ELECTRO SENSORS INC - Annual Report: 2019 (Form 10-K)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

Form 10-K

 

ELECTRO-SENSORS, INC.

(Exact name of registrant as specified in its charter)

 

 

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 every Interactive Data File required to be submitted 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 such files). Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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 $7,400,000 based upon the closing price of its common stock as reported on The Nasdaq Stock Market® on June 30, 2019.

 

The number of shares outstanding of the registrant’s Common Stock, $0.10 par value, on March 24, 2020 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.

 

 

 

ELECTRO-SENSORS, INC.
Form 10-K for the Year Ended December 31, 2019

 

 

 

 

Introduction

 

Electro-Sensors, Inc. (“we,” “us,” “our,” the “Company” or “ESI”) manufactures and sells industrial production monitoring and process control systems. 

 

In addition, we may periodically make strategic investments in other businesses and companies, including investments that we believe would facilitate the development of technology complementary to our existing products or investments that we believe present good opportunities for the Company and its shareholders.  Our primary focus is to remain an operating company and we do not intend to become an investment company.

 

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 a variety of monitoring systems that measure machine production and operation rates, as well as systems that regulate the speed of related machines in production processes.

 

Our goal is to develop meaningful annual updates to our standard products.

 

We have a sales agreement with Motrona GmbH, a German control and interface devices manufacturer, under which we have the right to distribute Motrona products in the United States. These products interface with our products on various applications for motion monitoring.

 

      Speed Monitoring Systems

Our speed monitoring systems compare revolutions per minute or speed against acceptable rates as determined by our customers. These systems vary in complexity, from simple systems that detect 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 shaft speed.

 

Our speed monitoring systems also include a line of products that measure production counts or rates, such as number of parts, gallons per minute, or board feet. These 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.

 

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.

 

      Temperature Application Products

 

Our main temperature applications include bearing, gear box, and motor temperature monitoring sensors.  These sensors alert an operator when the temperature exceeds or is less than a specified temperature.

 

      Position Application Products

 

We also offer production monitoring devices that include a belt alignment and slide gate position monitor.  The belt alignment monitor is used to determine if a belt is tracking correctly.  The slide gate position monitor is used in plant operations to provide feedback of the position of a slide gate.  One version has analog output and the second version has relay outputs that provide feedback of the position of a valve or control arm. 

 

     Vibration Monitoring Products 

 

A vibration monitor alerts an operator when the vibration of a machine in a production system exceeds or is less than a specified level.  

 

      Tilt Switches

 

A tilt switch is designed to alert the operator when a storage bin or production system reaches a certain capacity.  

 

      Hazard Monitoring Systems 

 

Electro-Sentry We offer the Electro-Sentry 1 and Electro-Sentry 16 hazard monitoring systems, which integrate our sensors for monitoring temperature, belt alignment, and shaft speed with programmable control logic and LED display interface to create a complete hazard monitoring system. These systems enable our customers to locate which part of their material handling system is operating incorrectly, typically in less than ten seconds, by using visual indication on the LED displays. 

 

HazardPRO^TM We market our wireless hazard technology monitoring system under the HazardPRO product name. This integrated hazard monitoring system captures and displays key information in an intuitive format allowing the user to quickly and comprehensively understand the status and history of its processes.  The simple but powerful interface gives the user insight into its operations as it strives to maximize safety and facility runtime, while minimizing costs associated with unscheduled maintenance and unplanned downtime.  Furthermore, the HazardPRO system has been approved for use in hazardous dust environments by a third-party nationally recognized testing laboratory.

 

The HazardPRO site system manager software efficiently collects data from sensors placed across a widely dispersed area of greater than 50 acres.  We have also added a complete antenna pair mounting system to the product line for easy and accurate customer installation.

 

We expect to continue to expend resources to develop new products and to market new and existing products for use in a wide variety of monitoring applications.

