================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------------- Form 10-QSB QUARTERLY REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ----------------------------- For the quarterly period ended March 31, 2005 Commission File Number: 333-87224 ELECTRONIC SENSOR TECHNOLOGY, INC. (Name of small business issuer in its charter) NEVADA 98-0372780 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1077 Business Center Drive, Newbury Park, California 91320 (805) 480-1994 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) Securities registered under section 12(b) of the Exchange Act: None Securities registered under section 12(g) of the Exchange Act: Common Shares, par value $0.001 per share Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. 53,968,643 shares of common stock as of May 13, 2005. Transitional Small Business Disclosure Format Yes [ ] No[X] ================================================================================ 1 ELECTRONIC SENSOR TECHNOLOGY FORM 10-QSB INDEX Page No. Item 1. Consolidated Financial Statements (unaudited): Condensed Consolidated Balance Sheet as of March 31, 2005 .......................................................2 Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2005 and 2004.........................................3 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004...............................................4 Notes to Condensed Consolidated Financial Statements .......................................................... 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................11 Item 3. Controls and Procedures..............................................17 PART II. OTHER INFORMATION Item 1. Legal Proceedings....................................................17 Item 2. Changes in Securities and Use of Proceeds............................18 Item 3. Defaults Upon Senior Securities......................................18 Item 4. Submission of Matters to a Vote of Security Holders..................18 Item 5. Other Information....................................................18 Item 6. Exhibits and Reports on Form 8-K.....................................19 SIGNATURES....................................................................20 2 Part I. FINANCIAL INFORMATION Item 1. Financial Statements ELECTRONIC SENSOR TECHNOLOGY, INC. CONSOLIDATED BALANCE SHEET MARCH 31, 2005 (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,879,647 Certificate of deposit 900,651 Accounts receivable, net of allowance for doubtful accounts 137,036 Prepaid expenses 21,582 Inventories 473,436 ------------ TOTAL CURRENT ASSETS 3,412,352 PROPERTY AND EQUIPMENT 88,334 SECURITY DEPOSITS 12,817 ------------ $ 3,513,503 ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Line of credit $ 1,769,137 Accounts payable and accrued expenses 335,101 Interest payable 21,417 Other current liabilities 34,649 ------------ TOTAL CURRENT LIABILITIES 2,160,304 ------------ STOCKHOLDERS' EQUITY: Preferred stock, $.001 par value 50,000,000 shares authorized non issued and outstanding -- Common stock, $.001 par value, 200,,000,000 shares authorized, 53,968,643 issued and outstanding, 53,969 Additional paid-in capital 12,232,316 Accumulated deficit (10,933,086) ------------ TOTAL STOCKHOLDERS' EQUITY 1,353,199 ------------ $ 3,513,503 ============ See notes consolidated to financial statements 3 ELECTRONIC SENSOR TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended March 31, ---------------------------- 2005 2004 ------------ ------------ REVENUES $ 207,011 $ 305,250 COST OF SALES 290,134 244,341 ------------ ------------ GROSS PROFIT (83,123) 60,909 OPERATING EXPENSES: Compensation 59,093 66,599 Selling 39,210 8,314 General and administrative 469,647 83,346 ------------ ------------ TOTAL OPERATING EXPENSES 567,950 158,259 LOSS FROM OPERATIONS (651,073) (97,350) ------------ ------------ OTHER INCOME AND EXPENSE: Other income (239) (24,834) Gain (loss) on sale of property and equipment 13,257 (7,711) Interest expense (20,566) (16,370) ------------ ------------ TOTAL OTHER INCOME AND EXPENSE (7,548) (48,915) ------------ ------------ NET LOSS $ (658,621) $ (146,265) ============ ============ Loss per share, basic and diluted $ (0.01) $ (0.00) Basic and diluted 52,640,310 49,983,643 ============ ============ 4 ELECTRONIC SENSOR TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended March 31, ---------------------------- 2005 2004 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) $ (658,621) $ (146,265) Adjustments to reconcile net income (loss) to net cash provided by (used in)operating activities: Depreciation and amortization 1,845 863 Donated services -- 6,000 Changes in assets and liabilities: Accounts receivable (106,349) 221,811 Inventories 7,212 (44,528) Prepaid expenses (7,324) (3,644) Security deposits 140 -- Accounts payable and accrued expenses 120,798 (36,080) Deferred revenue -- 250,000 Due to related party (60,000) 45,500 Interest payable (5,544) (5,534) Other current liabilities (1,016) (1,515) ----------- ----------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (708,860) 286,608 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of property and equipment 16,064 9,716 Purchase of property and equipment (55,044) -- ----------- ----------- NET CASH USED IN OPERATING ACTIVITIES (38,980) 9,716 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Decrease in line of credit (200,000) (205,000) Repayment of partners' loans payable (110,000) (230,000) Increase in partners' loans payable -- -- Proceeds from issuance of common stock 3,811,708 62,500 ----------- ----------- NET CASH PROVIDED BY FINANCING ACTIVITIES 3,501,708 (372,500) ----------- ----------- NET INCREASE IN CASH 2,753,868 (76,176) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 26,430 121,069 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,780,298 $ 44,893 =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period for: Interest $ 21,217 $ 16,412 =========== =========== 5 ELECTRONIC SENSOR TECHNOLOGY, INC. Notes to Financial Statements (Unaudited) March 31, 2005 (1) Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial statements and with the instructions to Form 10-QSB and Article 10 of Regulation S-X. Accordingly, they do not include all the information and disclosures required for annual financial statements. These financial statements should be read in conjunction with the consolidated financial statements and related footnotes for the year ended December 31, 2004, included in the Form 8-K filed with the SEC on April 19, 2005. In the opinion of the Company's management, all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company's financial position as of March 31, 2005, and the results of operations and cash flows for the three month period ending March 31, 2004 have been included. The results of operations for the three month period ended March 31, 2005 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Form 8-K as filed with the Securities and Exchange Commission for the year ended December 31, 2004. (2) Basis of Consolidation The accompanying financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. (3) Nature of Business and Summary of Significant Accounting Policies (a) Nature of Business Electronic Sensor Technology, Inc. (the "Company") (formerly Bluestone Ventures, Inc.) develops and manufactures electronic devices used for vapor analysis. (b) Cash and Cash Equivalents The Company considers highly liquid financial instruments with maturities of three months or less at the time of purchase to be cash equivalents. The Company did not have any cash equivalents at March 31, 2005. (c) Revenue Recognition The Company records revenue from direct sales of products to end-users when the products are shipped, collection of the purchase price is probable and the Company has no significant further obligations to the customer. Costs of remaining insignificant Company obligations, if any, are accrued as costs of revenue at the time of revenue recognition. Cash payments received in advance of product or service revenue are recorded as deferred revenue. 6 (d) Shipping and Handling The Company accounts for shipping and handling costs as a component of "Cost of Sales". (e) Property and Equipment Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of five years. (f) Inventories Inventories are comprised of raw materials, work in process, and finished goods. Inventories are stated at the lower of cost or market and are determined using the first-in, first-out method. (g) Use of Estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the recorded amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (h) Fair Value of Financial Instruments The fair value of certain financial instruments, including accounts receivable, accounts payable and accrued liabilities, approximates their carrying value due to the short maturity of these instruments. (i) Long-lived Assets The Company reviews long-lived assets, such as property and equipment, to be held and used or disposed of, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected cash flows, undiscounted and without interest, is less than the carrying amount of the asset, an impairment loss is recognized as the amount by which the carrying amount of the asset exceeds its fair value At March 31, 2005 no assets were impaired. (3) Mergers and Acquisitions Bluestone Ventures, Inc. ("Bluestone") executed an Agreement and Plan of Merger ("Merger Agreement") by and among Bluestone, Amerasia Technology, Inc., ("Amerasia"), holder of approximately 55% of the partnership interests of Electronic Sensor Technology, L.P., ("EST"), L & G Sensor Technology, L.P., ("L&G"), holder of approximately 45% of the partnership interests of EST, Amerasia Acquisition Corp., ("AAC") a wholly-owned subsidiary of Bluestone, and L & G Acquisition Corp., ("LAC") a wholly owned subsidiary of Bluestone on January 31, 2005. Under the Merger Agreement (i) AAC merged with and into Amerasia such that Amerasia became a wholly-owned subsidiary of Bluestone, (ii) LAC merged with and into L&G such that L&G became a wholly-owned subsidiary of Bluestone, (iii) as a result of the merger of (i) and (ii), Bluestone indirectly acquired all of the partnership interests of EST and (iv) Bluestone issued 20,000,000 shares of its common stock to the shareholders of Amerasia and L&G. This merger has been treated as a purchase only of the partnership interests of Electronic Sensor Technology L.P. 7 For accounting purposes, the transaction will be treated as a recapitalization of EST and accounted for as a reverse acquisition. Bluestone also entered into various Subscription Agreements with certain investors on January 31, 2005. Under these Subscription Agreements, Bluestone issued 3,985,000 shares of its common stock ("shares") and warrants to purchase 3,985,000 shares at $1.00 per share to certain investors for gross proceeds of $3,985,000. Bluestone received the gross proceeds of the sale of these shares on February 1, 2005. Bluestone received net proceeds of approximately $3,822,000. This amount was net of legal fees, including counsel fees for the investors and EST of approximately $163,000. By virtue of the Mergers, all shares of common stock of Amerasia were converted into the right to receive shares of common stock of Bluestone at an exchange ratio of 4.6223537 shares of Bluestone common stock for each share of Amerasia common stock and all shares of common stock L&G were converted into the right to receive shares of common stock of Bluestone at an exchange ratio of 90 shares of Bluestone common stock for each share of L&G common stock. In addition, all 200,000 Class C limited partnership units of Electronic Sensor Technology L.P. were automatically converted into 200,000 shares of Bluestone common stock. The purchase price for the Mergers was 20,000,000 shares of Bluestone common stock. The closing of the mergers occurred on February 1, 2005 (the "Closing Date"). In January 2005 the loans payable to three partners of Electronic Sensor Technology L.P., totaling $1,198,630 were converted into 1,198,630 shares of common stock of Bluestone. In January 2005 the notes payable to related parties of $1,272,000 plus accrued interest were converted into 1,585,111 shares of common stock of Bluestone. Bluestone has changed its name to Electronic Sensor Technology, Inc. as of February 2005. (b) Stock Option Plan The Company adopted a Stock Incentive Option Plan in April 2005. There were 969,500 initial options granted to former EST limited partnership employees. 