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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, 2005
[ ] 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: 18,777,790 shares
outstanding as of March 31, 2005
NESTOR, INC.
FORM 10 Q
March 31, 2005
INDEX
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Page
Number
------
PART 1 FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets
March 31, 2005 (Unaudited) and December 31, 2004 3
Condensed Consolidated Statements of Operations (Unaudited)
Quarters ended March 31, 2005 and 2004 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
Quarters ended March 31, 2005 and 2004 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of
Results of Operations and Financial Condition 11
Item 3 Quantitative and Qualitative Disclosure of Market Risk 15
Item 4 Controls and Procedures 15
PART 2 OTHER INFORMATION 16
-2-
NESTOR, INC.
Condensed Consolidated Balance Sheets
-------------------------------------
MARCH 31, 2005 DECEMBER 31, 2004
--------------- -----------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,459,195 $ 5,849,992
Marketable securities 57,964 571,860
Accounts receivable, net of allowance for doubtful accounts 653,254 763,573
Unbilled contract revenue 613,768 111,117
Inventory, net of reserve 1,233,084 1,031,891
Other current assets 305,707 307,938
------------- -------------
Total current assets 7,322,972 8,636,371
NONCURRENT ASSETS:
Capitalized system costs, net of accumulated depreciation 3,417,960 3,749,293
Property and equipment, net of accumulated depreciation 314,446 357,052
Goodwill 5,580,684 5,580,684
Patent development costs, net of accumulated amortization 158,785 161,740
Other long term assets 293,845 362,024
------------- -------------
TOTAL ASSETS $ 17,088,692 $ 18,847,164
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 772,976 $ 620,013
Accrued employee compensation 487,807 460,556
Accrued liabilities 622,189 643,906
Deferred revenue 91,667 91,667
Leases payable 22,455 23,010
Asset retirement obligation 11,500 11,500
------------- -------------
Total current liabilities 2,008,594 1,850,652
NONCURRENT LIABILITIES:
Long term convertible note payable 5,400,000 6,000,000
Long term asset retirement obligation 162,185 146,577
Long term deferred revenue 43,056 53,472
Long term leases payable 611 17,263
------------- -------------
Total liabilities 7,614,446 8,067,964
------------- -------------
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, 2005 and December 31, 2004 180,000 180,000
Common stock, $0.01 par value, authorized 30,000,000 shares;
issued and outstanding: 18,777,790 shares at March 31, 2005
and 18,673,498 shares at December 31, 2004 187,778 186,735
Warrants 35,562 66,358
Additional paid-in capital 63,065,510 62,430,361
Accumulated deficit (53,994,604) (52,084,254)
------------- -------------
Total stockholders' equity 9,474,246 10,779,200
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 17,088,692 $ 18,847,164
============= =============
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,
-----------------------------
2005 2004
---- ----
Revenue:
Product sales, lease and service fees $ 1,839,098 $ 1,074,782
Product royalties 12,859 24,550
------------ -----------
Total revenue 1,851,957 1,099,332
------------ -----------
Operating expenses:
Cost of goods sold 1,191,917 635,191
Engineering and operations 994,567 592,959
Research and development 297,017 219,520
Selling and marketing 409,239 141,726
General and administrative 854,964 492,715
------------ -----------
Total operating expenses 3,747,704 2,082,111
------------ -----------
Loss from operations (1,895,747) (982,779)
Gain on debt extinguishment, net --- 508,124
Other expense, net (14,603) (50,330)
------------ -----------
Net loss $ (1,910,350) $ (524,985)
============ ===========
Loss per share:
Loss per share, basic and diluted $ (0.10) $ (0.03)
============ ===========
Shares used in computing loss per share:
Basic and diluted 18,751,942 18,030,526
============ ===========
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,
-----------------------------------
2005 2004
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,910,350) $ (524,985)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 481,119 409,083
Gain on extinguishment of debt --- (508,124)
Unrealized loss on marketable securities 1,629 10,775
Dividend income reinvested (3,634) ---
Expenses charged to operations relating to
options, warrants and capital transactions --- 26,621
Provision for doubtful accounts 17,342 ---
Provision for inventory reserve 168,048 3,750
