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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, 2003
[ ] 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.
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(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: 13,937,738 shares
outstanding as of June 30, 2003
1
NESTOR, INC.
FORM 10 Q
June 30, 2003
INDEX
- --------------------------------------------------------------------------------
Page
Number
------
PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets
June 30, 2003 (Unaudited) and December 31, 2002 3
Condensed Consolidated Statements of Operations (Unaudited)
Quarters and six months ended June 30, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
Quarters and six months ended June 30, 2003 and 2002 5
Notes to Condensed Consolidated Financial Statements 6
----------------------------------------------------
Item 2 Management's Discussion and Analysis of
Results of Operations and Financial Condition 10
Item 3 Quantitative and Qualitative Disclosure of Market Risk 15
Item 4 Controls and Procedures 15
PART 2 OTHER INFORMATION 16
2
NESTOR, INC.
Condensed Consolidated Balance Sheets
-------------------------------------
JUNE 30, 2003 DECEMBER 31, 2002
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 706,009 $ 308,894
Accounts receivable 285,341 141,263
Unbilled contract revenue 121,557 122,684
Inventory 498,810 281,108
Other current assets 34,333 60,963
--------------- -------------
Total current assets 1,646,050 914,912
NONCURRENT ASSETS:
Capitalized system costs, net of accumulated depreciation 2,769,983 1,936,783
Property and equipment, net of accumulated depreciation 429,609 486,740
Goodwill 5,580,684 5,580,684
Patent development costs, net of accumulated amortization 175,353 153,275
Other long term assets 35,032 128,570
--------------- -------------
TOTAL ASSETS $ 10,636,711 $ 9,200,964
=============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 608,025 $ 616,878
Accrued employee compensation 293,867 354,269
Accrued liabilities 522,869 795,749
Leases payable 642,191 354,286
Restructuring reserve 284,328 365,939
--------------- -------------
Total current liabilities 2,351,280 2,487,121
Long term leases payable 2,589,420 2,849,126
--------------- -------------
Total liabilities 4,940,700 5,336,247
--------------- -------------
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, 2003 and December 31, 2002 235,000 235,000
Common stock, $.01 par value, authorized 20,000,000 shares;
issued and outstanding: 13,937,738 shares at June 30, 2003
and 5,024,111 shares at December 31, 2002 139,377 50,241
Warrants 1,263,840 1,072,825
Additional paid-in capital 49,002,939 45,227,851
Accumulated deficit (44,945,145) (42,721,200)
---------------- -------------
Total stockholders' equity 5,696,011 3,864,717
--------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 10,636,711 $ 9,200,964
=============== =============
The Unaudited 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,
------------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues:
Product royalties $ 5,205 $ 408,562 $ 28,455 $ 663,476
Product license and services 438,328 359,977 761,805 943,001
------------- ------------- ------------- -------------
Total revenues 443,533 768,539 790,260 1,606,477
------------- ------------- ------------- -------------
Operating expenses:
Cost of goods sold 283,685 463,321 533,707 1,139,996
Engineering services 746,440 442,803 1,418,082 848,642
Research and development 30,779 605,523 61,668 1,542,641
Selling and marketing expenses 101,777 183,236 169,541 425,262
General and administrative expenses 371,761 489,827 715,694 993,269
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 1,534,442 6,721,696 2,898,692 9,486,796
------------- ------------- ------------- -------------
Loss from operations (1,090,909) (5,953,157) (2,108,432) (7,880,319)
Contract termination reserve (Note 5) (125,000) --- (125,000) ---
Other income (expense) - net 37,311 (173,396) 9,487 (255,177)
------------- -------------- ------------- --------------
Net loss $ (1,178,598) $ (6,126,553) $ (2,223,945) $ (8,135,496)
============== ============== ============== ==============
Loss per Share:
Loss per share, basic and diluted $ (.08) $ (1.21) $ (.19) $ (1.61)
============== ============== ============== ==============
Shares used in computing loss per share:
Basic and diluted 13,961,169 5,047,611 11,954,390 5,047,611
============== ============== ============= ================
The Unaudited 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,
--------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net loss $ (2,223,945) $ (8,135,496)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 351,267 276,823