8 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. You should read the following discussion and analysis of our financial condition and results of operations together with our interim financial statements and the related notes appearing at the beginning of this report. The interim financial statements and this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2004 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on April 15, 2005. The following discussion and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can be identified by words such as "anticipates," "expects," "believes," "plans," and similar terms. Our actual results could differ materially from any future performance suggested in this report as a result of factors, including those discussed in "Factors That May Affect Future Operating Results" and elsewhere in this report and in our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004. All forward-looking statements are based on information currently available to Composite Technologies and we assume no obligation to update such forward-looking statements, except as required by law. Service marks, trademarks and trade names referred to in this Form 10-Q are the property of their respective owners. -------------------------------------------------------------------------------- Overview We are engaged in the development, manufacturing, and sales 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) is capable of measuring and quantifying the chemistry of any compound, fragrance, vapor or odor with parts per trillion sensitivity in 10 seconds. We also believe the zNose(R) has the unique ability to quantify and speciate the subject chemical vapor by creating visual olfactory images. This enables the measured odor or vapor to be easily identified by the user. We believe that our products will have broad applications in the homeland security and laboratory instrumentation markets. 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 assembling our sales and support organization. Electronic Sensor Technology, Inc. ("EST") was originally incorporated under the name "Bluestone Ventures, Inc.", on July 12, 2000. From inception until February 1, 2005, we engaged in the business of acquiring, exploring and developing certain mining properties in Canada. Upon the acquisition of Electronic Sensor Technology, LP (the "ELP"), we abandoned our mining business and adopted ELP's business of developing, manufacturing and selling the vapor analysis device. Prior to the closing of the Mergers, on January 26, 2005, we changed our name to "Electronic Sensor Technology, Inc." Our executive offices are located at 1077 Business Center Circle, Newbury Park, California 91320 and our telephone number is (805) 480-1994. Results of Operations The following table sets forth, as a percentage of revenues, certain items included in the Company's Income Statements (see Financial Statements and Notes) for the periods indicated: Three months ended March 31 --------------------------- 2005 2004 ----------- ----------- Statements of Operations Data: Revenues 100% 100% Cost of sales 140% 80% Gross profit 40% 20% Operating expenses 274% 52% Loss from operations (315)% (32%) Other Income and Expense 4% 16% Net loss (318)% (48%) 9 Quarter Ended March 31, 2005 Compared to Quarter Ended March 31, 2004 Revenues for the quarter ended March 31, 2005 were $207,000 compared to $305,000 in 2004. Our revenues experienced a decline of 32% due to the slip of deliveries of some newly re-designed parts. Gross profit was ($83,000) for the first quarter ended March 31, 2005 compared to $61,000 for the quarter ended March 31, 2004. This decrease of $144,000 resulted from increased manufacturing costs from additional personnel. Compensation expenses in the first quarter of 2005 were $59,000 as compared to $67,000 in 2004. As a percentage of sales, total compensation expenses increased from 22% of sales to 29% of sales. The decrease of $8,000 was due to a decrease of sales commissions. Selling expenses in the first quarter of 2005 were $39,000 as compared to $8,000 in 2004. As a percentage of sales, total selling expenses increased from 3% of sales to 19% of sales. This increase of $31,000 was due to an increase of personnel costs. General and administrative expenses for the first quarter of 2005 were $470,000 as compared to $83,000 in 2004. As a percentage of sales, general and administration expenses increased from 27% of sales to 227% of sales. This increase of $386,000 was primarily due to consulting and professional fees in connection with the reverse merger. Interest expense for the first quarter of 2005 was $20,566 as compared to $16,370 for the same period in 2004. This increase in interest expense is due to expanded line of credit and higher interest rate. Net Loss was $659,000 for the period ended March 31, 2005 as compared to a loss of $146,000 for the three- month period ended March 31, 2004. The increase was primarily due to higher operating expenses in first quarter of 2005 including one time charges in connection with the reverse merger. Liquidity and Capital Resources In the first quarter of 