** **

**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, 2003**                                                                                                                     |
|                                                                                                                                                                      |
| **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 the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes ý  No o

 

The number of shares outstandingof the registrant’s Common Stock, $0.10 par value, on August 14, 2003 was3,165,272.

 

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

 

 

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**ELECTRO-SENSORS, INC.**

**Form 10-QSB**

**For the Period Ended June 30, 2003**

** **

**TABLE OF CONTENTS**

 

 
| **PART I – FINANCIAL INFORMATION**                                 |
|-------------------------------------------------------------------------|
|                                                                    |
| Item 1. Financial Statements                                            |
| Item 2. Management’s Discussion and  Analysis or Plan of Operation |
| Item 3. Controls and Procedures                                         |
|                                                                    |
| **PART II – OTHER INFORMATION**                                    |
|                                                                    |
| Item 4. Submission of Matters to a Vote of  Security Holders            |
| Item 6. Exhibits and Reports on Form 8-K                                |
|                                                                    |
| **SIGNATURES**                                                          |
|                                                                    |
| **CERTIFICATIONS**                                                      |

 

2

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**PART I****– FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| Consolidated Balance Sheets – As of June 30, 2003 and  December 31, 2002                                            |
|------------------------------------------------------------------------------------------------------------------------------------|
| Consolidated Statements of Operations – For  the Three and Six-Month Periods Ended June 30, 2003 and June 30,  2002 |
| Consolidated Statements of Cash Flows – For  the Six-Month Periods Ended June 30, 2003 and June 30, 2002            |
| Notes to Consolidated Financial Statements                                                                                         |

 

3

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

**CONSOLIDATED BALANCESHEETS**

 
|                                                                                                                        |   | **June 30,  2003** |           | **December 31,  2002** |       |
|-----------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|----------------|-----------------------------|------------|
|                                                                                                                        |   | **(unaudited)**         |           | **(audited****)**           |       |
| **ASSETS**                                                                                                                  |   |                    |           |                        |       |
| **CURRENT ASSETS**                                                                                                          |   |                    |           |                        |       |
|                                                                                                                        |   |                    |           |                        |       |
| Cash and  cash equivalents                                                                                                  |   | $                       | 6,180,536      |                        | $          | 6,723,160 |   |
| Investments                                                                                                                 |   | 5,138,699               |           | 4,202,210                   |       |
| Trade  receivables                                                                                                          |   | 474,636                 |           | 550,252                     |       |
| Less  allowance for doubtful accounts of $18,739 and $7,000, respectively                                                   |   |                    |           |                        |       |
| Inventories                                                                                                                 |   | 753,722                 |           | 738,012                     |       |
| Prepaid  income taxes                                                                                                       |   | 478,113                 |           | 342,735                     |       |
| Other  current assets                                                                                                       |   | 88,630                  |           | 69,748                      |       |
| **Total current assets**                                                                                                    |   | 13,114,336              |           | 12,626,117                  |       |
| **Property and equipment, net**                                                                                             |   | 1,508,121               |           | 1,544,146                   |       |
| **Investment in equity method investee**                                                                                    |   | 15,262                  |           | 502,181                     |       |
| **TOTAL ASSETS**                                                                                                            |   | **$**                   | **14,637,719** | ** **                  | **$**      | **14,672,444** | ** ** |
|                                                                                                                        |   |                    | ** **     |                        | ** ** |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                              |   |                    |           |                        |       |
| **CURRENT LIABILITIES**                                                                                                     |   |                    |           |                        |       |
| Accounts  payable                                                                                                           |   | $                       | 213,189        |                        | $          | 285,539 |   |
| Accrued  expenses                                                                                                           |   | 103,320                 |           | 211,912                     |       |
| Accrued  income taxes                                                                                                       |   | 0                       |           | 0                           |       |
| Deferred  revenue                                                                                                           |   | 43,652                  |           | 50,398                      |       |
| Deferred  income taxes                                                                                                      |   | 1,775,932               |           | 1,424,600                   |       |
| **Total current  liabilities**                                                                                              |   | 2,136,093               |           | 1,972,449                   |       |
| **Deferred income taxes**                                                                                                   |   | 35,000                  |           | 30,000                      |       |
| **Total liabilities**                                                                                                       |   | 2,171,093               |           | 2,002,449                   |       |
|                                                                                                                        |   |                    |           |                        |       |
| **STOCKHOLDERS’ EQUITY**                                                                                               |   |                    | ** **     |                        | ** ** |
| Common  stock par value $0.10 per share;authorized 10,000,000 shares; issued 3,163,238 and 3,155,260 shares,  respectively. |   | 316,324                 |           | 315,526                     |       |
| Additional  paid-in capital                                                                                                 |   | 979,919                 |           | 966,447                     |       |
| Retained  earnings                                                                                                          |   | 8,061,273               |           | 8,860,476                   |       |
| Accumulated  other comprehensive income                                                                                     |   | 3,109,110               |           | 2,527,546                   |       |
| **Total stockholders’  equity**                                                                                        |   | 12,466,626              |           | 12,669,995                  |       |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                         |   | **$**                   | **14,637,719** | ** **                  | **$**      | **14,672,444** | ** ** |

