Electro-Sensors (ELSE) 10-Q 2023 Q3 Quarterly report

S

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2023

Or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

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)

(952) 930-0100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common stock, $0.10 par value	ELSE	Nasdaq Capital Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 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 ☐

1

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.

Large accelerated filer	☐	Accelerated filer ☐
Non-accelerated filer	☒	Smaller reporting company ☒
		Emerging growth company ☐

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 number of shares outstanding of the registrant’s common stock, $0.10 par value, on November 13, 2023 was 3,428,021.

2

ELECTRO-SENSORS, INC.

Form 10-Q

For the Period Ended September 30, 2023

TABLE OF CONTENTS
PART I – FINANCIAL INFORMATION	4
Item 1. Financial Statements (unaudited):	4
Condensed Balance Sheets – As of September 30, 2023 and December 31, 2022	4
Condensed Statements of Comprehensive Income (Loss) – For the Three and Nine Months ended September 30, 2023 and September 30, 2022	5
Condensed Statements of Changes in Stockholders' Equity – For the Three and Nine Months ended September 30, 2023 and September 30, 2022	6
Condensed Statements of Cash Flows – For the Nine Months ended September 30, 2023 and September 30, 2022	7
Notes to Condensed Financial Statements	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3. Quantitative and Qualitative Disclosures About Market Risk	21
Item 4. Controls and Procedures	21
PART II – OTHER INFORMATION	22
Item 1. Legal Proceedings	22
Item 1A. Risk Factors	22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 3. Defaults Upon Senior Securities	22
Item 4. Mine Safety Disclosures	22
Item 5. Other Information	22
Item 6. Exhibits	22
SIGNATURES	23

3

ELECTRO-SENSORS, INC.

(in thousands except share and per share amounts) 

	September 30, 2023			December 31, 2022
	(unaudited)
ASSETS
Current assets
Cash and cash equivalents	$	3,902		$	7,646
Investments		6,026			2,036
Trade receivables, less allowance for credit losses of $11		1,066			1,161
Inventories		1,836			1,745
Other current assets		279			214
Income tax receivable		136			11
Total current assets		13,245			12,813
Deferred income tax asset, net		198			256
Property and equipment, net		907			975
Total assets	$	14,350		$	14,044
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Current maturities of financing lease	$	1		$	6
Accounts payable		261			274
Accrued expenses		559			350
Total current liabilities		821			630
Commitments and contingencies
Stockholders’ equity
Common stock par value $0.10 per share; authorized 10,000,000 shares; 3,428,021 shares issued and outstanding		342			342
Additional paid-in capital		2,201			2,163
Retained earnings		10,988			10,908
Accumulated other comprehensive income (loss) (unrealized income (loss) on available-for-sale securities, net of income tax)		(2	)		1
Total stockholders’ equity		13,529			13,414
Total liabilities and stockholders’ equity	$	14,350		$	14,044

See accompanying notes to unaudited condensed financial statements

4

ELECTRO-SENSORS, INC.

(in thousands except share and per share amounts)  

(unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2023			2022			2023			2022
Net sales	$	2,057		$	2,216		$	6,239		$	6,915
Cost of goods sold		1,064			1,053			3,156			3,178
Gross profit		993			1,163			3,083			3,737
Operating expenses
Selling and marketing		307			357			1,021			1,230
General and administrative		494			497			1,458			2,125
Research and development		218			190			724			642
Total operating expenses		1,019			1,044			3,203			3,997
Operating income (loss)		(26	)		119			(120	)		(260	)
Non-operating income
Interest expense		0			(1	)		(1	)		(1	)
Interest income		109			36			297			44
Total non-operating income, net		109			35			296			43
Income (loss) before income tax expense (benefit)		83			154			176			(217	)
Income tax expense (benefit)		75			32			96			(46	)
Net income (loss)	$	8		$	122		$	80		$	(171	)
Other comprehensive loss
Change in unrealized value of available-for-sale securities, net of income tax	$	(1	)	$	(2	)	$	(3	)	$	0
Other comprehensive loss		(1	)		(2	)		(3	)		0
Net comprehensive income (loss)	$	7		$	120		$	77		$	(171	)
Net income (loss) per share data:
Basic
Net income (loss) per share	$	0.00		$	0.04		$	0.02		$	(0.05	)
Weighted average shares		3,428,021			3,401,880			3,428,021			3,397,664
Diluted
Net income (loss) per share	$	0.00		$	0.04		$	0.02		$	(0.05	)
Weighted average shares		3,428,021			3,482,996			3,428,021			3,397,664

See accompanying notes to unaudited condensed financial statements

5

ELECTRO-SENSORS, INC.

