** **

**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 March 31, 2005**                                                                                                                         |
| ** **                                                                                                                                                                |
| **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 as specified in its charter)

 
| **Minnesota**                                                   | ** ** | **41-0943459**                    |
|-----------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of incorporation or  organization) |       | (IRS Employer Identification No.) |
|                                                            |       |                              |
| **6111 Blue Circle Drive  Minnetonka, Minnesota 55343-9108**    |
| (Address of principal executive offices)                        |
| ** **                                                      | ** ** | ** **                        |
| **(952) 930-0100**                                              |
| (Issuer’s telephone number)                                |

 

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

Yes ý  No o

 

The number of shares outstanding of theregistrant’s Common Stock, $0.10 par value, on May 16, 2005 was 3,228,962.

 

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

 

 

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**ELECTRO-SENSORS, INC.**

**Form 10-QSB**

**For the Period Ended March 31, 2005**

 

**TABLE OF CONTENTS**

 

| **PART I – FINANCIAL INFORMATION**                                                                    | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** |
| Item 1. Financial Statements                                                                               |       |
|                                                                                                       |       |
| Consolidated Balance Sheets – As of March 31, 2005 and  December 31, 2004                        |       |
| Consolidated Statements of Operations – For  the Three Months Ended March 31, 2005 and March 31, 2004 |       |
| Consolidated Statements of Cash Flows – For  the Three Months Ended March 31, 2005 and March 31, 2004 |       |
| 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 6. Exhibits                                                                                           |       |
|                                                                                                       |       |
| **SIGNATURES**                                                                                             | ** ** |
|                                                                                                       |       |
| **EXHIBITS**                                                                                               | ** ** |

 

2

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**PART I.   FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

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

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                  | ** ** | **March 31,  2005** | ** **     | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|----------------|-----------------------------|------------|
| ** **                                                                                                                                  | ** ** | **(unaudited)**     | ** **     | **(audited)**               | ** ** |
| **ASSETS**                                                                                                                                  |       |                | ** **     |                        |       |
|                                                                                                                                        |       |                | ** **     |                        |       |
| **CURRENT ASSETS**                                                                                                                          |       |                | ** **     |                        |       |
|                                                                                                                                        |       |                | ** **     |                        |       |
| Cash and cash equivalents                                                                                                                   | ** ** | **$**               | **6,516,000**  | ** **                  | $          | 6,464,000 |   |
| Available for sale securities                                                                                                               | ** ** | **8,009,000**       | ** **     | 7,334,000                   |       |
| Trade receivables, less allowance for  doubtful accounts of $9,000 and $6,000, respectively                                                 |       | **567,000**         | ** **     | 559,000                     |       |
| Inventories                                                                                                                                 | ** ** | **822,000**         | ** **     | 810,000                     |       |
| Prepaid income tax                                                                                                                          | ** ** | **100,000**         | ** **     | 127,000                     |       |
| Other current assets                                                                                                                        | ** ** | **67,000**          | ** **     | 68,000                      |       |
| **Total current assets**                                                                                                                    | ** ** | **16,081,000**      | ** **     | 15,362,000                  |       |
|                                                                                                                                        |       |                | ** **     |                        |       |
| **PROPERTY AND EQUIPMENT, net**                                                                                                             | ** ** | **1,400,000**       | ** **     | 1,402,000                   |       |
|                                                                                                                                        |       |                | ** **     |                        |       |
| **INVESTMENT IN EQUITY METHOD INVESTEE**                                                                                                    | ** ** | **129,000**         | ** **     | 140,000                     |       |
| ** **                                                                                                                                  | ** ** | ** **          | ** **     | ** **                  | ** ** |
| **TOTAL ASSETS**                                                                                                                            | ** ** | **$**               | **17,610,000** | ** **                  | $          | 16,904,000 |   |
| ** **                                                                                                                                  | ** ** | ** **          | ** **     | ** **                  | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                               |       |                | ** **     |                        |       |
|                                                                                                                                        |       |                | ** **     |                        |       |
| **CURRENT LIABILITIES**                                                                                                                     |       |                | ** **     |                        |       |
|                                                                                                                                        |       |                | ** **     |                        |       |
| Accounts payable                                                                                                                            | ** ** | **$**               | **202,000**    | ** **                  | $          | 162,000 |   |
| Accrued expenses                                                                                                                            | ** ** | **302,000**         | ** **     | 248,000                     |       |
| Deferred revenue                                                                                                                            | ** ** | **71,000**          | ** **     | 68,000                      |       |
| Deferred income tax                                                                                                                         | ** ** | **2,880,000**       | ** **     | 2,623,000                   |       |
| **Total current liabilities**                                                                                                               | ** ** | **3,455,000**       | ** **     | 3,101,000                   |       |
|                                                                                                                                        |       |                | ** **     |                        |       |
| **COMMITMENTS AND CONTINGENCIES (Notes 6 and  8)**                                                                                          | ** ** | ** **          | ** **     | ** **                  | ** ** |
| ** **                                                                                                                                  | ** ** | ** **          | ** **     | ** **                  | ** ** |
| **STOCKHOLDERS’ EQUITY**                                                                                                               | ** ** | ** **          | ** **     | ** **                  | ** ** |
|                                                                                                                                        |       |                | ** **     |                        |       |
| Common stock par value $0.10 per share;  authorized 10,000,000 shares; issued and outstanding 3,222,212 and 3,218,345  shares, respectively | ** ** | **322,000**         | ** **     | 322,000                     |       |
| Additional paid-in capital                                                                                                                  | ** ** | **1,114,000**       | ** **     | 1,104,000                   |       |
| Retained earnings                                                                                                                           | ** ** | **7,887,000**       | ** **     | 7,964,000                   |       |
| Accumulated other comprehensive income                                                                                                      | ** ** | **4,832,000**       | ** **     | 4,413,000                   |       |
| **Total stockholders’ equity**                                                                                                         | ** ** | **14,155,000**      | ** **     | 13,803,000                  |       |
| ** **                                                                                                                                  | ** ** | ** **          | ** **     | ** **                  | ** ** |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                         | ** ** | **$**               | **17,610,000** | ** **                  | $          | 16,904,000 |   |

