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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 September 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. Employer
Identification No.)
400 Massasoit Avenue; Suite 200, East Providence, RI 02914
-------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
401-434-5522
(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 September 30, 2002
1
NESTOR, INC.
FORM 10 Q
September 30, 2002
INDEX
- --------------------------------------------------------------------------------
Page
Number
------
PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets
-------------------------------------
September 30, 2002 (Unaudited) and December 31, 2001 3
Condensed Consolidated Statements of Operations (Unaudited)
-----------------------------------------------------------
Quarters and nine months ended September 30, 2002 and 2001 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
-----------------------------------------------------------
Nine months ended September 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
-------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
(Unaudited) (Note 1)
Assets
------
Current assets:
- ---------------
Cash and cash equivalents $ 1,094,181 $ 2,294,987
Restricted cash 752,096 943,926
Accounts receivable - net of allowance for doubtful accounts 89,625 158,206
Unbilled contract revenue 77,718 595,023
Inventory (raw materials) 463,287 375,098
Other current assets 136,151 298,273
-------------- --------------
Total current assets 2,613,058 4,665,513
Noncurrent assets:
- ------------------
Long term unbilled contract revenue --- 421,399
Capitalized system costs - net of accumulated depreciation 1,872,873 2,079,938
Property and equipment - net of accumulated depreciation 543,045 652,644
Goodwill 5,580,684 14,080,684
Patent development costs - net of accumulated amortization 151,079 135,242
-------------- --------------
Total Assets $ 10,760,739 $ 22,035,420
============== ==============
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
- --------------------
Accounts payable $ 1,010,541 $ 601,361
Accrued employee compensation 317,064 478,444
Accrued liabilities 1,105,520 944,298
Deferred income 10,099 481,892
Leases payable 251,853 306,327
Restructuring reserve 608,540 ---
-------------- --------------
Total current liabilities 3,303,617 2,812,322
Noncurrent liabilities:
- -----------------------
Long term deferred income --- 421,399
Long term leases payable 2,957,440 2,409,202
-------------- --------------
Total liabilities 6,261,057 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 September 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 September 30, 2002
and December 31, 2001 502,411 502,411
Warrants 1,692,096 2,612,368
Additional paid-in capital 44,129,789 43,129,655
Retained deficit (42,059,614) (30,086,937)
--------------- ---------------
Total stockholders' equity 4,499,682 16,392,497
-------------- --------------
Total Liabilities and Stockholders' Equity $ 10,760,739 $ 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 Sept. 30, Nine Months Ended Sept. 30,
------------------------------ -------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Revenues:
Product royalties $ 925 $ 78,478 $ 664,401 $ 2,769,724
Product license and services 180,150 107,640 1,123,151 184,003
------------ ------------ -------------- ------------
Total revenues 181,075 186,118 1,787,552 2,953,727
------------ ------------ -------------- ------------
Operating expenses:
Cost of goods sold 239,212 --- 1,379,208 ---
Engineering services 625,763 155,912 1,474,406 239,502
Research and development 30,252 238,229 1,572,893 593,560
Selling and marketing expenses 93,154 52,817 518,416 457,285
General and administrative expenses 299,662 254,360 1,292,930 710,885
Restructuring costs --- --- 742,705 ---
Capitalized system costs impairment --- --- 794,281 ---
Goodwill impairment 5,500,000 --- 8,500,000 ---
------------ ------------ -------------- ------------
Total operating expenses 6,788,043 701,318 16,274,839 2,001,232
------------ ------------ -------------- ------------
Income (loss) from operations (6,606,968) (515,200) (14,487,287) 952,495
Gain on royalty assignment 2,811,590 --- 2,811,590 ---
Other expense - net (41,803) (14,608) (296,980) (71,637)
------------- ------------- --------------- -------------
Income (loss) for the period before income taxes
(benefit) and investment loss (3,837,181) (529,808) (11,972,677) 880,858