2005 net cash used by the Company for operating activities was $709,000. In the first quarter of 2004, the cash provided by Company's operations was $287,000. Cash used in the first quarter of 2005 was comprised of the net loss incurred for the quarter of $659,000, plus net non-cash expenses of $2,000 plus the net change in operating assets and liabilities of $(52,000). Cash used in operations in the first quarter of 2004 was comprised of the net loss of $146,000 plus net non-cash expenses of $7,000, plus the net change in operating assets and liabilities of cash of $426,000. Investing activities used cash of $39,000 in the first quarter of 2005 and provided $9,700 during the first quarter ended March 31, 2004. In 2005 and 2004 the cash was used to purchase of equipment. Financing activities provided cash of $3.5 million and used cash of $373,000 during the first quarters ended March 31, 2005 and 2004, respectively. At March 31, 2005 the Company had cash of $2.8 million compared to $45,000 at March 31, 2004. At March 31, 2005, the Company had working capital of $1.25 million, as compared to working deficit of $5.5 million at March 31, 2004. The Company, at present, has a credit facility in place with East West Bank for $1.8 million. Although we have a bank operating line of credit, there can be no assurance that these proceeds will be adequate for our capital needs. There can be no assurance that any required or desired financing will be available through any other bank borrowings, debt, or equity offerings, or otherwise, on acceptable terms. If future financing requirements are satisfied through the issuance of equity securities, investors may experience significant dilution in the net book value per share of common stock and there is no guarantee that a market will exist for the sale of the Company's shares. 10 The Company's primary capital needs are to fund its growth strategy, which includes creating a sales and marketing staff for the marketing, advertising and selling of zNose(R) family of chemical detection products, increasing distribution channels, introducing new products, improving existing product lines and development of a strong corporate infrastructure. Seasonality and Quarterly Results We do not foresee any seasonality to our revenues or our results of operations. Inflation Our raw materials and finished products are sourced from cost-competitive industries. As such, we do not foresee any material inflationary trends for our product sources. Our business is subject to a number of risks as outlined below. An investment in our securities is speculative in nature and involves a high degree of risk. You should read this annual report carefully and consider the following risk factors: FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS RISKS RELATED TO OUR COMPANY We have a significant accumulated deficit and have received an opinion from our auditors regarding our ability to continue as a going concern, and we may never achieve profitability. We have incurred significant net losses every year since our inception, including net losses in 2004 and 2003. These losses have resulted principally from expenses incurred in our research and development programs and general and administrative expenses. To date, we have not yet generated significant recurring revenues. Our limited revenues that derive from sales of the zNose(R) product have not been and may not be sufficient to sustain our operations. We anticipate that we will continue to incur substantial operating losses based on projected sales revenues less manufacturing, general and administrative and other operating costs for an indefinite period of time. We expect that our revenues will not be sufficient to sustain our operations for the foreseeable future, notwithstanding any anticipated revenues we may receive when our vapor detection products obtain increased visibility in our markets, due to the significant costs associated with the development and marketing of our products. No assurances can be given when we will ever be profitable. Our independent auditors have added an explanatory paragraph to their audit opinions issued in connection with the financial statements for each of the years ended December 31, 2004 and 2003 relative to the substantial doubt about our ability to continue as a going concern. Our ability to obtain additional funding will determine our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. We expect to continue to experience losses until the time, if ever, when we are able to sell products sufficient to generate revenues adequate to support our operations. If we fail to become profitable, we may be forced to cease operations. Our limited manufacturing experience and capacity may limit our ability to grow our revenues. To be successful, we must manufacture our products in compliance with industry standards and on a timely basis, while maintaining product quality and acceptable manufacturing costs. We also 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. We do not have agreements with our suppliers. Our manufacturing strategy presents the following risks: o delays in the quantities needed for product development could delay commercialization of or products in development; o if market demand for our products increases suddenly, our current suppliers might not be able to fulfill our commercial needs, which would require us to seek new supply arrangements and may result in substantial delays in meeting market demand; and o we may not have intellectual property rights, or may have to share intellectual property rights, to any improvements in the manufacturing processes or new manufacturing processes for our products. 