10-K 1 else151002_10k.htm FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2014

Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934   
   
 
For the fiscal year ended December 31, 2014
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
Commission file number 000-09587


 ELECTRO-SENSORS, INC.
(Exact name of registrant 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, including zip code)
     
(952) 930-0100
(Registrant’s telephone number)
     
Securities registered under Section 12(b) of the Exchange Act:
Common Stock, $0.10 par value, registered on the NASDAQ Capital Market
Securities registered under Section 12(g) of the Exchange Act: None
 

 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.  Yes ☐ No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of  registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐   Accelerated filer ☐
Non-accelerated filer   ☐ (Do not check if a smaller reporting company)   Smaller reporting company ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ☐ Yes  ☒ No

The aggregate market value of the voting stock held by non-affiliates (persons other than officers, directors, or holders of more than 5% of the outstanding stock) of the registrant was approximately $7,000,000 based upon the closing price of the Common Stock as reported on The Nasdaq Stock Market® on June 30, 2014.

The number of shares outstanding of the registrant’s Common Stock, $0.10 par value, on March 13, 2015 was 3,395,521.

DOCUMENTS INCORPORATED BY REFERENCE
Certain information called for by Part III of this Form 10-K is incorporated by reference from the registrant’s Definitive Proxy Statement, which will be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.



 

1


 
ELECTRO-SENSORS, INC.
Form 10-K for the Year Ended December 31, 2014
TABLE OF CONTENTS
     
   
 
3
 
7
 
7
 
7
 
8
     
   
 
8
 
8
 
9
 
12
 
13
 
34
 
34
 
34
     
   
 
35
 
35
 
35
 
36
 
36
     
   
 
36
     
 
37
 

2


Table of Contents

 
 
 
Introduction

Electro-Sensors, Inc. (“we,” “us,” “our,” the “Company” or “ESI”) is engaged in manufacturing and selling industrial production monitoring and process control systems.

In addition, through our subsidiary ESI Investment Company, we periodically make strategic investments in other businesses and companies, primarily when we believe that these investments will facilitate the development of technology complementary to our existing products. Although we invest in other businesses and companies through our subsidiary ESI Investment Company, we do not intend to become an investment company and intend to remain primarily an operating company.  As of March 12, 2015, our primary investment is 49,066 shares of Rudolph Technologies, Inc., which is accounted for using the available-for-sale method.

Unless indicated otherwise, the terms “Company” and “ESI” when used herein, include Electro-Sensors, Inc. and its consolidated subsidiaries. As of December 31, 2014, ESI had two consolidated subsidiaries: ESI Investment Company and Senstar Corporation.  Senstar Corporation has no business operations.

ESI was incorporated in Minnesota in July 1968.  Our executive offices are located at 6111 Blue Circle Drive, Minnetonka, Minnesota, 55343-9108.  Our telephone number is (952) 930-0100.

Products

We manufacture and sell several different types of monitoring systems that measure actual machine production and operation rates, as well as systems that regulate the speed of related machines in production processes.

Our original products—speed monitoring systems—compare machine revolutions per minute or speed against acceptable rates as determined by a customer. The monitors generally have the same relative operating principle and use a non-contacting sensing head that translates the speed of a rotating shaft into analog readouts. The systems vary in complexity, from a simple system that detects slow-downs or stoppages, to more sophisticated systems that warn of deviations from precise tolerances and that permit various subsidiary operations to be determined through monitoring the shaft speed.

The speed monitoring systems also include a line of digital products that translate sensor impulses from its production monitoring systems into digital readouts indicating production counts or rates, such as parts, gallons, or board feet.  The speed monitoring systems also include alarm systems, tachometers, and other devices that translate impulses from the sensors into alarm signals, computer inputs, or digital displays that are usable by the customer.

Three production monitoring devices that do not operate by measuring shaft speeds are also in the speed monitoring systems product line. These devices are the tilt switch, vibration monitor, and slide gate position monitor. A tilt switch is designed to alert the operator when a storage bin or production system reaches a certain capacity (e.g., when grain fills a silo).  A vibration monitor will alert an operator when the vibration of a machine in a production system exceeds or is below a specified level.  The slide gate position monitor is used in plant operations to provide feedback of the position of a slide gate. As part of our Electro-Sentry Hazard Monitoring system, we also have temperature sensors that are used to monitor bearing temperature and belt misalignment.

We have several products used in drive control systems that regulate the speed of motors on related machines in a production sequence to ensure that the performances of various operations are coordinated.  The products consist of a line of digital control products for motors that require a complete closed loop PID (Proportional Integral Derivative) control. The closed loop controllers coordinate production speed among process motors and reduce waste.

We have a sales agreement with Motrona GmbH, a West German manufacturer of control and interface devices, giving us rights to distribute its products in the United States.  These products interface with our products on various applications.

We believe that a wide variety of organizations can achieve significant savings in both time and materials by adding production monitoring and drive control technology to existing processes to coordinate the operation of related machines. Our products are sold into both the “retro-fit” market and into new manufacturing or processing systems.

3


Table of Contents


In 2008, we introduced our Electro-Sentry 1 hazard monitoring system, which integrates our sensors for montioring temperature, belt misalignment, and shaft speed with a programmable logic controller and touch screen interface to create a complete system for hazard monitoring.  The system enables our customers to locate which part of their material handling system is operating incorrectly, typically in less than ten seconds, by using visual diagrams on a touch screen.  In 2012, we introduced the Electro-Sentry 16 hazard monitoring system and added new features to the Electro-Sentry 1 system.

In 2013, the Company added ION Frequency/Discrete-In, a product that  allows users to remotely acquire shaft speed from  up to 12 pulse-frequency-output shaft speed sensors, or discrete state for up to 12 switches/sensors, or any combination (up to 12) of both.  This is our third ION product, completing the ION product line to support all ESI sensor products and providing the customer high-speed/accuracy signal acquisition at low cost and saved wiring costs.  The Company also expanded the Series 18 shaft speed sensors to include additional housings and connection options to reach a broader range of installations.  In addition, product upgrades for sensing capability and ruggedness were introduced on the Hall-effect sensors.

In 2014, we introduced a process meter for analog output sensors, such as our TT420, temperature sensors, ST420, speed sensors, and SG1000, slide gate position monitor.

On February 18, 2014, the Company purchased the Insta-Link wireless hazard technology monitoring system and product family, together with related technology and intellectual property rights,  from Harvest Engineering Inc., a privately held Illinois-based corporation, and its affiliated parties and owners (“Harvest”). The Company is marketing the wireless hazard monitoring products under its new HazardPROTM product line and manufacturing and servicing these products at its Minnetonka, Minnesota facility.  The Company agreed to pay $1,200,000 for the product line, of which $400,000 was paid at closing, and additional payments of $400,000 will be paid on each of the first and second anniversary of the closing.  Harvest may earn up to an additional $550,000 of purchase price, depending upon the achievement of revenue measures during the four calendar years following the closing.

We expect to continue to expend resources in new product development and the marketing of new and existing products for use in a wide variety of monitoring applications.

Our customers have diverse applications for our products in the grain, feed, bio-fuels, power generation, water utilities and waste water treatment, mining, chemical, and other processing areas.  We are continuing to look for new industries to expand sales and may also consider acquiring compatible businesses as part of our growth strategy.  Our corporate web site provides significant information and product application knowledge to existing and prospective customers and also direct knowledge to our sales partners.  Information on our website is not incorporated by reference herein and is not a part of this Form 10-K.

Marketing and Distribution

We sell our products primarily through both our internal sales team and a number of manufacturer’s representatives and distributors located throughout the United States, Canada, Mexico, Chile, Colombia, Guatemala, Peru, United Kingdom, Egypt, Saudi Arabia, Australia, China, Korea, Malaysia, Philippines, and Singapore.  Sales to customers outside the United States represent approximately 14% of sales.  The sensing and control units are sold under the Electro-Sensors, Inc. brand as a range of products from simple sensors to complex motor speed controllers.  These products are sold to businesses in a wide variety of industries, including grain, feed, biofuels, food processing, chemicals, agricultural, mining, utility, forest products, steel, tire, glass and electronics.  Any business that uses machinery with a rotating shaft is a potential customer.
 
