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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, 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.
(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
---------- ----------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act.)
Yes No X
---------- ----------
Common stock, par value .01 per share: 13,942,238 shares
outstanding as of September 30, 2003
1
NESTOR, INC.
FORM 10 Q
September 30, 2003
INDEX
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Page Number
-----------
PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets
September 30, 2003 (Unaudited) and December 31, 2002 3
----------------------------------------------------
Condensed Consolidated Statements of Operations (Unaudited)
Quarters and nine months ended September 30, 2003 and 2002 4
----------------------------------------------------------
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 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 17
2
NESTOR, INC.
Condensed Consolidated Balance Sheets
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 647,289 $ 308,894
Accounts receivable 512,492 141,263
Unbilled contract revenue 186,785 122,684
Inventory 457,148 281,108
Other current assets 234,785 60,963
--------------- -------------
Total current assets 2,038,499 914,912
NONCURRENT ASSETS:
Capitalized system costs, net of accumulated depreciation 3,384,127 1,936,783
Property and equipment, net of accumulated depreciation 392,580 486,740
Goodwill 5,580,684 5,580,684
Patent development costs, net of accumulated amortization 180,516 153,275
Other long term assets 126,612 128,570
--------------- -------------
TOTAL ASSETS $ 11,703,018 $ 9,200,964
=============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 463,639 $ 616,878
Accrued employee compensation 469,350 354,269
Accrued liabilities 639,755 795,749
Deferred income 75,000 ---
Note payable, net 608,010 ---
Leases payable 703,338 354,286
Restructuring reserve 238,521 365,939
--------------- -------------
Total current liabilities 3,197,613 2,487,121
Long term note payable, net 1,260,008 ---
Long term leases payable 2,438,919 2,849,126
--------------- -------------
Total noncurrent liabilities 3,698,927 2,849,126
--------------- -------------
TOTAL LIABILITIES 6,896,540 5,336,247
--------------- -------------
Commitments and contingencies --- ---
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value, authorized 10,000,000 shares;
issued and outstanding: Series B - 190,000 shares at
September 30, 2003 and 235,000 shares at December 31, 2002 190,000 235,000
Common stock, $.01 par value, authorized 20,000,000 shares;
issued and outstanding: 13,942,238 shares at September 30, 2003
and 5,024,111 shares at December 31, 2002 139,422 50,241
Warrants 1,254,728 1,072,825
Additional paid-in capital 49,242,005 45,227,851
Accumulated deficit (46,019,677) (42,721,200)
---------------- -------------
Total stockholders' equity 4,806,478 3,864,717
--------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 11,703,018 $ 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 Sept. 30, Nine Months Ended Sept. 30,
------------------------------- ----------------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues:
Product royalties $ --- $ 925 $ 28,455 $ 664,401
Product license and services 793,004 180,150 1,554,809 1,123,151
------------- ------------- ------------- -------------
Total revenues 793,004 181,075 1,583,264 1,787,552
------------- ------------- ------------- -------------
Operating expenses:
Cost of goods sold 317,037 239,212 850,744 1,379,208
Engineering services 740,668 625,763 2,158,750 1,474,406
Research and development 30,440 30,252 92,108 1,572,893
Selling and marketing expenses 97,908 93,154 267,449 518,416
General and administrative expenses 529,275 299,662 1,244,969 1,292,930
Restructuring costs --- --- --- 742,705
Capitalized system costs impairment --- --- --- 794,281
Goodwill impairment --- 5,500,000 --- 8,500,000
------------- ------------- ------------- -------------
Total operating expenses 1,715,328 6,788,043 4,614,020 16,274,839
------------- ------------- ------------- -------------
Loss from operations (922,324) (6,606,968) (3,030,756) (14,487,287)
Gain on royalty assignment --- 2,811,590 --- 2,811,590
Contract termination reserve --- --- (125,000) ---
Other expense - net (152,208) (41,803) (142,721) (296,980)
-------------- -------------- -------------- --------------
Net loss $ (1,074,532) $ (3,837,181) $ (3,298,477) $ (11,972,677)
============== ============== ============== ==============
Loss per Share:
Loss per share, basic and diluted $ (0.08) $ (0.76) $ (0.26) $ (2.37)
============== ============== ============== ==============
Shares used in computing loss per share:
Basic and diluted 13,961,238 5,047,611 12,623,363 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)
Nine Months Ended September 30,
-------------------------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net loss $ (3,298,477) $ (11,972,677)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 604,832 443,227
Loss on disposal of fixed assets 5,291 14,688
