UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-QSB

ý QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
EXCHANGE ACT

FOR THE TRANSITION PERIOD FROM           TO           

Commission File Number 0-9587

ELECTRO-SENSORS, INC.

(Exact name of small business issuer as specified in its charter)

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

Check whether the issuer (1) filed all 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 ý  No o

The number of shares outstanding of the registrant’s Common Stock, $0.10 par value, on November 15, 2004 was 3,218,345.

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

ELECTRO-SENSORS, INC.

Form 10-QSB

For the Period Ended September 30, 2004

TABLE OF CONTENTS

2

PART I.    FINANCIAL INFORMATION

Item 1.  Financial Statements

ELECTRO-SENSORS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	September 30, 2004			December 31, 2003
	(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$		6,620,384	$	6,863,046
Investments	4,933,801			13,415,625
Trade receivables, less allowance for doubtful accounts of $7,483 and $6,000, respectively	575,581			515,351
Inventories	803,723			758,103
Prepaid income tax	52,860			0
Other current assets	63,988			62,123
Total current assets	13,050,337			21,614,248
Property and equipment, net	1,422,657			1,470,133
Investment in equity method investee	146,985			152,115
TOTAL ASSETS	$	14,619,979		$		23,236,496
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable	$	159,818		$		106,065
Accrued expenses	308,393			263,143
Deferred revenue	54,933			48,022
Deferred income tax	1,689,361			4,795,000
Accrued income tax	0			96,196
Total current liabilities	2,212,505			5,308,426
Deferred income taxes	26,000			26,000
TOTAL LIABILITIES	$	2,238,505		$		5,334,426
STOCKHOLDERS’ EQUITY
Common stock par value $0.10 per share; authorized 10,000,000 shares; issued 3,218,345 and 3,174,522 shares, respectively.	321,835			317,452
Additional paid-in capital	1,103,948			999,762
Retained earnings	8,031,402			8,304,737
Accumulated other comprehensive income	2,924,289			8,280,119
TOTAL STOCKHOLDERS’ EQUITY	12,381,474			17,902,070
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	14,619,979		$		23,236,496

See accompanying notes to consolidated financial statements

3

ELECTRO-SENSORS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended September 30,								Nine Months Ended September 30,
	2004				2003				2004			2003
Net sales	$	1,242,642			$	1,147,210			$	3,664,207		$	3,157,996
Cost of goods sold	452,669				429,515				1,368,288			1,215,441
Gross profit	789,973				717,695				2,295,919			1,942,555
Operating expenses:
Selling and marketing	340,529				268,218				967,785			879,448
General and administrative	254,515				205,108				774,615			741,639
Research and development	205,993				157,189				566,525			574,813
Total operating expenses	801,037				630,515				2,308,925			2,195,901
Operating income (loss)	(11,064			)	87,180				(13,006		)	(253,346		)
Non-operating income (expense):
Gain (loss) on sale of investment securities	(957			)	516,639				425,339			546,168
Interest income	18,931				11,633				42,696			43,146
Other income (expense)	2,304				870				8,742			5,598
Equity in losses of equity method investee	(39,972			)	(207,303			)	(165,130		)	(694,222		)
Total non-operating income (expense)	(19,694			)	321,839				311,647			(99,310		)
Income (loss) before income taxes	(30,758			)	409,019				298,641			(352,656		)
Federal and state income tax provision (benefit)	4,457				260,187				187,422			107,659
Net income (loss)	$		(35,215	)	$		148,832		$	111,219		$	(460,315	)
Net income (loss) per share data:
Basic
Net income (loss) per share	$		(0.01	)	$		0.05		$	0.03		$	(0.15	)
Weighted average shares	3,218,009				3,168,938				3,202,089			3,162,792
Diluted
Net income (loss) per share	$		(0.01	)	$		0.05		$	0.03		$	(0.15	)
Weighted average shares	3,326,575				3,235,272				3,312,835			3,162,792
Dividends paid per share	$		0.04		$		0.03		$	0.12		$	0.09

