**UNITEDSTATESSECURITIES A****ND 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 March 31, 2004**                                                                                                                    |
|                                                                                                                                                                      |
| **o****TRANSITION REPORT  UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                                                                                            |
|                                                                                                                                                                      |
| **FOR THE TRANSITION PERIOD  FROM           TO           ** |
|                                                                                                                                                                      |
| **Commission File Number 0-9587**                                                                                                                                         |

 

**ELECTRO-SENSORS,INC.**

(Exact name of small business issuer asspecified 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 reports required to be filed bySection 13 of 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes ý  No o

 

The number of shares outstanding of the registrant’s Common Stock,$0.10 par value, on May 14, 2004 was 3,210,999.

 

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

 

 

----

 

**ELECTRO-SENSORS, INC.**

**Form 10-QSB**

**For the Period Ended March 31, 2004**

 

**TABLE OF CONTENTS**

 
| **PART I – FINANCIAL INFORMATION**                                                                                     |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                        |   |
| Item 1. Financial Statements                                                                                                |   |
|                                                                                                                        |   |
| Consolidated Balance Sheets – As of March 31, 2004 and  December 31, 2003                                    |   |
| Consolidated Statements of Operations – For  the Three-Month Periods Ended March 31, 2004 and March 31, 2003 |   |
| Consolidated Statements of Cash Flows – For  the Three-Month Periods Ended March 31, 2004 and March 31, 2003 |   |
| Notes to Consolidated 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**                                                                                                              |   |
|                                                                                                                        |   |
| **EXHIBITS**                                                                                                                |   |

 

2

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**PART I.   FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

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

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                        |   | **March 31,  2004** |           | **December 31,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|----------------|-----------------------------|--------|
|                                                                                                                        |   | **(unaudited)**          |           | **(audited)**               |   |
| **ASSETS**                                                                                                                  |   |                     |           |                        |   |
|                                                                                                                        |   |                     |           |                        |   |
| **CURRENT ASSETS**                                                                                                          |   |                     |           |                        |   |
|                                                                                                                        |   |                     |           |                        |   |
| Cash and  cash equivalents                                                                                                  |   | **$**                    | **6,895,213**  | ** **                  | $      | 6,863,046 |   |
| Investments                                                                                                                 |   | **10,744,555**           | ** **     | 13,415,625                  |   |
| Trade  receivables, less allowance for doubtful accounts of $9,000 and $6,000,  respectively                                |   | **539,568**              | ** **     | 515,351                     |   |
| Inventories                                                                                                                 |   | **801,554**              | ** **     | 758,103                     |   |
| Other  current assets                                                                                                       |   | **66,152**               | ** **     | 62,123                      |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **Total current  assets**                                                                                                   |   | **19,047,042**           | ** **     | 21,614,248                  |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **Property and  equipment, net**                                                                                            |   | **1,447,841**            | ** **     | 1,470,133                   |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **Investment in  equity method investee**                                                                                   |   | **87,421**               | ** **     | 152,115                     |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **TOTAL ASSETS**                                                                                                            |   | **$**                    | **20,582,304** | ** **                  | $      | 23,236,496 |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                              |   |                     | ** **     |                        |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **CURRENT LIABILITIES**                                                                                                     |   |                     | ** **     |                        |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| Accounts  payable                                                                                                           |   | **$**                    | **143,568**    | ** **                  | $      | 106,065 |   |
| Accrued  expenses                                                                                                           |   | **208,418**              | ** **     | 263,143                     |   |
| Deferred  revenue                                                                                                           |   | **54,129**               | ** **     | 48,022                      |   |
| Deferred  income tax                                                                                                        |   | **3,893,117**            | ** **     | 4,795,000                   |   |
| Accrued income tax                                                                                                          |   | **109,570**              | ** **     | 96,196                      |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **Total current  liabilities**                                                                                              |   | **4,408,802**            | ** **     | 5,308,426                   |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **Deferred income taxes**                                                                                                   |   | **26,000**               | ** **     | 26,000                      |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **TOTAL LIABILITIES**                                                                                                       |   | **$**                    | **4,434,802**  | ** **                  | $      | 5,334,426 |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **STOCKHOLDERS’ EQUITY**                                                                                               |   |                     | ** **     |                        |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| Common  stock par value $0.10 per share;authorized 10,000,000 shares; issued 3,185,999 and 3,174,522 shares,  respectively. |   | **318,600**              | ** **     | 317,452                     |   |
| Additional  paid-in capital                                                                                                 |   | **1,028,304**            | ** **     | 999,762                     |   |
| Retained  earnings                                                                                                          |   | **8,280,707**            | ** **     | 8,304,737                   |   |
| Accumulated  other comprehensive income                                                                                     |   | **6,519,891**            | ** **     | 8,280,119                   |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **TOTAL STOCKHOLDERS’  EQUITY**                                                                                        |   | **16,147,502**           | ** **     | 17,902,070                  |   |
|                                                                                                                        |   |                     | ** **     |                        |   |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                         |   | **$**                    | **20,582,304** | ** **                  | $      | 23,236,496 |   |