 

See notes to consolidated financial statements

 

3

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                 | ** ** | **Three Months Ended  March 31,** | ** **    |
|--------------------------------------------|------------|----------------------------------------|---------------|
| ** **                                 | ** ** | **2005**                               | ** **    | **2004** | ** ** |
|                                       |       |                                   |          |   |   |
| **Net sales**                              | ** ** | **$**                                  | **1,204,000** | ** ** | $ | 1,216,000 |   |
| **Cost of goods sold**                     | ** ** | **445,000**                            | ** **    | 466,000 |   |
| **Gross profit**                           | ** ** | **759,000**                            | ** **    | 750,000 |   |
|                                       |       |                                   | ** **    |   |   |
| **Operating expenses:**                    |       |                                   | ** **    |   |   |
|                                       |       |                                   | ** **    |   |   |
| Selling and marketing                      | ** ** | **308,000**                            | ** **    | 315,000 |   |
| General and administrative                 | ** ** | **329,000**                            | ** **    | 321,000 |   |
| Research and development                   | ** ** | **204,000**                            | ** **    | 171,000 |   |
| **Total operating expenses**               | ** ** | **841,000**                            | ** **    | 807,000 |   |
|                                       |       |                                   | ** **    |   |   |
| **Operating loss**                         | ** ** | **(82,000**                            | **)**         | (57,000 | ) |
|                                       |       |                                   | ** **    |   |   |
| **Non-operating income (expense):**        |       |                                   | ** **    |   |   |
|                                       |       |                                   | ** **    |   |   |
| Gain on sale of investment securities      | ** ** | **135,000**                            | ** **    | 324,000 |   |
| Interest income                            | ** ** | **32,000**                             | ** **    | 11,000 |   |
| Other income                               | ** ** | **4,000**                              | ** **    | 3,000 |   |
| Equity in losses of equity method investee | ** ** | **(11,000**                            | **)**         | (65,000 | ) |
| **Total non-operating income (expense)**   | ** ** | **160,000**                            | ** **    | 273,000 |   |
|                                       |       |                                   | ** **    |   |   |
| **Income before income taxes**             | ** ** | **78,000**                             | ** **    | 216,000 |   |
| **Federal and state income taxes**         | ** ** | **27,000**                             | ** **    | 113,000 |   |
| **Net income**                             | ** ** | **$**                                  | **51,000**    | ** ** | $ | 103,000 |   |
|                                       |       |                                   | ** **    |   |   |
| **Net income per share data:**             |       |                                   | ** **    |   |   |
|                                       |       |                                   | ** **    |   |   |
| **Basic**                                  |       |                                   | ** **    |   |   |
| Net income (loss) per share                | ** ** | **$**                                  | **0.02**      | ** ** | $ | 0.03 |   |
| Weighted average shares                    | ** ** | **3,219,664**                          | ** **    | 3,181,117 |   |
|                                       |       |                                   | ** **    |   |   |
| **Diluted**                                |       |                                   | ** **    |   |   |
| Net income (loss) per share                | ** ** | **$**                                  | **0.02**      | ** ** | $ | 0.03 |   |
| Weighted average shares                    | ** ** | **3,319,730**                          | ** **    | 3,300,097 |   |
|                                       |       |                                   | ** **    |   |   |
| **Dividends paid per share**               | ** ** | **$**                                  | **0.04**      | ** ** | $ | 0.04 |   |

