** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

# ** **

# **Form 10-QSB**

 

 
| **ý****QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**        |
|---------------------------------------------------------------------------------------------------------|
|                                                                                                    |
| **For the quarterly period ended September 30, 2002**                                                   |
|                                                                                                    |
| **o****TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE  EXCHANGE ACT**                               |
|                                                                                                    |
| **For the transition period  from           to** |

 

 

**CommissionFile Number 0-9587**

 

 

| **ELECTRO-SENSORS, INC.**                                          |
|--------------------------------------------------------------------|
| (Exact name of small business issuer as specified  in 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)                                   |

 

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 of 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes ý  No o

 

The number of sharesoutstanding of the registrant’s Common Stock, $0.10 par value, on November 11,2002 was 3,155,260.

 

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

 

 

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**ELECTRO-SENSORS, INC. ANDSUBSIDIARIES**

**Form 10-QSB for the Period EndedSeptember 30, 2002**

 

**TABLE OF CONTENTS**

 

 
| **PART I – FINANCIAL  INFORMATION**                                |
|-------------------------------------------------------------------------|
|                                                                    |
| Item 1. Financial  Statements                                           |
| Item  2. Management’s Discussion and Analysis or Plan of Operation |
| Item 3. Controls and  Procedures                                        |
|                                                                    |
|                                                                    |
| **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**                                                          |
|                                                                    |
| **CERTIFICATION**                                                       |

 

 

2

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**PART I – FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

The interim financialstatements included in this Form 10-QSB are unaudited and reflect, in theopinion of management, all adjustments (which include only normal recurringadjustments) necessary for a fair presentation of the results of operations forthese periods.

 

 

 

 

 

**INDEX TO CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 

 
| Consolidated Balance Sheets  – As of September 30, 2002 and December 31, 2001                                       |
|--------------------------------------------------------------------------------------------------------------------------|
| Consolidated  Statements of Income – For the Three and Nine Months Ended September 30, 2002  and September 30, 2001 |
| Consolidated  Statements of Cash Flows – For the Nine-Month Period Ended September 30, 2002  and September 30, 2001 |
| Notes to  Consolidated Financial Statements                                                                              |

 

3

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

**CONSOLIDATED BALANCE SHEETS**

 

 
|                                                                                                                        |   | **September 30, 2002** |           | **December 31, 2001** |       |
|-----------------------------------------------------------------------------------------------------------------------------|--------|------------------------|----------------|-----------------------|------------|
|                                                                                                                        |   | **(unaudited)**        |           |                  |       |
| **ASSETS**                                                                                                                  |   |                   |           |                  |       |
| **CURRENT  ASSETS**                                                                                                         |   |                   |           |                  |       |
|                                                                                                                        |   |                   |           |                  |       |
| Cash And Cash Equivalents                                                                                                   |   | $                      | 6,621,601      |                  | $          | 8,389,691 |   |
| Investments                                                                                                                 |   | 3,778,932              |           | 11,140,320            |       |
| Trade Receivables                                                                                                           |   | 616,643                |           | 498,283               |       |
| Less Allowance for Doubtful  Accounts of $27,180 and $25,000, respectively.                                                 |   |                   |           |                  |       |
| Inventories                                                                                                                 |   | 737,593                |           | 819,272               |       |
| Prepaid Income Taxes                                                                                                        |   | 303,739                |           | 0                     |       |
| Other Current Assets                                                                                                        |   | 280,384                |           | 210,551               |       |
| **Total Current Assets**                                                                                                    |   | 12,338,892             |           | 21,058,117            |       |
| **Property and  Equipment, Net**                                                                                            |   | 1,505,865              |           | 1,480,477             |       |
| **Investment in  Equity Method Investee**                                                                                   |   | 862,987                |           | 0                     |       |
| **TOTAL ASSETS**                                                                                                            |   | **$**                  | **14,707,744** | ** **            | **$**      | **22,538,594** | ** ** |
|                                                                                                                        |   |                   | ** **     |                  | ** ** |
| **LIABILTIES AND STOCKHOLDERS’ EQUITY**                                                                                |   |                   |           |                  |       |
| **CURRENT  LIABILITIES**                                                                                                    |   |                   |           |                  |       |
| Accounts Payable                                                                                                            |   | $                      | 222,115        |                  | $          | 65,530 |   |
| Accrued Expenses                                                                                                            |   | 250,232                |           | 140,014               |       |
| Accrued Income Taxes                                                                                                        |   | 0                      |           | 1,647,470             |       |
| Deferred Income Taxes                                                                                                       |   | 1,272,756              |           | 3,919,108             |       |
| **Total Current Liabilities**                                                                                               |   | 1,745,103              |           | 5,772,122             |       |
| **DEFERRED  INCOME TAXES**                                                                                                  |   | 0                      |           | 3,400                 |       |
|                                                                                                                        |   |                   |           |                  |       |
| **STOCKHOLDERS’  EQUITY**                                                                                              |   |                   | ** **     |                  | ** ** |
| Common Stock par value $0.10  per share;Authorized  10,000,000 shares; Issued 3,155,260 and 3,121,263 shares, respectively. |   | 315,526                |           | 312,126               |       |
| Additional Paid-In Capital                                                                                                  |   | 966,447                |           | 894,172               |       |
| Retained Earnings                                                                                                           |   | 9,408,984              |           | 8,592,074             |       |
| Accumulated Other  Comprehensive Income                                                                                     |   | 2,271,684              |           | 6,964,700             |       |
| **Total Stockholders’ Equity**                                                                                         |   | 12,962,641             |           | 16,763,072            |       |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                        |   | **$**                  | **14,707,744** | ** **            | **$**      | **22,538,594** | ** ** |

