TMCnet News

ELECTRO SENSORS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[August 13, 2014]

ELECTRO SENSORS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) 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, the results of which impact reported amounts and disclosures.



Changes in economic conditions or other business circumstances may affect the outcomes of management's estimates and assumptions. 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, 2013. New estimates for the allocation of the purchase price for acquired tangible and intangible assets and the contingent earn-out have been added to the estimates discussed in our Annual Report.

The following table contains selected financial information, for the periods indicated, from our consolidated statements of comprehensive income (loss) expressed as a percentage of net sales.


Three Months Ended June 30 Six Months Ended June 30 2014 2013 2014 2013 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 42.3 42.9 42.6 42.4 Gross profit 57.7 57.1 57.4 57.6 Operating expenses: Selling and marketing 22.7 24.8 22.8 25.3 General and administrative 16.6 18.1 18.6 18.7 Research and development 12.3 7.1 11.0 7.4 Total operating expenses 51.6 50.0 52.4 51.4 Operating income 6.1 7.1 5.0 6.2 Non-operating income (expense): Interest expense (0.3 ) 0.0 (0.2 ) 0.0 Loss on disposal of property and equipment (0.1 ) 0.0 0.0 0.0 Gain on sale of available-for-sale securities 11.5 19.0 21.7 12.9 Interest income 0.1 0.0 0.1 0.1 Other income 0.3 0.3 0.2 0.2 Total non-operating income 11.5 19.3 21.8 13.2 Income before income taxes 17.6 26.4 26.8 19.4 Income taxes 6.2 9.2 9.4 5.4 Net income 11.4 % 17.2 % 17.4 % 14.0 % The following discusses the Company's performance for the three and six months ended June 30, 2014 and 2013.

RESULTS OF OPERATIONS Net Sales Net sales for the three-month period ended June 30, 2014 increased $189,000, or 12.0%, when compared to the same period in 2013. Net sales for the six-month period ended June 30, 2014 increased $357,000, or 11.5%, when compared to the same period in 2013. The increase was primarily due to a strong performance in our north central region, which increased 43.8% and 27.8% in the three and six month periods ending June 30, 2014, respectively, as compared to the respective 2013 periods. In addition, in the second quarter we experienced an increase in OEM manufacturing orders in the bulk material handling segment of our business and an increase in the number of small and mid-sized projects driven by the continued need for plant facility upgrades.

Consistent with our prior disclosures, we continue to integrate the HazardPROTMwireless hazard monitoring technology we purchased earlier in the year. The Company has begun taking purchase orders for these systems and expects to recognize revenues from sale of these systems in the second half of 2014.

Furthermore, we continue to believe these products will be accretive to our quarterly earnings per share beginning in the second quarter of 2015.

14 -------------------------------------------------------------------------------- Table of Contents Gross Margin Gross margin for the three-month period ended June 30, 2014 was 57.7% versus 57.2% for the same period in 2013. For the six-month periods ended June 30, 2014 and 2013, gross margins were 57.4% and 57.6%, respectively. The changes in gross margin for both periods were due to the mix of products sold. We continue our efforts to maintain or increase gross margin by manufacturing products in the most cost effective manner.

Operating Expenses Total operating expenses increased $122,000, or 15.5%, for the three months ended June 30, 2014 when compared to the same period in 2013. Total operating expenses increased $216,000, or 13.5%, for the six months ended June 30, 2014 when compared to the same period in 2013.

• Selling and marketing costs increased $9,000, or 2.3%, for the three months ended June 30, 2014 when compared to the same period in 2013. For the six months ended June 30, 2014, selling and marketing costs increased $3,000, or 0.4%, when compared to the same period in 2013. For the three months ended June 30, 2014, the increase was due to an increase in outside sales representative compensation due to increased sales. For the six months ended June 30, 2014, the increase was due to an increase in outside sales representative commissions (due to increased sales), partially offset by a decrease in travel expenses.

• General and administrative costs increased $9,000, or 3.2%, for the three months ended June 30, 2014 compared to the same period in 2013.

For the six months ended June 30, 2014, general and administrative costs increased $62,000, or 10.7%, when compared to the same period in 2013.

For the three months ended June 30, 2014, the increase was due to higher noncash compensation expense related to stock options granted during the current quarter and 2013 third quarter, partially offset by a decrease in stock handling fees due to the timing of our year-end reporting. For the six months ended June 30, 2014, the increase was due to higher noncash compensation expense related to stock options granted during the current quarter and 2013 third quarter, insurance expense due to a new director and officer liability insurance policy, wages and salaries due to changes in management, and legal and professional fees incurred related to the acquisition completed in February 2014.