 

See accompanying notes to consolidatedfinancial statements

 

4

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                              |   | **Three Months Ended  June 30,** |      | **Six Months Ended  June 30,** |   |
|-------------------------------------------------------------------|--------|---------------------------------------|-----------|-------------------------------------|--------|
|                                                              |   | **2003**                              |      | **2002**                            |   | **2003** |   | **2002** |   |
|                                                              |   |                                  |      |                                |   |   |   |   |   |
| **Net sales**                                                     |   | $                                     | 1,024,247 |                                | $      | 1,124,439 |   | $ | 2,010,786 |   | $ | 2,263,095 |   |
| **Cost of goods sold**                                            |   | 385,742                               |      | 477,851                             |   | 786,264 |   | 971,078 |   |
| **Gross profit**                                                  |   | 638,505                               |      | 646,588                             |   | 1,224,522 |   | 1,292,017 |   |
|                                                              |   |                                  |      |                                |   |   |   |   |   |
| **Operating expenses:**                                           |   |                                  |      |                                |   |   |   |   |   |
| Selling and marketing                                             |   | 295,240                               |      | 256,758                             |   | 611,230 |   | 537,892 |   |
| General and administrative                                        |   | 238,686                               |      | 231,473                             |   | 536,531 |   | 442,823 |   |
| Research and development                                          |   | 206,026                               |      | 321,039                             |   | 417,624 |   | 546,180 |   |
| **Total operating  expenses**                                     |   | 739,953                               |      | 809,270                             |   | 1,565,385 |   | 1,526,895 |   |
| **Operating loss**                                                |   | (101,448                              | )         | (162,682                            | )      | (340,863 | ) | (234,878 | ) |
|                                                              |   |                                  |      |                                |   |   |   |   |   |
| **Non-operating  income (expense):**                              |   |                                  |      |                                |   |   |   |   |   |
| Gain on sale of investment securities                             |   | 17,425                                |      | 1,464,799                           |   | 29,528 |   | 2,097,573 |   |
| Interest income                                                   |   | 15,389                                |      | 27,023                              |   | 31,513 |   | 169,960 |   |
| Other income (expense)                                            |   | 4,055                                 |      | (3,419                              | )      | 4,729 |   | (26,162 | ) |
| Equity in losses of equity method investee                        |   | (291,448                              | )         | 0                                   |   | (486,919 | ) | 0 |   |
| **Total non-operating  income (expense)**                         |   | (254,579                              | )         | 1,488,403                           |   | (421,149 | ) | 2,241,371 |   |
|                                                              |   |                                  |      |                                |   |   |   |   |   |
| **Income (loss) from  continuing operations before income taxes** |   | (356,027                              | )         | 1,325,721                           |   | (762,012 | ) | 2,006,493 |   |
|                                                              |   |                                  |      |                                |   |   |   |   |   |
| **Federal and state  income tax provision (benefit)**             |   | (72,578                               | )         | 486,466                             |   | (152,528 | ) | 751,325 |   |
|                                                              |   |                                  |      |                                |   |   |   |   |   |
| **Income (loss) from  continuing operations**                     |   | (283,449                              | )         | 839,255                             |   | (609,484 | ) | 1,255,168 |   |
|                                                              |   |                                  |      |                                |   |   |   |   |   |
| **Per share data:**                                               |   |                                  |      |                                |   |   |   |   |   |
| Weighted  average basic shares outstanding                        |   | 3,161,622                             |      | 3,146,111                           |   | 3,160,373 |   | 3,134,048 |   |
| Basic net  income (loss) per share                                |   | (0.09                                 | )         | 0.27                                |   | (0.19 | ) | 0.40 |   |
| Weighted  average diluted shares outstanding                      |   | 3,161,622                             |      | 3,282,871                           |   | 3,160,373 |   | 3,391,365 |   |
| Diluted net income (loss) per share                               |   | (0.09                                 | )         | 0.26                                |   | (0.19 | ) | 0.37 |   |
|                                                                   |        |                                       |           |                                     |        |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidatedfinancial statements