We advertise in national industrial periodicals that cover a range of industrial products and attend several local, national and international tradeshows designated for the industry throughout the year.  We also use our corporate website and other related industry websites for advertising and marketing purposes.
 
Competition

We face substantial competition in the sale of our production monitoring systems from a broad range of industrial and commercial businesses.   Many of these competitors are well established and larger than us in terms of total sales volume. Among our larger competitors are Danaher Controls, Red Lion Controls, 4B Elevator Components Ltd., and Durant Corporation.  We believe our competitive advantages include our products superior design and quality, the fact that our products are sold as ready-to-install units, and they can be used in a wide range of applications.  Our major disadvantages include the fact that our major competitors are much larger, have a broader variety of sensing instruments, and have larger sales forces and established names.
 

4


Table of Contents

 
Suppliers

We purchase parts and materials for our systems from various manufacturers and distributors. In some instances, these materials are manufactured in accordance with proprietary designs.  Multiple sources of these parts and materials are generally available, and we are not dependent on any single source for these supplies and materials. We have not experienced any significant problem of short supply or delays from our suppliers.

Customers

We are not dependent upon a single or a few customers for a material (10% or more) portion of our sales.

Patents, Trademarks and Licenses

The Company relies on a combination of patent, trademark, and trade secret laws to establish proprietary right in its products.

The name “Electro-Sensors” is a trademark registered with the U.S. Patent and Trademark Office (“USPTO”), as Reg. No. 1,142,310. We believe this trademark has been and will continue to be useful in developing and protecting market recognition for our products.  We established the HazardPROTM trademark in the first quarter of 2014 and intend to register the trademark with the USPTO during 2015.

We hold six patents relating to our production monitoring systems.  The Company believes strongly in protecting its intellectual property and has a long history of obtaining patents, when available, in connection with its research and product development programs.  The Company also relies upon trade secrets and proprietary know-how.

The Company seeks to protect its trade secrets and proprietary intellectual property, including know-how, in part, through confidentiality agreements with employees, consultants, and other parties.  We cannot ensure, however, that these agreements will not be breached, that the Company would have adequate remedies for any breach, or that the Company’s trade secrets will not otherwise become known or independently developed by competitors.
 
Business Development Activities

We continue to seek growth opportunities, both internally through our existing portfolio of products, technologies and markets, as well as externally through technology partnerships or related-product acquisitions.

Governmental Approvals

We are not required to obtain governmental approval of our products.

Effect of Governmental Regulations

We do not believe that any existing or proposed governmental regulations will have a material effect on our business.

Research and Development

We invest in research and development programs to develop new products in related markets and to integrate state of the art technology into existing products.  We incurred research and development expenses of $810,000 and $560,000 during 2014 and 2013, respectively.  Our development projects are undertaken based upon the identified specific needs of our customer base.

Our future success is dependent in part upon our ability to develop new products in our varying segments.  Difficulties or delays in our ability to develop, produce, test and market new products could have a material adverse effect on future sales growth.

Compliance with Environmental Laws

Compliance with federal, state and local environmental laws has only a nominal effect on current or anticipated capital expenditures and has had no material effect on earnings or on our competitive position.
 

5


Table of Contents


Employees

As of March 13, 2015, we had 33 employees, all of whom are full-time.  We believe that our relations with our employees are good.  None of our employees are members of unions.
 
Our ability to maintain a competitive position and to continue to develop and market new products depends, in part, on our ability to retain key employees and qualified personnel.  If we are unable to retain our key employees, or recruit and train others, our product development, marketing and sales could be negatively impacted.

Fluctuations in Operating Results.

We have experienced fluctuations in our operating results in the past, and may experience fluctuations in the future, which may affect the market price of our Common Stock.  Sales can fluctuate as a result of a variety of factors, many of which are beyond our control. Some of these factors are: product competition and acceptance, timing of customer orders, cancellation of orders, the mix of products sold, downturns in the market and economic disruptions.  Because fluctuations can happen, we caution investors that results of our operations for preceding periods may not be indicative of how we will perform in the future.  We cannot ensure that we will experience revenue or earnings growth.

Further, investments held by our subsidiary, ESI Investment Company, are subject to significant positive and negative changes in value. In particular, our significant investment in Rudolph Technologies, Inc. has experienced substantial value fluctuations, both negative and positive, which are expected to continue.  Our current intention is to continue to gradually liquidate our investment securities.

Expending Funds for Changes in Industry Standards, Customer Preferences or Technology.

Our business depends upon periodically introducing new and enhanced products and solutions for customer needs. Our product development requires us to commit financial resources, personnel and time, usually in advance of significant market demand for these products. In order to compete, we must anticipate both future demand and the technology available to meet that demand.  We cannot ensure that our research and development efforts will lead to new products or product innovations that can be made available to or will be accepted by the market.

6


Table of Contents

 
Cautionary Statements

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by us or on our behalf. We have made, and may continue to make, forward-looking statements with respect to our business and financial matters, including statements contained in this document, other filings with the Securities and Exchange Commission, and reports to shareholders. Forward-looking statements generally include discussion of current expectations or forecasts of future events and can be identified by the use of terminology such as “believe,” “estimate,” “expect,” “intend,” “may,” “could,” “will,” and similar words or expressions. Any statement that does not relate solely to historical fact should be considered forward-looking.

Our forward-looking statements generally relate to our growth strategy, future financial results, product development and sales efforts. Forward-looking statements are made throughout this Annual Report, but primarily in this Item 1 and Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, and include statements relating to management’s intentions that we not become an investment company, our expectations and intentions with respect to growth, statements relating to management’s beliefs with respect to our marketing and product development, our expectations and beliefs with respect to the value of our intellectual property, our beliefs with respect to our competitive position in the marketplace, our beliefs with respect to the effect of governmental regulations on our business, our beliefs with respect to our employee relations, our intention with respect to gradually liquidating our investment securities to finance working capital needs, our expectations and beliefs with respect to the future performance of our investment securities, the adequacy of our facilities, expansion of our number of manufacturer’s representatives and exclusive distributors, our intention to develop new products, the possibility of acquiring compatible businesses as part of our growth strategy, and our expectations with respect to our cash requirements and use of cash.

Forward-looking statements cannot be guaranteed and actual results may vary materially due to the uncertainties and risks, known and unknown, associated with such statements, including our ability to successfully develop new products and manage our cash requirements. We undertake no obligations to update any forward-looking statements. We wish to caution investors that the following important factors, among others, in some cases have affected and in the future could affect our actual results of operations and cause these results to differ materially from those anticipated in forward-looking statements made in this document and elsewhere by us or on our behalf. We cannot foresee or identify all factors that could cause actual results to differ from expected or historical results. As such, investors should not consider any list of these factors to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions. These factors include our ability to:

 
successfully develop new products;

 
successfully integrate the wireless hazard technology and product line we purchased in February 2014;

 
quickly and successfully adapt to changing industry technological standards;

 
comply with existing and changing industry regulations;

 
manage cash requirements;

 
attract and retain new manufacturer’s representatives and distributors;

 
attract and retain key personnel, including senior management;

 
adapt to changing economic conditions and manage downturns in the economy in general; and

 
keep pace with competitors, some of whom are much larger and have substantially greater resources than us.
 
 
Not required for smaller reporting companies.
 
We own and occupy a 25,400 square foot facility at 6111 Blue Circle Drive, Minnetonka, Minnesota 55343-9108. All operations are conducted within this facility.  The facility is in excellent condition and we continue to maintain and update the facility as necessary.  We believe the facility will be adequate for our needs in 2015.
 
 
We are not the subject of any legal proceedings as of the date of this filing.  We are not aware of any threatened litigation.
 

7


Table of Contents

 
Item 4. Mine Safety Disclosures.

Not applicable.
 
 
Our Common Stock trades on the Nasdaq Capital Market of The Nasdaq Stock Market® under the symbol “ELSE.” The following table sets forth the quarterly high and low reported last sales prices for our Common Stock for each period indicated as reported on the Nasdaq system.

