** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

# ** **

# **Form 10-QSB**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**For the quarterly period ended March 31, 2002**

 

| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For the transition period from       to       **

 

**Commission File Number 0-9587**

 

**ELECTRO-SENSORS, INC.**

(Nameof Small Business Issuer in its Charter)

 

| **Minnesota**                                                   |   | **41-0943459**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State  or Other Jurisdiction of Incorporation or Organization) |   | (IRS  Employer Identification Number) |
|                                                            |   |                                  |
| **6111  Blue Circle Drive**                                     |
| **Minnetonka,  Minnesota 55343-9108**                           |
| (Address  of Principal Executive Offices, including Zip Code)   |
|                                                            |   |                                  |
| **(952)  930-0100**                                             |
| (Registrant’s  Telephone Number, including Area Code)      |

 

The number of shares outstanding of theregistrant’s Common Stock, $0.10 par value, on May 10, 2002 was 3,134,763.

 

Transitional Small Business Disclosure Format(check one): oYes   ý No

 

 

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

**Form 10-QSB for the Period Ended March 31, 2002**

 

**TABLE OF CONTENTS**

 
| **PART I — FINANCIAL  INFORMATION**                                |   |
|-------------------------------------------------------------------------|--------|
|                                                                    |   |
| Item 1. Financial  Statements                                           |
| Item  2. Management’s Discussion 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 — FINANCIALINFORMATION**

 

**Item 1.  Financial Statements**

 

The interim financial statements included inthis Form 10-QSB are unaudited and reflect, in the opinion of management, alladjustments (which include only normal recurring adjustments) necessary for afair presentation of the results of operations for these periods.

 

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

Consolidated Balance Sheets –For the Three Month Period Ended March 31, 2002

Consolidated Statementsof Income – For the Three Month Periods Ended March 31, 2002 and March 31,2001, respectively

ConsolidatedStatements of Cash Flows – For the Three Month Periods Ended March 31, 2002 andMarch 31, 2001, respectively

Notes toConsolidated Financial Statements

 

3

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

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
|                                                                                                                         |   | **March 31,  2002** |           | **December  31, 2001** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|----------------|------------------------|------------|
|                                                                                                                         |   |                | ** **     |                   | ** ** |
| **ASSETS**                                                                                                                   |   |                |           |                   |       |
| **CURRENT  ASSETS:**                                                                                                         |   |                |           |                   |       |
| Cash and Cash Equivalents                                                                                                    |   | $                   | 7,261,459      |                   | $          | 8,389,691 |   |
| Investments                                                                                                                  |   | 13,747,274          |           | 11,140,320             |       |
| Trade Receivables, Less  Allowance for Doubtful Accounts of $30,000 and $25,000, respectively                                |   | 620,339             |           | 498,283                |       |
| Inventories                                                                                                                  |   | 787,669             |           | 819,272                |       |
| Other Current Assets                                                                                                         |   | 260,416             |           | 210,551                |       |
| **Total  Current Assets**                                                                                                    |   | 22,677,157          |           | 21,058,117             |       |
| **PROPERTY  AND EQUIPMENT, net**                                                                                             |   | 1,491,218           |           | 1,480,477              |       |
| **INVESTMENTS**                                                                                                              |   | 653,410             |           | 742,087                |       |
| **DEFERRED  INCOME TAXES**                                                                                                   |   | 62,100              |           | 68,100                 |       |
| **TOTAL  ASSETS**                                                                                                            |   | **$**               | **24,883,886** | ** **             | **$**      | **23,348,781** | ** ** |
|                                                                                                                         |   |                | ** **     |                   | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                               |   |                |           |                   |       |
| **CURRENT  LIABILITIES:**                                                                                                    |   |                |           |                   |       |
| Accounts Payable                                                                                                             |   | $                   | 122,098        |                   | $          | 65,530 |   |
| Accrued Expenses                                                                                                             |   | 198,288             |           | 140,014                |       |
| Accrued Income Taxes                                                                                                         |   | 206,093             |           | 1,647,470              |       |
| **Total  Current Liabilities**                                                                                               |   | 526,479             |           | 1,853,014              |       |
| **DEFERRED  INCOME TAXES**                                                                                                   |   | 5,241,000           |           | 3,919,000              |       |
|                                                                                                                         |   |                |           |                   |       |
| **STOCKHOLDERS’  EQUITY**                                                                                               |   |                |           |                   |       |
| Common Stock, par value  $0.10 per share; Authorized 10,000,000 shares; Issued 3,134,763 and 3,121,263  shares, respectively |   | 313,476             |           | 312,126                |       |
| Additional Paid-In Capital                                                                                                   |   | 914,110             |           | 894,172                |       |
| Retained Earnings                                                                                                            |   | 9,855,318           |           | 9,533,073              |       |
| Accumulated Other  Comprehensive Income                                                                                      |   | 8,033,503           |           | 6,837,396              |       |
| **Total  Stockholders’ Equity**                                                                                         |   | 19,116,407          |           | 17,576,767             |       |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                         |   | **$**               | **24,883,886** | ** **             | **$**      | **23,348,781** | ** ** |