11 Any of these factors could delay commercialization of our products under development, entail higher costs and result in our being unable to effectively sell our products. We face significant competition and our business and financial results could suffer from competition. While we are unaware of any competitor that has created a vapor analysis device similar to the zNose(R), there are companies that offer products and services that compete with the zNose(R) in our markets. See "Business - Competition." We believe that manufacturers of X-Rays, Ion Mobility Spectroscopy, and other electronic noses compete with us in the security-related markets. In the analytic instrumentation markets, we compete with many gas chromatograph manufacturers including Perkin-Elmer (PKI:NYSE) and Agilent Technologies (A:NYSE). Many of our existing and potential competitors have longer operating histories, greater experience, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. Because of their greater resources, our competitors are able to undertake more extensive marketing campaigns for their products and services, and make more attractive offers to potential employees, strategic partners, and others. We may not be able to compete successfully against our current or future competitors and our business and financial results could suffer from such competition. If our products do not achieve a significant level of market acceptance, it is highly unlikely that we ever will become profitable. To our knowledge, electronic nose technology, and our zNose(R) product, has yet to receive widespread market acceptance in the markets we are focused on. The commercial success of our current and future products will depend upon the adoption of our zNose(R) technology by our customers. In order to be successful, our future products must meet the technical and cost requirements for the markets we intend to penetrate. Market acceptance will depend on many factors, including: o our ability to convince potential customers to adopt our products; o the willingness and ability of potential customers to adopt our products; o our ability to sell and service sufficient quantities of our products; and o new, advanced technology offered by other companies which compete with our products. Because of these and other factors, our products may not achieve market acceptance. If our products do not achieve a significant level of market acceptance, demand for our future products will not develop as expected and it is highly unlikely that we ever will become profitable. Other companies could create a technology which competes effectively with our zNose(R) technology, and we may be unable to maintain our existing, or capture additional, market share in our markets. Based upon our review of the industry, we are unaware of any company today that markets a technology which is similar to our zNose(R) technology. Nonetheless, our intended markets generally are dominated by a very large corporations (or their subsidiaries), which have greater access to capital, manpower, technical expertise, distribution channels and other elements which would give them a huge competitive advantage over us were they to begin to compete directly against us. It is possible that these and other competitors may implement new, advanced technologies before we are able to, allowing them to provide more effective products at more competitive prices. Any number of future technological developments could: o adversely impact our competitive position; o require write-downs of obsolete technology; o require us to discontinue production of obsolete products before we can recover any or all of our related research, development and commercialization expenses; or o require significant capital expenditures beyond those currently contemplated. 12 We cannot assure investors that we will be able to achieve the technological advances to remain competitive and profitable, that new products and services will be developed and manufactured on schedule or on a cost-effective basis, that anticipated markets will exist or develop for new products or services, or that any marketed product will not become technologically obsolete. We depend on key personnel in a competitive market for skilled employees, and failure to retain and attract qualified personnel could substantially harm our business. Our potential for success depends significantly on our executive officers, including, Edward Staples, our President; Francis Chang, our Vice President, Finance and Administration; and Teong Lim, our Vice President, Corporate Development. These individuals do not have employment agreements with the Company. We do not carry key-man life insurance on any executive. Given the early stage of our product development and commercialization and our plans for rapid expansion, the loss of the services of any executive or the services of any other key employees we may hire in the future would have a substantial, adverse effect on our business. We believe that our future success will depend in large part on our ability to attract and retain highly skilled sales, marketing and management personnel. If we are unable to hire the necessary personnel, the development of our business will likely be delayed or prevented. Competition for these highly skilled employees is intense. As a result, we cannot assure you that we will be successful in retaining our key personnel or in attracting and retaining the personnel we require for expansion. We may not be able to protect our intellectual property and may infringe on the intellectual property rights of others. The protection of our intellectual property, including our patents and other proprietary rights, is important to our success and our competitive position. Accordingly, we devote substantial resources to the maintenance and protection of intellectual property through various methods such as patents and patent applications, trademarks, copyrights, confidentiality and non-disclosure agreements. We also rely on trade secrets, proprietary methodologies and continuing technological innovation to remain competitive. We have taken measures to