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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 March 31, 2004
[ ] 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
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(State of incorporation) (I.R.S. Employer Identification No.)
400 Massasoit Avenue; Suite 200; East Providence, RI 02914
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(Address of principal executive offices) (Zip Code)
401-434-5522
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(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
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Common stock, par value $.01 per share: 18,016,526 shares outstanding as of
March 31, 2004.
1
NESTOR, INC.
FORM 10 Q
March 31, 2004
INDEX
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Page Number
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PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets 3
-------------------------------------
March 31, 2004 (Unaudited) and December 31, 2003
Condensed Consolidated Statements of Operations (Unaudited) 4
-----------------------------------------------------------
Quarters ended March 31, 2004 and 2003
Condensed Consolidated Statements of Cash Flows (Unaudited) 5
-----------------------------------------------------------
Quarters ended March 31, 2004 and 2003
Notes to Condensed Consolidated Financial Statements 6
----------------------------------------------------
Item 2 Management's Discussion and Analysis of
Results of Operations and Financial Condition 9
Item 3 Quantitative and Qualitative Disclosure of Market Risk 12
Item 4 Controls and Procedures 12
PART 2 OTHER INFORMATION 13
2
NESTOR, INC.
Condensed Consolidated Balance Sheets
-------------------------------------
MARCH 31, 2004 DECEMBER 31, 2003
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,757,669 $ 5,410,123
Marketable equity securities 1,489,225 ---
Accounts receivable, net 524,509 521,872
Unbilled contract revenue 129,929 158,952
Inventory 484,774 442,298
Other current assets 194,647 75,791
------------- -------------
Total current assets 6,580,753 6,609,036
NONCURRENT ASSETS:
Capitalized system costs, net of accumulated depreciation 3,417,329 3,514,908
Property and equipment, net of accumulated depreciation 359,856 385,165
Goodwill 5,580,684 5,580,684
Patent development costs, net of accumulated amortization 175,952 175,216
Other long term assets 77,795 34,425
------------- -------------
TOTAL ASSETS $ 16,192,369 $ 16,299,434
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Note payable $ 577,500 $ 884,750
Accounts payable 314,631 468,289
Accrued employee compensation 349,077 386,652
Accrued liabilities 555,520 765,676
Leases payable 21,648 662,541
Restructuring reserve 82,346 146,897
------------- -------------
Total current liabilities 1,900,722 3,314,805
NONCURRENT LIABILITIES:
Long term note payable 922,500 1,030,000
Long term leases payable 20,489 2,292,384
------------- -------------
Total liabilities 2,843,711 6,637,189
------------- -------------
Commitments and contingencies --- ---
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value, authorized 10,000,000 shares;
issued and outstanding: Series B - 180,000 shares at
March 31, 2004 and 190,000 at December 31, 2003 180,000 190,000
Common stock, $.01 par value, authorized 20,000,000 shares;
issued and outstanding: 18,016,526 shares at March 31, 2004
and 13,997,238 shares at December 31, 2003 180,165 139,972
Warrants 1,350,671 1,377,251
Additional paid-in capital 59,774,465 49,230,803
Stock pending issuance --- 6,335,877
Accumulated deficit (48,136,643) (47,611,658)
-------------- --------------
Total stockholders' equity 13,348,658 9,662,245
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 16,192,369 $ 16,299,434
============= =============
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 March 31,
-------------------------
2004 2003
---- ----
Revenue:
Product royalties $ 24,550 $ 23,250
Product sales, lease and service fees 1,074,782 323,477
------------ ------------
Total revenue 1,099,332 346,727
------------ ------------
Operating expenses:
Cost of goods sold 635,191 328,404
Engineering and operations 765,922 593,260
Research and development 46,557 30,889
Selling and marketing 141,726 67,764
General and administrative 492,715 343,933
------------ ------------
Total operating expenses 2,082,111 1,364,250
------------ ------------
Loss from operations (982,779) (1,017,523)
Gain on debt extinguishment, net 508,124 ---
Other expense - net (50,330) 27,824)
------------ ------------
Net loss $ (524,985) $ (1,045,347)
============ ============
Loss Per Share:
Loss per share, basic and diluted $ (.03) $ (0.10)
============ ============
Shares used in computing loss per share:
Basic and diluted 18,030,526 9,947,611
============ =============
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)
Quarter Ended March 31,
-----------------------
2004 2003
