EX-13 Annual Report to Shareholders

EX-13 1 exhibit13.htm EXHIBIT 13-ANNUAL REPORT TO SHAREHOLDERS EX-13 Annual Report to Shareholders

Annual Report
2000

Corporate Profile
Electro-Sensors, Inc. and Subsidiaries

Brief Summary of Business

Electro-Sensors, Inc. operates three distinct businesses. The first is the Controls Division which carries the name of Electro-Sensors, Inc. This division 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 telemarketing and distributors to a wide variety of manufacturers, OEMs and processors to monitor the efficiency of process machinery.

The second business is AutoData Systems, a division of Electro-Sensors, Inc. AutoData Systems designs and markets a desktop software based system that reads handprinted characters, checkmarks and bar code information from scanned or faxed forms. AutoData Systems products are designed to provide the capabilities to automate data collection and meet customers complete forms processing needs. These software packages are sold through telemarketing to end users, resellers and developers in the United States, Canada, Europe and Asia.

The third business is operated through a wholly owned subsidiary, Microflame, Inc. Microflame produces small hand held gas torches used primarily by hobbyists, electronic kit assemblers, creators of jewelry and do-it-yourselfers. The Microflame products are sold through distributors to retailers of hardware, hobby craft and electronic products.

In addition, through its ESI Investment Company subsidiary, the Company has invested funds in other companies and businesses. The value of the Company's investments fluctuates. It is the Company's intention, over a substantial period of time, to liquidate such investments in order to finance expansion of its operating activities. Although the Company has invested in other companies and businesses, Electro-Sensors, Inc. intends to remain primarily an operating company.

Selected Financial Data (Consolidated)
Electro-Sensors, Inc. and Subsidiaries

Fiscal Year Ended December 31 (in thousands, except per share data)

2000

1999

1998

1997

1996

1995

Net Sales	$6,010	$5,682	$6,358	$6,441	$6,143	$6,185
Gross Profit	3,594	3,187	3,587	3,743	3,502	3,525
Selling Expenses	1,470	1,717	1,806	1,637	1,339	1,214
General and Administrative Expenses	778	706	778	752	948	777
Research and Development Expenses	863	830	667	637	707	622
Provision for Income Taxes	353	(55)	107	237	283	371
Net Income	682	(22)	230	453	463	785
Earnings Per Share	0.34	(0.01)	0.12	0.23	0.24	0.41
Total Assets	27,132	8,379	9,078	10,895	11,485	13,181
Shareholders' Equity	19,855	7,440	8,133	9,108	9,147	9,466

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Letter to Shareholders
Electro-Sensors, Inc. and Subsidiaries

March 16, 2001

LETTER TO THE SHAREHOLDERS:

The much-heralded year of 2000 is finished and it was a good year for Electro-Sensors, Inc. The year started without any occurrence of the predicted computer glitches or power failures. Customers began refocusing on increasing productivity and new plant equipment. Total net sales increased 5.8% to $6,009,753. Operations generated $234,068 of the net income with the remainder coming from interest and investment sales. Sales in the production monitoring and motor control segment increased by 7.6%. In the first quarter, the production monitoring segment fulfilled a large order for shaft speed sensors and displays as part of an upgrade project at the facilities of a large end user. Multiple unit orders to OEM customers recovered through the year as their customers installed new machinery. Sales in the AutoData Systems division increased 3.9% over the previous year. The new Scannable Office software product was released for sale at the end of the first quarter. This product allows users to design scannable forms in Microsoft Word and stores the scanned information in Microsoft Excel or Access databases. An upgraded Survey+ 2000 software product was released in June. The Company's wholly owned subsidiary, Microflame, Inc., had decreased sales of 15.8%, but managed to generate a small profit due to reductions made in operating costs.

Throughout the year we worked on documenting and formalizing our Quality Management System. This was a team effort throughout the Company. We were rewarded for our efforts by receiving certification to the ISO9001:2000 international standard in February 2001. This standard not only mandates documented quality processes, but more importantly requires customer satisfaction to be measured and used to gauge the effectiveness of the overall quality system. We are very proud of obtaining this certification as it demonstrates our commitment to producing high quality products that meet the needs of our customers.

This annual report is a simpler format and lower cost than we have previously sent out. This was done not only to save expenses, but also because many shareholders and investors use the Internet to get corporate financial information. They do not want paper that has to be stored in a file and physically retrieved. We have also noticed the increase in sales leads and referrals through our web sites. Please visit our web site (www.electro-sensors.com) to learn more about Electro-Sensors, Inc. and the operating units.

In January 2001, the Company increased the quarterly dividend by 50% by maintaining the $0.03/share payment on the post-split shares. While we are pleased with the progress that these results show, we want to be diligent in advancing the growth and value of the Company through new products, new customers, and increasing operational efficiencies. We are committed to earning your support and confidence in us in the coming year! Please join us for our annual meeting on April 25, 2001 at the Radisson Hotel South in Bloomington, at 2:00 p.m.

Sincerely,

Bradley D. Slye
President

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Management's Discussion and Analysis of Financial Condition and Results of Operations
Electro-Sensors, Inc. and Subsidiaries

RESULTS OF OPERATIONS
2000 vs. 1999

The Company experienced sales of $6,009,753 for 2000, an increase of 5.8% when compared to sales of $5,682,301 for 1999. The increase in sales resulted from increased sales in the Production Monitoring segment and the continued growth of the Character Recognition Imaging segment. However, the Company's wholly owned subsidiary, Microflame, Inc., continued to have declining sales.

