** **

**UNITED STATESSECURITIES 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 June 30, 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 outstandingof the registrant’s Common Stock, $0.10 par value, on August 13, 2004 was3,216,999.

 

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

 

 

----

 

**ELECTRO-SENSORS, INC.**

**Form 10-QSB**

**For the Period Ended June 30, 2004**

 

**TABLE OF CONTENTS**

 

 
| **PART I – FINANCIAL INFORMATION**                                                                                            |   |
|------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                               |   |
| Item 1. Financial Statements                                                                                                       |   |
|                                                                                                                               |   |
| Consolidated Balance Sheets – As of June 30, 2004 and  December 31, 2003                                            |   |
| Consolidated Statements of Operations – For  the Three and Six-Month Periods Ended June 30, 2004 and June 30,  2003 |   |
| Consolidated Statements of Cash Flows – For  the Six-Month Periods Ended June 30, 2004 and June 30, 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 4. Submission of Matters to a Vote of  Security Holders                                                                       |   |
| Item 6. Exhibits and Reports on Form 8-K                                                                                           |   |
|                                                                                                                               |   |
| **SIGNATURES**                                                                                                                     |   |
|                                                                                                                               |   |
| **EXHIBITS**                                                                                                                       |   |

 

2

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**PART I.    FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

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

**CONSOLIDATED BALANCESHEETS**

 
|                                                                                                                        |   | **June 30,  2004** |           | **December 31,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|----------------|-----------------------------|--------|
|                                                                                                                        |   | **(unaudited)**         |           | **(audited)**               |   |
| **ASSETS**                                                                                                                  |   |                    |           |                        |   |
|                                                                                                                        |   |                    |           |                        |   |
| **CURRENT ASSETS**                                                                                                          |   |                    |           |                        |   |
|                                                                                                                        |   |                    |           |                        |   |
| Cash and  cash equivalents                                                                                                  |   | **$**                   | **6,718,330**  |                        | $      | 6,863,046 |   |
| Investments                                                                                                                 |   | **8,796,095**           |           | 13,415,625                  |   |
| Trade  receivables, less allowance for doubtful accounts of $10,111 and $6,000,  respectively                               |   | **489,645**             |           | 515,351                     |   |
| Inventories                                                                                                                 |   | **818,473**             |           | 758,103                     |   |
| Other  current assets                                                                                                       |   | **48,000**              |           | 62,123                      |   |
|                                                                                                                        |   |                    |           |                        |   |
| **Total current  assets**                                                                                                   |   | **16,870,543**          |           | 21,614,248                  |   |
|                                                                                                                        |   |                    |           |                        |   |
| **Property and  equipment, net**                                                                                            |   | **1,445,394**           |           | 1,470,133                   |   |
|                                                                                                                        |   |                    |           |                        |   |
| **Investment in  equity method investee**                                                                                   |   | **186,957**             |           | 152,115                     |   |
|                                                                                                                        |   |                    |           |                        |   |
| **TOTAL ASSETS**                                                                                                            |   | **$**                   | **18,502,894** |                        | $      | 23,236,496 |   |
|                                                                                                                        |   |                    |           |                        |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                              |   |                    |           |                        |   |
|                                                                                                                        |   |                    |           |                        |   |
| **CURRENT LIABILITIES**                                                                                                     |   |                    |           |                        |   |
|                                                                                                                        |   |                    |           |                        |   |
| Accounts  payable                                                                                                           |   | **$**                   | **91,050**     |                        | $      | 106,065 |   |
| Accrued  expenses                                                                                                           |   | **216,121**             |           | 263,143                     |   |
| Deferred  revenue                                                                                                           |   | **58,221**              |           | 48,022                      |   |
| Deferred  income tax                                                                                                        |   | **3,153,306**           |           | 4,795,000                   |   |
| Accrued income tax                                                                                                          |   | **28,983**              |           | 96,196                      |   |
|                                                                                                                        |   |                    |           |                        |   |
| **Total current  liabilities**                                                                                              |   | **3,547,681**           |           | 5,308,426                   |   |
|                                                                                                                        |   |                    |           |                        |   |
| **Deferred income taxes**                                                                                                   |   | **26,000**              |           | 26,000                      |   |
|                                                                                                                        |   |                    |           |                        |   |
| **TOTAL LIABILITIES**                                                                                                       |   | **$**                   | **3,573,681**  |                        | $      | 5,334,426 |   |
|                                                                                                                        |   |                    |           |                        |   |
| **STOCKHOLDERS’ EQUITY**                                                                                               |   |                    |           |                        |   |
|                                                                                                                        |   |                    |           |                        |   |
| Common  stock par value $0.10 per share;authorized 10,000,000 shares; issued 3,216,999 and 3,174,522 shares,  respectively. |   | **321,700**             |           | 317,452                     |   |
| Additional  paid-in capital                                                                                                 |   | **1,099,331**           |           | 999,762                     |   |
| Retained  earnings                                                                                                          |   | **8,195,351**           |           | 8,304,737                   |   |
| Accumulated  other comprehensive income                                                                                     |   | **5,312,831**           |           | 8,280,119                   |   |
|                                                                                                                        |   |                    |           |                        |   |
| **TOTAL STOCKHOLDERS’  EQUITY**                                                                                        |   | **14,929,213**          |           | 17,902,070                  |   |
|                                                                                                                        |   |                    |           |                        |   |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                         |   | **$**                   | **18,502,894** |                        | $      | 23,236,496 |   |