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (524,985) $ (1,045,347)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 409,083 153,894
Loss on disposal of fixed assets --- 5,291
Gain on extinguishment of debt (508,124) ---
Unrealized loss on marketable equity securities 10,775 ---
Expenses charged to operations relating to
options, warrants and capital transactions 26,621 26,621
Increase (decrease) in cash arising from
changes in assets and liabilities:
Accounts receivable - net (2,637) (25,004)
Unbilled contract revenue 29,023 (26,561)
Inventory (45,474) (101,185)
Other assets (101,226) 73,762
Accounts payable and accrued expenses (373,157) (66,494)
Restructuring reserve (64,551) (35,880)
----------- ------------
Net cash used by operating activities (1,144,652) (1,040,903)
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in marketable equity securities (1,500,000) ---
Investment in capitalized systems (246,796) (537,198)
Purchase of property and equipment (32,893) (4,000)
Patent development costs (4,244) (15,602)
----------- ------------
Net cash used by investing activities (1,783,933) (556,800)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of obligations under capital leases (2,258,251) (3,919)
Proceeds from notes payable 98,028 ---
Proceeds from issuance of common stock - net 3,436,354 2,163,601
----------- ------------
Net cash provided by financing activities 1,276,131 2,159,682
----------- ------------
Net change in cash and cash equivalents (1,652,454) 561,979
Cash and cash equivalents - beginning of period 5,410,123 308,894
----------- ------------
Cash and cash equivalents - end of period $ 3,757,669 $ 870,873
=========== ============
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid $ 3,012 $ 444
=========== ============
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)
March 31, 2004
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. 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.
B. Liquidity and management's plans
The Company has incurred significant losses to date and at March 31,
2004 has an accumulated deficit. Management believes that the
significant financing obtained in 2003 and early 2004, the resulting
improved liquidity and current contracts with municipalities will
enable the Company to continue the development and upgrading of its
products and sustain operations through the end of 2004. There can be
no assurance, however, that the Company's operations will be sustained
or be profitable in the future, 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 March 31, 2004 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2004.
There were no material unusual charges or credits to operations during
the recently completed fiscal quarter.
The balance sheet at December 31, 2003 has been derived from the
audited financial statements at that date but does not include all of
the information and footnotes required by generally accepted
accounting principles for complete financial statements.
For further information, refer to the audited consolidated financial
statements and footnotes thereto included in the Registrant Company
and Subsidiaries' annual report on Form 10-K for the year ended
December 31, 2003.
Certain operating expenses reported at March 31, 2003 have been
reclassified to conform to the 2004 presentation. The reclassification
had no effect on results of operations.
Marketable equity securities - The Company's marketable equity
securities consist of investments in closed-end insured municipal and
international bond funds. The securities are classified as "trading
securities" and accordingly are reported at fair value with unrealized
gains and losses included in other income (expense).
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.
6
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 - Private Placement:
The Company sold 2,843,000 shares of its common stock to accredited
investors in private placements conducted during December 2003
(1,596,560 shares), and January 2004 (1,246,440 shares). The shares
were sold at $3.00 per share, with net proceeds to Nestor (after
$682,000 of expenses of the offering) of $2.76 per share totaling
$7,846,680 ($3,440,000 in January 2004). The Securities and Exchange
Commission declared the Registration Statement on Form S-2 (SEC File
No. 333-112359) for the resale of these shares effective on April 23,
2004. The Company has continuing obligations in connection with the
registration, including causing the registration statement filed to
remain continuously effective for two years or, if earlier, until the
sale of shares covered by the registration statement is complete and
indemnifying the holders 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.
Although the proceeds from the initial closing were received in
December 2003, the associated stock certificates were not issued until
January 2004. As such, these shares are classified as "Stock Pending
Issuance" on the balance sheet at December 31, 2003.