The Production Monitoring segment includes both the Speed Monitoring Systems and the Drive Control Systems divisions. The combined sales inceased 7.6% during the year from volume increases in the signal conditioner, speed switch and sensor products.

Sales by the Character Recognition Imaging segment, which contains AutoData Systems, increased 3.9% during 2000. The Scannable Office product had a significant contribution to sales, and offset decreased sales of the AutoData PRO and SDK products. Scannable Office, released in March 2000, combines the Company's forms processing and character recognition technology with the versatility of Microsoft's Office suite. Scannable Office "reads" and automatically places extracted data directly into an Excel spreadsheet or Access database utilizing only a PC and scanner. AutoData will continue to develop a marketing strategy in order to establish itself in an evolving market.

Microflame sales declined 15.8% in 2000. The sales decrease continues to reflect a decreased demand and weak consumer marketplace for the gas torch products. Radio Shack's decision in 1998 to discontinue buying the Company's two-gas torch product continued to impact 2000 sales. The Company continued efforts to reduce operating costs, resulting in a slightly profitable year for this segment.

The Company's cost of sales decreased in 2000 both as a percentage of sales and when compared to 1999. The decrease in margin resulted from decreased fixed costs being distributed over more manufactured units, and Microflame's fixed costs, since relocating to the Company's current facility in 1999, continued to add savings.

Operating expenses decreased 4.4% when compared to 1999. The decrease in expenses occurred primarily in the sales and marketing area. This decrease offset the increase in the administrative and research and development areas.

ESI Investment continues to provide an alternative source of earnings for the Company through investments in marketable securities. Gains realized in 2000 were due to the investment in August Technology Corporation. The cumulative net unrealized gain on securities was $19,228,728, $895,808, and $1,602,820 as of December 31, 2000, 1999 and 1998, respectively. The Company recognizes gains and losses when realized and, therefore, the change in net unrealized gains and losses on securities have not been reflected in the net income of the Company during the respective periods. The Company's investments in marketable securities are subject to significant positive and negative changes in value.

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LIQUIDITY AND CAPITAL RESOURCES

The Company continues to generate strong cash flows from operations. Working capital and funds for capital expenditures have been provided through current earnings. These funds have been placed in secure short-term investments. The funds are being used primarily for dividend distributions, working capital needs and general corporate purposes, which may include acquisitions. Accounts receivable and inventories increased due to increased sales. Accounts payable decreased slightly. The customer deposit amount resulted in 1999 from an existing customer prepaying plant upgrade orders with expected shipping dates in early 2000. Those orders were shipped in 2000 and the customer deposit account was adjusted accordingly.

The Company experienced an increase in investments and the related accumulated other comprehensive income due to an increase in unrealized gain on investment securities. This increase resulted primarily from the Company's holdings of August Technology Corporation, which completed the process of registering its securities with the Securities Exchange Commission for sale in an offering. The market's acceptance of this offering increased the value of the Company's investment substantially. In October of 2000, the Company filed Form 144 in order to make available shares of August Technology for sale on the open market. The Company proceeded to sell a nominal amount of shares in the last quarter of 2000, resulting in a realized gain.

The Company carries its investments in unregistered closely-held securities on its balance sheet at cost which may not reflect the investments' fair value at any given time. the Company believes that the current fair value of the investments' fair value in unregistered holdings exceeds its carrying value. The value of the Companys investments in marketable securities should be expected to fluctuate.

Capital expenditures resulted mainly from the purchase of additional manufacturing and office equipment. The Company does not anticipate the need for additional working capital from outside sources.

CHANGING PRICES AND INFLATION

The Company did not experience any significant inflationary pressure during 2000. Cost management programs and modest price increases have enabled the Company to minimize inflation's impact on operating performance. The Company continually works to control product cost increases through engineering improvements, selection and use of more cost efficient product components and through improved operating efficiency.

CAUTIONARY STATEMENT

This Annual Report includes certain forward-looking statements, which provide 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.

The Company cautions investors that actual results of future operations may materially differ from those anticipated in forward looking statements made in this document and elsewhere by or on behalf of the Company due to a number of factors including: the uncertainty of market acceptance of products of the Company's AutoData Systems division; fluctuations in operating results due to the impact of non-recurring large orders for products and gains or losses from sales on investment securities; competition from lower-priced and new products of competitors; and the availability of components for certain of the Company's products which may for periods of time be available only from a single supplier. The Company's forward-looking statements generally relate to its growth strategy, financial results, product development and sales efforts. Forward-looking statements cannot be guaranteed and actual results may vary materially due to the uncertainties and risks, known and unknown, associated with such statement. The Company undertakes no obligation to update any forward-looking statements. The Company notes these factors as permitted by the Private Securities Litigation Reform Act of 1995. It is not possible to foresee or identify all factors that could cause actual results to differ from expected or historic results. As such, investors should not consider any list of such factors to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions. For additional information, see the Company's periodic filings with the Securities and Exchange Commission.