protect our trade secrets and know-how, including the use of confidentiality agreements with our employees. However, it is possible that these agreements may be breached and that the available remedies for any breach will not be sufficient to compensate us for damages incurred. We currently have four patents in the United States and patents in various foreign countries. There can be no assurance that the claims allowed under any patents held by us will be sufficiently broad to protect our technology against competition from third parties with similar technologies or products. Moreover, we cannot assure you that others will not assert rights in, or ownership of, patents and other proprietary rights we may establish or acquire or that we will be able to successfully resolve such conflicts. In addition, we cannot assure you that any patents issued to us will not be challenged, invalidated or circumvented or that the rights granted under these patents will provide a competitive advantage to us. Moreover, the laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States, and we could experience various obstacles and high costs in protecting our intellectual property rights in foreign countries. If we are unable to obtain or maintain these protections, we may not be able to prevent third parties from using our intellectual property. RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK Our stock price is subject to extreme volatility. The trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in response to factors such as actual or anticipated variations in the Company's quarterly operating results, announcements of technological innovations, or new products by the Company or its competitors, changes in financial estimates by securities analysts, conditions or trends in the analytic instrumentation markets, changes in the market valuations of other security-detection oriented companies, announcements by the Company or its competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments, additions or departures of key personnel, sales of common stock or other securities of the Company in the open market and other events or factors, many of which are beyond the Company's control. Further, the stock markets in general, and the market for technology companies have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of such companies. These broad market and industry factors may materially and adversely affect the market price of the common stock, regardless of the Company's operating performance. Market fluctuations, as well as general political and economic conditions such as recession or interest rate or currency rate fluctuations, may also adversely affect the market price of the common stock. In the past, following periods of volatility in the market price of a company's securities, securities class-action litigation has often been instituted against such company. Such litigation, if instituted, could result in substantial costs and a diversion of management's attention and resources, which would have a material adverse effect on the Company's business, results of operations and financial condition. 13 There is no established trading market for our shares of common stock. The liquidity of our common stock will be affected by its limited trading market. Bid and ask prices for our common stock are quoted on the Over-the-Counter Bulletin Board under the symbol "ESNR.OB." There is currently no broadly followed, established trading market for our common stock. An established trading market for our shares may never develop or be maintained. Although we intend, as soon as is practicable, to undertake the process to become listed on one of the national stock exchanges or with Nasdaq, there is no assurance as to when or if those events will occur. Active trading markets generally result in lower price volatility and more efficient execution of buy and sell orders. The absence of an active trading market reduces the liquidity of our shares. Prior to the consummation of the merger, we had no reported trading volume in our common stock. Since then, we have had sporadic reported trading in our shares. As a result of this lack of trading activity, the quoted price for our common stock on the Over-the-Counter Bulletin Board is not necessarily a reliable indicator of its fair market value. Further, if we cease to be quoted, holders would find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock, and the market value of our common stock would likely decline. If and when a trading market for our common stock develops, because we are a technology company, we expect that the trading prices will be extremely volatile. The trading prices of technology company stocks in general tend to experience extreme price fluctuations. The valuations of many technology companies without consistent product revenues or earnings, if any, are not based on conventional valuation standards such as price to earnings and price to sales ratios. Any negative change in the public's perception of the prospects of technology companies could depress our stock price regardless of our results of operations if a trading market for our stock develops. Other broad market and industry factors may decrease the trading price of our common stock, regardless of our performance. Market fluctuations, as well as general political and economic conditions such as war, recession or interest rate or currency rate fluctuations, also may decrease the trading price of our common stock. In addition, our stock price could be subject to wide fluctuations in response to factors including, but not limited to, the following: o announcements of new technological innovations or new products by us or our competitors; o conditions or trends in the sensor technology or chemical detection industry; o changes in the market valuations of other technology companies; o developments in domestic and international governmental policy or regulations; o announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; o developments in patent or other proprietary rights held by us or by others; o loss or expiration of our intellectual property rights; o lawsuits initiated by or against us; o period-to-period fluctuations in our operating results; o sales of our common stock or other securities in the open market. In the past, shareholders have often instituted securities class action litigation after periods of volatility in the market price of a company's securities. If a shareholder files a securities class action suit against us, we would incur substantial legal fees and our management's attention and resources would be diverted from operating our business to respond to the litigation. 