Note 4 - Notes Payable:
First Laurus Convertible Note:
On July 31, 2003, the Company entered into a Securities Purchase
Agreement ("the 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. During November
and December 2003, Laurus converted $85,250 of the Note into 55,000
shares of Nestor common stock at $1.55 per share. On January 14, 2004,
the Company satisfied its remaining payment obligations on the Note by
issuing 492,904 shares of its common stock to Laurus at the fixed
conversion price of $1.55 per share and redeeming the remaining
$1,150,750 note balance by a "payment" of $1,340,972, which included
accrued interest and a $172,613 prepayment penalty which was recorded
as a loss on debt extinguishment. This "payment" was netted against
the proceeds from the Second Laurus Convertible Note (see below),
resulting in $98,028 net cash proceeds to the Company.
Second Laurus Convertible Note:
On January 14, 2004, the Company entered into a securities purchase
agreement with Laurus. Pursuant to that agreement, the Company issued
to Laurus a new convertible note in the principal amount of $1,500,000
that bears interest at the prime rate plus 1.25% (subject to a floor
of 5.25% per year) and matures on January 14, 2006. Principal
repayments commence May 2004 with $375,000 due in 2004, $1,012,500 due
in 2005 and $112,500 due in 2006. The net proceeds from the new note
will be used for the construction, installation, and maintenance of
traffic surveillance systems and for other general corporate purposes.
The new note may be repaid at the Company's option, in cash or,
subject to limitations, through the issuance of shares of its common
stock. The Company has an option to pay the monthly amortized amount
in shares of its common stock at the fixed conversion price of $3.50
per share if the shares are registered with the Securities and
Exchange Commission for public resale and the then current market
price is 120% above the fixed conversion price. The Company agreed to
file a registration statement with the Commission to register the
public resale by Laurus of the common stock to be issued upon
conversion of the note and to pay Laurus damages if that registration
statement is not declared effective by the Commission by July 30,
2004. 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 new 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. In
conjunction with this transaction, Management Services Group/Sage
Investments, Inc. is entitled to a fee of $60,000 and an affiliate of
7
Laurus received a management fee of $45,000 and reimbursement of
certain expenses. 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.
Note 5 - Leases Payable:
On June 28, 2001, NTS executed a Master Lease Purchase Agreement with
Electronic Data Systems Corporation ("EDS"), later amended on January
10, 2003, whereby EDS provided lease financing to support installation
of the NTS CrossingGuard product to municipalities under leasing
terms. On January 26, 2004, the Company satisfied its remaining
obligations to EDS by making a payment of $2,178,764. This transaction
resulted in the Company recording a gain on early extinguishment of
debt of $680,737 in January 2004.
Note 6 - Subsequent Event:
The State of Delaware Department of Transportation (DelDOT) executed a
Master Lease Agreement with NTS in February 2004 whereby NTS would
provide lease financing for equipment installed under its
CrossingGuard contract under lease terms offered by GE Capital Public
Finance, Inc. ("GE"). NTS received $240,000 from GE on April 27, 2004
pursuant its Assignment and Security Agreement with GE. NTS retains a
first priority interest in the equipment and assigned its interest in
the DelDOT lease and right to receive rental payments thereunder to
GE.
Note 7 - 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 Ended March 31,
---------------------------
2004 2003
---- ----
Net loss, as reported $(524,985) $(1,045,347)
Add: Total stock-based employee
compensation expense determined
under fair value based method
for all awards, net of related
tax effects (13,095) (13,497)
--------- -----------
Pro forma net loss $(538,080) $(1,058,844)
Pro forma net loss per share:
Basic and diluted $ (0.03) $ (0.11)
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 1.174; a
risk-fee interest rate of 1.58%; and an expected option holding
period of 8 years.
8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
PROSPECTIVE STATEMENTS
The following discussion includes "forward-looking statements" within the
meaning of Section 21E of the Securities and Exchange Act of 1934, and is
subject to the safe harbor created by that section. Forward-looking statements
give our current expectations or forecasts of future events. All statements,
other than statements of historical facts, included or incorporated in this
report regarding our strategy, future operations, financial position, future
revenues, projected costs, prospects, plans and objectives of management are
forward-looking statements. The words "anticipates," "believes," "estimates,"
"expects," "intends," "may," "plans," "projects," "will," "would" and similar
expressions are intended to identify forward-looking statements, although not
all forward-looking statements contain these identifying words. Factors that
could cause results to differ materially from those projected in the
forward-looking statements are set forth in this section and in Exhibit 99.1 to
the Company's Annual Report on Form 10-K for the year ended December 31, 2003.