(in thousands except share and per share amounts)

For the three months ended September 30
	Common Stock Issued			Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity
	Shares	Amount
June 30, 2023	3,428,021	$	342	$	2,163	$	10,980	$	(1	)	$	13,484
Other comprehensive loss									(1	)		(1	)
Stock-based compensation expense					38							38
Net income							8					8
Balance September 30, 2023 (unaudited)	3,428,021	$	342	$	2,201	$	10,988	$	(2	)	$	13,529
June 30, 2022	3,395,521	$	339	$	2,043	$	10,515	$	2		$	12,899
Exercise of common stock options	7,500		1		30							31
Other comprehensive income									(2	)		(2	)
Stock-based compensation expense					2							2
Net income							122					122
Balance September 30, 2022 (unaudited)	3,403,021	$	340	$	2,075	$	10,637	$	0		$	13,052

For the nine months ended September 30
	Common Stock Issued			Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
	Shares	Amount
December 31, 2022	3,428,021	$	342	$	2,163	$	10,908		$	1		$	13,414
Other comprehensive loss										(3	)		(3	)
Stock-based compensation expense					38								38
Net income							80						80
Balance September 30, 2023 (unaudited)	3,428,021	$	342	$	2,201	$	10,988		$	(2	)	$	13,529
December 31, 2021	3,395,521	$	339	$	2,041	$	10,808		$	0		$	13,188
Exercise of common stock options	7,500		1		30								31
Stock-based compensation expense					4								4
Net loss							(171	)					(171	)
Balance September 30, 2022 (unaudited)	3,403,021	$	340	$	2,075	$	10,637		$	0		$	13,052

See accompanying notes to unaudited condensed financial statements 

6

ELECTRO-SENSORS, INC.

(in thousands)

(unaudited) 

	Nine Months Ended September 30,
	2023			2022
Cash flows from (used in) operating activities
Net income (loss)	$	80		$	(171	)
Adjustments to reconcile net income (loss) to net cash from (used in) operating activities:
Depreciation and amortization		69			117
Deferred income taxes		58			(15	)
Stock-based compensation expense		38			4
Interest accrued on Treasury Bills		(163	)		(8	)
Change in:
Trade receivables		95			(175	)
Inventories		(91	)		(127	)
Other current assets		(65	)		13
Accounts payable		(13	)		(48	)
Accrued expenses		209			250
Income tax receivable/payable		(125	)		(53	)
Net cash from (used in) operating activities		92			(213	)
Cash flows from (used in) investing activities
Purchases of Treasury Bills		(13,830	)		(4,992	)
Proceeds from the maturity of Treasury Bills		10,000			8,000
Purchase of property and equipment		(1	)		(17	)
Net cash from (used in) investing activities		(3,831	)		2,991
Cash flows from (used in) financing activities
Proceeds from the exercise of common stock options		0			31
Payments on financing lease		(5	)		(4	)
Net cash from (used in) financing activities		(5	)		27
Net increase (decrease) in cash and cash equivalents		(3,744	)		2,805
Cash and cash equivalents, beginning		7,646			6,713
Cash and cash equivalents, ending	$	3,902		$	9,518
Supplemental cash flow information
Cash paid for income taxes	$	164		$	22
Cash paid for interest	$	1		$	1

See accompanying notes to unaudited condensed financial statements

7

ELECTRO-SENSORS, INC.

FOR THE PERIOD ENDED SEPTEMBER 30, 2023

(in thousands except share and per share amounts)

(unaudited)

Note 1. Basis of Presentation 

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions and regulations of the Securities and Exchange Commission to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

This report should be read together with the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, including the audited financial statements and footnotes therein.

