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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, 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.
(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
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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
------ ------
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: 18,673,498 shares
outstanding as of November 9, 2004
-1-
NESTOR, INC.
FORM 10 Q
September 30, 2004
INDEX
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Page
Number
------
PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets
-------------------------------------
September 30, 2004 (Unaudited) and December 31, 2003 3
Condensed Consolidated Statements of Operations (Unaudited)
-----------------------------------------------------------
Quarters and nine months ended September 30, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
-----------------------------------------------------------
Nine months ended September 30, 2004 and 2003 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 14
Item 4 Controls and Procedures 15
PART 2 OTHER INFORMATION 16
-2-
NESTOR, INC.
Condensed Consolidated Balance Sheets
-------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,702,862 $ 5,410,123
Marketable equity securities 1,071,887 ---
Accounts receivable, net 800,049 521,872
Unbilled contract revenue 209,729 158,952
Inventory 835,140 442,298
Other current assets 205,955 75,791
------------- -------------
Total current assets 4,825,622 6,609,036
NONCURRENT ASSETS:
Capitalized system costs, net of accumulated depreciation 3,911,749 3,514,908
Property and equipment, net of accumulated depreciation 375,563 385,165
Goodwill 5,580,684 5,580,684
Patent development costs, net of accumulated amortization 167,571 175,216
Other long term assets 62,541 34,425
------------- -------------
TOTAL ASSETS $ 14,923,730 $ 16,299,434
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Note payable $ 817,500 $ 884,750
Accounts payable 725,257 468,289
Accrued employee compensation 416,252 386,652
Accrued liabilities 860,675 745,676
Leases payable 21,648 662,541
Deferred income 91,667 20,000
Restructuring reserve --- 146,897
------------- -------------
Total current liabilities 2,932,999 3,314,805
NONCURRENT LIABILITIES:
Long term note payable 427,500 1,030,000
Long term deferred income 63,889 ---
Long term leases payable 17,159 2,292,384
------------- -------------
Total liabilities 3,441,547 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
September 30, 2004 and 190,000 at December 31, 2003 180,000 190,000
Common stock, $.01 par value, authorized 30,000,000 shares;
issued and outstanding: 18,274,380 shares at September 30, 2004
and 13,997,238 shares at December 31, 2003 182,744 139,972
Warrants 160,015 1,377,251
Additional paid-in capital 61,084,635 49,230,803
Stock pending issuance --- 6,335,877
Accumulated deficit (50,125,211) (47,611,658)
-------------- --------------
Total stockholders' equity 11,482,183 9,662,245
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 14,923,730 $ 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 Sept. 30, Nine Months Ended Sept. 30,
------------------------------- ----------------------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues:
Product royalties $ 6,333 $ --- $ 34,007 $ 28,455
Product sales, lease and service fees 1,826,664 793,004 4,450,293 1,554,809
------------- ------------- ------------- -------------
Total revenues 1,832,997 793,004 4,484,300 1,583,264
------------- ------------- ------------- -------------
Operating expenses:
Cost of goods sold 1,037,375 443,408 2,624,723 1,176,359
Engineering and operations 873,259 614,297 2,464,324 1,833,135
Research and development 32,513 30,440 125,073 92,108
Selling and marketing 190,886 97,908 496,480 267,449
General and administrative 606,466 529,275 1,600,248 1,244,969
------------- ------------- ------------- -------------
Total operating expenses 2,740,499 1,715,328 7,310,848 4,614,020
------------- ------------- ------------- -------------
Loss from operations (907,502) (922,324) (2,826,548) (3,030,756)
Gain on debt extinguishment, net --- --- 508,124 ---
Contract termination reserve --- --- --- (125,000)
Other income/(expense) - net 38,946 (152,208) (195,129) (142,721)
------------- ------------- ------------- -------------
Net loss $ (868,556) $ (1,074,532) $ (2,513,553) $ (3,298,477)
============= ============= ============= =============
Loss per Share:
Loss per share, basic and diluted $ (0.05) $ (0.08) $ (0.14) $ (0.26)
============= ============= ============= =============
