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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-----------------------------
FORM 10-QSB
[x] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
-----------------------------
For the quarterly period ended September 30, 2005
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from ____________ to _____________
Commission file number: 333-87224
ELECTRONIC SENSOR TECHNOLOGY, INC.
(Exact Name of Small Business Issuer as Specified in Its Charter)
NEVADA 98-0372780
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1077 Business Center Drive
Newbury Park, California 91320
(Address of Principal Executive Offices)
(805) 480-1994
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
53,525,865 shares of common stock as of November 11, 2005
Transitional Small Business Disclosure Format Yes [ ] No [X]
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1
ELECTRONIC SENSOR TECHNOLOGY, INC.
FORM 10-QSB
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheet as of September 30, 2005............... 3
Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 2005 and 2004................. 5
Consolidated Statements of Cash Flows for the Three Months
and Nine Months Ended September 30, 2005 and 2004................. 6
Notes to Consolidated Financial Statements........................ 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 11
Item 3. Controls and Procedures........................................... 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 20
Item 2. Changes in Securities and Use of Proceeds......................... 20
Item 3. Defaults Upon Senior Securities................................... 20
Item 4. Submission of Matters to a Vote of Security Holders............... 20
Item 5. Other Information................................................. 20
Item 6. Exhibits.......................................................... 20
2
PART I.
FINANCIAL INFORMATION
Item 1. Financial Statements
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2005
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 220,047
Certificate of deposit 912,651
Accounts receivable, net of allowance for
doubtful accounts of $20,000 474,764
Prepaid expenses 43,203
Inventories 733,843
------------------
TOTAL CURRENT ASSETS 2,384,508
PROPERTY AND EQUIPMENT 118,442
SECURITY DEPOSITS 12,817
------------------
$ 2,515,767
==================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 1,700,137
Accounts payable and accrued expenses 503,527
------------------
TOTAL CURRENT LIABILITIES 2,203,664
------------------
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value 50,000,000 shares authorized
non issued and outstanding -
3
Common stock, $.001 par value 200,000,000
shares authorized, 53,968,643 issued and outstanding, 53,969
Additional paid-in capital 12,233,816
Accumulated deficit (11,975,682)
------------------
TOTAL STOCKHOLDERS' EQUITY 312,103
------------------
$ 2,515,767
==================
See notes consolidated to financial statements
4
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Nine Months Ended Three Months Ended
September 30, September 30,
----------------------------- -----------------------------
2005 2004 2005 2004
------------- ------------- ------------- -------------
REVENUES $ 1,380,237 $ 958,606 $ 753,585 $ 175,997
COST OF SALES 1,087,064 723,386 381,018 234,268
------------- ------------- ------------- -------------
GROSS PROFIT 293,173 235,220 372,567 (58,271)
------------- ------------- ------------- -------------
OPERATING EXPENSES:
Research and development 124,145 - 124,145 -
Compensation 332,061 60,112 156,263 17,269
Selling 359,358 122,980 180,345 38,856
General and administrative 1,133,538 252,651 384,766 67,013
------------- ------------- ------------- -------------
TOTAL OPERATING EXPENSES 1,949,102 435,743 845,519 123,138
------------- ------------- ------------- -------------
LOSS FROM OPERATIONS (1,655,929) (200,523) (472,952) (181,409)
------------- ------------- ------------- -------------
OTHER INCOME AND EXPENSE:
Other income 83 (73,059) - (2,902)
Gain (loss) on sale of property and equipment 9,287 (7,711) - -
Interest expense (54,658) (61,854) (20,387) (24,255)
------------- ------------- ------------- -------------
TOTAL OTHER INCOME AND EXPENSE (45,288) (142,624) (20,387) (27,157)
------------- ------------- ------------- -------------
NET LOSS $ (1,701,217) $ (343,147) $ (493,339) $ (208,566)
============= ============= ============= =============
Loss per share, basic and diluted $ (0.03) $ (0.01) $ (0.01) $ (0.00)
============= ============= ============= =============
Weighted average number of shares, basic and diluted 53,525,865 49,983,643 53,968,643 49,983,643
============= ============= ============= =============
See notes to consolidated financial statements
5
ELECTRONIC SENSOR TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
-----------------------------
2005 2004
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) $ (1,701,217) $ (343,147)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 11,430 2,641
Donated services - 6,000
Changes in assets and liabilities:
Accounts receivable (444,077) 331,986
Inventories (253,195) (86,439)
Prepaid expenses (28,946) 1,952
Security deposits 140 (2)
Accounts payable and accrued expenses 290,725 (39,361)
Due to related party (60,000) 11,500
Interest payable (26,961) (3,340)
Other current liabilities (35,665) (4,608)
------------- -------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (2,247,766) (122,818)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 30,280 (3,826)
Purchase of property and equipment (108,954) -
------------- -------------
NET CASH (USED IN) OPERATING ACTIVITIES (78,674) (3,826)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in line of credit (269,000) 162,000
Repayment of partners' loans payable (110,000) (230,000)
Proceeds from issuance of common stock 3,811,708 74,500
------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,432,708 6,500
------------- -------------
NET INCREASE (DECREASE) IN CASH 1,106,268 (120,144)
6
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 26,430 121,069
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,132,698 $ 925
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 67,380 $ 61,897
============= =============
See notes to consolidated financial statements.