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Consolidated Balance Sheets
Electro-Sensors, Inc. and Subsidiaries

December 31,

2000

1999

ASSETS

CURRENT ASSETS:

Cash and cash equivalents, including temporary cash deposits of

$2,057,927 and $1,704,167, respectively

$ 3,191,176

$ 2,507,689

Investments

3,266,753

254,699

Trade receivables, less allowance for doubtful accounts,

2000 $26,500; 1999 $23,000

730,577

682,015

Inventories

922,610

867,144

Other current assets

127,177

86,166

Prepaid income taxes

74,606

125,609

Total Current Assets

8,312,899

4,523,322

PROPERTY AND EQUIPMENT

1,615,994

1,690,387

INVESTMENTS

17,202,689

2,164,902

Total Assets

$ 27,131,582

$ 8,378,611

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:

Accounts payable

$ 108,482

$ 144,324

Customer deposits

6,493

353,645

Accrued expenses

234,212

142,050

Deferred income taxes

1,047,900

1,500

Total Current Liabilities

1,397,087

641,519

DEFERRED INCOME TAXES

5,879,400

297,100

COMMITMENTS AND CONTINGENCIES (Notes 6 and 8)

STOCKHOLDERS' EQUITY:

Common stock, par value $.10 per share; authorized 10,000,000 shares;

issued 2,077,112 and 1,985,608 shares, respectively

207,711

198,561

Additional paid-in capital

985,410

720,306

Retained earnings

6,391,246

5,949,317

Accumulated other comprehensive income

12,270,728

571,808

Total Stockholders' Equity

19,855,095

7,439,992

Total Liabilities and Stockholders' Equity

$ 27,131,582

$ 8,378,611

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Consolidated Statements of Income
Electro-Sensors, Inc. and Subsidiaries

Years Ended December 31,

2000

1999

1998

Net Sales

$ 6,009,753

$ 5,682,301

$ 6,358,262

Cost of Goods Sold

2,416,149

2,495,508

2,771,496

Gross Profit

3,593,604

3,186,793

3,586,766

Operating Expenses:

Selling

1,470,401

1,717,480

1,805,995

Administrative

778,254

706,308

778,429

Research and development

862,503

830,134

667,461

Total Operating Expenses

3,111,158

3,253,922

3,251,885

Operating Income (Loss)

482,446

(67,129)

334,881

Nonoperating Income (Expense):

Gain (loss) on sale of investment securities

536,006

23,748

Interest income

130,842

88,751

106,325

Other

(114,553)

(99,135)

(127,531)

Total Nonoperating Income (Expense)

552,295

(10,384)

2,542

Income (Loss) Before Income Taxes

1,034,741

(77,513)

337,423

Federal and State Income Taxes

353,000

(55,100)

107,000

Net Income (Loss)

$ 681,741

$ (22,413)

$ 230,423

Income per Common Share:

Basic

$ 0.34

$ (0.01)

$ 0.12

Diluted

$ 0.34

$ (0.01)

$ 0.12

Weighted Average Shares Outstanding:

Basic

2,001,907

1,977,630

1,968,935

Diluted

2,029,713

1,977,952

1,975,648

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Consolidated Statements of Cash Flows
Electro-Sensors, Inc. and Subsidiaries

Years Ended December 31,

2000

1999

1998

CASH FLOWS FROM OPERATING ACTIVITIES:

Cash:

Received from customers

$ 5,614,039

$ 6,074,220

$ 6,384,022

Paid to suppliers and employees

(5,535,369)

(5,656,207)

(6,141,524)

Interest received

130,842

88,751

106,325

Interest taxes paid

(307,297)

(96,705)

Interest tax refund received

5,648

Net cash provided by (used in) operating activities

(97,785)

512,412

252,118

CASH FLOWS FROM INVESTING ACTIVITIES:

Purchase of property and equipment

(72,238)

(54,918)

(104,777)

Sales of marketable securities

819,068

31,099

Repayments of notes receivable

1,336

Net cash provided by (used in) investing activities

746,830

(54,918)

(72,342)

CASH FLOWS FROM FINANCING ACTIVITIES:

Dividends paid

(239,812)

(237,314)

(236,301)

Net proceeds (payments) on short-term borrowings

(44,843)

(195,932)

Proceeds from issuance of stock

74,274

18,746

29,378

Net cash provided by (used in) financing activities

34,442

(263,411)

(402,855)

Net increase (decrease) in cash and cash equivalents

683,487

194,083

(223,079)

Cash and cash equivalents:

Beginning

2,507,689

2,313,606

2,536,685

Ending

$ 3,191,176

$ 2,507,689

$ 2,313,606

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Consolidated Statements of Cash Flows (continued)
Electro-Sensors, Inc. and Subsidiaries

Years Ended December 31,

2000

1999

1998

RECONCILIATION OF NET INCOME (LOSS) TO NET CASH

PROVIDED BY (USED IN) OPERATING ACTIVITIES:

Net income (loss)

$ 681,741

$ (22,413)

$ 230,423

Adjustments to reconcile net income (loss) to net cash provided

by (used in) operating activities:

Depreciation and amortization

146,648

139,900

137,358

Realized (gain) loss on sale of investment securities, net

(536,006)

(23,748)

Deferred taxes

(5,300)

(21,100)

6,800

(Increase) decrease in:

Trade receivables

(48,562)

38,274

25,760

Inventories

(55,466)

107,468

(98,423)

Other current assets

(41,011)

(16,197)

6,952

Prepaid income taxes

51,003

(28,352)

3,495

Increase (decrease) in:

Accounts payable

(35,842)

2,075

44,251

Customer deposits

(347,152)

353,645

Accrued expenses

92,162

(40,888)

(80,750)