Shares used in computing loss per share:
Basic and diluted 18,208,242 13,961,238 18,091,556 12,623,363
============= ============= ============= =============
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,
-------------------------------------------
2004 2003
---- ----
Cash flows from operating activities:
Net loss $ (2,513,553) $ (3,298,477)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 1,331,748 604,832
Loss on disposal of fixed assets 5,378 5,291
Gain on extinguishment of debt (508,124) ---
Realized loss on marketable equity securities 96,367 ---
Unrealized loss on marketable equity securities 5,276 ---
Dividends reinvested (30,289) ---
Expenses charged to operations relating to options,
warrants and capital transactions 62,115 93,061
Increase (decrease) in cash arising from
changes in assets and liabilities:
Accounts receivable, net (278,177) (371,229)
Unbilled contract revenue (50,777) (64,101)
Inventory (400,562) (171,706)
Other assets (97,280) (158,666)
Accounts payable and accrued expenses 429,800 (194,152)
Deferred income 135,556 75,000
Restructuring reserve (146,897) (127,418)
-------------- --------------
Net cash used by operating activities (1,959,419) (3,607,565)
-------------- --------------
Cash flows from investing activities:
Investment in marketable equity securities (1,500,000) ---
Liquidation of marketable securities 356,759 ---
Investment in capitalized systems (1,519,306) (1,869,763)
Purchase of property and equipment (184,061) (54,000)
Patent developments costs (5,633) (33,119)
-------------- --------------
Net cash used by investing activities (2,852,241) (1,956,882)
-------------- --------------
Cash flows from financing activities:
Repayment of obligations under capital leases (2,261,581) (99,155)
Proceeds from note payable 98,028 2,000,000
Repayment of note payable (195,000) ---
Proceeds from issuance of common stock - net 3,462,952 4,001,997
------------- -------------
Net cash provided by financing activities 1,104,399 5,902,842
------------- -------------
Net change in cash and cash equivalents (3,707,261) 338,395
Cash and cash equivalents - beginning of period 5,410,123 308,894
------------- -------------
Cash and cash equivalents - end of period $ 1,702,862 $ 647,289
============= =============
Supplemental cash flows information
Interest paid $ 80,307 $ 84,172
============= =============
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, 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
September 30, 2004 has an accumulated deficit. Management
believes that the significant financing obtained in 2003 and
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 September 30, 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.
Deferred income at December 31, 2003, and certain operating
expenses reported at September 30, 2003 have been reclassified to
conform to the 2004 presentation. The reclassifications 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).
-6-
Deferred income - Certain customer contracts allow the Company to
bill and/or collect payment prior to the performance of services,
resulting in deferred revenue.
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 - Master Lease Agreement:
The State of Delaware Department of Transportation (DelDOT)
executed a Master Lease Agreement with NTS in February 2004
whereby lease financing for equipment installed under this
CrossingGuard contract would be financed under lease terms
offered by GE Capital Public Finance, Inc. ("GE"). Under this
sales-type lease agreement, NTS received $240,000 on April 27,
2004 and another $240,000 on September 17, 2004, from GE on
behalf of DelDOT pursuant to 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 4 - Equity Transactions and Debt Conversions:
During the quarter ended September 30, 2004, all warrants with an
expiration date of August 1, 2004 were exercised on a cashless
basis. This resulted in Company issuing 136,292 shares of its
common stock at conversion prices from $3.98 to $4.28 per share
in exchange for 269,856 warrants with exercise prices from $.49
to $2.65 per share. The Company also reclassified $850,000
related to these warrants and $375,000 related to other expired
warrants from warrants to additional paid-in capital on the
balance sheet.
Additionally during the quarter, Laurus Master Fund, Ltd.
exercised their 140,000 warrants with exercise prices from $1.78
to $2.25 per share on a cashless basis, resulting in the Company
issuing 76,466 shares of its common stock at a conversion price
of $4.18 per share. Laurus also converted $60,000 due on its
convertible note to 17,143 shares of Nestor common stock.