7
ELECTRONIC SENSOR TECHNOLOGY, INC.
Notes to Financial Statements
(Unaudited)
September 30, 2005
(1) Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial statements and with the instructions to Form 10-QSB and
Article 10 of Regulation S-B. Accordingly, they do not include all the
information and disclosures required for annual financial statements. These
financial statements should be read in conjunction with the consolidated
financial statements and related footnotes for the year ended December 31,
2004, included in the Annual Report filed on Form 10-KSB for the year then
ended.
In the opinion of the management of Electronic Sensor Technology, Inc.
(formerly Bluestone Ventures, Inc.) (the "Company"), all adjustments
(consisting of normal recurring accruals) necessary to present fairly the
Company's financial position as of September 30, 2005, and the results of
operations and cash flows for the nine month period ending September 30,
2005 have been included. The results of operations for the nine month
period ended September 30, 2005 are not necessarily indicative of the
results to be expected for the full year. For further information, refer to
the consolidated financial statements and footnotes thereto included in the
Company's Annual Report filed on Form 10-KSB 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
The Company develops and manufactures electronic devices used for
vapor analysis.
(b) Cash and Cash Equivalents
The Company considers highly liquid financial instruments with
maturities of three months or less at the time of purchase to be cash
equivalents. The Company did not have any cash equivalents at
September 30, 2005.
(c) Revenue Recognition
The Company records revenue from direct sales of products to end-users
when the products are shipped, collection of the purchase price is
probable and the Company has no significant further obligations to the
customer. Costs of remaining insignificant Company obligations, if
any, are accrued as costs of revenue at the time of revenue
recognition. Cash payments received in advance of product or service
revenue are recorded as deferred revenue.
8
(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 September 30,
2005 no assets were impaired.
(4) Mergers and Acquisitions
Bluestone Ventures, Inc. ("Bluestone") executed an Agreement and Plan of
Merger (the "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.P."),
L & G Sensor Technology, L.P. ("L&G"), holder of approximately 45% of the
partnership interests of EST, L.P., 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, L.P. and (iv) Bluestone issued
20,000,000 shares of its common stock to the shareholders of Amerasia and
L&G. The merger has been treated as a purchase only of the partnership
interests of EST, L.P.
9
For accounting purposes, the transaction will be treated as a
recapitalization of EST, L.P. 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, L.P. 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 EST, 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 EST, L.P., totaling
$1,198,630 were converted into 1,198,630 shares of common stock of
Bluestone.
In January 2005 the notes payable to related parties of $1,272,000 plus
accrued interest were converted into 1,585,111 shares of common stock of
Bluestone. Bluestone has changed its name to Electronic Sensor Technology,
Inc. as of February 2005.
The Company adopted a Stock Incentive Option Plan in April 2005. There were
969,500 initial options granted to former EST, L.P. limited partnership
employees.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
You should read the following discussion and analysis of our financial
condition and results of operations together with our interim financial
statements and the related notes appearing at the beginning of this report. The
interim financial statements and this Management's Discussion and Analysis of
Financial Condition and Results of Operations should be read in conjunction with
the financial statements and notes thereto for the year ended December 31, 2004
and the related Management's Discussion and Analysis of Financial Condition and
Results of Operations, both of which are contained in our Annual Report on Form
10-KSB filed with the Securities and Exchange Commission on April 15, 2005.
The following discussion and other parts of this Form 10-QSB contain
forward-looking statements that involve risks and uncertainties. Forward-looking
statements can be identified by words such as "anticipates," "expects,"
"believes," "plans," and similar terms. Our actual results could differ
materially from any future performance suggested in this report as a result of
factors, including those discussed in "Factors That May Affect Future Operating
Results" and elsewhere in this report and in our Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2004. All forward-looking statements are
based on information currently available to the Company and we assume no
obligation to update such forward-looking statements, except as required by law.