Net cash provided by (used in) operating activities

$ (97,785)

$ 512,412

$ 252,118

SUPPLEMENTAL SCHEDULE OF NONCASH

INVESTING AND FINANCING ACTIVITIES:

Net change in unrealized holding gains on marketable securities

$ 18,332,920

$ (707,012)

$ (1,564,746)

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Consolidated Statements of Changes in Stockholders' Equity
Electro-Sensors, Inc. and Subsidiaries

Additional

Accum Other

Total

Common Stock Issued

Paid-In

Retained

Comprehensive

Notes

Stockholders'

Amount

Capital

Earnings

Income

Receivable

Equity

Balance, December 31, 1997

1,964,586

$ 196,459

$ 674,284

$ 6,214,922

$ 2,023,566

$ (1,336)

$ 9,107,895

Exercise of stock options

4,874

487

13,577

14,064

Repayment of note receivable

1,336

1,336

Unrealized gains (losses) on

investments, net of

reclassification adjustment

(999,746)

(999,746)

Stock issued through the

Employee Stock

Purchase Plan

5,994

599

14,715

15,314

Dividend on common

stock $.12 per share

(236,301)

(236,301)

Net income (loss)

230,423

230,423

Balance, December 31, 1998

1,975,454

197,545

702,576

6,209,044

(769,323)

1,023,820

8,132,985

Unrealized gains (losses) on

investments, net of

reclassification adjustment

(452,012)

(452,012)

Stock issued through the

Employee Stock

Purchase Plan

10,154

1,016

17,730

18,746

Dividend on common

stock $.12 per share

(237,314)

(237,314)

Net income (loss)

(22,413)

(22,413)

Balance, December 31, 1999

1,985,608

198,561

720,306

5,949,317

(474,425)

571,808

7,439,992

Exercise of stock options

87,900

8,790

259,431

268,221

Unrealized gains (losses) on

investments, net of

reclassification adjustment

11,698,920

11,698,920

Stock issued through the

Employee Stock

Purchase Plan

3,604

360

5,673

6,033

Dividend on common

stock $.12 per share

(239,812)

(239,812)

Net income (loss)

681,741

681,741

Balance, December 31, 2000

2,077,112

$ 207,711

$ 985,410

$ 6,391,246

$12,380,661

$12,270,728

$ 0

$19,855,095

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Notes to Consolidated Financial Statements
Electro-Sensors, Inc. and Subsidiaries

Note 1. Nature of Business and Significant Accounting Policies

Nature of Business:

The accompanying consolidated financial statements include the accounts of Electro-Sensors, Inc. and its wholly owned subsidiaries: Microflame, Inc., and ESI Investment Company.

Electro-Sensors, Inc. manufactures production monitoring and character recognition software systems, and Microflame, Inc. produces miniature brazing torches used for hobbies and crafts. ESI Investment Company manages a varied investment portfolio. Intercompany accounts, transactions and earnings have been eliminated in consolidation.

Electro-Sensors, Inc. markets its products to a number of different industries located throughout the United States and abroad. The Company grants credit to customers under normal industry terms, generally 30 days. Microflame, Inc. also markets its products throughout the U.S. and abroad under normal credit terms. The majority of Microflame, Inc. sales are concentrated in the hobby and craft industry. ESI Investment Company has investments in marketable securities, which are subject to normal market risks.

Significant accounting policies of the Company are summarized below:

Use of estimates:

The preparation of financial statements in conformity with generally accepted accounting principles 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.

Cash and cash equivalents:

For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost plus accrued interest which approximates market value.

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

Investments:

The Company has a portfolio of investments. 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.

The Company's investments consist of marketable equity securities, primarily common stocks, government debt securities, money-market funds and unregistered equity securities. The estimated fair value of marketable equity securities is based on quoted market prices and therefore subject to the inherent risk of market fluctuations.

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Note 1. Nature of Business and Significant Accounting Policies (Continued)

Significant accounting policies of the Company are summarized below: (continued)

Investments: (continued)

Since the Company does not buy investments in anticipation of short-term fluctuations in market prices, the investments in marketable equity securities has been classified as available-for-sale. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity. Dividends on marketable equity securities are recognized in income when declared. Investments in unregistered securities are reported at original cost.

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

Inventories:

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

Fair value of financial instruments:

The Company's financial instruments consist of cash and cash equivalents, investments, short-term trade receivables and payables for which current carrying amounts approximate fair market value.

Property and equipment:

Property and equipment are recorded at cost. Expenditures for renewals and betterments are capitalized and repairs and maintenance costs are charged to expense as incurred. When items are disposed of, the cost and accumulated depreciation are eliminated from the accounts, and any gain or loss is reflected in the results of operations.

Impairment of long-lived assets:

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the assets. If these assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

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. Warranty reserves are provided at the time revenue is recognized for the estimated cost of replacing defective products.

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Note 1. Nature of Business and Significant Accounting Policies (Continued)

Significant accounting policies of the Company are summarized below: (continued)

Advertising costs:

The Company generally charges to expense the production costs of advertising the first time the advertising takes place, except for direct-response advertising, which is capitalized and amortized over the expected period of future benefits. Advertising expense was $375,833, $562,413, and $518,433 for the years ended December 31, 2000, 1999, and 1998, respectively.

Research and development:

Expenditures for research and development are expensed as incurred.

Depreciation:

The cost of property and equipment is depreciated on the straight-line method over the estimated useful lives.