Readers are cautioned not to place undue reliance on these prospective
statements, which speak only as of the date of this report. The Company
undertakes no obligation to revise any forward-looking statements in order to
reflect events or circumstances that may subsequently arise. Readers are urged
to carefully review and consider the various disclosures made by the Company in
this report and in the Company's other reports filed with the Securities and
Exchange Commission.
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.
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.
EXECUTIVE SUMMARY
The Company primarily operates through Nestor Traffic Systems, Inc. (NTS), a
wholly owned subsidiary. Its leading product is its CrossingGuard video-based
red light enforcement system and services. CrossingGuard is marketed,
maintained, and distributed through direct sales to states and municipalities in
the United States. Our principal competitors concentrate on multiple business
segments however NTS's sole focus is its intelligent traffic violation
enforcement systems.
The following is a summary of key performance measurements monitored by
management:
Quarter Ended March 31,
--------------------------------
2004 2003
---- ----
Financial:
Revenue $ 1,099,000 $ 347,000
Loss from operations 983,000 1,018,000
Net loss 525,000 1,045,000
Working capital (deficit) 4,680,000 (894,000)
Investment in capitalized systems 247,000 537,000
Cash and marketable equity securities 5,246,000 871,000
9
Number of CrossingGuard Approaches:
Installed and operational 91 44
Planned under existing contracts 144 91
------------ ------------
Total installed and planned 235 135
The Company considers following areas to be of highest importance in 2004:
o Improve technology and performance to maximize revenue per approach
o Aggressively market CrossingGuard to states and municipalities
o Identify and develop strategic relationships to jointly offer related
products and services
o Vigorously defend our patented technology from infringement
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Nestor, Inc.'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 Financial
Statements included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2003). 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
direct 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 Company had consolidated cash, cash equivalents and marketable equity
securities of approximately $5,247,000 at March 31, 2004 as compared with
approximately $5,410,000 at December 31, 2003. At March 31, 2004, the Company
had working capital of $4,680,000 as compared with $3,294,000 at December 31,
2003.
10
The Company's net worth at March 31, 2004 was $13,349,000, as compared with a
net worth of $9,662,000 at December 31, 2003. The increase in net worth is
primarily the result of private placement equity transactions and conversion of
the Laurus 2003 Note, both in January 2004, offset by the net operating loss
reported for the quarter.
The Company continues to seek additional sources of equity and debt to be
prepared for the development of new growth opportunities.
Future Commitments
During the quarter ended March 31, 2004, the Company invested $247,000 in
capitalized systems as compared to $537,000 in the same quarter last year.
Management expects that NTS will make future commitments for capitalized systems
related to its CrossingGuard contracts.
RESULTS OF OPERATIONS
For the quarter ended March 31, 2004, the Company realized consolidated revenues
totaling $1,099,000 and expenses of $2,082,000, which resulted in a consolidated
operating loss for the quarter of $983,000. The Company reported a consolidated
net loss of $525,000 for the current quarter after recording a net gain on
extinguishment of debt of $508,000 and $50,000 of other expenses. In the
corresponding quarter of the prior year, consolidated revenues and expenses
totaled $347,000 and $1,364,000, respectively, resulting in a consolidated
operating loss of $1,018,000; and after other expenses of $28,000, the Company
reported a net loss of $1,045,000.
Revenues
- --------
During the quarter ended March 31, 2004, consolidated revenues increased
$752,000 (217%) to $1,099,000 from $347,000 in the quarter ended March 31, 2003.
This increase is primarily attributable to the installed approach base more than
doubling between the two quarters.
Operating Expenses
- ------------------
Total operating expenses amounted to $2,082,000 in the quarter ended March 31,
2004, an increase of $718,000 (53%) from total operating costs of $1,364,000 in
the corresponding quarter of the prior year. The 2004 operating expenses reflect
higher costs required to support the substantial growth of installed approaches
and patent lawsuit defense expenses which began in the fourth quarter of 2003.