Service marks, trademarks and trade names referred to in this Form 10-QSB are
the property of their respective owners.
--------------------------------------------------------------------------------
Overview
The Company is engaged in the development, manufacturing, and sales of a
patented product called zNose(R): a device designed to detect and analyze
chemical odors and vapors, or, in other words, an electronic "nose." We
believe the zNose(R) is superior to other electronic "noses" because of its
speed, specificity and sensitivity. The zNose(R) is capable of measuring and
quantifying the chemistry of any compound, fragrance, vapor or odor with parts
per trillion sensitivity in 10 seconds. We also believe the zNose(R) has the
unique ability to quantify and speciate the subject chemical vapor by creating
visual olfactory images. This enables the measured odor or vapor to be easily
identified by the user.
We believe that our products will have broad applications in the homeland
security and laboratory instrumentation markets. The Company is involved in
ongoing product research and development efforts in that regard. The Company has
also concentrated its efforts on further product development, testing and
proving and assembling a sales and support organization.
The Company 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 EST, L.P., we abandoned our mining business and
adopted EST, L.P.'s business of developing, manufacturing and selling the vapor
analysis device. Prior to the closing of the mergers, on January 26, 2005,
pursuant to which EST, L.P. was acquired, we changed our name to "Electronic
Sensor Technology, Inc."
The Company executive offices are located at 1077 Business Center Circle,
Newbury Park, California 91320, telephone: (805) 480-1994.
Critical Accounting Policies
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.
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.
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 September 30, 2005 no assets were impaired.
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:
Nine months ended
September 30
----------------------------
2005 2004
-------- ------
Statements of Operations Data:
Revenues.............................. 100% 100%
Cost of sales ....................... 79% 75%
Gross profit ......................... 21% 25%
Operating expenses.................... 141% 45%
11
Loss from operations.................. 120% 21%
Other Income and Expense.............. 3% 15%
Net loss.............................. 123% 36%
Nine Months Ended September 30, 2005 Compared to Nine Months Ended
September 30, 2004
Revenues for the nine months ended September 30, 2005 were $1,380,000
compared to $959,000 in 2004. It showed an increase of 44% due to an increase in
the number of zNose(R) units shipped from 20 units in 2004 to 37 units in 2005
for the nine month period, which represents an 85% increase over the same nine
month period in 2004.
Gross profit was $293,172 for the nine months ending September 30, 2005,
compared to $235,220 for the nine months period ending September 30, 2004. This
increase of $57,952 resulted from increased sales, offset by an increase in
direct manufacturing costs.
Compensation expenses in the first nine months of 2005 were $332,000, as
compared to $60,000 in 2004. As a percentage of sales, total compensation
expenses increased from 6% of sales, to 24% of sales. The increase of
$272,000 was due to the increase of personnel costs, due to the hiring of new
employees.
Selling expenses for the first nine months of 2005 were $359,000, as
compared to $123,000 in 2004. As a percentage of sales, total selling expenses
increased from 13% of sales to 26% of sales. This increase of $236,000 was due
to an increase in Sales and Marketing personnel costs and expanded sales
activities.
General and administrative expenses for the first nine months of 2005 were
$1,134,000, as compared to $253,000 in 2004. As a percentage of sales, general
and administration expenses increased from 26% of sales to 82% of sales. This
increase of $881,000 was primarily due to costs incurred in connection with the
reverse merger in February 2005, and the added costs involved in being a
publicly traded company.
Interest expense for the first nine months of 2005 was $54,658, as compared
to $61,896 in 2004. This slight decrease is due to an offsetting interest
income of $12,722 from a certificate of deposit in the amount of $900,000.
Net Loss was $1,701,000 for the period ending September 30, 2005 as
compared to a loss of $343,000 for the nine- month period ending September 30,
2004. The increase was primarily due to higher operating expenses in the nine-
month period of 2005 including a one time charge in connection with the reverse
merger, increased sales activities, increased personnel costs and an expanded
new product development effort.
Liquidity and Capital Resources
In the first nine months of 2005, net cash used by the Company for
operating activities was $2,248,000. In the first nine months of 2004, the cash
used by Company's operations was $123,000. Cash used in the first nine months of
2005 was comprised of the net loss incurred for the nine- month period of
$1,701,000, plus net non-cash expenses of $11,000 plus the net change in
operating assets and liabilities of $536,000. Cash used in operations in the
first nine months of 2004 was comprised of the net loss of $343,000, plus net
non-cash expenses of $9,000, plus the net change in operating assets and
liabilities of $212,000.