 

See accompanying notes to consolidatedfinancial statements

 

3

----

 

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                  |   | **Three  Months Ended  June 30,** |      | **Six Months  Ended  June 30,** |     |
|-------------------------------------------------------|--------|----------------------------------------|-----------|--------------------------------------|----------|
| **2004**                                              |   | **2003**                               | **2004**  |                                 | **2003** |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Net sales**                                         |   | $                                      | 1,205,554 |                                 | $        | 1,024,247 |   | $ | 2,421,565 |   | $ | 2,010,786 |   |
| **Cost of goods sold**                                |   | 449,164                                |      | 385,742                              |     | 915,618 |   | 786,264 |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Gross profit**                                      |   | 756,390                                |      | 638,505                              |     | 1,505,947 |   | 1,224,522 |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Operating expenses:**                               |   |                                   |      |                                 |     |   |   |   |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| Selling and marketing                                 |   | 312,278                                |      | 295,240                              |     | 627,256 |   | 611,230 |   |
| General and administrative                            |   | 199,546                                |      | 238,686                              |     | 520,100 |   | 536,531 |   |
| Research and development                              |   | 189,738                                |      | 206,026                              |     | 360,533 |   | 417,624 |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Total operating  expenses**                         |   | 701,562                                |      | 739,953                              |     | 1,507,889 |   | 1,565,385 |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Operating income  (loss)**                          |   | 54,828                                 |      | (101,448                             | )        | (1,942 | ) | (340,863 | ) |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Non-operating  income (expense):**                  |   |                                   |      |                                 |     |   |   |   |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| Gain on sale of investment securities                 |   | 102,324                                |      | 17,425                               |     | 426,296 |   | 29,528 |   |
| Interest income                                       |   | 12,974                                 |      | 15,389                               |     | 23,765 |   | 31,513 |   |
| Other income (expense)                                |   | 3,135                                  |      | 4,055                                |     | 6,438 |   | 4,729 |   |
| Equity in losses of equity method investee            |   | (60,464                                | )         | (291,448                             | )        | (125,158 | ) | (486,919 | ) |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Total non-operating  income (expense)**             |   | 57,969                                 |      | (254,579                             | )        | 331,341 |   | (421,149 | ) |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Income (loss)  before income taxes**                |   | 112,797                                |      | (356,027                             | )        | 329,399 |   | (762,012 | ) |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Federal and state  income tax provision (benefit)** |   | 69,713                                 |      | (72,578                              | )        | 182,965 |   | (152,528 | ) |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Net income (loss)**                                 |   | $                                      | 43,084    |                                 | $        | (283,449 | ) | $ | 146,434 |   | $ | (609,484 | ) |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Net income (loss)  per share data:**                |   |                                   |      |                                 |     |   |   |   |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Basic**                                             |   |                                   |      |                                 |     |   |   |   |   |
| Net income (loss) per share                           |   | $                                      | 0.01      |                                 | $        | (0.09 | ) | $ | 0.05 |   | $ | (0.19 | ) |
| Weighted average shares                               |   | 3,205,458                              |      | 3,161,622                            |     | 3,194,043 |   | 3,160,373 |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Diluted**                                           |   |                                   |      |                                 |     |   |   |   |   |
| Net income (loss) per share                           |   | $                                      | 0.01      |                                 | $        | (0.09 | ) | $ | 0.04 |   | $ | (0.19 | ) |
| Weighted average shares                               |   | 3,310,149                              |      | 3,161,622                            |     | 3,305,879 |   | 3,160,373 |   |
|                                                  |   |                                   |      |                                 |     |   |   |   |   |
| **Dividends paid per  share**                         |   | $                                      | 0.04      |                                 | $        | 0.03 |   | $ | 0.08 |   | $ | 0.06 |   |