 
Period
 
High
   
Low
 
               
2014
First Quarter
  $ 4.33     $ 3.94  
 
Second Quarter
  $ 4.42     $ 3.86  
 
Third Quarter
  $ 4.25     $ 3.42  
 
Fourth Quarter
  $ 4.20     $ 3.09  
                   
2013
First Quarter
  $ 4.62     $ 3.67  
 
Second Quarter
  $ 4.66     $ 4.04  
 
Third Quarter
  $ 4.83     $ 4.00  
 
Fourth Quarter
  $ 4.59     $ 3.85  
 
Based on data provided by our transfer agent, as of March 13, 2015, we had 77 shareholders of record who held 905,581 shares of the Company’s common stock.  In addition, nominees held an additional 2,489,940 shares for approximately 304 shareholders holding shares in street name.

The Company had paid cash dividends for a number of years, paying $272,000 in 2013 by paying cash dividends of $.04 per share on February 22, 2013 and May 24, 2013.  The Board did not pay dividends in the third and fourth quarter of 2013 and in February 2014, the Board formally suspended the dividend to give the Company flexibility to pursue opportunities for future growth.  The Board will continue to assess its capital resources and its working capital and liquidity needs, as well as strategic opportunities.  The Company will consider various options for increasing shareholder value.  These options may include acquisitions, partnerships, purchasing our own shares in the open market and in privately negotiated transactions, and resuming the payment of cash dividends.

From time to time, we may be required to repurchase some of our equity securities as a result of obligations described in Note 12 to our 2014 consolidated financial statements.  We did not repurchase any equity securities during the years ended December 31, 2014 and 2013, respectively.

The information required by Item 201(d) is set forth in Item 12 of this Form 10-K.
 
 
Not required for smaller reporting companies.
 

8


Table of Contents

 
The following discussion should be read in conjunction with our consolidated financial statements and related notes. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated due to various factors discussed under “Forward-Looking Statements” elsewhere in this Annual Report on Form 10-K.

RESULTS OF OPERATIONS

The following table contains selected financial information, for the periods indicated, from our consolidated statements of comprehensive income expressed as a percentage of net sales.
 
   
Year Ended December 31,
 
   
2014
   
2013
 
Net Sales
    100.0 %     100.0 %
Cost of Goods Sold
    42.0       42.8  
Gross Profit
    58.0       57.2  
                 
Operating Expenses
               
Selling and marketing
    22.1       22.0  
General and administrative
    18.9       20.7  
Research and development
    11.5       8.6  
Total Operating Expenses
    52.5       51.3  
                 
Operating Income
    5.5       5.9  
                 
Non-operating Income (Expense)
               
Gain on sale of available-for-sale securities
    16.5       8.1  
Other income
    0.2       0.2  
Interest income
    0.0       0.1  
Interest expense
    (0.2 )     0.0  
Total Non-operating Income, Net
    16.5       8.4  
                 
Income before Income Taxes
    22.0       14.3  
                 
Income Taxes
    6.5       3.5  
                 
Net Income
    15.5 %     10.8 %
 
The following paragraphs discuss the Company’s performance for years ended December 31, 2014 and 2013.
 
Comparison of 2014 vs. 2013

Net Sales

Net sales increased $500,000 or 7.6%, to $7,041,000 in 2014 from $6,541,000 in 2013.  This increase was primarily driven by a 13.6% growth in sales to customers in the North Central U.S. led by strong performances in our agriculture and bulk material handling industry segments.  We believe much of this growth was generated by record setting corn and soybean volumes which resulted in a strong demand for storage, processing, and handling facilities.

On a product line basis, our Slide Gate Monitor family of products continued to be well received by our customers and achieved a greater than 30% increase in sales as compared to 2013. These products provide critical position data to our OEM and system integrator customers that typically supply systems to the bulk materials handling industry.

Additionally, our international business continues to represent an important part of our business strategy and represented approximately 14% of revenue.  Furthermore, during 2014 we sold and shipped into 46 countries.

Gross Profit

Gross profit for 2014 was 58.0% compared to 57.2% in 2013.  The slight increase in the gross margin was primarily due to a slight shift in the mix of products sold, and our focus on decreasing manufacturing costs.
 

9


Table of Contents

 
Operating Expenses

Total operating expenses increased by $341,000, or 10.2%, to $3,695,000 in 2014 compared to $3,354,000 in 2013.  This increase was due to the following:

 
Selling and marketing expenses increased by $114,000, or 7.9%, to $1,556,000 in 2014 compared to $1,442,000 in 2013, but only increased slightly as a percentage of sales to 22.1% from 22.0%.  The increase was due to increased wages and benefit expense related to additional sales personnel and increased outside sales representative commissions due to higher sales, partially offset by decreases in contract personnel.

 
General and administrative expenses decreased by $23,000, or 1.7%, to $1,329,000 in 2014 compared to $1,352,000 in 2013, and decreased as a percentage of sales to 18.9% from 20.7%.  The decrease was due primarily to a higher level of noncash compensation expense related to stock option grants to non-employee directors and our chief executive officer and legal fees incurred in 2013 versus 2014.  The decreases were partially offset by higher amortization expense associated with the February 2014 acquisition of the HazardPRO technology.  Stock-based compensation for 2014 was approximately $67,000 compared to approximately $162,000 in 2013.

 
Research and development expenses increased $250,000, or 44.6%, to $810,000 in 2014 compared to $560,000 in 2013, and increased as a percentage of sales to 11.5% from 8.6%.  The 2014 increase resulted from higher wages and benefits due to changes in management responsibilities, lab testing fees for the certification of new products for use in hazardous locations, and the development of new product prototypes.

Operating Income

Operating income increased by $2,000 or 0.5%, to $391,000 in 2014 from $389,000 in 2013, but decreased slightly as a percentage of sales to 5.5% from 5.9%, due primarily to the sales and gross profit increases, offset by the increase in operating expenses discussed above, particularly research and development.

Non-Operating Income

ESI Investment Company continues to provide us with an alternative source of earnings through investments in available-for-sale securities and other investments.  We intend to remain an operations-based company. Our investments in available-for-sale securities are subject to significant positive and negative changes in value.  In addition to gains from the sale of investments, we also realize interest income from certain short-term holdings.

Non-operating income increased by $614,000 to $1,163,000 in 2014 from $549,000 in 2013, primarily as a result of additional realized gains on sales of shares of Rudolph Technologies, Inc.  The Company is in the process of slowly liquidating that investment.

Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders’ equity.  Dividends on marketable equity securities are recognized on the ex-dividend date.

Realized gains and losses, including losses from declines in value of specific securities determined by management to be other-than-temporary, are included in the statement of comprehensive income.  Realized gains and losses are determined on the basis of the specific securities sold.
 
Net Income After Tax

We reported net income of $1,094,000 in 2014 as compared to net income of $706,000 in 2013, an increase of $388,000, or 55.0%.  Basic and diluted earnings per share were $0.32 and $0.30, respectively, in 2014, compared to basic and diluted earnings per share of $0.20 in 2013.
 

10


Table of Contents

 
OFF-BALANCE SHEET ARRANGEMENTS

We are not a party to any off-balance sheet transactions, arrangements or obligations that have, or are reasonably likely to have, a material effect on our financial condition, changes in the financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents were $1,190,000 and $1,505,000 at December 31, 2014 and 2013, respectively.  The decrease was mainly   due to net cash used in investing activities, as described below.  Working capital was $10,136,000 at 2014 year end compared to $11,068,000 at 2013 year end.

Cash generated from 2014 operating activities was $263,000, compared to $127,000 generated in 2013, an increase of $136,000.  The increase was primarily a result of a decrease in trade receivable, an increase in accounts payable and income tax accruals, partially offset by an increase in inventories.  The decrease in trade receivables is due to decreased sales in the fourth quarter of 2014.  The increase in accounts payable is due to the timing of inventory purchases.  The net change in income taxes was due to an increase in the payable balance of $78,000 at December 31, 2014 when compared to the prior year and a decrease in the payable of $314,000 at December 31, 2013 when compared to the prior year.  The 2014 payable increase resulted from the increase in the gain of available-for-sale securities when comparing 2014 to 2013.  The Company paid the 2012 tax year balance due in March 2013.  Those changes were partially offset by an increase in inventory due to increased sales and the purchase of HazardPROTM components.

