** **

**UNITED STATES**

**SECURITIES ANDEXCHANGE COMMISSION**

**Washington,DC 20549**

 

**Form 10-QSB**

 

**ý****QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For thequarterly period ended June 30, 2002**

 

**o****TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**

 

**For thetransition period from           to          **

 

**CommissionFile Number 0-9587**

 

**ELECTRO-SENSORS,INC.**

(Exact name of small business issuer as specifiedin its charter)

 

| **Minnesota**                                                   |   | **41-0943459**                    |
|-----------------------------------------------------------------|--------|-----------------------------------|
| (State or other jurisdiction of incorporation or  organization) |   | (IRS Employer Identification No.) |
|                                                            |   |                              |
| **6111 Blue Circle Drive**                                      |
| **Minnetonka, Minnesota 55343-9108**                            |
| (Address of principal executive offices)                        |
|                                                            |   |                              |
| **(952) 930-0100**                                              |
| (Issuer’s telephone number)                                |

 

The number of sharesoutstanding of the registrant’s Common Stock, $0.10 par value, on August 12,2002 was 3,155,260.

 

Transitional SmallBusiness Disclosure Format (check one): o Yes   ý No

 

 

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**ELECTRO-SENSORS, INC. AND SUBSIDIARIES**

**Form 10-QSB for the Period Ended June 30,2002**

 

**TABLE OF CONTENTS**

 

 

**PART I – FINANCIAL INFORMATION**

 

Item 1. Financial Statements

Item 2. Management’sDiscussion and Analysis or Plan of Operation

 

 

**PART II – OTHER INFORMATION**

 

Item 1.  Legal Proceedings

Item 2.  Changes in Securities

Item 3.Defaults Upon Senior Securities

Item 4.Submission of Matters to a Vote of Security Holders

Item 5.  Other Information

Item 6.Exhibits and Reports on Form 8-K

 

 

**SIGNATURES**

 

2

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**PART I –FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

Theinterim financial statements included in this Form 10-QSB are unaudited andreflect, in the opinion of management, all adjustments (which include onlynormal recurring adjustments) necessary for a fair presentation of the resultsof operations for these periods.

 

 

**INDEX TO CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 

ConsolidatedBalance Sheets — For the Six-Month Period Ended June 30, 2002 and December 31,2001

ConsolidatedStatements of Income — For the Three-Month Period Ended June 30, 2002 and June30, 2001, and for the Six-Month Period Ended June 30, 2002 and June 30, 2001

ConsolidatedStatements of Cash Flows — For the Six-Month Period Ended June 30, 2002 andJune 30, 2001

Notesto Consolidated Financial Statements

 

3

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**ELECTRO-SENSORS,INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**

 

 
|                                                                                                                        |   | **June  30, 2002** |           | **December  31, 2001** |       |
|-----------------------------------------------------------------------------------------------------------------------------|--------|--------------------|----------------|------------------------|------------|
|                                                                                                                        |   |               |           |                   |       |
| **ASSETS**                                                                                                                  |   |               |           |                   |       |
| **CURRENT  ASSETS**                                                                                                         |   |               |           |                   |       |
|                                                                                                                        |   |               |           |                   |       |
| Cash And Cash Equivalents                                                                                                   |   | $                  | 7,290,310      |                   | $          | 8,389,691 |   |
| Investments                                                                                                                 |   | 8,290,429          |           | 11,140,320             |       |
| Trade Receivables                                                                                                           |   | 532,200            |           | 498,283                |       |
| Less Allowance for Doubtful  Accounts of $29,346 and $25,000, respectively.                                                 |   |               |           |                   |       |
| Inventories                                                                                                                 |   | 767,053            |           | 819,272                |       |
| Other Current Assets                                                                                                        |   | 241,399            |           | 210,551                |       |
| **Total Current Assets**                                                                                                    |   | 17,121,391         |           | 21,058,117             |       |
| **Property and  Equipment, Net**                                                                                            |   | 1,489,991          |           | 1,480,477              |       |
| **Investment in  Equity Method Investee**                                                                                   |   | 1,098,168          |           | 0                      |       |
| **TOTAL ASSETS**                                                                                                            |   | **$**              | **19,709,550** | ** **             | **$**      | **22,538,594** | ** ** |
|                                                                                                                        |   |               |           |                   |       |
| LIABILTIIES AND STOCKHOLDERS’ EQUITY                                                                                   |   |               |           |                   |       |
| **CURRENT  LIABILITIES**                                                                                                    |   |               |           |                   |       |
| Accounts Payable                                                                                                            |   | $                  | 142,222        |                   | $          | 65,530 |   |
| Accrued Expenses                                                                                                            |   | 157,549            |           | 140,014                |       |
| Accrued Income Taxes                                                                                                        |   | 416,580            |           | 1,647,470              |       |
| Deferred Income Taxes                                                                                                       |   | 2,893,104          |           | 3,919,108              |       |
| **Total Current Liabilities**                                                                                               |   | 3,609,455          |           | 5,772,122              |       |
| **DEFERRED  INCOME TAXES**                                                                                                  |   | 3,400              |           | 3,400                  |       |
|                                                                                                                        |   |               |           |                   |       |
| **STOCKHOLDERS’S  EQUITY**                                                                                             |   |               | ** **     |                   | ** ** |
| Common Stock par value $0.10  per share;Authorized  10,000,000 shares; Issues 3,154,613 and 3,121,263 shares, respectively. |   | 315,461            |           | 312,126                |       |
| Additional Paid-In Capital                                                                                                  |   | 964,305            |           | 894,172                |       |
| Retained Earnings                                                                                                           |   | 9,658,936          |           | 8,592,074              |       |
| Accumulated Other  Comprehensive Income                                                                                     |   | 5,157,993          |           | 6,964,700              |       |
| **Total Stockholders’ Equity**                                                                                         |   | 16,096,695         |           | 16,763,072             |       |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                        |   | **$**              | **19,709,550** | ** **             | **$**      | **22,538,594** | ** ** |