Loss on disposal of fixed assets 5,291 12,262
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 (144,078) (120,787)
Unbilled contract revenue 1,127 110,122
Inventory (209,172) 5,077
Other assets 120,167 192,289
Accounts payable and accrued expenses (342,135) 629,765
Deferred income --- (261,906)
Restructuring reserve (81,611) 698,505
-------------- -------------
Net cash used by operating activities (2,469,847) (1,923,923)
-------------- --------------
Cash flows from investing activities:
Investment in capitalized systems (1,068,612) (843,702)
Purchase of property and equipment (31,819) (21,450)
Proceeds from sale of property and equipment --- 10,100
Patent developments costs (24,803) (15,657)
-------------- --------------
Net cash used by investing activities (1,125,234) (870,709)
-------------- --------------
Cash flows from financing activities:
Repayment of obligations under capital leases (9,801) (30,885)
Proceeds from leases payable --- 530,530
Proceeds from issuance of common stock - net 4,001,997 ---
------------- -------------
Net cash provided by financing activities 3,992,196 499,645
------------- -------------
Net change in cash and cash equivalents 397,115 (2,294,987)
Cash and cash equivalents - beginning of period 308,894 2,294,987
------------- -------------
Cash and cash equivalents - end of period $ 706,009 $ ---
============= =============
Supplemental cash flows information
Interest paid $ 4,565 $ 123,156
============= =============
Income taxes paid $ --- $ ---
============= =============
The Unaudited 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, 2003
Note 1 - Nature of Operations:
A. Organization Nestor, Inc. (the "Company") was organized on March
21, 1983 in Delaware to develop and succeed to certain patent rights
and know-how which the Company acquired from its predecessor, Nestor
Associates, a limited partnership. Two wholly-owned subsidiaries,
Nestor Traffic Systems, Inc. ("NTS") and Nestor Interactive, Inc.
("Interactive"), were formed effective January 1, 1997. Effective
November 7, 1998, the Company ceased further investment in the
Interactive subsidiary. CrossingGuard, Inc., a wholly-owned subsidiary
of NTS, was formed July 18, 2003 in connection with the financing
discussed in Note 7. The Company's principal office is located in East
Providence, RI.
The Company's current focus is to offer customers products and
services to be utilized in intelligent traffic management
applications. Its leading product is its CrossingGuard video-based red
light enforcement system and services, sold and distributed
exclusively by NTS. Effective July 1, 2002, the Company assigned its
royalty rights in the field of financial services, substantially
eliminating ongoing product royalty revenue from all other lines of
business.
B. Liquidity and management's plans
The Company has incurred significant losses to date and at June 30,
2003 has a significant accumulated deficit. These conditions raise
substantial doubt about the Company's ability to continue as a going
concern without additional financing 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 or 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.
On July 31, 2003, the Company raised $2,000,000 through the issuance
of a convertible note to Laurus Master Fund, Ltd (see Note 7). The
Company continues to actively pursue the raising of additional equity
and debt financing. There can be no assurance, however, that the
Company's operations will be sustained or be profitable in the future,
that adequate sources of financing will be available at all, when
needed or on commercially acceptable terms or that the Company's
product development and marketing efforts will be successful.
Note 2 - 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 adjustments) considered necessary for a fair presentation of
financial results have been included. Operating results for the
quarter ended June 30, 2003 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2003.
There were no material unusual charges or credits to operations during
the recently completed fiscal quarter except as discussed in Note 5.
The balance sheet at December 31, 2002 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.
6
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, 2002 and the Company's Form 8-K filed on August 6, 2003.
Certain operating expenses reported at June 30, 2002 have been
reclassified to conform to the 2003 presentation. The reclassification
had no effect on results of operations. Common stock and loss per
share as previously reported at June 30, 2002 have been adjusted to a
post-reverse split basis.