 

See accompanying notes to consolidatedfinancial statements

 

3

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                  |   | **Three  Months Ended  March 31,** |          |
|-------------------------------------------------------|--------|-----------------------------------------|---------------|
|                                                  |   | **2004**                                |          | **2003** |   |
|                                                  |   |                                    |          |   |   |
| **Net sales**                                         |   | **$**                                   | **1,216,011** | ** ** | $ | 986,539 |   |
| **Cost of goods sold**                                |   | **466,455**                             | ** **    | 400,522 |   |
|                                                  |   |                                    | ** **    |   |   |
| **Gross profit**                                      |   | **749,556**                             | ** **    | 586,017 |   |
|                                                  |   |                                    | ** **    |   |   |
| **Operating expenses:**                               |   |                                    | ** **    |   |   |
|                                                  |   |                                    | ** **    |   |   |
| Selling and marketing                                 |   | **314,977**                             | ** **    | 315,989 |   |
| General and administrative                            |   | **320,554**                             | ** **    | 297,845 |   |
| Research and development                              |   | **170,795**                             | ** **    | 211,598 |   |
|                                                  |   |                                    | ** **    |   |   |
| **Total operating  expenses**                         |   | **806,326**                             | ** **    | 825,432 |   |
|                                                  |   |                                    | ** **    |   |   |
| **Operating income  (loss)**                          |   | **(56,770**                             | **)**         | (239,415 | ) |
|                                                  |   |                                    | ** **    |   |   |
| **Non-operating  income (expense):**                  |   |                                    | ** **    |   |   |
|                                                  |   |                                    | ** **    |   |   |
| Gain on sale of investment securities                 |   | **323,972**                             | ** **    | 12,104 |   |
| Interest income                                       |   | **10,791**                              | ** **    | 16,123 |   |
| Other income (expense)                                |   | **3,303**                               | ** **    | (246 | ) |
| Equity in losses of equity method investee            |   | **(64,694**                             | **)**         | (195,471 | ) |
|                                                  |   |                                    | ** **    |   |   |
| **Total non-operating  income (expense)**             |   | **273,372**                             | ** **    | (167,490 | ) |
|                                                  |   |                                    | ** **    |   |   |
| **Income (loss)  before income taxes**                |   | **216,602**                             | ** **    | (406,906 | ) |
|                                                  |   |                                    | ** **    |   |   |
| **Federal and state  income tax provision (benefit)** |   | **113,252**                             | ** **    | (79,950 | ) |
|                                                  |   |                                    | ** **    |   |   |
| **Net income (loss)**                                 |   | **$**                                   | **103,350**   | ** ** | $ | (326,955 | ) |
|                                                  |   |                                    | ** **    |   |   |
| **Net income (loss)  per share data:**                |   |                                    | ** **    |   |   |
|                                                  |   |                                    | ** **    |   |   |
| **Basic**                                             |   |                                    | ** **    |   |   |
| Net income (loss) per share                           |   | **$**                                   | **0.03**      | ** ** | $ | (0.10 | ) |
| Weighted average shares                               |   | **3,181,117**                           | ** **    | 3,159,167 |   |
|                                                  |   |                                    | ** **    |   |   |
| **Diluted**                                           |   |                                    | ** **    |   |   |
| Net income (loss) per share                           |   | **$**                                   | **0.03**      | ** ** | $ | (0.10 | ) |
| Weighted average shares                               |   | **3,300,097**                           | ** **    | 3,159,167 |   |
|                                                  |   |                                    | ** **    |   |   |
| **Dividends paid per  share**                         |   | **$**                                   | **0.04**      | ** ** | $ | 0.03 |   |