• Research and development costs increased $104,000, or 92.9%, for the three months ended June 30, 2014 compared to the same period in 2013.

For the six months ended June 30, 2014, research and development costs increased $151,000, or 65.6%, when compared to the same period in 2013. For the three and six months ended June 30, 2014, the increase was due to an increase in wages and benefits due to changes in management responsibilities and lab testing fees for product approval for hazardous locations.

Non-Operating Income Non-operating income decreased by $100,000, or 33.0%, for the three-month period ended June 30, 2014 compared to the same period for 2013. For the six months ended June 30, 2014, non-operating income increased $342,000, or 83.2%, when compared to the same period in 2013. During the three months ended June 30, 2014, the decrease is due to a lower number of shares of Rudolph Technologies, Inc. ("Rudolph") stock sold and an increase in interest expense. During the three months ended June 30, 2014 and 2013, we sold 18,240 and 24,431 shares, respectively, of Rudolph stock and recognized a gain of $203,000 and $297,000, respectively. During the three months ended June 30, 2014, we recognized $5,000 of interest expense related to our 2014 acquisition. For the six months ended June 30, 2014, the increase is primarily due to an increase in the number of shares of Rudolph sold, partially offset by an increase in interest expense.

During the six months ended June 30, 2014 and 2013, we sold 67,419 and 31,931 shares, respectively, of Rudolph stock and recognized a gain of $750,000 and $400,000, respectively. During the six months ended June 30, 2014, we recognized $7,000 of interest expense related to our 2014 acquisition.

15 -------------------------------------------------------------------------------- Table of Contents Income Before Income Taxes Income before income taxes was $311,000 for the three months ended June 30, 2014, representing a decrease of $104,000, or 25.1%, when compared to the same period in 2013. Income before income taxes was $926,000 for the six months ended June 30, 2014, representing an increase of $322,000, or 53.3%, when compared to the same period in 2013.

The Production Monitoring Division had income before income taxes of $107,000 for the three months ended June 30, 2014 compared to $117,000 for the same period in 2013, a decrease of $10,000, or 8.5%. For the six months ended June 30, 2014, the Production Monitoring Division had income before income taxes of $174,000 compared to $201,000 for the same period in 2013, a decrease of $27,000, or 13.4%. These decreases in income before income taxes were mainly due to increased expenses (see "Operating Expenses"), including interest expense on the acquisition note payable.

ESI Investment Company had income before taxes of $204,000 for the three-month period ended June 30, 2014 compared to $298,000 for the same period in 2013 a decrease of $94,000, or 31.5%. ESI Investment Company had income before taxes of $752,000 for the six-month period ended June 30, 2014 compared to $403,000 for the same period in 2013, an increase of $349,000, or 86.6%. The changes for the two periods were a result of the gain realized on sales of available-for-sale securities in 2014 compared to 2013 (see "Non-Operating Income").

The net decrease in the unrealized value of available-for-sale securities was $283,000 and $674,000 for the three and six months, respectively, ended June 30, 2014. The net decrease is due to the sale of Rudolph stock, which resulted in a $203,000 and $750,000 realized gain on the sales, and the decrease in the market price of Rudolph during the three and six months, respectively, ended June 30, 2014. ESI Investment Company has approximately $1,598,000 in unrealized gain on the Rudolph investment with period change in unrealized value, which is reported in Other Comprehensive Income (Loss) (see Note 4 "Investments" in the notes to the accompanying consolidated financial statements).

LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents were $837,000 at June 30, 2014, and $1,505,000 at December 31, 2013. The decrease was mainly from investing activities. As of June 30, 2014 and December 31, 2013, the Company owned $6,334,000 and $5,227,000, respectively, in Treasury Bills with a maturity of more than three months from the date of purchase. We owned $5,424,000 in Treasury Bills with a maturity of more than three months from the date of purchase as of June 30, 2013. The Company paid $400,000 for the acquisition of the HazardPROTMwireless hazard monitoring technology in February 2014.