During the period October 6 through November 3, 2004, Laurus
converted their remaining $1,245,000 note balance into 355,714
shares of Nestor common stock.
Note 5 - 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:
-7-
Quarter Ended September 30, Nine Months Ended September 30,
------------------------------ -------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net loss, as reported $ (868,556) $ (1,074,532) $ (2,513,553) $ (3,298,477)
Add: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards, net of related
tax effects (96,800) (14,210) (491,380) (42,305)
----------- ------------- ------------- -------------
Pro forma net loss $ (965,356) $ (1,088,742) $ (3,004,933) $ (3,340,782)
Pro forma net loss per share:
Basic and diluted $ (.05) $ (.08) $ (.17) $ (.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 1.158; a risk-fee interest rate of 1.6-6.8%; and an expected
option holding period of 8 years.
On June 24, 2004, the Company adopted the 2004 Stock Incentive
Plan, which provides for the grant of awards to employees,
officers and directors. Subject to adjustments for changes in the
Company's common stock and other events, the stock plan is
authorized to grant up to 4,500,000 shares, either in the form of
options to purchase Nestor common stock or as restricted stock
awards.
Note 6 - Private Placement of Senior Convertible Notes:
On November 5 and 9, 2004, the Company completed the sale of
$6,000,000 aggregate principal amount of its 5% Senior
Convertible Notes due October 31, 2007 (the "Senior Convertible
Notes") in a private placement. The Senior Convertible Notes are
convertible into Nestor common stock at the option of the
investors at $5.82 per share and accrue interest at 5% per year.
The Company must make quarterly interest-only payments until the
Senior Convertible Notes are either paid in full or are converted
into common stock. At the option of the holders, all amounts due
may be accelerated upon certain events of default, including
failures to pay principal or interest when due, breach of
covenants that remain uncured after notice, bankruptcy of the
Company or certain similar events and defaults under other
material credit arrangements.
The Company may, at its option, redeem the Senior Convertible
Notes in whole or in part, at a redemption price of 105% before
November 1, 2005, 102.5% before November 1, 2006, and 101%
thereafter, plus unpaid interest, upon 30 to 60 days prior
written notice. The Company is obligated to offer to repurchase
the Senior Convertible Notes at the then-current redemption price
in the event of a change in control of the Company or upon the
occurrence certain financing events. In connection with the
Senior Convertible Notes, the Company issued a warrant to a
placement agent for the purchase of 60,000 shares of common stock
at $5.21 per share exercisable through October 31, 2009.
Pursuant to a registration rights agreement between the Company
and the investors, the Company has agreed to file a registration
statement with the SEC registering the resale of the shares of
the Company's common stock underlying the Senior Convertible
Notes. Pursuant to the terms of the warrant, the Company has
agreed to include the resale of the shares of the Company's
common stock underlying the warrant in future registration
statements upon the request of such holder.
8
Note 7 - Litigation:
On July 13, 2004, the Company filed a second lawsuit for patent
infringement against Redflex Traffic Systems, Inc. but
subsequently withdrew this claim without prejudice. In addition,
Nestor amended its pending lawsuit against Transol USA, Inc., to
assert like claims for patent infringement. Original infringement
claims against these Australian-based competitors were filed by
Nestor in November 2003, alleging infringement of Nestor's U.S.
Patent No. 6,188,329 and reported in the Company's Annual Report
on Form 10-K for the year ended December 31, 2003. The additional
lawsuit filed against Redflex, and the amended claims asserted
against Transol, allege infringement of U.S. Patent No.
6,754,663, issued to Nestor on June 22, 2004. The original
lawsuit against Redflex is pending in US District Court, District
of Rhode Island. The lawsuit against Transol is pending in US
District Court, Central District of California. The Company
cannot give assurance that we will be successful in either
action.