 

See AccompanyingNotes to Consolidated Financial Statements

 

4

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**ELECTRO-SENSORS,INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**(Unaudited)**

 
|                                                                     |   | **Three Months Ended** |      | **Six Months Ended** |   |
|--------------------------------------------------------------------------|--------|------------------------|-----------|----------------------|--------|
|                                                                     |   | **2002**               |      | **2001**             |   | **2002** |   | **2001** | ** ** |
|                                                                     |   |                   |      |                 |   |   |   |   |   |
| **Net Sales**                                                            |   | $                      | 1,124,439 |                 | $      | 1,183,979 |   | $ | 2,263,095 |   | $ | 2,485,348 |   |
| **Cost of Goods Sold**                                                   |   | 477,851                |      | 440,472              |   | 971,078 |   | 915,168 |   |
| **Gross Profit**                                                         |   | 646,588                |      | 743,507              |   | 1,292,017 |   | 1,570,180 |   |
|                                                                     |   |                   |      |                 |   |   |   |   |   |
| **Operating Expenses:**                                                  |   |                   |      |                 |   |   |   |   |   |
| Selling and Marketing                                                    |   | 256,758                |      | 313,609              |   | 537,892 |   | 611,914 |   |
| General and Administrative                                               |   | 231,473                |      | 247,785              |   | 442,823 |   | 510,485 |   |
| Research and Development                                                 |   | 321,039                |      | 187,657              |   | 546,180 |   | 375,685 |   |
| **Total Operation Expenses**                                             |   | 809,270                |      | 753,051              |   | 1,526,895 |   | 1,498,084 |   |
| **Operating Income (Loss)**                                              |   | (162,682               | )         | (9,544               | )      | (234,878 | ) | 72,096 |   |
|                                                                     |   |                   |      |                 |   |   |   |   |   |
| **Non-Operating Income (Expense):**                                      |   |                   |      |                 |   |   |   |   |   |
| Gain (Loss) on Sale of Investment  Securities                            |   | 1,464,799              |      | 2,737,663            |   | 2,097,573 |   | 4,164,230 |   |
| Interest Income                                                          |   | 27,023                 |      | 65,006               |   | 169,960 |   | 98,504 |   |
| Other Income (Expense)                                                   |   | (3,419                 | )         | 0                    |   | (26,162 | ) | 0 |   |
| Equity in Losses of Equity Method Investee                               |   | 0                      |      | (59,820              | )      | 0 |   | (104,510 | ) |
| **Total Non-Operating Income (Expense)**                                 |   | 1,488,403              |      | 2,742,849            |   | 2,241,371 |   | 4,158,224 |   |
|                                                                     |   |                   |      |                 |   |   |   |   |   |
| **Income (Loss) from Continuing Operations**                             |   |                   |      |                 |   |   |   |   |   |
| **Before Income Taxes**                                                  |   | 1,325,721              |      | 2,733,305            |   | 2,006,493 |   | 4,230,320 |   |
|                                                                     |   |                   |      |                 |   |   |   |   |   |
| **Federal and State Income Taxes**                                       |   | 486,466                |      | 980,434              |   | 751,325 |   | 1,535,459 |   |
|                                                                     |   |                   |      |                 |   |   |   |   |   |
| **Income (Loss) from Continuing Operations**                             |   | 839,255                |      | 1,752,871            |   | 1,255,168 |   | 2,694,861 |   |
|                                                                     |   |                   |      |                 |   |   |   |   |   |
| **Discontinued Operations:**                                             |   |                   |      |                 |   |   |   |   |   |
| Income (Loss) from Operation of Microflame Division, net of income taxes |   | 0                      |      | (2,524               | )      | 0 |   | (3,510 | ) |
| Loss on Disposal of Microflame Division, Net of income taxes             |   | 0                      |      | (69,229              | )      | 0 |   | (69,229 | ) |
| **Total Income (Loss) from Discontinued  Operations**                    |   | 0                      |      | (71,753              | )      | 0 |   | (72,739 | ) |
| **Net Income (Loss)**                                                    |   | $                      | 839,255   |                 | $      | 1,681,118 |   | $ | 1,255,168 |   | $ | 2,622,122 |   |

 

See Accompanying Notes to Consolidated Financial Statements

 

