ELECTRONIC SYSTEMS TECHNOLOGY, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 - BASIS OF PRESENTATION

The financial statements, including notes, of Electronic Systems Technology, Inc. (the "Company") are representations of the Company’s management, which is responsible for their integrity and objectivity. The accompanying unaudited financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, as well as the instructions to Form 10-Q. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, the accompanying unaudited financial statements contain all adjustments, consisting of only normal recurring adjustments, necessary for a fair statement of its financial position as of September 30, 2020,March 31, 2021, and its results of operations, cash flows, and changes in stockholders’ equity for the three months ended March 31, 2021 and nine months ended September 30, 2020 and 2019.2020.  The balance sheet at December 31, 20192020 was derived from audited annual financial statements but does not contain all of the footnote disclosures from the annual financial statements. All amounts presented are in U.S. dollars. For further information, refer to the financial statements and footnotes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.  2020.  

The results of operations for the three month and nine-monththree-month period ended September 30, 2020March 31, 2021 are not necessarily indicative of the results expected for the full fiscal year or for any other fiscal period. The Company estimates that for 20202021 the anticipated effective annual federal income tax rate will be 0%.

New Accounting Standards Updates AdoptedPronouncements

In August 2018, the FASB issued ASU No. 2018-13 Fair Value Measurement (Topic 820):  Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.  The update removes, modifies and makes additions to the disclosure requirements on fair value measurements.  The update is effective for fiscal years beginning after December 15, 2019, with early adoption permitted.  The adoption of this update on January 1, 2020 had no impact on the financial statements.  

Other accountingAccounting standards that have been issued or proposed by FASBthe Financial Accounting Standards Board that do not require adoption until a future date are not expected to have a material impact on the financial statements upon adoption.

NOTE 2 - INVENTORIES

Inventories are stated at lower of direct cost or net realizable value with cost determined using the FIFO (first in, first out) method.  Inventories consist of the following:

ELECTRONIC SYSTEMS TECHNOLOGY, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 - EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share excludes dilution and is computed by dividing income (loss) available to common stockholders by the weighted-average number of common shares of Common Stock outstanding for the period.  Diluted earnings (loss) per share reflects potential dilution occurring if securities or other contracts to issue Common Stockcommon stock were exercised or converted into Common Stockcommon stock or resulted in the issuance of Common Stockcommon stock that then shared in the earnings of the Company.  ForAt March 31, 2021 and 2020, the nine month period ending September 30, 2020 and 2019 and the three month period ending September 30, 2020, allCompany had 180,000 outstanding stock options, (Note 4)respectively, that could have a dilutive effect on future periods’ net income. The stock options were excluded from the computation of diluted loss per share because they were anti-dilutive due to net lossesnot included in those periods. For the three month period ending September 30, 2019, the calculation of the weighted average number of common shares outstanding–diluted included the common stock equivalents of the outstanding stock options. earnings per share for either period as they were anti-dilutive.

ELECTRONIC SYSTEMS TECHNOLOGY, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 4 - STOCK OPTIONS

As of September 30, 2020, theThe Company hadhas outstanding stock options, which have been granted periodically to individual employees and directors.directors with no less than three years of continuous tenure with the Company.  On March 13, 2020, the Board of Directors canceled all 120,000 outstanding stock options that were granted on August 7, 2017 and were due to expire on August 6, 2020. In addition, on that date, the Board of Directors granted 180,000 options to employees. The new options have an exercise price of $0.40, a term of 5 years, and vestedvest immediately.    The fair value of the options was determined using the Black-Scholes model using the following variables:   stock price of $0.40, volatility of 79.27%, expected term of 5 years with a forfeiture rate of 95%, and a discount factor of 0.72%. Share based compensation of $2,282 was recognized during the nine-monththree month period ended September 30,March 31, 2020.

A summaryAs of option activity during the nine-month period ended September 30, 2020 is as follows:March 31, 2021, there were 180,000 options outstanding with a weighted average exercise price of $0.40 per share, a weighted average remaining life of 4 years and no intrinsic value.