 

See AccompanyingNotes to Consolidated Financial Statements

 

4

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

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**

 
|                                                                     |   | **Three Months Ended  September 30,** |      | **Nine Months Ended  September 30,** |   |
|--------------------------------------------------------------------------|--------|---------------------------------------|-----------|--------------------------------------|--------|
|                                                                     |   | **2002**                              |      | **2001**                             |   | **2002** |   | **2001** |   |
|                                                                     |   |                                  |      |                                 |   |   |   |   |   |
| **Net Sales**                                                            |   | $                                     | 1,154,287 |                                 | $      | 1,111,625 |   | $ | 3,417,382 |   | $ | 3,596,973 |   |
| **Cost of Goods Sold**                                                   |   | 480,038                               |      | 470,527                              |   | 1,451,111 |   | 1,386,085 |   |
| **Gross Profit**                                                         |   | 674,249                               |      | 641,098                              |   | 1,966,271 |   | 2,210,888 |   |
|                                                                     |   |                                  |      |                                 |   |   |   |   |   |
| **Operating Expenses:**                                                  |   |                                  |      |                                 |   |   |   |   |   |
| Selling and Marketing                                                    |   | 300,650                               |      | 285,233                              |   | 838,542 |   | 897,147 |   |
| General and Administrative                                               |   | 245,555                               |      | 192,055                              |   | 688,379 |   | 704,445 |   |
| Research and Development                                                 |   | 272,100                               |      | 206,115                              |   | 818,279 |   | 581,800 |   |
| **Total Operating Expenses**                                             |   | 818,305                               |      | 683,403                              |   | 2,345,200 |   | 2,183,392 |   |
| **Operating Income (Loss)**                                              |   | (144,056                              | )         | (42,305                              | )      | (378,929 | ) | 27,496 |   |
|                                                                     |   |                                  |      |                                 |   |   |   |   |   |
| **Non-Operating Income (Expense):**                                      |   |                                  |      |                                 |   |   |   |   |   |
| Gain (Loss) on Sale of Investment  Securities                            |   | 121,313                               |      | 1,214,425                            |   | 2,218,886 |   | 5,341,871 |   |
| Interest Income                                                          |   | 27,840                                |      | 0                                    |   | 197,801 |   | 0 |   |
| Other Income (Expense)                                                   |   | (29                                   | )         | (12,573                              | )      | (26,191 | ) | 125,220 |   |
| Equity in Losses of Equity Method Investee                               |   | (245,697                              | )         | (193,936                             | )      | (245,697 | ) | (298,446 | ) |
| **Total Non-Operating Income (Expense)**                                 |   | (96,573                               | )         | 1,007,916                            |   | 2,144,799 |   | 5,168,645 |   |
|                                                                     |   |                                  |      |                                 |   |   |   |   |   |
| **Income (Loss) from Continuing Operations**                             |   |                                  |      |                                 |   |   |   |   |   |
| **Before Income Taxes**                                                  |   | (240,629                              | )         | 965,611                              |   | 1,765,870 |   | 5,196,141 |   |
|                                                                     |   |                                  |      |                                 |   |   |   |   |   |
| **Federal and State Income Taxes (Credit)**                              |   | (85,328                               | )    | 417,520                              |   | 665,996 |   | 1,952,979 |   |
|                                                                     |   |                                  |      |                                 |   |   |   |   |   |
| **Income (Loss) from Continuing Operations**                             |   | (155,301                              | )         | 548,091                              |   | 1,099,874 |   | 3,243,162 |   |
|                                                                     |   |                                  |      |                                 |   |   |   |   |   |
| **Discontinued Operations:**                                             |   |                                  |      |                                 |   |   |   |   |   |
| Income (Loss) from Operation of Microflame Division, net of income taxes |   | 0                                     |      | 0                                    |   | 0 |   | (3,510 | ) |
| Loss on Disposal of Microflame Division, Net of income taxes             |   | 0                                     |      | 0                                    |   | 0 |   | (69,229 | ) |
| **Total Income (Loss) from Discontinued  Operations**                    |   | 0                                     |      | 0                                    |   | 0 |   | (72,739 | ) |
| **Net Income (Loss)**                                                    |   | $                                     | (155,301  | )                                    | $      | 548,091 |   | $ | 1,099,874 |   | $ | 3,170,423 |   |

 

See AccompanyingNotes to Consolidated Financial Statements

 