5

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**ELECTRO-SENSORS,INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**(Unaudited)**

 
| **Net Income (Loss) Per Share Data:**                    |   |      | ** ** |      | ** ** |      | ** ** |      | ** ** |
|----------------------------------------------------------|--------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|
| ***Basic***                                              |   |      |       |      |       |      |       |      |       |
| Income (Loss) from Continuing Operations                 |   | $         | 839,255    |      | $          | 1,752,871 |       | $         | 1,255,168  |   | $ | 2,694,861 |   |
| Income (Loss) from Discontinued Operations               |   | —    |       | (71,753   | )          | —    |       | (72,739   | )          |
|                                                     |   | $         | 839,255    |      | $          | 1,681,118 |       | $         | 1,255,168  |   | $ | 2,622,122 |   |
|                                                     |   |      |       |      |       |      |       |      |       |
| Net Income (Loss) Per Share from Continuing Operations   |   | $         | 0.27       |      | $          | 0.56      |       | $         | 0.40       |   | $ | 0.86 |   |
| Net Income (Loss) Per Share from Discontinued Operations |   | —    |       | (.02      | )          | —    |       | (.02      | )          |
|                                                     |   | $         | 0.27       |      | $          | 0.54      |       | $         | 0.40       |   | $ | 0.84 |   |
|                                                     |   |      |       |      |       |      |       |      |       |
| Shares Used in Per Share Calculations                    |   | 3,146,111 |       | 3,118,948 |       | 3,134,048 |       | 3,118,948 |       |
|                                                     |   |      |       |      |       |      |       |      |       |
| ***Diluted***                                            |   |      |       |      |       |      |       |      |       |
| Income (Loss) from Continuing Operations                 |   | $         | 839,255    |      | $          | 1,752,871 |       | $         | 1,255,168  |   | $ | 2,694,861 |   |
| Income (Loss) from Discontinued Operations               |   | —    |       | (71,753   | )          | —    |       | (72,739   | )          |
|                                                     |   | $         | 839,255    |      | $          | 1,681,118 |       | $         | 1,255,168  |   | $ | 2,622,122 |   |
|                                                     |   |      |       |      |       |      |       |      |       |
| Net Income (Loss) Per Share from Continuing Operations   |   | $         | 0.26       |      | $          | 0.54      |       | $         | 0.37       |   | $ | 0.83 |   |
| Net Income (Loss) Per Share from Discontinued Operations |   | —    |       | (.02      | )          | —    |       | (.02      | )          |
|                                                     |   | $         | 0.26       |      | $          | 0.52      |       | $         | 0.37       |   | $ | 0.81 |   |
|                                                     |   |      |       |      |       |      |       |      |       |
| Shares Used in Per Share Calculations                    |   | 3,282,871 |       | 3,240,749 |       | 3,391,365 |       | 3,255,828 |       |
|                                                     |   |      |       |      |       |      |       |      |       |

 

See Accompanying Notes to Consolidated FinancialStatements

 

6

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ELECTRO-SENSORS, INC. ANDSUBSIDIARIES

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                         |   | **Six  Months Ended** |      |
|------------------------------------------------------------------------------|--------|-----------------------|-----------|
|                                                                         |   | **2002**              |      | **2001** |   |
| **Reconciliation of Net Income to Net Cash**                                 |   |                  |      |   |   |
| **Provided by  Operating Activities**                                        |   |                  |      |   |   |
|                                                                         |   |                  |      |   |   |
| **Net Income**                                                               |   | $                     | 1,255,168 |   | $ | 2,622,122 |   |
| Adjustments to Reconcile Net  Income to Net Cash                             |   |                  |      |   |   |
| Provided By/(used in)  Operating Activities:                                 |   |                  |      |   |   |
| Provision for Losses on Trade  Receivables                                   |   | —                |      | (10,640 | ) |
| Loss of Disposal of Segment                                                  |   | —                |      | 71,753 |   |
| Depreciation                                                                 |   | 13,294                |      | 60,919 |   |
| Deferred Taxes                                                               |   | (200                  | )         | 219,533 |   |
| Realized (Gain)/Loss on Sale  of Investments                                 |   | (2,097,573            | )         | (4,164,230 | ) |
| Equity Method Losses of Equity  Method Investee                              |   | 0                     |      | 104,510 |   |
| (Increase)/Decrease In:                                                      |   |                  |      |   |   |
| Trade Receivables                                                            |   | (39,626               | )         | (61,682 | ) |
| Inventory                                                                    |   | 52,219                |      | (79,612 | ) |
| Prepaid Expenses                                                             |   | (30,848               | )         | 86,519 |   |
| Prepaid Income Taxes                                                         |   | —                |      | (74,606 | ) |
| Accounts Payable                                                             |   | 76,892                |      | (18,022 | ) |
| Customer Deposits                                                            |   | —                |      | 1,605 |   |
| Accrued Expenses                                                             |   | 17,535                |      | 20,613 |   |
| Accrued Income Taxes                                                         |   | (1,230,890            | )         | 1,411,447 |   |
| Net Cash Provided by Operating  Activities                                   |   | (1,984,029            | )         | 190,229 |   |
|                                                                         |   |                  |      |   |   |
| Cash Flows from Investing  Activities:                                       |   |                  |      |   |   |
| Proceeds From Sale of  Investments                                           |   | 2,114,753             |      | 4,205,032 |   |
| Additional Investment in  Equity Method Investee                             |   | (1,098,168            | )         | — |   |
| Purchase of Property and  Equipment                                          |   | (22,808               | )         | (18,475 | ) |
| Principal Payments Received on  Note Receivable                              |   | 5,709                 |      | 1,000 |   |
| Proceeds from Disposed Segment                                               |   | —                |      | 5,000 |   |
| Net Cash Provided By/ (used  in) Investing Activities                        |   | 999,486               |      | 4,192,557 |   |
|                                                                         |   |                  |      |   |   |
| Cash Flows from Financing  Activities:                                       |   |                  |      |   |   |
| Proceeds from Issuance of  Stock                                             |   | 73,468                |      | 6,538 |   |
| Dividends Paid                                                               |   | (188,306              | )         | (187,245 | ) |
|                                                                         |   |                  |      |   |   |
| Net Cash Used in Financing  Activities                                       |   | (114,838              | )         | (180,707 | ) |
|                                                                         |   |                  |      |   |   |
| Net Increase in Cash &  Cash Equivalents                                 |   | (1,099,381            | )         | 4,202,079 |   |
| Cash & Cash Equivalents,  Beginning                                      |   | 8,389,691             |      | 3,191,176 |   |
| Cash & Cash Equivalents,  Ending                                         |   | 7,290,310             |      | 7,393,255 |   |
|                                                                         |   |                  |      |   |   |
| **Supplemental  Schedule of Non-Cash Investing****and Financing Activities** |   |                  |      |   |   |
|                                                                         |   |                  |      |   |   |
| Net change in Unrealized Gain/  (Loss) on Marketable Securities              |   | (2,832,711            | )         | 3,495,598 |   |
| Issuance of Note Receivable  Related to Sale of Segment                      |   | —                |      | 36,000 |   |
|                                                                              |        |                       |           |  |  |  |  |