 

 See notes to consolidatedfinancial statements

 

4

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
| ** **                                                                     | ** ** | **Three Months Ended  March 31,** | ** **    |
|--------------------------------------------------------------------------------|------------|-----------------------------------|---------------|
| ** **                                                                     | ** ** | **2005**                          | ** **    | **2004** | ** ** |
| **Cash flows from operating activities**                                       |       |                              | ** **    |   |   |
|                                                                           |       |                              | ** **    |   |   |
| **Net income**                                                                 | ** ** | **$**                             | **51,000**    | ** ** | $ | 103,000 |   |
|                                                                           |       |                              | ** **    |   |   |
| Adjustments to reconcile net income to net  cash used in operating activities: |       |                              | ** **    |   |   |
|                                                                           |       |                              | ** **    |   |   |
| Depreciation                                                                   | ** ** | **24,000**                        | ** **    | 22,000 |   |
| Realized gain on sale of investments                                           | ** ** | **(135,000**                      | **)**         | (324,000 | ) |
| Equity in loss of equity method investee                                       | ** ** | **11,000**                        | ** **    | 65,000 |   |
| (Increase)/decrease in:                                                        |       |                              | ** **    |   |   |
| Trade receivables                                                              | ** ** | **(8,000**                        | **)**         | (24,000 | ) |
| Inventory                                                                      | ** ** | **(12,000**                       | **)**         | (43,000 | ) |
| Other current assets                                                           | ** ** | **1,000**                         | ** **    | (4,000 | ) |
| Prepaid income taxes                                                           | ** ** | **27,000**                        | ** **    | 0 |   |
| Accounts payable                                                               | ** ** | **40,000**                        | ** **    | 38,000 |   |
| Accrued expenses                                                               | ** ** | **54,000**                        | ** **    | (55,000 | ) |
| Deferred revenue                                                               | ** ** | **3,000**                         | ** **    | 6,000 |   |
| Accrued income taxes                                                           | ** ** | **0**                             | ** **    | 13,000 |   |
|                                                                           |       |                              | ** **    |   |   |
| Net cash provided by/(used in) operating  activities                           | ** ** | **56,000**                        | ** **    | (203,000 | ) |
|                                                                           |       |                              | ** **    |   |   |
| Cash flows from investing activities:                                          |       |                              | ** **    |   |   |
|                                                                           |       |                              | ** **    |   |   |
| Proceeds from sale of investments                                              | ** ** | **136,000**                       | ** **    | 449,000 |   |
| Purchase of equity securities                                                  | ** ** | **0**                             | ** **    | (116,000 | ) |
| Purchase of property and equipment                                             | ** ** | **(22,000**                       | **)**         | 0 |   |
|                                                                           |       |                              | ** **    |   |   |
| Net cash provided by investing activities                                      | ** ** | **114,000**                       | ** **    | 333,000 |   |
|                                                                           |       |                              | ** **    |   |   |
| Cash flows from financing activities:                                          |       |                              | ** **    |   |   |
|                                                                           |       |                              | ** **    |   |   |
| Proceeds from issuance of stock                                                | ** ** | **10,000**                        | ** **    | 30,000 |   |
| Dividends paid                                                                 | ** ** | **(128,000**                      | **)**         | (127,000 | ) |
|                                                                           |       |                              | ** **    |   |   |
| Net cash used in financing activities                                          | ** ** | **(118,000**                      | **)**         | (97,000 | ) |
|                                                                           |       |                              | ** **    |   |   |
| Net increase/decrease in cash & cash  equivalents                          | ** ** | **52,000**                        | ** **    | 33,000 |   |
|                                                                           |       |                              | ** **    |   |   |
| Cash & cash equivalents, beginning                                         | ** ** | **6,464,000**                     | ** **    | 6,863,000 |   |
| Cash & cash equivalents, ending                                            | ** ** | **$**                             | **6,516,000** | ** ** | $ | 6,896,000 |   |
|                                                                           |       |                              | ** **    |   |   |
| **Supplemental schedule of non-cash investing  and financing activities**      | ** ** | ** **                        | ** **    | ** ** | ** ** |
| Net change in unrealized gain/ (loss) on  investments                          | ** ** | **$**                             | **(676,000**  | **)** | $ | (2,662,000 | ) |