5

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

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**

** **
|                                                     |   | **Three Months Ended  September 30,** |         | **Nine Months Ended  September 30,** |         |
|----------------------------------------------------------|--------|---------------------------------------|--------------|--------------------------------------|--------------|
|                                                     |   | **2002**                              |         | **2001**                             |         | **2002** |   | **2001** |   |
|                                                     |   |                                  |         |                                 |         |   |   |   |   |
| **Net Income (Loss) Per Share Data:**                    |   |                                  |         |                                 |         |   |   |   |   |
| ***Basic***                                              |   |                                  | *** *** |                                 | *** *** |   | * * |   | * * |
| Income (Loss) from Continuing Operations                 |   | $                                     | (155,301     | )                                    | $            | 548,091 |   | $ | 1,099,874 |   | $ | 3,243,162 |   |
| Income (Loss) from Discontinued Operations               |   | —                                |         | —                               |         | — |   | (72,739 | ) |
|                                                     |   | $                                     | (155,301     | )                                    | $            | 548,091 |   | $ | 1,099,874 |   | $ | 3,170,423 |   |
|                                                     |   |                                  |         |                                 |         |   |   |   |   |
| Net Income (Loss) Per Share from Continuing Operations   |   | $                                     | (0.05        | )                                    | $            | 0.18 |   | $ | 0.35 |   | $ | 1.04 |   |
| Net Income (Loss) Per Share from Discontinued Operations |   | —                                |         | 0.00                                 |         | — |   | -.02 |   |
|                                                     |   | $                                     | (0.05        | )                                    | $            | 0.18 |   | $ | 0.35 |   | $ | 1.02 |   |
|                                                     |   |                                  |         |                                 |         |   |   |   |   |
| Shares Used in Per Share Calculations                    |   | 3,154,627                             |         | 3,120,323                            |         | 3,155,047 |   | 3,120,323 |   |
|                                                     |   |                                  |         |                                 |         |   |   |   |   |
| ***Diluted***                                            |   |                                  | *** *** |                                 | *** *** |   | * * |   | * * |
| Income (Loss) from Continuing Operations                 |   | $                                     | (155,301     | )                                    | $            | 548,091 |   | $ | 1,099,874 |   | $ | 3,243,162 |   |
| Income (Loss) from Discontinued Operations               |   | —                                |         | —                               |         | — |   | (72,739 | ) |
|                                                     |   | $                                     | (155,301     | )                                    | $            | 548,091 |   | $ | 1,099,874 |   | $ | 3,170,423 |   |
|                                                     |   |                                  |         |                                 |         |   |   |   |   |
| Net Income (Loss) Per Share from Continuing Operations   |   | $                                     | (0.05        | )                                    | $            | 0.17 |   | $ | 0.34 |   | $ | 1.03 |   |
| Net Income (Loss) Per Share from Discontinued Operations |   | —                                |         | —                               |         | — |   | -.02 |   |
|                                                     |   | $                                     | (0.05        | )                                    | $            | 0.17 |   | $ | 0.34 |   | $ | 1.01 |   |
|                                                     |   |                                  |         |                                 |         |   |   |   |   |
| Shares Used in Per Share Calculations                    |   | 3,235,847                             |         | 3,164,538                            |         | 3,240,137 |   | 3,154,811 |   |

 

See AccompanyingNotes to Consolidated Financial Statements

 