Cost of Goods Sold
Cost of goods sold (CGS) totaled $635,000 in the 2004 quarter as compared
$328,000 in the prior year. The $307,000 increase is primarily attributable to
(i) an increase in amortization costs of more installed approaches and (ii) an
increase in internal labor costs to support the additional installed approaches.
Engineering and Operations
Costs related to engineering and operations totaled $766,000 in the quarter
ended March 31, 2004, as compared to $593,000 in the corresponding quarter of
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. The $173,000 expense increase in 2004
resulted from more customers to support, requiring additional staff and
supplies.
Research and Development
Research and development expenses totaled $47,000 in the quarter ended March 31,
2004, as compared with $31,000 in the year-earlier period. The $16,000 increase
is directly attributable to materials purchased in support of research
activities.
11
Selling and Marketing
Selling and marketing costs totaled $142,000 in the quarter ended March 31,
2004, as compared with $68,000 in the corresponding quarter of the prior year.
The $74,000 increase reflects a more aggressive marketing effort, including the
use of consultants in targeted areas.
General and Administrative
General and administrative expenses totaled $493,000 in the quarter ended March
31, 2004, as compared with $344,000 in the corresponding quarter of the prior
year. The $149,000 (43%) increase over last year substantially related to
ongoing patent infringement legal expenses which amounted to $109,000 during the
quarter ending March 31, 2004.
Gain on Debt Extinguishment
- ---------------------------
Obligations to EDS and Laurus (under the July 2003 note) were fully satisfied in
January 2004, resulting in a net gain of $508,000 for the quarter ended March
31, 2004. The early payment to EDS resulted in a gain of $681,000 which was
offset in part by a prepayment penalty of $173,000 incurred in the Laurus
settlement.
Other Expense - Net
- -------------------
Other expenses totaled $50,000 in the quarter ended March 31, 2004, as compared
with $28,000 in the corresponding quarter of the prior year, an increase of
$22,000 (79%). The higher current year amount includes an unrealized loss of
$11,000 on marketable equity security positions and $18,000 of interest expense
on the Laurus notes.
Loss Per Share
- --------------
During the quarter ended March 31, 2004, the Company reported a net loss of
$525,000, or ($.03) per share as compared with a net loss of $1,045,000, or
($.10) per share in the corresponding period of the prior year. During the
quarter ended March 31, 2004, there were outstanding 18,031,000 basic and
diluted shares of common stock as compared with 9,948,000 basic and diluted
shares during the corresponding quarter of the previous year. The increase in
the outstanding shares reflects additional shares issued in April 2003 in
connection with the Silver Star investment and in January 2004 relating to the
Laurus and Silver Star note conversions and the private placement closings.
ITEM 3: QUANTATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The Company's marketable equity securities (primarily insured municipal and
international bond funds), valued at $1,489,225 at March 31, 2004, are exposed
to market risk due to changes in U.S. interest rates and fluctuations in foreign
currency exchange rates. The primary objective of the Company's investment
activities is the preservation of principal while maximizing investment income.
The Company's exposure to this risk is moderately high in the short-term,
although the risk may be able to be managed if the securities are not required
to be sold when a loss will be realized. The securities are classified as
"trading securities" and accordingly are reported at fair value with unrealized
gains and losses included in other income (expense).
The Company also has a convertible note payable at prime plus 1.25% through its
January 2006 maturity. Management assesses the exposure to this risk as
immaterial.
ITEM 4: CONTROLS AND PROCEDURES
Nestor, Inc. management, including the Chief Executive Officer and Chief
Financial Officer, conducted an evaluation of the effectiveness of the design
and operation of the Company's disclosure controls and procedures as defined in
Exchange Act Rule 13a-15(e) and 15d-15(e) as of March 31, 2004. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective as of March
31, 2004. There have been no significant changes in internal controls, or in
factors that could significantly affect internal controls, subsequent to the
date the Chief Executive Officer and Chief Financial Officer completed their
evaluation.
12
PART 2: OTHER INFORMATION
NESTOR, INC.