See accompanying notes to consolidated financial statements

4

ELECTRO-SENSORS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended September 30,
	2004			2003
Cash flows from operating activities
Net income (loss)	$	111,219		$	(460,315	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation	68,328			76,336
Realized (gain)/loss on sale of investments	(425,339		)	(546,168		)
Equity in loss of equity method investee	165,130			694,222
(Increase)/decrease in:
Trade receivables	(60,230		)	(35,106		)
Inventory	(45,620		)	9,708
Other current assets	(1,865		)	(7,305		)
Prepaid income taxes	(52,860		)	124,809
Increase/(decrease) in:
Accounts payable	53,753			(163,758		)
Accrued expenses	45,250			(47,876		)
Deferred revenue	6,911			(14,714		)
Accrued income taxes	(96,196		)	(91,650		)
Net cash provided by/(used) in operating activities	(231,519		)	(461,817		)
Cash flows from investing activities:
Proceeds from sale of investments	771,895			587,864
Purchase of equity securities	(326,202		)	0
Payment for purchase of investments	(160,000		)	(384,359		)
Purchase of property and equipment	(20,852		)	(22,666		)
Net cash provided by/(used) in investing activities	264,841			180,839
Cash flows from financing activities:
Proceeds from issuance of stock	108,569			35,241
Dividends paid	(384,554		)	(284,677		)
Net cash provided by/(used) in financing activities	(275,985		)	(249,436		)
Net increase/(decrease) in cash & cash equivalents	(242,662		)	(530,414		)
Cash & cash equivalents, beginning	6,863,046			6,723,160
Cash & cash equivalents, ending	6,620,384			6,192,746
Supplemental schedule of non-cash investing and financing activities
Net change in unrealized gain/ (loss) on investments	$	(8,461,469	)	$	4,181,048

See accompanying notes to consolidated financial statements

5

ELECTRO-SENSORS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.  Nature of Business

The accompanying consolidated financial statements include the accounts of Electro-Sensors, Inc. and its wholly owned subsidiary ESI Investment Company. Intercompany accounts, transactions and earnings have been eliminated in consolidation. The consolidated entity is referred to as “the Company.”

Electro-Sensors, Inc. operates two distinct businesses. The first is the Controls Division, which manufactures and markets a complete line of speed monitoring and motor control systems for industrial machinery. The Controls Division utilizes leading-edge technology to continuously improve its products and make them easier to use. The Controls Division’s goal is to manufacture the industry-preferred product for every market served. These products are sold through an internal sales staff, manufacturers representatives, and distributors to a wide variety of manufacturers, OEM’s and processors to monitor process machinery operations. The Controls Division markets its products to a number of different industries located throughout the United States and abroad.

The second business is AutoData Systems (ADS).  ADS designs and markets a desktop software-based system that reads hand printed characters, checkmarks and bar code information from scanned or faxed forms. ADS products are designed to provide capabilities to automate data collection and are sold by internal sales staff to end users, resellers and developers in the United States, Canada, Europe and Asia.

In both divisions, the Company grants credit to customers under normal industry terms, generally 30 days.

ESI Investment Company (INV) owns equity securities in August Technology Corporation and PPTV Vision Inc. (PPTV), and membership interests in a la mode, LLC, among other investments.  Shares of August Technology common stock have experienced significant appreciation in value since its initial public offering in 2000.  ESI Investment acquired shares of PPTV in May 2002 and September 2003.  In May 2002, the Company adopted the equity method of accounting for its investments in PPTV.  In April 2004, ESI Investment purchased 20% of a la mode, LLC’s membership interests for $160,000.  The Company has adopted the equity method of accounting to report this investment.  The Company’s investments in securities are subject to market and other investment risks.  See Note 6 for additional information regarding INV’s investments.

Note 2.  Basis of Presentation

The accompanying unaudited consolidated 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 to Form 10-QSB.  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.  It is the opinion of management that the unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring accruals, necessary to fairly state the financial position and results of operations for the three and nine month periods ended September 30, 2004 and September 30, 2003. The results of interim periods may not be indicative of results to be expected for the year.

The Balance Sheet at December 31, 2003 has been derived from the Company’s audited financial statements for the year ended December 31, 2003, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  For further information, refer to the financial statements and footnotes thereto included in the Company’s annual report on Form 10-KSB for the year ended December 31, 2003.

Note 3.  Revenue Recognition

Revenue recognition of production monitoring equipment:

All production monitoring equipment is shipped without an evaluation or acceptance period. Revenues from the sale of the products and any related warranty costs are recognized at the time of shipment. The Company’s distributors are not granted any price protection. Sales to all customers, including distributors, are final and no right of return after shipment exists.

6

Software revenue recognition:

The Company recognizes revenue upon shipment of its character recognition software. The product is sold to the end user and risk of loss is transferred, and the Company has no continuing obligations, once its products are delivered to the shipper. The Company recognizes revenue upon shipment, net of return reserves based on historical experience. To recognize revenue, it must also be probable that the Company will collect the accounts receivable from its customers. In some situations, the Company receives advance payments from its customers. Revenue associated with these advance payments is deferred until the product is shipped.