 

5

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

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
|                                                                                     |   | **Six Months Ended  June 30,** |       |
|------------------------------------------------------------------------------------------|--------|-------------------------------------|------------|
|                                                                                     |   | **2003**                            |       | **2002** |   |
| **Reconciliation of  net income (loss) to net cash****used in o****perating activities** |   |                                |       |   |   |
|                                                                                     |   |                                |       |   |   |
| **Net income (loss)**                                                                    |   | $                                   | (609,484   | ) | $ | 1,255,168 |   |
| Adjustments  to reconcile net income (loss) to net cash used in operating activities:    |   |                                |       |   |   |
| Depreciation                                                                             |   | 53,814                              |       | 13,294 |   |
| Deferred  taxes                                                                          |   | 0                                   |       | (200 | ) |
| Realized  gain on sale of investments                                                    |   | (29,528                             | )          | (2,097,573 | ) |
| Equity in loss of equity method investee                                                 |   | 486,919                             |       | 0 |   |
| (Increase)/decrease  in:                                                                 |   |                                |       |   |   |
| Trade receivables                                                                        |   | 75,616                              |       | (39,626 | ) |
| Inventory                                                                                |   | (15,710                             | )          | 52,219 |   |
| Other  current assets                                                                    |   | (18,882                             | )          | (30,848 | ) |
| Prepaid  income taxes                                                                    |   | (135,378                            | )          | 0 |   |
| Increase/(decrease)  in:                                                                 |   |                                |       |   |   |
| Accounts  payable                                                                        |   | (72,350                             | )          | 76,892 |   |
| Accrued  expenses                                                                        |   | (108,592                            | )          | 17,535 |   |
| Deferred  revenue                                                                        |   | (6,746                              | )          | 0 |   |
| Accrued  income taxes                                                                    |   | 0                                   |       | (1,230,890 | ) |
| Net cash  used in operating activities                                                   |   | (380,321                            | )          | (1,984,029 | ) |
|                                                                                     |   |                                |       |   |   |
| Cash  flows from investing activities:                                                   |   |                                |       |   |   |
| Proceeds  from sale of investments                                                       |   | 30,935                              |       | 2,114,753 |   |
| Additional  investment in equity method investee                                         |   | 0                                   |       | (1,098,168 | ) |
| Purchase  of property and equipment                                                      |   | (17,789                             | )          | (22,808 | ) |
| Principal  payments received on note receivable                                          |   | 0                                   |       | 5,709 |   |
| Net cash  provided by investing activities                                               |   | 13,146                              |       | 999,486 |   |
|                                                                                     |   |                                |       |   |   |
| Cash  flows from financing activities:                                                   |   |                                |       |   |   |
| Proceeds  from issuance of stock                                                         |   | 14,270                              |       | 73,468 |   |
| Dividends  paid                                                                          |   | (189,719                            | )          | (188,306 | ) |
|                                                                                     |   |                                |       |   |   |
| Net cash  used in financing activities                                                   |   | (175,449                            | )          | (114,838 | ) |
|                                                                                     |   |                                |       |   |   |
| Net  decrease in cash & cash equivalents                                             |   | (542,624                            | )          | (1,099,381 | ) |
| Cash  & cash equivalents, beginning                                                  |   | 6,723,160                           |       | 8,389,691 |   |
| Cash  & cash equivalents, ending                                                     |   | 6,180,536                           |       | 7,290,310 |   |
|                                                                                     |   |                                |       |   |   |
| **Supplemental schedule of non-cash investing and financing activities**                 |   |                                | ** ** |   | ** ** |
| Net  change in unrealized gain/ (loss) on marketable securities                          |   | 964,152                             |       | (2,832,711 | ) |
|                                                                                          |        |                                     |            |  |  |  |  |