Management believes that the unaudited financial statements include all adjustments, consisting of normal recurring accruals, necessary to fairly state the financial position and results of operations as of September 30, 2023 and for the three and nine-month periods ended September 30, 2023 and 2022, in accordance with accounting principles generally accepted in the United States of America. The results of interim periods may not be indicative of results to be expected for the year.

Nature of Business

Electro-Sensors, Inc. (the "Company") manufactures and markets a complete line of monitoring and control systems for a wide range of industrial machine applications. The Company uses leading-edge technology to continuously improve its products, with the goal of manufacturing the industry-preferred product for each of our served markets. The Company sells these products through an internal sales staff and distributors to a wide range 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.

Note 5 provides information regarding the Merger Agreement that we entered into on June 10, 2022 and that was terminated January 30, 2023.

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 credit losses that reflects management’s best estimate of the amounts that will not be collected. Management assesses collectability by reviewing trade receivables on a collective and individual basis. In determining the amount of the allowance for credit losses, we consider historical collectability and past due status and make judgements about the creditworthiness of customers based on ongoing credit evaluations. We also consider customer-specific information and current market conditions.

8

ELECTRO-SENSORS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2023

(in thousands except share and per share amounts)

(unaudited)

Revenue Recognition

At contract inception, the Company assesses the goods and services to be provided to a customer and identifies a performance obligation for each distinct 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 to be provided 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. Certain contracts have a second performance obligation, which typically is the initialization of the HazardPRO^TM 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.

Fair Value Measurements 

The carrying value of trade receivables, accounts payable, and other financial working capital items approximates fair value at September 30, 2023 and December 31, 2022, due to the short maturity nature of these instruments.

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”) option pricing 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 interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option.   

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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. Current significant estimates, including the underlying assumptions, consist of 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.  

9

ELECTRO-SENSORS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2023

(in thousands except share and per share amounts)

(unaudited)

Net Income (Loss) per Common Share

Basic income (loss) per share excludes dilution and is determined by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share reflects the potential dilution that could occur if securities such as options or restricted stock units were exercised or converted into common stock.

Diluted earnings per share ("Diluted EPS") considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential shares would have an anti-dilutive effect. Diluted EPS also excludes the impact of common shares issuable upon the exercise of outstanding stock options in periods in which the option exercise price is greater than the average market price of our common stock during the period.

For the three-month periods ended September 30, 2023, and 2022, 175,000 and 243,884 respectively, weighted average common shares for underlying stock options have been excluded from the calculation because their effect would be anti-dilutive. For the nine-month periods ended September 30, 2023 and 2022, 175,000 and 325,000 respectively, weighted average common shares for underlying stock options have been excluded from the calculation.

In addition, for the three and nine-month periods ended September 30, 2023, 105,000 restricted stock units have been excluded from the calculation because their effect would be anti-dilutive. 

New Accounting Standard Adopted

Accounting Standard Update (“ASU”) No. 2016-13, Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Statements requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The adoption of ASU 2016-13 on January 1, 2023 had no significant impact on our financial statements.

10

ELECTRO-SENSORS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2023

(in thousands except share and per share amounts)

(unaudited)

Note 2. Investments

The Company has investments in commercial paper, money market savings, Treasury Bills, and common equity securities of two private U.S. companies. The commercial paper investment is in U.S. debt with ratings of A-1+, P-1, and F1+. The Treasury Bills have remaining terms ranging from one month to three months at September 30, 2023.  

The Company classifies its investments in commercial paper and Treasury Bills as available-for-sale, accounted for at fair value with unrealized income and losses recognized in accumulated other comprehensive income (loss) on the balance sheet.  Equity securities are stated at fair value and unrealized gains and losses, if any, are reported in our statements of comprehensive income (loss) in non-operating income.

The cost and estimated fair value of the Company’s investments are as follows:

	Cost		Gross unrealized gain		Gross unrealized loss		Fair value
September 30, 2023
Money Market Savings	$	1,694	$	0	$	0	$	1,694
Treasury Bills		7,898		47		0		7,945
Equity Securities		54		2		0		56
		9,646		49		0		9,695
Less Cash Equivalents		3,668		1		0		3,669
Total Investments, September 30, 2023	$	5,978	$	48	$	0	$	6,026
December 31, 2022
Commercial Paper	$	1,377	$	0	$	0	$	1,377
Treasury Bills		7,922		32		0		7,954
Equity Securities		54		2		0		56
		9,353		34		0		9,387
Less Cash Equivalents		7,319		32		0		7,351
Total Investments, December 31, 2022	$	2,034	$	2	$	0	$	2,036

11

ELECTRO-SENSORS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2023

(in thousands except share and per share amounts)

(unaudited)

Note 3. Fair Value Measurements

The following table provides information on those assets and liabilities measured at fair value on a recurring basis.