Cash used in 2014 investing activities was $581,000, compared to $539,000 cash generated from investing activities in 2013.  We received $1,178,000 on the sale of available-for-sale securities during 2014 compared to $536,000 during 2013.  During 2014, the Company’s sales and purchases of Treasury Bills with maturity dates greater than three months resulted in net purchases of $1,313,000, compared to net proceeds of $26,000 in 2013.  In addition, the Company acquired the Harvest Engineering, Inc. wireless hazard monitoring technology and Insta-Link product families in February 2014, paying $400,000 and financing the remaining purchase price through a seller-financed note. We purchased $46,000 and $23,000 of property and equipment in the years ended December 31, 2014 and 2013, respectively.

Cash from financing activities in 2014 was $3,000 compared to cash used in financing activities of $263,000 for 2013.  During 2013, we paid aggregate dividends of $272,000.  During 2014 and 2013, we had $3,000 and $9,000, respectively, in stock purchases under our 1996 Employee Stock Purchase Plan.

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

Our primary investment is 122,649 and 231,336 shares of Rudolph Technologies, Inc. (“Rudolph”), as of December 31, 2014 and 2013, respectively, listed on the Nasdaq stock market.  We account for the Rudolph investment using the available-for-sale method.  The fair value of the Rudolph investment totaled $1,254,000 and $2,716,000 as of December 31, 2014 and 2013, respectively.  Our Rudolph shares are subject to fluctuations in price and could have a negative effect on our liquidity.  Liquid securities are periodically sold as deemed appropriate by management. The market value of the Rudolph stock as of March 12, 2015 was approximately $584,000.
 

11


Table of Contents

 
CRITICAL ACCOUNTING ESTIMATES
 
The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make decisions based upon estimates, assumptions, and factors it considers relevant to the circumstances. Those decisions include the selection of applicable accounting principles and the use of judgment in their application, the results of which impact reported amounts and disclosures. Changes in economic conditions or other business circumstances may affect the outcomes of management’s estimates and assumptions.

Significant estimates, including the underlying assumptions, consist of the economic lives of property and equipment, realizability of accounts receivable, and valuation of deferred tax assets/liabilities, inventory, investments, allocation of the purchase price for acquired tangible and intangible assets, contingent earn-out and stock compensation expense.  It is at least reasonably possible that these estimates may change in the near term.

Economic lives of long-lived assets
We estimate the economic useful life of long-lived assets used in the business.  Expected asset lives may be shortened or an impairment may be recorded based on a change in the expected use of the asset.

Realizability of accounts receivable
We estimate our allowance for doubtful accounts based on prior history and the aging of our accounts receivable.   We are unable to predict which, if any, of our customers will be unable to pay their open invoices at a future date.

Valuation of deferred tax assets/liabilities
We estimate our deferred tax assets and liabilities based on current tax laws and rates.  The tax laws and rates could change in the future to either disallow the deductions or increase/decrease the tax rates.

Valuation of inventory
We purchase inventory based on estimated demand of products.  It is possible that the inventory we have purchased will not be used in the products that our customers need or will not meet future technological requirements.

Valuation of investments
Our investments in equity securities are valued at market prices in an open market.  The prices are subject to the normal fluctuations that could be either negative or positive.

Valuation of stock-based compensation expense
We estimate the expected life and forfeiture rates of stock options granted when calculating the value of options using the Black-Sholes-Merton model.  The actual life and forfeiture rate could be different from what we estimated.

Allocation of the purchase price for acquired tangible and intangible assets
We estimated the noncompete agreement using a discounted cash flow model.  We estimated the value of the deferred service costs based on the estimated time and cost to complete.  The balance of the purchase price was allocated to the technology purchased.  It is possible that we over valued the components and that an impairment may be recorded to reflect the proper value.

Valuation of the contingent earn-out
We estimated the probability of meeting the revenue targets over the measurement period to determine the fair value of the contingent liability.  The actual payout could be more or less than what we have estimated.
 
Additional information regarding our significant accounting policies is provided below in Part II, Item 8, Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements, Note 1, Nature of Business and Significant Accounting Policies.
 
 
Not applicable.
 

12


Table of Contents

 
 
Item 8.  Financial Statements and Supplementary Data.
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


13


Table of Contents

 
(BOULAY LOGO)
 
 
Board of Directors
Electro-Sensors, Inc. and Subsidiaries
Minnetonka, Minnesota

We have audited the accompanying consolidated balance sheets of Electro-Sensors, Inc. and Subsidiaries (the Company) as of December 31, 2014, and 2013, and the related consolidated statements of comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2014. Electro-Sensors, Inc. and Subsidiaries’ management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Electro-Sensors, Inc. and Subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America.
 
/s/ Boulay PLLP
Certified Public Accountants
 
Minneapolis, Minnesota
March 18, 2015

14


Table of Contents


CONSOLIDATED BALANCE SHEETS
(in thousands except share and per share amounts)
             
   
December 31
 
   
2014
   
2013
 
ASSETS
           
             
Current assets
           
             
Cash and cash equivalents
  $ 1,190     $ 1,505  
Treasury bills
    6,542       5,227  
Available-for-sale securities
    1,256       2,718  
Trade receivables, less allowance for doubtful accounts of $10 and $8, respectively
    738       746  
Inventories
    1,224       1,060  
Other current assets
    163       136  
                 
Total current assets
    11,113       11,392  
                 
Intangible assets, net
    1,505       0  
                 
Property and equipment, net
    1,146       1,217  
                 
Total assets
  $ 13,764     $ 12,609  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Current liabilities
               
                 
Current maturities of note payable
  $ 381     $ 0  
Accounts payable
    126       59  
Accrued expenses
    392       265  
        Income tax payable
    82       0  
                 
Total current liabilities
    981       324  
                 
Long-term liabilities
               
                 
Note payable – long term
    390       0  
Contingent earn-out
    472       0  
Deferred income tax liability
    391       1,022  
                 
Total long-term liabilities
    1,253       1,022  
 
               
Commitments and contingencies
               
                 
Stockholders’ equity
               
                 
Common stock par value $0.10 per share; authorized 10,000,000 shares; issued and outstanding: 3,395,521 and 3,394,707  shares, respectively
    339       339  
Additional paid-in capital
    1,816       1,746  
Retained earnings
    8,641       7,547  
Accumulated other comprehensive income (unrealized gain on available-for-sale securities, net of income tax)
    734       1,631  
                 
Total stockholders’ equity
    11,530       11,263  
                 
Total liabilities and stockholders’ equity
  $ 13,764     $ 12,609  
See Notes to Consolidated Financial Statements
 

15


Table of Contents

 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands except share and per share amounts)
       
   
Years ended December 31,
 
   
2014
   
2013
 
             
Net Sales
  $ 7,041     $ 6,541  
Cost of Goods Sold
    2,955       2,798  
                 
Gross Profit
    4,086       3,743  
                 
Operating Expenses
               
                 
Selling and marketing
    1,556       1,442  
General and administrative
    1,329       1,352  
Research and development
    810       560  
                 
Total Operating Expenses
    3,695       3,354  
                 
Operating Income
    391       389  
                 
Non-operating Income (Expense)
               
                 
Gain on sale of available-for-sale securities
    1,163       530  
Other income
    15       14  
Interest income
    2       5  
Interest expense
    (17 )     0  
                 
Total Non-operating Income, Net
    1,163       549  
                 
Income before Income Taxes
    1,554       938  
                 
Income Taxes
    460       232  
                 
Net Income
    1,094       706  
                 
Other Comprehensive Income (Loss)
               
Change in unrealized value of available-for-sale securities, net of income tax
    (176 )     (262 )
Reclassification of gains included in net income, net of income tax
    (721 )     (329 )
                 