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 93,061 79,862
Increase (decrease) in cash arising from
changes in assets and liabilities:
Restricted cash --- 191,830
Accounts receivable (371,229) 68,581
Unbilled contract revenue (64,101) 77,807
Inventory (171,706) (141,866)
Other assets (158,666) 162,122
Accounts payable and accrued expenses (194,152) 409,022
Deferred income 75,000 (260,805)
Restructuring reserve (127,418) 608,540
-------------- ---------------
Net cash used by operating activities (3,607,565) (3,836,978)
-------------- ----------------
Cash flows from investing activities:
Proceeds from royalty assignment - net --- 3,040,100
Investment in capitalized systems (1,869,763) (842,767)
Purchase of property and equipment (54,000) (47,849)
Proceeds from sale of property and equipment --- 11,600
Patent developments costs (33,119) (18,676)
-------------- ----------------
Net cash used by investing activities (1,956,882) 2,142,408
-------------- ---------------
Cash flows from financing activities:
Repayment of obligations under capital leases (99,155) (36,766)
Proceeds from note payable 2,000,000 ---
Proceeds from leases payable --- 530,530
Proceeds from issuance of common stock - net 4,001,997 ---
------------- ---------------
Net cash provided by financing activities 5,902,842 493,764
------------- ---------------
Net change in cash and cash equivalents 338,395 (1,200,806)
Cash and cash equivalents - beginning of period 308,894 2,294,987
------------- ---------------
Cash and cash equivalents - end of period $ 647,289 $ 1,094,181
============= ===============
Supplemental cash flows information
Interest paid $ 84,172 $ 136,013
============= ===============
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)
September 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 4. 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 prior non-traffic
related lines of business.
B. Liquidity and management's plans
The Company has incurred significant losses to date and at September
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 October 15, 2003, the Company raised $2,000,000 through the
issuance of a convertible note to Silver Star Partners I, LLC (see
Note 5). The Company continues to actively seek additional sources of
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 September 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 3.
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 Current Report on Form 8-K filed
on October 17, 2003.
Common stock and loss per share as previously reported at September
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 $131,012 at September 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 - 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 the Company's Current Report on Form 8-K dated April
9, 2003 for further information. The Company is discussing possible
settlement offers and, accordingly, recorded an accrual for estimated
costs, if any, within accrued employee compensation during the quarter
ended September 30, 2003.
Note 4 - Laurus 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
the 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
7
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.
The Black-Scholes value of the warrants and options issued in
connection with this financing totaled $143,980 and $14,398,
respectively, and were recorded as additional paid-in capital. The
warrant value was recorded as a discount on the note payable. During
the quarter ended September 30, 2003, the Company amortized $11,998 of
the discount as interest expense. The remaining unamortized discount
of $131,982 at September 30, 2003 is a reduction to the note payable.
The warrants and options have not been exercised as of September 30,
2003.
Note 5 - Silver Star Convertible Note Financing:
On October 15, 2003, the Company sold a $2,000,000 convertible note
(the "Note") to Silver Star Partners I, LLC ("Silver Star"). William
B. Danzell is the Chief Executive Officer of Nestor, Inc., the
President of Danzell Investment Management Ltd. and the Managing
Director of Silver Star. The note is due on January 15, 2004 and bears
interest at the rate of 7% per year. The Company's obligations under
the note may, at the Company's option, be satisfied, in whole or part,
by issuing shares of the Company's common stock, par value $.01
("Common Stock") to Silver Star. If the Company chooses to satisfy any
of its obligations under the note by issuing shares of Common Stock,
the conversion price will be the price to broker-dealers acting as
underwriters or placement agents in the first registered public
offering of such shares made after October 15, 2003 or, if no such
offering is made before the maturity date of the Note, then the 20 day
moving average closing price of the Common Stock during the first
thirty day period starting on or after November 1, 2003 during which,
in the Company's reasonable judgment, all material information about
the Company has been publicly available less a 20% discount. The
conversion price is subject to adjustment for stock splits, reverse
stock splits or stock dividends.
Silver Star owns 63.9% of the outstanding shares of Common Stock.