Estimated useful lives are as follows:

Years

Equipment

5-10

Furniture and fixtures

Building

7-40

Depreciation expense for the years ended December 31, 2000, 1999, and 1998 was $146,648, $139,900, and $137,358, respectively.

Income taxes:

Deferred income taxes are provided on an asset and liability approach to financial accounting and reporting for income taxes. The difference between the financial statement and tax bases of assets and liabilities is determined annually. Deferred income tax assets and liabilities are computed for those differences that have future tax consequences using the currently enacted tax laws and rates that apply to the periods in which they are expected to affect taxable income. Income tax expense is the current tax payable or refundable for the period plus or minus the net change in the deferred tax assets and liabilities.

Earnings per share:

Basic earnings per share (EPS) excludes dilution and is determined by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities and other contracts to issue common stock were exercised or converted into common stock. Diluted EPS is computed similarly to fully diluted earnings per share under current accounting rules.

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Note 1. Nature of Business and Significant Accounting Policies (Continued)

Significant accounting policies of the Company are summarized below: (continued)

Earnings per share: (continued)

The following information presents the Company's computations of basic and diluted EPS for the periods presented in the income statements.

Income

Shares

Per Share Amt

2000:

Basic EPS

$ 681,741

2,001,907

$ 0.34

Effect of dilutive employee stock options

27,806

Diluted EPS

$ 681,741

2,029,713

$ 0.34

1999:

Basic EPS

$ (22,413)

1,977,630

$ (0.01)

Effect of dilutive employee stock options

322

Diluted EPS

$ (22,413)

1,977,952

$ (0.01)

1998:

Basic EPS

$ 230,423

1,968,935

$ 0.12

Effect of dilutive employee stock options

6,713

Diluted EPS

$ 230,423

1,975,648

$ 0.12

Recent accounting standards:

During 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income", which requires disclosure of all changes in equity that result from transactions and economic events other than transactions with owners. Comprehensive income includes the Company's net income plus other comprehensive income items, which are excluded from net income. The Company's other comprehensive income consists of unrealized gains (losses), net of income taxes and reclassification adjustment for gains and losses included in net income. This reclassification adjustment for gains and losses included in net income was $(205,282), $0, and $23,600 for 2000, 1999, and 1998, respectively. The Company does not have any additional transactions or other economic events which qualify as other comprehensive income as defined under SFAS No. 130, and adoption of SFAS No. 130 had no effect on the Company's results of operations, cash flows or financial position.

The Company has also adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes new standards for reporting information about business segments and related disclosures about products and services, geographic areas and major customers, if applicable. Under SFAS No. 131, operating segments are determined consistent with the way management organizes and evaluates financial information internally for making decisions and assessing performance. The Company's adoption of SFAS No. 131 had no effect on the Company's results of operations, cash flows or financial position.

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Note 2. Investments

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

Gross

Unrealized

Fair

Cost

Gain

Loss

Value

December 31, 2000

Treasury Bills

$ 2,057,927

$ 0

$ 2,057,927

Money-market funds

772,499

Equity Securities

1,240,714

19,500,860

(272,132)

20,469,442

4,071,140

19,500,860

(272,132)

23,299,868

Less cash equivalents

(2,830,426)

Total investments

$ 1,240,714

$19,500,860

$ (272,132)

$20,469,442

December 31, 1999

Treasury Bills

$ 1,704,167

$ 0

$ 1,704,167

Money-market funds

203,807

Equity Securities

1,523,793

1,324,775

(428,967)

2,419,601

3,431,767

1,324,775

(428,967)

4,327,575

Less cash equivalents

(1,907,974)

Total investments

$ 1,523,793

$ 1,324,775

$ (428,967)

$ 2,419,601

December 31, 1998

Treasury Bills

$ 1,866,859

$ 0

$ 1,866,859

Money-market funds

208,230

Equity Securities

1,523,793

1,983,263

(380,443)

3,126,613

3,598,882

1,983,263

(380,443)

5,201,702

Less cash equivalents

(2,075,089)

Total investments

$ 1,523,793

$ 1,983,263

$ (380,443)

$ 3,126,613

Realized gains and losses on investments are as follows:

December 31,

2000

1999

1998

Gross realized gains

$ 796,624

$ 0

$ 23,748

Gross realized losses

$ (260,618)

$ 0

Net realized gain

$ 536,006

$ 0

$ 23,748

The change in the net unrealized holding gain on investments at December 31, 2000 and 1999 consisted of the following:

2000

1999

Unrealized gain on current portfolio of marketable equity securities

$ 19,500,860

$ 1,324,775

Unrealized loss on current portfolio of marketable equity securities

(272,132)

(428,967)

Related deferred tax effect

(6,958,000)

(324,000)

Total unrealized holding gain, net

$ 12,270,728

$ 571,808

----- Page 15 -----

Note 3. Inventories

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

December 31,

2000

1999

1998

Raw materials

$ 630,985

$ 580,908

$ 671,545

Work in process

129,723

126,151

124,055

Finished goods

161,902

160,085

$179,012

Total inventories

$ 922,610

$ 867,144

$ 974,612

Note 4. Property and Equipment

The following is a summary of property and equipment:

December 31,

2000

1999

Equipment

$ 393,116

$ 366,454

Furniture and fixtures

457,883

422,241

Building

1,333,824

1,333,823

Land

414,540

414,540

2,599,363

2,537,058

Less accumulated depreciation

983,369

846,671

Total property and equipment

$ 1,615,994

$ 1,690,387

Note 5. Accrued Expenses

Accrued expenses at December 31, 2000 and 1999 include:

2000

1999

Wages and commissions

$ 116,452

$ 99,104

Other

117,760

42,946

Total accrued expenses

$ 234,212

$ 142,050

Note 6. Commitments

Lease commitments:

The Company is leasing office equipment under operating leases expiring at various dates through 2005.