Note 4.  Stock-Based Compensation

In accordance with Accounting Principles Board (APB) Opinion No. 25 and related interpretations, the Company uses the intrinsic value-based method for measuring stock-based compensation cost which measures compensation cost as the excess, if any, of quoted market price of the Company’s common stock at the grant date over the amount the employee must pay for the stock.  The Company’s general policy is to grant stock options at fair value at the date of grant.

Had compensation cost been recognized based on the fair values of options at the grant dates consistent with the provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock Based Compensation,” the Company’s net income (loss) and basic and diluted net income (loss) per common share would have been changed to the following pro forma amounts:

	Three Months Ended September 30,							Nine Months Ended September 30,
	2004					2003		2004		2003
Net income (loss):
As reported	$			(35,215	)	$	148,832	$	111,219	$	(460,315	)
Pro forma	$		(68,225		)	$	141,199	$	66,650	$	(478,954	)
Basic net income (loss) per common share:
As reported	(0.01				)	0.05		0.03		(0.15		)
Pro forma	(0.02				)	0.04		0.02		(0.15		)
Diluted net income (loss) per common share:
As reported	(0.01				)	0.05		0.03		(0.15		)
Pro forma	(0.02				)	0.04		0.02		(0.15		)
Stock based compensation:
As reported	0					0		0		0
Pro forma	$	33,010				$	7,633	$	44,569	$	18,639

In determining the compensation cost of options granted during the three and nine months ended September 30, 2004 and 2003, as specified by SFAS No. 123, the fair value of each option grant has been estimated on the date of grant using the Black-Scholes option pricing model and the weighted average assumptions used in these calculations are summarized as follows:

	Three Months Ended September 30,			Nine Months Ended September 30,
	2004		2003	2004		2003
Risk-free interest rate	3.00	%	N/A	3.00	%	N/A
Expected life of options granted	5 years		N/A	5 years		N/A
Expected volatility	52.19	%	N/A	52.19	%	N/A
Expected dividend yield	0.00	%	N/A	0.00	%	N/A

Note 5.  Net Income (Loss) Per Share

The Company’s basic net income (loss) per share amounts have been computed by dividing net income (loss) by the weighted average number of outstanding common shares. The Company’s diluted net income (loss) per share is computed by dividing net income (loss) by the weighted average number of outstanding common shares and common share equivalents relating to stock options and warrants, when dilutive. For the three months ended September 30, 2004, 108,566 shares of common stock equivalents were excluded from the computation of diluted net income (loss) per share as their effect was anti-dilutive due to our reported net loss for the period.  For the nine months ended September 30, 2004, 110,746 shares of common stock equivalents were included in the computation of diluted net income (loss) per share.  For the three months ended June 30, 2003, 66,334 shares of common stock equivalents were included in the computation of diluted net income (loss) per share.  For the nine months ended September 30, 2003, the shares were anti-dilutive.

7

Options to purchase 9,000 shares of common stock with a weighted average exercise price of $4.49 were outstanding for the three months ending September 30, 2004, but were excluded from the computation of common share equivalents because their exercise prices were greater than the average market price of the common shares for the period.

Note 6.  Investments

INV’s investments consist of equity securities, primarily common stocks, government debt securities and money market funds. The estimated fair value of publicly traded equity securities (other than those accounted for based upon the equity method of accounting) is based on quoted market prices, and therefore subject to the inherent risk of market fluctuations.  Shares of common stock for which there is no readily determinable value (i.e., no quoted market price) are accounted for on a historical cost method (unless accounted for based upon the equity method of accounting).  Management determines the appropriate classification of securities at the date individual investments are acquired, and evaluates the appropriateness of such classification at each balance sheet date.

Since the Company generally does not buy investments in anticipation of short-term fluctuations in market prices, investments in equity securities are classified as available-for-sale (unless accounted for on the equity method of accounting).  Available-for-sale securities 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 separate component of stockholders’ equity.

Realized gains and losses on securities, including losses from declines in value of specific securities determined by management to be other-than-temporary (unless accounted for on the equity method of accounting), are included in income in the period realized.

At September 30, 2004, the Company owned 671,215 shares of August Technology.  The fair value of its holdings based on the quoted market price at September 30, 2004 was approximately $4,611,247.  Shares of August Technology common stock are eligible for trading on the Nasdaq National Market.  The Company’s investment in August Technology are classified as available-for-sale securities.