ELECTRONIC SYSTEMS TECHNOLOGY, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 5 – REVENUE

The Company derives revenues from the sales ofproduct revenue includes industrial wireless products and accessories such as antennas, power supplies and cable assemblies. The Company also provides direct site support and engineering services to customers, such as repair and upgrade of its products.  During the three month period ended March 31, 2021 and 2020, the Company’s revenue from products sales was $421,675 and $252,968, respectively.  Revenue from site support and engineering services was $3,100 and $21,000 respectively, over the same periods.

The Company’s customers, to which trade credit terms are extended, consist of United States and local governments and foreign and domestic companies.  Domestic sales for the three month period ended March 31, 2021 and March 31, 2020 were $362,115 and $241,975, respectively.  Sales to foreign customers for the three month period ended March 31, 2021 and March 31, 2020 were $62,660 and $31,993, respectively.

For the three-monththree month period ended September 30,March 31, 2021 and 2020, sales to fourthree customers represented more than 10% of total revenue.  Two customers representedrepresenting more than 10% of total revenue for the same period in 2019.were as follows:

For the nine-month period ended September 30, 2020, sales to one customer represented more than 10% of total revenue.  One customer represented more than 10% of total revenue for the same period in 2019.

As of September 30,March 31, 2021 and 2020, and 2019, the Company had a sales order backlog of $3,400$91,064 and $6,691,$5,028, respectively.

ELECTRONIC SYSTEMS TECHNOLOGY, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 6 - LEASES

The Company leases its facilities from a port authority for $5,639 per month for three years, expiring in September 2020, with annual increases based upon the Consumer Price Index. The original lease was effective October 1, 2014 and contained a three-year renewal option and a provision for an annual increase of 2% per year, plus Leasehold Tax of 12.84%.  On September 5, 2017, the Company exercised the three-year option. The first year of this option was not subject to the 2% increase. The lease did not contain the option to extend the lease beyond the September 2020 expiration.  

For the three month and nine-month periods ended September 30, 2020 and 2019, lease expenses are included in the following expense classifications on the statement of operations:

On September 23, 2020, the Company signed a new two-year lease for its facilities for $3,568 and $3,687 per month for the respective year.facilities.  The base lease is $3,162 and $3,267 per month for years one and two.two, respectively. There is a leasehold tax applied to the base lease at 12.84%.  The Company has the right to terminate the lease with 90 days’ notice. There is no renewal clause contained in the current lease.  Upon signing the lease, the Company recognized a lease liability and right of use asset of $74,005.$74,005 based on the two-year payment stream discounted using an estimated incremental borrowing rate of 4.0%. At March 31, 2021, the remaining lease term is eighteen months.

TotalPrior to the new lease in September 23, 2020, the Company’s lease for its facilities was for $5,639 per month.

For the three month periods ended March 31, 2021 and 2020, lease expense of $10,862 and $16,918, respectively, are included in the following expense classifications on the statements of operations:

As of March 31, 2021, total future lease payments under the new lease are as follows:

ELECTRONIC SYSTEMS TECHNOLOGY, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 7 – STOCK REPURCHASE

On January 13, 2016, the Company’s Board of Directors approved a resolution authorizing the repurchase of up to $100,000 of the Company’s Common Stock at the price of $0.38 per share. The Company’s share repurchase program does not obligate it to acquire any specific number of shares. On March 2, 2016, the Company’s Board of Director approved a resolution authorizing the repurchase of an additional $150,000 of the Company’s Common Stock at the price of $0.38 per share. Under the program (the “Stock Repurchase Plan”), shares may be repurchased in open market transactions, complying with Rule 10b5-1 and Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Shares repurchased are retired. During the nine-month periodthree-month periods ended September 30,March 31, 2021 and 2020, no shares were repurchased; 39,246 shares for $14,920 were repurchased in the nine-month period ended September 30, 2019.repurchased. Since inception of the Stock Repurchase Plan, the Company has repurchased 212,165 shares for a total of $80,622 through September 30, 2020March 31, 2021 and $169,378 of the original $250,000 approved by the board remains.  On April 23, 2020, repurchases were suspended indefinitely.

ELECTRONIC SYSTEMS TECHNOLOGY, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 8 – CARES ACT LOANS PAYABLE

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (the “CARES Act”) Act was signed into United States law.   