Accounts payable - Included in accounts payable is a $221,000 note
payable to a vendor with a balance of $185,000 at June 30, 2003. The
note bears interest at 8% and monthly principal and interest payments
of $19,218 are due through April 2004.
Loss per share - Loss per share is computed using the weighted average
number of shares of stock outstanding during the period. Diluted per
share computations are not presented since the effect would be
antidilutive.
Stock-based compensation - The Company measures compensation expense
relative to employee stock-based compensation plans using the
intrinsic value-based method of accounting as prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees". The Company applies the disclosure only provisions of
Statement of Financial Accounting Standards ("SFAS) No. 123,
"Accounting for Stock-based Compensation" and SFAS No. 148,
"Accounting for Stock-based Compensation - Transition and Disclosure".
Note 3 - One-for-Ten Reverse Stock Split:
The Company filed a certificate of amendment to its certificate of
incorporation on April 11, 2003, causing a one-for-ten reverse stock
split of the outstanding shares of the Company common stock effective
on that date. The Company's common stock began trading on a post
reverse split basis on April 21, 2003 under the new trading symbol
"NESO" (previously "NEST"). These financials reflect common stock and
loss per share on a post-split basis.
Note 4 - Second Closing of Financing:
On April 16, 2003, the Company completed the second closing of the
financing transaction with Silver Star Partners I, LLC. Silver Star
purchased an additional 4,013,557 shares (post-reverse stock split)
for $2,000,000. In the first closing on January 15, 2003, Silver Star
purchased 49 million shares of Nestor common stock for $2,300,000
(pre-reverse stock split). Danzell Investment Management, Ltd., in
which William B. Danzell, the Managing Director of Silver Star, serves
as president, has provided investment-related services (including
consulting services) to the Company and has received a fee for
services rendered in an amount equal to 3% of the cash proceeds
generated by the Company in connection with the financing transactions
with Silver Star. Upon completion of the second closing, Silver Star
owned 64.8% of the issued and outstanding shares of Company common
stock. See Form 8-K dated April 9, 2003 for further information.
Note 5 - Contingency:
A significant customer contract in the Rail line of business may be
terminated by the customer prior to its completion as a result of the
Company's recent reorganization and decision to focus on CrossingGuard
systems and services. The Company has accrued $125,000 of estimated
contract termination fees.
Note 6 - Litigation:
During April 2003, the former president of NTS resigned as a member of
the board of directors of the Company. The president's employment with
the Company and NTS terminated. The president has filed a complaint
against the Company and NTS in the Providence Superior Court seeking
severance benefits, including twelve months salary of $180,000, upon
termination. See Form 8-K dated April 9, 2003 for further information.
7
Note 7 - Convertible Note Financing:
On July 31, 2003, the Company entered into a Securities Purchase
Agreement ("Agreement") with Laurus Master Fund, Ltd. ("Laurus").
Pursuant to the Agreement, the Company issued to Laurus a Convertible
Note ("Note") in the principal amount of $2,000,000 that bears
interest at the prime rate plus 1.25% (subject to a floor of 5.25%)
and matures on July 31, 2005. The initial principal payment of $20,000
is due in December 2003 and increases over the term of the loan such
that aggregate principal payments of $950,000 are due in 2004 and
aggregate principal payments of $1,030,000 are due in 2005. The net
proceeds from the Note shall be used for the construction,
installation and maintenance of the Company's traffic surveillance
systems. The Note may be repaid, at the Company's option, in cash or,
subject to certain limitations, through the issuance of shares of the
Company's common stock. The Company has an option to pay the monthly
amortized amount in shares at the fixed conversion price of $1.55 per
share after the shares are registered with the Securities and Exchange
Commission for public resale if the then current market price is above
120% of the fixed conversion price. The Note includes a right of
conversion in favor of Laurus. If Laurus exercises its conversion
right at any time or from time to time at or prior to maturity, the
Note will be convertible into shares of the Company's common stock at
a fixed conversion price, subject to adjustments for stock splits,
combinations and dividends and for shares of common stock issued for
less than the fixed conversion price (unless exempted pursuant to the
Agreement). The Company has the option of redeeming for cash any
outstanding principal by paying 115% of such amount plus accrued but
unpaid interest.