At September 30, 2004, the Company owned 2,207,036 shares of PPTV, which is 18.2% of PPTV’s outstanding common stock.  The fair value of its holdings based on the quoted market price at September 30, 2004 was approximately $1,677,347.  Shares of PPTV common stock are eligible for trading on the Nasdaq SmallCap Market.  The Company exercised warrants to purchase 549,084 additional shares of PPTV common stock at a per share price of $0.70 in September 2003.  The Company holds no more warrants to purchase additional PPTV common stock.  In connection with a 2002 investment in PPTV, the Company determined, solely for financial accounting purposes, that it could likely exercise significant influence over the operations of PPTV.  As a result, the Company’s ownership interest is reported using the equity method of accounting.  The investment was previously reported as an available-for-sale security, showing the market value on the balance sheet and recording any unrealized gains and losses in other comprehensive income.

In April 2004, ESI Investment purchased 20% of a la mode, LLC’s outstanding membership interests for $160,000. The Company has adopted the equity method of accounting for this investment.

Under the equity method of accounting, the Company’s proportionate share of PPTV and a la mode income or loss is included in the Company’s net income (loss) with a corresponding increase or decrease in the carrying value of its investment.

Note 7.  Comprehensive Income

Comprehensive income includes the Company’s net income (loss) plus other comprehensive income items that are excluded from net income (loss).  The Company’s other income consists of unrealized gains (losses), net of income taxes and reclassification adjustments for gains and losses included in net income (loss).

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Net Income (Loss)	$	(35,215	)	$	148,832		$	111,219		$	(460,315	)
Other Comprehensive Gain (Loss):
Change in unrealized value investments, net	(2,388,542		)	4,025,841			(5,355,830		)	5,246,081
Less:
Reclassification adjustment for gains included in net income	0			(516,639		)	(297,704		)	(546,168		)
Total comprehensive income (loss)	$	(2,423,757	)	$	3,658,034		$	(5,642,315	)	$	4,239,598

8

Note 8.  Segment Information

The Company has three reportable operating segments based on the nature of its product lines:  production monitoring, character recognition, and investments.  The production monitoring division (or Controls Division) manufactures and markets a complete line of speed monitoring and motor control systems for industrial machinery.  The character recognition division (or ADS) designs and markets a desktop software-based system that reads hand-printed characters, checkmarks, and bar code information from scanned or faxed forms.  Sales of this system include software and can include hardware.  The investments division (or INV) holds investments in freely tradeable and restricted securities.

In evaluating segment performance, management focuses on sales and income before taxes.  The Company has no inter-segment sales.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
External sales
Production monitoring	$	1,030,770		$	1,038,542		$	3,090,484		$	2,760,872
Character recognition	211,872			108,668			573,723			397,124
Investments	0			0			0			0
Total	$	1,242,642		$	1,147,210		$	3,664,207		$	3,157,996
Net income before taxes and discontinued operations
Production monitoring	$	96,649		$	216,009		$	373,045		$	109,517
Character recognition	8,939			(35,214		)	(33,724		)	(78,046		)
Investments	(136,346		)	228,222			(40,680		)	(384,130		)
Total	$	(30,758	)	$	409,019		$	298,641		$	(352,656	)

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

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

RESULTS OF OPERATIONS

Net Sales

Net sales for the three month period ended September 30, 2004 increased $95,432 or 8.3% when compared to net sales for the same period in 2003.  For the nine month period ended September 30, 2004, net sales increased $506,211 or 16.0% when compared to the same period in 2003.

The increase from the three months ended September 30, 2004 from the same period in 2003, includes a decrease in net sales from the Controls Division of $7,772 or 0.07%.  For the nine-months ended September 30, 2004 compared to the same period in 2003, the Controls Division contributed an increase in net sales of $329,612 or 11.9%.  The Controls Division has experienced an increase in sales for the first and second quarter of 2004 due in part to the recovery in the US economy and increased capital spending by our installed customer base.   The bulk of our sales volume continues to be derived from the Speed Monitoring product lines to the grain and feed markets, as well as other key industrial markets.

ADS had an increase in net sales of $103,204 or 95.0% from the three months ended September 30, 2004 to the same period in 2003.  For the nine months ended September 30, 2004 compared to the same period in 2003, ADS contributed an increase in net sales of $176,599 or 44.5%.  The ExpertScan software product has become the leading product for the division and is well-received by customers for its performance and ease of use.