 

Our corporate website, www.electro-sensors.com, provides significant product application information for our existing and prospective customers and 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, Bolivia, Chile, Colombia, Guatemala, Peru, United Kingdom, Ukraine, Egypt, Saudi Arabia, India, Indonesia, Australia, New Zealand, China, Taiwan, Korea, Vietnam, Malaysia, Philippines, and Singapore. Sales to customers outside the United States represented approximately 12% of our 2019 sales. We sell our products under the Electro-Sensors, Inc. brand as a range of products from simple sensors to complex integrated monitoring systems.  Our customers are businesses in a wide variety of industries, including grain/feed/milling, bulk materials, manufacturing, food products, ethanol, power generation, and other processing industries.

 

We continue to explore new industries and applications within the current industries we serve to expand sales and may also consider acquiring compatible businesses or product lines as part of our growth strategy.  In addition, we may make investments that we believe present good opportunities for the Company and its shareholders.

 

We believe that a wide variety of organizations could 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. We sell our products into both the “retro-fit” market and into new manufacturing or processing systems.

 

We advertise in national industrial periodicals that cover a range of industrial products and attend several local, national and international industry tradeshows 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 have greater 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, and the fact that we sell our products as ready-to-install units that can be used in a wide range of applications. Our major disadvantages include the fact that our major competitors are larger, have better established names, have a broader range of sensing instruments, and have larger sales forces.

 

Suppliers

 

We purchase parts and materials for our systems from various manufacturers and distributors. In some instances, these materials are manufactured in accordance with our proprietary designs. Multiple sources of these parts and materials are generally available, and we, typically, do not depend on any single source for these supplies and materials. We have not experienced any significant problem of short supply or delays from our suppliers.  However, due to the outbreak of the COVID-19 virus, we are concerned and closely watching lead times and availability of components, especially those components that our suppliers purchase from outside the United States.  We are currently assessing our current inventory levels and taking actions to minimize disruptions to our supply chain, although such actions may not be successful.

 

Customers

 

We do not depend upon a single or a few customers for a material (10% or more) portion of our sales.  The extent of the impact of COVID-19 on our business will depend largely on future developments, including new information that may emerge concerning the severity and action taken to contain or prevent further spread within the United States and the related impact on consumer spending, all of which are highly uncertain and cannot be predicted.

 

Patents, Trademarks and Licenses

 

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

 

We have registered the name “Electro-Sensors” as a trademark with the U.S. Patent and Trademark Office (“USPTO”), 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 HazardPRO trademark in the first quarter of 2014 and intend to register this trademark.

 

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

 

We seek to protect our 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 we would have adequate remedies for any breach, or that our trade secrets will not otherwise become known or independently developed by competitors.

 

Seasonality

 

Generally, the Company experiences seasonality in the sale of its products with the second and third calendar quarters historically the strongest.

 

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.  In addition, we may make investments that we believe present good opportunities for the Company and its shareholders.

 

Governmental Approvals

 

Although we are not required to obtain governmental approval of our products, we choose to obtain certain third-party certifications to meet our customers’ needs. These certifications may expand our market opportunities in certain industries.

 

Effect of Governmental Regulations

 

We do not believe that, other than adjustments in tariffs imposed on imported products, 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 and to integrate state-of-the-art technology into our existing products. We undertake development projects based upon the identified specific needs of the markets we serve.  Our "Management's Discussion and Analysis of Financial Condition and Results of Operations” section describes the nature and amount of our Research and Development expenditures.

 

Our future success depends 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.

 

Employees 

 

As of March 24, 2020, we had 40 employees, all of whom but one 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 adversely affected.

 

Fluctuations in Operating Results

 

We have experienced fluctuations in our past operating results and expect to experience fluctuations in the future.  These fluctuations 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. These factors include: product competition and acceptance, timing of customer orders, cancellation of orders, the mix of products sold, downturns in the markets we serve and economic disruptions. Because fluctuations may occur, we caution investors that results of our operations for recent periods may not accurately predict how we will perform in the future. We cannot ensure that we will achieve revenue or earnings growth.

 

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

 

Our business depends on periodically introducing new and enhanced products and solutions for customer needs. Our product development efforts require 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.

 

Forward-Looking 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. We make forward-looking statements 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. These include statements relating to our beliefs and expectations and intentions with respect to (i) our growth and profitability, (ii) our marketing and product development, (iii) the value of our intellectual property, (iv) our competitive position in the marketplace, (v) the effect of governmental regulations on our business, (vi) our employee relations, (vii) the adequacy of our facilities, (viii) our intention to develop new products, (ix) the possibility of us acquiring compatible businesses or product lines as part of our growth strategy, and (x) our future cash requirements and use of cash.