Silver Star has the right to require the Company to register with the
SEC Silver Star's resale of all shares of Common Stock that it owns,
including any Common Stock issued in satisfaction of the Company's
obligations under the Note as soon as practicable after Silver Star
requests that registration. The Company is obligated to pay all
expenses associated with that registration. The Company has other
obligations in connection with that registration, including causing
the registration statement filed to remain continuously effective
until the distribution of shares covered by the registration statement
is complete and indemnifying Silver Star from liabilities it may incur
resulting from any untrue statement or omission of a material fact in
the registration statement and related documents and from other
liabilities related to the registration. Danzell Investment
Management, Ltd. will receive a 3% finders fee, to be paid by the
Company, in connection with the sale of the Note by the Company.
Note 6 - 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:
8
Quarter Ended Nine Months Ended
September 30, 2003 September 30, 2003
------------------ ------------------
Net loss, as reported $ (1,074,532) $ (3,298,477)
Add: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (14,210) (42,305)
------------- --------------
Pro forma net loss $ (1,088,742) $ (3,340,782)
Pro forma net loss per share
Basic and diluted $ (.08) $ (.26)
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.
Note 7 - Contract Termination Reserve:
A significant customer contract in the Rail line of business may be
terminated prior to its completion as a result of the Company's
decision to focus its resources on CrossingGuard systems and services.
The Company accrued $125,000 of estimated contract termination fees
during the quarter ended June 30, 2003.
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 Annual Report on 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 and 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 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; the Company's ability to protect its
intellectual property; 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 Annual Report on Form 10-K
for the year ended December 31, 2002 and Current Reports on Form 8-K filed on
August 6, 2003, September 2, 2003, October 17, 2003 and October 28, 2003.
10
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 Company's Annual
Report on Form 10-K for the year ended December 31, 2002). 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 Annual
Report on 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 Annual Report on 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 $647,000 at September
30, 2003, as compared with $309,000 at December 31, 2002. At September 30, 2003,
the Company had a working capital deficit of $1,159,000 as compared with a
working capital deficit of $1,572,000 at December 31, 2002.
11
The Company's net worth at September 30, 2003 was $4,806,000, 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
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.
In addition to the $2,000,000 Silver Star Partners I, LLC convertible note
financing secured on October 15, 2003, 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 nine months ended September 30, 2003, the Company invested $1,870,000
in capitalized systems as compared to $843,000 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 royalty revenues from
Applied Communications, Inc. ("ACI") and significantly higher operating expenses
than those experienced after the June 2002 restructuring, which lowered ongoing
personnel and facilities costs. Effective July 1, 2002, the Company assigned its
ACI royalty rights to Churchill Lane Associates.
For the quarter ended September 30, 2003, the Company realized consolidated
revenues totaling $793,000 and expenses of $1,715,000, which resulted in a
consolidated operating loss for the quarter of $922,000. The Company reported a
consolidated net loss of $1,075,000 for the quarter ended September 30, 2003
after other net expense of $153,000. In the corresponding quarter of the prior
year, consolidated revenues and expenses totaled $181,000 and $6,788,000,
respectively, producing a loss from operations of $6,607,000; and after gain
from royalty assignment and other net expenses of $2,812,000 and $42,000
respectively, the Company reported a net loss of $3,837,000.
For the nine-month period ended September 30, 2003, the Company realized
consolidated revenues totaling $1,583,000 and expenses of $4,614,000, which
resulted in a consolidated operating loss for the nine-month period of
$3,031,000. The Company reported a consolidated net loss of $3,298,000 for the
nine-month period after a contract termination reserve and other net expenses of
$125,000 and $142,000 respectively. In the corresponding nine-month period of
the prior year, consolidated revenues and expenses totaled $1,788,000 and
$16,275,000, respectively, producing a loss from operations of $14,487,000; and
after gain on royalty assignment and other net expenses of $2,812,000 and
$297,000, respectively, the Company reported net a net loss of $11,973,000.
Revenues
In 2002, 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. Substantially all of 2003 revenue is from CrossingGuard products and
there were no royalty revenues from ACI
12
During the quarter ended September 30, 2003, consolidated revenues increased
338% to $793,000 from $181,000 in the quarter ended September 30, 2002. During
the nine months ended September 30, 2003, consolidated revenues decreased 11% to
$1,583,000 from $1,788,000 in the corresponding months of the prior year.