 

See accompanying notes to consolidated financialstatements

 

4

----

 

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

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                  |   | **Six Months  Ended  June 30,** |           |
|---------------------------------------------------------------------------------------|--------|--------------------------------------|----------------|
| **2004**                                                                              |   | **2003**                             |
| **Cash flows from  operating activities**                                             |   |                                 |           |   |   |
|                                                                                  |   |                                 |           |   |   |
| **Net income (loss)**                                                                 |   | **$**                                | **146,434**    | ** ** | $ | (609,484 | ) |
|                                                                                  |   |                                 | ** **     |   |   |
| Adjustments to reconcile net income (loss)  to net cash used in operating activities: |   |                                 | ** **     |   |   |
|                                                                                  |   |                                 | ** **     |   |   |
| Depreciation                                                                          |   | **44,622**                           | ** **     | 53,814 |   |
| Realized (gain)/loss on sale of investments                                           |   | **(426,296**                         | **)**          | (29,528 | ) |
| Equity in loss of equity method investee                                              |   | **125,158**                          | ** **     | 486,919 |   |
| (Increase)/decrease in:                                                               |   |                                 | ** **     |   |   |
| Trade receivables                                                                     |   | **25,706**                           | ** **     | 75,616 |   |
| Inventory                                                                             |   | **(60,370**                          | **)**          | (15,710 | ) |
| Other current assets                                                                  |   | **14,123**                           | ** **     | (18,882 | ) |
| Prepaid income taxes                                                                  |   | **0**                                | ** **     | (135,378 | ) |
| Increase/(decrease) in:                                                               |   |                                 | ** **     |   |   |
| Accounts payable                                                                      |   | **(15,015**                          | **)**          | (72,350 | ) |
| Accrued expenses                                                                      |   | **(47,022**                          | **)**          | (108,592 | ) |
| Deferred revenue                                                                      |   | **10,199**                           | ** **     | (6,746 | ) |
| Accrued income taxes                                                                  |   | **(67,213**                          | **)**          | 0 |   |
|                                                                                  |   |                                 | ** **     |   |   |
| Net cash provided by/(used) in operating  activities                                  |   | **(249,674**                         | **)**          | (380,321 | ) |
|                                                                                  |   |                                 | ** **     |   |   |
| Cash flows from investing activities:                                                 |   |                                 | ** **     |   |   |
|                                                                                  |   |                                 | ** **     |   |   |
| Proceeds from sale of investments                                                     |   | **689,986**                          | ** **     | 30,935 |   |
| Purchase of equity securities                                                         |   | **(253,142**                         | **)**          | 0 |   |
| Payment for purchase of investments                                                   |   | **(160,000**                         | **)**          | 0 |   |
| Purchase of property and equipment                                                    |   | **(19,883**                          | **)**          | (17,789 | ) |
|                                                                                  |   |                                 |           |   |   |
| Net cash provided by/(used) in investing  activities                                  |   | **256,961**                          |           | 13,146 |   |
|                                                                                  |   |                                 |           |   |   |
| Cash flows from financing activities:                                                 |   |                                 |           |   |   |
|                                                                                  |   |                                 |           |   |   |
| Proceeds from issuance of stock                                                       |   | **103,817**                          |           | 14,270 |   |
| Dividends paid                                                                        |   | **(255,820**                         | **)**          | (189,719 | ) |
|                                                                                  |   |                                 |           |   |   |
| Net cash provided by/(used) in financing  activities                                  |   | **(152,003**                         | **)**          | (175,449 | ) |
|                                                                                  |   |                                 |           |   |   |
| Net increase/(decrease) in cash & cash  equivalents                               |   | **(144,716**                         | **)**          | (542,624 | ) |
|                                                                                  |   |                                 |           |   |   |
| Cash & cash equivalents, beginning                                                |   | **6,863,046**                        |           | 6,723,160 |   |
| Cash & cash equivalents, ending                                                   |   | **6,718,330**                        |           | 6,180,536 |   |
|                                                                                  |   |                                 |           |   |   |
| **Supplemental  schedule of non-cash investing and financing activities**        |   |                                 |           |   |   |
| Net change in unrealized gain/ (loss) on  investments                                 |   | **$**                                | **(4,608,982** | **)** | $ | 964,152 |   |

 

See accompanying notes to consolidatedfinancial statements

 

5

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

##### **NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1.  Nature of Business**

 