Minimum lease payments required under non-cancelable operating leases are as follows:

Year	Amount

2001	$ 23,652

2002	23,652

2003	22,012

2004	19,716

2005

1,362

Total minimum lease payments

$ 90,394

Rental expense charged to operations was $38,576, $36,451, and $83,629 for years ended December 31, 2000, 1999, and 1998, respectively.

----- Page 16 -----

Note 7. Common Stock Options and Stock Purchase Plan

Stock-based compensation:

The Company has a stock option plan and an employee stock purchase and bonus plan. Under the 1997 Stock Option Plan, the Company is authorized to grant up to 300,000 shares of its common stock. The Company granted 40,500 options under this plan during 2000, and at December 31, 2000, 148,500 shares remained available for grant under this plan. Under the Employee Stock Purchase and Bonus Plan, the Company is authorized to sell and issue up to 100,000 shares of its common stock to its full-time employees. During 2000, 1999, and 1998, 3,604, 10,154 and 5,994 shares, respectively, were issued under this plan. At December 31, 2000, 69,089 shares were available for future issuance.

The Company applies Accounting Principles Board ("APB") No. 25, Accounting for Stock Issued to Employees, and related interpretations to account for its stock-based compensation plans, when applicable, but has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, which requires pro forma disclosures regarding the Company's stock-based compensation plans.

Stock options:

The 1997 Stock Option Plan includes 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 plan, incentive stock options are granted at 100% of fair market value on the date of grant and may be exercised at various times depending upon the term of the option. The nonqualified stock options were granted to directors to purchase shares of the Company's common stock. All existing options expire 10 years from the date of grant or one year from the date of death.

A summary of stock options outstanding and exercisable under the plans is as follows:

Number of shares

Incentive Options

Director Options

Stock

Weighted Avg

Stock

Weighted Avg

Options

Exercise Price

Options

Exercise Price

Balance, December 31, 1997

71,260

$ 3.23

58,500

$ 3.88

Granted

23,000

3.67

4,000

3.88

Exercised

(374)

2.38

(4,500)

3.13

Forfeited

(886)

2.38

Balance, December 31, 1998

93,000

3.41

58,000

3.95

Granted

78,000

2.20

6,000

3.00

Expired

(4,500)

3.25

Forfeited

(2,500)

3.73

Balance, December 31, 1999

168,500

2.84

59,500

3.91

Granted

34,500

5.17

6,000

3.50

Exercised

(78,900)

3.02

(9,000)

3.31

Forfeited

(23,100)

4.23

Balance, December 31, 2000

101,000

$ 3.18

56,500

$ 3.96

Options exercisable at

December 31, 2000

58,200

$ 3.00

56,500

$ 3.96

----- Page 17 -----

Note 7. Common Stock Options and Stock Purchase Plan (Continued)

Stock options: (continued)

Price range of outstanding options:

As of December 31, 2000

Incentive Options

Directors Options

Options

$2.00 to $5.75

$3.00 to $4.75

Expiration dates

2007 to 2010

2001 to 2010

Stock purchase plan:

The Employee Stock Purchase and Bonus Plan (the Employee Stock Plan) allows employees to set aside up to 10% of their earnings for the purchase of shares of the Company's common stock. Shares are purchased annually under the Employee Stock Plan at a price equal to 85% of the market price on the last day of the calendar year.

Compensation costs:

The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized in the accompanying statements of operations. Had compensation cost been recognized based on the fair values of options at the grant dates consistent with the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net income and net income per common share would have been decreased to the following pro forma amounts:

Years Ended December 31,

2000

1999

1998

Net income

As reported

$ 681,741

$ (22,413)

$ 230,423

Pro forma

$ 645,161

$ (65,142)

$ 194,656

Net Income

As reported

$ 0.34

$ (0.01)

$ 0.12

Pro forma

$ 0.32

$ (0.03)

$ 0.10

The weighted average fair values of options granted and Employee Stock Plan shares were as follows:

1987 and 1997 Plan

Employee Stock

Employees

Directors

Plan

1998 grants

$ 1.22

$ 1.29

$ 0.63

1999 grants

$ 0.98

$ 1.38

$ 0.45

2000 grants

$ 2.12

$ 1.07

$ 1.91

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in fiscal 1999 and 2000:

2000

1999

Risk-free interest rate

5.44%-6.46%

4.71%-6.27%

Expected life of options

5 years

7 years

Expected life of Employee Stock Plan shares

3 months

3 months

Expected volatility

84%-113%

61%-76%

Expected dividend yield

3.65%

5.34%

----- Page 18 -----

Note 7. Common Stock Options and Stock Purchase Plan (Continued)

Compensation costs: (continued)

The tax benefits associated with the exercise of stock options or issuance of shares under the Company's stock option plans, not related to expenses recognized for financial reporting purposes, have been credited to capital in excess of par value in the accompanying consolidated balance sheets.