Net decrease in comprehensive income
    (897 )     (591 )
                 
Net Comprehensive Income
  $ 197     $ 115  
                 
Net Income per share data
               
                 
Basic
               
Net income per share
  $ 0.32     $ 0.20  
Weighted average shares
    3,395,510       3,394,208  
                 
Diluted
               
Net income per share
  $ 0.30     $ 0.20  
Weighted average shares
    3,654,382       3,496,873  
                 
Dividends paid per common share
  $ 0.00     $ 0.08  
                 
See Notes to Consolidated Financial Statements
 

16


Table of Contents

 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands except share and per share amounts)
                                     
                           
Accumulated
       
   
 Common Stock Issued
   
Additional
          other     Total  
         
paid-in
   
Retained
   
comprehensive
    Stockholders’  
   
Shares
   
Amount
   
capital
   
earnings
   
income
    equity  
                                     
Balance, December 31, 2012
    3,391,912     $ 339     $ 1,575     $ 7,113     $ 2,222     $ 11,249  
                                                 
Other comprehensive loss
                                    (591 )     (591 )
Stock issued through the employee stock purchase plan
    2,795       0       9                       9  
Stock compensation expense
                    162                       162  
Dividend on common stock
                            (272 )             (272 )
Net income
                            706               706  
 
                                               
                                                 
Balance, December 31, 2013
    3,394,707       339       1,746       7,547       1,631       11,263  
                                                 
Other comprehensive loss
                                    (897 )     (897 )
Stock issued through the employee stock purchase plan
    814       0       3                       3  
Stock compensation expense
                    67                       67  
Net income
                            1,094               1,094  
 
                                               
Balance, December 31, 2014
    3,395,521     $ 339     $ 1,816     $ 8,641     $ 734     $ 11,530  
 
See Notes to Consolidated Financial Statements
 

17


Table of Contents

 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
       
   
Years ended December 31,
 
   
2014
   
2013
 
Cash flows from (used in) operating activities
           
             
Net Income
  $ 1,094     $ 706  
                 
Adjustments to reconcile net income to net cash from operating activities:
               
                 
Depreciation and amortization
    209       110  
Realized gain on sale of available-for-sale securities
    (1,163 )     (530 )
Allowance for doubtful accounts
    2       (2 )
Deferred income taxes
    (81 )     (71 )
Stock compensation expense
    67       162  
Other
    (1 )     (5 )
Changes in operating assets and liabilities, net of acquisition:
               
    Trade receivables
    6       (142 )
    Inventories
    (164 )     270  
    Other current assets
    18       (60 )
    Accounts payable
    67       (35 )
    Accrued expenses
    127       38  
    Accrued income taxes
    82       (314 )
                 
Net cash from operating activities
    263       127  
                 
Cash flows from (used in) investing activities:
               
                 
Proceeds from sale of available-for-sale securities
    1,178       536  
Purchase of treasury bills
    (14,184 )     (6,425 )
Proceeds from the maturity of treasury bills
    12,871       6,451  
Cash paid for acquisition
    (400 )     0  
Purchase of property and equipment
    (46 )     (23 )
                 
Net cash from (used in) investing activities
    (581 )     539  
                 
Cash flows from (used in) financing activities:
               
                 
Proceeds from issuance of common stock
    3       9  
Dividends paid
    0       (272 )
                 
Net cash from (used in) financing activities
    3       (263 )
                 
Net increase (decrease) in cash and cash equivalents
    (315 )     403  
                 
Cash and cash equivalents, beginning
    1,505       1,102  
Cash and cash equivalents, ending
  $ 1,190     $ 1,505  
                 
Supplemental cash flow information
               
Cash paid during the year for income taxes
  $ 462     $ 617  
Cash paid during the year for interest
  $ 0     $ 0  
                 
Supplemental disclosures of non-cash investment and financing activities
               
Note payable issued to fund acquisition, net of discount
  $ 771     $ 0  
                 
Contingent consideration liability recorded in connection with the acquisition
  $ 472     $ 0  

See Notes to Consolidated Financial Statements
 

18


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)

Note 1. Nature of Business and Significant Accounting Policies

Nature of business:

The accompanying consolidated financial statements include the accounts of Electro-Sensors, Inc. and its wholly-owned subsidiaries, ESI Investment Company and Senstar Corporation.  Senstar has no operations.  Intercompany accounts, transactions and earnings have been eliminated in consolidation. The consolidated entity is referred to as “the Company” or “ESI.”

Electro-Sensors, Inc. manufactures and markets a complete line of speed monitoring and motor control systems for industrial machinery. The Company uses leading-edge technology to continuously improve its products and make them easier to use, with the ultimate goal of manufacturing the industry-preferred product for every market served. The Company’s products are sold through an internal sales staff, manufacturer’s representatives, and distributors in a wide variety of manufacturers and processors who use the products to monitor process machinery operations. The Company markets its products to a variety of different industries located throughout the United States, Canada, Latin America, Europe, and Asia.

In addition, through its subsidiary ESI Investment Company, the Company periodically makes strategic investments in other businesses, primarily when the Company believes that these investments will facilitate development of technology complementary to the Company’s products. Although ESI, through its subsidiary ESI Investment Company, invests in other businesses, the Company does not intend to become an investment company and intends to remain primarily an operating company. See Note 3 for additional information regarding its investments.  The Company’s investments in securities are subject to normal market risks.

Significant accounting policies of the Company are summarized below:

Use of estimates

The preparation of the consolidated financial statements, in accordance with accounting principles generally accepted in the United States of America (US GAAP), requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Significant estimates, including the underlying assumptions, consist of the economic lives of long lived assets, realizability of accounts receivable, and valuation of deferred tax assets/liabilities, inventory, investments, allocation of the purchase price for acquired tangible and intangible assets, contingent earn-out, and stock compensation expense. It is at least reasonably possible that these estimates may change in the near term.

Cash and cash equivalents

The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.  Cash equivalents are invested in commercial paper, money market accounts and may also be invested in three month Treasury Bills.  Cash equivalents are carried at cost plus accrued interest which approximates fair value.

The Company maintains its cash and cash equivalents in primarily one bank deposit account, which, at times, may exceed federally insured limits. The Company has not experienced any losses on these accounts. The Company believes it is not exposed to any significant credit risk on cash.

Trade receivables and credit policies

Trade receivables are uncollateralized customer obligations due under normal trade terms requiring payment within 30 days from the invoice date.  Trade receivables are stated at the amount billed to the customer.  Customer account balances with invoices over 90 days are considered delinquent. The Company does not accrue interest on delinquent trade receivables.

Payments of trade receivables are allocated to the specific invoices identified on the customer’s remittance advice or, if unspecified, are applied to the earliest unpaid invoices.

19


Table of Contents


ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
The carrying amount of trade receivables is reduced by an allowance for doubtful accounts that reflects management’s best estimate of the amounts that will not be collected.  Management individually reviews all trade receivable balances that exceed 90 days from the invoice date and based on an assessment of current creditworthiness, estimates the portion, if any, of the balance that may not be collected. Management uses this information to estimate the allowance.
 
Available-for-sale securities
 
The Company’s investments consist of equity securities, primarily common stocks and government debt securities.  The estimated fair value of publicly traded equity securities is based on reported market prices, and therefore subject to the inherent risk of market fluctuations.
 
Management determines the appropriate classification of securities at the date individual investments are acquired, and evaluates the appropriateness of this classification at each balance sheet date.
 
Since the Company does not buy and sell investments with the objective of generating profits on short-term fluctuations in market price, the investments in marketable equity securities have been classified as available-for-sale. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders’ equity and within accumulated other comprehensive income. Dividends on marketable equity securities are recognized as income on the ex-dividend date.
 
Realized gains and losses, including losses from declines in value of specific securities determined by management to be other-than-temporary, are included in the statement of comprehensive income. Realized gains and losses are determined on the basis of the specific securities sold.  There were no other-than-temporary impairments recognized in the years ended December 31, 2014 and 2013.
 