 

Forward-looking statements cannot be guaranteed and our actual results may vary materially due to the uncertainties and risks, known and unknown, associated with these 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:

 

 

 

 

 

 

 

 

 

This item is not required for smaller reporting companies, but above under “Forward-Looking Statements,” we discuss some of the risk factors that are relevant to our business and operating results. 

 

 

We own and occupy a 25,400 square foot facility at 6111 Blue Circle Drive, Minnetonka, Minnesota 55343-9108. All our 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 2020.

 

 

We are not the subject of any legal proceedings as of the date of this filing. We are not aware of any threatened litigation.

 

 

Not applicable. 

 

 

Our common stock trades on the Nasdaq Capital Market of The Nasdaq Stock Market® under the symbol “ELSE.”

 

Based on data provided by our transfer agent, as of February 26, 2020, we had 67 shareholders of record who held 877,252 shares of the Company’s common stock. In addition, nominees held an additional 2,518,269 shares for approximately 675 shareholders holding shares in street name.

 

From time to time, we may be required to repurchase some of our equity securities as a result of obligations described in Note 10 to our 2019 financial statements. We did not repurchase any equity securities during the years ended December 31, 2019 and 2018.

 

The information required by Item 201(d) of SEC Regulation S-K is set forth in Item 12 of this Form 10-K.

 

 

Not required for smaller reporting companies

 

 

 

The following discussion should be read in conjunction with our 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 statements of comprehensive income (loss) expressed as a percentage of net sales.

 

 

The following paragraphs discuss the Company’s performance for years ended December 31, 2019 and 2018.

 

Comparison of 2019 vs. 2018 (dollars in thousands)

 

Net Sales

 

Net sales for 2019 were $8,258, an increase of $763, or 10.2%, from $7,495 in 2018.  The increase in net sales for the year was primarily driven by an increase in sales of our HazardPRO wireless hazard monitoring systems, which included several repeat sales to existing HazardPRO customers.  Net international sales increased $139 in 2019 to 12% of total net sales.  The international sales growth was led by an increase in sales to Brazil as compared to the prior year.

 

 

Gross Profit

 

Gross profit for 2019 increased $319, or 7.9%, to $4,366 from $4,047 in 2018.  Our gross profit margin for 2019 was 52.9% compared to 54.0% in 2018. The slight decrease in the gross margin was primarily due to product mix and higher material costs resulting from the increase in United States government tariffs imposed on imported products.

 

Operating Expenses

 

Total operating expenses increased $205, or 4.9%, to $4,397 in 2019 from $4,192 in 2018, but decreased as a percentage of net sales to 53.2% from 55.9%.  The increases in operating expenses was due to additional personnel and changes in internal compensation plans, partially offset by decreases in legal and professional expenses and lab testing and certification expenses.

 

 

 

 

Operating Income (Loss)

 

Our operating loss decreased $114 to a loss of $31 in 2019 compared to an operating loss of $145 in 2018; the operating loss improved as a percentage of net sales to -0.4% from -1.9%.  The decrease was primarily related to the increase in net sales.

 

Non-Operating Income (Expense)

 

Non-operating income increased $90 to $217 in 2019 from $127 in 2018, primarily as a result of increased interest income earned from higher interest rates on Treasury Bills.

 

Available-for-sale equity securities are stated at fair value, and unrealized holding gains and losses are reported in our statement of comprehensive income (loss) in the non-operating income (expense) section.  All other 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.

 

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 (loss). Realized gains and losses are determined on the basis of the specific securities sold.

 

Income Taxes

 

Income tax benefit was $1 in 2019 compared to $8 in 2018. The decrease was due primarily to tax credits and deferred tax adjustments.  Detailed information on our income taxes are described in Note 11 to our financial statements.

 

 

Net Income (Loss)

 

We reported net income of $187 in 2019 compared to net loss of $10 in 2018, an increase of $197, or 1,970.0%. Basic and diluted earnings per share were $0.06 and zero in 2019 and 2018, respectively.

