report on Form 8-K/A filed on January 14, 2008).
10.13 Conversation and Termination Agreement dated as of February 26, 2008,
among Electronic Sensor Technology, Inc., Midsummer Investment, Ltd.
and Islandia L.P. (incorporated by reference from Exhibit 10.2 of the
current report on Form 8-K filed on February 28, 2008).
10.14 Securities Purchase Agreement dated as of March 28, 2008, between
Electronic Sensor Technology, Inc. and Halfmoon Bay Capital Ltd
(incorporated by reference from Exhibit 10.1 of the current report on
Form 8-K filed on April 3, 2008).
10.15 Severance Agreement and Mutual Release dated as of July 25, 2008,
between Electronic Sensor Technology and Barry S. Howe (incorporated
by reference from Exhibit 10.1 of the current report on Form 8-K filed
on July 28, 2008).
10.16 Independent Contractor Agreement dated as of November 24, 2008, among
Electronic Sensor Technology, Wittham, a California corporation, and
William Wittmeyer (incorporated by reference from Exhibit 10.1 of the
amended current report on Form 8-K/A filed on January 5, 2009).
14.1 Code of Ethics (incorporated by reference from Exhibit 14 of the
annual report on Form 10-KSB for the fiscal year ended December 31,
2004 filed on April 15, 2005).
21.1 Subsidiaries of Electronic Sensor Technology (incorporated by
reference from Exhibit 21.1 of the registration statement on Form SB-2
filed on January 6, 2006).
24.1 Power of Attorney.
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.
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ELECTRONIC SENSOR TECHNOLOGY, INC.
(Registrant)
Date: April 15, 2009 By: /s/ Teong C. Lim
-------------------------------------
Teong C. Lim
President and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: April 15, 2009 By: /s/ Teong C. Lim
-------------------------------------
Teong C. Lim
President and Chief Executive Officer
(Principal Executive Officer)
Date: April 15, 2009 By: /s/ Philip Yee
-------------------------------------
Philip Yee
Secretary, Treasurer and Chief
Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
Date: April 15, 2009 By: *
-------------------------------------
Teong Lim, Chairman
Date: April 15, 2009 By: *
-------------------------------------
Thomas Dudley, Director
Date: April 15, 2009 By: *
--------------------------------
Low Gay Teck, Director
Date: April 15, 2009 By: *
-------------------------------------
Maggie Tham, Director
Date: April 15, 2009 By: *
-------------------------------------
William Wittmeyer, Director
*By: /s/ Philip Yee
------------------------------
Philip Yee
Attorney-in-Fact