 

See Accompanying Notes to Consolidated FinancialStatements

 

4

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

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**

 
|                                                                       |   | **Three  Months Ended  March 31,** |      |
|----------------------------------------------------------------------------|--------|------------------------------------|-----------|
|                                                                       |   | **2002**                           |      | **2001** | ** ** |
|                                                                       |   |                               |      |   |   |
| **Net Sales**                                                              |   | $                                  | 1,138,656 |   | $ | 1,301,369 |   |
| **Cost of  Goods Sold**                                                    |   | 493,227                            |      | 474,696 |   |
| **Gross  Profit**                                                          |   | 645,429                            |      | 826,673 |   |
|                                                                       |   |                               |      |   |   |
| **Operating  Expenses:**                                                   |   |                               |      |   |   |
| Selling and Marketing                                                      |   | 281,134                            |      | 294,305 |   |
| General and Administrative                                                 |   | 211,350                            |      | 208,443 |   |
| Research and Development                                                   |   | 225,141                            |      | 188,027 |   |
| **Total  Operating Expenses**                                              |   | 717,625                            |      | 690,775 |   |
|                                                                       |   |                               |      |   |   |
| **Operating  Income (Loss)**                                               |   | (72,196                            | )         | 135,898 |   |
|                                                                       |   |                               |      |   |   |
| **Non-Operating  Income (Expense):**                                       |   |                               |      |   |   |
| Gain (Loss) on Sale of  Investment Securities                              |   | 632,774                            |      | 1,426,567 |   |
| Interest Income                                                            |   | 142,937                            |      | 33,498 |   |
| Other Income (Expense)                                                     |   | (22,743                            | )         | (54,257 | ) |
| **Total  Non-Operating Income (Expense)**                                  |   | 752,968                            |      | 1,405,808 |   |
|                                                                       |   |                               |      |   |   |
| **Income  (Loss) from Continuing Operations Before Income Taxes**          |   | 680,772                            |      | 1,541,706 |   |
|                                                                       |   |                               |      |   |   |
| **Federal  and State Income Taxes**                                        |   | 264,859                            |      | 555,025 |   |
|                                                                       |   |                               |      |   |   |
| **Income  (Loss) from Continuing Operations**                              |   | 415,913                            |      | 986,681 |   |
|                                                                       |   |                               |      |   |   |
| **Discontinued  Operations (Note 13):**                                    |   |                               |      |   |   |
| Income (Loss) from  Operations of Microflame Division, net of income taxes |   | 0                                  |      | (983 | ) |
| Loss on Disposal of  Microflame Division, net of income taxes              |   | 0                                  |      | 0 |   |
| **Total  Income (Loss) from Discontinued Operations**                      |   | 0                                  |      | (983 | ) |
|                                                                       |   |                               |      |   |   |
| **Net Income  (Loss)**                                                     |   | $                                  | 415,913   |   | $ | 985,698 |   |

 

See Accompanying Notes to Consolidated FinancialStatements

 