 

See accompanying notes to consolidated financial statements

 

5

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

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

**(Unaudited)**

 

**Note 1.  Nature of Business**

 

The accompanying consolidated financial statements include the accountsof Electro-Sensors, Inc. and its wholly owned subsidiaries, ESI InvestmentCompany and Senstar Corporation. Senstar Corporation does not have any businesstransactions.  Intercompany accounts,transactions and earnings have been eliminated in consolidation. Theconsolidated entity is referred to as “the Company.”

 

Electro-Sensors, Inc. operates two distinct businesses. The first isthe Controls Division, which manufactures and markets a complete line of speedmonitoring and motor control systems for industrial machinery. The ControlsDivision utilizes leading-edge technology to continuously improve its productsand make them easier 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, manufacturer’s 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.

 

The second business is AutoData® Systems (ADS).  ADS designs and markets a desktop softwarebased system that reads hand printed characters, checkmarks and bar codeinformation from scanned or faxed forms. ADS products are designed to providecapabilities to automate data collection and are sold by internal sales staffto end users, resellers and developers in the United States, Canada, Europe andAsia.

 

ESI Investment Company (INV) owns marketable securities which haveexperienced significant appreciation in value since the IPO of August Technologyin 2000.  August Technology Corporationdesigns, manufactures, and sells automated defect inspection systems used inthe manufacture of microelectronic devices. The Company has recognized income from the sale of its holdings inAugust Technology Corporation. See Note 6 for additional information regardingits investments.  The Company’sinvestments in marketable securities are subject to normal market risks.

 

**Note 2.  Basis of Presentation**

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and with theinstructions to Form 10-QSB. Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States ofAmerica for complete financial statements. It is the opinion of management that the unaudited condensedconsolidated financial statements include all adjustments, consisting of normalrecurring accruals, necessary to fairly state the financial position andresults of operations for the three months ended March 31, 2005 and March 31,2004. The results of interim periods may not be indicative of results to beexpected for the year.

 

The Balance Sheet at December 31, 2004 has been derived from theCompany’s audited financial statements for the year ended December 31,2004, but does not include all of the information and footnotes required byaccounting principles generally accepted in the United States of America forcomplete financial statements.  Forfurther information, refer to the financial statements and footnotes theretoincluded in the Company’s annual report on Form 10-KSB for the year endedDecember 31, 2004.

 

**Note 3.  Revenue Recognition**

 

**Revenue recognition of production monitoring equipment:**

 

Inrecognizing revenue, the Company applies the provisions of the Securities andExchange Commission Staff Accounting Bulletin (SAB) No. 101 (as amended bySAB No. 104), Revenue Recognition. The Company recognizes revenue from the saleof its products when persuasive evidence of an arrangement exists, the producthas been delivered, the fee is fixed and determinable and collection of theresulting receivable is reasonably assured.

 

**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.  To recognize revenue, it mustalso be probable that the Company will collect the accounts receivable from itscustomers. In some situations, the Company receives advance payments from its customers.Revenue associated with these advance payments is deferred until the product isshipped.  ADS customers pay an annualmaintenance fee for software support, which is recognized as deferred revenueon the balance sheet and on a monthly basis, it is recognized as revenue overthe life of the contract.

 

6

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**Note 4.  Stock-Based Compensation**

 

The Company uses the intrinsic valuemethod prescribed by Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations in accounting foremployee stock options.  Under the intrinsic value method, compensationexpense is recorded only to the extent that the market price of the commonstock exceeds the exercise price of the stock option on the date of grant.