6

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

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
|                                                                                         |   | **Nine Months Ended  September 30,** |       |
|----------------------------------------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                                                         |   | **2002**                             |       | **2001** |   |
| **Reconciliation of Net Income to Net Cash****Provided by Operating  Activities**            |   |                                 |       |   |   |
|                                                                                         |   |                                 |       |   |   |
| **Net Income**                                                                               |   | $                                    | 1,099,874  |   | $ | 3,170,423 |   |
| Adjustments to Reconcile Net  Income to Net Cash Provided By/(used in) Operating Activities: |   |                                 |       |   |   |
| Provision for Losses on Trade  Receivables                                                   |   | —                               |       | (10,863 | ) |
| Loss of Disposal of Segment                                                                  |   | —                               |       | 69,229 |   |
| Depreciation                                                                                 |   | 36,534                               |       | 93,109 |   |
| Deferred Taxes                                                                               |   | (200                                 | )          | 9,882 |   |
| Realized (Gain)/Loss on Sale  of Investments                                                 |   | (2,218,886                           | )          | (5,341,871 | ) |
| Equity Method Losses of Equity  Method Investee                                              |   | 245,697                              |       | 298,446 |   |
| (Increase)/Decrease In:                                                                      |   |                                 |       |   |   |
| Trade Receivables                                                                            |   | (127,069                             | )          | 99,096 |   |
| Inventory                                                                                    |   | 81,679                               |       | 55,594 |   |
| Prepaid Expenses                                                                             |   | (69,833                              | )          | (188,612 | ) |
| Prepaid Income Taxes                                                                         |   | (303,739                             | )          | 72,767 |   |
| Accounts Payable                                                                             |   | 156,585                              |       | (14,197 | ) |
| Customer Deposits                                                                            |   | —                               |       | (6,493 | ) |
| Accrued Expenses                                                                             |   | 110,218                              |       | 95,711 |   |
| Accrued Income Taxes                                                                         |   | (1,647,470                           | )          | 1,760,082 |   |
| Net Cash Provided by Operating  Activities                                                   |   | (2,636,610                           | )          | 162,303 |   |
|                                                                                         |   |                                 |       |   |   |
| Cash Flows from Investing  Activities:                                                       |   |                                 |       |   |   |
| Proceeds From Sale of  Investments                                                           |   | 2,237,706                            |       | 5,380,801 |   |
| Additional Investment in  Equity Method Investee                                             |   | (1,108,684                           | )          | — |   |
| Purchase of Property and  Equipment                                                          |   | (61,922                              | )          | (19,649 | ) |
| Principal Payments Received on  Note Receivable                                              |   | 8,709                                |       | 1,000 |   |
| Proceeds from Disposed Segment                                                               |   | —                               |       | 5,000 |   |
| Net Cash Provided By/ (used  in) Investing Activities                                        |   | 1,075,809                            |       | 5,367,152 |   |
|                                                                                         |   |                                 |       |   |   |
| Cash Flows from Financing  Activities:                                                       |   |                                 |       |   |   |
| Proceeds from Issuance of  Stock                                                             |   | 75,675                               |       | 10,140 |   |
| Dividends Paid                                                                               |   | (282,964                             | )          | (280,855 | ) |
|                                                                                         |   |                                 |       |   |   |
| Net Cash Used in Financing  Activities                                                       |   | (207,289                             | )          | (270,715 | ) |
|                                                                                         |   |                                 |       |   |   |
| Net Increase in Cash &  Cash Equivalents                                                 |   | (1,768,090                           | )          | 5,258,740 |   |
| Cash & Cash Equivalents,  Beginning                                                      |   | 8,389,691                            |       | 3,191,176 |   |
| Cash & Cash Equivalents,  Ending                                                         |   | 6,621,601                            |       | 8,449,916 |   |
|                                                                                         |   |                                 |       |   |   |
| **Supplemental  Schedule of Non-Cash Investing and Financing Activities**                    |   |                                 | ** ** |   | ** ** |
|                                                                                         |   |                                 |       |   |   |
| Net change in Unrealized Gain/  (Loss) on Marketable Securities                              |   | (4,693,016                           | )          | (5,544,346 | ) |
| Issuance of Note Receivable  Related to Sale of Segment                                      |   | —                               |       | 36,000 |   |
|                                                                                              |        |                                      |            |  |  |  |  |

 

See Accompanying Notes to Consolidated FinancialStatements

 

7

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

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

** **

**Note 1.  Nature of Business**

** **

Theaccompanying consolidated financial statements include the accounts ofElectro-Sensors, Inc. and its wholly owned subsidiary, ESI InvestmentCompany.  Intercompany accounts,transactions and earnings have been eliminated in consolidation.  The consolidated entity is referred to as“the Company”.

 

Electro-Sensors,Inc. operates two distinct businesses. The first is the Controls Division, which carries the name ofElectro-Sensors, Inc.  This divisionmanufactures and markets a complete line of speed monitoring and motor controlsystems for industrial machinery.  TheControls Division utilizes leading-edge technology to continuously improve itsproducts and make them easier to use. The Controls Division’s goal is to manufacture the industry-preferredproduct for every market served.  Theseproducts are sold through an internal sales staff and distributors to a widevariety of manufacturers, 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.

 

Thesecond business is AutoData Systems (ADS), a division of Electro-Sensors,Inc.  ADS designs and markets desktopsoftware based systems that read hand printed characters, checkmarks and barcode information from scanned or faxed forms. ADS products are designed to provide capabilities to automate datacollection and are marketed through internal sales staff to end users,resellers and developers in the United States, Canada, Europe and Asia.

 

ESIInvestment Company owns marketable securities which have experiencedsignificant appreciation in value since the IPO of August TechnologyCorporation in 2000.  During 2000, 2001and 2002, the Company has recognized income from the sale of its holdings inAugust Technology.

 

DuringMay 2002 ESI Investment participated in a rights offering by PPT Vision, Inc.(PPTV). As a result of the additional investment in PPTV the Company haschanged its reporting of this investment to the equity method of accounting.See note 3 for additional information about this investment and the relatedchange to the equity method.

 

TheCompany previously operated a third business, Microflame, Inc. (MFI), a whollyowned subsidiary, which was sold in May 2001. MFI produced small hand held gas torches used primarily by hobbyists,electronic kit assemblers and creators of jewelry.  MFI products were sold through distributors to retailers ofhardware, craft and electronic products.

 

**Note 2.  Basis of Presentation**

** **

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and with the instructions to Form10-QSB and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States ofAmerica for complete financial statements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair presentation have beenincluded.

 

TheBalance Sheet at December 31, 2001 has been derived from the Company’s auditedfinancial statements for the year ended December 31, 2001, but does not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements.

 

Forfurther information, refer to the financial statements and footnotes theretoincluded in the Company’s annual report on Form 10-KSB for the year endedDecember 31, 2001.