 

See accompanying notes to consolidatedfinancial statements

 

4

----

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                  |   | **Three  Months Ended  March 31,** |           |
|---------------------------------------------------------------------------------------|--------|-----------------------------------------|----------------|
|                                                                                  |   | **2004**                                |           | **2003** |   |
| **Cash flows from  operating activities**                                             |   |                                    |           |   |   |
|                                                                                  |   |                                    |           |   |   |
| **Net income (loss)**                                                                 |   | **$**                                   | **103,348**    | ** ** | $ | (326,955 | ) |
|                                                                                  |   |                                    | ** **     |   |   |
| Adjustments to reconcile net income (loss)  to net cash used in operating activities: |   |                                    | ** **     |   |   |
|                                                                                  |   |                                    | ** **     |   |   |
| Depreciation                                                                          |   | **22,292**                              | ** **     | 27,076 |   |
| Realized (gain)/loss on sale of investments                                           |   | **(323,972**                            | **)**          | (12,104 | ) |
| Equity in loss of equity method investee                                              |   | **64,694**                              | ** **     | 195,471 |   |
| (Increase)/decrease in:                                                               |   |                                    | ** **     |   |   |
| Trade receivables                                                                     |   | **(24,217**                             | **)**          | 13,397 |   |
| Inventory                                                                             |   | **(43,451**                             | **)**          | 17,411 |   |
| Other current assets                                                                  |   | **(4,029**                              | **)**          | 2,995 |   |
| Prepaid income taxes                                                                  |   | **0**                                   | ** **     | (79,951 | ) |
| Increase/(decrease) in:                                                               |   |                                    | ** **     |   |   |
| Accounts payable                                                                      |   | **37,503**                              | ** **     | (77,868 | ) |
| Accrued expenses                                                                      |   | **(54,725**                             | **)**          | (32,564 | ) |
| Deferred revenue                                                                      |   | **6,107**                               | ** **     | (10,011 | ) |
| Accrued income taxes                                                                  |   | **13,374**                              | ** **     | 0 |   |
|                                                                                  |   |                                    | ** **     |   |   |
| Net cash provided by/(used) in operating  activities                                  |   | **(203,076**                            | **)**          | (283,103 | ) |
|                                                                                  |   |                                    | ** **     |   |   |
| Cash flows from investing activities:                                                 |   |                                    | ** **     |   |   |
|                                                                                  |   |                                    | ** **     |   |   |
| Proceeds from sale of investments                                                     |   | **448,986**                             | ** **     | 12,374 |   |
| Purchase of equity securities                                                         |   | **(116,055**                            | **)**          | 0 |   |
| Purchase of property and equipment                                                    |   | **0**                                   | ** **     | (14,180 | ) |
|                                                                                  |   |                                    | ** **     |   |   |
| Net cash provided by/(used) in  investing activities                             |   | **332,931**                             | ** **     | (1,806 | ) |
|                                                                                  |   |                                    | ** **     |   |   |
| Cash flows from financing activities:                                                 |   |                                    | ** **     |   |   |
|                                                                                  |   |                                    | ** **     |   |   |
| Proceeds from issuance of stock                                                       |   | **29,690**                              | ** **     | 10,272 |   |
| Dividends paid                                                                        |   | **(127,378**                            | **)**          | (93,971 | ) |
|                                                                                  |   |                                    | ** **     |   |   |
| Net cash provided by/(used) in financing  activities                                  |   | **(97,688**                             | **)**          | (83,699 | ) |
|                                                                                  |   |                                    | ** **     |   |   |
| Net increase/(decrease) in cash & cash  equivalents                               |   | **32,167**                              | ** **     | (368,606 | ) |
|                                                                                  |   |                                    | ** **     |   |   |
| Cash & cash equivalents, beginning                                                |   | **6,863,046**                           | ** **     | 6,723,160 |   |
| Cash & cash equivalents, ending                                                   |   | **6,895,213**                           | ** **     | 6,354,554 |   |
|                                                                                  |   |                                    | ** **     |   |   |
| **Supplemental  schedule of non-cash investing and financing activities**        |   |                                    | ** **     |   |   |
| Net change in unrealized gain/ (loss) on  investments                                 |   | **$**                                   | **(2,662,111** | **)** | $ | (696,701 | ) |