 

See accompanying notes to consolidatedfinancial statements

 

6

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

##### **NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1.  Nature of Business**

 

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

 

Electro-Sensors, Inc. (ESI) operates twodistinct businesses.  The first is theControls Division, a division of ESI. This division manufactures and markets a complete line of speedmonitoring and motor control 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 tomanufacture the industry-preferred product for every market served.  These products are sold through an internalsales staff and distributors to a wide variety of manufacturers, OEM’s andprocessors to monitor process machinery operations.  The Controls Division markets its products to a number ofdifferent industries located throughout the United States and abroad.

 

The second business is AutoData Systems(ADS), also a division of ESI.  ADSdesigns and markets desktop software systems that read hand-printed characters,checkmarks and bar code information from scanned or faxed forms.  ADS’ products are designed to providecapabilities to automate data collection to end users, resellers and developersin the United States, Canada, Europe and Asia.

 

Inboth divisions, the Company grants credits to customers under normal industryterms, generally 45 days.

 

ESIInvestment Company (INV) owns marketable securities, including equitysecurities in August Technology, Inc. and PPT Vision, Inc (PPTV).   The value of INV’s marketable securities haveexperienced significant appreciation in value since the IPO ofAugust Technology in 2000.  DuringMay 2002, INV participated in a rights offering by PPTV.  As a result of the additional investment inPPTV, the Company has changed its reporting of this investment to the equitymethod of accounting.  See Note 4 foradditional information about the Company’s investments and this change to theequity method.  The Company’s investmentsin marketable securities are subject to normal market risks, which are unhedged.

 

**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.  In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included.

 

The Balance Sheet at December 31, 2002has been derived from the Company’s audited financial statements for the yearended December 31, 2002, 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, 2002.

 

It is the opinion of management that the unaudited condensedconsolidated financial statements include all adjustments, consisting of normalrecurring accruals, necessary to fairly state the results of operations for thethree and six-month periods ended June 30, 2003 and 2002. The results ofinterim periods may not be indicative of results to be expected for the year.

 

7

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**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 related warrantycosts are recognized at the time of shipment. The Company’s distributors arenot granted any price protection. Sales to all customers, includingdistributors, 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. Warranty reserves are provided at the time revenue is recognized forthe estimated cost of replacing defective products.

 

**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 basedon the fair values of options at the grant dates consistent with the provisionsof Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting forStock Based Compensation,” the Company’s net income (loss) and basic and dilutednet income (loss) per common share would have been changed to the following proforma amounts:

 
|                                         |   | **Three  Months  Ended  June 30,** |     |     |   | **Six Months  Ended  June 30,** |   |     |     |
|----------------------------------------------|--------|-----------------------------------------|----------|----------|--------|--------------------------------------|--------|----------|----------|
|                                         |   | **2003**                                |     | **2002** |   | **2003**                             |   | **2002** |     |
| Net income (loss):                           |   |                                    |     |     |   |                                 |   |     |     |
| As reported                                  |   | $                                       | (282,529 | )        | $      | 839,255                              |   | $        | (609,484 | ) | $ | 1,255,168 |   |
| Pro forma                                    |   | $                                       | (288,032 | )        | $      | 821,799                              |   | $        | (620,490 | ) | $ | 1,229,256 |   |
| Basic net income (loss) per common  share:   |   |                                    |     |     |   |                                 |   |     |     |
| As reported                                  |   | (.09                                    | )        | .27      |   | (.19                                 | )      | .40      |     |
| Pro forma                                    |   | (.09                                    | )        | .27      |   | (.19                                 | )      | .40      |     |
| Diluted net income (loss) per common  share: |   |                                    |     |     |   |                                 |   |     |     |
| As reported                                  |   | (.09                                    | )        | .26      |   | (.19                                 | )      | .37      |     |
| Pro forma                                    |   | (.09                                    | )        | .25      |   | (.19                                 | )      | .36      |     |
| Stock based compensation:                    |   |                                    |     |     |   |                                 |   |     |     |
| As reported                                  |   | 0                                       |     | 0        |   | 0                                    |   | 0        |     |
| Pro forma                                    |   | $                                       | 5,503    |     | $      | 17,456                               |   | $        | 11,006   |   | $ | 25,912 |   |