5

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| **Net Income  (Loss) Per Share Data:**                    |   |      |    |      |   |
|-----------------------------------------------------------|--------|-----------|---------|-----------|--------|
|                                                      |   |      |    |      |   |
| ***Basic***                                               |   |      |    |      |   |
|                                                      |   |      |    |      |   |
| Income (Loss) from  Continuing Operations                 |   | $         | 415,913 |      | $      | 986,681 |   |
| Income (Loss) from  Discontinued Operations               |   | $         | —  |      | $      | (983 | ) |
|                                                      |   | $         | 415,913 |      | $      | 985,698 |   |
|                                                      |   |      |    |      |   |
| Net Income (Loss) Per Share  from Continuing Operations   |   | $         | 0.13    |      | $      | 0.32 |   |
| Net Income (Loss) Per Share  from Discontinued Operations |   | $         | —  |      | $      | (0.00 | ) |
|                                                      |   | $         | 0.13    |      | $      | 0.32 |   |
| Shares Used in Per Share  Calculations                    |   | 3,123,558 |    | 3,043,727 |   |
|                                                      |   |      |    |      |   |
| ***Diluted***                                             |   |      |    |      |   |
|                                                      |   |      |    |      |   |
| Income (Loss) from  Continuing Operations                 |   | $         | 415,913 |      | $      | 986,681 |   |
| Income (Loss) from  Discontinued Operations               |   | $         | —  |      | $      | (983 | ) |
|                                                      |   | $         | 415,913 |      | $      | 985,698 |   |
|                                                      |   |      |    |      |   |
| Net Income (Loss) Per Share  from Continuing Operations   |   | $         | 0.12    |      | $      | 0.32 |   |
| Net Income (Loss) Per Share  from Discontinued Operations |   | $         | —  |      | $      | (0.00 | ) |
|                                                      |   | $         | 0.12    |      | $      | 0.32 |   |
|                                                      |   |      |    |      |   |
| Shares Used in Per Share  Calculations                    |   | 3,433,064 |    | 3,071,533 |   |

 

See Accompanying Notes to Consolidated FinancialStatements

 

6

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                             |   | **Three  Months Ended  March 31,** |       |
|------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                             |   | **2002**                           |       | **2001** | ** ** |
|                                                             |   |                               |       |   |   |
| **CASH FLOWS  FROM OPERATING ACTIVITIES:**                       |   |                               |       |   |   |
| Cash Received from  Customers                                    |   | $                                  | 1,011,600  |   | $ | 1,364,563 |   |
| Cash Paid to Suppliers and  Employees                            |   | (1,146,637                         | )          | (1,248,646 | ) |
| Interest Received                                                |   | 142,937                            |       | 47,323 |   |
| Income Taxes Paid                                                |   | (1,700,236                         | )          | 0 |   |
|                                                             |   |                               |       |   |   |
| **Net Cash  Provided By (Used In) Operating Activities**         |   | (1,692,336                         | )          | 163,240 |   |
|                                                             |   |                               |       |   |   |
| **CASH FLOWS  FROM INVESTING ACTIVITIES:**                       |   |                               |       |   |   |
| Purchase of Property and  Equipment                              |   | (1,290                             | )          | (14,286 | ) |
| Proceeds from Sale of  Marketable Securities                     |   | 632,774                            |       | 1,426,566 |   |
| Payments Received on Notes  Receivable                           |   | 5,000                              |       | 0 |   |
|                                                             |   |                               |       |   |   |
| **Net Cash  Provided By (Used In) Investing Activities**         |   | 636,484                            |       | 1,412,280 |   |
|                                                             |   |                               |       |   |   |
| **CASH FLOWS  FROM FINANCING ACTIVITIES:**                       |   |                               |       |   |   |
| Dividends Paid                                                   |   | (93,668                            | )          | (93,568 | ) |
| Proceeds from Issuance of  Stock                                 |   | 21,288                             |       | 6,538 |   |
| **Net Cash Provided  By (Used In) Financing Activities**         |   | (72,380                            | )          | (87,030 | ) |
|                                                             |   |                               |       |   |   |
| **Net  Increase (Decrease) in Cash and Cash Equivalents**        |   | (1,128,232                         | )          | 1,488,490 |   |
|                                                             |   |                               |       |   |   |
| **Cash and  Cash Equivalents:**                                  |   |                               |       |   |   |
| Beginning                                                        |   | 8,389,691                          |       | 3,191,176 |   |
| Ending                                                           |   | $                                  | 7,261,459  |   | $ | 4,679,666 |   |
|                                                             |   |                               |       |   |   |
| **RECONCILIATION  OF NET INCOME (LOSS) TO NET CASH**             |   |                               |       |   |   |
| **PROVIDED  BY (USED IN) OPERATING ACTIVITIES:**                 |   |                               |       |   |   |
| Net Income (Loss)                                                |   | 415,913                            |       | 985,695 |   |
| Adjustments to Reconcile  Net Income (Loss) to Net               |   |                               |       |   |   |
| Cash Provided By (Used In) Operating  Activities:                |   |                               |       |   |   |
| Depreciation and  Amortization                                   |   | 9,622                              |       | 28,362 |   |
| Realized (Gain) Loss on  Sale of Investment Securities, net      |   | (638,874                           | )          | 0 |   |
| Provision for Losses on  Trade Receivables                       |   | (5,000                             | )          | (4,300 | ) |
| Deferred Taxes                                                   |   |                               |       | (1,266,229 | ) |
| (Increase) Decrease In:                                          |   |                               |       |   |   |
| Trade Receivables                                                |   | (132,056                           | )          | (34,704 | ) |
| Inventories                                                      |   | 31,603                             |       | (33,054 | ) |
| Other Current Assets                                             |   | (49,865                            | )          | 71,342 |   |
| Prepaid Income Taxes                                             |   | 0                                  |       | (74,606 | ) |
| Increase (Decrease) In:                                          |   |                               |       |   |   |
| Accounts Payable                                                 |   | 56,568                             |       | 231 |   |
| Accrued Customer Deposits                                        |   | 2,856                              |       | 243 |   |
| Accrued Expenses                                                 |   | 58,274                             |       | 59,799 |   |
| Accrued Income Taxes                                             |   | (1,441,377                         | )          | 430,461 |   |
|                                                             |   |                               |       |   |   |
| **Net Cash  Provided By (Used In) Operating Activities**         |   | $                                  | (1,692,336 | ) | $ | 163,240 |   |
|                                                             |   |                               |       |   |   |
| **SUPPLEMENTAL  SCHEDULE OF NON-CASH**                           |   |                               |       |   |   |
| **INVESTING  AND FINANCING ACTIVITIES:**                         |   |                               |       |   |   |
|                                                             |   |                               |       |   |   |
| Net Change in Unrealized  Holding Gains on Marketable Securities |   | $                                  | 1,190,277  |   | $ | (3,200,908 | ) |