 

See accompanying notes to consolidatedfinancial statements

 

5

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

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1.  Nature of Business**

 

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

 

Electro-Sensors,Inc. operates two distinct businesses. The first is the Controls Division,which manufactures and markets a complete line of speed monitoring and motorcontrol systems for industrial machinery. The Controls Division utilizes leading-edgetechnology to continuously improve its products and make them easier to use.The Controls Division’s goal is to manufacture the industry-preferred productfor every market served. These products are sold through an internal salesstaff, manufacturers representatives, and distributors to a wide variety ofmanufacturers, OEM’s and processors to monitor process machinery operations.The Controls Division markets its products to a number of different industrieslocated throughout the United States and abroad.

 

Thesecond business is AutoData Systems (ADS). ADS designs and markets a desktop software based system that reads handprinted characters, checkmarks and bar code information from scanned or faxedforms. ADS products are designed to provide capabilities to automate datacollection and are sold by internal sales staff to end users, resellers anddevelopers in the United States, Canada, Europe and Asia.

 

Inboth divisions, the Company grants credit to customers under normal industryterms, generally 30 days.

 

ESIInvestment Company (INV) owns marketable securities which have experiencedsignificant appreciation in value since the IPO of August Technology in2000.  August TechnologyCorporation designs, manufactures, and sells automated defect inspectionsystems used in the manufacture of microelectronic devices.  Since then, the Company has recognizedincome from the sale of its holdings in August Technology Corporation. SeeNote 2 for additional information regarding its investments. During May 2002,ESI Investment participated in a rights offering by PPT Vision, Inc.(PPTV).  As a result of the additionalinvestment in PPTV, the Company has changed its reporting of this investment tothe equity method of accounting. The Company’s investments in marketablesecurities are subject to normal market risks.

 

**Note 2.  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.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  It is the opinion ofmanagement that the unaudited condensed consolidated financial statementsinclude all adjustments, consisting of normal recurring accruals, necessary tofairly state the financial position and results of operations for the threemonth periods ended March 31, 2004 and March 31, 2003. The results ofinterim periods may not be indicative of results to be expected for the year.

 

The Balance Sheet at December 31, 2003has been derived from the Company’s audited financial statements for the yearended December 31, 2003, but does not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements.  For further information, refer to the financial statements andfootnotes thereto included in the Company’s annual report on Form 10-KSB forthe year ended December 31, 2003.

 

**Note 3.  Revenue Recognition**

 

**Revenue recognition of production monitoring equipment:**

 

All production monitoring equipment is shipped without an evaluation oracceptance period. Revenues from the sale of the products and any relatedwarranty costs are recognized at the time of shipment. The Company’sdistributors are not granted any price protection. Sales to all customers,including distributors, are final and no right of return after shipment exists.

 

**Software revenue recognition:**

 

TheCompany recognizes revenue upon shipment of its character recognition software.The product is sold to the end user and risk of loss is transferred, and theCompany has no continuing obligations, once its products are delivered to theshipper. The Company recognizes revenue upon shipment, net of return reservesbased on historical experience. To recognize revenue, it must also be probablethat the Company will collect the accounts receivable from its customers. Insome situations, the Company receives advance payments from its customers.Revenue associated with these advance payments is deferred until the product isshipped.

 

6

----

 

**Note 4.  Stock-Based Compensation**

 

In accordance with Accounting Principles Board (APB) Opinion No. 25 andrelated interpretations, the Company uses the intrinsic value-based method formeasuring stock-based compensation cost which measures compensation cost as theexcess, if any, of quoted market price of the Company’s common stock at thegrant date over the amount the employee must pay for the stock.  The Company’s general policy is to grantstock options at fair value at the date of grant.