 

8

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**Note 3.  Revenue Recognition**

** **

Allproduction monitoring equipment are shipped without an evaluation or acceptanceperiod.  Revenues from the sale of theproducts and any related warranty costs are recognized at the time ofshipment.  The Company’s distributorsare not granted any price protection. Sales to all customers including distributors are final and no right ofreturn after shipment exists.

 

TheCompany recognizes revenue upon shipment of its character recognitionsoftware.  The product is sold to theend user and risk of loss is transferred, and the Company has no continuingobligations, once its products are delivered to the shipper.  The Company recognizes revenue uponshipment, net of return reserves based on historical experience.

 

TheCompany recognizes revenue on support contracts for its character recognitionsoftware over the life of the contract.

 

Torecognize revenue, it must be probable that the Company will collect theaccounts receivable from its customers. In some situations, the Company receives advance payments from itscustomers.  Revenue associated withthese advance payments is deferred until the product is shipped.  Warranty reserves are provided at the timerevenue is recognized for the estimated cost of replacing defective product.

 

**Note 4.  Investments**

** **

Managementdetermines the appropriate classification of securities at the date individualinvestments are acquired, and evaluates the appropriateness of suchclassification at each balance sheet date.

 

TheCompany’s investments consist of marketable equity securities, primarily commonstocks, government debt securities, and money market funds.  The estimated fair value of marketableequity securities is based on quoted market prices and therefore subject to theinherent risk of market fluctuations. The Company owned 792,500 and 981,000 sharesof August Technologies Corporation as of September 30, 2002 and December 31,2001, respectively.

 

Sincethe Company does not buy investments in anticipation of short-term fluctuationsin market prices, the investments in marketable equity securities has beenclassified as available-for-sale.  Available-for-sale securities are stated at fair value, andunrealized holding gains and losses, net of the related deferred tax effect,are reported as separate component of stockholders’ equity.  Dividends on marketable equity securitiesare recognized in income when declared.

 

9

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

** **

During 2002, theCompany purchased 1,108,868 units of PPT Vision, Inc. (PPT).   PPT is a publicly traded corporation inwhich the Company had previously owned 549,084 shares, 10.0% of PPT’soutstanding common stock.  At September30, 2002, the Company owned 1,657,952 shares of PPT, which is 16.4% of PPT’soutstanding common stock.  The fairvalue of its holdings based on the quoted market price at September 30, 2002was approximately $1,160,000.

 

At this time, itwas determined that the Company now has significant influence over theoperations of PPT, and as a result its ownership interest should be reportedusing the equity method of accounting for investments.  The investment was previously reported as anavailable-for-sale security, showing the market value on the balance sheet andrecording any unrealized gains and losses in other comprehensive income.

 

Under the equitymethod of accounting, the Company’s proportionate share of PPT income or lossthrough July 31, 2002 is included in the Company’s net income with acorresponding increase or decrease in the carrying value of its investment.

 

As a result ofthis change to the equity method of accounting, the balance sheets at September30, 2002 and December 31, 2001 have been adjusted to show the Company’sinvestment in PPT based on the equity method rather than based on market valuemethod of accounting.  Retained earningsat those dates has been adjusted to reflect equity method earnings from priorperiods and accumulated other comprehensive income at those dates has beenadjusted to eliminate unrealized gains and losses from PPT that were recordedin prior periods.  In addition, theincome statements for the three months and nine months ended both September 30,2002 and  September 30, 2001 have beenadjusted to show the Company’s portion of PPT’s earnings from those periods.

 

10

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Summary financialinformation of PPT Vision, Inc. as of July 31, 2002 is as follows:

 
| **Balance Sheet**              |   | **July 31, 2002** | ** ** |
|--------------------------------|--------|-------------------|------------|
| Current asset                  |   | $                 | 8,707,000  |   |
| Fixed asset                    |   | 1,528,000         |       |
| Intangible & other assets  |   | 2,686,000         |       |
| Total assets                   |   | $                 | 12,921,000 |   |
|                           |   |              |       |
| Current liabilities            |   | $                 | 1,106,000  |   |
| Stockholder equity             |   | 11,815,000        |       |
| Total liabilities & equity |   | $                 | 12,921,000 |   |

 
| **Income Statements** |   | **Three Months Ended  July 31, 2002** | ** ** | **Nine Months Ended  July 31, 2002** | ** ** |
|-----------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
| Net revenues          |   | $                                     | 2,027,000  |                                 | $          | 5,290,000 |   |
| Gross profit          |   | 1,020,000                             |       | 2,542,000                            |       |
| Total expenses        |   | 2,526,000                             |       | 7,277,000                            |       |
| Net loss              |   | (1,492,000                            | )          | (4,684,000                           | )          |
|                       |        |                                       |            |                                      |            |  |  |

 

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

 

11

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**Note 5. Comprehensive Income**

** **

Comprehensive incomeincludes the Company’s net income plus other comprehensive income items, whichare excluded from net income.  TheCompany’s other income consists of unrealized gains (losses), net of incometaxes and reclassification adjustments for gains and losses included in netincome.