Theaccompanying consolidated financial statements include the accounts ofElectro-Sensors, Inc. and its wholly owned subsidiary ESI 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 utilizesleading-edge technology to continuously improve its products and make themeasier to use. The Controls Division’s goal is to manufacture theindustry-preferred product for every market served. These products are soldthrough an internal sales staff, manufacturers representatives, anddistributors to a wide variety of manufacturers, OEM’s and processors tomonitor process machinery operations. The Controls Division markets itsproducts to a number of different industries located throughout the UnitedStates 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 equity securities in August TechnologyCorporation and PPTV Vision Inc. (PPTV), and membership interests in a la mode,LLC, among other investments.  Shares ofAugust Technology common stock have experienced significant appreciation invalue since its initial public offering in 2000.  ESI Investment acquired shares of PPTV in May 2002 andSeptember 2003.  In May 2002, theCompany adopted the equity method of accounting for its investments inPPTV.  In April 2004, ESIInvestment purchased 20% of a la mode, LLC’s membership interests for$160,000.  The Company has adopted theequity method of accounting to report this investment.  The Company’s investments in securities aresubject to market and other investment risks. See Note 6 for additional information regarding INV’s investments.

 

**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 of management that theunaudited condensed consolidated financial statements include all adjustments,consisting of normal recurring accruals, necessary to fairly state thefinancial position and results of operations for the three and six-monthperiods ended June 30, 2004 and June 30, 2003. The results of interim periodsmay 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.

 

6

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**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.

 

**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  June 30,** |     | **Six-Months  Ended  June 30,** |     |
|---------------------------------------------|--------|----------------------------------------|----------|--------------------------------------|----------|
| **2004**                                    |   | **2003**                               | **2004** |                                 | **2003** |
| Net income (loss):                          |   |                                   |     |                                 |     |   |   |   |   |
| As reported                                 |   | $                                      | 43,084   |                                 | $        | (282,529 | ) | $ | 146,434 |   | $ | (609,484 | ) |
| Pro forma                                   |   | $                                      | 37,305   |                                 | $        | (288,032 | ) | $ | 134,875 |   | $ | (620,490 | ) |
| Basic net income (loss) per common share:   |   |                                   |     |                                 |     |   |   |   |   |
| As reported                                 |   | 0.01                                   |     | (0.09                                | )        | 0.05 |   | (0.19 | ) |
| Pro forma                                   |   | 0.01                                   |     | (0.09                                | )        | 0.04 |   | (0.19 | ) |
| Diluted net income (loss) per common share: |   |                                   |     |                                 |     |   |   |   |   |
| As reported                                 |   | 0.01                                   |     | (0.09                                | )        | 0.04 |   | (0.19 | ) |
| Pro forma                                   |   | 0.01                                   |     | (0.09                                | )        | 0.04 |   | (0.19 | ) |
| Stock based compensation:                   |   |                                   |     |                                 |     |   |   |   |   |
| As reported                                 |   | 0                                      |     | 0                                    |     | 0 |   | 0 |   |
| Pro forma                                   |   | $                                      | 5,779    |                                 | $        | 5,503 |   | $ | 11,559 |   | $ | 11,006 |   |

 

The company did not grant any options during the three-months endedJune 30, 2004.

 

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

 

The Company’s basic net income (loss) per shareamounts have been computed by dividing net income (loss) by the weightedaverage number of outstanding common shares. The Company’s diluted net income(loss) per share is computed by dividing net income (loss) by the weightedaverage number of outstanding common shares and common share equivalents relatingto stock options and warrants, when dilutive. For the three months endedJune 30, 2004, 104,691 shares of common stock equivalents were included inthe computation of diluted net income (loss) per share.  For the six months ended June 30, 2004,111,836 shares of common stock equivalents were included in the computation ofdiluted net income (loss) per share. For the three and six months ended June 30, 2003, the shares wereanti-dilutive.

 

7

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#### **Note 6. Investments**

#### ** **

INV’sinvestments consist of equity securities, primarily common stocks, governmentdebt securities and money market funds. The estimated fair value of publiclytraded equity securities (other than those accounted for based upon the equitymethod of accounting) is based on quoted market prices, and therefore subjectto the inherent risk of market fluctuations. Shares of common stock for which there is no readily determinable value(i.e., no quoted market price) are accounted for on an historical cost method(unless accounted for based upon the equity method of accounting).  Managementdetermines the appropriate classification of securities at the date individualinvestments are acquired, and evaluates the appropriateness of suchclassification at each balance sheet date.

 

Sincethe Company generally does not buy investments in anticipation of short-termfluctuations in market prices, investments in equity securities are classifiedas available-for-sale (unless accounted for on the equity method ofaccounting).  Available-for-salesecurities with readily determinable values 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.

