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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file Number 0-12965
NESTOR, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3163744
- --------------------------------------- -----------------------------------
(State of incorporation) (I.R.S. EmployerIdentification No.)
One Richmond Square, Providence, RI 02906
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
401-331-9640
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period than the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No _________
---
Common stock, par value .01 per share: 50,241,112 shares
outstanding as of June 30, 2002
1
NESTOR, INC.
FORM 10 Q
June 30, 2002
INDEX
- --------------------------------------------------------------------------------
Page
Number
------
PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets
June 30, 2002 (Unaudited) and December 31, 2001 3
Condensed Consolidated Statements of Operations (Unaudited)
Quarters and six months ended June 30, 2002 and 2001 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
Six months ended June 30, 2002 and 2001 5
Notes to Condensed Consolidated Financial Statements 6
----------------------------------------------------
Item 2 Management's Discussion and Analysis of
Results of Operations and Financial Condition 9
Item 3 Quantitative and Qualitative Disclosure of Market Risk 16
PART 2 OTHER INFORMATION 17
2
Nestor, Inc.
Condensed Consolidated Balance Sheets
June 30, 2002 December 31, 2001
------------- -----------------
(Unaudited) (Note 1)
Assets
Current assets:
Cash and cash equivalents $ --- $ 2,294,987
Restricted cash 122,026 943,926
Accounts receivable - net of allowance for doubtful accounts 278,993 158,206
Unbilled contract revenue 593,879 595,023
Inventory (work-in-progress) 364,910 375,098
Other current assets 105,984 298,273
--------------- ---------------
Total current assets 1,465,792 4,665,513
Noncurrent assets:
Long term unbilled contract revenue 312,421 421,399
Capitalized system costs - net of accumulated depreciation 1,981,839 2,079,938
Property and equipment - net of accumulated depreciation 529,433 652,644
Goodwill 11,080,684 14,080,684
Patent development costs - net of accumulated amortization 149,006 135,242
--------------- ---------------
Total Assets $ 15,519,175 $ 22,035,420
=============== ===============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,306,278 $ 601,361
Accrued employee compensation 432,830 478,444
Accrued liabilities 914,760 944,298
Deferred income 328,964 481,892
Leases payable 23,523 306,327
Restructuring reserve 698,505 ---
--------------- ---------------
Total current liabilities 3,704,860 2,812,322
Noncurrent liabilities:
Long term deferred income 312,421 421,399
Long term leases payable 3,191,651 2,409,202
--------------- ---------------
Total liabilities 7,208,932 5,642,923
--------------- ---------------
Commitments and contingencies --- ---
Stockholders' equity:
Preferred stock, $1.00 par value, authorized 10,000,000 shares;
issued and outstanding: Series B - 235,000 shares at
June 30, 2002 and December 31, 2001 235,000 235,000
(liquidation value $1.00 per share)
Common stock, $.01 par value, authorized 100,000,000 shares; Issued and
outstanding 50,241,112 shares at June 30, 2002
and at December 31, 2001 502,411 502,411
Warrants 1,723,175 2,612,368
Additional paid-in capital 44,072,090 43,129,655
Retained deficit (38,222,433) (30,086,937)
---------------- ----------------
Total stockholders' equity 8,310,243 16,392,497
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 15,519,175 $ 22,035,420
=============== ===============
The Notes to the Condensed Consolidated Financial Statements are an integral part of this statement.
3
Nestor, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)
Quarter Ended June 30, Six Months Ended June 30,
------------------------------- -------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Revenues:
Product royalties $ 408,562 $ 1,056,004 $ 663,476 $ 2,691,246
Product license and services 359,977 6,799 943,001 76,363
------------- ------------- ------------- -------------
Total revenues 768,539 1,062,803 1,606,477 2,767,609
------------- ------------- ------------- -------------
Operating expenses:
Cost of goods sold 348,793 --- 902,716 ---
Engineering services 470,933 16,845 906,922 83,590
Research and development 653,745 72,220 1,642,548 355,331
Selling and marketing expenses 195,292 97,902 450,239 404,468
General and administrative expenses 515,947 342,400 1,047,385 456,525
Restructuring costs 742,705 --- 742,705 ---
Capitalized system costs impairment 794,281 --- 794,281 ---
Goodwill impairment 3,000,000 --- 3,000,000 ---
------------- ------------- ------------- -------------
Total operating expenses 6,721,696 529,367 9,486,796 1,299,914
------------- ------------- ------------- -------------
Income (loss) from operations (5,953,157) 533,436 (7,880,319) 1,467,695
Other expense - net (173,396) (21,927) (255,177) (57,029)
-------------- -------------- -------------- --------------
Income (loss) for the period before income taxes
(benefit) and investment loss (6,126,553) 511,509 (8,135,496) 1,410,666
Income taxes (benefit) --- --- --- ---
Loss from investment in affiliate --- --- --- (81,100)
------------- ------------- ------------- --------------
Net income (loss) for the period $(6,126,553) $ 511,509 $ (8,135,496) $ 1,329,566
============ ============= ============== =============
Income (loss) per share, basic and diluted $ (0.12) $ 0.03 $ (0.16) $ 0.07
=============== ============= ============== =============
Basic shares 50,476,112 17,989,438 50,476,112 17,956,610
Net effect of dilutive shares -
based on the treasury stock method:
Warrants --- 721,016 --- 421,556
Stock options --- 457,161 --- 254,269
------------- ------------- ------------- -------------
Diluted shares 50,476,112 19,167,615 50,476,112 18,632,435
============= ============= ============= =============
The Notes to the Condensed Consolidated Financial Statements are an integral part of this statement.