 

In December 2002, the FinancialAccounting Standards Board (FASB) issued Statement of Financial AccountingStandards (SFAS) No. 148, “Accounting for Stock-Based Compensation - Transitionand Disclosure.”  SFAS No. 148 is an amendment to SFAS No. 123 providingalternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation and alsoprovides requires additional disclosures about the method of accounting forstock-based employee compensation.  The amendments are effective forfinancial statements for fiscal years ending after December 31, 2002 andfor the interim periods beginning after December 15, 2002.  TheCompany adopted the annual disclosure provision of SFAS No. 148 and chose notto adopt the voluntary change to the fair value based method of accounting forstock-based employee compensation, pursuant to SFAS No. 148.  The company’s policy is to grant stockoptions at the fair market value on the date of grant.

 

The Company has adopted thedisclosure-only provisions of SFAS No. 148, Accounting for Stock-BasedCompensation.  Accordingly, no compensation cost has been recognized withrespect to stock options.  Had compensation cost for stock options beendetermined based on the fair value methodology prescribed by SFAS 123, theCompany’s net loss and net loss per share would have been reduced to the proforma amounts indicated below:

 

| ** **                                  | ** ** | **Three Months  Ended  March 31,** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|
| ** **                                  | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Net income (loss):                          |       |                               |       |   |   |
| As reported                                 | ** ** | **$**                              | **51,000** | ** ** | $ | 103,000 |   |
| Pro forma                                   | ** ** | **$**                              | **37,000** | ** ** | $ | 98,000 |   |
| Basic net income (loss) per common share:   |       |                               | ** ** |   |   |
| As reported                                 | ** ** | **$**                              | **0.02**   | ** ** | $ | 0.03 |   |
| Pro forma                                   | ** ** | **$**                              | **0.01**   | ** ** | $ | 0.03 |   |
| Diluted net income (loss) per common share: |       |                               | ** ** |   |   |
| As reported                                 | ** ** | **$**                              | **0.02**   | ** ** | $ | 0.03 |   |
| Pro forma                                   | ** ** | **$**                              | **0.01**   | ** ** | $ | 0.03 |   |
| Stock based compensation:                   |       |                               | ** ** |   |   |
| As reported                                 | ** ** | **0**                              | ** ** | 0 |   |
| Pro forma                                   | ** ** | **$**                              | **14,000** | ** ** | $ | 5,000 |   |

 

The company did not grant any options duringthe three-months ended March 31, 2005 and March 31, 2004.

 

**Note 5.  NetIncome 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 March 31, 2005, 100,066shares of common stock equivalents were included in the computation of dilutednet income per share.  For the threemonths ended March 31, 2004, 118,980 shares of common stock equivalents wereincluded in the computation of diluted net income per share.

 

Options to purchase 9,000 shares ofcommon stock with a weighted average exercise price of $4.49 were outstandingfor the three months ending March 31, 2005, but were excluded from thecomputation of common share equivalents because their exercise prices weregreater than the average market price of the common shares for the period.

 

7

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#### **Note6.  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 a 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.

 

The Company’s significant investment in equity securities is 657,765shares of August Technology Corporation whose shares are traded on the NasdaqStock Exchange with a March 31, 2005 market value of approximately $7,709,000with an approximate cost of $66,000.

 

**InvestmentReported on Equity Method:**

 

At March 31, 2005, the Company owned 2,207,036 shares of PPT, which is approximately18.4% of PPT’s outstanding common stock. The fair value of its holdings based on the quoted market price at March31, 2005 was approximately $1,302,000 with an approximate cost of $2,434,000.

 

Since the Company owns approximately 18.4% of PPT’s outstanding stock,and the Company’s Secretary, Peter R Peterson owns approximately 21.6% of PPT’soutstanding stock, it has been determined that the Company has “significantinfluence” over the operations of PPT, and as a result its ownership interestshould be reported using the equity method of accounting for investments.

 

Under the equity method of accounting, the Company’s proportionateshare of PPT net income or loss is included in the Company’s net income (loss)with a corresponding increase or decrease in the carrying value of itsinvestment.  Losses in excess of investedamounts are not recognized in the financial statements, but rather aresuspended and applied against future equity in earnings for the investee until exhausted.  At March 31, 2005, the Company hadapproximately $810,000 in suspended losses from its investment in PPT that willbe used to offset future recognition of equity method earnings from theinvestment.

 

InApril 2004, INV purchased 20% of a la mode, LLC’s outstanding membershipinterests for $160,000.  The Company hasadopted the equity method of accounting for this investment.

 

Underthe equity method of accounting, the Company’s proportionate share of a la mode’sloss is included in the Company’s net income with a corresponding decrease inthe carrying value of its investment.