Income taxes (benefit) --- --- --- ---
Loss from investment in affiliate --- --- --- (81,100)
------------ ------------ -------------- -------------
Net income (loss) for the period $ (3,837,181) $ (529,808) $ (11,972,677) $ 799,758
============= ============= =============== ============
Income (loss) per share:
Basic $ (0.08) $ (0.02) $ (0.24) $ 0.04
============= ============= ============== ============
Diluted $ (0.08) $ (0.02) $ (0.24) $ 0.03
============= ============= ============== ============
Basic shares 50,476,112 28,885,738 50,476,112 21,599,653
Net effect of dilutive shares -
based on the treasury stock method:
Warrants --- --- --- 1,863,239
Stock options --- --- --- 764,498
------------ ------------ -------------- ------------
Diluted shares 50,476,112 28,885,738 50,476,112 24,227,390
============ ============ ============== ============
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)
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income (loss) $ (11,972,677) $ 799,758
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization 443,227 125,937
Loss on disposal of fixed assets 14,688 ---
Loss from investment in affiliate --- 81,100
Goodwill impairment 8,500,000 ---
Capitalized system costs impairment 794,281 ---
Gain on royalty assignment (2,811,590) ---
Expenses charged to operations relating to options,
warrants and capital transactions 79,862 79,863
Increase (decrease) in cash arising from
changes in assets and liabilities:
Restricted cash 191,830 ---
Accounts receivable 68,581 579,693
Unbilled contract revenue 77,807 383,858
Inventory (141,866) 92,367
Other assets 162,122 65,263
Accounts payable and accrued expenses 409,022 (115,762)
Deferred income (260,805) (578,013)
Restructuring reserve 608,540
--------------- --------------
Net cash provided (used) by operating activities (3,836,978) 1,514,064
---------------- --------------
Cash flows from investing activities:
Payments from affiliate - net --- 322,952
Cash of acquired affiliate --- 361,804
Acquisition costs --- (550,270)
Proceeds from royalty assignment - net 3,040,100 ---
Investment in capitalized systems (842,767) ---
Purchase of property and equipment (47,849) (23,280)
Proceeds from sale of property and equipment 11,600 ---
Patent development costs (18,676) (53,732)
--------------- --------------
Net cash provided by investing activities 2,142,408 57,474
--------------- --------------
Cash flows from financing activities:
Repayment of line of credit --- (419,769)
Repayment of obligations under capital leases (36,766) (11,243)
Proceeds from leases payable 530,530 ---
Proceeds from issuance of common stock - net --- 3,950,123
--------------- --------------
Net cash provided by financing activities 493,764 3,519,111
--------------- --------------
Net change in cash and cash equivalents (1,200,806) 5,090,649
Cash and cash equivalents - beginning of period 2,294,987 150,035
--------------- --------------
Cash and cash equivalents - end of period $ 1,094,181 $ 5,240,684
=============== ==============
Supplemental cash flows information
Interest paid $ 223,164 $ 20,331
=============== ==============
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)
September 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 nine months ended
September 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.
Certain operating expenses reported at March 31, 2002 and June 30,
2002 have been reclassified to conform to the September 30, 2002
presentation.
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 September 30, 2002, and
operating results for the period from September 13, 2001 through year
end and for the quarter and nine months ended September 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 continued to receive royalties from ACI licensing revenues
realized from licensing of the Company's products through June 30,
2002 (See Note 4 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 September
30, 2001 and for the quarter and nine months then ended: September 30,
2001
Current assets $ 4,472,000
Noncurrent assets 2,297,000
Current liabilities 1,397,000
Long term liabilities 1,749,000
Stockholders' equity 3,623,000
6
Quarter Ended Nine Months Ended
Sept. 30, 2001 Sept. 30, 2001
-------------- -----------------
Total revenues $ 336,000 $ 896,000
Operating expenses 2,065,000 5,230,000
Net loss 1,812,000 4,520,000
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 for purposes of
performing these analyses.