 

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 $8,785 and $1,057 at December 31, 2019 and 2018, respectively. The increase was mainly due to net cash generated from investing activities, and the fact that at December 31, 2019, we held substantially all our available funds in assets defined as cash and cash equivalents, as described below. Working capital was $11,155 at December 31, 2019 compared to $10,942 at December 31, 2018.

 

Cash generated from operating activities increased $22 from $130 in 2018 to $152 in 2019. The increase was primarily due to net income in 2019 compared to a 2018 net loss and an increase in accounts payable, partially offset by an increase in trade receivables. The 2019 net income was primarily due to increased net sales.  The increase in accounts payable is due to the timing of payments.  The increase in trade receivables is due to the timing of sales and collections on accounts.

 

Cash generated from investing activities in 2019 was $7,581, compared to $115 in 2018. The increase was due to an increase in investment maturities resulting from recent Treasury Bill purchases classified as cash and cash equivalents.  In addition, we purchased $257 and $32 of property, equipment, and intangibles in 2019 and 2018, respectively.

 

Cash used in financing activities during 2019 was $5 compared to $151 in 2018. The Company entered into a financing lease for three office copiers during 2018 reported as right-to-use assets.  The lease is for 63 months with principal payments of $5 and $1 in 2019 and 2018, respectively.  Detailed information on our financing lease is described in Note 8 to our 2019 financial statements.  In addition, cash used in 2018 was primarily due to making the final payment on the Harvest Engineering, Inc. contingent earn-out in the 2018 first quarter.  

 

Our ongoing cash usage requirements will be primarily used for capital expenditures, potential acquisitions, investments we believe present good opportunities for the Company and its shareholders, 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.

CRITICAL ACCOUNTING ESTIMATES 

The preparation of our 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 long-lived assets, realizability of trade receivables, valuation of deferred tax assets/liabilities, inventory, investments, 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. If the expected life of an asset is shortened or an impairment recorded, it could result in an additional charge to depreciation expense.

 

Realizability of trade receivables

We estimate our allowance for doubtful accounts based on prior history and the aging of our trade receivables. We are unable to predict which, if any, of our customers will be unable to pay their open invoices at a future date. If an account becomes uncollectible and we are required to write off the balance, we would recognize the amount of the additional expense within general and administrative expenses.

 

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. We recognize changes in deferred tax assets and liabilities in the period in which the tax law changes become effective. Any change in our deferred tax assets or liabilities could have a material negative or positive effect on our income tax expense.

 

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. If we are unable to use the inventory in our products and it does not meet future technological requirements, we would be required to remove the items from inventory and expense the amount in cost of goods sold.

 

Valuation of investments

Our investments in available-for-sale 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. Changes in value of our equity securities affect our profitability as the value fluctuates.  Any change in the value of our equity securities could have a material negative or positive effect on our profitability.  Changes in the value of our treasury bills do not affect our profitability until the treasury bill is sold.  At the time of sale, we recognize the interest earned on the treasury bill.

 

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-Scholes-Merton model. The actual life and forfeiture rate could differ from what we estimated. Changes in the life or forfeiture rate of stock options could have a negative or positive impact on our stock-based compensation.

 

Additional information regarding our significant accounting policies is provided below in Part II, Item 8, Financial Statements and Supplementary Data – Notes to Financial Statements, Note 1, Nature of Business and Significant Accounting Policies.

 

 

Not applicable.

 

 

INDEX TO FINANCIAL STATEMENTS 

​

 

 

 

 

 

To the Board of Directors and Stockholders of
Electro-Sensors, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying balance sheets of Electro-Sensors, Inc. (the Company) as of December 31, 2019 and 2018, and the related statements of comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes (collectively referred to as the financial statements).  In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, 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. 

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. 

 

/s/ Boulay PLLP

We have served as the Company's auditor since 2006.

 

Minneapolis, Minnesota

March 25, 2020

ELECTRO-SENSORS, INC.

(in thousands except share and per share amounts) 

See Notes to Financial Statements

ELECTRO-SENSORS, INC.