Cash from operating activities was $90,000 for the six months ended June 30, 2014, compared to cash used in operating activities of $283,000 for the six months ended June 30, 2013. Cash from operating activities increased $373,000 for the six months ended June 30, 2014 when compared to the same period in 2013 mainly due to the increase in accounts payable and accrued income taxes, offset by a decrease in net income adjusted for the gain on sales of available-for-sale securities and noncash stock compensation. The net change in accounts payable is due to the increase in the payable balance of $102,000 at June 30, 2014 when compared to the prior year and a decrease in the payable balance of $4,000 at June 30, 2013 when compared to the prior year. The increase in the prior year is due to the purchase of inventory for HazardPROTM parts. The net change in income taxes was due to an increase in the payable balance of $97,000 at June 30, 2014 when compared to the prior year and a decrease in the payable of $249,000 at June 30, 2013 when compared to the prior year. The 2014 payable increase resulted from the increase in gain on sales of available-for-sale securities when comparing 2014 to 2013. The Company paid the 2012 tax year balance due in March 2013.

Cash used in investing activities was $762,000 for the six months ended June 30, 2014 and cash from investing activities was $218,000 for the six months ended June 30, 2013. The Company had net purchases of Treasury Bills with a maturity date of more than three months from the date of purchase of $1,105,000 in 2014 compared to $175,000 in 2013. In addition, the Company acquired the Harvest Engineering, Inc. wireless hazard monitoring technology and Insta-Link product family in February 2014, paying $400,000 and financing the remaining purchase price through a seller-financed note. We received $759,000 on the sales of available-for-sale securities during the six months ended June 30, 2014 compared to $405,000 received during the six months ended June 30, 2013.

The Company issued a non-interest bearing note payable to Harvest Engineering, Inc. for $800,000, payable in annual installments of $400,000. In addition, the agreement includes an earn-out that is payable if specified revenue targets are met over the four calendar years following closing. The maximum amount of the earn-out is $550,000. The estimated fair value of the earn-out is $472,000 as of June 30, 2014.

Cash from financing activities was $4,000 for the six months ended June 30, 2014, compared to cash used in financing activities of $266,000 for the six months ended June 30, 2013. During the six-month period ended June 30, 2013, we paid aggregate dividends of $272,000. We did not pay any dividends during the six months ended June 30, 2014. During the six-month periods ended June 30, 2014 and 2013, we had $4,000 and $6,000, respectively, in stock purchases under the Employee Stock Purchase Plan.

16 -------------------------------------------------------------------------------- Table of Contents Our ongoing cash requirements will be primarily for capital expenditures, 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.

As of June 30, 2014, our primary investment is 163,917 shares of Rudolph Technologies, Inc., listed on the Nasdaq stock market, accounted for using the available-for-sale method. The investment is subject to fluctuations in market price and could have a negative effect on our liquidity.

Off-balance Sheet Arrangements As of June 30, 2014, the Company had no off-balance sheet arrangements or transactions.

February 2014 Acquisition and Future Business Development Activities During the first quarter of 2014, the Company acquired assets of Harvest Engineering, Inc. that include wireless hazard monitoring technology system and Insta-Link product family, together with related technology and intellectual property rights, for a total purchase price of $1,643,000. The Company will manufacture and service this new hazard monitoring product line at its Minnetonka, Minnesota facility and market and sell the products under its new HazardPROTMproduct line.

The Company continues to seek growth opportunities, both internally through the Company's existing portfolio of products, technologies and markets, as well as externally through technology partnerships or related-product acquisitions.

Although the Company is continuing to explore these external opportunities, it currently has no agreements or understandings with any third parties.

FORWARD-LOOKING STATEMENTS This Form 10-Q 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 our expectations, beliefs, intentions or strategies regarding the future. Forward-looking statements include, but are not limited to, statements relating to our marketing efforts or our efforts to accelerate growth; our business development activities; our efforts to maintain or reduce production costs; management's intention that we not become an investment company; our expected use of cash on hand; our cash requirements; and the sufficiency of our cash flows. 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 us as of the date hereof, and we assume no obligation to update any such forward-looking statements, other than as required by law. It is important to note that our actual results could differ materially from those in such forward-looking statements. The forward-looking statements we make in this Quarterly Report are subject to certain risks and uncertainties that could cause future results to differ materially from our recent results or those projected in the forward-looking statements, including the accuracy of management's assumptions with respect to industry trends, fluctuations in industry conditions, the accuracy of management's assumptions regarding expenses and our cash needs and those listed under the heading "Cautionary Statements" under "Item 1-Business," in our Annual Report on Form 10-K for the year ended December 31, 2013.

[ Back To TMCnet.com's Homepage ]