 

See AccompanyingNotes to Consolidated Financial Statements

 

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**ELECTRO-SENSORS, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note1.  Nature of Business**

 

The accompanying consolidatedfinancial statements include the accounts of Electro-Sensors, Inc. and itswholly owned subsidiary, ESI Investment Company.  Intercompany accounts, transactions and earnings have beeneliminated in consolidation.  Theconsolidated entity is referred to as “the Company”.

 

Electro-Sensors, Inc. operatestwo distinct businesses.  The first isthe Controls Division, which carries the name of Electro-Sensors, Inc.  This division manufactures and markets acomplete line of speed monitoring and motor control systems for industrialmachinery.  The Controls Divisionutilizes leading-edge technology to continuously improve its products and makethem easier to use.  The ControlsDivision’s goal is to manufacture the industry-preferred product for everymarket served.  These products are soldthrough an internal sales staff and distributors to a wide variety ofmanufacturers, OEM’s and processors to monitor process machineryoperations.  The Controls Divisionmarkets its products to a number of different industries located throughout theUnited States and abroad.

 

The second business is AutoDataSystems (ADS), a division of Electro-Sensors, Inc.  ADS designs and markets desktop software based systems that readhand printed characters, checkmarks and bar code information from scanned orfaxed forms.  ADS products are designedto provide capabilities to automate data collection and are marketed throughtelemarketing to end users, resellers and developers in the United States,Canada, Europe and Asia.

 

ESI Investment Company ownsmarketable securities which have experienced significant appreciation in valuesince the IPO of August Technology in 2000. During 2000, 2001 and 2002, the Company has recognized income from thesale of its holdings in August Technology Corporation.

 

During May 2002 ESI Investmentparticipated in a rights offering by PPT Vision, Inc. (PPTV). As a result ofthe additional investment in PPTV the Company has changed its reporting of thisinvestment to the equity method of accounting. See note 3 for additionalinformation about this investment and the related change to the equity method.

 

The Company previously operateda third business, Microflame, Inc. (MFI), a wholly owned subsidiary, which wassold in May 2001.  MFI produced smallhand held gas torches used primarily by hobbyists, electronic kit assemblersand creators of jewelry.  MFI productswere sold through distributors to retailers of hardware, craft and electronicproducts.

 

**Note 2.  Basis of Presentation**

 

The accompanying unauditedconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America forinterim financial information and with the instructions to Form 10-QSB and Rule10-01 of Regulation S-X.  Accordingly,they do not include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.

 

The Balance Sheet at December31, 2001 has been derived from the Company’s audited financial statements forthe year ended December 31, 2001, but does not include all of the informationand footnotes required by accounting principles generally accepted in theUnited States of America for complete financial statements.

 

For further information, referto the financial statements and footnotes thereto included in the Company’sannual report on Form 10-KSB for the year ended December 31, 2001.

 

8

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**Note3.  Investments**

 

The Company has a portfolio ofinvestments.  Management determines theappropriate classification of securities at the date individual investments areacquired, and evaluates the appropriateness of such classification at eachbalance sheet date.

 

The Company’s investmentsconsist of marketable equity securities, primarily common stocks, governmentdebt securities, and money market funds. The estimated fair value of marketable equity securities is based onquoted market prices and therefore subject to the inherent risk of marketfluctuations. The Company owned 809,000 and 981,000 shares of AugustTechnologies, Inc. as of June 30, 2002 and December 31, 2001, respectively.

 

Since the Company does not buyinvestments in anticipation of short-term fluctuations in market prices, theinvestments in marketable equity securities has been classified asavailable-for-sale.  Available-for-sale securitiesare stated at fair value, and unrealized holding gains and losses, net of therelated deferred tax effect, are reported as separate component ofstockholders’ equity.  Dividends onmarketable equity securities are recognized in income when declared.