Increase (decrease) in cash arising from
changes in assets and liabilities:
Accounts receivable 92,977 (2,637)
Unbilled contract revenue (502,651) 29,023
Inventory (372,383) (49,224)
Other assets 70,410 (101,226)
Accounts payable and accrued expenses 143,506 (373,157)
Deferred revenue (10,416) ---
Restructuring reserve --- (64,551)
------------ ------------
Net cash used in operating activities (1,824,403) (1,144,652)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale of (investment in) marketable securities 515,901 (1,500,000)
Investment in capitalized systems (60,383) (246,796)
Purchase of property and equipment (22,215) (32,893)
Investment in patent development costs (2,877) (4,244)
------------ ------------
Net cash provided by (used in) investing activities 430,426 (1,783,933)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of obligations under capital leases (2,220) (2,258,251)
Proceeds from notes payable --- 98,028
Proceeds from issuance of common stock, net 5,400 3,436,354
------------ ------------
Net cash provided by financing activities 3,180 1,276,131
------------ ------------
Net change in cash and cash equivalents (1,390,797) (1,652,454)
Cash and cash equivalents - beginning of period 5,849,992 5,410,123
------------ ------------
Cash and cash equivalents - end of period $ 4,459,195 $ 3,757,669
============ ============
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid $ 72,282 $ 3,012
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
March 31, 2005
(Unaudited)
Note 1 - Nature of Operations:
A. Organization
Nestor, Inc. was organized on March 21, 1983 in Delaware to develop
and succeed to certain patent rights and know-how, which was 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, Nestor, Inc. ceased
further investment in the Interactive subsidiary. CrossingGuard, Inc.,
a wholly owned subsidiary of NTS, was formed July 18, 2003 in
connection with a financing. The condensed consolidated financials
statements include the accounts of Nestor, Inc. and its wholly-owned
subsidiaries. All intercompany transactions and balances have been
eliminated. Our principal office is located in East Providence, RI.
Our current focus is to offer customers products and services to be
utilized in intelligent traffic management applications. Our leading
product is the CrossingGuard video-based red light enforcement system
and services, sold and distributed exclusively by NTS. Effective July
1, 2002, we assigned 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
We have incurred significant losses to date and at March 31, 2005, we
have an accumulated deficit of $53,994,604. Management believes that
the significant financing obtained in 2004 and 2005 (see Note 9 --
Subsequent Event -- Laurus Fixed Price Convertible Note Financing),
strong liquidity at March 31, 2005 and current contracts with
municipalities will enable us to continue the development and
upgrading of our products and sustain operations through the end of
2005. There can be no assurance, however, that our operations will be
sustained or be profitable in the future, that our product development
and marketing efforts will be successful, or that if we have to raise
additional funds to expand and sustain our operations that the funds
will be available on terms acceptable to us, if at all.
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 ending March 31, 2005 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2005.
There were no material unusual charges or credits to operations during
the recently completed fiscal quarter, except for a provision for
inventory reserve for obsolescence of $168,048.
The balance sheet at December 31, 2004 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 our annual report on Form
10-K for the year ended December 31, 2004.
Certain operating expenses reported for the quarter ended March 31,
2004 have been reclassified to conform to the 2005 presentation. The
reclassifications had no net effect on results of operations.
-6-
Marketable securities - our marketable securities consist of an
investment in a closed-end insured municipal bond fund. The securities
are classified as "trading securities" and accordingly are reported at
fair value with unrealized gains and losses included in other income
(expense).
Deferred revenue - certain customer contracts allow us 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, which would include shares from the effect of
common stock equivalents and other dilutive securities are not
presented since their effect would be antidilutive.