 

See Accompanying Notes to Consolidated FinancialStatements

 

7

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

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**Note1.  Nature of Business**

 

The accompanying consolidated financialstatements include the accounts of Electro-Sensors, Inc. and its wholly ownedsubsidiary, ESI Investment Company. Intercompany accounts, transactions and earnings have been eliminated inconsolidation.  The consolidated entityis referred to as “the Company”.

 

Electro-Sensors, Inc. operates two distinctbusinesses.  The first is the ControlsDivision, 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 of manufacturers,OEM’s and processors to monitor process machinery operations.  The Controls Division markets its productsto a number of different industries located throughout the United States andabroad.

 

The second business is AutoData Systems (ADS), adivision of Electro-Sensors, Inc.  ADSdesigns and markets a desktop software based system that reads hand printedcharacters, checkmarks and bar code information from scanned or faxed forms.  ADS products are designed to providecapabilities to automate data collection through telemarketing to end users,resellers and developers in the United States, Canada, Europe and Asia.

 

ESI Investment Company owns marketablesecurities which have experienced significant appreciation in value since theIPO of August Technology in 2000. During late 2000, 2001 and 2002, the Company has recognized income fromthe sale of its holdings in August Technology Corporation.

 

The Company previously operated a thirdbusiness, Microflame, Inc. (MFI), a wholly owned subsidiary, which was sold inMay 2001.  MFI produced small hand heldgas torches used primarily by hobbyists, electronic kit assemblers and creatorsof jewelry.  MFI products were soldthrough distributors to retailers of hardware, craft and electronic products.

 

**Note2.  Basis of Presentation**

 

The accompanying unaudited consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information and with the instructions to Form 10-QSB and Rule 10-01of Regulation S-X.  Accordingly, they donot 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.

 

Intercompany accounts, transactions and earningsare eliminated through consolidation.

 

The Balance Sheet at December 31, 2001 has beenderived from the Company’s audited financial statements for the year endedDecember 31, 2001, but does not include all of the information and footnotesrequired by accounting principles generally accepted in the United States ofAmerica for complete financial statements.

 

For further information, refer to the financialstatements and footnotes thereto included in the Company’s annual report onForm 10-KSB for the year ended December 31, 2001.

 

8

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**Note3.  Investments**

 

The Company has a portfolio of investments.  Management determines the appropriateclassification of securities at the date individual investments are acquired,and evaluates the appropriateness of such classification at each balance sheetdate.