4
Nestor, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended June 30,
---------------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income (loss) $ (8,135,496) $ 1,329,566
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization 276,823 73,418
Loss on disposal of fixed assets 12,262 ---
Loss from investment in affiliate --- 81,100
Goodwill impairment 3,000,000 ---
Capitalized system costs impairment 794,281 ---
Expenses charged to operations relating to options,
warrants and capital transactions 53,242 53,242
Increase (decrease) in cash arising from
changes in assets and liabilities:
Restricted cash 821,900 ---
Accounts receivable (120,787) 432,443
Unbilled contract revenue 110,122 298,951
Inventory 5,077 ---
Other assets 192,289 22,831
Accounts payable and accrued expenses 629,765 656,152
Deferred income (261,906) (480,861)
Restructuring reserve 698,505 ---
------------- -------------
Net cash provided (used) by operating activities (1,923,923) 2,466,842
-------------- -------------
Cash flows from investing activities:
Payments from affiliate - net --- 179,374
Investment in capitalized systems (843,702) ---
Purchase of property and equipment (21,450) ---
Proceeds from sale of property and equipment 10,100 ---
Patent developments costs (15,657) (55,960)
Deferred merger costs --- (358,105)
------------- -------------
Net cash used by investing activities (870,709) (234,619)
-------------- --------------
Cash flows from financing activities:
Repayment of line of credit --- (419,769)
Repayment of obligations under capital leases (30,885) (10,515)
Proceeds from leases payable 530,530
Proceeds from issuance of common stock --- 94,589
------------- -------------
Net cash provided (used) by financing activities 499,645 (335,695)
------------- --------------
Net change in cash and cash equivalents (2,294,987) 1,896,456
Cash and cash equivalents - beginning of period 2,294,987 150,036
------------- -------------
Cash and cash equivalents - end of period $ --- $ 2,046,492
============= =============
Supplemental cash flows information
Interest paid $ 210,307 $ 16,390
============= =============
Income taxes paid $ --- $ ---
============= =============
Significant non-cash transactions are described in Notes 2 and 4.
The Notes to the Condensed Consolidated Financial Statements are an integral part of this statement.
5
Nestor, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
June 30, 2002
Note 1 - Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the quarter and six months ended
June 30, 2002 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2002.
The balance sheet at December 31, 2001 has been derived from the
audited financial statements at that date but does not include all of
the information and footnotes required by generally accepted
accounting principles for complete financial statements.
For further information, refer to the audited consolidated financial
statements and footnotes thereto included in the Registrant Company
and Subsidiaries' annual report on Form 10-K for the year ended
December 31, 2001.
Nestor, Inc. organized two wholly-owned subsidiaries, Nestor Traffic
Systems, Inc. ("NTS") and Nestor Interactive, Inc. ("Interactive")
effective January 1, 1997. Effective November 7, 1998, the Company
ceased further investment in the Interactive subsidiary. In 1999 and
2000, NTS sold shares of its common stock to private investors,
bringing the Company's ownership of NTS to 34.62%. On September 12,
2001, NTS was merged into a wholly-owned subsidiary of the Company.
Accordingly, the consolidated financial statements include NTS balance
sheet accounts at December 31, 2001 and June 30, 2002, and operating
results for the period from September 13, 2001 through year end and
for the quarter and six months ended June 30, 2002. All intercompany
transactions and balances have been eliminated.
On May 18, 2001, Nestor, Inc. ceased direct product development, sales
and support in the fields of fraud detection, financial risk
management, and customer relationship management ("CRM"). Through
license agreements entered into with Applied Communications, Inc.
("ACI") on February 1, 2001, and with Retail Decisions, Inc. ("ReD")
on May 18, 2001, co-exclusive development, licensing and support
rights were granted to these resellers in fraud and risk management;
and non-exclusive rights in the field of CRM were granted to ReD.
Nestor continues to receive royalties from ACI licensing revenues
realized from licensing of the Company's products (See Note 5 also.).
In addition, all expenses associated with development, support and
selling these products were transferred to these parties.