(in thousands except share and per share amounts)

See Notes to Financial Statements

 

(in thousands except share and per share amounts)

 

See Notes to Financial Statements

 

 

(in thousands)

See Notes to Financial Statements

YEARS ENDED DECEMBER 31, 2019 AND 2018 

(in thousands except share and per share amounts)

 

Note 1. Nature of Business and Significant Accounting Policies

 

Nature of business:

Electro-Sensors, Inc. manufactures and markets a complete line of monitoring and control systems for a variety of industrial machinery. The Company uses leading-edge technology to continuously improve its products, with the ultimate goal of manufacturing the industry-preferred product for each market served. The Company sells these products through an internal sales staff, manufacturer’s representatives, and distributors to a wide variety of industries that use the products in a variety of applications to monitor process machinery operations. The Company markets its products to customers located throughout the United States, Canada, Latin America, Europe, and Asia.

In addition, we may periodically make strategic investments in other businesses and companies, including investments that we believe would facilitate the development of new relationships, or technology complementary to our existing products, or other investments that we believe present good opportunities for the Company and its shareholders. Our primary focus is to remain an operating company and we do not intend to become an investment company. See Note 2 for additional information regarding the Company’s 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 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 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 trade receivables, valuation of deferred tax assets/liabilities, inventory, investments, stock compensation expense, and the potential estimated impact on operations due to the outbreak of the COVID-19 virus as it relates to disruptions to our supply chain and customer demand. 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 fair value.

 

The Company maintains its cash and cash equivalents primarily in two bank deposit accounts, 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.

 

 

ELECTRO-SENSORS, INC.
NOTES TO FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2019 AND 2018 

(in thousands except share and per share amounts)

 

Trade receivables and credit policies

 

Trade receivables are uncollateralized customer obligations due under normal trade terms generally 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.

 

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.

As of December 31, 2019, the Company had one customer that accounted for approximately 19% of outstanding accounts receivable.  As of December 31, 2018, there was one customer that accounted for approximately 12% of the accounts receivable balance.

 

Available-for-sale securities

 

Substantially all the Company’s current investments consist of government debt securities. The estimated fair value of publicly traded securities is based on reported market prices or management’s reasonable market price when quoted prices are not available, 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 generally does not make investments in anticipation of short-term fluctuations in market price, the Company classifies its investments in equity securities and treasury bills as available-for-sale. Treasury bills with readily determinable values 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 gain.  Unrealized gains and losses on equity securities are reported in the statement of comprehensive income in non-operating income.

 

Realized gains and losses on securities, 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 in non-operating 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, 2019 and 2018.

  

ELECTRO-SENSORS, INC.
NOTES TO FINANCIAL STATEMENTS 

YEARS ENDED DECEMBER 31, 2019 AND 2018 

(in thousands except share and per share amounts)

 

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 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 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:

 

 

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, trade receivables, accounts payable, and other financial working capital items approximate fair value at December 31, 2019 and 2018 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 net realizable value.

 

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 the Company to test a long-lived asset 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, the Company recognizes impairment to the extent that the carrying value of an asset exceeds its fair value. The Company determines fair value through various valuation techniques including, but not limited to, discounted cash flow models, quoted market values and third-party independent appraisals.

 

  

ELECTRO-SENSORS, INC.
NOTES TO FINANCIAL STATEMENTS 

YEARS ENDED DECEMBER 31, 2019 AND 2018 

(in thousands except share and per share amounts)

 

Intangible assets

 

Intangible assets are comprised of the HazardPRO technology and a communication technology. The Company amortizes the cost of these intangible assets on a straight-line method over the estimated useful lives.  At December 31, 2018, the Company also had a non-compete agreement that expired in February 2019.

 

Revenue recognition

 

At contract inception, the Company assesses the goods and services promised to a customer and identifies a performance obligation for each distinct promised good or service.   We also determine the transaction price for each performance obligation at contract inception.  Our contracts, generally in the form of a purchase order, specify the product or service that is promised to the customer. The typical contract life is less than one month and contains a single performance obligation, to provide conforming goods or services to the customer.  On some contracts, we have a second performance obligation, which typically is the initialization of the HazardPRO product.  For contracts that have multiple performance obligations, we allocate the transaction price to each performance obligation using the relative stand-alone selling price.  We generally determine stand-alone selling prices based on the observable stand-alone prices charged to customers.  We recognize product revenue at the point in time when control of the product is transferred to the customer, which typically occurs when we ship the products.  We recognize service revenue at the point in time when we have provided the service.