Fair value measurements
 
The Company’s policies incorporate the guidance for accounting for fair value measurements of financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis.  These policies also incorporate the guidance for fair value measurement related to nonfinancial items that are recognized and disclosed at fair value in the consolidated financial statements on a nonrecurring basis.  The guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

 
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
 
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
 
Level 3 inputs are unobservable inputs for the asset or liability.

The level in the fair value hierarchy within which a fair measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety.   The Company currently has no nonfinancial or financial items that are measured on a nonrecurring basis.

The carrying value of cash equivalents, treasury bills, commercial paper, money market funds, trade receivables, accounts payable, and other financial working capital items approximate fair value at December 31, 2014 and 2013 due to the short term maturity nature of these instruments.

Inventories

Inventories include material, labor and overhead and are valued at the lower of cost (first-in, first-out) or market.

20


Table of Contents


ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
Property and equipment

Property and equipment are stated at cost. Depreciation is provided over estimated useful lives by use of the straight-line method. Maintenance and repairs are expensed as incurred.  Major improvements and betterments are capitalized.

Long-lived assets, such as property and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset.  If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value.  Fair value is determined through various valuation techniques including, but not limited to, discounted cash flow models, quoted market values and third-party independent appraisals.

Estimated useful lives are as follows
       
   
Years
 
       
Equipment
 
3-10
 
Furniture and Fixtures
 
3-10
 
Building
 
7-40
 
 
Intangible assets

Intangible assets are comprised of a noncompete agreement and the HazardPROTM technology.  The cost of intangible assets is amortized on a straight-line method over the estimated useful lives.

Revenue recognition

The Company recognizes revenue from the sale of its production monitoring equipment when persuasive evidence of an arrangement exists, the product has been picked up by common carrier, the fee is fixed and determinable and collection of the resulting receivable is reasonably assured.  The Company recognizes revenue on products sold to customers and distributors upon shipment because the contracts do not include post-shipment obligations.  The Company may offer discounts that are recorded at the time of sale.  In addition to exchanges and warranty returns, customers have limited refund rights.  Historically, returns and refunds have been minimal and immaterial to the financial statements and are generally recognized when the returned product is received by the Company.  In some situations, the Company receives advance payments from its customers.  The recognition of revenue associated with these advance payments is deferred until the product is shipped or services performed.

Advertising costs

The Company expenses advertising costs as incurred. Total advertising expense was $57 and $59 for the years ended December 31, 2014 and 2013, respectively.

Research and development

Expenditures for research and development are expensed as incurred.  The Company incurred expenses of $810 and $560 during the years ended December 31, 2014 and 2013, respectively.

21


Table of Contents


ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
Income taxes

Deferred income taxes are provided on an asset and liability approach to financial accounting and reporting for income taxes.  The difference between the financial statement and tax bases of assets and liabilities is determined annually.  Deferred income tax assets and liabilities are computed for those differences that have future tax consequences using the currently enacted tax laws and rates that apply to the periods in which they are expected to affect taxable income. Income tax expense is the current tax payable or refundable for the period plus or minus the net change in the deferred tax assets and liabilities, excluding the portion of the deferred liability allocated to other comprehensive income.  Deferred taxes are reduced by a valuation allowance to the extent that realization of the related deferred tax asset is not assured.  No valuation allowance was deemed necessary at December 31, 2014 and 2013.

The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely to be realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.

The Company records interest and penalties related to unrecognized tax benefits in income tax expense.

Net income per common share

Basis EPS excludes dilution and is determined by dividing net income by the weighted average number of common shares outstanding during the period.  Diluted EPS reflects the potential dilution that could occur if securities and other contracts to issue common stock were exercised or converted into common stock.

The following information presents the Company’s computations of basic and diluted EPS for the periods presented in the statements of comprehensive income.
                   
   
Income
   
Shares
   
Per share
amount
 
                   
2014:
                 
Basic EPS
  $ 1,094       3,395,510     $ 0.32  
Effect of dilutive stock options
            258,872          
Diluted EPS
  $ 1,094       3,654,382     $ 0.30  
                         
2013:
                       
Basic EPS
  $ 706       3,394,208     $ 0.20  
Effect of dilutive stock options
            102,665          
Diluted EPS
  $ 706       3,496,873     $ 0.20  
 
Stock Compensation

The Company records compensation expense for stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes-Merton (“BSM”) model. The Company uses historical data, among other factors, to estimate the expected price volatility, the expected option life and the expected forfeiture rate.  The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option.  At December 31, 2014, the Company had two stock-based compensation plans.
 

22


Table of Contents

 
ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
Note 2.  Business Combination

On February 18, 2014, the Company acquired Harvest Engineering, Inc.’s wireless hazard monitoring technology and Insta-Link product family, together with related technology and intellectual property rights, for a total purchase price of $1,643.

The fair value of the consideration transferred on the acquisition date consisted of the following:
         
Cash consideration
  $ 400  
Note payable issued to seller (Note 9)
    771  
Contingent earn-out liability
    472  
Total consideration
  $ 1,643  
 
The transaction was recorded as a business combination and the results of operations have been included in the consolidated statement of comprehensive income since the date of acquisition. Acquisition fees of approximately $15 incurred in connection with the transaction are recorded as operating expenses in 2014.

In connection with the acquisition, the Company is obligated to pay an earn-out of up to $550 based upon the level of revenues generated from the acquired products during the four calendar years following closing.  The Company currently has recorded a liability of $472 related to this obligation.  This contingent liability represents the fair value estimate of the earn-out based upon the Company’s projected likelihood of meeting the revenue targets.

The following table summarizes the estimated fair value of the assets acquired at the acquisition date:
       
In process research and development
  $ 1,478  
Noncompete agreement
    120  
Deferred service costs
    45  
Total assets acquired
  $ 1,643  

The noncompete agreement is being amortized over a five-year period.  The fair value of the noncompete agreement was estimated using a discounted cash flow model.  The unobservable inputs are considered Level 3 inputs in the fair value hierarchy.

The Company has not presented pro forma results of operations for this current acquisition because the acquisition is not material to the Company’s consolidated results of operations, financial position or cash flows.
 

23


Table of Contents

 
ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
Note 3. Investments

The cost and estimated fair value of the investments are as follows:
                         
   
Cost
   
Gross
unrealized
gain
   
Gross
unrealized
loss
   
Fair
value
 
December 31, 2014
                       
Money Market Funds
  $ 510     $ 0     $ 0     $ 510  
Commercial Paper
    345       0       0       345  
Treasury Bills
    6,542       0       0       6,542  
Equity Securities
    72       1,238       (54 )     1,256  
      7,469       1,238       (54 )     8,653  
Less Cash Equivalents
    855       0       0       855  
Total Investments, December 31, 2014
  $ 6,614     $ 1,238     $ (54 )   $ 7,798  
                                 
December 31, 2013
                               
Money Market Funds
  $ 540     $ 0     $ 0     $ 540  
Commercial Paper
    601       0       0       601  
Treasury Bills
    5,226       1       0       5,227  
Equity Securities
    86       2,686       (54 )     2,718  
      6,453       2,687       (54 )     9,086  
Less Cash Equivalents
    1,141       0       0       1,141  
Total Investments, December 31, 2013
  $ 5,312     $ 2,687     $ (54 )   $ 7,945  
 
Realized gains and losses on investments are as follows:
       
   
Years Ended December 31,
 
   
2014
   
2013
 
             
Gross Realized Gains
  $ 1,163     $ 530  
Gross Realized Losses
    0       0  
Net Realized Gain
  $ 1,163     $ 530  
 
At December 31, 2014 and 2013, the Company’s significant investment in equity securities is 122,649 and 231,336, respectively, shares of Rudolph, accounted for under the available-for-sale method.  As of December 31, 2014 and 2013, the aggregate value of the Company’s Rudolph shares as reported on the Nasdaq Stock Exchange was approximately $1,254 and $2,716, respectively, with an approximate cost of $16 and $30, respectively.  During the years ended December 31, 2014 and 2013, the Company sold 108,687 and 41,931 shares, respectively, of Rudolph stock and reported a gain of $1,163 and $529, respectively, in other income.
 