Presented below is summarized NTS financial information at June 30,
2001 and for the quarter and six months then ended: June 30, 2001
Current assets $ 1,226,000
Noncurrent assets 1,492,000
Convertible note payable 4,000,000
Other current liabilities 1,159,000
Stockholders' deficit 2,474,000
Quarter Ended Six Months Ended
June 30, 2001 June 30, 2001
------------- ----------------
Total revenues $ 387,000 $ 560,000
Operating expenses 1,780,000 3,165,000
Net loss 1,460,000 2,708,000
6
Note 2 - Goodwill and Other Intangible Assets:
As of January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 142 sets forth new financial
accounting and reporting standards that require goodwill to be
separately disclosed from other intangible assets in the statement of
financial position, and no longer amortized, but tested for impairment
on an annual basis, or whenever indicators of impairment are
identified. The provisions of this accounting standard also require
the completion of a transitional impairment test within six months of
adoption, with any impairment identified accounted for as a cumulative
effect of a change in accounting principle. The Company completed the
transitional impairment test during the quarter ended June 30, 2002
and concluded that no impairment existed on January 1, 2002, when the
standard was adopted. Management considers the Company's quoted stock
price to be the best indicator of fair value.
Based on the decline of the Company's stock price during the second
quarter however, the fair value was recomputed using the quoted June
30, 2002 stock price of $.25. Such computation resulted in a goodwill
impairment charge of $3,000,000 recorded as an operating expense
during the quarter. If the Company's stock price declines below $.25
at a future quarterly measurement date, further impairment changes
will be required in the respective future period. The Company will
continue to monitor goodwill for potential impairment.
As all of the goodwill recorded on the Company's books was created
subsequent to June 30, 2001, no goodwill amortization was recorded
during 2001; in accordance with SFAS No. 142. As no amortization of
goodwill has been recorded, adoption of SFAS No. 142 has had no pro
forma effect on the net loss or earnings per share calculations.
Amortization of other intangible assets has been immaterial to
operating results and is expected to remain at existing levels until
such time as the patents have been approved and amortization begins.
Note 3 - Restructuring:
In June 2002, the Company underwent a significant restructuring
involving management changes and cost control to lower personnel and
facilities expenses as the Company refocused its efforts solely on its
red-light video enforcement contracts for CrossingGuard installations.
The Company terminated 19 full-time employees, affecting all
departments, and offices were consolidated into smaller facilities.
During the quarter ended June 30, 2002, the Company recorded
restructuring costs (which are separately disclosed in the Statement
of Operations) of $743,000 primarily comprised of $332,000 in employee
severance agreements and estimated lease obligations associated with
closing its Providence, RI and San Diego, CA offices. After offsetting
security deposits against restructuring costs, at June 30, 2002,
$699,000 remains outstanding and is recorded on the balance sheet as a
restructuring reserve. No amounts accrued were actually paid during
the quarter.
Note 4 - Impairment Charge:
During the quarter ended June 30, 2002, the Company determined that
potential citation revenues from certain CrossingGuard installations
in two cities would not exceed the cost of the underlying carrying
value of the capitalized systems. These contracts were signed in the
early stages of CrossingGuard development and the site selection
procedures and contract terms have since been improved. In accordance
with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company wrote off capitalized systems cost of
$794,000 and recorded a corresponding impairment charge in operating
expenses. Ongoing revenues from these installations are expected to
offset future costs of system operations.
7
Note 5 - Subsequent Events:
On August 9, 2002, the Company filed a Schedule 14C Preliminary
Information Statement with the Securities and Exchange Commission
regarding the following agreements.
Churchill Lane Associates Financing Agreement
On July 15, 2002, the Company entered into a Memorandum of
Understanding ("MOU") with Churchill Lane Associates, LLC ("CLA"),
assigning CLA certain of the Company's rights to royalty income under
the license agreement between the Company and ACI ("ACI License"). CLA
is owned and controlled by Alan M. Wiener, Alvin J. Siteman and Robert
M. Carroll, directors and shareholders of the Company. The assignment
will be consummated upon the execution by the parties of a definitive
assignment agreement reasonably satisfactory to both parties and the
consent of ACI to the transfer. The MOU also provides a schedule for
advances by CLA of up to $1.3 million to provide interim financing to
the Company during the period prior to the closing. Upon closing, CLA
will pay the Company $3.1 million in cash (less advances) for the
irrevocable assignment of all of its royalty rights under the ACI
License from July 1, 2002 and in perpetuity. No obligations or other
rights of the Company are being transferred or assigned to CLA.
The MOU will terminate and the Company will be obligated to refund any
deposits, plus interest at an annualized rate of 12%, if certain
conditions are not satisfied or waived by CLA, including: (i) ACI
fails to consent to the transfer by August 14, 2002; (ii) the closing
of the transfer does not take place by September 30, 2002, through no
fault of CLA; (iii) every non-participating board member does not
approve (iv) the Company fails to obtain the written consent of at
least 51% of the outstanding voting shares of stock by August 15,
2002; or (v) the Company accepts and closes on an alternative
financial transaction and, as a result, terminates the MOU. In
addition, in the event that the Company accepts and closes on an
alternative financial transaction and, as a result, terminates the
MOU, the Company must pay CLA a break-up fee of $93,000.
As of August 14, 2002, CLA has advanced a total of $740,000 to the
Company in deposits towards the purchase price for the royalty rights,
which deposits (in addition to any other deposits made after such
date) will be offset against the total amount due to the Company at
the closing of the transaction.