In April 2020, the Company received a loan of $171,712 pursuant to the Paycheck Protection Program (the “PPP”) under Division A, Title I, Section 1102 and 1106 of the CARES Act.   The loan, which was in the form of a promissory note, as amended, dated April 13, 2020 issued by the Company (the “Note”); the Note matures on April 13, 2022 and bears interest at a rate of 1% per annum.

In February 2021, the Company received a second loan of $130,255 pursuant to the Paycheck Protection Program (the “PPP”) under Division A, Title I, Section 1102 and 1106 of the CARES Act.   The loan, which was in the form of a promissory note, as amended, dated February 21, 2021 issued by the Company (the “Note”); the Note matures on February 21, 2023 and bears interest at a rate of 1% per annum. The Note may be prepaid by the Company at any time prior to maturity with no prepayment penalties.

Under the terms of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses as described in the CARES Act. Qualifying expenses include payroll costs, costs used to continue group health care benefits, mortgage payments, rent, and utilities. As of September 30, 2020,March 31, 2021, the Company has used funds from the loan to pay qualifying expenses.  The Company intends to applyhas applied for forgiveness of the first loan when it receives instructionsand is awaiting notification from the lenderSmall Business administration at which time grant incomea gain on forgiveness of debt of $171,712 will be recognized. As of March 31, 2021, $91,488 of the proceeds from the second loan have been used for purposes that are qualifying expenses.  The Company intends to use the entire loan amount for qualifying expenses, but there is no guarantee that the loan will be forgiven.

During the nine months ended September 30, 2020, the Company received $9,000 under Division A, Title I, Section 1110 of the CARES Act.    The Company is not required to pay this amount back and thus recognized $9,000 as government grant income during the period.

.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATION

Management's discussion and analysis is intended to be read in conjunction with the Company's unaudited financial statements and the integral notes thereto for the quarter ended September 30, 2020.March 31, 2021.  The following statements may be forward looking in nature and actual results may differ materially.

A.RESULTS OF OPERATIONS 

As a result of COVID-19, and governmental responses thereto, are experiencing some negative impacts to our business, primarily as a result of reductions in staffing by our customers, and their customers, which is lengthening our normal sales cycles. Many of our customers are also restricting visits from vendors. All of our planned trade shows and sales presentations have been canceled or postponed as a result of the risks associated with face to face meetings. We have utilized various platforms to provide current customers and potential customers with presentations about our products and services. We have also experienced some delays in our supply chain but none of these COVID-19 related disruptions, to the supply chain, has been significant at this point.

REVENUES: Total revenues from sales decreasedincreased to $202,869$424,775 for the thirdfirst quarter of 2021 as compared to $273,968 in the first quarter of 2020, as compared to $371,915 in the third quarterreflecting an increase of 2019, reflecting a decrease of 45.5%55.0%.  Management believes the decreaseincrease in sales revenues is due to increased product demand from both the impactDomestic and Foreign markets first quarter of the COVID-19 stay at home orders2021 when compared with the same quarter of 2019. Year to date total revenues from sales decreased to $722,333 in 2020 as compared to $1,141,343 in 2019, reflecting a decrease of 36.7%.  Management believes the decrease in sales revenues is due to the impact of the COVID-19 stay at home orders when compared with the same period of 2019.   2020.

The Company's revenues have historically fluctuated from quarter to quarter due to timing factors such as product shipments to customers, customer order placement, customer buying trends, and changes in the general economic environment.  The procurement process regarding plant and project automation, or project development, which usually surrounds the decision to purchase ESTeem products, can be lengthy.  This procurement process may involve bid activities unrelated to the ESTeem products, such as additional systems and subcontract work, as well as capital budget considerations on the part of the customer.  Because of the complexity of this procurement process, forecasts with regard to the Company's revenues are difficult to predict.

Although theThe COVID-19 situation representsrepresented a significant disruption to operations in 2020,most of 2020.  During the three month period ending March 31, 2021, we have taken steps intendedseen orders for projects that we believe were delayed due to keep our staff safe. Staff, whose jobs allow, are telecommuting.  Those whose jobs require specialized equipment continuethe impact of the restrictions related to work on site and are keeping safe distances to minimizepreventing the potential to contract or spread the virus.of COVID-19. We are observing social distancing for those employees that remain on-site. Masks have been provided to all employees to minimizeexperiencing some disruptions in the risk of exposure. Daily monitoring of temperatures as well as adding sanitizers have also been instituted.supply chain, but at this point do not see it having a material impact on sales.