 

Realizedgains and losses on securities, including losses from declines in value ofspecific securities determined by management to be other-than-temporary (unlessaccounted for on the equity method of accounting), are included in income inthe period realized.

 

At June 30, 2004, the Company owned 671,215shares of August Technology, the fair value of its holdings based on thequoted market price at June 30, 2004 was approximately $8,417,036.  Shares of August Technology commonstock are eligible for trading on the Nasdaq National Market.  The Company’s investment inAugust Technology are classified as available-for-sale securities.

 

At June 30, 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 June 30, 2004 was approximately $2,946,393.  Shares of PPTV common stock are eligible fortrading on the Nasdaq SmallCap Market. The Company exercised warrants to purchase 549,084 additional shares ofPPTV common stock at a per share price of $0.70 in September 2003.  The Company holds no more warrants topurchase additional PPTV common stock. In connection with a 2002 investment in PPTV, the Company determined,solely for financial accounting purposes, that it could likely exercisesignificant influence over the operations of PPTV.  As a result, the Company’s ownership interest is reported usingthe equity method of accounting.  Theinvestment was previously reported as an available-for-sale security, showingthe market value on the balance sheet and recording any unrealized gains andlosses in other comprehensive income.

InApril 2004, ESI Investment purchased 20% of a la mode, LLC’s outstandingmembership interests for $160,000. *** ***TheCompany has adopted the equity method of accounting for this investment.

 

Under the equity method of accounting, theCompany’s proportionate share of PPTV and a la mode income or loss is includedin the Company’s net income (loss) with a corresponding increase or decrease inthe carrying value of its investment.

 

**Note 7. Comprehensive Income**

 

Comprehensive income includesthe Company’s net income (loss) plus other comprehensive income items that areexcluded from net income (loss).  TheCompany’s other income consists of unrealized gains (losses), net of incometaxes and reclassification adjustments for gains and losses included in netincome (loss).

 
|                                                          |   | **Three  Months Ended  June 30,** |       | **Six Months  Ended  June 30,** |     |
|---------------------------------------------------------------|--------|----------------------------------------|------------|--------------------------------------|----------|
| **2004**                                                      |   | **2003**                               | **2004**   |                                 | **2003** |
| **Net Income (Loss)**                                         |   | $                                      | 43,084     |                                 | $        | (283,449 | ) | $ | 146,434 |   | $ | (609,484 | ) |
|                                                          |   |                                   |       |                                 |     |   |   |   |   |
| **Other Comprehensive  Gain (Loss):**                         |   |                                   |       |                                 |     |   |   |   |   |
| Change in unrealized value investments, net                   |   | (1,141,219                             | )          | 1,289,165                            |     | (2,669,584 | ) | 600,464 |   |
|                                                          |   |                                   |       |                                 |     |   |   |   |   |
| **Less:**                                                     |   |                                   |       |                                 |     |   |   |   |   |
| Reclassification adjustment for gains included  in net income |   | (65,841                                | )          | (10,900                              | )        | (297,704 | ) | (18,900 | ) |
|                                                          |   |                                   |       |                                 |     |   |   |   |   |
| Total comprehensive income (loss)                             |   | $                                      | (1,163,976 | )                                    | 994,816  |   | (2,820,854 | ) | (27,920 | ) |
|                                                               |        |                                        |            |                                      |          |  |  |  |  |  |  |  |  |

 

 

8

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**Note 8. Segment Information**

 

The Company has three reportableoperating segments based on the nature of its product lines:  production monitoring, characterrecognition, and investments.  Theproduction monitoring division (or Controls Division) manufactures and marketsa complete line of speed monitoring and motor control systems for industrialmachinery.  The character recognitiondivision (or ADS) designs and markets a desktop software-based system thatreads hand-printed characters, checkmarks, and bar code information fromscanned or faxed forms.  Sales of thissystem include software and can include hardware.  The investments division (or INV) holds investments in freelytradeable and restricted securities.