Electronic Data Systems Corporation Agreement Modifications
Pursuant to a letter agreement between NTS and Electronic Data Systems
Corporation ("EDS"), dated July 18, 2002, the EDS Master Lease
Purchase Agreement dated June 28, 2001 was modified to provide: (i) a
moratorium on NTS' interest obligations under the lease for the period
from July 1, 2002 through June 30, 2003; (ii) a moratorium on all
principal repayments through June 30, 2003, at which time regular
monthly payments will resume; (iii) all lease payments in arrears as
of June 30, 2002 will be accrued and payable as follows, $150,000 on
September 30, 2003, $100,000 on December 31, 2003, and $100,000 on
March 30, 2004; and (iv) effective July 1, 2002, the interest rate
factor upon which the lease payments are based will be lowered from
approximately 19% to 12% per annum. Accordingly, the entire EDS lease
payable is classified as long term at June 30, 2002. These
modifications were initiated because the Company was delinquent on
payments and had fallen out of compliance with the lease agreement.
EDS has informed NTS that it will not extend additional financing.
In addition, EDS has agreed to amend the Services Agreement by; (i)
eliminating the monthly minimum fee, (ii) reducing the per ticket
processing fees charged, (iii) obtaining a license to the Company's
CrossingGuard citation composer software to support their services,
and (iv) applying the amendments retroactive to January 1, 2002.
During this period January through June 2002, NTS recorded in cost of
goods sold approximately $210,000 in processing fees under the
original service agreement terms. The amendment reduces fees owed for
this period to approximately $50,000. NTS will record the necessary
reduction in cost of goods sold during the quarter ended September 30,
2002.
8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
PROSPECTIVE STATEMENTS
- ----------------------
The following discussion contains prospective statements regarding Nestor, Inc.
and its subsidiaries, its business outlook, ability to obtain financing and
results of operations that are subject to certain risks and uncertainties and to
events that could cause the Company's actual business, prospects and results of
operations to differ materially from those that may be anticipated by, or
inferred from, such prospective statements. Factors that may affect the
Company's prospects include, without limitation: the Company's ability to
successfully raise capital, develop new contracts for technology development;
the impact of competition on the Company's revenues or market share; delays in
the Company's introduction of new products; and failure by the Company to keep
pace with emerging technologies.
The Company's quarterly revenues and operating results have varied significantly
in the past and may do so in the future. A significant portion of the Company's
business has been derived from individually substantial contracts, and the
timing of such licenses has caused material fluctuations in the Company's
operating results. In addition, because the Company provides certain of its
products to customers under licenses with no significant continuing obligations,
it recognizes a significant portion of its revenue upon the delivery of the
software and acceptance by the customer. Thus, revenues derived by the Company
may be more likely to be recognized in irregular patterns that may result in
quarterly variations in the Company's revenues.
The Company's expense levels are based in part on its product development
efforts and its expectations regarding future revenues and in the short term are
generally fixed. Therefore, the Company may be unable to adjust its spending in
a timely manner to compensate for any unexpected revenue shortfall. As a result,
if anticipated revenues in any quarter do not occur or are delayed, the
Company's operating results for the quarter would be disproportionately
affected. Operating results also may fluctuate due to factors such as the demand
for the Company's products, product life cycles, the development, introduction
and acceptance of new products and product enhancements by the Company or its
competitors, changes in the mix of distribution channels through which the
Company's products are offered, changes in the level of operating expenses,
customer order deferrals in anticipation of new products, competitive conditions
in the industry and economic conditions generally or in various industry
segments.
The Company expects quarterly fluctuations to continue for the foreseeable
future. Accordingly, the Company believes that period-to-period comparisons of
its financial results should not be relied upon as an indication of the
Company's future performance. No assurance can be given that the Company will be
able to achieve or maintain profitability on a quarterly or annual basis in the
future.
Readers are cautioned not to place undue reliance on these prospective
statements, which speak only as of the date of this report. The Company
undertakes no obligation to revise any forward-looking statements in order to
reflect events or circumstances that may subsequently arise. Readers are urged
to carefully review and consider the various disclosures made by the Company in
this report and in the Company's reports filed with the Securities and Exchange
Commission, including Exhibit 99.1 to the Company's December 31, 2001 Form 10-K
and the Company's Schedule 14C Preliminary Information Statement filed on August
9, 2002.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
Nestor's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require the
Company to make estimates and assumptions (see Note 1 to the Consolidated
Financial Statements). The Company believes that of its significant accounting
policies (see Note 1 to the Consolidated Financial Statements), the following
may involve a higher degree of judgment and complexity.
9
REVENUE RECOGNITION
Contract accounting is applied to fixed-fee contracts, primarily in the Rail and
TrafficVision product lines. This methodology involves a
percentage-of-completion approach, based on progress-to-completion measures on
estimated total costs. If the Company does not accurately estimate these total
costs, or the projects are not properly managed to planned periods and
expectations, then future margins may be significantly and negatively affected
or losses on existing contracts may need to be recognized.