Based on the decline of the Company's stock price during the second
and third quarters however, the fair value was recomputed using the
quoted June 30, 2002 stock price of $.25 and September 30, 2002 stock
price of $.09. Such computations resulted in goodwill impairment
charges of $3,000,000 and $5,500,000 recorded as operating expenses
during the respective quarters. If the Company's stock price declines
below $.09 at a future quarterly measurement date and is deemed to be
other than temporary, 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 and paying $85,000 in
severance benefits, at September 30, 2002, $609,000 remains
outstanding and is recorded on the balance sheet as a restructuring
reserve.
Note 4 - Financing and Service Agreements:
On September 3, 2002, the Company filed a Schedule 14C Definitive
Information Statement with the Securities and Exchange Commission
regarding the following agreements.
7
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 MOU also
provided a schedule for advances by CLA to provide interim financing
to the Company during the period prior to the closing. Upon closing on
September 30, 2002, CLA paid the Company $3.1 million in cash (less
advances) for the irrevocable assignment of its royalty rights under
the ACI License from July 1, 2002 and in perpetuity. No obligations or
other rights of the Company were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000
of ACI deferred income and $60,000 in related professional fees, the
Company recorded a $2,812,000 gain on this royalty assignment on
September 30, 2002. The elimination of ACI unbilled contract revenue
and deferred income were recorded as non-cash reductions.
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, $228,000 of EDS lease
payable is classified as short term at September 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. The
letter agreement has not yet been formally documented or executed.
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
the period January through September 2002 to approximately $70,000.
NTS will record the necessary reduction in cost of goods sold upon
execution of the amended agreement.
Note 5 - Litigation:
On July 12, 2002, Baldwin Line Construction of Maryland, Inc. filed a
lawsuit against Nestor Traffic Systems, Inc. in Fairfax County,
Virginia, seeking $117,105 plus interest related to invoices they
claim are owed for construction work in Falls Church, Virginia. The
suit has been transferred to Arlington County, Virginia. On November
15, 2002, NTS answered by filing its Grounds of Defense, asking the
court to dismiss the case. Additionally on November 15, 2002, NTS
filed a counterclaim alleging breach of contract and breach of
warranty, seeking a $400,000 judgment to cover NTS's losses in
remedying the installation and lost revenues suffered from late
delivery of the system.
Management believes that all bona-fide invoices for services due to
Baldwin have been paid and intends to defend itself against these
additional claims. Costs associated with the suit are being expensed
as incurred. Although NTS believes that it will prevail, there can be
no assurance as to the outcome of Baldwin's suit and NTS's
counterclaim. Any conclusion of this litigation in a manner adverse to
NTS may have an adverse effect on its financial condition.
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 installations and 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 product 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 Definitive Information Statement filed on
September 3, 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 additional impairment charges. 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 for purposes of performing these anaylses.
Based on the decline of the Company's stock price during the second and third
quarters however, the fair value was recomputed using the quoted June 30, 2002
stock price of $.25 and September 30, 2002 stock price of $.09. Such computation
resulted in goodwill impairment charges of $3,000,000 and $5,500,000 recorded as
operating expenses during the respective quarters. If the Company's stock price
declines below $.09 at a future quarterly measurement date and is deemed to be
other than temporary, further impairment changes 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 and paying $85,000 in severance benefits, at
September 30, 2002, $609,000 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 Definitive Information Statement
filed on September 3, 2002. On September 30, 2002, the Company assigned certain
of its rights to ACI royalty income in exchange for $3,100,000 in cash. The
assignment is discussed more fully in Note 4 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. At
September 30, 2002, the Company had cash and cash equivalents of $1,094,000
remaining from the ACI royalty assignment after replenishing $752,000 of
restricted cash. The Company had restricted cash of approximately $122,000 at
June 30, 2002, and $944,000 at December 31, 2001. At September 30, 2002, the
Company had a working capital deficit of $691,000 as compared with a working
capital deficit of $2,239,000 at June 30, 2002 and working capital of $1,853,000
at December 31, 2001.
The Company's net worth at September 30, 2002 was $4,500,000, as compared with a
net worth of $8,310,000 at June 30, 2002 and $16,392,000 at December 31, 2001.
The decrease in net worth results primarily from the net operating loss reported
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 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.