9
ITEM 2: Management's Discussion and Analysis of Results of Operations and
Financial Condition
PROSPECTIVE STATEMENTS
The following discussion includes and incorporates "forward-looking statements"
within the meaning of Section 27A of the Securities and Exchange Act of 1933 and
Section 21E of the Securities and Exchange Act of 1934. 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. We cannot
guarantee that we actually will achieve the plans, intentions or expectations
disclosed in our forward-looking statements and you should not place undue
reliance on our forward-looking statements. Actual results or events could
differ materially from the plans, intentions and expectations disclosed in the
forward-looking statements we make. 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.
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. Our forward-looking
statements do not reflect the potential impact of any future acquisitions,
mergers, dispositions, joint ventures or investments we may make. 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 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's quarterly revenues and operating results have varied significantly
in the past due to the timing of new customer contracts and approaches
installed, and the Company expects such 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. In August 2004, NTS entered into a distributorship agreement
with Vitronic Machine Vision Ltd. for exclusive rights to market and sell
PoliScan, a speed enforcement system, throughout the United States, Canada and
Mexico, subject to minimum sales goals.
10
The following is a summary of key performance measurements monitored by
management:
Quarter Ended September 30, Nine Months Ended September 30,
----------------------------- -------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Financial:
Revenue $ 1,833,000 $ 793,000 $ 4,484,000 $ 1,583,000
Loss from operations 908,000 922,000 2,827,000 3,031,000
Net loss 869,000 1,075,000 2,514,000 3,298,000
Additional investment in
capitalized systems 842,000 801,000 1,519,000 1,870,000
Cash and marketable equity securities 2,775,000 647,000
Working capital (deficit) 1,893,000 (1,159,000)
Number of CrossingGuard Approaches*: 102 70
Installed and operational
Planned under existing contracts 127 65
------------ ------------
Total installed and planned 229 135
* At end of period.
The management team focus is to expand the Company's market share in the
emerging traffic safety market: The Company plans to expand that market share
by:
o Continuing to aggressively market CrossingGuard video-based red light
enforcement systems and services to states and municipalities for red
light enforcement and safety
o Implementing a marketing program for PoliScan speed enforcement
systems and services to states and municipalities for speed
enforcement and safety
o Enhancing and seeking patents for our traffic safety technology to
maintain or improve our position and competitive advantages in the
industry
o Vigorously defending our patented technology from competitors'
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.
11
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 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, contract renewal
options 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 totaling $2,775,000 at September 30, 2004 as compared with $5,410,000
at December 31, 2003. At September 30, 2004, the Company had working capital of
$1,893,000 as compared with $3,294,000 at December 31, 2003.
The Company's net worth at September 30, 2004 was $11,482,000, 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 period.
The Company continues to seek additional sources of equity and debt to be
prepared for the development of new growth opportunities. On November 5 and 9,
2004, the Company completed the sale of $6,000,000 aggregate principal amount of
its 5% Senior Convertible Notes due October 31, 2007.
Future Commitments
For the nine months ended September 30, 2004, the Company invested $1,519,000 in
capitalized systems, $348,000 in system costs expensed under sales-type lease
accounting for Delaware approaches, and $233,000 in pre-construction
mobilization (system) costs for Baltimore, as compared to $1,870,000, $0, and $0
in the same period last year. Management expects that NTS will make future
commitments for systems related to its CrossingGuard contracts.
Results of Operations
For the quarter ended September 30, 2004, the Company realized consolidated
revenues totaling $1,833,000 and expenses of $2,740,000, which resulted in a
consolidated operating loss for the quarter of $908,000. The Company reported a
consolidated net loss of $869,000 for the current quarter after recording
$39,000 of other income-net. In the corresponding quarter of the prior year,
consolidated revenues and expenses totaled $793,000 and $1,715,000,
respectively, resulting in net loss of $1,075,000 after application of $153,000
of other expenses.