September 30, 2023

	Carrying amount				Fair Value Measurement Using
	in balance sheet		Fair Value		Level 1		Level 2		Level 3
Assets:
Cash equivalents
Money Market Savings	$	1,694	$	1,694	$	1,694	$	0	$	0
Treasury Bills		1,975		1,975		1,975		0		0
Treasury Bills - maturity date greater than three months		5,970		5,970		5,970		0		0
Equity Securities		56		56		0		0		56

December 31, 2022

	Carrying amount				Fair Value Measurement Using
	in balance sheet		Fair Value		Level 1		Level 2		Level 3
Assets:
Cash equivalents
Commercial paper	$	1,377	$	1,377	$	1,377	$	0	$	0
Treasury Bills		5,974		5,974		5,974		0		0
Treasury Bills - maturity date greater than three months		1,980		1,980		1,980		0		0
Equity Securities		56		56		0		0		56

The fair value of the commercial paper and Treasury Bills is based on quoted market prices in an active market. The equity securities owned by the Company are investments in two non-publicly traded companies.  There is an undeterminable market for each of these two companies and the Company has determined the fair value based on financial and other factors that are considered level 3 inputs in the fair value hierarchy.  

The changes in level 3 assets measured at fair value on a recurring basis are as follows:  

	Nine Months Ended September 30,
	2023		2022
Beginning Balance	$	56	$	56
Change in Fair Value		0		0
Ending Balance	$	56	$	56

12

ELECTRO-SENSORS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2023

(in thousands except share and per share amounts)

(unaudited)

Note 4. Inventories

Inventories used in the determination of cost of goods sold are as follows: 

	September 30,  2023			December 31,  2022
Raw Materials	$	1,210		$	1,162
Work In Process		317			278
Finished Goods		319			315
Reserve for Obsolescence		(10	)		(10	)
Total Inventories, net	$	1,836		$	1,745

Note 5. Merger Agreement with Mobile X Global, Inc. 

On June 10, 2022, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Mobile X Newco, Inc., a Delaware corporation, a wholly owned subsidiary of the Company (the “Merger Sub”), and Mobile X Global, Inc., a Delaware corporation (“Mobile X”).

On January 30, 2023, the Company and Mobile X terminated the Merger Agreement.  A condition to the closing of the merger transaction was the consummation of an equity financing that the parties anticipated would be a PIPE investment (private investment in public entity).  The financing necessary to consummate the merger was pursued but was not available due to difficult conditions in the financial markets, including the markets for PIPE investments.

Note 6. Stock-Based Compensation

Stock options

The 2013 Equity Incentive Plan (the “2013 Plan”) authorizes 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 2013 Plan, 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, subject to early termination 12 months after termination of employment or service due to death, disability, or termination other than for cause.

During the 2023 third quarter, the Company granted 25,000 non-qualified stock options to its Chief Executive Officer and to three of its four non-employee board members. The options vest 20% on the grant date, with an additional 20% vesting annually thereafter.

13

 ELECTRO-SENSORS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2023

(in thousands except share and per share amounts)

(unaudited)

The assumptions made in estimating the fair value of the options on the grant date based upon the BSM option-pricing model for the three-month period ended September 30, 2023 are as follows:

Dividend Yield	0.00%
Expected Volatility	25.56%
Risk Free Interest Rate	4.35%
Expected Life	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.

The Company had 225,000 in options that expired during the quarter. There were no options exercised during the nine-month period ended September 30, 2023. There was 7,500 options exercised during the nine-months ended September 30, 2022.