The funding provided by the ACI royalty assignment is expected to be adequate to
support the Company's operating expenses through the remainder of the year. As
of September 30, 2002, the Company had 138 CrossingGuard approaches under
contract, of which 41 were operational and 97 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
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, $228,000 of EDS lease payable is classified as short
term at September 30, 2002. EDS has informed the Company that it will not extend
additional financing. The letter agreement has not yet been formally documented
or executed.
11
Deferred Income
Most of the licenses underlying ACI royalties provided for a minimum monthly
license fee over the term of the respective license. The Company had deferred
recognition of these amounts over the customer license term prior to September
30, 2002 when such deferred income was eliminated in connection with the royalty
assignment (See Note 4 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 may make such future commitments.
RESULTS OF OPERATIONS
Prior to September 12, 2001, the 2001 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. received 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 September 30, 2002, the Company realized consolidated
revenues totaling $181,000 and expenses of $6,788,000, which resulted in a
consolidated operating loss for the quarter of $6,607,000. The Company reported
a consolidated net loss of $3,837,000 for the current quarter after recording a
$2,812,000 gain on the ACI royalty assignment and other expenses of $42,000,
primarily interest expense on capital leases. In the corresponding quarter of
the prior year, consolidated revenues and expenses totaled $186,000 and
$701,000, respectively, producing a loss from operations of $515,000; and after
other expenses of $15,000, the Company reported net income of $530,000.
For the nine-month period ended September 30, 2002, the Company realized
consolidated revenues totaling $1,788,000 and expenses of $16,275,000, which
resulted in a consolidated operating loss for the nine-month period of
$14,487,000. The Company reported a consolidated net loss of $11,973,000 for the
nine-month period after recording a $2,812,000 gain on the ACI royalty
assignment and other expenses of $296,000, primarily interest expense on capital
leases. In the corresponding nine-month period of the prior year, consolidated
revenues and expenses totaled $2,954,000 and $2,001,000, respectively, producing
income from operations of $953,000; and after other expenses and loss from
investment in affiliate, the Company reported net income of $800,000.
12
Revenues
The Company's consolidated revenues arose (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 September 30, 2002, consolidated revenues decreased 3%
to $181,000 from $186,000 in the quarter ended September 30, 2001. During the
nine months ended September 30, 2002, consolidated revenues decreased 39% to
$1,788,000 from $2,954,000 in the prior year.
Product Royalties
Product royalty revenues were $925 in the quarter ended September 30, 2002, a
99% decrease from $78,000 reported in the same quarter of the prior year. For
the nine-month period ended September 30, 2002, product royalties were $664,000,
a 76% decrease from $2,770,000 reported in the corresponding nine-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
royalties were substantially eliminated with the ACI royalty assignment
effective July 1, 2002.
Product License and Processing Services
During the quarter ended September 30, 2002, revenues from product license and
services increased 67% to $180,000 from $108,000 in the corresponding quarter of
the prior year. During the nine-months ended September 30, 2002, revenues from
product license and services increased 510% to $1,123,000 from $184,000 for the
comparable period of the prior year.
The prior year revenues realized by Nestor, Inc. of $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.
Year-to-date 2002 reflects revenues realized by NTS and traffic management
license and services. NTS revenues of $417,000 were generated from Rail projects
substantially completed during the first quarter, TrafficVision revenues of
$165,000 earned in April 2002 and CrossingGuard revenues of $541,000 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 $6,788,000 in the quarter ended September
30, 2002, an increase of $6,087,000 (768%) from total operating costs of
$701,000 in the corresponding quarter of the prior year. Operating expenses
totaled $16,275,000 in the nine-month period ended September 30, 2002, an
increase of $14,274,000 (613%) over the $2,001,000 reported for the
corresponding period of the prior year. The 2001 operating expenses reflect risk
management operations that were transferred to ACI and ReD in 2001. The 2002
operating expenses reflect current traffic management operations.