Lease and service fees for the Company's CrossingGuard product: Revenues are
expected to be generated from fees received from associated services. Management
estimates the percentage of citations that are expected to be collectible and
recognizes revenue accordingly. To the extent these estimates are not accurate,
the Company's operating results may be significantly and negatively affected.
GOODWILL AND LONG-LIVED ASSET IMPAIRMENT
In assessing the recoverability of the Company's long-term assets, management
must make assumptions regarding estimated future cash flows and other factors to
determine the fair value. If these estimates change in the future, the Company
may be required to record impairment charges that were not previously recorded.
On January 1, 2002, the Company adopted Statements of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" and No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." The Company
completed the transitional impairment test of goodwill during the quarter ended
June 30, 2002 and concluded that no impairment existed on January 1, 2002, when
the standard was adopted. Management considers the Company's quoted stock price
to be the best indicator of fair value.
Based on the decline of the Company's stock price during the second quarter
however, the fair value was recomputed using the quoted June 30, 2002 stock
price of $.25. Such computation and hypothetical allocation of fair value to the
other Company assets and liabilities resulted in a goodwill impairment charge of
$3,000,000 recorded as an operating expense during the quarter. If the Company's
stock price declines below $.25 at a future quarterly measurement date, further
impairment charges will be required in the respective future period. The Company
will continue to monitor goodwill for potential impairment.
Standard No. 144 requires the Company to consider whether there are indicators
of impairment of long-lived assets and, if so, recognize an impairment loss.
During the quarter ended June 30, 2002, the Company determined that potential
citation revenues from certain CrossingGuard installations in two cities would
not exceed the cost of the underlying carrying value of the capitalized systems.
These contracts were signed in the early stages of CrossingGuard development and
the site selection procedures and contract terms have since been improved. In
accordance with SFAS No. 144, the Company wrote off capitalized system costs of
$794,000 and recorded a corresponding impairment charge in operating expenses.
Ongoing revenues from these installations are expected to offset future costs of
system operations.
RESTRUCTURING COST AND RESERVE
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts solely on its red-light video enforcement
contracts for CrossingGuard installations. The Company terminated 19 full-time
employees, affecting all departments, and offices were consolidated into smaller
facilities. During the quarter ended June 30, 2002, the Company recorded
restructuring costs of $743,000 primarily comprised of $332,000 in employee
severance agreements and estimated lease obligations associated with closing its
Providence, RI and San Diego, CA offices. After offsetting security deposits
against restructuring costs, at June 30, 2002, $699,000 remains outstanding and
is recorded on the balance sheet as a restructuring reserve.
10
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CASH POSITION AND WORKING CAPITAL
The accompanying financial statements have been prepared assuming that Nestor,
Inc. will continue as a going concern. As discussed in Note 1 of the Form 10-K
financial statements, the Company is currently expending cash in excess of cash
generated from operations, as revenues are not yet sufficient to support future
operations. These conditions raise substantial doubt about the Company's ability
to continue as a going concern without additional financing. Management's plans
in regard to these matters are discussed in Note 1 of the Form 10-K financial
statements and in the Company's Schedule 14C Preliminary Information Statement
filed on August 9, 2002. On July 15, 2002, the Company entered into a Memorandum
of Understanding ("MOU"), assigning certain of the Company's rights to ACI
royalty income in exchange for $3,100,000 in cash. The MOU also provides a
schedule for advances of up to $1,300,000 to provide interim financing to the
Company prior to the closing. The MOU is discussed more fully in Note 5 to the
financial statements. The quarterly financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of the Company's ultimate ability to raise
additional financing and/or capital.
The Company had consolidated cash and cash equivalents of approximately
$2,295,000 at December 31, 2001 which were fully expended by June 30, 2002. The
Company had restricted cash of approximately $122,000 at June 30, 2002, and
$944,000 at December 31, 2001. At June 30, 2002, the Company had a working
capital deficit of $2,239,000 as compared with working capital of $1,853,000 at
December 31, 2001. During the period July 1 through August 14, 2002, the Company
has received $740,000 in advances towards the purchase of ACI royalty rights
pursuant to the MOU.
The Company's net worth at June 30, 2002 was $8,310,000, as compared with a net
worth of $16,392,000 at December 31, 2001. The decrease in net worth results
primarily from the net operating loss reported in the current period including
the write-down of goodwill and certain capitalized system costs, as well as
recorded restructuring costs.
Additional capital will be required to enable the Company to carry out product
delivery efforts under current contracts, to underwrite the delivery costs of
future systems delivered under turnkey agreements with municipalities, for
continued development and upgrading of its products, for customer support, and
for other operating uses. If the Company does not realize additional equity
and/or debt capital and revenues sufficient to maintain its operations at the
current level, management of the Company would be required to modify certain
initiatives including the cessation of some or all of its operating activities
until additional funds become available through investment or revenues.
As further discussed in Note 5 to the financial statements, the Company entered
into an MOU that will provide $3.1 million to the Company upon closing in
exchange for future rights to royalties due under the ACI license agreement.