A percentage breakdown of the Company’s market segments of Domestic and Foreign Export sales for the threefirst quarter of 2021 and nine month periods ended September 30, 2020 and 2019 are as follows:

BACKLOG:

As of September 30, 2020,March 31, 2021, the Company had a sales order backlog of $3,400.$91,064.   The Company’s customers generally place orders on an "as needed basis".  Shipment for most of the Company’s products is generally made within 1 to 5 working days after receipt of customer orders, with the exception of ongoing, scheduled projects, and custom designed equipment.  

COST OF SALES:

Cost of sales percentages for the third quarterfirst quarters of 2021 and 2020 were 42% and 2019 were 52% and 44%53% of respective net sales.sales and are calculated excluding site support expenses of $2,079 and $15,080 respectively. The cost of sales percentage increasedecrease in the thirdfirst quarter of 20202021 is the result of the product mix sold during the same quarter of 2019. Cost of sales percentages for the nine month periods ended September 30, 2020 and 2019 were 54% and 46%. The cost of sales percentage increase in the third quarter of 2020 is the result of the product mix sold during the same period of 2019.2020.

OPERATING EXPENSES:

Operating expenses for the first quarter of 2021 increased $1,912 from first quarter of 2020 levels.  The following is a delineation of operating expenses:

General and administrative:  For the thirdfirst quarter of 2020,2021, general and administrative expenses decreased $8,995$2,210 to $55,761,$93,503, due to decreased wages, taxes and benefits when compared with the same quarter of 2019. For the nine-month period, general and administrative expenses decreased by $6,019 to $221,431, due to decreased wages and professional services.2020.

Research and development:  Research and development expenses increased $1,294decreased $2,197 to $49,739$52,700 during the thirdfirst quarter of 20202021 due to increased wagesdecreased expenses related to prototype build costs when compared with the same quarter of 2019. For the nine-month period, research and development expenses decreased by $10,547 to $154,850, due to decreased prototype build costs.2020.

Marketing and sales: During the thirdfirst quarter of 2020,2021, marketing and sales expenses increased $815$6,319 to $90,229$94,215 when compared with the same period of 2019,2020, due to increased wages. Forpayroll, taxes and benefits during the nine-month period, marketing and sales expenses decreased by $22,201 to $264,420, due to decreased travel and trade shows.first quarter of 2021.

OTHERINTEREST INCOME:

The Company earned $2,444$861 in interest income during the quarter ended September 30, 2020 and $8,396 forMarch 31, 2021 compared to $3,463 during the nine-month period.same period in 2020.  Sources of this income were money market accounts and certificates of deposit. The Company received a government grant under the CARES Act in the amount of $9,000 for COVID relief.

NET LOSS:INCOME (LOSS):

The Company had net income of $4,682 for the first quarter of 2021 compared to a net loss of $95,826 for the third quarter of 2020 compared to a net income of $11,769$110,306 for the same quarter of 2019.  For the nine-month period ended September 30, 2020, the Company recorded a net loss of $288,007 compared with a net loss of $49,275 for the same period of 2019.2020.  The increase in net lossprofits during 20202021 is the result of decreasedincreased sales revenues, gross margins and gross income.management of variable expenses.

B.FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES 

The Corporation's current asset to current liabilities ratio at September 30, 2020March 31, 2021 was 19.914.7 compared to 11.820.7 at December 31, 2019.2020.  The increasedecrease in current ratio is due to the reductionincrease in accounts payable and accrued wages liability at September 30, 2020March 31, 2021 as compared to December 31, 2019.2020.

At September 30, 2020,March 31, 2021, the Company had cash and cash equivalents of $143,340$794,734 as compared to cash and cash equivalent of $274,936$308,110 at December 31, 2019,2020, primarily reflecting cash provided in investingredemption of certificates of deposits that were held at December 31, 2020, proceeds from the second PPP loan and financing activities.the reduction of inventory on hand.