The note is collateralized by a first lien on all available
CrossingGuard, Inc. assets. Laurus has a general security interest in
four customer contracts assigned by NTS to CrossingGuard, Inc. and NTS
has pledged the common stock of CrossingGuard, Inc. In connection with
financing, Laurus was paid a fee of $80,000, had certain of its
expenses reimbursed and received a warrant to purchase 140,000 shares
of the Company's common stock. The warrant exercise price is as
follows: $1.78 per share for the purchase of up to 83,000 shares;
$1.94 per share for the purchase of an additional 33,000 shares; and
$2.25 per share for the purchase of an additional 24,000 shares. The
warrant exercise price may be paid in cash, in shares of the Company's
common stock (if the fair market value of a single share of common
stock exceeds the value of the per share warrant exercise price), or
by a combination of both. The warrant expiration date is July 31,
2008.
Also in connection with financing, Management Services Group/Sage
Investments, Inc. ("Sage") was paid a fee of $80,000 and will receive
$4,444 per month for nine months for continuing consultation. Sage
will receive options to purchase 14,000 shares of Company stock as
follows: $1.78 per share for the purchase of up to 8,300 shares; $1.94
per share for the purchase of an additional 3,300 shares; and $2.25
per share for the purchase of an additional 2,400 shares. The option
expiration date is July 31, 2008.
Note 8 - Stock Options:
The Company applies the disclosure only provisions of SFAS No. 123,
"Accounting for Stock-based Compensation" and SFAS No. 148,
"Accounting for Stock-based Compensation - Transition and Disclosure".
Had compensation cost for the Company's stock options been determined
in accordance with the fair value-based method prescribed under SFAS
123, the Company's net loss and loss per share would have approximated
the following pro forma amounts:
Quarter Six Months
Ended Ended
June 30, 2003 June 30, 2003
------------- -------------
Net loss, as reported $(1,178,598) $(2,223,945)
Add: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects (14,598) (28,095)
----------- ------------
Pro forma net loss $(1,193,196) $(2,252,040)
Pro forma net loss per share:
Basic and diluted $ (.09) $ ( .19)
8
The fair value of stock options used to compute pro forma net loss and
net loss per share disclosures was estimated on the date of grant
using the Black-Scholes option-pricing model with the following
assumptions: dividend yield of 0%; expected volatility of 1.059; a
risk-fee interest rate of 3.97%; and an expected option holding period
of 8 years.
9
Item 2 Management's Discussion and Analysis of
Results of Operations and Financial Condition
- ------------------------------------------------------
PROSPECTIVE STATEMENTS
As discussed in detail in the Company's December 31, 2002 Form 10-K, significant
operating changes took place in 2001 and 2002. The Company changed its operating
focus from financial services (related royalty revenues ended June 2002) to
intelligent traffic management products and services, primarily red-light
enforcement systems and services. In June 2002, the Company underwent a
significant restructuring involving management changes and cost control to lower
personnel and facilities expenses as efforts were focused on its contracts for
CrossingGuard installation.
The following discussion contains prospective statements regarding Nestor, Inc.
and its subsidiaries, its business outlook and results of operations that
constitute forward-looking statements within the meaning of Section 21E of the
Securities Exchange Act of 1934 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 forward-looking statements. Factors that may affect
the Company's prospects include, without limitation: the Company's limited
liquidity, the Company's ability to finance delivery of current contracts, the
Company's ability to successfully realize new contracts; 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, during 2002 as the Company
provided certain of its products to customers under licenses with no significant
continuing obligations, it recognized 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 forward-looking
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, 2002 Form 10-K
and Form 8-K filed on August 6, 2003.
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 2 to the December 31, 2002
10
Form 10-K). The Company believes that of its significant accounting policies,
the following may involve a higher degree of judgment and complexity.