#### ** **

8

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In determining the compensation cost ofoptions granted during the three and six months ended June 30, 2003 and2002, as specified by SFAS No. 123, the fair value of each option grant hasbeen estimated on the date of grant using the Black-Scholes option pricingmodel and the weighted average assumptions used in these calculations aresummarized as follows:

 
|                             |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |       |
|----------------------------------|--------|----------------------------------------|--------|--------------------------------------|------------|
|                             |   | **2003**                               |   | **2002**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
|                             |   |                                   |   |                                 |       |   |   |   |   |
| Risk-free interest rate          |   | N/A                                    |   | 4.62                                 | %          | N/A |   | 4.62 | % |
| Expected life of options granted |   | N/A                                    |   | 5  years                             |       | N/A |   | 5  years |   |
| Expected volatility              |   | N/A                                    |   | 52.2                                 | %          | N/A |   | 52.2 | % |
| Expected dividend yield          |   | N/A                                    |   | 2.67                                 | %          | N/A |   | 2.67 | % |

 

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

 

The Company’s basic net income pershare amounts have been computed by dividing net income by the weighted averagenumber of outstanding common shares. The Company’s diluted net income per shareis computed by dividing net income by the weighted average number of outstandingcommon shares and common share equivalents relating to stock options andwarrants, when dilutive. For the three months ended June 30, 2002, 136,760shares of common stock equivalents were included in the computation of dilutednet income (loss) per share. For the six months ended June 30, 2002,257,317 shares of common stock equivalents were included in the computation ofdiluted net income per share. For the three months and six months endedJune 30, 2003, the shares were anti-dilutive.

 

Options to purchase 9,000 shares ofcommon stock with a weighted average exercise price of $4.49 were outstandingfor the three and six months ending June 30, 2002, but were excluded fromthe computation of common share equivalents because their exercise prices were greaterthan the average market price of the common shares for the period

 

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

#### ** **

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

 

Managementdetermines the appropriate classification of securities at the date individual investmentsare acquired, and evaluates the appropriateness of such classification at eachbalance sheet date.

 

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.

 

9

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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.

 

**Changein Reporting for the Company’s Investment in PPT Vision, Inc.**

 

During 2002, the Company purchased 1,108,868 sharesof common stock of PPTV.   PPTV is apublicly-traded corporation in which the Company had previously owned 549,084shares, or 10.0%, of PPTV’s outstanding common stock.  At June 30, 2003, the Company owned 1,657,952 shares ofPPTV, which is 16.4% of PPTV’s outstanding common stock.  The fair value of its holdings based on thequoted market price at June 30, 2003 was approximately $1,243,464.  The Company also owns warrants to purchaseapproximately 549,084 additional shares of PPTV common stock at a per shareprice of $2.50.  The warrants arecurrently exercisable, and expire September 30, 2003.

 

In connection with the 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 now 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.

 

As a result of this change to the equity method ofaccounting, the balance sheets at June 30, 2003 and December 31, 2002have been adjusted to show the Company’s investment in PPTV based on the equitymethod rather than based on market value method of accounting.  Retained earnings at those dates have beenadjusted to reflect equity method earnings from prior periods and accumulatedother comprehensive income at those dates has been adjusted to eliminateunrealized gains and losses from PPTV that were recorded in prior periods.  In addition, the income statements for thethree and six-month periods ended June 30, 2003 and 2002 show theCompany’s portion of PPTV’s earnings from those periods.