 

The Company’s investments consist of marketableequity securities, primarily common stocks, government debt securities, moneymarket funds and unregistered equity securities.  The estimated fair value of marketable equity securities is basedon quoted market prices and therefore subject to the inherent risk of marketfluctuations.

 

Since the Company does not buy investments inanticipation of short-term fluctuations in market prices, the investments inmarketable equity securities has been classified as available-for-sale.  Available-for-sale securities are stated atfair value, and unrealized holding gains and losses, net of the relateddeferred tax effect, are reported as separate component of stockholders’equity.  Dividends on marketable equitysecurities are recognized in income when declared.  Investments in unregistered securities are reported at originalcost.

 

Realized gains and losses, including losses fromdeclines in value of specific securities determined by management to beother-than-temporary, are included in income. Realized gains and losses are determined on the basis of the specificsecurities sold.

 

**Note4.  Recent Accounting Pronouncements**

 

In December 1999, the Securities and ExchangeCommission issued SAB No. 101, “Revenue Recognition in Financial Statements”,which provides guidance in applying accounting principles generally accepted inthe United States of America to revenue recognition in financialstatements.  The application of this SABdid not have a material impact on the Company’s operating results or financialposition.

 

On July 1, 2000, the Company adopted Statementof Financial Accounting Standards (SFAS) No. 133, “Accounting for DerivativeInstruments and Hedging Activities”, as amended by SFAS No. 138, “Accountingfor Certain Derivative Instruments and Certain Hedging Activities”.  SFAS No. 133 establishes accounting andreporting standards for derivative instruments and for hedging activities.  It requires that all derivatives, includingthose embedded in other contracts, be recognized as either assets orliabilities and that those financial instruments be measured at fairvalue.  The accounting for changes inthe fair value of derivatives depends on their intended use anddesignation.  Management has reviewedthe requirements of SFAS No. 133 and has determined that they have nofreestanding or embedded derivatives. All contracts that contain provisions meeting the definition of aderivative also meet the requirements of, and have been designated as, normalpurchases or sales.  The Company’spolicy is to not use freestanding derivatives and to not enter into contractswith terms that cannot be designated as normal purchases or sales.

 

In July 2001, the Financial Accounting StandardsBoard issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwilland Other Intangible Assets”.  SFAS No.141 applies to all business combinations initiated after June 30, 2001 andprohibits the use of the pooling-of-interests method of accounting.  There is also transition provisions providedthat apply to business combinations completed before July 1, 2001 that wereaccounted for using the purchase method. Under SFAS No. 142, goodwill as well as other

 

intangibles determined to have an infinite lifewill no longer be amortized; however, these assets will be reviewed forimpairment on a periodic basis.  SFASNo. 142 also includes provisions for the reclassification of certain existingrecognized intangibles as goodwill, reclassification of certain intangibles outof previously reported goodwill and the identification of reporting units forpurposes of assessing potential future impairments of goodwill.  The Company plans to adopt SFAS No. 142 onJuly 1, 2002.  The Company does not holdany net goodwill or other intangible assets and therefore believes that theapplication of this SFAS will not have a material impact on the Company’soperating results or financial position.

 

9

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**Note5.  Comprehensive Income**

 

Comprehensive income includes the Company’s netincome plus other comprehensive income items, which are excluded from netincome.  The Company’s other incomeconsists of unrealized gains (losses), net of income taxes and reclassificationadjustments for gains and losses included in net income.

 
|                                                          |   | **Three  Months Ended  March 31,** |       |
|---------------------------------------------------------------|--------|------------------------------------|------------|
|                                                          |   | **2002**                           |       | **2001** | ** ** |
| **Net Income**                                                |   | $                                  | 415,913    |   | $ | 985,698 |   |
|                                                          |   |                               |       |   |   |
| **Other  Comprehensive Gain:**                                |   |                               |       |   |   |
| Change in Unrealized Value  Investments,  net            |   | 1,624,900                          |       | (2,497,729 | ) |
|                                                          |   |                               |       |   |   |
| **Less:**                                                     |   |                               |       |   |   |
| Reclassification Adjustment  for Gains Included in Net Income |   | (428,793                           | )          | (929,967 | ) |
|                                                          |   |                               |       |   |   |
| **Total  Comprehensive Income**                               |   | **1,612,020**                      | ** ** | **(2,441,998** | **)** |
|                                                               |        |                                    |            |  |  |  |  |

 

10

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**Note6.  Discontinued Operations**

 

On May 14, 2001, the Company disposed of itsbrazing torches segment through a sale of all of its shares of stock inMicroflame, Inc. to an unrelated party. The Company has restated its prior financial statements to present theoperating results of the brazing torch operations as discontinued.