Cash used inFor the three-month period ended March 31, 2021, cash provided by operating activities increased by $144,177 for the nine-month period ended September 30, 2020 whenwas $106,401 compared to cash used of $127,031for the same period in 2019. The increase is attributable2020. This change was driven by net income of $4,682 during the three months ended March 31, 2021 compared to an increase in net loss forof $110,306 in the three months ended March 31, 2020.   Change in operating assets and liabilities was $100,430 during the three month period being $238,732 greater than the same periodended March 31, 2021 compared to ($20,745) in 2019.  2020.

Net cashCash provided from investing was $50,001$249,999 due to the redemption of certificates of deposits maturinga CD during the nine monthsfirst quarter of 2020. Cash provided from financing activities was $171,712, which were the proceeds of the CARES Act loan received during the nine-month period ended September 30, 2020. We believe that the entire loan will be forgiven based on recent amendments2021. With 12 month yields currently at a rate comparable to the CARES Act for forgiveness.rates offered by Money Market accounts, maturing CDs are being deposited in these type accounts.

In management's opinion, the Company's cash and cash equivalents and other working capital at September 30, 2020March 31, 2021 is sufficient to satisfy requirements for operations, capital expenditures, and other expenditures as may arise during 2020.

As a result of COVID-19, and governmental responses thereto, we are experiencing some negative impacts to our business, primarily as a result of reductions in staffing by our customers, and their customers, which is lengthening our normal sales cycles. Many of our customers are also restricting visits from vendors. All of our planned trade shows and sales presentations have been canceled or postponed as a result of the risks associated with face to face meetings. We have utilized various platforms to provide current customers and potential customers with presentations about our products and services. We have also experienced some delays in our supply chain but none of these COVID-19 related disruptions has been significant at this point.2021.

FORWARD LOOKING STATEMENTS:  The above discussion may contain forward looking statements that involve a number of risks and uncertainties.  In addition to the factors discussed above, among other factors that could cause actual results to differ materially are the following: competitive factors such as rival wireless architectures and price pressures; availability of third party component products at reasonable prices; inventory risks due to shifts in market demand and/or price erosion of purchased components; change in product mix, and risk factors that are listed in the Company's reports and registration statements filed with the Securities and Exchange Commission.  

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to its stockholders.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

There is no established market for trading the common stock of the Company. The market for the Company’s common stock is limited, and as such shareholders may have difficulty reselling their shares when desired or at attractive market prices.  The Common Stock is not regularly quoted in the automated quotation system of a registered securities system or association.  Our common stock, par value $0.001 per share, is quoted on the OTC Markets Group QB (OTCQB) under the symbol “ELST”.  The OTCQB is a network of security dealers who buy and sell stock. The dealers are connected by a computer network which provides information on current “bids” and “asks” as well as volume information. The OTCQB is not considered a “national exchange”.  The “over-the-counter” quotations do not reflect inter-dealer prices, retail mark-ups commissions or actual transactions.  The Company’s common stock has continued to trade in low volumes and at low prices. Some investors view low-priced stocks as unduly speculative and therefore not appropriate candidates for investment. Many institutional investors have internal policies prohibiting the purchase or maintenance of positions in low-priced stocks.

Item 4.  Controls and Procedures

An evaluation has been performed under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Accounting Officer, of the effectiveness of the design and the operation of our "disclosure controls and procedures" (as such term is defined in Rules 13a-15(e) under the Securities Exchange Act of 1934) as of September 30, 2020.March 31, 2021.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have determined that there was a material weakness affecting our internal control over financial reporting and, as a result of that weakness, our disclosure controls and procedures were not effective as of September 30, 2020.March 31, 2021.  

The material weakness is as follows:

We did not maintain effective controls to ensure appropriate segregation of duties as the same officer and employee was responsible for the initiating and recording of transactions, thereby creating segregation of duties weaknesses. Due to the (1) significance of segregation of duties to the preparation of reliable financial statements; (2) the significance of potential misstatement that could have resulted due to the deficient controls; and, (3) the absence of sufficient other mitigating controls; we determined that this control deficiency resulted in more than a remote likelihood that a material misstatement or lack of disclosure within the annual or interim financial statements will not be prevented or detected.

Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1.  Legal Proceedings

None.

Item 2. Unregistered Sales of Securities

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable

Item 5.  Other Information

None.None

Item 6.  Exhibits

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ELECTRONIC SYSTEMS TECHNOLOGY, INC.

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