Investing activities used cash of $79,000 in the first nine months of 2005
and used $4,000 during the same period in 2004. In both 2005 and 2004 the cash
was used to purchase of equipment.
12
Financing activities provided cash of $3.4 million and $7,000 during the
first nine months ending September 30, 2005 and 2004, respectively. The
increase was primarily due to the issuance of common stock of $3.8 million.
On September 30, 2005 the Company retained cash on hand of $1.1 million,
compared to $1,000 on September 30, 2004. On September 30, 2005 the Company had
working capital of $180,844, as compared to a working deficit of $ 5.7 million
on September 30, 2004. The Company, at present, has a credit facility in place
with East West Bank for $1.8 million. The outstanding line of credit on the East
West Bank facility as of September 30, 2005 was $1,700,137 with an annual
interest rate of 0.5% above the bank prime rate, payable monthly.
Although the Company possesses a bank operating line of credit, there can
be no assurance that these proceeds will be adequate for our capital needs.
There can be no assurance that any required or desired financing will be
available through any other bank borrowings, debt, or equity offerings, or
otherwise, on acceptable terms. If future financing requirements are satisfied
through the issuance of equity securities, investors may experience significant
dilution in the net book value per share of common stock and there is no
guarantee that a market will exist for the sale of the Company's shares.
The Company's primary capital needs are to fund its growth strategy, which
includes creating a sales and marketing staff for the marketing, advertising and
selling of the zNose(R) family of chemical detection products, increasing
distribution channels both in U.S. and foreign countries, introducing new
products, improving existing product lines and development of a strong corporate
infrastructure.
Seasonality and Quarterly Results
We do not foresee any seasonality to our revenues or our results of
operations.
Inflation
Our raw materials and finished products are sourced from cost-competitive
industries. As such, we do not foresee any material inflationary trends for our
product sources.
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 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.
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:
13
o delays in the quantities needed for product development could delay
commercialization of our 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.
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. We believe that
manufacturers of X-Rays, Ion Mobility Spectrometer, and other electronic noses
compete with us in the security-related markets. In the analytical
instrumentation markets, we compete with many gas chromatograph manufacturers
including Perkin-Elmer (NYSE:PKI) and Agilent Technologies (NYSE:A). 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 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 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:
14
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.
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.
We believe that our future success will depend in large part on our ability
to attract and retain highly skilled engineering, sales and 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. The trading
15
prices of many technology companies' stocks do not reflect valuations.
There can be no assurance that trading prices and valuations will be sustained.
These broad market and industry factors may materially and adversely affect the
market price of the Company's 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 Company's common
stock. Following periods of volatility in the market price of a company's
securities, securities class action litigation is often instituted against such
company. If such securities class action litigation were to be instituted
against the Company, it 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.
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 in February 2005, 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.
16
We may raise additional capital through a securities offering that could dilute
the ownership interests of our shareholders.
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 of Directors of
the Company (the "Board") is authorized to issue, without obtaining shareholder
approval, shares of preferred stock having the rights, privileges and is
designated 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 satisfying certain
conditions to the application of Rule 144, sell into the market shares up to an
amount equal to 1% of the outstanding shares (and potentially more) of common
stock of the Company. These sales may be repeated once each three months. In
addition, an unlimited amount of 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 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.
17
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:
o we may issue preferred stock with rights senior to those of our common
stock;
o the Board 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 the Company 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 EST, L.P., we engaged in businesses unrelated
to the Company's current operations. As a result, liabilities of the prior
business before the acquisition of EST, L.P. may have a material adverse
effect on us.
18
Item 3. Controls and Procedures
As of September 30, 2005, the Company carried out an evaluation, under the
supervision and with the participation of the Company's management, including
the Company's President and Chief Executive Officer along with the Company's
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15(b). Based upon that evaluation, the Company's President and Chief
Executive Officer along with the Company's Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company required to be
included in this Form 10-QSB.
There have been no changes in the Company's internal controls or in other
factors, which could significantly affect the internal controls subsequent to
the date the Company carried out its evaluation.
19
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.
No equity securities of the Company that were not registered under the
Securities Act of 1933 were sold by the Company during the quarter ended
September 30, 2005.
Item 3. Defaults Upon Senior Securities
There were no material 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.
Exhibit
No. Description
------- -----------
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.
--------------------------------------------------------------------------------
20
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 November 14, 2005 By: /s/ Matthew Collier
---------------------------
Name: Matthew Collier
Title: Chief Executive Officer
(Principal Executive Officer)
Dated November 14, 2005 By: /s/ Francis Chang
---------------------------
Name: Francis Chang
Title: Vice President, Finance and
Administration (Principal
Accounting Officer)