 
|                                                          |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|---------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                          |   | **2002**                              |       | **2001**                             |       | **2002** |   | **2001** |   |
|                                                          |   |                                  |       |                                 |       |   |   |   |   |
| **Net Income**                                                |   | $                                     | (155,301   | )                                    | $          | 548,091 |   | $ | 1,099,874 |   | $ | 3,170,423 |   |
|                                                          |   |                                  | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| **Other Comprehensive Gain:**                                 |   |                                  | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Change in Unrealized Value Investments, net                   |   | (2,628,252                            | )          | (2,761,189                           | )          | (4,227,335 | ) | (1,180,479 | ) |
|                                                          |   |                                  |       |                                 |       |   |   |   |   |
| **Less:**                                                     |   |                                  |       |                                 |       |   |   |   |   |
| Reclassification Adjustment  for Gains Included In net Income |   | (102,756                              | )          | (403,800                             | )          | (1,565,555 | ) | (5,639,604 | ) |
|                                                          |   |                                  |       |                                 |       |   |   |   |   |
| Total Comprehensive Income                                    |   | $                                     | (2,886,309 | )                                    | (2,616,898 | ) | (4,693,016 | ) | (3,649,660 | ) |
|                                                               |        |                                       |            |                                      |            |  |  |  |  |  |  |  |  |

** **

**Note 6.  SegmentInformation**

** **

The Company has threereportable operating segments based on the nature of its product lines:  Production Monitoring, CharacterRecognition, and Investments.  TheProduction Monitoring Division manufactures and markets a complete line ofspeed monitoring and motor control systems for industrial machinery.  The Character Recognition Division designsand markets a desktop software-based system that reads hand printed characters,checkmarks, and bar code information from scanned or faxed forms.  Sales of this system include software andcan include hardware.  The InvestmentsDivision holds investments in marketable and non-marketable securities.

 

In evaluating segmentperformance, management focuses on sales and income before taxes.  The Company has no inter-segment sales.

 

12

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The following isfinancial information relating to the continuing operating segments:

 
|                                                       |   | **Three Months Ended  September 30,** |          | **Nine Months Ended  September 30,** |   |
|------------------------------------------------------------|--------|---------------------------------------|---------------|--------------------------------------|--------|
|                                                       |   | **2002**                              |          | **2001**                             |   | **2002** |   | **2001** |   |
| **External Sales**                                         |   |                                  |          |                                 |   |   |   |   |   |
| Production Monitoring                                      |   | $                                     | 974,886       |                                 | $      | 925,838 |   | $ | 2,828,457 |   | $ | 3,079,845 |   |
| Character Recognition                                      |   | 179,401                               |          | 185,787                              |   | 588,925 |   | 517,128 |   |
| Investments                                                |   | 0                                     |          | 0                                    |   | 0 |   | 0 |   |
| **Total**                                                  |   | **$**                                 | **1,154,287** | ** **                           | **$**  | **1,111,625** | ** ** | **$** | **3,417,382** | ** ** | **$** | **3,596,973** | ** ** |
|                                                       |   |                                  |          |                                 |   |   |   |   |   |
| **Net Income Before Taxes and****Discontinued Operations** |   |                                  |          |                                 |   |   |   |   |   |
| Production Monitoring                                      |   | $                                     | (20,759       | )                                    | $      | (48,132 | ) | $ | (46,499 | ) | $ | 60,690 |   |
| Character Recognition                                      |   | (85,500                               | )             | (6,746                               | )      | (154,568 | ) | 33,673 |   |
| Investments                                                |   | (134,370                              | )             | 1,011,489                            |   | 1,966,937 |   | 5,101,778 |   |
| **Total**                                                  |   | **$**                                 | **(240,629**  | **)**                                | **$**  | **956,611** | ** ** | **$** | **1,765,870** | ** ** | **$** | **5,196,141** | ** ** |

 

The Company’ssubsidiary Microflame, Inc. was sold in May 2001.  Segment information related to Microflame, Inc. previously hasbeen included as the Brazing Torches operations segment.

 

13

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**Item 2.  Management’s Discussionand Analysis or Plan of Operation**

** **

**RESULTS OF OPERATIONS**

** **

**Comparison of Quarter 3, 2002 vs. Quarter 3, 2001**

** **

***Operating Income (Loss)***

 

During 2002, the Companypurchased 1,108,868 units of PPT Vision, Inc. (PPT).   PPT is a publicly traded corporation in which the Company hadpreviously owned 549,084 shares, 10.0% of PPT’s outstanding common stock.  At September 30, 2002, the Company owned1,657,952 shares of PPT, which is 16.4% of PPT’s outstanding common stock.  The fair value of its holdings based on thequoted market price at September 30, 2002 was approximately $1,160,000.

 

At this time, it was determinedthat the Company now has significant influence over the operations of PPT, andas a result its ownership interest should be reported using the equity methodof accounting for investments.  Theinvestment was previously reported as an available-for-sale security, showingthe market value on the balance sheet and recording any unrealized gains andlosses in other comprehensive income.