Unbilled contract revenue
Unbilled contract revenue represents revenue earned by the Company in advance of
being billable under customer contract terms. Under the terms of some current
contracts, the Company cannot bill the municipality until the court has
collected the citation fine. Management records unbilled contract revenue in
these situations at a net amount, based upon a historical pattern of collections
by the courts for the municipalities. The pattern of collections on these
citations is continually reviewed and updated by management.
Revenue Recognition
Revenue is derived mainly from the lease of products which incorporate NTS's
software and the delivery of services based upon such products. Product license
and service fees include software licenses and processing service fees tied to
citations issued to red-light violators. NTS provides equipment (either under
sales or operating lease agreements), postcontract customer processing and
support services, and engineering services. In arrangements that include
multiple elements, some of which include software, the total arrangement fee is
allocated among each deliverable based on the relative fair value of each of the
deliverables determined based on vendor-specific objective evidence. 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.
Long Term 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.
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 March 14, 2003. 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 $706,000 at June 30,
2003, as compared with $309,000 at December 31, 2002. At June 30, 2003, the
Company had a working capital deficit of $705,000 as compared with a working
capital deficit of $1,572,000 at December 31, 2002.
The Company's net worth at June 30, 2003 was $5,696,000, as compared with a net
worth of $3,865,000 at December 31, 2002. The increase in net worth is primarily
the result of the Silver Star equity transactions, offset by the net operating
loss reported for the period.
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
11
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 Company is actively pursuing the raising of additional equity, debt or lease
financing. 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.
Future Commitments
During the six months ended June 30, 2003, the Company invested $1,069,000 in
capitalized systems as compared to $844,000 in the same period last year.
Management expects that NTS will continue to make future commitments for
capitalized systems related to its CrossingGuard contracts.
RESULTS OF OPERATIONS
The January through June 2002 reported operations included ACI royalty revenues
and significantly higher operating expenses than experienced after the June 2002
restructuring to lower ongoing personnel and facilities costs. Effective July 1,
2002, the Company assigned its ACI royalty rights to Churchill Lane Associates.
For the quarter ended June 30, 2003, the Company realized consolidated revenues
totaling $443,000 and expenses of $1,534,000, which resulted in a consolidated
operating loss for the quarter of $1,091,000. The Company reported a
consolidated net loss of $1,179,000 for the current quarter after other net
expense of $88,000. In the corresponding quarter of the prior year, consolidated
revenues and expenses totaled $769,000 and $6,722,000, respectively, producing a
loss from operations of $5,953,000; and after other net expenses of $174,000,
the Company reported a net loss of $6,127,000.
For the six-month period ended June 30, 2003, the Company realized consolidated
revenues totaling $790,000 and expenses of $2,898,000, which resulted in a
consolidated operating loss for the six-month period of $2,108,000. The Company
reported a consolidated net loss of $2,224,000 for the six-month period after
other net expenses of $116,000. In the corresponding six-month period of the
prior year, consolidated revenues and expenses totaled $1,606,000 and
$9,486,000, respectively, producing a loss from operations of $7,880,000; and
after other net expenses of $255,000 the Company reported net a net loss of
$8,135,000.
Revenues
- --------
The Company's consolidated revenues arose (i) through NTS services, software
licensing, equipment leasing, and support activities regarding its CrossingGuard
and other traffic management products, and, to a lesser degree (ii) directly
from licensing of Nestor, Inc.'s technology and products in specific fields of
use (primarily risk management with ACI) or a related royalty stream.
During the quarter ended June 30, 2003, consolidated revenues decreased 42% to
$443,000 from $769,000 in the quarter ended June 30, 2002. During the six months
ended June 30, 2003, consolidated revenues decreased 51% to $790,000 from
$1,606,000 in the prior year. Fiscal 2003 revenues consisted primarily of
traffic related revenues and there were no royalty revenues from ACI.
Product Licenses and Services
During the quarter ended June 30, 2003, revenues from product licenses and
services increased 22% to $438,000 from $360,000 in the corresponding quarter of
the prior year. During the six-months ended June 30, 2003, revenues from product
license and services decreased 19% to $762,000 from $943,000 for the comparable
period of the prior year. Included in 2002 revenues was $407,000 realized from
Rail projects substantially completed during the first quarter and $165,000 of
TrafficVision revenues earned in April 2002. In 2003, CrossingGuard
installations contributed the substantially all of the revenue.