The following table summarizes the activity for all stock options outstanding for the nine months ended September 30: 

	2023				2022
	Shares			Weighted Average Exercise Price	Shares			Weighted Average Exercise Price
Options outstanding at beginning of year	300,000		$	4.36	332,500		$	4.25
Granted	100,000			4.11	0
Exercised	0				(7,500	)		4.15
Expired	(225,000	)		4.57	0
Options outstanding at September 30	175,000		$	4.03	325,000		$	4.30
Options exercisable at September 30	50,000		$	4.21	320,000		$	4.31
Weighted average grant date fair for options exercised during the period	0				7,500		$	4.15

As of September 30, 2023, the total unrecognized compensation expense related to outstanding stock options was $119, which the Company expects to recognize over a period of five years. The Company recognized compensation expense in connection with the vesting of stock options of approximately $30 for the three and nine months ended September 30, 2023.

14

ELECTRO-SENSORS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2023

(in thousands except share and per share amounts)

(unaudited)

Restricted stock units

The 2013 Plan authorizes the issuance of restricted stock units.  Stock-based compensation expense is determined on the grant date based on the closing market value of our common stock. The amount of expense is calculated based on an estimate of the number of awards expected to vest at the end of each vesting period and is expensed evenly over the vesting period.  In connection with the time of vesting and issuance of shares, an eligible recipient of common stock may elect to have some shares withheld by the Company to satisfy any requirement for withholding taxes.

In September 2023, the Company granted 35,000 restricted stock units to its Chief Executive Officer and 17,500 restricted stock units to each of its four non-employee board members. The restricted stock units vest 20% on the first anniversary of the grant and 20% annually thereafter.

The following table summarizes restricted stock unit activity for the nine months ended September 30, 2023:

	Unvested Restricted Stock Units
	Number of Shares		Weighted-Average Grant-Date Fair Value
Unvested as of December 31, 2022	0	$	0
Granted	105,000		4.11
Vested	0		0
Forfeited/canceled	0		0
Unvested as of September 30, 2023	105,000	$	4.11

As of September 30, 2023, the total unrecognized compensation expenses related to outstanding restricted stock units is $424, which the Company expects to recognize over a period of five years. The Company recognized compensation expense in connection with the vesting of restricted stock units of approximately $8 for the three and nine months ended September 30, 2023.

Note 7. Contingencies

The Company sometimes becomes subject to claims against it in the ordinary course of business.  There are currently no pending or threatened claims against the Company that it believes will have a material adverse effect on its results of operations or liquidity.

15

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 Form 10-Q, but primarily in this Management’s Discussion and Analysis of Financial Condition and Results of Operations section. 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) our ability to continue to obtain parts and materials for our products from various manufacturers and distributors in a timely manner and at reasonable prices, (iv) the value of our intellectual property, (v) our competitive position in the marketplace, (vi) the effect of governmental regulations on our business, (vii) our employee relations, (viii) the adequacy of our facilities, (ix) our intention to develop new products, (x) the possibility of us acquiring compatible businesses or product lines as part of our growth strategy, and (xi) 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 obligation to update any forward-looking statements. 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 forward-looking statements are subject to certain risks and uncertainties that could cause future results to differ materially from our recent results listed under the heading “Forward-Looking Statements” under “Item 1—Business,” in our Annual Report on Form 10-K for the year ended December 31, 2022, as well as the following:

• Respond to events beyond our control such as any disruption in the economy caused by (i) a government shutdown similar to those that have occurred over the past decade or (ii) the recent October 2023 outbreak of violence in the Middle East,
• Continue to procure components for our products, and maintain a steady and reliable workforce, as described below under "Supply Chain and Labor Dynamics".

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. These decisions include the selection of applicable accounting principles and the use of judgment in their application and affect reported amounts and disclosures. Changes in economic conditions or other business circumstances may affect the outcomes of management’s estimates and assumptions. An in-depth description of our accounting estimates can be found in the interim financial statements included in this report and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. 

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SELECTED FINANCIAL INFORMATION

The following table contains selected financial information, for the periods indicated, from our Condensed Statements of Comprehensive Income (Loss) expressed as a percentage of net sales. 