 

Had compensation cost been recognized based on the fair values ofoptions at the grant dates consistent with the provisions of Statement ofFinancial Accounting Standards (SFAS) No. 123, “Accounting for Stock BasedCompensation,” the Company’s net income (loss) and basic and diluted net income(loss) per common share would have been changed to the following pro formaamounts:

 
|                                        |   | **Three  Months Ended  March 31,** |        |
|---------------------------------------------|--------|-----------------------------------------|-------------|
|                                        |   | **2004**                                |        | **2003** |   |
| Net income (loss):                          |   |                                    |        |   |   |
| As reported                                 |   | **$**                                   | **103,350** | ** ** | $ | (326,955 | ) |
| Pro forma                                   |   | **$**                                   | **97,571**  | ** ** | $ | (333,937 | ) |
| Basic net income (loss) per common share:   |   |                                    | ** **  |   |   |
| As reported                                 |   | **$**                                   | **0.03**    | ** ** | $ | (0.10 | ) |
| Pro forma                                   |   | **$**                                   | **0.03**    | ** ** | $ | (0.11 | ) |
| Diluted net income (loss) per common share: |   |                                    | ** **  |   |   |
| As reported                                 |   | **$**                                   | **0.03**    | ** ** | $ | (0.10 | ) |
| Pro forma                                   |   | **$**                                   | **0.03**    | ** ** | $ | (0.10 | ) |
| Stock based compensation:                   |   |                                    | ** **  |   |   |
| As reported                                 |   | **0**                                   | ** **  | 0 |   |
| Pro forma                                   |   | **$**                                   | **5,779**   | ** ** | $ | 6,982 |   |

 

In determining the compensation cost of options granted during thethree months ended March 31, 2004 and March 31, 2003, as specified bySFAS No. 123, the fair value of each option grant has been estimated on thedate of grant using the Black-Scholes option pricing model and the weightedaverage assumptions used in these calculations are summarized as follows:

 
|                             |   | **Three  Months Ended  March 31,** |   |
|----------------------------------|--------|-----------------------------------------|--------|
|                             |   | **2004**                                |   | **2003** |   |
|                             |   |                                    |   |   |   |
| Risk-free interest rate          |   | N/A                                     |   | N/A |   |
| Expected life of options granted |   | N/A                                     |   | N/A |   |
| Expected volatility              |   | N/A                                     |   | N/A |   |
| Expected dividend yield          |   | N/A                                     |   | N/A |   |

 

**Note 5.  Net Income(loss) Per Share**

 

The Company’s basic net income (loss) per share amounts have beencomputed by dividing net income (loss) by the weighted average number ofoutstanding common shares. The Company’s diluted net income (loss) per share iscomputed by dividing net income (loss) by the weighted average number of outstandingcommon shares and common share equivalents relating to stock options andwarrants, when dilutive. For the three months ended March 31, 2004,118,980 shares of common stock equivalents were included in the computation ofdiluted net income (loss) per share. For the three months ended March 31, 2004, the company had a loss,resulting in all shares being anti-dilutive.

 

**Note 6. Investments**

 

INV’sinvestments consist of marketable equity securities, primarily common stocks,government debt securities, money market funds and unregistered equitysecurities. The estimated fair value of marketable equity securities is basedon quoted market prices and therefore subject to the inherent risk of marketfluctuations.

 

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

 

7

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Sincethe Company does not buy investments in anticipation of short-term fluctuationsin market prices, investments in marketable equity securities are classified asavailable-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.  Investments in unregistered securities arereported at original cost. Dividends on equity securities held for investmentare recognized in income when declared.

 

Realizedgains and losses, including losses from declines in value of specificsecurities determined by management to be other-than-temporary, are included inincome in the period realized.

 

At March 31, 2004, the Company owned 2,207,036shares of PPTV, which is 18.7% of PPTV’s outstanding common stock.  The fair value of its holdings based on thequoted market price at March 31, 2004 was approximately $3,354,695.  The Company exercised its warrants topurchase 549,084 additional shares of PPTV common stock at a per share price of$0.70 on September 29, 2003.  TheCompany holds no more warrants to purchase additional PPTV common stock.