 

**Change in Reporting for theCompany’s Investment in PPT Vision, Inc.**

 

During 2002, theCompany purchased 1,098,168 units of PPT Vision, Inc. (PPT).  Each unit consists of one share of commonstock and a warrant to purchase one-half share of common stock.  The warrants are exercisable at $2.50 untilSeptember 30, 2003.  PPT is a publiclytraded corporation in which the Company had previously owned 549,084 shares,9.96% of PPT’s outstanding common stock. At June 30, 2002, the Company owned 1,647,252 shares of PPT, which is16.36% of PPT’s outstanding common stock. The fair value of its holdings based on the quoted market price at June30, 2002 was approximately $1,280,000.

 

At this time, itwas determined that the Company now has significant influence over theoperations of PPT, and as a result its ownership should be reported using theequity method of accounting for investments. The investment was previously reported as an available-for-salesecurity, showing the market value on the balance sheet and recording anyunrealized gains and losses in other comprehensive income.

 

Resulting fromthis change to the equity method of accounting, the balance sheets at June 30,2002 and December 31, 2001 have been adjusted to show the Company’s investmentin PPT based on the equity method rather than based on market value.  Retained earnings at those dates has beenadjusted to reflect equity method earnings from prior periods and accumulatedother comprehensive income at those dates has been adjusted to eliminateunrealized gains and losses from PPT that were recorded in prior periods.  In addition, the income statements for thethree months and six months ended both June 30, 2002 and June 30, 2001 havebeen adjusted to show the Company’s portion of PPT’s earnings from thoseperiods.

 

Under the equitymethod of accounting, the Company’s proportionate share of PPT income or lossthrough April 30, 2002 is included in the Company’s net income with acorresponding increase or decrease in the carrying value of its investment.

 

9

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**Change in Reporting for theCompany’s Investment in PPT Vision, Inc. (Continued)**

 

Summary financialinformation of PPT Vision, Inc. as of April 30, 2002 is as follows:

 
| **Balance Sheet**              |   | **April 30, 2002** |       |
|--------------------------------|--------|--------------------|------------|
| Current asset                  |   | $                  | 6,109,000  |   |
| Fixed asset                    |   | 1,721,000          |       |
| Intangible & other assets  |   | 2,765,000          |       |
| Total assets                   |   | $                  | 10,595,000 |   |
|                           |   |               |       |
| Current liabilities            |   | $                  | 1,701,000  |   |
| Stockholder equity             |   | 8,894,000          |       |
| Total liabilities & equity |   | $                  | 10,595,000 |   |

 
|                  |   |                                     |      |                                   |   |
|-----------------------|--------|------------------------------------------|-----------|----------------------------------------|--------|
| **Income Statements** |   | **Three Months Ended****April 30, 2002** |      | **Six Months Ended****April 30, 2002** |   |
| Net revenues          |   | $                                        | 1,607,000 |                                   | $      | 3,263,000 |   |
| Gross profit          |   | 802,000                                  |      | 1,523,000                              |   |
| Total expenses        |   | 2,420,000                                |      | 4,752,000                              |   |
| Net loss              |   | (1,612,000                               | )         | (3,192,000                             | )      |
|                       |        |                                          |           |                                        |        |  |  |

 

Realizedgains and losses, including losses from declines in value of specificsecurities determined by management to be other-than-temporary, are included inincome.  Realized gains and losses aredetermined on the basis of the specific securities sold.

 

**Note 4.  Recent Accounting Pronouncements**

 

InJuly 2001, the Financial Accounting Standards Board issued SFAS No. 141,“Business Combinations” and SFAS No. 142, “Goodwill and Other IntangibleAssets”.  SFAS No. 141 applies to allbusiness combinations initiated after June 30, 2001 and prohibits the use ofthe pooling-of-interests method of accounting. There are also transition provisions provided that apply to businesscombinations completed before July 1, 2001 that were accounted for using the purchasemethod.  Under SFAS No. 142, goodwill aswell as other intangibles determined to have an infinite life will no longer beamortized; however, these assets will be reviewed for impairment on a periodicbasis.  SFAS No. 142 also includesprovisions for the reclassification of certain existing recognized intangiblesas goodwill, reclassification of certain intangibles out of previously reportedgoodwill and the identification of reporting units for purposes of assessingpotential future impairments of goodwill. The Company plans to adopt SFAS No. 142 on July 1, 2002.  The Company does not hold any net goodwillor other intangible assets and therefore believes that the application of thisSFAS will not have a material impact on the Company’s operating results orfinancial position.

 

10

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**Note5.  Comprehensive Income**

 

Comprehensive income includesthe Company’s net income plus other comprehensive income items, which areexcluded from net income.  The Company’sother income consists of unrealized gains (losses), net of income taxes andreclassification adjustments for gains and losses included in net income.

 
|                                                          |   | **Three Months Ended** |       | **Six Months Ended** |      |
|---------------------------------------------------------------|--------|------------------------|------------|----------------------|-----------|
|                                                          |   | **2002**               |       | **2001**             |      | **2002** |   | **2001** |   |
|                                                          |   |                   |       |                 |      |   |   |   |   |
| **Net Sales**                                                 |   | $                      | 839,255    |                 | $         | 1,681,118 |   | $ | 1,255,168 |   | $ | 2,622,122 |   |
|                                                          |   |                   |       |                 |      |   |   |   |   |
| **Other Comprehensive Gain:**                                 |   |                   |       |                 |      |   |   |   |   |
| Change in Unrealized Value Investments, net                   |   | (2,025,561             | )          | 3,056,101            |      | (343,908 | ) | 1,808,407 |   |
|                                                          |   |                   |       |                 |      |   |   |   |   |
| **Less:**                                                     |   |                   |       |                 |      |   |   |   |   |
| Reclassification Adjustment  for Gains Included In net Income |   | (1,034,006             | )          | (3,412,608           | )         | (1,462,799 | ) | (5,236,804 | ) |
|                                                          |   |                   |       |                 |      |   |   |   |   |
| **Total Comprehensive Income**                                |   | $                      | (2,220,312 | )                    | 1,324,611 |   | (551,539 | ) | (806,275 | ) |
|                                                               |        |                        |            |                      |           |  |  |  |  |  |  |  |  |

