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| ESNR.OB > SEC Filings for ESNR.OB > Form 10-K on 15-Apr-2009 | All Recent SEC Filings |
15-Apr-2009
Annual Report
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
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
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%
------------ ------------ ------------
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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%
============= ============ ============
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The following table sets forth, as a percentage of revenues, certain items included in our Income Statements (see Financial Statements and Notes) for the periods indicated:
Year Ended
December 31,
---------------------
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%)
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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.
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
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.
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