12
Operating Expenses
- ------------------
Total operating expenses amounted to $1,534,000 in the quarter ended June 30,
2003, a decrease of $5,188,000 (77%) from total operating costs of $6,722,000 in
the corresponding quarter of the prior year. Operating expenses totaled
$2,899,000 in the six-month period ended June 30, 2003, a decrease of $6,587,000
(69%) from the $9,486,000 reported for the corresponding period of the prior
year. The 2002 operating expenses reflect higher costs than the current post
restructuring level and certain non-recurring reserves.
Cost of Goods Sold
Cost of goods sold (CGS) totaled $284,000 in the 2003 quarter as compared
$463,000 in the prior year. CGS totaled $533,000 in the six-month period ended
June 30, 2003 as compared to $1,140,000 reported for the corresponding period of
the prior year. The 2003 CGS relates to CrossingGuard products while 2002 CGS is
primarily higher cost Rail product deployment, coupled with Electronic Data
Systems monthly minimum processing fees of $35,000 which were significantly
lower in the first quarter of 2003 and then performed internally by NTS
thereafter.
Engineering Services
Costs related to engineering services totaled $746,000 in the quarter ended June
30, 2003, as compared to $443,000 in the corresponding quarter of the prior
year. During the six-months ended June 30, 2003, engineering costs were
$1,418,000 as compared to $849,000 in the prior year. These costs include the
salaries of field and office personnel as well as operating expenses related to
product design, delivery, configuration, maintenance and service. This expense
increased in 2003, as there were more customers to support, requiring some staff
realignments from R&D to assist in the engineering efforts.
Research and Development
Research and development expenses totaled $31,000 in the quarter ended June 30,
2003, as compared with $606,000 in the year-earlier period. During the
six-months ended June 30, 2003, R&D costs were $62,000 as compared to $1,543,000
in the prior year. R&D efforts were significant to rollout Rail and
CrossingGuard products, which occurred in 2002. The Company will continue its
R&D activities on a smaller scale and as deemed necessary. In March 2002,
management took steps to reduce the heavy use of third party contractors to
support development projects.
Selling and Marketing
Selling and marketing costs totaled $102,000 in the quarter ended June 30, 2003,
as compared with $183,000 in the corresponding quarter of the prior year, a
decrease of 44%. During the six-months ended June 30, 2003, selling and
marketing costs were $170,000 as compared to $425,000 in the prior year. The
decrease reflects the reduction in expenses after the June 2002 reorganization.
General and Administrative
General and administrative expenses totaled $372,000 in the quarter ended June
30, 2003, as compared with $490,000 in the corresponding quarter of the prior
year, representing a decrease of 24%. General and administrative expenses
totaled $716,000 in the six-month period ended June 30, 2003, as compared to
$993,000 in the corresponding period of the prior year, representing an decrease
of 28%. The June 2002 reorganization significantly reduced ongoing general and
administrative expenses.
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
13
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.
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 for purposes of performing these analyses.
Based on the decline of the Company's stock price during the second quarter of
2002 however, the fair value was recomputed using the quoted June 30, 2002 stock
price of $.25 (pre-reverse stock split). Such computation resulted in a goodwill
impairment charge of $3,000,000 recorded as an operating expense during the
quarter. The Company continues to monitor goodwill for potential impairment.
Contract Termination Reserve
- ----------------------------
A significant customer contract in the Rail line of business may be terminated
by the customer prior to its completion as a result of the Company's recent
reorganization and decision to focus on CrossingGuard systems and services. The
Company has accrued $125,000 of estimated contract termination fees during the
current quarter.
Other Income (Expense) - Net
- ----------------------------
Other income totaled $37,000 in the quarter ended June 30, 2003, as compared
with other expense of $173,000 in the corresponding quarter of the prior year.