 

**Note 6.  Discontinued Operations**

 

OnMay 14, 2001, the Company disposed of its brazing torches segment through a saleof all of its shares of stock in Microflame, Inc. to an unrelated party.  The Company has restated its prior financialstatements to present the operating results of the brazing torch operations asdiscontinued.

 

**Note 7.  Segment Information**

 

TheCompany has three reportable operating segments based on the nature of itsproduct lines:  Production Monitoring,Character Recognition, and Investments. The Production Monitoring Division manufactures and markets a completeline of speed monitoring and motor control systems for industrialmachinery.  The Character RecognitionDivision designs and markets a desktop software-based system that reads handprinted characters, checkmarks, and bar code information from scanned or faxedforms.  Sales of this system includesoftware and can include hardware.  TheInvestments Division holds investments in marketable and non-marketablesecurities.

 

Inevaluating segment performance, management focuses on sales and income beforetaxes.  The Company has no inter-segmentsales.

 

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**Note 7.  Segment Information (Continued)**

 

Thefollowing is financial information relating to the continuing operatingsegments:

 
|                                                       |   | **Three Months Ended** |          | **Six Months Ended** |   |
|------------------------------------------------------------|--------|------------------------|---------------|----------------------|--------|
|                                                       |   | **2002**               |          | **2001**             |   | **2002** |   | **2001** |   |
|                                                       |   |                   |          |                 |   |   |   |   |   |
| **External Sales**                                         |   |                   |          |                 |   |   |   |   |   |
| Production Monitoring                                      |   | $                      | 921,106       |                 | $      | 1,033,090 |   | $ | 1,853,570 |   | $ | 2,154,008 |   |
| Character Recognition                                      |   | 203,333                |          | 150,889              |   | 409,525 |   | 331,340 |   |
| Investments                                                |   | 0                      |          | 0                    |   | 0 |   | 0 |   |
| **Total**                                                  |   | **$**                  | **1,124,439** | ** **           | **$**  | **1,183,979** | ** ** | **$** | **2,263,095** | ** ** | **$** | **2,485,348** | ** ** |
|                                                       |   |                   |          |                 |   |   |   |   |   |
| **Net Income Before Taxes and****Discontinued Operations** |   |                   |          |                 |   |   |   |   |   |
| Production Monitoring                                      |   | $                      | (56,582       | )                    | $      | 10,971 |   | $ | (25,752 | ) | $ | 108,625 |   |
| Character Recognition                                      |   | (68,761                | )             | 15,464               |   | (69,068 | ) | 40,419 |   |
| Investments                                                |   | 1,451,064              |          | 2,706,870            |   | 2,101,313 |   | 4,081,276 |   |
| **Total**                                                  |   | **$**                  | **1,325,721** | ** **           | **$**  | **2,733,305** | ** ** | **$** | **2,006,493** | ** ** | **$** | **4,230,320** | ** ** |

 

TheCompany’s subsidiary Microflame, Inc. was sold in May 2001.  See Note 6 above regarding thistransaction.  Segment informationrelated to Microflame, Inc. previously has been included as the Brazing Torchesoperations segment.

 

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**Item 2.  Management’s Discussion and Analysis or Planof Operation**

 

**RESULTS OF OPERATIONS**

 

**Comparison of Quarter2, 2002 vs. Quarter 2, 2001**

 

***Operating Income (Loss)***

 

During 2002, theCompany purchased 1,098,168 units of PPT Vision, Inc. (PPT).  Each unit consists of one share of commonstock and a warrant to purchase one-half share of common stock.  The warrants are exercisable at $2.50 untilSeptember 30, 2003.  PPT is a publiclytraded corporation in which the Company had previously owned 549,084 shares,9.96% of PPT’s outstanding common stock. At June 30, 2002, the Company owned 1,647,252 shares of PPT, which is16.36% of PPT’s outstanding common stock. The fair value of its holdings based on the quoted market price at June30, 2002 was approximately $1,280,000.

 

At this time, itwas determined that the Company now has significant influence over theoperations of PPT, and as a result its ownership should be reported using theequity method of accounting for investments. The investment was previously reported as an available-for-salesecurity, showing the market value on the balance sheet and recording anyunrealized gains and losses in other comprehensive income.

 

Resulting fromthis change to the equity method of accounting, the balance sheets at June 30,2002 and December 31, 2001 have been adjusted to show the Company’s investmentin PPT based on the equity method rather than based on market value.  Retained earnings at those dates has beenadjusted to reflect equity method earnings from prior periods and accumulatedother comprehensive income at those dates has been adjusted to eliminateunrealized gains and losses from PPT that were recorded in prior periods.  In addition, the income statements for thethree months and six months ended both June 30, 2002 and June 30, 2001 havebeen adjusted to show the Company’s portion of PPT’s earnings from thoseperiods.