 

In connection with a 2002 additional investment inPPTV, it was determined, solely for financial accounting purposes, that theCompany could likely exercise significant influence over the operations ofPPTV.  As a result, its ownershipinterest is reported using the equity method of accounting forinvestments.  The investment waspreviously reported as an available-for-sale security, showing the market valueon the balance sheet and recording any unrealized gains and losses in othercomprehensive income.

 

Under the equity method of accounting, theCompany’s proportionate share of PPTV income or loss is included in theCompany’s net income (loss) with a corresponding increase or decrease in thecarrying value of its investment.

 

**Note 7. Comprehensive Income**

 

Comprehensive income includes the Company’s net income (loss) plusother comprehensive income items that are excluded from net income (loss).  The Company’s other income consists ofunrealized gains (losses), net of income taxes and reclassification adjustmentsfor gains and losses included in net income (loss).

 
|                                                                 |   | **Three  Months Ended  March 31,** |           |
|----------------------------------------------------------------------|--------|-----------------------------------------|----------------|
|                                                                 |   | **2004**                                |           | **2003** |   |
| **Net Income (Loss)**                                                |   | **$**                                   | **103,350**    | ** ** | $ | (326,955 | ) |
|                                                                 |   |                                    | ** **     |   |   |
| **Other Comprehensive  Gain (Loss):**                                |   |                                    | ** **     |   |   |
| Change in unrealized value of investments,  net of income taxes      |   | **(1,528,365**                          | **)**          | (688,701 | ) |
|                                                                 |   |                                    | ** **     |   |   |
| **Less:**                                                            |   |                                    | ** **     |   |   |
| Reclassification adjustment for gains  included in net income (loss) |   | **(231,863**                            | **)**          | (8,000 | ) |
|                                                                 |   |                                    | ** **     |   |   |
| Total comprehensive income (loss)                                    |   | **$**                                   | **(1,656,878** | **)** | $ | (1,023,656 | ) |

 

**Note 8. Segment Information**

 

The Company has three reportable operating segments based on the natureof its product lines:  productionmonitoring, character recognition, and investments.  The production monitoring division (or Controls Division)manufactures and markets a complete line of speed monitoring and motor controlsystems for industrial machinery.  TheCharacter recognition division (or ADS) 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 (or INV) holdsinvestments in marketable and non-marketable securities.

 

In evaluating segment performance, management focuses on sales andincome before taxes.  The Company has nointer-segment sales.

 

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The following is financial information relating to the continuingoperating segments:

 
|                                   |   | **Three  Months Ended  March 31,** |          |
|----------------------------------------|--------|-----------------------------------------|---------------|
|                                   |   | **2004**                                |          | **2003** |   |
| **External sales**                     |   |                                    |          |   |   |
| Production monitoring                  |   | **$**                                   | **1,007,083** | ** ** | $ | 844,013 |   |
| Character recognition                  |   | **208,928**                             | ** **    | 142,526 |   |
| Investments                            |   | **0**                                   | ** **    | 0 |   |
| **Total**                              |   | **$**                                   | **1,216,011** | ** ** | $ | 986,539 |   |
|                                   |   |                                    | ** **    |   |   |
| **Income (loss)  before income taxes** |   |                                    | ** **    |   |   |
| Production monitoring                  |   | **$**                                   | **76,415**    | ** ** | $ | (121,939 | ) |
| Character recognition                  |   | **(13,492**                             | **)**         | (28,670 | ) |
| Investments                            |   | **153,679**                             | ** **    | (256,297 | ) |
| **Total**                              |   | **$**                                   | **216,602**   | ** ** | $ | (406,906 | ) |

 

**Item2.  Management’s Discussion and Analysisor Plan of Operation**

 

**RESULTS OF OPERATIONS**

 

***Net Sales***

 

Net sales for the three-month period ended March 31, 2004increased $229,472 or 23.3% when compared to net sales for the same period in2003.

 

The increase from the three-months ending March 31, 2004 whencompared to the same period in 2003, includes an increase in net sales from thecontrols division of $163,070 or 19.3%. The controls division has experienced a sharp increase in sales for thefirst quarter of 2004 due in large part to the recovery in the US economy andincreased capital spending by our installed customer base.   The bulk of our sales volume continues tobe derived from the Speed Monitoring product lines to the grain and feedmarkets, as well as other key industrial markets.