This funding will be adequate to support the Company's operating expenses
through the remainder of the year. As of June 30, 2002, the Company had 111
CrossingGuard approaches under contract, of which 74 approaches were in various
stages of analysis and delivery. To complete these approaches, the Company will
be required to raise additional capital to cover the equipment, construction and
delivery costs.
The Company has retained investment advisors and is actively pursuing the
raising of additional capital. The possible success of these efforts, and the
effect of any new capital on the current structure of the Company, cannot be
determined as of the date of this filing.
LEASE FINANCING
Pursuant to a letter agreement between NTS and Electronic Data Systems
Corporation ("EDS"), dated July 18, 2002, the EDS Master Lease Purchase
Agreement dated June 28, 2001 was modified to provide: (i) a moratorium on NTS'
interest obligations under the lease for the period from July 1, 2002 through
June 30, 2003; (ii) a moratorium on all principal repayments through June 30,
2003, at which time regular monthly payments will resume; (iii) all lease
11
payments in arrears as of June 30, 2002 will be accrued and payable as follows,
$150,000 on September 30, 2003, $100,000 on December 31, 2003, and $100,000 on
March 30, 2004; and (iv) effective July 1, 2002, the interest rate factor upon
which the lease payments are based will be lowered from approximately 19% to 12%
per annum. Accordingly, the entire EDS lease payable is classified as long term
at June 30, 2002. EDS has informed the Company that it will not extend
additional financing.
DEFERRED INCOME
Most of the licenses underlying royalties due from ACI provided for a minimum
monthly license fee over the term of the respective license. The Company defers
recognition of these amounts over the customer license term (See Note 5 also).
Total deferred income was $641,000 at June 30, 2002 as compared with $903,000 at
December 31, 2001. The change is substantially due to the decrease in recorded
minimum license fees as customers approach the end of their initial license
terms. Upon execution of the ACI source code license on February 1, 2001, the
Company ceased the capitalization of expected minimum payments due from new
PRISM sublicensees of ACI as the necessary information was no longer directly
available to the Company.
FUTURE COMMITMENTS
The Company has no material commitments for capital expenditures although
management expects that the Company may make future commitments for the purchase
of additional computers and related equipment, for consulting and for
promotional and marketing expenses.
RESULTS OF OPERATIONS
- ---------------------
During the first six months of 2001, the reported operations of the Company
included only those revenues and expenses related to Nestor, Inc. operations of
licensing risk management products and services, primarily through ACI and ReD.
All prior year operating expenses related primarily to risk management support
services, and were eliminated by May 2001 through two source code license
agreements, with ACI and Retail Decisions, Inc., and the transfer of associated
operating personnel to these companies in support of these source code licenses.
During 2002, Nestor, Inc. receives royalties from ACI, and prior licensees of
the technology, and carries no operating expenses except for miscellaneous
administrative expenses associated with risk management and related services,
patent maintenance activities and general corporate matters.
As a result of the merger with Nestor Traffic Systems, Inc. (NTS) on September
12, 2001, the revenues and expenses of NTS are included in the operating results
of the Company subsequent to the merger, and represent the majority of 2002
operating expenses reported.
For the quarter ended June 30, 2002, the Company realized consolidated revenues
totaling $768,000 and expenses of $6,721,000, which resulted in a consolidated
operating loss for the quarter of $5,953,000. The Company reported a
consolidated net loss of $6,127,000 for the current quarter after other expenses
of $173,000, primarily interest expense on capital leases. In the corresponding
quarter of the prior year, consolidated revenues and expenses totaled $1,062,000
and $529,000, respectively, producing income from operations of $533,000; and
after other expenses of $22,000, the Company reported net income of $512,000.
For the six-month period ended June 30, 2002, the Company realized consolidated
revenues totaling $1,606,000 and expenses of $9,486,000, which resulted in a
consolidated operating loss for the six-month period of $7,880,000. The Company
reported a consolidated net loss of $8,135,000 for the six-month period after
other expenses of $255,000, primarily interest expense on capital leases. In the
corresponding six-month period of the prior year, consolidated revenues and
expenses totaled $2,768,000 and $1,300,000, respectively, producing income from
operations of $1,468,000; and after other expenses and loss from investment in
affiliate, the Company reported net income of $1,330,000.
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Revenues
- --------
The Company's consolidated revenues arise (i) directly from licensing of the
Company's technology and products in specific fields of use (risk management
with ACI and character recognition with Pearson NCS), and (ii) through its
wholly-owned subsidiary NTS from services, software licensing, equipment
leasing, and support activities regarding its CrossingGuard and other traffic
management products.
During the quarter ended June 30, 2002, consolidated revenues decreased 28% to
$768,000 from $1,062,000 in the quarter ended June 30, 2001. During the six
months ended June 30, 2002, consolidated revenues decreased 42% to $1,606,000
from $2,768,000 in the prior year.
PRODUCT ROYALTIES
Product royalty revenues were $409,000 in the quarter ended June 30, 2002, a 61%
decrease from $1,056,000 reported in the same quarter of the prior year. For the
six-month period ended June 30, 2002, product royalties were $664,000, a 75%
decrease from $2,691,000 reported in the corresponding six-month period of the
prior year.