	Three Months Ended September 30				Nine Months Ended September 30
	2023		2022		2023			2022
Net sales	100.0	%	100.0	%		100.0	%	100.0	%
Cost of goods sold	51.7		47.5			50.6		46.0
Gross profit	48.3		52.5			49.4		54.0
Operating expenses
Selling and marketing	14.9		16.1			16.3		17.7
General and administrative	24.0		22.4			23.4		30.7
Research and development	10.6		8.6			11.6		9.3
Total operating expenses	49.5		47.1			51.3		57.7
Operating income (loss)	(1.2	)	5.4			(1.9	)	(3.7	)
Non-operating income
Interest income	5.3		1.6			4.8		0.6
Total non-operating income, net	5.3		1.6			4.8		0.6
Income (loss) before income tax expense (benefit)	4.1		7.0			2.9		(3.1	)
Income tax expense (benefit)	3.6		1.4			1.5		(0.7	)
Net income (loss)	0.5	%	5.6	%		1.4	%	(2.4	)%

The following paragraphs discuss the Company’s performance for the three and nine months ended September 30, 2023 and 2022.

RESULTS OF OPERATIONS (in thousands) 

Net Sales

Net sales for the three-month period ended September 30, 2023 were $2,057, a decrease of $159, or 7.2%, from $2,216 during the comparable period in 2022.  Net sales for the nine months ended September 30, 2023 were $6,239, a decrease of $676, or 9.8%, from $6,915 during the comparable period in 2022.  The decrease during the three-month period was the result of decreased sales of our wired sensor products, partially offset by increased sales of HazardPRO^TM wireless hazard monitoring systems.  The decrease during the nine-month period was a result of decreased sales of both traditional wired products and HazardPRO wireless hazard monitoring systems.   

Gross Profit

Gross profit for the third quarter of 2023 was $993, a decrease of $170, or 14.6%, over the same period in 2022. Gross profit for the nine months ended September 30, 2023 was $3,083, a decrease of $654, or 17.5%, over the same period in 2022. Gross margin decreased in the third quarter of 2023 to 48.3% from 52.5% during the same period in 2022. Gross margin for the nine months ended September 30, 2023 decreased to 49.4% from 54.0% over the same period in 2022. The decrease in gross margin for both periods was primarily due to an increase in product and labor costs across all product lines.  

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 Operating Expenses

Total operating expenses decreased $25, or 2.4%, to $1,019 for the third quarter of 2023 compared to the same period in 2022 and increased as a percentage of net sales to 49.5% from 47.1%. Total operating expenses decreased $794, or 19.9%, to $3,203 for the nine months ended September 30, 2023 compared to the same period in 2022 and decreased as a percentage of net sales to 51.3% from 57.7%. The decrease in operating expenses for both periods was primarily due to lower legal and professional fees related to the terminated merger agreement with Mobile X as discussed in Note 5 to the financial statements and decreased sales headcount.

● Selling and marketing expenses in the third quarter of 2023 decreased $50 to $307, or 14.0%, from the same period in 2022 and decreased as a percentage of net sales to 14.9% from 16.1%. Selling and marketing expenses in the nine months ended September 30, 2023 decreased $209 to $1,021, or 17.0%, from the same period in 2022 and decreased as a percentage of net sales to 16.3% from 17.7%. The decrease for both periods was primarily due to lower sales headcount and variable compensation related to lower revenue.

● General and administrative expenses decreased $3 to $494, or 0.6%, in the third quarter of 2023 compared to the same period in 2022 but increased as a percentage of net sales to 24.0% from 22.4%. General and administrative expenses decreased $667 to $1,458, or 31.4%, in the nine months ended September 30, 2023 compared to the same period in 2022 and decreased as a percentage of net sales to 23.4% from 30.7%. The decrease in both periods was primarily due to a decrease in legal and professional fees related to the terminated merger agreement, partially offset by an increase in stock-based compensation expense primarily related to the 2023 third quarter stock option grants.

● Research and development expenses increased $28 to $218, or 14.7%, in the third quarter of 2023 compared to the same period in 2022 and increased as a percentage of net sales to 10.6% from 8.6%. Research and development expenses increased $82 to $724, or 12.8%, in the nine months ended September 30, 2023 compared to the same period in 2022 and increased as a percentage of net sales to 11.6% from 9.3%. The increase for both periods was due to higher contract engineering costs related to product development and enhancements.