 

The character recognition division had an increase in net sales of$66,402 or 46.6% when comparing the three months ending March 31, 2004 tothe same period in 2003.  The ExpertScansoftware product has become the leading product for the division and iswell-received by customers for its performance and ease of use.

 

***Costof Goods Sold***

 

The Company’s cost of goods sold increased $65,933 or 16.5% for thethree months ended March 31, 2004 when comparing the same period in2003.  This increase is a direct resultof increased sales for both divisions.

 

***GrossProfit***

 

Gross margins for the three-month period ended March 31, 2004 were61.6% versus 59.4% for the same period of the prior fiscal year. In line withthe cost of sales decrease, the increases in margins are due to the Company’sefforts to reduce production costs.

 

***OperatingExpenses***

 

Total operating expenses decreased $19,106 or 2.3% for the three monthsended March 31, 2004 when compared to the same period of the prioryear.  Of this decrease, the controlsdivision contributes $88,290 or 13.6% which is offset by an increase inoperating expenses for both the character recognition division and theinvestment company.  The characterrecognition division’s increase in operating expenses is $43,033 or 24.2%, theinvestment company contributes an increase of $26,151, or 100%.

 

Selling and marketing costs decreased $1,012 or 0.3% for the threemonths ended March 31, 2004 when compared to the same period in 2003.  Of this decrease, the Controls Divisioncontributed $14,523 or 6.2%, which is offset by an increase from ADS of $13,511or 16.7%.  Marketing communicationsdevelopment for product launches, new literature, and ad development are thepredominant expenses in the increase for the character recognitiondivision.  The decrease in selling andmarketing costs for the controls division is due to personnel change over andless travel expense when comparing the three months ended March 31, 2004to the same period for 2003.

 

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General and administrative costs increased $22,709 or 7.6% for thethree months ended March 31, 2004 compared to the same period in 2003. Ofthis increase, the controls division contributed a decrease of $12,878 or 4.7%offset by an increase of $9,435 or 35.5% from the character recognitiondivision.  The decrease in general andadministrative costs from the controls division is due to a few key expenses,mainly general liability insurance, and some personnel costs.  This decrease is offset with the increase incosts for being a publicly held company. The increase in general and administrative costs for the characterrecognition division is solely due to increased costs of being a publicly heldcompany.  The other expenses for generaland administrative in the character recognition division remained level whencomparing the three months ended March 31, 2004 to the same period for theprior year.

 

Research and development costs decreased $40,803 or 19.3% for the threemonths ended March 31, 2004 compared to the same period in 2003.  Of this decrease, the controls divisioncontributed $60,889 or 43.0% which is offset by an increase in the characterrecognition division of $20,087 or 28.7%. The decrease in the controls division is due to reduced outsidedevelopment costs in both contract engineering and prototype development.  The increase in the character recognitiondivision is due to increased personnel.

 

***Non-OperatingIncome (Loss)***

 

Non-operating income increased by $440,862 for the three-month periodending March 31, 2004 compared to the same period for 2003.  Also contributing to the increase innon-operating income is the equity losses of equity method for PPT.  For the three months ending March 31,2003, there was a loss of $195,471, for the same period in 2004, there was aloss of $64,694, a difference of $130,777 or 66.9%.

 

***Income(Loss) Before Income Taxes***

 

Income (loss) before income taxes increased$623,508 to an income of $216,602 for the three-month period endingMarch 31, 2004 compared to the same period in 2003.

 

The controls division had income before income taxes of $76,416 for thethree months ending March 31, 2004 compared to a net loss of $121,019 forthe same period in 2003.  In addition tothe increased sales for the controls division, our efforts to reduce operatingexpenses contribute to the net income before income taxes.

 

ADS had a net loss before income taxes of $13,492 for the three monthsending March 31, 2004 compared to the net loss before income taxes of $28,669for same period in 2003. This increase in net income before income taxes ismainly attributable to reduced research and development costs related tocontract software development.