Product Licenses and Services
During the quarter ended September 30, 2003, revenues from product licenses and
services increased 338% to $793,000 from $180,000 in the corresponding quarter
of the prior year. During the nine-months ended September 30, 2003, revenues
from product license and services increased 38% to $1,555,000 from $1,123,000
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 substantially all of the revenue.
Operating Expenses
Total operating expenses amounted to $1,715,000 in the quarter ended September
30, 2003, a decrease of $5,073,000 (75%) from total operating costs of
$6,788,000 in the corresponding quarter of the prior year. Operating expenses
totaled $4,614,000 in the nine-month period ended September 30, 2003, a decrease
of $11,661,000 (72%) from the $16,275,000 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 $317,000 in the 2003 quarter as compared
$239,000 in the prior year, an increase of 33%. CGS totaled $851,000 in the
nine-month period ended September 30, 2003 as compared to $1,379,000 reported
for the corresponding period of the prior year, a decrease of 38%. 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 $741,000 in the quarter ended
September 30, 2003, an 18% increase as compared to $626,000 in the corresponding
quarter of the prior year. During the nine-months ended September 30, 2003,
engineering costs increased 46% to $2,159,000 from $1,474,000 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 $30,000 in both the quarter ended
September 30, 2003 and in the year-earlier period. During the nine-months ended
September 30, 2003, R&D costs were $92,000 as compared to $1,573,000 in the
prior year. R&D efforts were significant to rollout Rail and CrossingGuard
products, which occurred in 2002. In March 2002, management took steps to reduce
the heavy use of third party contractors to support development projects. The
Company continues its R&D activities on a smaller scale and as deemed necessary.
Selling and Marketing
Selling and marketing costs totaled $98,000 in the quarter ended September 30,
2003, as compared with $93,000 in the corresponding quarter of the prior year,
an increase of 5%. During the nine-months ended September 30, 2003, selling and
marketing costs were $267,000 as compared to $518,000 in the prior year. The 48%
decrease reflects the reduction in expenses after the June 2002 reorganization.
13
General and Administrative
General and administrative expenses totaled $529,000 in the quarter ended
September 30, 2003, as compared with $300,000 in the corresponding quarter of
the prior year, representing an increase of 77%. This increase includes legal
fees incurred as well as estimated settlement costs in connection with
litigation, financing fees related to the July 2003 Laurus note and professional
fees associated with the registration of the underlying Laurus shares. General
and administrative expenses totaled $1,245,000 in the nine-month period ended
September 30, 2003, as compared to $1,293,000 in the corresponding period of the
prior year. The June 2002 reorganization reduced routine 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
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 and third
quarters of 2002 however, the fair value was recomputed using the quoted quarter
end stock prices. Such computations resulted in goodwill impairment charges of
$3,000,000 and $5,500,000 recorded as an operating expense during the respective
2002 quarters. The Company continues to monitor goodwill for potential
impairment.
Gain on Royalty Assignment
On September 30, 2002, the Company entered into an agreement with Churchill Lane
Associates, LLC ("CLA") which assigned CLA certain of the Company's rights to
royalty income under the license agreement between the Company and ACI ("ACI
License"). CLA paid the Company $3.1 million in cash (net of 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.
14
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 decision to
focus its resources on CrossingGuard systems and services. The Company accrued
$125,000 of estimated contract termination fees during the quarter ended June
30, 2003.
Other Expense - Net
Other expense totaled $152,000 in the quarter ended September 30, 2003, as
compared to $42,000 in the corresponding quarter of the prior year. Other
expense was $143,000 in the nine-month period ended September 30, 2003, as
compared to $297,000 in the corresponding period of the prior year. The current
year includes $40,000 of quarter and year to date interest expense associated
with the July 2003 Laurus financing. The prior year includes EDS interest
expense on leases payable of $9,000 for the quarter and $212,000 for the nine
months ended September 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. The current year
includes $84,000 quarter and year to date for interest expense pertaining to the
amended EDS lease obligation. 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 September 30, 2003, the Company reported a net loss of
$1,075,000, or ($.08) per share as compared with a net loss of $3,837,000, or
($.76) per share in the corresponding period of the prior year. During the
quarter ended September 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 nine months ended September 30, 2003, the Company reported a net loss
of $3,298,000, or ($.26) per share as compared with a net loss of $11,973,000,
or ($2.37) per share in the corresponding period of the prior year. During the
nine months ended September 30, 2003, there were outstanding 12,623,000 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.