14 We may raise additional capital through a securities offering that could dilute your ownership interest We require substantial working capital to fund our business. If we raise additional funds through the issuance of equity, equity-related or convertible debt securities, these securities may have rights, preferences or privileges senior to those of the holders of our common stock. The issuance of additional common stock or securities convertible into common stock by our management will also have the effect of further diluting the proportionate equity interest and voting power of holders of our common stock. In addition, under our Articles of Incorporation, the Board is authorized to issue, without obtaining shareholder approval, shares of preferred stock having the rights, privileges and designates as determined by the Board. Therefore, the Board could issue shares of preferred stock that would have preferential liquidation, distribution, voting, dividend or other rights, which would be superior to the rights of common stockholders. A significant number of our shares are eligible for sale, and their sale could depress the market price of our common stock. Sales of a significant number of shares of our common stock in the open market could harm the market price of our common stock. A reduced market price for our shares could make it more difficult to raise funds through future offerings of common stock. Approximately 27 million shares are eligible for trading in the open market. As additional shares become available for resale in the open market, including new shares issued upon the exercise of our outstanding options, warrants, and contractual obligations to issue shares, the number of our publicly tradable shares will increase, which could decrease their trading price. In addition, some of our shares may be offered from time to time in the open market pursuant to Rule 144, and these sales may have a depressive effect on the market for our shares. In general, a person who has held restricted shares for a period of one year may, upon filing with the SEC a notification on Form 144 and satisfying certain other conditions to the application of Rule 144, sell into the market shares up to an amount equal to 1% of the outstanding shares of common stock. These sales may be repeated once each three months. In addition, any of the restricted shares may be sold by a non-affiliate after they have been held for two years pursuant to Rule 144(k). We may be subject to the SEC's penny stock rules. Broker-dealer practices in connection with transactions in "penny stocks" are regulated by certain rules adopted by the SEC. Penny stocks generally are equity securities with a price of less than $5.00, other than securities registered on certain national securities exchanges or quoted on the Nasdaq Stock Market if current price and volume information with respect to transactions in such securities is provided by the exchange or system. The rules require that a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in connection with the transaction and monthly account statements showing the market value of each penny stock held in the customer's account. In addition, the rules generally require that prior to a transaction in a penny stock, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. These disclosure requirements may have the effect of reducing the liquidity of penny stocks. If our securities become subject to the penny stock rules, holders of our shares of common stock may find it more difficult to sell their securities. We have not paid dividends in the past and do not expect to pay dividends in the future. Any return on investment may be limited to potential future appreciation in the value of our stock. We have never paid cash dividends on our stock and do not anticipate paying cash dividends on our stock in the foreseeable future. The payment of dividends on our shares, if ever, will depend on our earnings, financial condition and other business and economic factors affecting us at such time as the board of directors may consider relevant. If we do not pay dividends, our stock may be less valuable because a return on investment will only occur if and to the extent that our stock price appreciates, and if the price of our stock does not appreciate, then there will be no return on investment. Our anti-takeover defense provisions may deter potential acquirers and depress our stock price. Certain provisions of our articles of incorporation, bylaws and Nevada law, as well as certain agreements we have with our executives, could be used by our incumbent management to make it substantially more difficult for a third party to acquire control of us. These provisions include the following: 15 o we may issue preferred stock with rights senior to those of our common stock; o our Board of Directors has the exclusive right to fill vacancies and set the number of directors; o we require advance notice for nomination of directors by our shareholders and for shareholder proposals. These provisions may discourage certain types of transactions involving an actual or potential change in