 

Investment income from investment securities increased $409,975 for anincome before income taxes of $153,678 for the three months endingMarch 31, 2004 compared to the same period in 2003.  This increase is explained under thesection titled non-operating income (loss) in the management’s discussionand analysis section of this 10-QSB filing.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Cash and cash equivalents were $6,895,213 at March 31, 2004 and$6,354,554 at March 31, 2003.  Cashused in operating activities of $203,076 for the three months endedMarch 31, 2004 was primarily a result of our net loss adjusted fornon-cash charges.

 

Cash provided by investing activities was $332,931 for the three-monthperiod ended March 31, 2004 and cash used in investing activities was$1,806 at March 31, 2003.  Proceeds from the sale of investments forthe three months ended March 31, 2004 increased to $448,986 from $12,374when compared to the same period in 2003.

 

Cash used in financing activities was $97,688 and $83,699 for thethree months ended March 31, 2004 and March 31, 2003, respectively.  During the three months ended March 31,2004 and 2003, the Company paid aggregate dividends of $127,378 and $93,971,respectively.

 

Our ongoing cash requirements will be primarily for capitalexpenditures, acquisitions, research and development and working capital. Management believes that cash on hand and any cash provided by operations willbe sufficient to meet our cash requirements through at least the next 12months.

 

The primary investments in the Investment division are 678,715 sharesof August Technology Corporation and 2,207,036 shares of PPT Vision, Inc.both of which are traded on the Nasdaq Stock Exchange.  The PPT Vision investment is accounted forunder the equity method of accounting. These stocks are subject to fluctuations in price and could have anegative effect on the liquidity of the Company.  Investment division holdings are periodically sold as deemed bymanagement.

 

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**FORWARD-LOOKING STATEMENTS**

 

This Form 10-QSB contains forward-looking statements within the meaningof Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934, including statements regarding the Company’sexpectations, beliefs, intentions or strategies regarding the future.  Forward-looking statements include, but arenot limited to, statements regarding the extent and timing of future revenuesand expenses and customer demand, the market value of our investmentsecurities, future financial condition and availability of capital resources,changes in worldwide general economic conditions, cyclical 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.  Anystatement that is not based upon historical facts should be considered aforward-looking statement.

 

All forward-looking statements in this document are based oninformation available to the Company as of the date hereof, and the Companyassumes no obligation to update any such forward-looking statements.  It is important to note that the Company’sactual results could differ materially from those in such forward-lookingstatements.  The forward-lookingstatements of the Company are subject to risks and uncertainties.  Some of the factors that could cause futureresults to differ materially from the Company’s recent results or thoseprojected in the forward-looking statements are detailed in the Company’sAnnual Report on Form 10-KSB for the year ended December 31, 2003, filedwith the Securities and Exchange Commission.

 

**Item3.  Controls and Procedures.**

 

As of the end of the period covered by this report, the Companyconducted an evaluation, under the supervision and with the participation ofthe principal executive officer and principal financial officer, of theCompany’s disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)).  Based on this evaluation, the principalexecutive officer and principal financial officer concluded that the Company’sdisclosure controls and procedures are effective to ensure that informationrequired to be disclosed by the Company in reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in Securities and Exchange Commission rules andforms.

 

There was no change in the Company’s internal control over financialreporting during the Company’s most recently completed fiscal quarter that hasmaterially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

**PARTII – OTHER INFORMATION**

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)          Exhibits

31.1                           Certification of CEO and CFO Pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

32.1                           Certificationof CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)         Reportson Form 8-K – None.

 

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**SIGNATURES**

 

In accordance with the requirements of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| **Electro-Sensors, Inc.** |   |                                                      |
|---------------------------|--------|-----------------------------------------------------------|
|                      |   |                                                      |
| May 14, 2004              |   | /s/  Bradley D. Slye                                      |
|                      |   | Bradley  D. Slye                                          |
|                      |   | Chief  Executive Officer and Principal Accounting Officer |

 

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**EXHIBIT INDEX**

 

**ELECTRO-SENSORS, INC.**

 

**FORM 10-QSB FOR QUARTER ENDED MARCH 31, 2004**

 
| **Exhibit** |   | **Description**                                                                              |
|-------------|--------|----------------------------------------------------------------------------------------------|
|        |   |                                                                                         |
| 31.1        |   | Certification of  CEO and CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|        |   |                                                                                         |
| 32.1        |   | Certification of  CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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