24


Table of Contents

 
ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
Changes in Accumulated Other Comprehensive Income

Changes in Accumulated Other Comprehensive Income are as follows:
       
   
December 31,
 
   
2014
   
2013
 
Unrealized Gains (Losses)
           
Unrealized holding losses arising during the period
  $ (284   $ (422 )
Less: Reclassification of gains included in net income
    (1,163 )     (530 )
      (1,447 )     (952 )
                 
Deferred Taxes on Unrealized Gains (Losses):
               
Decrease in deferred taxes on unrealized losses arising during the period
    (108 )     (160 )
Less: Reclassification of taxes on gains included in net income
    (442 )     (201 )
      (550 )     (361 )
                 
Net Change in Accumulated Other Comprehensive Income
  $ (897   $ (591 )
 
Note 4. Fair Value Measurements

The following table provides information on those assets measured at fair value on a recurring basis.
                               
December 31, 2014
                 
                   
    Carrying              
   
amount in
             
   
consolidated
         
Fair Value Measurement Using
 
   
balance sheet
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                             
Cash and cash equivalents:
                             
Money market
  $ 510     $ 510     $ 510     $ 0     $ 0  
Commercial paper
    345       345       345       0       0  
Treasury bills
    6,542       6,542       6,542       0       0  
Available for sale:
                                       
Equities:
                                       
Small cap technology sector
    1,256       1,256       1,256       0       0  
Liabilities:
                                       
Contingent earn-out
    472       472       0       0       472  
 
                               
December 31, 2013
                             
                               
   
Carrying
                         
   
amount in
                         
   
consolidated
         
Fair Value Measurement Using
 
   
balance sheet
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                             
Cash and cash equivalents:
                             
Money market
  $ 540     $ 540     $ 540     $ 0     $ 0  
Commercial paper
    601       601       601       0       0  
Treasury bills
    5,227       5,227       5,227       0       0  
Available for sale:
                                       
Equities:
                                       
Small cap technology sector
    2,718       2,718       2,718       0       0  

25


Table of Contents

 
ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
The fair value of the money market funds, commercial paper, and treasury bills is based on quoted market prices in an active market. Available-for-sale securities include equity securities that are traded in an active market.  Closing stock prices are readily available from active markets and are used as being representative of fair value.  The Company classifies these securities as level 1.  Management estimated the probability of meeting the revenue targets over the measurement period to determine the fair value of the contingent earn-out, which is considered a level 3 input in the fair value hierarchy.

The change in level 3 liabilities at fair value on a recurring basis is summarized as follows:
       
Balance at December 31, 2013
  $ 0  
Additions (Note 2)
    472  
Balance at December 31, 2014
  $ 472  
 
Note 5. Inventories

Inventories used in the determination of cost of goods sold are as follows:
       
    
December 31,
 
   
2014
   
2013
 
Raw Materials
  $ 729     $ 658  
Work In Process
    263       226  
Finished Goods
    232       176  
Total Inventories
  $ 1,224     $ 1,060  
 
Note 6. Property and Equipment, Net

The following is a summary of property and equipment:
       
    
December 31,
 
   
2014
   
2013
 
Equipment
  $ 266     $ 272  
Furniture and Fixtures
    380       388  
Building
    1,365       1,365  
Land
    415       415  
      2,426       2,440  
Less Accumulated Depreciation
    1,280       1,223  
Total Property and Equipment
  $ 1,146     $ 1,217  
 
Depreciation expense for the years ended December 31, 2014 and 2013 was $116 and $110, respectively.
 

26


Table of Contents


ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)

Note 7. Net Intangible Assets

Intangible assets include the following:
                               
         
December 31, 2014
 
   
Average
Useful
Lives
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net
Carrying
Amount
 
Noncompete
 
5 Years
    $ 120     $ 22     $ 98  
Technology
 
7 Years
      1,478       71       1,407  
   Net Intangible Assets
        $ 1,598     $ 93     $ 1,505  
 
Amortization expense for the year ended December 31, 2014 was $93.

Estimated amortization expense over the next five years is as follows:
         
2015
  $ 235  
2016
    235  
2017
    235  
2018
    235  
2019
    213  
 
Note 8. Accrued Expenses

Accrued expenses include the following:
       
    
December 31,
 
   
2014
   
2013
 
Wages and Commissions
  $ 276     $ 195  
Other
    116       70  
Total Accrued Expenses
  $ 392     $ 265  
 
Note 9.  Note Payable

The note payable consists of the following at December 31, 2014:
         
Note Payable to seller (Note 2)
  $ 800  
Payable in two annual installments of principal of $400 with a maturity date of February 2016.  This note is non-interest bearing and unsecured.
       
         
Less: Discount of debt instrument listed above
    (29 )
Net note payable
    771  
Less: Current maturities
    381  
         
Note Payable – Long Term
  $ 390  

27


Table of Contents


ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)

Scheduled maturities of the note payable are as follows at December 31, 2014
       
2015
  $ 381  
2016
    390  
       Total
  $ 771  
 
Note 10. Commitments

Lease commitments

The Company is leasing office equipment under an operating lease expiring in 2017.

Minimum lease payments required under non-cancelable operating leases are as follows:
       
Year
 
Amount
 
       
2015
  $ 8  
2016
    8  
2017
    3  
Total Minimum Lease Payments
  $ 19  
 
Rental expense charged to operations was $21 and $25 for the years ended December 31, 2014 and 2013, respectively.

Note 11. Common Stock Options and Stock Purchase Plan

Stock options

The 1997 Stock Option Plan (the “1997 Plan”) and 2013 Equity Incentive Plan (the “2013 Plan”) authorize the issuance of both nonqualified and incentive stock options. Payment for the shares may be made in cash, shares of the Company’s Common Stock or a combination thereof.  Under the terms of the plans, incentive stock options and non-qualified stock options are granted at a minimum of 100% of fair market value on the date of grant and may be exercised at various times depending upon the terms of the option. All existing options expire 10 years from the date of grant or one year from the date of death.

Stock-based compensation

Pursuant to the 2013 Plan, the Company is authorized to grant options to purchase up to 300,000 shares of its Common Stock.  As of December 31, 2014, options to purchase an aggregate of 250,000 shares were outstanding and 125,000 shares were exercisable under the 2013 Plan, and 50,000 shares were available for issuance pursuant to awards that may be granted under the plan in the future.

Pursuant to the 1997 Plan, the Company is authorized to grant options to purchase up to 450,000 shares of its Common Stock.  As of December 31, 2014, options to purchase an aggregate of 7,500 shares were outstanding and exercisable under the 1997 Plan.  The board terminated the plan in 2014.  The existing grants may be exercised according to the terms of the grant agreements but no additional options will be granted under the 1997 Plan.

During the third quarter of 2013, the Company granted to its Chief Executive Officer options to purchase 50,000 shares of common stock.  The options were granted at a strike price equal to the fair market value, vested immediately, and expire ten years from the date of the grant.

During the year ended December 31, 2014, options to purchase 11,980 shares of common stock expired for four employees.
 

28


Table of Contents

 
ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)

The following table summarizes the activity for outstanding incentive stock options under both plans to employees of the company:
                                 
   
Options Outstanding
 
   
Number of
Shares
   
Weighted-
Average
Exercise
Price
   
Weighted-
Average
Remaining Contractual
Term
(in years)
   
Aggregate
Intrinsic Value
(1)
 
                                 
Balance at January 1, 2013
   
11,980
   
$
4.16
     
1.6
         
      Granted
   
50,000
     
4.21
     
10.0
         
      Exercised
   
0
                         
      Canceled/forfeited/expired
   
0
                         
Balance at December 31, 2013
   
61,980
     
4.20
     
9.7
         
      Granted
   
0
                         
      Exercised
   
0
                         
      Canceled/forfeited/expired
   
(11,980
)
   
(4.16
)
               
Balance at December 31, 2014
   
50,000
   
$
4.21
     
8.6
         
   Vested and exercisable as of December 31, 2014
   
50,000
                   
$
0
 
 
 
(1)
The aggregate intrinsic value is calculated as approximately the difference between the weighted average exercise price of the underlying awards and the Company’s estimated current fair market value at December 31, 2014.
 