Other income was $9,000 in the six-month period ended June 30, 2003, as compared
to other expense of $255,000 in the corresponding period of the prior year. The
prior year includes EDS interest expense on leases payable of $142,000 for the
quarter and $203,000 for the six months ended June 30, 2002. The EDS lease
agreement was amended on January 10, 2003 to provide a moratorium on NTS'
interest obligations under the lease for the period from July 1, 2002 through
June 30, 2003. Additionally, in April 2003, the Company reached a favorable
settlement agreement in a vendor dispute and recorded $64,000 in other income.
Loss Per Share
- --------------
During the quarter ended June 30, 2003, the Company reported a net loss of
$1,179,000, or ($.08) per share as compared with a net loss of $6,127,000, or
($1.21) per share in the corresponding period of the prior year. During the
quarter ended June 30, 2003, there were outstanding 13,961,000 basic and diluted
shares of common stock as compared with 5,048,000 basic and diluted shares
during the corresponding quarter of the previous year.
During the six months ended June 30, 2003, the Company reported a net loss of
$2,224,000, and ($.19) per share as compared with a net loss of $8,135,000, or
($1.61) per share in the corresponding period of the prior year. During the six
months ended June 30, 2003, there were outstanding 11,954,000 basic and diluted
shares of common stock as compared with 5,048,000 basic and diluted shares
during the corresponding period of the previous year. These financials reflect
common stock and loss per share on a post-split basis. The increase in the
outstanding shares reflects the additional shares issued in connection with the
Silver Star financing in January and April 2003.
14
ITEM 3: Quantative and Qualitative Disclosure of Market Risk
- -------------------------------------------------------------
The Company has long term lease obligations, however the interest rate is fixed.
Therefore, 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 and 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.
As of June 30, 2003, the Company's management evaluated, with the participation
of the Company's President/Chief Executive Officer and Chief Financial Officer,
the effectiveness of the design and operation of the Company's disclosure
controls and procedures. Based on that evaluation, the President/Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures were effective.
No change in the Company's internal Part 2:Other InformationItem 2:Management's
Discussion and Analysis of Results of Operations and Financial Condition control
over financial reporting occurred during the fiscal quarter ended June 30, 2003
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
15
PART 2: OTHER INFORMATION
NESTOR, INC.
FORM 10 Q - June 30, 2003
Item 1: Legal Proceedings
During April 2003, the former president of NTS resigned as a member of
the board of directors of the Company. The president's employment with
the Company and NTS terminated. The president has filed a complaint
against the Company and NTS in the Providence Superior Court seeking
severance benefits, including twelve months salary of $180,000, upon
termination. See Form 8-K dated April 9, 2003 for further information.
Item 2: Changes in Securities
(a) One-for-Ten Reverse Stock Split
The Company filed a certificate of amendment to its certificate
of incorporation on April 11, 2003, causing a one-for-ten reverse
stock split of the outstanding shares of the Company common stock
effective on that date. The Company's common stock began trading
on a post reverse split basis on April 21, 2003 under the new
trading symbol "NESO" (previously "NEST").
(c) Sale of Securities
On January 15, 2003, the Company completed the first closing of
the financing transaction with Silver Star Partners I, LLC, and
issued 49,000,000 shares of Nestor common stock (pre-reverse
split) to Silver Star at a purchase price of $.0485 per share. On
April 16, 2003, the Company completed the second closing of the
financing transaction with Silver Star, and issued 4,013,557
shares of common stock (post-reverse split) at a purchase price
of $.485 per share. The Company received $4,323,075 in aggregate
cash proceeds which, after payment of financing fees, will be
used for working capital purposes.
This sale was made without general solicitation or advertising
and no underwriters received fees in connection with this
security sale. The purchaser was an accredited and sophisticated
investor with access to all relevant information necessary to
evaluate the merits and risks of the investment in the
securities. The shares were issued pursuant to exemptions from
registration under Rule 506 of Regulation D and Section 4(2) of
the Securities Act of 1933, as amended, as a transaction not
involving any public offering.