 

Under the equity method ofaccounting, the Company’s proportionate share of PPT income or loss throughJuly 31, 2002 is included in the Company’s net income with a correspondingincrease or decrease in the carrying value of its investment.

 

As a result of this change tothe equity method of accounting, the balance sheets at September 30, 2002 and December31, 2001 have been adjusted to show the Company’s investment in PPT based onthe equity method rather than based on market value method of accounting.  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 the threemonths and nine months ended both September 30, 2002 and  September 30, 2001 have been adjusted toshow the Company’s portion of PPT’s earnings from those periods.

 

Under the equitymethod of accounting, the Company’s proportionate share of PPT income or lossthrough July 31, 2002 is included in the Company’s net income with acorresponding increase or decrease in the carrying value of its investment.

 

Income fromcontinuing operations decreased $703,392 to a loss of $155,301 for thethree-month period ended September 30, 2002, compared to income from continuingoperations of $548,091 for the same period in fiscal 2001.  For the nine-month period ending September30, 2002, income from continuing operations decreased 66.0% to $1,099,874,compared to the income from continuing operations of $3,243,162 for the sameperiod in fiscal 2001.  This decreasewas primarily due to reduction in the sale of investment securities through theCompany’s subsidiary, ESI Investment Company. Also contributing to the decrease was higher operating expenses.  See Operating Expense detail below.

 

Investment income forthe three-month period ended September 30, 2002 decreased 90.0% from the sameperiod in fiscal 2001, $1,214,425 to $121,313. As a result of the general decline in the stock market and particularlythe decline in the price of August Technology, the Company reduced the numberof  shares sold as compared to the priorquarters.

 

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

 

The Controls Divisionhad a three-month ending September 30, 2002 net loss of $20,759 compared to netloss of $48,132 when compared to the same period for the prior year.  The loss for the nine-month period ended September30, 2002 is $46,499 and for the same period ending fiscal 2001, there was anoperating income of $60,690, a difference of $107,189.  This difference is primarily due to theSoftware Conversion training costs and additional funds invested into thedevelopment of current products and new products.

 

The CharacterRecognition Division had a three-month ending September 30, 2002 net loss of$85,500 compared to the loss of $6,746 when compared to the same period for theprior year.  The loss for the nine-monthperiod ended September 30, 2002 is $154,568 and for the same period endingfiscal 2001, there was a net income of $33,673, a difference of $78,754 and$188,241 respectively.  These losses area result of research and development costs related to the next generation softwareproduct being developed.

 

***Net Revenues***

 

Net revenues for thethree-month period ended September 30, 2002 increased $42,662 or 3.8% whencompared to net revenues for the same period in fiscal 2001.   For the nine-month period ended September30, 2002, net revenues decreased $179,591 or 5.0% when compared to the sameperiod for fiscal 2001.

 

Of this three-monthincrease, $49,048 is attributable to the Controls Division, and a decrease of$6,386 is due to the Character Recognition Division.  The Production Monitoring Divisions $251,388 nine-month decrease,is due to a general reduction in demand for all of its products.  This decline in demand for productioncontrol is attributable to the slowdown in the United States economy.  The Production Monitoring decrease inrevenues was offset partially by a $71,797 increase in the nine-month CharacterRecognition revenues.  This increase wasprimarily an increase in the sale of the Scannable Office product and scannerhardware Sales.

 

***Cost of Sales***

 

The Company’s cost ofsales increased from $470,527 to $480,038, a difference of $9,511 or 2.02% whencomparing the three-months ended September 30, 2002 to the same period endingfiscal 2001.  When comparing thenine-month ending September 30, 2002 to fiscal 2001, the cost of salesincreased 4.69% from $1,386,085 to $1,451,111. 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***

 

Gross margins for thethree-month period ended September 30, 2002 were 58.4% versus 57.6% for thesame period of the prior fiscal year. Gross margins for the nine-month period ended September 30, 2002 were57.5% versus 61.4% 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***

 

Total operatingexpenses increased $134,902 or 19.7% for the three-months ended September30,2002 when compared to the same period of the prior fiscal year.  For the nine-months ended September 30,2002, total operating expenses increased $161,808 or 7.4% when compared to thesame period of the prior fiscal year.

 

Selling and marketingcosts increased  $15,417, an increase of5.4% for the three-months ended September 30, 2002.  For the nine-months ended 2002, selling and marketing costsdecreased to $838,542 or 6.5%; general and administrative costs decreased by$16,066; and research and development costs increased $236,479, an increase of40.7%.  During the economic slow down,the Company has focused its engineering resources on the development andenhancement of new and existing products.

 

General andadministrative costs are up for the three-months ended September 30, 2002primarily due to software conversion training costs.

 

Research anddevelopment costs increased primarily due to the Company’s increased effort indeveloping new products to be introduced to our market in fiscal year 2002 and2003.

 

***Non-Operating Income***

 

ESI InvestmentCompany, the Company’s subsidiary, continues to provide an alternative sourceof earnings for the Company through investments in marketable securities.  However, the Company’s intent is to remainan operations-based company.

 

The Company’sinvestments in marketable securities are subject to significant positive andnegative changes in value.