13
Cost of Goods Sold
Cost of goods sold (CGS) totaled $239,000 in the quarter and $1,379,000 in the
nine months ended September 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 due to (i) rail projects completed in the first quarter that
carried higher equipment and construction costs than prior experience as NTS
acted as 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 4, 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
upon execution of the amended agreement. Additionally, in the quarter ended
September 30, 2002, NTS reclassified customer-related telecommunications
expenses from various operating expenses to CGS, effective October 1, 2001.
Engineering Services
Costs related to engineering services totaled $626,000 in the quarter ended
September 30, 2002, as compared to $156,000 in the corresponding quarter of the
prior year. During the nine-months ended September 30, 2002, engineering costs
were $1,474,000 as compared to $240,000 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 $30,000 in the quarter ended September
30, 2002, as compared with $238,000 in the year-earlier period. During the
nine-months ended September 30, 2002, R&D costs were $1,573,000 as compared to
$593,000 in the prior year. R&D activity was initially 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.
Selling and Marketing
Selling and marketing costs totaled $93,000 in the quarter ended September 30,
2002, as compared with $53,000 in the corresponding quarter of the prior year,
an increase of 75%. During the nine-months ended September 30, 2002, selling and
marketing costs were $518,000 as compared to $457,000 in the prior year. The
increase reflects the transition to the traffic management business. The June
2002 reorganization significantly reduced ongoing sales and marketing expenses.
General and Administrative
General and administrative expenses totaled $300,000 in the quarter ended
September 30, 2002, as compared with $254,000 in the corresponding quarter of
the prior year, representing an increase of 18%. General and administrative
expenses totaled $1,293,000 in the nine-month period ended September 30, 2002,
as compared to $711,000 in the corresponding period of the prior year,
representing an increase of 82%. 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 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 and paying $85,000 in severance benefits, at
September 30, 2002, $609,000 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 and third
quarters however, the fair value was recomputed using the quoted June 30, 2002
stock price of $.25 and the September 30, 2002 stock price of $.09. Such
computations resulted in a goodwill impairment charges of $3,000,000 and
$5,500,000 recorded as an operating expense during the respective quarters. If
the Company's stock price declines below $.09 at a future quarterly measurement
date and is deemed to be other than temporary, further impairment charges will
be required in the respective future periods. The Company will continue to
monitor goodwill for potential impairment.
Gain on Royalty Assignment
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 MOU also provided a schedule for advances by CLA to provide interim
financing to the Company during the period prior to the closing. Upon closing on
September 30, 2002, CLA paid the Company $3.1 million in cash (less advances)
for the irrevocable assignment of its royalty rights under the ACI License from
July 1, 2002 and in perpetuity. No obligations or other rights of the Company
were transferred or assigned to CLA.
After offsetting $860,000 of unbilled ACI contract revenue, $632,000 of ACI
deferred income and $60,000 in related professional fees, the Company recorded a
$2,812,000 gain on this royalty assignment on September 30, 2002. The
elimination of ACI unbilled contract revenue and deferred income were recorded
as non-cash reductions.
15
Other Expense - Net
Other expenses totaled $42,000 in the quarter ended September 30, 2002, as
compared with $15,000 in the corresponding quarter of the prior year,
representing an increase of 180%. Other expenses totaled $297,000 in the
nine-month period ended September 30, 2002, as compared to $72,000 in the
corresponding period of the prior year, representing an increase of 313%. 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 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 March 31,
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. The 2002
operations include the accounts of NTS in the consolidated results reported.
Net Loss Per Share
During the quarter ended September 30, 2002, the Company reported a net loss of
$3,837,000, or ($.08) per share as compared with a net loss of $530,000, or
($.02) per share in the corresponding period of the prior year. During the
quarter ended September 30, 2002, there were outstanding 50,476,000 basic and
diluted shares of common stock as compared with 28,886,000 basic and 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 nine months ended September 30, 2002, the Company reported a net loss
of $11,973,000, and ($.24) per share as compared with net income of $800,000, or
$.04 per basic and $.03 per diluted share in the corresponding period of the
prior year. During the nine months ended September 30, 2002, there were
outstanding 50,476,000 basic and diluted shares of common stock as compared with
21,600,000 basic and 24,227,000 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.