 

**Note7.  Segment Information**

 

The Company has three reportable operatingsegments based on the nature of its product lines:  Production Monitoring, Character Recognition, andInvestments.  The Production MonitoringDivision manufactures and markets a complete line of speed monitoring and motorcontrol systems for industrial machinery. The Character Recognition Division designs and markets a desktopsoftware-based system that reads hand printed characters, checkmarks, and barcode information from scanned or faxed forms. Sales of this system include software and can include hardware.  The Investments Division holds investmentsin marketable and non-marketable securities.

 

In evaluating segment performance, managementfocuses on sales and income before taxes. The Company has no inter-segment sales.

 

The following is financial information relatingto the continuing operating segments:

 
|                                                     |   | **Three  Months Ended  March 31,** |       |
|----------------------------------------------------------|--------|------------------------------------|------------|
|                                                     |   | **2002**                           |       | **2001** | ** ** |
|                                                     |   |                               |       |   |   |
| **External  Sales**                                      |   |                               |       |   |   |
| Production Monitoring                                    |   | $                                  | 932,464    |   | $ | 1,120,918 |   |
| Character Recognition                                    |   | 206,192                            |       | 180,451 |   |
| Investments                                              |   | 0                                  |       | 0 |   |
| **Total**                                                |   | **1,138,656**                      | ** ** | **1,301,369** | ** ** |
|                                                     |   |                               | ** ** |   | ** ** |
| **Net Income  Before Taxes and Discontinued Operations** |   |                               |       |   |   |
| Production Monitoring                                    |   | 30,830                             |       | 97,653 |   |
| Character Recognition                                    |   | (307                               | )          | 24,955 |   |
| Investments                                              |   | 650,249                            |       | 1,419,098 |   |
| **Total**                                                |   | **680,772**                        | ** ** | **1,541,706** | ** ** |
|                                                          |        |                                    |            |  |  |  |  |

 

The Company’s subsidiary Microflame, Inc. wassold in May 2001.  See Note 6 aboveregarding this transaction.  Segmentinformation related to Microflame, Inc. previously has been included as theBrazing Torches operations segment.

 

 

11

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

 

**RESULTSOF OPERATIONS**

 

**Comparisonof Quarter 1, 2002 vs. Quarter 1, 2001**

 

***OperatingIncome (Loss)***

 

Income from continuing operations decreased55.8% to $680,772 for the three-month period ended March 31, 2002, compared toincome from continuing operations of $1,541,706 for the same period in fiscal2001.  This decrease was primarily dueto a decrease in the sale of investment securities through the Company’ssubsidiary, ESI Investment Company.

 

Investment income for the three-month periodended March 31, 2002 decreased $793,793 to $632,774.  The Company continued to sell a portion of its investment inAugust Technology.  The increase ininterest income earned on temporary cash investments increased $109,439 as aresult of an increase in interest rates in the market.

 

The Controls Division had operating income of$12,624 compared to operating income of $62,488 when compared to the sameperiod for the prior year, a decrease of $49,864 or 79.8%.  This decrease is a direct result of adecrease in net revenues for this division.

 

The Character Recognition Division had anoperating loss of ($2,310) compared to operating income of $15,972 whencompared to the same period for the prior year, a decrease of $18,282 or114.5%.  This decrease is a result of anincrease in research and development costs for currently upgrading thisDivision’s software products.

 

Available-for-sale securities are stated at fairvalue, and unrealized holding gains and losses, net of the related deferred taxeffect, are reported as a separate component of stockholders’ equity.  Dividend on marketable equity securities arerecognized in income when declared. Investments in unregistered securities are reported at original cost.

 

Realized gains and losses, including losses fromdeclines in value of specific securities determined by management to beother-than-temporary, are included in income. Realized gains and losses are determined on the basis of the specificsecurities sold.

 

***Net Revenues***

 

Net revenues for the three-month period endedMarch 31, 2002 decreased $162,713 to $1,138,656 or 12.5% when compared to net revenuesfor the same period in fiscal 2001.