 

In addition to incomefrom the sale of investments, the Company also realized interest income from itsshort-term holdings.

 

**LIQUIDITY AND CAPITAL RESOURCES**

** **

The Company continuesto generate strong cash flows from the sale of investments.   However working capital has decreased$4,700,000 since December 31, 2001.   This reduction in working capital is primarily the result of the declinein the market price of August Technology investments.  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 offeringof common 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.

 

The Company holds aninvestment in August Technology which is valued at the quoted market price onSeptember 30, 2002.  The quoted marketprice represents an estimate of what the Company may have realized if theshares were traded on the open exchange. The potential amount realized from asale of a significant portion of the Company’s holdings in either August or PPTmay be affected by factors that are not reflected in the current quoted marketprice, the most significant of which is the market’s ability to absorb a largeblock of securities. In addition the market value of the securities may besubject to significant fluctuation in quoted market prices. The market value ofAugust Technology investments held at September 30 and October 7, 2002 was$3,560,000 and $4,750,000 respectively. The market value of the equity method investment in PPT is approximately$1,280,000 at September 30 and $1,560,000 at October 7, 2002.

 

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**Item 3.  Controls and Procedures.**

 

The Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,evaluated the Company’s disclosure controls and procedures (as defined in Rule13a – 14(c) under the Securities and Exchange Act of 1934, asamended) within 90 days prior to the filing date of this quarterly report.Based on this evaluation the Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures areeffective. There were no significant changes in internal controls that couldsignificantly affect the disclosure controls and procedures since the date ofthe evaluation.

 

**PART II – OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

There were nomaterial developments in previously reported legal proceedings.

 

**Item 2.  Changes in Securities**

 

No changes have beenmade to any registered securities nor were there any sales of unregisteredsecurities during the quarter ended September 30, 2002.

 

**Item 3.  Defaults Upon SeniorSecurities**

** **

No event constitutinga default has occurred with respect to any senior security of the Registrant.

 

**Item 4.  Submission of Matters toa Vote of Security Holders**

** **

No matters were votedon by the Company’s security holders.

 

**Item 5.  Other Information**

** **

This Form 10-QSBcontains forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,including statements regarding the Company’s expectations, beliefs, intentionsor strategies regarding the future. Forward-looking statements include, without limitation, statements regardingthe extent and timing of future revenues and expenses and customer demand.  These statements include, but are notlimited to, changes in worldwide general economic conditions, cyclical capitalspending by customers, the Company’s ability to keep pace with technologicaldevelopments and evolving industry standards, worldwide competition, and theCompany’s ability to protect its existing intellectual property from challengesfrom third parties and other factors.

 

All forward-lookingstatements in this document are based on information available to the Companyas of the date hereof, and the Company assumes no obligation to update any suchforward-looking statements.  It isimportant to note that the Company’s actual results could differ materiallyfrom those in such forward-looking statements.  The forward-looking statements of the Company are subject to risksand uncertainties.  Some of the factorsthat could cause future results to differ materially from the Company’s recentresults or those projected in the forward-looking statements are detailed inthe Company’s Annual Report on Form 10-KSB for the year ended December 31,2001, filed with the Securities and Exchange Commission.

 

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**Item 6.  Exhibits and Reports onForm 8-K**

** **

(a)           Exhibits99.1 Certification Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

(b)         We filed areport 8-K on August 12, 2002 reporting the submission to the Securities andExchange Commission of certifications under the Sarbanes-Oxley Act of 2002.

 

 

**SIGNATURES**

** **

In accordance withthe requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

**Electro-Sensors, Inc.**

** **
| November 11, 2002 | /s/ Bradley D. Slye                                         |
|-------------------|-------------------------------------------------------------|
|              | Bradley D. Slye,  President                                 |
|              | (Chief Executive  Officer and Principal Accounting Officer) |

 

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**CERTIFICATION**

 

I, Bradley D. Slye, ChiefExecutive Officer and Principal Accounting Officer of Electro-Sensors, Inc.,certify that:

 

1.     I have reviewed this quarterly report on Form10-QSB of Electro-Sensors Inc.

 

2.     Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.     Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report

 

4.     Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)     designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)    evaluated the effectivenessof the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this quarterly report (the “Evaluation Date”);and

 

c)     presented in this quarterlyreport our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5.     Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction);

 

a)     allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)    any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.     Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| November 11,  2002 |                                                       |
|--------------------|------------------------------------------------------------|
|               |                                                       |
|               |                                                       | /s/ Bradley D. Slye |
|               | Bradley D. Slye, President                                 |
|               | (Chief Executive Officer and Principal Accounting Officer) |

 

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**EXHIBITINDEX**

** **

**ELECTRO-SENSORS,INC.**

** **

**FORM10-QSB FOR QUARTER ENDED SEPTEMBER 30, 2002**

** **

** **
| **Exhibit** |   | **Description**                                                      |
|-------------|--------|----------------------------------------------------------------------|
|        |   |                                                                 |
| 99.1        |   | Certification Pursuant  to Section 906 of Sarbanes-Oxley Act of 2002 |

 

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