FORM 10 Q - March 31, 2004
Item 1: Legal Proceedings
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 on the Company's patent. Redflex denies this
allegation. On November 25, 2003, the Company filed a complaint in the
United States District Court for the District of Central California
against Transol USA, Inc., alleging that Transol's automated red light
enforcement systems infringe on the Company's patent. Transol has
counterclaimed that Nestor's patent is invalid and that Transol does
not infringe on it. Nestor was denied a preliminary injunction in the
Transol litigation. The Company cannot give assurance that it will be
successful in either action.
Item 2: Changes in Securities
(c) Sale of Securities
The Company issued 2,843,000 shares of its common stock in
January 2004 in a series of private placements made to accredited
investors, at an aggregate price of $8,529,000. In connection
with those private placements, the Company paid an aggregate
sales commission of $682,320. The shares of common stock were
issued without registration under the Securities Act in reliance
on the exemption provided by Section 4(2) of the Securities Act.
The net proceeds from the placement will be used for the
construction, installation, and maintenance of traffic
surveillance systems and for other general corporate purposes.
The resale of these shares is registered on Registration
Statement on Form S-2 (SEC File No. 333-112359), which was
declared effective on April 23, 2004 by the Securities and
Exchange Commission. The Company has continuing obligations in
connection with the this registration, including causing the
registration statement filed to remain continuously effective for
two years or, if earlier, until the sale of shares covered by the
registration statement is complete and indemnifying the holders
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.
On January 14, 2004, the Company entered into a securities
purchase agreement with Laurus Master Fund Ltd. ("Laurus").
Pursuant to that agreement, the Company issued to Laurus a
convertible note in the principal amount of $1,500,000 that bears
interest at the prime rate plus 1.25% (subject to a floor of
5.25% per year) and matures on January 14, 2006. Principal
repayments commence May 2004 with $375,000 due in 2004,
$1,012,500 due in 2005 and $112,500 due in 2006. The net proceeds
from the note will be used for the construction, installation,
and maintenance of traffic surveillance systems and for other
general corporate purposes. The note may be repaid at the
Company's option, in cash or, subject to limitations, through the
issuance of shares of its common stock. The Company has an option
to pay the monthly amortized amount in shares of its common stock
at the fixed conversion price of $3.50 per share if the shares
are registered with the Securities and Exchange Commission for
public resale and the then current market price is 120% above the
fixed conversion price. The Company agreed to file a registration
statement with the Commission to register the public resale by
Laurus of the common stock to be issued upon conversion of the
note and to pay Laurus damages if that registration statement is
not declared effective by the Commission by July 30, 2004. 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 new 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. The Note was issued without registration under the
Securities Act in reliance on the exemption provided by Section
4(2) of the Securities Act. In conjunction with this transaction,
Sage Investments, Inc. is entitled to a fee of $60,000.
13
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
(b) Exhibits
Exhibit Number Description
31.1 Certification of principal executive officer
pursuant to Rule 13a-14(a)/15d-14(a) of the
Securities Exchange Act of 1934, as amended
31.2 Certification of principal financial officer
pursuant to Rule 13a-14(a)/15d-14(a) of the
Securities Exchange Act of 1934, as amended
32 Statement Pursuant to 18 U.S.C.ss.1350
(c) Reports on Form 8-K
On January 15, 2004, the Corporation filed with the Securities
and Exchange Commission a current report on Form 8-K under items
5 and 7 reporting the Silver Star note conversion, the private
placement of common stock and transactions with Laurus Master
Fund, Ltd., which is hereby incorporated by reference.
On January 28, 2004, the Corporation filed with the Securities
and Exchange Commission a current report on Form 8-K under items
5 and 7 reporting the early extinguishment of EDS debt and the
private placement of common stock, which is hereby incorporated
by reference.
14
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: May 11, 2004 By: /s/ Claire M. Iacobucci
------------------------------------------
Claire M. Iacobucci
Treasurer and Chief Financial Officer
15
EXHIBIT INDEX
Exhibit Number Description
31.1 Certification of principal executive officer pursuant to
Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as amended
31.2 Certification of principal financial officer pursuant to
Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as amended
32 Statement Pursuant to 18 U.S.C.ss.1350
16