Cost of Goods Sold

The Company’s cost of goods sold increased $23,154 or 5.4% for the three months ended September 30, 2004 from the same period in 2003.  For the nine months ended September 30, 2004, the cost of goods sold increased by $152,847 or 12.6%.  These increases are a direct result of increased sales for both divisions.

9

Gross Profit

Gross margins for the three month period ended September 30, 2004 were 63.6% versus 62.6% for the same period in 2003.  For the nine months ended September 30, 2004 gross margins were 62.7% versus 61.5% for the same period in 2003.  The increases in margins are due primarily to the Company’s continuing efforts to effectively manage and reduce production costs in both divisions.

Operating Expenses

Total operating expenses increased $170,522 or 27.0% for the three months ended September 30, 2004 when compared to the same period of the prior year.  Of this increase, the Controls Division contributed $110,200 or 24.0%, ADS’ contributed $37,788 or 22.0%, and INV contributed an increase of $22,534 or 100%.

For the nine months ended September 30, 2004 operating expenses increased $113,024 or 5.1% from the same period for 2003.  Of this increase, the Controls Division contributed a decrease of $47,752 or 2.9% which was offset by an increase in operating expenses for both ADS and INV.  ADS’ increase in operating expenses was $89,520 or 16.7%, and INV contributed an increase of $71,256, or 100%.

Selling and marketing costs increased $72,311 or 27.0% for the three months ended September 30, 2004 when compared to the same period in 2003.  For the nine months ended September 30, 2004, selling and marketing costs increased $88,337 or 10.0%.  Of the increase for the three months ended September 30, 2004, the Controls Division contributed $75,817 or 39.2%, which was offset by a decrease from ADS of $3,506 or 4.7%.  Of the increase for the nine months ended September 30, 2004, the Controls Division contributed $80,788 or 12.7%, ADS contributed an increase of $7,549 or 3.1%.  Marketing communications development for product launches, new literature, and ad development are the predominant expenses in the increase for both ADS and the Controls Division.

General and administrative costs increased $49,407 or 24.1% for the three months ended September 30, 2004 compared to the same period in 2003. For the nine months ended September 30, 2004, general and administrative costs increased $32,976 or 4.4%.  Of this increase for the three months ended September 30, 2004, the Controls Division contributed an increase of $18,591 or 9.7%, ADS contributed an increase of $8,283 or 62.0%, and INV contributed an increase of $22,533 or 100%.  Of the increase for the nine months ended September 30, 2004, the Controls Division contributed a decrease of $50,384 or 7.4%, offset by increases in both ADS and INV.  ADS increase for the nine months ended September 30, 2004 was $12,106 or 20.2%, and INV contributed an increase of $71,257 or 100%.  The overall decrease in general and administrative costs from the Controls Division was due to a few key expenses, mainly general liability insurance, and some personnel costs.  This decrease was offset by increasing costs of being a publicly held company.

Research and development costs increased $48,804 or 31.0% for the three months ended September 30, 2004 compared to the same period in 2003.  For the nine months ended September 30, 2004 compared to the same period in 2003, research and development costs decreased $8,289 or 1.4%.  Of the increase for the three months ended September 30, 2004, the Controls Division contributed $15,793 or 21.5%, and ADS contributed an increase of $33,011 or 39.4%.  For the nine months ended September 30, 2004, compared to the same period in 2003, the Controls Division contributed a decrease of $78,156 or 22.9% offset by in increase from ADS of $69,869 or 29.9%.  The decrease in the Controls Division was due to reduced outside development costs in both contract engineering and prototype development.  The increase in ADS was due to increased software development costs.

Non-Operating Income (Loss)

Non-operating income decreased by $341,533 for the three-month period ended September 30, 2004 compared to the same period for 2003.  For the nine months ended September 30, 2004, compared to the same period in 2003, non-operating income increased $410,957.

Gain on the sale of investment securities decreased $517,596 for the three month period ended September 30, 2004, compared to the same period in 2003.  For the nine month period ended September 30, 2004, gain on sale of investment securities decreased $120,829 compared to the same period in 2003.

Interest income increased $7,298 or 62.7% when comparing the three months ended September 30, 2004 to the same period in 2003.  This increase was due to the higher interest rates on treasury bills.  For the nine months ended September 30, 2004, the decrease was $450 or 1.0% when compared to the same period in 2003.