ITEM 3: Quantative and Qualitative Disclosure of Market Risk
- -------------------------------------------------------------
The Company has long term lease obligations; however the interest rate is fixed.
The Company also has a convertible note payable at prime plus 1.25% through its
July 2005 maturity as well as an October 15, 2003 convertible note payable at a
fixed interest rate. 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 September 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
15
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 September 30,
2003 that has materially affected, or is reasonably likely to materially affect,
the Company's internal control over financial reporting.
16
Part 2: Other Information
-----------------
NESTOR, INC.
FORM 10 Q - September 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 the Company's Current Report on Form 8-K dated April
9, 2003 for further information. The Company is discussing a
settlement offer and, accordingly, recorded an accrual for estimated
costs during the quarter ended September 30, 2003.
On November 6, 2003, the Company filed a complaint in the United
States District Court for Rhode Island against Redflex Traffic Systems
Inc., alleging that Redflex's automated red light enforcement systems
infringe the Company's patent. The Company is seeking to enjoin
Redflex from further infringement and to recover damages.
Item 2: Changes in Securities
(c) Sale of Securities
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 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 the 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.
On October 15, 2003, the Company sold a $2,000,000 convertible note
(the "Note") to Silver Star Partners I, LLC ("Silver Star"). William
B. Danzell is the Chief Executive Officer of Nestor, Inc., the
President of Danzell Investment Management Ltd. and the Managing
Director of Silver Star. The note is due on January 15, 2004 and bears
interest at the rate of 7% per year. The Company's obligations under
the note may, at the Company's option, be satisfied, in whole or part,
by issuing shares of the Company's common stock, par value $.01
("Common Stock") to Silver Star. If the Company chooses to satisfy any
of its obligations under the note by issuing shares of Common Stock,
the conversion price will be the price to broker-dealers acting as
underwriters or placement agents in the first registered public
offering of such shares made after October 15, 2003 or, if no such
offering is made before the maturity date of the Note, then the 20 day
17
moving average closing price of the Common Stock during the first
thirty day period starting on or after November 1, 2003 during which,
in the Company's reasonable judgment, all material information about
the Company has been publicly available less a 20% discount. The
conversion price is subject to adjustment for stock splits, reverse
stock splits or stock dividends.
Silver Star owns 63.9% of the outstanding shares of Common Stock.
Silver Star has the right to require the Company to register with the
SEC Silver Star's resale of all shares of Common Stock that it owns,
including any Common Stock issued in satisfaction of the Company's
obligations under the Note as soon as practicable after Silver Star
requests that registration. The Company is obligated to pay all
expenses associated with that registration. The Company has other
obligations in connection with that registration, including causing
the registration statement filed to remain continuously effective
until the distribution of shares covered by the registration statement
is complete and indemnifying Silver Star from liabilities it may incur
resulting from any untrue statement or omission of a material fact in
the registration statement and related documents and from other
liabilities related to the registration. Danzell Investment
Management, Ltd. will receive a 3% finders fee, to be paid by the
Company, in connection with the sale of the Note by the Company.
Both sales were 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 - None
Item 5: Other Information - None
Item 6: Exhibits and reports on Form 8-K
(a) Exhibits
Exhibit Number Description
-------------- -----------
31 Rule 13a-14(a)/15d-14(a) Certifications
32 Section 1350 Certification
(c) 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.
On September 2, 2003, the Corporation filed with the Securities
and Exchange Commission a current report of Form S-2 dated
September 2, 2003, which is hereby incorporated by reference.
On October 17, 2003, the Corporation filed with the Securities
and Exchange Commission a current report on Form 8-K dated
September 23, 2003, which is hereby incorporated by reference.
On October 28, 2003, the Corporation filed with the Securities
and Exchange Commission a current report on Form 8-K dated
October 22, 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: November 14, 2003 By: /s/ Nigel P. Hebborn
---------------------------------------
Nigel P. Hebborn
Treasurer and Chief Financial Officer
19
EXHIBIT INDEX
Exhibit Number Description
-------------- -----------
31 Rule 13a-14(a)/15d-14(a) Certifications
32 Section 1350 Certification
20