 

Under the equitymethod of accounting, the Company’s proportionate share of PPT income or lossthrough April 30, 2002 is included in the Company’s net income with acorresponding increase or decrease in the carrying value of its investment.

 

Incomefrom continuing operations decreased 52.1% to $839,255 for the three-monthperiod ended June 30, 2002, compared to income from continuing operations of$1,752,871 for the same period in fiscal 2001. For the six-month period ending June 30, 2002, income from continuing operationsdecreased 53.4% to $1,255,168, compared to the income from continuingoperations of $2,694,861 for the same period in fiscal 2001.  This decrease was primarily due to reductionin the sale of investment securities through the Company’s subsidiary, ESIInvestment Company. Also contributing to the decrease was higher operatingexpenses.  See Operating Expense detailbelow.

 

Investmentincome for the three-month period ended June 30, 2002 decreased 46.49% from thesame period in fiscal 2001, $2,737,663 to $1,464,799.  For the six-month period ending June 30, 2002, the Investmentincome decreased 49.63%.

 

Theincrease of 72.54% for the six-months ending June 30, 2002 of interest incomeoverall is due to the increase in interest earned on treasury bills purchasedfrom stock sales.  The decrease of58.43% for the three-months ended June 30, 2002 is due to lower interest rates.

 

Available-for-salesecurities are stated at fair value, and unrealized holding gains and losses,net of the related deferred tax effect, are reported as a separate component ofstockholders’ equity.  Dividends onmarketable equity securities are recognized in income when declared.  Investments in unregistered securities arereported at original cost.

 

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***Operating Income (Loss) — (Continued)***

 

Realizedgains and losses, including losses from declines in value of specificsecurities determined by management to be other-than-temporary, are included inincome.  Realized gains and losses aredetermined on the basis of the specific securities sold.

 

TheControls Division had a three-month ending June 30, 2002 net loss of $35,640compared to net loss of $39,566 when compared to the same period for the prioryear.  The loss for the six-month periodended June 30, 2002 is $23,016 and for the same period ending fiscal 2001,there was an operating income of $23,079, a difference of $46,095.  This difference is primarily due to thedecrease in net revenues in 2002.  Thecompany anticipates an increase in net revenues for the rest of this fiscalyear as we are planning 3 new product releases.  We have also hired a new sales manager during this quarter.

 

TheCharacter Recognition Division had a three-month ending June 30, 2002 net lossof $43,320 compared to net income of $9,897 when compared to the same periodfor the prior year.  The loss for thesix-month period ended June 30, 2002 is $45,630 and for the same period endingfiscal 2001, there was a net income of $25,870, a difference of $53,217 and $71,500respectively.  These losses are a resultof research and development costs related to the next generation softwareproduct being developed.

 

***Net Revenues***

 

Netrevenues for the three-month period ended June 30, 2002 decreased $59,540 or5.0% when compared to net revenues for the same period in fiscal 2001.   For the six-month period ended June 30,2002, net revenues decreased $222,253 or 8.9% when compared to the same periodfor fiscal 2001.

 

Ofthis decrease, $111,984 and $300,438 for the three and six month periods,respectively, is attributable to the Controls Division.  All of the Division’s products contributedto this decline.  This decline in demandfor production control is attributable to the slowdown in the United Stateseconomy.  This decrease was offsetpartially by an increase in the three and six month period CharacterRecognition Division revenues of $52,444 and $78,185, respectively.  This increase was primarily an increase inthe sale of the Scannable Office product and Scanner Hardware Sales.

 

***Cost of Sales***

 

TheCompany’s cost of sales increased from $440,472 to $477,851, a difference of$37,379 or 8.49% when comparing the three-months ended June 30, 2002 to thesame period ending fiscal 2001.  Whencomparing the six-month ending June 30, 2002 to fiscal 2001, the cost of salesincreased 6.11% from $915,168 to $971,078. This increase is a result of fixed costs, including labor and overhead,being absorbed by a decrease in net revenues for the current fiscal period.

 

***Gross Margins***

 

Grossmargins for the three-month period ended June 30, 2002 were 57.5% versus 62.8%for the same period of the prior fiscal year. Gross margins for the six-month period ended June 30, 2002 were 57.1%versus 63.2% for the same period of the prior fiscal year.  The declines in margins are due to unchangedfixed costs, including labor and overhead, being absorbed by lower salesamounts.

 

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***Operating Expenses***

 

Totaloperating expenses increased $56,219 or 7.47% for the three-months ended 2002when compared to the same period of the prior fiscal year.  For the six-months ended June 30, 2002,total operating expenses increased $28,811 or 1.92% when compared to the sameperiod of the prior fiscal year.

 

Sellingand marketing costs decreased to $256,758, a decrease of 19.16% for thethree-months ended June 30, 2002.  Forthe six-months ended 2002, selling and marketing costs decreased to $537,892 or12.1%; general and administrative costs decreased by $16,312 and $67,662, adecrease of 6.58% and 13.25% respectively; and research and development costsincreased $133,382 and $170,495, an increase of 71.08% and 45.38% respectively.

 

Researchand development costs increased primarily due to the company’s increased effortin developing new products to be introduced to our market in fiscal year 2002.

 

***Non-Operating Income***

 

ESIInvestment Company, the Company’s subsidiary, continues to provide analternative source of earnings for the Company through investments inmarketable securities.  However, theCompany’s intent is to remain an operations-based company.