For the nine month period ended September 30, 2004, the Company realized
consolidated revenues totaling $4,484,000 and expenses of $7,311,000, which
resulted in a consolidated operating loss for the nine month period of
$2,826,000. The Company reported a consolidated net loss of $2,514,000 for the
12
nine month period after gain on extinguishment of debt of $508,000 and other net
expenses of $195,000. In the corresponding nine month period of the prior year,
consolidated revenues and expenses totaled $1,583,000 and $4,614,000,
respectively, producing a loss from operations of $3,031,000, and after contract
termination reserve of $125,000 and other net expense of $142,000, the Company
reported a net loss of $3,298,000.
Revenues
- --------
During the quarter ended September 30, 2004, consolidated revenues increased
$1,040,000 (131%) to $1,833,000 from $793,000 in the quarter ended September 30,
2003. This increase is attributable to the installed approach base increasing
46% between the two quarters, the commencement of revenues under our agreement
with ACS for the City of Baltimore and $240,000 recorded under sales-type lease
accounting for Delaware approaches installed during the current quarter. During
the nine months ended September 30, 2004, consolidated revenues increased 183%
to $4,484,000 from $1,583,000 in the prior year. This increase is largely
attributable to revenue generated as a result of our agreement with ACS for the
Baltimore agreement, our sales-type lease arrangement with Delaware and a marked
increase in the installed approach base.
Operating Expenses
- ------------------
Total operating expenses amounted to $2,740,000 in the quarter ended September
30, 2004, an increase of $1,025,000 (60%) from total operating costs of
$1,715,000 in the corresponding quarter of the prior year. Operating expenses
totaled $7,311,000 in the nine month period ended September 30, 2004, an
increase of $2,697,000 (58%) from the $4,614,000 reported for the corresponding
period 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 $1,037,000 in the quarter ended September 30,
2004 as compared to $443,000 in the prior year quarter. CGS totaled $2,625,000
in the nine month period ended September 30, 2004 as compared to $1,176,000
reported for the corresponding period of the prior year. The 2004 CGS reflects
higher amortization and direct support costs resulting from the increase in
installed approaches, costs associated with ACS revenue recognized in the
current quarter and the cost of Delaware systems installed under sales-type
lease accounting.
Engineering and Operations
Costs related to engineering and operations totaled $873,000 in the quarter
ended September 30, 2004, as compared to $614,000 in the corresponding quarter
of the prior year. During the nine months ended September 30, 2004, engineering
costs were $2,464,000 as compared to $1,833,000 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 2004, as there were more customers and installations
to support.
Research and Development
Research and development expenses totaled $33,000 in the quarter ended September
30, 2004, as compared with $30,000 in the year-earlier period. During the nine
months ended September 30, 2004, research and development costs were $125,000 as
compared to $92,000 in the prior year. The cost increase is directly
attributable to materials purchased in support of on-going research activities.
Selling and Marketing
Selling and marketing costs totaled $191,000 in the quarter ended September 30,
2004, as compared with $98,000 in the corresponding quarter of the prior year.
During the nine months ended September 30, 2004, selling and marketing costs
were $496,000 as compared to $267,000 in the prior year. The increase reflects a
more aggressive marketing effort, including the cost associated with building a
sales force, and use of consultants in targeted areas.
13
General and Administrative
General and administrative expenses totaled $606,000 in the quarter ended
September 30, 2004, as compared with $529,000 in the corresponding quarter of
the prior year. The $77,000 increase over last year substantially related to
ongoing patent infringement legal expenses, which amounted to $128,000 during
the current quarter, offset by reductions in other administrative expenses.
General and administrative expenses totaled $1,600,000 in the nine month period
ended September 30, 2004, as compared to $1,245,000 in the corresponding period
of the prior year. The $355,000 increase over last year again substantially
reflects costs of ongoing patent infringement legal expenses, which were
$344,000 for the nine months ending September 30, 2004.
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 2002
reorganization and decision to focus on CrossingGuard systems and services. The
Company accrued $125,000 of estimated contract termination fees for the quarter
ended June 30, 2003.