Non-Operating Income

Net non-operating income increased by $74, or 211.4%, for the three-month period ended September 30, 2023 compared to the same period in 2022.  Net non-operating income increased by $253, or 588.4%, for the nine months ended September 30, 2023 compared to the same period in 2022. The increase for both periods is the result of additional interest income earned as a result of higher interest rates on Treasury Bills.

Income (Loss) Before Income Tax Expense (Benefit)

Income before income tax expense was $83 for the third quarter of 2023, representing a decrease of $71 compared to $154 for the same period in 2022. Income before income tax expense was $176 for the nine months ended September 30, 2023, representing an increase of $393 compared to a loss before income tax benefit of $217 for the same period in 2022. The decrease for the three-month period was primarily due to lower revenues and gross margins, as discussed above.  The increase for the nine months was primarily the result of lower operating expenses and an increase in interest income, partially offset by lower revenues and gross margins, as discussed above.

Income Tax Expense (Benefit)

Income tax expense was $75, or 3.6%, of net sales in the third quarter of 2023 compared to an income tax expense of $32, or 1.4%, of net sales in the third quarter of 2022. Income tax expense was $96, or 1.5%, of net sales for the nine months ended September 30, 2023, compared to an income tax benefit of $46, or (0.7)%, of net sales for the nine months ended September 30, 2023.  Income tax expense in the 2023 periods was higher than federal tax rates due to the 2023 third quarter write-off of deferred tax asset related to the 2023 expired options.

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LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents were $3,902 at September 30, 2023 and $7,646 at December 31, 2022. The decrease was primarily the result of an increase in Treasury Bills classified as investments as of September 30, 2023 as compared to December 31, 2022. Cash, cash equivalents, and investments were $9,928 at September 30, 2023 as compared to $9,682 at December 31, 2022.

Cash from operating activities was $92 for the nine months ended September 30, 2023 as compared to cash used in operating activities of $213 for the nine months ended September 30, 2022. The $305 increase in cash from operating activities was due primarily to an increase in net income and a decrease in trade receivables.  The 2023 net income compared to the 2022 net loss was primarily due to decreased expenses related to the terminated merger agreement described in Note 5 to the financial statements and an increase in interest income, partially offset by a decrease in net revenues. The decrease in trade receivables is due to the timing of sales and collections. 

Cash used in investing activities was $3,831 for the nine months ended September 30, 2023 compared to cash from investing activities of $2,991 for the nine months ended September 30, 2022. The increase in cash used in investing activities was due to the 2023 increase in the purchases of Treasury Bills classified as investments compared to maturities. As shown on the Statement of Cash Flows, during 2023, the Company purchased more Treasury Bills with maturity dates greater than three months to secure higher interest rates.

Cash used in financing activities in the nine months ended September 30, 2023 was $5 compared to cash from investing activities of $27 for the nine months ended September 30, 2022.  In the third quarter of 2022, three non-employee directors exercised a total of 7,500 stock options for a total exercise price of $31.

Subject to the following section, entitled "Supply Chain and Labor Dynamics," the Company believes its ongoing cash requirements will be primarily for capital expenditures, research and development, working capital, corporate and business development and other strategic alternatives and that existing cash, cash equivalents, and investments and any cash generated from operations will be sufficient to meet these cash requirements through at least the next 12 months.

Supply Chain and Labor Dynamics

We traditionally have had one or more robust sources for production components and materials. However, we continue to experience disruptions in our supply chain, resulting in difficulty sourcing some components. We are also experiencing price increases for many of the components used in our products. To meet these challenges, we are seeking additional sources for components and modifying product designs to accommodate new components that are more readily available at competitive prices. There is no guarantee that we will continue to be successful in modifying these designs and sourcing alternative components. As a result, we could experience significant delays in receiving certain components needed to make timely customer deliveries, as well as increased costs that erode gross margins. Supply chain dynamics may have an effect on the efficiency of our business operations, our customer base, and the domestic or worldwide economy.  Furthermore, the labor market for qualified employees able to fill our various open positions is challenging and may result in delays in filling these positions. In addition, we may experience changes in transportation and freight availability that may make it difficult to have materials and components shipped to us, or our products shipped to customers, in a timely and cost-effective manner. While we continue to closely manage each of these activities, our actions may not be successful and may result in a negative effect on our sales and profit margins.