 

**Note 7. Comprehensive Income**

 

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

 
|                                                          |   | **Three Months Ended  June 30,** |       | **Six Months Ended  June 30,** |       |
|---------------------------------------------------------------|--------|---------------------------------------|------------|-------------------------------------|------------|
|                                                          |   | **2003**                              |       | **2002**                            |       | **2003** |   | **2002** |   |
| **Net Income (Loss)**                                         |   | $                                     | (283,449   | )                                   | $          | 839,255 |   | $ | (609,484 | ) | $ | 1,255,168 |   |
|                                                          |   |                                  | ** ** |                                | ** ** |   | ** ** |   | ** ** |
| **Other Comprehensive  Gain (Loss):**                         |   |                                  | ** ** |                                | ** ** |   | ** ** |   | ** ** |
| Change in Unrealized Value Investments, net                   |   | 1,289,165                             |       | (2,025,561                          | )          | 600,464 |   | (343,908 | ) |
|                                                          |   |                                  |       |                                |       |   |   |   |   |
| **Less:**                                                     |   |                                  |       |                                |       |   |   |   |   |
| Reclassification  Adjustment for Gains Included In net Income |   | (10,900                               | )          | (1,034,006                          | )          | (18,900 | ) | (1,462,799 | ) |
|                                                          |   |                                  |       |                                |       |   |   |   |   |
| Total Comprehensive Income                                    |   | $                                     | 994,816    |                                | (2,220,312 | ) | (27,920 | ) | (551,539 | ) |
|                                                               |        |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

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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.  ADS (or ADS) designs andmarkets a desktop software-based system that reads hand-printed characters,checkmarks, and bar code information from scanned or faxed forms.  Sales of this system include software andcan include hardware.  The investmentsdivision (or INV) holds investments in marketable and non-marketablesecurities.

 

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,** |   |
|-------------------------------------------------------------|--------|---------------------------------------|---------------|-------------------------------------|--------|
|                                                        |   | **2003**                              |          | **2002**                            |   | **2003** |   | **2002** |   |
| **External sales**                                          |   |                                  |          |                                |   |   |   |   |   |
| Production monitoring                                       |   | $                                     | 878,317       |                                | $      | 921,106 |   | $ | 1,722,330 |   | $ | 1,853,570 |   |
| Character recognition                                       |   | 145,930                               |          | 203,333                             |   | 288,456 |   | 409,525 |   |
| Investments                                                 |   | 0                                     |          | 0                                   |   | 0 |   | 0 |   |
| **Total**                                                   |   | **$**                                 | **1,024,247** | ** **                          | **$**  | **1,124,439** | ** ** | **$** | **2,010,786** | ** ** | **$** | **2,263,095** | ** ** |
|                                                        |   |                                  |          |                                |   |   |   |   |   |
| **Net income before  taxes and****discontinued operations** |   |                                  |          |                                |   |   |   |   |   |
| Production monitoring                                       |   | $                                     | 14,189        |                                | $      | (56,582 | ) | $ | (106,829 | ) | $ | (25,752 | ) |
| Character recognition                                       |   | (14,162                               | )             | (68,761                             | )      | (42,832 | ) | (69,068 | ) |
| Investments                                                 |   | (356,054                              | )             | 1,451,064                           |   | (612,351 | ) | 2,101,313 |   |
| **Total**                                                   |   | **$**                                 | **(356,027**  | **)**                               | **$**  | **1,325,721** | ** ** | **$** | **(762,012** | **)** | **$** | **2,006,493** | ** ** |

 

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

 

**RESULTS OF OPERATIONS**

 

***NetRevenues***

 

Net revenues for the three-monthperiod ended June 30, 2003 decreased $100,192 or 9.8% when compared to netrevenues for the same period in 2002. For the six-month period endedJune 30, 2003, net revenues decreased $252,309 or 12.5% for the sameperiod in 2002.  Of this decrease,$42,789 and $131,240 for the three and six-month periods, respectively, isattributable to the Controls Division.  ADS contributed decreases in revenue of $57,403 and $121,069 forthe three and six-month periods.  Thecontinued reduced demand for production control instruments is attributable tothe on-going softness in purchase of capital equipment for manufacturing processes.  Capacity utilization at many plants issufficiently low that new machine purchases are not presently warranted.  The decrease in sales is evenly distributedacross the product line.  New productsthat have been developed and added to the product line include a metal-sensingspeed sensor with a wide range of target sizes and a new vibration monitor withset points up to 20 inches per second.