ITEM 4: CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and that such information is accumulated
and communicated to the Company's management, including its President/Chief
Executive Officer/Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosures. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's President/Chief Executive Officer/Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on the foregoing, the
President/Chief Executive Officer/Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect the internal controls subsequent
to the date the Company completed its evaluation.
16
PART 2: OTHER INFORMATION
NESTOR, INC.
FORM 10 Q - September 30, 2002
Item 1: Legal Proceedings
On July 12, 2002, Baldwin Line Construction of Maryland, Inc. filed a
lawsuit against Nestor Traffic Systems, Inc. in Fairfax County,
Virginia, seeking $117,105 plus interest related to invoices they
claim are owed for construction work in Falls Church, Virginia. The
suit has been transferred to Arlington County, Virginia. On November
15, 2002, NTS answered by filing its Grounds of Defense, asking the
court to dismiss the case. Additionally on November 15, 2002, NTS
filed a counterclaim alleging breach of contract and breach of
warranty, seeking a $400,000 judgment to cover NTS's losses in
remedying the installation and lost revenues suffered from late
delivery of the system.
Management believes that all bona-fide invoices for services due to
Baldwin have been paid and intends to defend itself against these
additional claims. Costs associated with the suit are being expensed
as incurred. Although NTS believes that it will prevail, there can be
no assurance as to the outcome of Baldwin's suit and NTS's
counterclaim. Any conclusion of this litigation in a manner adverse to
NTS may have an adverse effect on its financial condition.
Item 2: Changes in Securities
Item 3: Defaults on Senior Securities
Item 4: Submission of Matters to a Vote of Security Holders
The Registrant's annual meeting of stockholders was held on May 22,
2002. Each matter voted upon at such meeting and the number of shares
cast for, against or withheld, and abstained are as follows:
1. Election of Directors For Against
--------------------- --- -------
Robert M. Carroll 36,371,924 119,272
Leon N Cooper 36,371,924 119,272
Charles Elbaum 36,371,924 119,272
J. Steve Emerson 36,371,924 119,272
David Fox 36,371,924 119,272
David A. Polak 36,371,924 119,272
Bruce W. Schnitzer 36,331,924 159,272
Alvin J. Siteman 36,371,924 119,272
Alan M. Wiener 36,371,924 119,272
2. Ratification of Appointment of Ernst & Young, LLP as
Independent Auditors for 2002
For Against Abstain
--- ------- -------
36,457,055 27,369 6,772
Item 5: Other Information
On August 9 and 29, 2002, the Corporation filed with the Securities
and Exchange Commission a Schedule 14C Preliminary Information
Statement, which is hereby incorporated by reference.
On September 3, 2002, the Corporation filed with the Securities and
Exchange Commission a Schedule 14C Definitive Information Statement,
which is hereby incorporated by reference.
17
On November 6, 2002, the Corporation filed with the Securities and
Exchange Commission a Schedule 13D for J. Steven Emerson and J. Steven
Emerson Roth IRA, dated October 31, 2002, which is hereby incorporated
by reference.
On November 6, 2002, the Corporation filed with the Securities and
Exchange Commission a Schedule 13D for David A. Polak, Polak
Investors, LLC, and NTS Investors, LLC, dated October 31, 2002, which
is hereby incorporated by reference.
Item 6: Exhibits and reports on Form 8-K
(a) Exhibits - None
(b) On October 10, 2002, the Corporation filed with the
Securities and Exchange Commission a current report on Form
8-K dated September 30, 2002, which is hereby incorporated
by reference.
18
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: November 18, 2002 By: Nigel P. Hebborn
President, Chief Executive Officer
and Chief Financial Officer
CERTIFICATION UNDER SECTION 906
OF THE SARABANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned
certifies that this periodic report fully complies with the requirements of
Section 13 (a) or 15 (d) of the Securities Exchange Act of 1934 and that
information contained in this periodic report fairly presents, in all material
respects, the financial condition and results of operations of Nestor, Inc.
/s/ Nigel P. Hebborn
-----------------------------------------
By: Nigel P. Hebborn
President, Chief Executive Officer
and Chief Financial Officer
19