As part of the financing transaction, the Company granted Silver
Star the right to require Nestor to file a registration statement
with the SEC as soon as practicable after Silver Star exercises
its demand registration right. The registration statement will
cover Silver Star's resale of common stock purchased at the first
closing and second closing.
On July 31, 2003, the Company entered into a Securities Purchase
Agreement ("Agreement") with Laurus Master Fund, Ltd. ("Laurus").
Pursuant to the Agreement, the Company issued to Laurus a
Convertible Note ("Note") in the principal amount of $2,000,000
that bears interest at the prime rate plus 1.25% (subject to a
floor of 5.25%) and matures on July 31, 2005. The initial
principal payment of $20,000 is due in December 2003 and
increases over the term of the loan such that aggregate principal
payments of $950,000 are due in 2004 and aggregate principal
16
payments of $1,030,000 are due in 2005. The net proceeds from the
Note shall be used for the construction, installation and
maintenance of the Company's traffic surveillance systems. The
Note may be repaid, at the Company's option, in cash or, subject
to certain limitations, through the issuance of shares of the
Company's common stock. The Company will have an option to pay
the monthly amortized amount in shares at the fixed conversion
price of $1.55 per share after the shares are registered with the
Securities and Exchange Commission for public resale and if the
then current market price is above 120% of the fixed conversion
price. The Note includes a right of conversion in favor of
Laurus. If Laurus exercises its conversion right at any time or
from time to time at or prior to maturity, the Note will be
convertible into shares of the Company's common stock at a fixed
conversion price, subject to adjustments for stock splits,
combinations and dividends and for shares of common stock issued
for less than the fixed conversion price (unless exempted
pursuant to the Agreement). The Company has the option of
redeeming for cash any outstanding principal by paying 115% of
such amount plus accrued but unpaid interest.
This sale was made without general solicitation or advertising
and no underwriters received fees in connection with this
security sale. The purchaser was an accredited and sophisticated
investor with access to all relevant information necessary to
evaluate the merits and risks of the investment in the
securities. The shares were issued pursuant to exemptions from
registration under Rule 506 of Regulation D and Section 4(2) of
the Securities Act of 1933, as amended, as a transaction not
involving any public offering.
Item 3: Defaults on Senior Securities - None
Item 4: Submission of Matters to a Vote of Security Holders
The Registrant's annual meeting of stockholders was held on June 26,
2003. The matter voted upon at such meeting and the number of shares
cast for or against are as follows:
1. Election of Directors For Against
--------------------- --- -------
William Danzell 12,508,321 2,393
David Jordan 12,508,564 2,150
Robert Krasne 12,508,564 2,150
Stephen Marbut 12,508,564 2,150
David Polak 12,508,564 2,150
No abstentions or broker non-votes were recorded on the election of
directors.
Item 5: Other Information
On June 26, 2003, David Polak, by letter, resigned from the Company's
Board of Directors.
Item 6: Exhibits and reports on Form 8-K
(b) Exhibits
Exhibit Number Description
-------------- -----------
3.1 Amended and Restated Certificate of Incorporation
of Nestor, Inc.
3.2 Amended By-laws of Nestor, Inc.
31 Rule 13a-14(a)/15d-14(a) Certifications
32 Section 1350 Certification
17
(c) On April 21, 2003, the Corporation filed with the Securities and
Exchange Commission a current report on Form 8-K dated April 9,
2003, which is hereby incorporated by reference.
On August 6, 2003, the Corporation filed with the Securities and
Exchange Commission a current report on Form 8-K dated August 5,
2003, 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)
By: /s/ William B. Danzell
--------------------------------------
William B. Danzell
President and Chief Executive Officer
DATE: August 13, 2003 By: /s/ Nigel P. Hebborn
--------------------------------------
Nigel P. Hebborn
Treasurer and Chief Financial Officer
19
EXHIBIT INDEX
-------------
Exhibit Number Description
-------------- -----------
3.1 Amended and Restated Certificate of Incorporation
of Nestor, Inc.
3.2 Amended By-laws of Nestor, Inc.
31 Rule 13a-14(a)/15d-14(a) Certifications
32 Section 1350 Certification
20