Future Corporate and 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 or business acquisitions. In addition, we continue to explore other strategic alternatives that we believe present good opportunities for the Company and its shareholders. On June 13, 2022, we announced that we had entered into a Merger Agreement with Mobile X Newco, Inc. and Mobile X Global, Inc.  On January 30, 2023, we announced that the Merger Agreement had been terminated and that the Company's Board of Directors had established a special committee to explore and pursue business development and other strategic alternatives.

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Off-balance Sheet Arrangements

As of September 30, 2023, the Company had no off-balance sheet arrangements or transactions.

Non-GAAP Financial Measure

In addition to financial results reported in accordance with accounting principles generally accepted in the United States of America (“GAAP”), the Company is providing a non-GAAP financial measure in this Form 10-Q and an itemized reconciliation between Net Income (Loss), a GAAP financial measure, and Adjusted Net Income, the non-GAAP financial measure.

The Company is using "Adjusted Net Income" as a non-GAAP financial measure to facilitate period-to-period comparisons and analysis of its operating performance and believes it is useful to investors as a supplement to GAAP measures in analyzing, trending and benchmarking the performance and value of the Company’s business. This measure is not intended to be a substitute for, or more meaningful than, Net Income (Loss) in accordance with GAAP, but is provided as supplemental information. This measure may be different from Adjusted Net Income or similar financial measures used by other companies, even when similar terms are used to identify these measures. 

As discussed below, to calculate Adjusted Net Income, the Company added back the costs and expenses, less estimated taxes, related to the negotiation and execution of the June 10, 2022 proposed Mobile X merger transaction to Net Income (Loss) for the three and nine months ended September 30, 2022. The Company believes adding back these costs and expenses more accurately portrays the underlying results and trends of the ongoing business.

On January 30, 2023, the Company and Mobile X jointly agreed to terminate the merger agreement. Although the costs and expenses related to the Company-Mobile X Merger Agreement were incurred primarily in general and administrative expenses, the Company is not presenting any other non-GAAP information because it believes it has adequately described these expenses in the Management's Discussion and Analysis section of this Form 10-Q and past filings with the Securities and Exchange Commission.

The Company incurred approximately $79 and $856 in legal and other professional fees for the three and nine months ended September 30, 2022, respectively, related to the Mobile X merger opportunity.  The following table sets forth a reconciliation of Net Income (Loss), a GAAP financial measure, to Adjusted Net Income (as defined above), the non-GAAP measure, for the periods noted.

	Three Months Ended September 30					Nine Months Ended September 30
		2023		2022		2023		2022
Net Income (Loss) - GAAP	$	8	$	122		$	80	$	(171	)
Merger-related expenses		0		79			0		856
Income tax benefit of merger-related expenses		0		(17	)		0		(180	)
Adjusted Net Income	$	8	$	184		$	80	$	505

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Not Applicable.

Evaluation of Disclosure Controls and Procedures

Based on an evaluation with the participation of the Company’s management, the Company’s principal executive officer and principal financial officer has concluded that the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), were effective as of September 30, 2023.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the third quarter of 2023 that were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. 

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Exhibit	Description
10.3	Form of Non-Qualified Stock Option Agreement under the 2013 Equity Incentive Plan, as updated August 2023
10.4	Form of Restricted Stock Unit Agreement under the 2013 Equity Incentive Plan
31.1	Certification of CEO and CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following financial information from Electro-Sensors, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2023, formatted in iXBRL (Inline Extensible Business Reporting Language), (i) Condensed Balance Sheets as of September 30, 2023 and December 31, 2022, (ii) Condensed Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2023 and September 30, 2022, (iii) Condensed Statements of Changes in Stockholders' Equity for the three and nine months ended September 30, 2023 and September 30, 2022, (iv) Condensed Statements of Cash Flows for the nine months ended September 30, 2023 and September 30, 2022, and (v) Notes to Financial Statements.

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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Electro-Sensors, Inc.
November 14, 2023	/s/ David L. Klenk
	David L. Klenk
	Chief Executive Officer and Chief Financial Officer (Principal Executive Officer and Principal Financial Officer)

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