The decrease in revenues from the prior-year is attributable to source code
licenses realized from ACI ($1,104,000) in February 2001 and Retail Decisions,
Inc. ($832,000) in May 2001, the decrease in monthly software license royalties
received from ACI, from 40% to 15% of risk management product revenues, as a
result of the termination of the former ACI agreement effective February 1,
2001. These decreases are offset in part by $174,000 in increased initial
license fees from ACI customers during the second quarter of 2002.
PRODUCT LICENSE AND PROCESSING SERVICES
During the quarter ended June 30, 2002, revenues from product license and
services increased 5195% to $360,000 from $7,000 in the corresponding quarter of
the prior year. During the six-months ended June 30, 2002, revenues from product
license and services increased 1135% to $943,000 from $76,000 for the comparable
period of the prior year.
The prior year revenues realized by Nestor, Inc. of $7,000 for the quarter and
$76,000 year-to-date were not repeated in 2002 since installation,
customization, and modeling services are no longer provided to ACI customers
under the new ACI agreement. Fiscal 2002 reflects revenues realized by NTS and
traffic management license and services. NTS revenues of $407,000 were generated
from Rail projects substantially completed during the first quarter,
TrafficVision revenues of $165,000 earned in April 2002 and CrossingGuard
revenues of $371,000 were derived primarily from (i) pilot projects delivered in
Dubuque, IA, and Overland Park, KS in February 2002 and (ii) citation processing
volumes in Falls Church, VA, Long Beach, CA, Rancho Cucamonga, CA and Vienna, VA
installations.
Operating Expenses
- ------------------
Total operating expenses amounted to $6,721,000 in the quarter ended June 30,
2002, an increase of $6,192,000 (1171%) from total operating costs of $529,000
in the corresponding quarter of the prior year. Operating expenses totaled
$9,486,000 in the six-month period ended June 30, 2002, an increase of
$8,186,000 (630%) over the $1,300,000 reported for the corresponding period of
the prior year. Calendar 2001 operating expenses reflect risk management
operations that were transferred to ACI and ReD in 2001. Calendar 2002 operating
expenses reflect current traffic management operations.
13
COST OF GOODS SOLD
Cost of goods sold (CGS) totaled $349,000 in the quarter and $903,000 in the six
months ended June 30, 2002 as compared to none in the prior year. As NTS was not
consolidated until September 13, 2001, there is no related CGS for the prior
periods reported.
CGS expenses also include third party goods and services related to revenues
recorded in the respective periods. CGS expenses are high in proportion to
revenues realized in the current period due to (i) rail projects completed in
the first quarter that carried higher equipment and construction costs than
prior experience as NTS acted a prime contractor on these construction related
projects, and (ii) our back-office processing agreement with EDS required a
monthly minimum fee that was proportionately high in relation to actual ticket
volumes generated. As discussed in Note 5, in July 2002 a letter agreement was
reached to eliminate the monthly minimum fee, reducing the per-ticket processing
fees charged retroactive to January 1, 2002. NTS will record the necessary
reduction in CGS during the quarter ended September 30, 2002.
ENGINEERING SERVICES
Costs related to engineering services totaled $471,000 in the quarter ended June
30, 2002, as compared to $17,000 in the corresponding quarter of the prior year.
During the six-months ended June 30, 2002, engineering costs were $907,000 as
compared to $84,000 in the prior year. The increases reflect the transition from
risk management software licensing engineering support in 2001 to traffic
management delivery and support activities in 2002.
RESEARCH AND DEVELOPMENT
Research and development expenses totaled $654,000 in the quarter ended June 30,
2002, as compared with $72,000 in the year-earlier period. During the six-months
ended June 30, 2002, R&D costs were $1,643,000 as compared to $355,000 in the
prior year. R&D activity is much higher in regards to the newer traffic
management product line than in the prior risk management line. In March 2002
and June 2002, management took steps to reduce the level of expenses in the
Company, including the heavy use of third party contractors to support
development projects. These cost reductions are partially reflected in the
second quarter 2002 results.
SELLING AND MARKETING
Selling and marketing costs totaled $195,000 in the quarter ended June 30, 2002,
as compared with $98,000 in the corresponding quarter of the prior year, an
increase of 99%. During the six-months ended June 30, 2002, selling and
marketing costs were $450,000 as compared to $404,000 in the prior year. The
increase reflects the transition to the traffic management business. The June
2002 reorganization has significantly reduced ongoing sales and marketing
expenses.
GENERAL AND ADMINISTRATIVE
General and administrative expenses totaled $516,000 in the quarter ended June
30, 2002, as compared with $342,000 in the corresponding quarter of the prior
year, representing an increase of 51%. General and administrative expenses
totaled $1,047,000 in the six-month period ended June 30, 2002, as compared to
$457,000 in the corresponding period of the prior year, representing an increase
of 129%. The increase reflects the combination of general and administrative
expenses as a result of the September 2001 NTS merger. General and
administrative expenses had been shared by the two companies previously and are
now combined, and NTS also contributed higher expenses related to broader
operational and territorial operations. The June 2002 reorganization has
significantly reduced ongoing general and administrative expenses.