During the second quarter of 2014, the Company granted one outside director options to purchase 25,000 shares of common stock.  The options were priced above fair market value and vested 20% on the grant date, with an additional 20% vesting on the first four anniversaries of the grant date.  The options expire ten years from the date of grant.
 
During the third quarter of 2013, the Company granted to three of its outside directors options to each purchase 50,000 shares of common stock, and granted options to a fourth director to purchase 25,000 shares of common stock.  The options granted to outside directors had a strike price above fair market value and vested 20% on the grant date, with an additional 20% vesting on the first four anniversaries of the grant date thereafter.  All of the stock option grants expire ten years from the date of the grant.
 
During the year ended December 31, 2014, one former outside director forfeited options to purchase 2,500 shares of common stock.
 

29


Table of Contents


ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
The following table summarizes the activity for outstanding director stock options under both plans:
                                 
    Options Outstanding  
   
Number of
Shares
   
Weighted-
Average
Exercise
Price
   
Weighted-
Average
Remaining
Contractual
Term
(in years)
   
Aggregate
Intrinsic Value
(1)
 
                                 
Balance at January 1, 2013
   
10,000
   
$
4.15
     
9.5
         
      Granted
   
175,000
     
4.67
     
10.0
         
      Exercised
   
0
                         
      Canceled/forfeited/expired
   
0
                         
Balance at December 31, 2013
   
185,000
     
4.64
     
9.5
         
      Granted
   
25,000
     
4.39
     
10.0
         
      Exercised
   
0
                         
      Canceled/forfeited/expired
   
(2,500
)
   
(4.15
)
               
Balance at December 31, 2014
   
207,500
   
$
4.62
     
8.4
         
   Vested and exercisable as of December 31, 2014
   
82,500
                   
$
0
 
 
 
(1)   The aggregate intrinsic value is calculated as approximately the difference between the weighted average exercise price of the underlying awards and the Company’s estimated current fair market value at December 31, 2014.
 
The weighted average grant date fair value of options granted during the years ended December 31, 2014 and 2013 was $35 and $367, respectively.  The Company recognized compensation expense of approximately $67 and $162 during the years ended December 31, 2014 and 2013, respectively, in connection with the issuance of the options.
 
The assumptions made in estimating the fair value of the options on the grant date based upon the BSM option-pricing model are as follows:
       
    
Year Ended December 31
 
   
2014
   
2013
 
Dividend Yield
    0.00 %     0.00 %
Expected Volatility
    44.11 %     44.27-45.00 %
Risk Free Interest Rate
    2.02 %     1.33-1.92 %
Expected Life
 
6 Years
   
5.5-6 Years
 
 
The Company calculates expected volatility for stock options and other awards using historical volatility as the Company believes the expected volatility will approximate historical volatility.

There were no options exercised during the years ended December 31, 2014 and 2013.

As of December 31, 2014, there was approximately $172 of unrecognized compensation expense under the 2013 Plan.  The Company expects to recognize this expense over the next four years.  To the extent the forfeiture rate is different than we have anticipated, stock-based compensation related to these awards will be different from our expectations.
 

30


Table of Contents

 
ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
Stock purchase plan

The 1996 Employee Stock Purchase Plan (the “ESPP”) allows employees to set aside up to 10% of their earnings for the purchase of shares of the Company’s Common Stock. The purchase price is the lower of 85% of the market value at the date of the grant or the exercise date, which is six months from the date of the grant.  Under the ESPP, the Company was authorized to sell and issue up to 150,000 shares of its Common Stock to its full-time employees.  There were 81,653 shares issued under the plan.   During 2014 and 2013, 814 shares and 2,795 shares, respectively, were issued under the ESPP.  The plan was terminated effective January 1, 2014.

Note 12. Benefit Plans

Employee stock ownership plan

The Company sponsors an employee stock ownership plan (“ESOP”) that covers substantially all employees who work 1,000 or more hours during the year.  The ESOP has, at various times, secured financing from the Company to purchase the Company’s shares on the open market. When the Plan purchases shares with the proceeds of the Company loans, the shares are pledged as collateral for these loans. The shares are maintained in a suspense account until released and allocated to participant accounts.  The Plan owns 164,382 shares of the Company’s stock at December 31, 2014. All shares held by the Plan have been released and allocated. The dividends paid by the Company on shares held by the Plan are allocated to participant accounts. The Plan had no debt to the Company at December 31, 2014 or 2013.

The Company recognized compensation expense for contributions of $18 to the ESOP plan in 2014 and 2013.

In the event a terminated ESOP participant desires to sell his or her shares of the Company’s stock and the shares are not readily tradable, the Company may be required to purchase the shares from the participant at fair market value. In addition, the Company may distribute the ESOP’s shares to the terminated participant at the Company’s election.  At December 31, 2014, 164,382 shares of the Company’s stock, with an aggregate fair market value of approximately $653, are held by ESOP participants who, if terminated, would have rights under the repurchase provisions.  The Company believes that the market for its shares meets the ESOP requirements and that there would not be a current obligation to repurchase shares.

Profit sharing plan and savings plan

The Company has a salary reduction and profit sharing plan that conforms to IRS provisions for 401(k) plans. The Company may make profit sharing contributions with the approval of the Board of Directors. There were no profit sharing contributions by the Company in 2014 or 2013.
 

31


Table of Contents

 
ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)
 
Note 13. Income Taxes

The components of the income tax provision for the years ended December 31, 2014 and 2013 are as follows:

   
2014
   
2013
 
             
Current:
           
Federal
  $ 540     $ 302  
State
    1       1  
Deferred:
               
Federal
    (60 )     (47 )
State
    (21     (24 )
Total Federal and State Income Taxes
  $ 460     $ 232  

The provision for income taxes for the years ended December 31, 2014 and 2013 differs from the amount obtained by applying the U.S. federal income tax rate to pretax income due to the following:

   
2014
   
2013
 
             
Computed “Expected” Federal Tax Expense
  $ 529     $ 319  
Increase (Decrease) in Taxes Resulting From:
               
State Income Taxes, net of Federal Benefit
    10       9  
Credits
    (47 )     (70 )
    Domestic Production Activities Deduction
    (17 )     (18 )
    Permanent Differences
    4       3  
    Rate Change for Deferred Taxes
    0       (11 )
    Other
    (19 )     0  
Total Federal and State Income Taxes
  $ 460     $ 232  

The components of the net deferred tax liability consist of:
   
2014
   
2013
 
             
Deferred Tax Assets:
           
Vacation Accrual
  $ 33     $ 27  
Allowance for Doubtful Accounts
    4       3  
Stock Compensation
    80       57  
State Carryforward R&D Credit
    31       12  
Total Deferred Tax Assets
  $ 148     $ 99  
                 
Deferred Tax Liabilities:
               
Prepaid Expenses
  $ 35     $ 30  
    Depreciation and amortization
    54       91  
Net Unrealized Gain on Investments
    450       1,000  
Total Deferred Tax Liabilities
  $ 539     $ 1,121  
                 
Net Deferred Tax Liability
  $ (391   $ (1,022
 
The Company is subject to the following material taxing jurisdictions: U.S. and Minnesota.  The tax years that remain open to examination by the Internal Revenue Service are 2011 through 2014.  We have no accrued interest or penalties related to uncertain tax positions as of January 1, 2014 or December 31, 2014 and uncertain tax positions are not significant.
 

32


Table of Contents

 
ELECTRO-SENSORS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014 AND 2013
(in thousands except share and per share amounts)

Note 14. Segment Information

As of December 31, 2014, the Company has two reportable operating segments: Production Monitoring and Investments.  The Production Monitoring Division manufactures and markets a complete line of production monitoring equipment, in particular speed monitoring and motor control systems for industrial machinery.  ESI Investment Company holds investments in marketable and non-marketable securities.

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

The following is financial information relating to the continuing operating segments:

   
2014
   
2013
 
             
Net revenues
           
Production Monitoring
  $ 7,041     $ <