The following table summarizes stock options outstanding at December 31, 2000:

Weighted Avg

Exercise

Contractual

Exercise

Price Range

Options

Life Remaining

Price

$2.00-$3.00

54,500

8.70

$2.27

$3.01-$4.52

69,000

5.93

$3.65

$4.53-$5.75

34,000

5.72

$4.99

Note 8. Benefit Plans

Employee stock ownership plan:

The Company sponsors an employee stock ownership plan (ESOP) that covers substantially all employees who work 1,000 or more hours during the year. The ESOP has, at various times, secured financing from the Company to purchase the Company's shares on the open market. When the Plan purchases shares with the proceeds of the Company loans, the shares are pledged as collateral for its debt. The shares are maintained in a suspense account until released and allocated to participant accounts. The Plan owns 142,819 shares of the Company's stock at December 31, 2000. All shares held by the Plan have been released and allocated. The dividends paid by the Company on shares held by the Plan are allocated to the participant accounts. The Plan had no debt to the Company at December 31, 2000.

ESOP compensation expense was $18,000, $0 and $36,000, for the years ended December 31, 2000, 1999 and 1998, respectively.

In the event a terminated ESOP participant desires to sell his or her shares of the Company's stock and the shares are not readily tradable, the Company may be required to purchase the shares from the participant at their fair market value. At December 31, 2000, 142,819 shares of the Company's stock, with an aggregate fair market value of approximately $458,000, are held by ESOP participants, who if terminated, would be subject to the repurchase requirement.

Profit sharing plan and savings plan:

The Company has a salary reduction and profit sharing plan which conforms to IRS provisions for 401(k) plans. The Company may make profit sharing contributions with the approval of the Board of Directors. The Board of Directors agreed to make an $18,000 contribution for 2000 in addition to its matching of 401(k) salary reductions.

----- Page 19 -----

Note 9. Income Taxes

The components of the income tax provision for the years ended December 31, 2000, 1999 and 1998, are as follows:

2000

1999

1998

Current:

Federal

$ 344,700

$ (35,000)

$ 96,371

State

13,600

1,000

3,829

Deferred:

Federal

(23,600)

(2,000)

6,300

State

18,300

(19,100)

500

Total federal and state income taxes

$ 353,000

$ (55,100)

$ 107,000

The 2000 current federal tax component includes a $12,100 tax credit carryback.

The 1999 current federal tax component consists of a net operating loss carryback and a portion of a tax credit carryback.

The provision for income taxes for the years ended December 31, 2000, 1999 and 1998, differs from the amount obtained by applying the U.S. federal income tax rate to pretax income due to the following:

2000

1999

1998

Computed 'expected' tax expense

$ 362,000

$ (26,000)

$ 115,000

Increase (decrease) in taxes from:

State income taxes, net of federal benefit

9,000

(11,900)

2,500

Credits

(12,100)

(24,200)

(15,700)

Other

(5,900)

7,000

5,200

Total federal and state income taxes

$ 353,000

$ (55,100)

$ 107,000

The components of the net deferred tax asset (liability) consist of:

2000

1999

Deferred tax assets:

Vacation disallowance

$ 22,700

23,100

Allowance for doubtful accounts

9,600

8,300

Tax carryforwards

28,400

31,600

Total deferred tax assets

$ 60,700

$ 63,000

Deferred tax liabilities:

Depreciation

$ (30,000)

(37,600)

Unrealized investment holding gain

(6,958,000)

(324,000)

Total deferred liabilities

$(6,988,000)

$ (361,600)

Net deferred tax asset (liability)

$(6,927,300)

$ (298,600)

----- Page 20 -----

Note 9. Income Taxes (Continued)

The 2000 tax carryforwards component of deferred tax assets in 2000 consists entirely of a federal tax credit carryforward expiring in 2020.

The 1999 tax carryforwards component of deferred tax assets in 1999 consists of $1,500 resulting from state tax carryforward, $1,200 resulting from federal charitable contributions carryforward, $16,800 state tax credit carryforward, and $12,100 federal tax credit carryforward. These carryforwards expire in 2014, 2004, 2014, and 2019, respectively.

Note 10. Subsequent Event

The Company declared a 3-for-2 stock split effected in the form of a 50% stock dividend. The stock dividend is payable on February 26, 2001 to shareholders of record on February 12, 2001.

Note 11. Segment Information

The Company has four reportable operating segments based on the nature of its product lines: Production Monitoring, Character Recognition, Brazing Torches, and Investments. The Production Monitoring Division manufactures and markets a complete line of speed monitoring and motor control systems for industrial machinery. The Character Recognition Division designs and markets a desktop software based system that reads hand-printed characters, check marks and bar code information from scanned or faxed forms. Sales of this system include software and can include hardware. The Brazing Torches Division produces small hand held gas torches used primarily by hobbyists, electronic kit assemblers, creators of jewelry and do-it-yourselfers. The Investments Division holds investments in marketable and nonmarketable securities.

The accounting policies of the segments are the same as those described in Note 1. In evaluating segment performance, management focuses on sales and income before taxes.