 

**Note 7. Comprehensive Income**

 

Comprehensive income includes the Company’snet income plus other comprehensive income items that are excluded from netincome.  The Company’s comprehensiveincome consists of unrealized gains (losses) on available for sale securities,net of income taxes and reclassification adjustments for gains and lossesincluded in net income.

 
| ** **                                                      | ** ** | **Three Months Ended  March 31,** | ** **  |
|-----------------------------------------------------------------|------------|----------------------------------------|-------------|
| ** **                                                      | ** ** | **2005**                               | ** **  | **2004** | ** ** |
| **Net Income (Loss)**                                           | ** ** | **$**                                  | **51,000**  | ** ** | $ | 103,000 |   |
| ** **                                                      | ** ** | ** **                             | ** **  | ** ** | ** ** |
| **Other Comprehensive Gain (Loss):**                            | ** ** | ** **                             | ** **  | ** ** | ** ** |
| Change in unrealized value of investments,  net of income taxes | ** ** | **496,000**                            | ** **  | (1,528,000 | ) |
|                                                            |       |                                   | ** **  |   |   |
| **Less:**                                                       |       |                                   | ** **  |   |   |
| Reclassification adjustment for gains  included in net income   | ** ** | **(77,000**                            | **)**       | (232,000 | ) |
|                                                            |       |                                   | ** **  |   |   |
| Total comprehensive income (loss)                               | ** ** | **$**                                  | **470,000** | ** ** | $ | (1,657,000 | ) |

 

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**Note 8. Segment Information**

 

The Company has three reportable operating segments based on the natureof its product lines: Production Monitoring, Character Recognition, andInvestments. The Controls Division manufactures and markets a complete line of productionmonitoring equipment, in particular speed monitoring and motor control systemsfor industrial machinery. ADS designs and markets a desktop software-basedcharacter recognition system that reads hand printed characters, checkmarks,and bar code information from scanned or faxed forms. Sales of this systeminclude software and can include hardware. INV holds investments in marketableand non-marketable securities.

 

The accounting policies of the segments are the same as those describedin Note 1. In evaluating segment performance, management focuses on sales andincome before taxes. The Company has no inter-segment sales.

 

The following is financial information relating to the continuingoperating segments:

 
| ** **                            | ** ** | **Three Months Ended  March 31,** | ** **    |
|---------------------------------------|------------|----------------------------------------|---------------|
| ** **                            | ** ** | **2005**                               | ** **    | **2004** | ** ** |
| **Net sales**                         | ** ** | ** **                             | ** **    | ** ** | ** ** |
| Production monitoring                 | ** ** | **$**                                  | **1,075,000** |   | $ | 1,007,000 |   |
| Character recognition                 | ** ** | **129,000**                            |          | 209,000 |   |
| Investments                           | ** ** | **0**                                  |          | 0 |   |
| **Total**                             | ** ** | **$**                                  | **1,204,000** |   | $ | 1,216,000 |   |
|                                  |       |                                   |          |   |   |
| **Income (loss) before income taxes** |       |                                   |          |   |   |
| Production monitoring                 | ** ** | **$**                                  | **84,000**    |   | $ | 76,000 |   |
| Character recognition                 | ** ** | **(37,000**                            | **)**         | (14,000 | ) |
| Investments                           | ** ** | **31,000**                             |          | 154,000 |   |
| **Total**                             | ** ** | **$**                                  | **78,000**    |   | $ | 216,000 |   |

 

Certain expenses related to the conduct ofour investment activities are included in general and administrative expensesin the accompanying consolidated statements of operations, but have beenallocated to net income (loss) from our Investments segment in the above table.

 

**Recent accounting standards:**

 

InDecember 2004, FASB issued SFAS No. 123R which requires companies to recognizein the income statement the grant-date fair value of stock options and otherequity-based compensation issued to employees, but expressed no preference forthe type of valuation model.  FASB No.123R is effective for small business issuers as of the beginning of interim orannual reporting periods that begin after December 15, 2005.  The impact of SFAS NO. 123R has not beendetermined at this time.