 

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

 

The following is financialinformation relating to the continuing operating segments:

 
|                                                     |   | **Three  Months Ended  June 30,** |          | **Six Months  Ended  June 30,** |     |
|----------------------------------------------------------|--------|----------------------------------------|---------------|--------------------------------------|----------|
| **2004**                                                 |   | **2003**                               | **2004**      |                                 | **2003** |
| **External sales**                                       |   |                                   |          |                                 |     |   |   |   |   |
| Production monitoring                                    |   | $                                      | 1,052,631     |                                 | $        | 878,317 |   | $ | 2,059,715 |   | $ | 1,722,330 |   |
| Character recognition                                    |   | 152,923                                |          | 145,930                              |     | 361,850 |   | 288,456 |   |
| Investments                                              |   | 0                                      |          | 0                                    |     | 0 |   | 0 |   |
| **Total**                                                |   | **$**                                  | **1,205,554** | ** **                           | **$**    | **1,024,247** | ** ** | **$** | **2,421,565** | ** ** | **$** | **2,010,786** | ** ** |
|                                                     |   |                                   |          |                                 |     |   |   |   |   |
| **Net income before  taxes and discontinued operations** |   |                                   |          |                                 |     |   |   |   |   |
| Production monitoring                                    |   | $                                      | 199,985       |                                 | $        | 14,189 |   | $ | 276,402 |   | $ | (106,829 | ) |
| Character recognition                                    |   | (29,170                                | )             | (14,162                              | )        | (42,663 | ) | (42,832 | ) |
| Investments                                              |   | (58,018                                | )             | (356,054                             | )        | 95,660 |   | (612,351 | ) |
| **Total**                                                |   | **$**                                  | **112,797**   | ** **                           | **$**    | **(356,027** | **)** | **$** | **329,399** | ** ** | **$** | **(762,012** | **)** |

 

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

 

**RESULTS OF OPERATIONS**

 

***NetSales***

 

Net sales for the three-monthperiod ended June 30, 2004 increased $181,307 or 17.7% when compared tonet sales for the same period in 2003. For the six-month period ended June 30, 2004, net sales increased$410,779 or 20.4% when compared to the same period in 2003.

 

The increase from thethree-months ended June 30, 2004 from the same period in 2003, includes anincrease in net sales from the Controls Division of $174,314 or 19.8%.  For the six-months ended June 30, 2004compared to the same period in 2003, the Controls Division contributed anincrease in net sales of $337,385 or 19.6%. The Controls Division has experienced an increase in sales for the firstand second quarter of 2004 due in 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.

 

ADS had an increase in net salesof $6,993 or 4.8% from the three months ended June 30, 2004 to the sameperiod in 2003.  For the six-monthsended June 30, 2004 compared to the same period in 2003, ADS contributedan increase in net sales of $73,394 or 25.4%. The ExpertScan software product has become the leading product for thedivision and is well-received by customers for its performance and ease of use.

 

***Costof Goods Sold***

 

The Company’s cost of goods soldincreased $63,422 or 16.4% for the three months ended June 30, 2004 fromthe same period in 2003.  For the sixmonths ended June 30, 2004, the cost of goods sold increased by $129,354or 16.5%.  These increases are a directresult of increased sales for both divisions.

 

***GrossProfit***

 

Gross margins for thethree-month period ended June 30, 2004 were 62.7% versus 62.3% for thesame period in 2003.  For the six monthsended June 30, 2004 gross margins were 62.2% versus 60.9% for the sameperiod in 2003.  The increases inmargins are due primarily to the Company’s continuing efforts to effectivelymanage and reduce production costs.

 

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***OperatingExpenses***

 

Total operating expensesdecreased $38,391 or 5.2% for the three months ended June 30, 2004 whencompared to the same period of the prior year. Of this decrease, the Controls Division contributed $69,526 or 12.5%, whichis offset by an increase in operating expenses for both ADS and INV.  ADS’ increase in operating expenses was$8,563 or 4.6%, and INV contributed an increase of $22,572 or 100%.

 

For the six months endedJune 30, 2004 operating expenses decreased $57,496 or 3.7% from the sameperiod for 2003.  Of this decrease, theControls Division contributed $157,953 or 13.1% which was offset by an increasein operating expenses for both ADS and INV. ADS’ increase in operating expenses was $51,733 or 14.3%, INV contributedan increase of $48,723, or 100%.

 

Selling and marketing costsincreased $17,038 or 5.8% for the three months ended June 30, 2004 whencompared to the same period in 2003. For the six months ended June 30, 2004, selling and marketing costsincreased $16,026 or 2.6%.  Of theincrease for the three months ended June 30, 2004, the Controls Divisioncontributed $19,493 or 9.3%, which was offset by a decrease from ADS of $2,455or 2.9%.  Of the increase for the sixmonths ended June 30, 2004, the Controls Division contributed $4,970 or1.1%, ADS contributed an increase of $11,056 or 6.6%.  Marketing communications development for product launches, newliterature, and ad development are the predominant expenses in the increase forboth ADS and the Controls Division.