 

Of this decrease, $188,454 is attributable tothe Controls Division.  All of theDivision’s products contributed to this decline.  This decline in demand for production control is attributable tothe slowdown in the United States economy. This decrease was offset by an increase in the Character RecognitionDivision of $25,741.  This increase wasprimarily an increase in the sale of the Scannable Office product.

 

***Cost of Sales***

 

The Company’s cost of sales increased from$474,696 to $493,227, a difference of $18,531 or 3.8%.  This increase is a result of fixed costs,including labor and overhead, being absorbed by a decrease in net revenues forthe current fiscal period.

 

***Gross Margins***

 

Gross margin for the three-month period endedMarch 31, 2002 were 56.7% versus 63.5% for the same period of the prior fiscalyear.  The decline in margins are due tounchanged fixed costs, including labor and overhead, being absorbed by lowersales amounts.  The Controls Division grossmargins decreased minimally, while the Character Recognition Division grossmargins increased slightly.

 

 

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***OperatingExpenses***

 

Total operating expenses increased $26,850 or3.9% when compared to the same period of the prior fiscal year.  Selling and marketing costs decreased to$281,134, a decrease of 4.5%; general and administrative costs increased to$211,350, an increase of 1.4%; and research and development costs increased$37,114, an increase of 19.7%.

 

Research and development costs increasedprimarily due to the Character Recognition Division’s upgrading of theirsoftware products in the current fiscal year.

 

***Non-OperatingIncome***

 

ESI Investment Company, the Company’ssubsidiary, continues to provide an alternative source of earnings for theCompany through investments in marketable securities.  However, the Company’s intent is to remain an operations-basedcompany.

 

The Company’s investments in marketablesecurities are subject to significant positive and negative changes in value.

 

In addition to income from the sale ofinvestments, the Company also realized interest income from its short-termholdings.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

The Company continues to generate strong cashflows from operations.  Working capitalremained consistent for the three-month period ended March 31, 2002 whencompared to the same period for the prior fiscal year.  Working capital and funds for capitalexpenditures have been generated through current earnings.  These funds have been placed in secureshort-term investments.  The funds arebeing used primarily for dividend distributions, working capital needs andgeneral corporate purposes, which may include acquisitions.  Capital expenditures resulted from thepurchase of additional equipment.  TheCompany does not anticipate the need for additional working capital fromoutside sources.  The Company holdsinvestments in August Technologies, Inc. and PPT Vision, Inc., which are valuedat the quoted market price on March 31, 2002. The quoted market price represents an estimate of what the Company mayhave realized if the shares were traded on the open exchange.

 

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**PART II – OTHERINFORMATION**

 

**Item 1.  Legal Proceedings**

 

There were no material developments inpreviously reported legal proceedings.

 

**Item 2.  Changes in Securities**

 

No changes have been made to any registeredsecurities.

 

**Item 3.  Defaults Upon Senior Securities**

 

No event constituting a default has occurred withrespect to any senior security of the Registrant.

 

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

 

No matters were voted on by the Company’ssecurity holders.

 

**Item 5.  Other Information**

 

This Form 10-QSB contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934, including statementsregarding the Company’s expectations, beliefs, intentions or strategiesregarding the future.  Forward-looking statementsinclude, without limitation, statements regarding the extent and timing offuture revenues and expenses and customer demand.  These statements include, but are not limited to, changes inworldwide general economic conditions, cyclicality of capital spending bycustomers, the Company’s ability to keep pace with technological developmentsand evolving industry standards, worldwide competition, and the Company’sability to protect its existing intellectual property from challenges fromthird parties and other factors.

 

All forward-looking statements in this documentare based on information available to the Company as of the date hereof, andthe Company assumes no obligation to update any such forward-lookingstatements.  It is important to notethat the Company’s actual results could differ materially from those in suchforward-looking statements.  Theforward-looking statements of the Company are subject to risks anduncertainties.  Some of the factors thatcould 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.

 

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

 

(a)          Exhibits **–** No exhibits are attached tothis filing of Form 10-QSB.

(b)         Reports on Form 8-K **–** No reports on Form 8-K werefiled during the three months ended March 31, 2002.

 

 

**SIGNATURES**

 

In accordance with the requirements of theExchange Act, the Registrant caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

**Electro-Sensors,Inc.**

 
| May 15, 2001 |   | /s/ Bradley D. Slye        |   |   |
|--------------|--------|----------------------------|--------|--------|
|         |   | Bradley D. Slye, President |   |   |

 

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