 

Advertising costs

 

The Company expenses advertising costs as incurred. Total advertising expense was $61 and $48 in 2019 and 2018, respectively.

 

Research and development

 

Expenditures for research and development are expensed as incurred. The Company incurred expenses of $811 and $813 in 2019 and 2018, respectively.

 

Income taxes

 

The Company presents deferred income taxes on an asset and liability approach to financial accounting and reporting for income taxes. The Company annually determines the difference between the financial reporting and tax bases of assets and liabilities. The Company computes deferred income tax assets and liabilities for those differences that have future tax consequences using the currently enacted tax laws and rates that apply to the periods in which these laws 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 asset or liability allocated to other comprehensive gain (loss). Deferred taxes are reduced by a valuation allowance to the extent that realization of the related deferred tax asset is not certain.  We recorded a valuation allowance on our deferred tax asset of $121 and $81 at December 31, 2019 and 2018, respectively. 

 

The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. The Company recognizes income tax positions at the largest amount that is more likely than not to be realized. The Company reflects changes in recognition or measurement in the period in which the Company's change in judgment occurs.

 

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

 

 

ELECTRO-SENSORS, INC.
NOTES TO FINANCIAL STATEMENTS 

YEARS ENDED DECEMBER 31, 2019 AND 2018 

(in thousands except share and per share amounts)

 

Net income (loss) per common share

Basic earnings per share (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 such as options and other contracts to issue common stock were exercised or converted into common stock.  For the years ending December 31, 2019 and 2018, respectively, options to purchase 329,986 and 332,500 weighted average common shares have been excluded from the diluted weighted average shares because their effect would be anti-dilutive.

 

The following information presents the Company’s computations of basic and diluted EPS for the periods presented in the statements of comprehensive income (loss).

 

		Income (loss)				Shares				Per share amount
2019:
Basic EPS		$	187				3,395,521			$	0.06
Effect of dilutive stock options							2,514				0.00
Diluted EPS		$	187				3,398,035			$	0.06
2018:
Basic EPS		$	(10	)			3,395,521			$	0.00
Effect of dilutive stock options							0				0.00
Diluted EPS		$	(10	)			3,395,521			$	0.00

Stock-based 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, 2019, the Company had two stock-based compensation plans.

ELECTRO-SENSORS, INC.
NOTES TO FINANCIAL STATEMENTS 

YEARS ENDED DECEMBER 31, 2019 AND 2018 

(in thousands except share and per share amounts)

 

Recently Adopted Accounting Pronouncements

 

Financial Instruments

In January 2016, the FASB issued Accounting Standards Update No. 2016-01 (ASU 2016-01) "Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities," which amends various aspects of the recognition, measurement, presentation, and disclosure of financial instruments. The Company adopted ASU 2016-01 as of January 1, 2018 using the modified retrospective method for marketable equity securities. This resulted in a $7 reclassification of net unrealized losses from accumulated other comprehensive income (AOCI) to retained earnings. The adoption of ASU 2016-01 increases the possibility of increased volatility of non-operating income, as a result of the requirement to remeasure our equity securities each reporting period. For further information see Note 2.

 

Leases

In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (ASU 2016-02) "Leases (Topic 842)" which was modified in July 2018, Accounting Standards Update No. 2018-11 (ASU 2018-11) "Leases (Topic 842): Targeted Improvements" to increase transparency and comparability among organizations by requiring the recognition of Right of Use ("ROU") assets and lease liabilities on the balance sheet. Most prominent among the changes in the standard is the recognition of ROU assets and lease liabilities by lessees for those leases classified as operating leases. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We elected to early adopt the standard effective October 1, 2018 in conjunction with the Company entering into a financing lease using the optional effective date method. The standard did not have a material impact in our balance sheets, statements of comprehensive income (loss), or statement of cash flows compared to the legacy accounting guidance for leases.