 

General and administrative costsdecreased $39,140 or 16.4% for the three months ended June 30, 2004compared to the same period in 2003. For the six months ended June 30,2004, general and administrative costs decreased $16,431 or 3.1%.  Of this decrease for the three months endedJune 30, 2004, the Controls Division contributed a decrease of $55,960 or25.6%, and ADS contributed a decrease of $5,752 or 28.7%, which were offset byan increase of $22,572 or 100% from INV. Of the decrease for the six months ended June 30, 2004, the ControlsDivision contributed a decrease of $68,974 or 14.1%, offset by increases inboth ADS and INV.  ADS increase for thesix months ended June 30, 2004 was $3,820 or 8.2%, and INV contributed anincrease of $48,723 or 100%.  Theoverall decrease in general and administrative costs from the Controls Divisionwas due to a few key expenses, mainly general liability insurance, and somepersonnel costs.  This decrease wasoffset by increasing costs of being a publicly held company.

 

Research and development costs decreased$16,288 or 7.9% for the three months ended June 30, 2004 compared to thesame period in 2003.  For the six monthsended June 30, 2004 compared to the same period in 2003, research anddevelopment costs decreased $57,091 or 13.7%. Of the decrease for the three months ended June 30, 2004, theControls Division contributed $33,059 or 26.1%, which was offset by an increasein ADS of $16,771 or 21.1%.  For the sixmonths ended June 30, 2004, compared to the same period in 2003, theControls Division contributed a decrease of $93,948 or 35.0% offset by inincrease from ADS of $36,857 or 24.7%. The decrease in the Controls Division was due to reduced outsidedevelopment costs in both contract engineering and prototype development.  The increase in ADS was due to increasedpersonnel.

 

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

 

Non-operating income increasedby $312,548 for the three-month period ended June 30, 2004 compared to thesame period for 2003.  For the sixmonths ended June 30, 2004, compared to the same period in 2003,non-operating income increased $752,490.

 

Gain on the sale of investmentsecurities increased $84,899 for the three month period ended June 30,2004, compared to the same period in 2003. For the six month period ended June 30, 2004, gain on sale ofinvestment securities increased $396,768 compared to the same period in 2003.

 

Interest income decreased $2,415or 15.7% when comparing the three months ended June 30, 2004 to the sameperiod in 2003.  For the six monthsended June 30, 2004, the decrease was 7,748 or 24.6% when compared to thesame period in 2003.  This decrease wasdue to the lowered interest rates on treasury bills.

 

The Company made an investmentof $160,000 in a la mode, LLC in April 2004. The equity method ofaccounting is used to account for this investment.  The Company’s equity in a la mode’s losses was $60,464 for thethree months ended June 30, 2004 compared to $291,448 for the same periodin 2003.  For the six months endedJune 30, 2004, the Company’s equity in a la mode’s losses was $125,158compared to $486,919 for the same period in 2003.

 

10

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

 

Income before income taxesincreased $468,824, to $112,797 for the three-month period ended June 30,2004 compared to the same period in 2003. For the six month period ended June 30, 2004, income before incometaxes was $329,399, an increase of $1,091,411 when compared to the same periodfor 2003.

 

The Controls Division had incomebefore income taxes of $199,984 for the three months ended June 30, 2004compared to $14,189 for the same period in 2003, an increase of $185,795.  For the six months ended June 30, 2004,the Controls Division had income before taxes of $276,401 compared to a loss of$106,829 for the same period in 2003. In addition to the increased sales for the Controls Division, ourefforts to reduce operating expenses contributed to the increase in net incomebefore income taxes.

 

ADS had a net loss before incometaxes of $29,170 for the three months ended June 30, 2004 compared to thenet loss before income taxes of $14,162 for same period in 2003. For the sixmonths ended June 30, 2004, the Controls Division had a loss of $42,663compared to a loss of $42,832 for the same period in 2003, or an increase of$169.

 

Investment income frominvestment securities increased $298,036 to a loss before income taxes of$58,018 for the three months ended June 30, 2004 compared to the sameperiod in 2003.  For the six monthsended June 30, 2004, investment income increased $708,011 to net incomebefore income tax of $95,660.  Theseincreases are explained under the section titled non-operating income(loss) in the management’s discussion and analysis section of this 10-QSBfiling.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Cash and cash equivalents were $6,718,330 atJune 30, 2004 and $6,180,536 at June 30, 2003.  Cash used in operating activities of$409,674 for the six months ended June 30, 2004 was primarily a resultof our net operating loss adjusted for non-cash charges.