control. These provisions may also limit our shareholders' ability to approve transactions that they may deem to be in their best interests and discourage transactions in which our shareholders might otherwise receive a premium for their shares over the then current market price. Some of our existing shareholders can exert control over us, and may not make decisions that are in the best interests of all shareholders. Our officers, directors and principal shareholders together control approximately 42% of our outstanding common stock. Land & General Berhad through its wholly owned subsidiary, L & G Resources (1994), Inc., owns approximately 18.3% of our outstanding common stock. As a result, these shareholders, if they act together, will be able to exert a significant degree of influence over our management and affairs and over matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of us and might affect the market price of our shares, even when a change may be in the best interests of all shareholders. Moreover, the interests of this concentration of ownership may not always coincide with our interests or the interests of other shareholders, and, accordingly, they could cause us to enter into transactions or agreements which we would not otherwise consider. Past activities of the Company and its affiliates may lead to future liability for us. Prior to the acquisition of ELP, we engaged in businesses unrelated to its current operations. As a result, liabilities of the prior business before to the acquisition of ELP may have a material adverse effect on us. Item 3. Controls and Procedures Within 90 days prior to the date of this Form 10-QSB, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's President and Chief Executive Officer along with the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company's President and Chief Executive Officer along with the Company's Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company required to be included in this Form 10-QSB. There have been no changes in the Company's internal controls or in other factors, which could significantly affect the internal controls subsequent to the date the Company carried out its evaluation. PART II - OTHER INFORMATION Item 1. Legal Proceedings We are not a party to any pending material legal proceedings and are not aware of any threatened or contemplated proceeding by any governmental authority against us. Item 2. Changes in Securities and Use of Proceeds. During the first quarter ended March 31, 2005, the Company issued unregistered common stock and various warrants as outlined below: The Company issued 20,000,000 shares of its common stock on February 1, 2005 in connection with the acquisition of the sole shareholders of Electronic Sensor Technology, LP, a California limited partnership. 16 As of February 1, 2005, the Company issued 3,985,000 shares of its common stock and warrants to purchase 3,985,000 shares of its common stock at an exercise price of $1.00 per share for three years to certain investors. The Company received gross proceeds of $3,985,000. In addition, certain bridge investors of Electronic Sensor Technology, LP ("LP"), exchanged Class C Partnership Interests in the LP for 200,000 shares of Company common stock and 200,000 Investor Warrants. The Company also issued 2,783,741 shares of its common stock and warrants to purchase 1,391,871 shares of its common stock at an exercise price of $1.00 per share for three years, so long as the trading price of the stock was at least $1.50 per share ("Debtholder Warrants") in exchange for cancellation of certain debt by LP debt holders. The Company relied upon Section 4(2) of the Securities Act for the above listed offers and sales. It believed that Section 4(2) was available because the offers and sales did not involve a public offering and there was not general solicitation or general advertising involved in suxh offers or sales. Item 3. Defaults Upon Senior Securities There were no defaults upon senior securities. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to the vote of security holders. Item 5. Other Information There is no other information to report Item 6. Exhibits and Reports on Form 8-K A. Exhibits Exhibit No. Description 10.1 Agreement and Plan of Merger dated as of January 31, 2005 by and among the Registrant, Amerasia Technology, Inc., L & G Sensor Technology, Inc., Amerasia Acquisition Corp., and L&G Acquisition Corp. * 10.2 Form of Subscription Agreement by the Registrant and the purchaser on the signature page thereto. * 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2 Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. 32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act. 32.2 Certification of Principal Financial and Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act. -------------------------------------------------------------------------------- * Previously filed B. Reports on Form 8-K 1. On January 10, 2005 the Registrant filed a Form 8-K disclosing execution of a merger agreement pursuant to which Electronic Sensor Technology, LLC would become a wholly-owned subsidiary of the Registrant. 2. On February 7, 2005 the Registrant filed a Form 8-K disclosing the closing of the merger in which Electronic Sensor Technology, LLC became an indirect wholly-owned subsidiary of the Registrant, management of EST, LLC became directors and officers of the Registrant, and the Registrant closed a $3.85 million sale of common stock to various investors. 17 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ELECTRONIC SENSOR TECHNOLOGY, INC. Dated May 20, 2005 By: /s/ Edward Staples ------------------------------ Name: Edward Staples Title: Chief Executive Officer (Principal Executive Officer) Dated May 20, 2005 By: /s/ Francis Chang ------------------------------ Name: Francis Chang Title: Vice President, Finance and Administration (Principal Accounting Officer) 18