 

Two manufacturer representativefirms in Colorado and California have begun working with the Electro-Sensors’products to better market them in these areas. In ADS, sales results were higher in the first half of 2002 due tospecial one-time marketing incentives for existing customers to upgrade theirsoftware to the newly released ExpertScan software.  A new marketing staff person was hired for AutoData Systems inthe last half of 2002 to expand the sales efforts in reaching new customers.

 

***Costof Sales***

 

The Company’s cost of salesdecreased $92,109 or 23.9% for the three months ended June 30, 2003 whencomparing the same period in 2002.  Whencomparing the six-month period ending June 30, 2003 to the same period in2003, the decrease is $184,814 or 23.5%. In addition to the decrease resulting from the lower sales volume, costof sales was reduced as a result of staff reduction and the company’s effortsto reduce production costs.

 

***GrossMargins***

 

Gross margins for thethree-month period ended June 30, 2003 were 62.3% versus 57.5% for thesame period of the prior fiscal year. Gross margins for the six-month period ended June 30, 2003 were60.9% versus 57.1% for the same period of the prior fiscal year.  In line with the cost of sales decrease, theincreases in margins are due to the company’s efforts to reduce productioncosts.  There are less personnel involvedin production when comparing the three-month period ending June 30, 2003to the same period ending June 30, 2002. Also, business insurance premiums have decreased by 14.3%, a significantdecrease when comparing the three- and six-month periods ending June 30,2003 to the same periods ending June 30, 2002.

 

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***OperatingExpenses***

 

Total operating expensesdecreased $69,317 or 9.4% for the three months ended June 30, 2003 whencompared to the same period of the prior year. Operating expenses for the six-month period ended June 30, 2003increased $38,490 or 2.5%.

 

Selling and marketing costsincreased $38,482 or 13.0% for the three months ended June 30, 2003 whencompared to the same period in 2002.  Ofthis increase, the Controls Division contributed $4,234 and ADS contributed$34,248.  For the six-month period endedJune 30, 2003, the selling and marketing costs increased $73,338 or 12%when compared to the same period for 2002. Of this increase, the Controls Division contributed $17,713 and ADScontributed $55,625.  Marketingcommunications development for product launches, a greater number of fieldsales trips, new literature, and ad development are the predominant expenses inthe increases.  Salaries and personnelexpenses are up due to sales and marketing personnel being hired in the secondhalf of 2002 in both divisions when comparing 2003 versus 2002.

 

General and administrative costsincreased $7,213 or 3.0% for the three months ended June 30, 2003 comparedto the same period in 2002.  Thisincrease in general and administrative costs is offset by a decrease of $11,055from the Controls Division.  For thesix-month period ended June 30, 2003, the general and administrative costsincreased $93,708 or 17.5%.  Of thisincrease, the Controls Division contributed $54,050 and ADS contributed$39,658.  The increase is primarily dueto a change in procedure for accounting for general company expenses.  Historically, the company divided generalexpenses such as liability insurance, office supplies, and building expensesover the various departments based on a set percentage.  Beginning January 2003, we havedetermined to classify such general expenses into General and Administrativecosts.

 

Research and development costsdecreased $115,013 or 55.8% for the three months ended June 30, 2003compared to the same period in 2002.  Ofthis decrease, the Controls Division contributed $52,875 and ADS contributed$62,138.  The decrease in the ControlsDivision is due to reduced outside development costs in both contractengineering and prototype development. The decrease in ADS is due to reduced development expenses for theExpertScan products, which were released in December 2002.  Software personnel for on-going product developmenthave been brought in-house at a lower cost than external services.

 

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

 

Non-operating income decreasedby $1,742,982 for the three-month period ending June 30, 2003 compared tothe same period for 2002.  For thesix-month period ending June 30, 2003, non-operating income decreased$2,662,520.  Non-operating incomedecreased primarily due to reduced sales of investment securities.  As a result of recent declines in the marketprice, management decided to reduce the number of August Technology sharessold during the three and six months ended June 30, 2003.

 

***NetIncome (Loss) Before Taxes***

 

Netincome before taxes decreased $1,681,748 to a loss of $356,027 for thethree-month period ended June 30, 2003 compared to the same period in2002.  When comparing the six-monthperiod ended June 30, 2003 to the same period in 2002, net income beforetaxes decreased $2,768,505, to a loss of $762,012.