Other Expense - Net
- -------------------
Other income, net of other expenses, totaled $39,000 in the quarter ended
September 30, 2004, as compared with other expense of $152,000 in the
corresponding quarter of the prior year, which represents a net reduction of
expense of $191,000 (126%). The higher current year quarter includes an
unrealized gain of $158,000, a realized loss of $97,000, and dividend income of
$15,000, all on marketable equity security positions. The prior year quarter
includes interest expense of $84,000 paid to EDS. Other expenses were $195,000
in the nine month period ended September 30, 2004, as compared to $143,000 in
the corresponding period of the prior year. The current year includes a realized
loss of $96,000, and unrealized loss of $5,000, and dividend income of $30,000,
all on marketable equity security positions, and an increase in Laurus note
interest of $39,000. The prior year includes $84,000 of interest expense paid to
EDS offset by $64,000 of other income derived as a result of a favorable
settlement with a vendor.
Loss Per Share
- --------------
During the quarter ended September 30, 2004, the Company reported a net loss of
$869,000, or ($.05) per share as compared with a net loss of $1,075,000, or
($.08) per share in the corresponding period of the prior year. During the
quarter ended September 30, 2004, there were outstanding 18,208,000 basic and
diluted shares of common stock as compared with 13,961,000 basic and diluted
shares during the corresponding quarter of the previous year. During the nine
months ended September 30, 2004, the Company reported a net loss of $2,514,000
and ($.14) per share as compared with a net loss of $3,298,000, or ($.26) per
share in the corresponding period of the prior year. During the nine months
ended September 30, 2004, there were outstanding 18,092,000 basic and diluted
shares of common stock as compared with 12,623,000 basic and diluted shares
during the corresponding period of the previous year. The increase in the
outstanding shares is primarily the additional shares issued in January 2004
relating to the Laurus and Silver Star note conversions and the private
placement equity transactions, together with third quarter 2004 warrant
exercises and note conversion.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The Company's marketable equity securities (primarily cash reserves and an
insured municipal bond fund), valued at $1,072,000 at September 30, 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. During the third quarter of 2004, the Company realized a net loss of
$96,000 on securities sold and has an unrealized loss of $5,000 on securities
held at September 30, 2004. 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% that was
converted into Nestor common stock on November 3, 2004. Management assessed the
exposure to this risk as immaterial.
14
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 September 30, 2004. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that as of September 30, 2004, the Company's disclosure controls and
procedures were effective, in that they provide reasonable assurance that
information required to be disclosed by us in the reports we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms. No change in the
Company's internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal
quarter ended September 30, 2004 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
15
PART 2 OTHER INFORMATION
NESTOR, INC.
FORM 10 Q - September 30, 2004
Item 1: Legal Proceedings
On July 13, 2004, the Company filed a second lawsuit for patent
infringement against Redflex Traffic Systems, Inc. but subsequently
withdrew this claim without prejudice. In addition, Nestor amended its
pending lawsuit against Transol USA, Inc., to assert like claims for
patent infringement. Original infringement claims against these
Australian-based competitors were filed by Nestor in November 2003,
alleging infringement of Nestor's U.S. Patent No. 6,188,329 and
reported in the Company's Annual Report on Form 10-K for the year
ended December 31, 2003. The additional lawsuit filed against Redflex,
and the amended claims asserted against Transol, allege infringement
of U.S. Patent No. 6,754,663, issued to Nestor on June 22, 2004. The
original lawsuit against Redflex is pending in US District Court,
District of Rhode Island. The lawsuit against Transol is pending in US
District Court, Central District of California. The Company cannot
give assurance that we will be successful in either action.
Item 2: Changes in Securities - None
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
Exhibit
Number Description
------- -----------
10.1 Distributorship agreement by and between the Company and
Vitronics Machine Vision, Ltd. dated August 17, 2004
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
99.1 Safe Harbor for Forward-Looking Statements Under the Private
Securities Litigation Reform Act of 1995
16
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 15, 2004 By: /s/ Claire M. Iacobucci
--------------------------------------
Claire M. Iacobucci
Treasurer and Chief Financial Officer
17