 

InNovember 2004, FASB issued SFAS No. 151 “Inventory Costs” which amends theguidance in ARB No. 43, Chapter 4 “Inventory Pricing,”  to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs, and wasted material(spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that under somecircumstances, items such as idle facility expense, excessive spoilage, doublefreight, and rehandling costs may be so abnormal as to require treatment ascurrent period charges.” SFAS No. 151 requires that those items be recognizedas current-period charges regardless of whether they meet the criterion of “soabnormal.” In addition, SFAS No, 151 requires that allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities.  SFAS No.151 shall be effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005. Earlier application is permitted for inventorycosts incurred during fiscal years beginning after the date SFAS No. 151 wasissued. SFAS No. 151 shall be applied prospectively.  The Company does not expect the adoption ofSFAS No. 151 to have a material effect on its consolidated financialstatements.

 

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

 

**RESULTS OF OPERATIONS**

 

***Net Sales***

 

Total net sales for the three month periodended March 31, 2005 decreased $12,000 or 1.0% when compared to net sales forthe same period in 2004.

 

For the three months ended March 31, 2005compared to the same period in 2004, the Controls Division contributed anincrease in net sales $68,000 or 6.8%.  ADSexperienced a decrease in net sales of $80,000 or 38.3% for the three monthsended March 31, 2005 compared to the same period in 2004.

 

The Controls Division has experienced anincrease in sales for the first quarter of 2005 due in part to the recovery inthe US economy and increased capital spending by our installed customerbase.  The bulk of our sales volumecontinues to be derived from the Speed Monitoring product lines to the grainand feed markets, as well as other key industrial markets.  We are continuing to develop additionalchannel partners in the form of distributors and independent representatives,with the goal of finding customers and additional product applications.

 

In the first 3 months of 2004, there wereseveral multi-license sales of software and scanners in ADS.  This type of sale did not reoccur in thefirst quarter of 2005.

 

***Cost of Goods Sold***

 

The Company’s cost of goods sold decreased$21,000 or 4.5% for the three months ended March 31, 2005 compared to the sameperiod in 2004.  This decrease isprimarily a direct result of decreased sales, but also reflects the Company’scontinuing efforts to manage costs and create efficiencies.

 

***Gross Profit***

 

Gross margins for the three month periodended March 31, 2005 were 63.0% versus 61.7% for the same period in 2004.  This increase in margin is due primarily tothe Company’s continuing efforts to effectively manage and reduce productioncosts in both divisions.

 

***Operating Expenses***

 

Total operating expenses increased $34,000 or4.2% for the three months ended March 31, 2005 when compared to the same periodof the prior year.  Of this increase, theControls Division contributed $81,000 or 14.5%, offset by a decrease in ADS of $21,000or 9.5%, and INV contributed a decrease of $26,000 or 100%.

 

Selling and marketing costs decreased $6,000or 2.2% for the three months ended March 31, 2005 when compared to the sameperiod in 2004.  Of the decrease for thethree months ended March 31, 2005, the Controls Division contributed anincrease of $27,000 or 12.3%, which was offset by a decrease from ADS of$33,000 or 34.7%.  Marketingcommunications development for product launches, new literature, and addevelopment are the predominant expenses in the increase for the ControlsDivision.  The decrease in ADS isprimarily due to less personnel.

 

General and administrative costs increased$8,000 or 2.5% for the three months ended March 31, 2005 compared to the sameperiod in 2004.  Of this increase, theControls Division contributed an increase of $34,000 or 13.2%, offset by adecrease in INV of $26,000 or 100%.  Theoverall increase in general and administrative costs from the Controls Divisionwas due to a few key expenses, mainly general liability insurance, and somepersonnel costs.

 

Research and development costs increased$33,000 or 19.3% for the three months ended March 31, 2005 compared to the sameperiod in 2004.  Of the increase, theControls Division contributed $21,000 or 25.9%, and ADS contributed an increaseof $12,000 or 13.3%.  The increase in theControls Division was due to increased costs of product development and producttesting.  The increase in ADS was due toincreased personnel costs associated with software development.

 

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***Non-Operating Income (Loss)***

 

Non-operating income decreased by $113,000for the three-month period ended March 31, 2005 compared to the same period for2004.

 

Gain on the sale of investment securities decreased$189,000 for the three month period ended March 31, 2005, compared to the sameperiod in 2004.  This decrease is adirect result of a lower volume of August Technology stock sold.  For the three month period ended March 31,2005, 11,950 shares of August Technology stock were sold with an average saleprice of $11.46 per share, compared to the same period in 2004 in which 15,000shares of August Technology stock were sold with an average sale price of$22.19 per share.