 

The Controls Division had netincome of $14,189 for the three months ended June 30, 2003 compared to anet loss of $56,582 for the same period in 2002.  For the six-month period ended June 30, 2003, the ControlsDivision had a net loss of $106,829, compared to a net loss of $25,752 for thesame period in 2002.  This difference isdue to sales revenue declines that occurred at a faster rate than did expensereductions.

 

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ADS had a net loss of $14,162for the three months ending June 30, 2003 compared to the loss of $68,761for same period in 2002. For the six-month period ended June 30, 2003, ADShad a net loss of $42,832, compared to a net loss of $69,068 for the sameperiod in 2002. This decrease is mainly attributable to reduced research anddevelopment costs following the ExpertScan software release inDecember 2002.

 

Investment income frominvestment securities decreased $1,897,118 for a net loss of $356,054 for thethree months ended June 30, 2003 compared to the same period in 2002.  For the six-month period ended June 30,2003, the investment income decreased $2,713,664 to a loss of $612,351.  As a result of the decline in the price ofAugust Technology, the Company reduced the number of shares sold ascompared to the prior quarters.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Cash and cash equivalents were$6,180,536 at June 30, 2003 and $7,290,310 at June 30, 2002. Cashused in operating activities of $380,321 for the six months endedJune 30, 2003 was primarily a result of our net loss adjusted for non-cashcharges.

 

Cash provided by investing activitieswas $13,146 for the sixth-month period ended June 30, 2003 and $999,486 atJune 30, 2002.  Cash used for capital expenditures was $17,789 and$22,808 for the six months ended June 30, 2003 and 2002, respectively.  Proceeds from the sale of investments forthe sixth months ended June 30, 2003 declined to $30,935 from $2,114,753when compared to the same period in 2002.

 

Cash used in financing activities was$175,449 and $114,838 for the six months ended June 30, 2003 and2002, respectively.  During the sixmonths ended June 30, 2003 and 2002, the Company paid aggregate dividendsof $189,719 and $188,306, 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 remainder ofthe year.

 

**FORWARD-LOOKING STATEMENTS**

 

This Form 10-QSB containsforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934, includingstatements regarding the Company’s expectations, beliefs, intentions orstrategies 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 isimportant to note that the Company’s actual results could differ materially fromthose in such forward-looking statements. The forward-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 31,2002, filed with the Securities and Exchange Commission.

 

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**Item 3. Controls and Procedures.**

 

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 ofMatters to a Vote of Security Holders**

 

The Annual Meeting of shareholders was heldApril 23, 2003

 

The following matters were voted on byshareholders during the period covered by this Form 10-QSB:

 

1.                                       Setnumber of directors at five

2.                                       Electfive directors:  B. Slye, P. Peterson,G. Miller, J. Marino, and J. Strom

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

 
| **Proposal** |   |        |   | **Yes**   |   | **No** |   | **Abstain** |   |
|--------------|--------|-------------|--------|-----------|--------|--------|--------|-------------|--------|
| 1            |   |        |   | 2,453,442 |   | 94,276 |   | 200         |   |
| 2            |   | B. Slye     |   | 2,452,892 |   | 95,026 |   | 0           |   |
| 2            |   | P. Peterson |   | 2,452,892 |   | 95,026 |   | 0           |   |
| 2            |   | G. Miller   |   | 2,452,892 |   | 95,026 |   | 0           |   |
| 2            |   | J. Marino   |   | 2,452,892 |   | 95,026 |   | 0           |   |
| 2            |   | J. Strom    |   | 2,452,892 |   | 95,026 |   | 0           |   |
| 3            |   |        |   | 2,481,128 |   | 64,276 |   | 2,514       |   |

 

**Item 6. 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                           Certification of CEO and CFO Pursuant to Section 906 of the Sarbanes-OxleyAct of 2002.

 

(b)         Reports on Form 8-K – In a form 8-K filed July 1, 2003, the Companyreported a change in the Company's Certifying Accountant.

 

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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 14, 2003      | /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, 2003**

 
| **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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