----- Page 21 -----

Note 11. Segment Information: (continued)

The following is financial information relating to the operating segments:

2000

1999

1998

Net Revenue

Production Monitoring

$ 4,825,250

$ 4,483,083

$ 5,099,753

Character Recognition

922,325

887,967

785,680

Brazing Torches

262,178

311,251

472,829

Investments

Total

6,009,753

5,682,301

6,358,262

Sales in Foreign Countries

Production Monitoring

295,744

280,673

305,400

Character Recognition

65,073

19,115

34,640

Brazing Torches

7,574

17,057

8,500

Investments

Total

368,391

316,845

348,540

Interest Income

Production Monitoring

118,457

82,499

100,875

Character Recognition

Brazing Torches

Investments

12,385

6,251

5,450

Total

130,842

88,750

106,325

Depreciation Expense

Production Monitoring

126,699

114,538

123,992

Character Recognition

18,517

23,836

11,840

Brazing Torches

1,432

1,526

Investments

Total

146,648

139,900

137,358

Capital Purchases

Production Monitoring

72,238

34,549

89,037

Character Recognition

20,369

15,740

Brazing Torches

Investments

Total

72,238

54,918

104,777

Total Assets

Production Monitoring

5,503,085

5,526,271

5,370,902

Character Recognition

83,504

225,513

263,070

Brazing Torches

102,594

58,003

175,328

Investments

21,442,399

2,568,824

3,268,415

Total

27,131,582

8,378,611

9,077,715

Net Income (Loss) Before Taxes

Production Monitoring

749,612

543,271

824,676

Character Recognition

(237,099)

(499,258)

(316,545)

Brazing Torches

23,012

(85,074)

(155,149)

Investments

499,216

(36,452)

(15,559)

Total

1,034,741

(77,513)

337,423

Income Tax Expense (Benefit)

Production Monitoring

256,000

175,900

356,400

Character Recognition

(81,000)

(200,600)

(193,400)

Brazing Torches

8,000

(18,000)

(51,000)

Investments

170,000

(12,400)

(5,000)

Total

$ 353,000

$ (55,100)

$ 107,000

----- Page 22 -----

Independent Auditor's Report
Electro-Sensors, Inc. and Subsidiaries

The Board of Directors and Stockholders
Electro-Sensors, Inc.
Minneapolis, Minnesota

We have audited the accompanying consolidated balance sheets of Electro-Sensors, Inc. and Subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Electro-Sensors, Inc. and Subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for the three years in the period ended December 31, 2000, in conformity with generally accepted accounting principles.

SCHWEITZER KARON & BREMER, LLC
Certified Public Accountants
Minneapolis, Minnesota
February 23, 2001

----- Page 23 -----

Price Range of Common Stock
Electro-Sensors, Inc. and Subsidiaries

The Company's Common Stock trades on the Nasdaq Small Cap tier of The Nasdaq Stock Market^SM under the symbol "ELSE". The following table sets forth the quarterly high and low reported last sales prices for the Company's common stock over the past two years as reported on the Nasdaq system.

Period

High

Low

2000

First Quarter

$4.604

$1.313

Second Quarter

$6.542

$1.500

Third Quarter

$5.000

$3.042

Fourth Quarter

$4.000

$2.083

1999

First Quarter

$3.500

$2.688

Second Quarter

$3.250

$2.438

Third Quarter

$3.000

$2.063

Fourth Quarter

$2.313

$1.688

On March 16, 2001 there were approximately 550 shareholders of record. Electro-Sensors, Inc. paid cash dividends on its common stock of $0.12 per share in 1999 and 2000 on a quarterly basis.

----- Page 24 -----

Investor Information
Electro-Sensors, Inc. and Subsidiaries

Annual Meeting
The annual meeting of shareholders will be held at the Radisson South, 7800 Normandale Boulevard, Minneapolis, Minnesota on April 25, 2001, at 2:00 p.m. local time. All shareholders are welcome to attend and take part in the discussion of company affairs.

Board of Directors
Bradley D. Slye
Chairman of the Board
President of Electro-Sensors, Inc.

P. R. Peterson
President of P. R. Peterson Company
Secretary of Electro-Sensors, Inc.

John S. Strom
Retired

Joseph A. Marino
President/Chief Executive Officer
Applied Biometrics, Inc.

Geoffrey W. Miller
Vice President Operations and Finance
of Amsan MN, Inc.

Officers
Bradley D. Slye
President

P. R. Peterson
Secretary

Transfer Agent & Registrar
Firstar Trust Company
Corporate Trust Services
1555 North River Center Drive
Suite 301
Milwaukee, WI 53212

Auditors
Schweitzer Karon & Bremer, LLC
1400 TCF Tower
Minneapolis, MN 55402

Counsel
Fredrikson & Byron, P.A.
1100 International Centre
900 Second Avenue South
Minneapolis, MN 55402

Form 10-KSB Available
A copy of Electro-Sensors, Inc. Form 10-KSB annual report filed with the Securities and Exchange Commission is available without charge to shareholders by writing to:
   Electro-Sensors, Inc.
   Attn: Investor Relations
   6111 Blue Circle Drive
   Minnetonka, MN 55343

CAUTIONARY STATEMENT
The Company cautions investors that actual results of future operations may materially differ from those anticipated in forward looking statements made in this document and elsewhere by or on behalf of the Company due to a number of factors including: the uncertainty of market acceptance of products of the Company's AutoData Systems division; fluctuations in operating results due to the impact of non-recurring large orders for produtcts and gains or losses from sales on investment securities; competition from lower-priced and new products of competitors; and the availability of components for certain of the Company's products which may for periods of time be available only from a single supplier. For additional information, see the Company's periodic filings with the Securities and Exchange Commission.

----- Page 25 -----