 

Cash provided by investing activities was $416,962for the six-month period ended June 30, 2004 and $13,146 for the sameperiod in 2003.  Proceeds from the sale of investments for the six monthsended June 30, 2004 increased to $689,987 from $30,935 when compared tothe same period in 2003.

 

Cash used in financing activities was$152,003 and $175,449 for the six months ended June 30, 2004 andJune 30, 2003, respectively. During the six months ended June 30, 2004 and 2003, the Companypaid aggregate dividends of $255,820 and $189,719, respectively.

 

Our ongoing cash requirements will beprimarily for capital expenditures, acquisitions, research and development andworking capital.  Management believes that cash on hand and any cashprovided by operations will be sufficient to meet our cash requirements throughat least the next 12 months.

 

INV’s primary investments are 671,215 sharesof August Technology Corporation and 2,207,036 shares of PPT Vision, Inc.both of which are traded on the Nasdaq Stock Exchange.  The investment in PPTV 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.

 

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**FORWARD-LOOKING STATEMENTS**

 

This Form 10-QSB containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934, including statements regarding the Company’s expectations, beliefs,intentions or strategies regarding the future. Forward-looking statements include, but are not limited to, statementsregarding the extent and timing of future revenues and expenses and customerdemand, the market value of our investment securities, future financialcondition and availability of capital resources, changes in worldwide generaleconomic conditions, cyclical capital spending by customers, the Company’sability to keep pace with technological developments and evolving industrystandards, worldwide competition, and the Company’s ability to protect itsexisting intellectual property from challenges from third parties and otherfactors.  Any statement that is notbased upon historical facts should be considered a forward-looking statement.

 

All forward-looking statementsin this document are based on information available to the Company as of thedate hereof, and the Company assumes no obligation to update any suchforward-looking statements.  It is importantto note that the Company’s actual results could differ materially from those insuch forward-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 31,2003, filed with the Securities and Exchange Commission.

 

**Item 3****.  Controls andProcedures.**

 

As of the end of the period covered by thisreport, the Company conducted an evaluation, under the supervision and with theparticipation of the principal executive officer and principal financialofficer, of the Company’s disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the“Exchange Act”)).  Based on thisevaluation, the principal executive officer and principal financial officerconcluded that the Company’s disclosure controls and procedures are effectiveto ensure that information required to be disclosed by the Company in reportsthat it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in Securities andExchange Commission rules and forms.

 

There was no change in the Company’s internalcontrol over financial reporting during the Company’s most recently completedfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

**PART II – OTHER INFORMATION**

 

**Item 4.****           Submission of Mattersto a Vote of Security Holders**

 

The Company held its Annual Meeting of Shareholders on April 14,2004.

 

At the meeting the following matters were voted upon, and the number ofvotes cast for or against, as well as the number of abstentions and brokernonvotes, as to each such matter, along with a separate tabulation with respectto each nominee for office, is set forth below:

 

1.                                       Set the numberof directors at five for the ensuing year.

 
| **For**   |   | **Against** |   | **Abstention** |   |
|-----------|--------|-------------|--------|----------------|--------|
| 2,845,663 |   | 21,446      |   | 1,600          |   |

 

2.                                       Election ofdirectors to serve for the ensuing year and until their successors are dulyelected and qualified.

 
|               |   | **For**   |   | **Against** |   | **Withheld** |   |
|--------------------|--------|-----------|--------|-------------|--------|--------------|--------|
| Bradley D. Slye    |   | 2,845,486 |   | 23,223      |   | 0            |   |
| Peter R. Peterson  |   | 2,844,486 |   | 24,223      |   | 0            |   |
| John S. Strom      |   | 2,845,486 |   | 23,223      |   | 0            |   |
| Joseph A. Marino   |   | 2,845,486 |   | 23,223      |   | 0            |   |
| Geoffrey W. Miller |   | 2,845,486 |   | 23,223      |   | 0            |   |

 

3.                                       Ratificationof the appointment of Virchow, Krause & Company, LLP as the Company’sindependent accountants for the current fiscal year ending December 31,2004.

 
| **For**   |   | **Against** |   | **Abstention** |   |
|-----------|--------|-------------|--------|----------------|--------|
| 2,864,834 |   |  1,300 |   | 2,575          |   |

 

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**Item 6****.  Exhibits and Reportson Form 8-K**

 

(a)                                  Exhibits - See Exhibit Index followingsignature page.

 

(b)                                 Reports on Form 8-K – None.

 

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**SIGNATURES**

 

In accordance with therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
| **Electro-Sensors, Inc.** |                                                      |
|---------------------------|-----------------------------------------------------------|
|                      |                                                      |
| August 13, 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 JUNE 30, 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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