 

Interest income increased $21,000 or 190.9%when comparing the three months ended March 31, 2005 to the same period in2004. This increase was due to the higher interest rates on treasury bills.

 

Equity in losses of equity method investeedecreased $54,000 or 83.1% for the three months ended March 31, 2005 whencompared to the same period in 2004. Please refer to Note 6 to the Company’s interim financial statementsincluded in this report for more information.

 

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

 

Income before income taxes decreased $138,000to an income before tax of $78,000 for the three-month period ended March 31,2005 compared to the same period in 2004.

 

The Controls Division had income beforeincome taxes of $84,000 for the three months ended March 31, 2005 compared to $76,000for the same period in 2004, an increase of $8,000.  In addition to the increased sales for theControls Division, our overall efforts to reduce operating expenses contributedto the increase in net income before income taxes.

 

ADS had net loss before income taxes of $37,000for the three months ended March 31, 2005 compared to the net loss beforeincome taxes of $14,000 for same period in 2004.  This decrease in net income before income taxis due to decreased sales in this division.

 

Investment income from investment securities decreased$123,000 to an income before income taxes of $31,000 for the three months endedMarch 31, 2005 compared to the same period in 2004.  This decrease is primarily due to loweredAugust Technology stock sales when comparing the three months ended March 31,2005 to the same period in 2004.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Cash and cashequivalents were $6,516,000 at March 31, 2005 and $6,464,000 at March 31, 2004.  Cash provided by operating activities of $56,000 forthe three months ended March 31, 2005 is primarily a result of our netoperating loss adjusted for non-cash charges.

 

Cash providedby investing activities was $114,000 for the three month period ended March 31,2005 and $333,000 for the same period in 2004.  Proceeds from the sale ofinvestments for the three months ended March 31, 2005 decreased to $136,000from $449,000 when compared to the same period in 2004.

 

Cash used infinancing activities was $118,000 and $97,000 for the three months ended March31, 2005 and March 31, 2004, respectively. During the three months ended March 31, 2005 and 2004, the Company paidaggregate dividends of $128,000 and $127,000, 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 657,765 sharesof August Technology Corporation and 2,207,036 shares of PPT Vision, Inc. bothof which are listed on a Nasdaq stock market. The investment in PPTV is accounted for under the equity method ofaccounting.  These stocks are subject tofluctuations in price and could have a negative effect on the liquidity of theCompany.

 

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**FORWARD-LOOKING STATEMENTS**

 

This Form 10-QSB contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934, including statementsregarding the Company’s expectations, beliefs, intentions or strategiesregarding the future.  Forward-lookingstatements include, but are not limited to, statements regarding the extent andtiming of future revenues and expenses and customer demand, the market value ofour investment securities, future financial condition and availability ofcapital resources, changes in worldwide general economic conditions, cyclicalcapital spending by customers, the Company’s ability to keep pace withtechnological developments and evolving industry standards, worldwidecompetition, and the Company’s ability to protect its existing intellectualproperty from challenges from third parties and other factors.  Any statement that is not based solely uponhistorical facts, including strategies for the future and the outcome of eventsthat have not yet occurred, is considered a forward-looking statement.

 

All forward-looking statements in thisdocument are based on information available to the Company as of the datehereof, and the Company assumes no obligation to update any suchforward-looking statements.  It isimportant to note that the Company’s actual results could differ materiallyfrom those in such forward-looking statements. The forward-looking statements of the Company are subject to 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 31,2004, filed with the Securities and Exchange Commission.

 

**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 “ExchangeAct”)).  Based on this evaluation, theprincipal executive officer and principal financial officer concluded that theCompany’s disclosure controls and procedures are effective to ensure thatinformation required to be disclosed by the Company in reports that it files orsubmits under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rulesand 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.

 

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**PART II – OTHER INFORMATION**

 

**Item 6.  Exhibits**

 

(a)           Exhibits - See Exhibit Indexfollowing signature page.

 

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**SIGNATURES**

 

In accordance with the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
| **Electro-Sensors, Inc.** |                                                      |
|---------------------------|-----------------------------------------------------------|
|                      |                                                      |
| May 16, 2005              | /s/ Bradley D. Slye                                       |
|                      | Bradley D. Slye                                           |
|                      | Chief Executive Officer and Principal  Accounting Officer |

 

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**EXHIBITINDEX**

 

**ELECTRO-SENSORS, INC.**

 

**FORM 10-QSB FOR QUARTER ENDED March 31, 2005**

 
| **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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