 

TheCompany’s investments in marketable securities are subject to significantpositive and negative changes in value.

 

Inaddition to income from the sale of investments, the Company also realizedinterest income from its short-term holdings.

 

**LIQUIDITY AND CAPITALRESOURCES**

 

TheCompany continues to generate strong cash flows from the sale ofinvestments.   However working capitalhas decreased $1,200,000 since December 31, 2001.    Excess funds generated from the sale of securities have beenplaced in secure short-term investments. The funds are being used primarily for tax payments on the gainsrealized on sale of investments, dividend distributions, working capital needsand general corporate purposes.  Inaddition the Company utilized $1,098,168 to participate in a rights offering ofcommon stock by PPT Vision, Inc.  Capital expenditures resulted from the purchase of additionalequipment.  The Company does notanticipate the need for additional working capital from outside sources.

 

TheCompany holds an investment in August Technologies, Inc., which is valued atthe quoted market price on June 30, 2002. The quoted market price represents an estimate of what the Company mayhave realized if the shares were traded on the open exchange. The potentialamount realized from a sale of a significant portion of the Company’s holdingsin either August or PPT may be affected by factors that are not reflected inthe current quoted market price, the most significant of which is the market’sability to absorb a large block of securities. In addition the market value ofthe securities may be subject to significant fluctuation in quoted marketprices. The market value of investments held at June 30 and August 2, 2002 was$8,300,000 and $3,660,000 respectively. The market value of the equity method investment in PPT is approximately$1,280,000 at June 30 and $1,560,000 at August 2, 2002.

 

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**PART II — OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

Therewere no material developments in previously reported legal proceedings.

 

**Item 2.  Changes in Securities**

 

Nochanges have been made to any registered securities.

 

**Item 3.  Defaults Upon Senior Securities**

 

Noevent constituting a default has occurred with respect to any senior securityof the Registrant.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

TheAnnual Meeting of shareholders was held April 17, 2002

 

Thefollowing matters were voted on by shareholders during the period covered bythis Form 10-QSB:

 

1.                                       Set number ofdirectors at five

2.                                       Elect fivedirectors:  B. Slye, P. Peterson, G.Miller, J. Marino, and J. Strom

3.                                       Approveappointment of Schweitzer Karon & Bremer, LLC as independent auditors forthe current fiscal year

 
| **Proposal** |   | **Yes**     |   | **Yes**   |   | **No** |   | **Abstain** |   | **% Voted** |   |
|--------------|--------|-------------|--------|-----------|--------|--------|--------|-------------|--------|-------------|--------|
| 1            |   |        |   | 2,953,930 |   | 71,694 |   | 6,200       |   | 94.61       | %      |
| 2            |   | B. Slye     |   | 2,960,257 |   | 0      |   | 71,567      |   | 94.81       | %      |
| 2            |   | P. Peterson |   | 2,959,282 |   | 0      |   | 72,542      |   | 94.78       | %      |
| 2            |   | G. Miller   |   | 2,960,257 |   | 0      |   | 71,567      |   | 94.81       | %      |
| 2            |   | J. Marino   |   | 3,018,849 |   | 0      |   | 12,975      |   | 96.69       | %      |
| 2            |   | J. Strom    |   | 3,016,874 |   | 0      |   | 14,950      |   | 96.62       | %      |
| 3            |   |        |   | 2,962,986 |   | 64,926 |   | 3,912       |   | 94.90       | %      |

 

**Item 5. Other Information**

 

ThisForm 10-QSB contains forward-looking statements within the meaning of Section27A of the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934, including statements regarding the Company’s expectations,beliefs, intentions or strategies regarding the future.  Forward-looking statements include, withoutlimitation, statements regarding the extent and timing of future revenues andexpenses and customer demand.  Thesestatements include, but are not limited to, changes in worldwide general economicconditions, cyclical capital spending by customers, the Company’s ability tokeep pace with technological developments and evolving industry standards,worldwide competition, and the Company’s ability to protect its existingintellectual property from challenges from third parties and other factors.

 

Allforward-looking statements in this document are based on information availableto the Company as of the date hereof, and the Company assumes no obligation toupdate any such forward-looking statements. It is important to note that the Company’s actual results could differmaterially from those in such forward-looking statements.  The forward-looking statements of theCompany are subject to risks and uncertainties.  Some of the factors that could cause future results to differmaterially from the Company’s recent results or those projected in theforward-looking statements are detailed in the Company’s Annual Report on Form10-KSB for the year ended December 31, 2001, filed with the Securities andExchange Commission.

 

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**Item 6.  Exhibits and Reports on Form 8-K**

 

(a)          Exhibits — No exhibits are attached to this filing of Form 10-QSB.

(b)         We filed a report 8-K on May 10, 2002 regarding our purchase of PPTVstock during the Quarter ended June 30, 2002

 

**SIGNATURES**

 

Inaccordance with the requirements of the Exchange Act, the Registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
| **Electro-Sensors,  Inc.** |                                                        |
|----------------------------|-------------------------------------------------------------|
|                       |                                                        |
| August 12, 2002            | /s/ Bradley D. Slye                                         |
|                       | Bradley D. Slye,  President                                 |
|                       |                                                        |
|                       | (Chief Executive  Officer and Principal Accounting Officer) |

 

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