14
RESTRUCTURING COSTS
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts solely on its red-light video enforcement
contracts for CrossingGuard installations. The Company terminated 19 full-time
employees, affecting all departments, and offices were consolidated into smaller
facilities. During the quarter ended June 30, 2002, the Company recorded
restructuring costs of $743,000 primarily comprised of $332,000 in employee
severance agreements and estimated lease obligations associated with closing its
Providence, RI and San Diego, CA offices. After offsetting security deposits
against restructuring costs, at June 30, 2002, $699,000 remains outstanding and
is recorded on the balance sheet as a restructuring reserve.
CAPITALIZED SYSTEM COST IMPAIRMENT
During the quarter ended June 30, 2002, the Company wrote off capitalized system
costs of $794,000 as an impairment charge after management determined that
potential citation revenues from certain CrossingGuard installations in two
cities would not exceed the cost of the underlying carrying value of the
capitalized systems. These contracts were signed in the early stages of
CrossingGuard development and the site selection procedures and contract terms
have since been improved. Ongoing revenues from these installations are expected
to offset future costs of system operations.
GOODWILL IMPAIRMENT
On January 1, 2002, the Company adopted Statements of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets". The Company completed
the transitional impairment test of goodwill during the quarter ended June 30,
2002 and concluded that no impairment existed on January 1, 2002, when the
standard was adopted. Management considers the Company's quoted stock price to
be the best indicator of fair value.
Based on the decline of the Company's stock price during the second quarter
however, the fair value was recomputed using the quoted June 30, 2002 stock
price of $.25. Such computation resulted in a goodwill impairment charge of
$3,000,000 recorded as an operating expense during the quarter. If the Company's
stock price declines below $.25 at a future quarterly measurement date, further
impairment charges will be required in the respective future periods. The
Company will continue to monitor goodwill for potential impairment.
OTHER EXPENSE - NET
Other expenses totaled $173,000 in the quarter ended June 30, 2002, as compared
with $22,000 in the corresponding quarter of the prior year, representing an
increase of 691%. Other expenses totaled $255,000 in the six-month period ended
June 30, 2002, as compared to $57,000 in the corresponding period of the prior
year, representing an increase of 347%. The increases reflect interest expense
realized on capital leases incurred by NTS to assist in financing the delivery
costs of CrossingGuard systems under service fee contracts to municipalities.
LOSS FROM INVESTMENT IN AFFILIATE
During March and November 1999, the Company's subsidiary NTS sold, in the
aggregate, common stock interests totaling 58% of its equity. In June 2000, NTS
sold additional common stock equity reducing the Company's equity position in
the affiliate to 34.6%.
As a result, the Company's interests in NTS during Fiscal 2000 and through
September 12, 2001 are accounted for under the equity method of accounting. The
Company reported a loss from investment in NTS of $81,000 in the quarter ended
June 30, 2001, representing 35% of NTS's actual net loss in the quarter of
$1,248,000, limited to the carrying value of its investment in NTS at that time.
Fiscal 2002 operations include the accounts of NTS in the consolidated results
reported.
15
Net Loss Per Share
- ------------------
During the quarter ended June 30, 2002, the Company reported a net loss of
$6,127,000, or ($.12) per share as compared with net income of $512,000, or $.03
per share in the corresponding period of the prior year. During the quarter
ended June 30, 2002, there were outstanding 50,476,000 basic and diluted shares
of common stock as compared with 17,989,000 basic and 19,168,000 diluted shares
during the corresponding quarter of the previous year. The increase in the
outstanding shares reflects (i) the additional shares issued in connection with
the $8 million financing realized in 2001 and (ii) the associated merger and
acquisition of NTS shares through the exchange of shares of Nestor, Inc.
During the six months ended June 30, 2002, the Company reported a net loss of
$8,135,000, and ($.16) per share as compared with net income of $1,330,000, or
$.07 per share in the corresponding period of the prior year. During the six
months ended June 30, 2002, there were outstanding 50,476,000 basic and diluted
shares of common stock as compared with 17,957,000 basic and 18,632,000 diluted
shares during the corresponding period of the previous year.
ITEM 3: QUANTATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
- ------- ----------------------------------------------------
Management assesses their exposure to these risks as immaterial.
16
PART 2: OTHER INFORMATION
NESTOR, INC.
FORM 10 Q - June 30, 2002
Item 1: Legal Proceedings
Item 2: Changes in Securities
Item 3: Defaults on Senior Securities
Item 4: Submission of Matters to a Vote of Security Holders
Item 5: Other Information
Item 6: Exhibits and reports on Form 8-K
(a) Exhibits - None
(b) Reports on Form 8-K - None
17
FORM 10-Q
NESTOR, INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NESTOR, INC.
(REGISTRANT)
/s/ Nigel P. Hebborn
DATE: August 14, 2002 --------------------------------------
Chief Financial Officer
(Principal Accounting Officer)
18