Equity in losses of equity method investee decreased $167,331 or 80.7% for the three months ended September 30, 2004 when compared to the same period in 2003.  For the nine months ended September 30, 2004, the loss decreased $529,092 or 76.2%.

10

Income (Loss) Before Income Taxes

Income before income taxes decreased $439,777, to a loss of $30,758 for the three-month period ended September 30, 2004 compared to the same period in 2003.  For the nine month period ended September 30, 2004, income before income taxes was $298,641, an increase of $651,297 when compared to the same period for 2003.

The Controls Division had income before income taxes of $96,649 for the three months ended September 30, 2004 compared to $216,009 for the same period in 2003, a decrease of $119,360.  This decrease was primarily due to increased operating expenses.  For the nine months ended September 30, 2004, the Controls Division had income before taxes of $373,045 compared to $109,417, an increase of $263,628 for the same period in 2003.  In addition to the increased sales for the Controls Division, for the nine months ended September 30, 2004, our overall efforts to reduce operating expenses contributed to the increase in net income before income taxes.

ADS had net income before income taxes of $8,939 for the three months ended September 30, 2004 compared to the net loss before income taxes of $35,214 for same period in 2003.  For the nine months ended September 30, 2004, ADS had a loss of $33,724 compared to a loss of $78,046 for the same period in 2003, or an increase of $44,322.  This increase is due to increased sales in this division.

Investment income from investment securities decreased $364,568 to a loss before income taxes of $136,346 for the three months ended September 30, 2004 compared to the same period in 2003.  For the nine months ended September 30, 2004, investment income increased $343,450 to net loss before income tax of $40,680.  These changes are explained under the section titled non-operating income (loss) in the management’s discussion and analysis section of this 10-QSB filing.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents were $6,620,384 at September 30, 2004 and $6,192,746 at September 30, 2003.  Cash used in operating activities of $231,519 for the nine months ended September 30, 2004 was primarily a result of our net operating loss adjusted for non-cash charges.

Cash provided by investing activities was $264,841 for the nine month period ended September 30, 2004 and $180,839 for the same period in 2003.  Proceeds from the sale of investments for the nine months ended September 30, 2004 increased to $771,895 from $587,864 when compared to the same period in 2003.

Cash used in financing activities was $275,985 and $249,436 for the nine months ended September 30, 2004 and September 30, 2003, respectively.  During the nine months ended September 30, 2004 and 2003, the Company paid aggregate dividends of $384,554 and $284,677, respectively.

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

INV’s primary investments are 671,215 shares of August Technology Corporation and 2,207,036 shares of PPT Vision, Inc. both of which are traded on the Nasdaq Stock Exchange.  The investment in PPTV is accounted for under the equity method of accounting.  These stocks are subject to fluctuations in price and could have a negative effect on the liquidity of the Company.

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FORWARD-LOOKING STATEMENTS

This Form 10-QSB contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding the Company’s expectations, beliefs, intentions or strategies regarding the future.  Forward-looking statements include, but are not limited to, statements regarding the extent and timing of future revenues and expenses and customer demand, the market value of our investment securities, future financial condition and availability of capital resources, changes in worldwide general economic conditions, cyclical capital spending by customers, the Company’s ability to keep pace with technological developments and evolving industry standards, worldwide competition, and the Company’s ability to protect its existing intellectual property from challenges from third parties and other factors.  Any statement that is not based solely upon historical facts, including strategies for the future and the outcome of events that have not yet occurred, is considered a forward-looking statement.

All forward-looking statements in this document are based on information available to the Company as of the date hereof, and the Company assumes no obligation to update any such forward-looking statements.  It is important to note that the Company’s actual results could differ materially from those in such forward-looking statements.  The forward-looking statements of the Company are subject to risks and uncertainties.  Some of the factors that could cause future results to differ materially from the Company’s recent results or those projected in the forward-looking statements are detailed in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2003, filed with the Securities and Exchange Commission.

Item 3.  Controls and Procedures.

As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of 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 (the “Exchange Act”)).  Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

There was no change in the Company’s internal control over financial reporting during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 6.  Exhibits

(a)           Exhibits - See Exhibit Index following signature page.

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SIGNATURES

In accordance with 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 15, 2004	/s/ Bradley D. Slye
	Bradley D. Slye
	Chief Executive Officer and Principal Accounting Officer

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EXHIBIT INDEX

ELECTRO-SENSORS, INC.

FORM 10-QSB FOR QUARTER ENDED September 30, 2004

Exhibit	Description
31.1	Certification of CEO and CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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