Stock-based compensation - We measure compensation expense for
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". We have adopted the pro forma 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, $240,000 on September 17, 2004
and $160,000 on March 31, 2005, and recorded $400,000 as unbilled
contract revenue as of March 31, 2005, from GE on behalf of DelDOT
pursuant to DelDOT's 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 - Stock Options:
We have adopted the pro forma 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 our stock options been determined in
accordance with the fair value-based method prescribed under SFAS 123,
our net loss and loss per share would have approximated the following
pro forma amounts:
Quarter Ended March 31,
-----------------------
2005 2004
---- ----
Net loss, as reported $(1,910,350) $(524,985)
Add: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (1,254,463) (13,095)
----------- ---------
Pro forma net loss $(3,164,813) $(538,080)
=========== =========
Pro forma net loss per share:
Basic and diluted $ (0.17) $ (0.03)
=========== =========
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 110.6%; a
risk-fee interest rate of 1.6-6.8%; and an expected option holding
period of 8 years.
-7-
On June 24, 2004, we adopted the 2004 Stock Incentive Plan, which
provides for the grant of awards to employees, officers and directors.
Subject to adjustments for changes in our 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. The Board of Directors will determine the
award amount, price (usually equal to the market price of the stock on
the date of the grant), vesting provisions and expiration period (not
to exceed ten years) in each applicable agreement. The awards are not
transferable except by will or domestic relations order.
Note 5 - Private Placement of Senior Convertible Notes:
In November 2004, we completed the sale of $6,000,000 aggregate
principal amount of our 5% Senior Convertible Notes due October 31,
2007 (the "Senior Convertible Notes") in a private placement. We
received $5,555,000 of note proceeds after $445,000 of placement fees
and related expenses. 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. We 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 or
certain similar events and defaults under other material credit
arrangements.
We may, at our 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. We are obligated to offer to
repurchase the Senior Convertible Notes at the then current redemption
price in the event of a change in control of us or upon the occurrence
of certain financing events, as defined. In connection with the Senior
Convertible Notes, we 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.
The Securities and Exchange Commission declared the Registration
Statement on Form S-2 (SEC File No. 333-121015) for the resale of
these shares effective on January 28, 2005. Pursuant to the terms of
the warrant, we have agreed to include the resale of the shares of our
common stock underlying the warrant in future registration statements
upon the request of such holder.
During February 2005, two noteholders converted an aggregate $600,000
note face value into 103,092 shares of Nestor stock at $5.82 per
share. Any unamortized deferred financing costs associated with the
converted notes was expensed upon conversion.
Note 6 - Commitments and Contingencies:
We have two customers operating photo red light enforcement programs
under Virginia General Assembly authority, which currently ends July
1, 2005. Many bills to extend the photo red program have been
defeated, despite significant program support. If the program is not
extended, one customer contract will terminate prematurely, with
approximately $191,000 of unamortized costs at July 1, 2005. Contract
renewal discussions with the other customer are on hold until program
authorization is extended.
Note 7 - Litigation:
On November 6, 2003, we 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 our U.S. Patent No. 6,188,329, describing a system using
digitized video and integrating traffic light violation related
vehicle information with court date scheduling information.
-8-
Court-ordered mediation in that lawsuit took place on October 1, 2004,
but no agreement was reached through that mediation. Redflex has
asserted as a defense that our patent is invalid.
On November 25, 2003, we 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 that same patent. We were denied a preliminary
injunction in the Transol litigation, in part because we had not shown
a likelihood of success on our claim that Transol's products infringe
on our patent. Transol has filed a counterclaim asserting the
invalidity of that patent.
On June 22, 2004, the United States Patent and Trademark Office issued
Patent Number 6,754,663 to us, describing a system using multiple
cameras, including at least one video camera, to capture multiple
images of a traffic light violation and a user interface that
simultaneously displays those multiple images.
On July 13, 2004, we filed an additional lawsuit for patent
infringement against Redflex Traffic Systems, Inc., alleging that
Redflex's automated red light enforcement systems infringe our U.S.
Patent Number 6,754,663, but we have since withdrawn that additional
lawsuit.
We have amended our lawsuit against Transol to include claims alleging
that Transol's automated red light enforcement systems infringe our
U.S. Patent Number 6,754,663. Transol has filed a counterclaim
asserting the invalidity of that patent as well.
Transol moved for summary judgment against us on all of our claims of
infringement against Transol. A decision granting Transol's motion for
summary judgment on all of our claims of infringement was granted on
April 29, 2005, finding that the Transol system did not infringe
either of our patents at issue. Transol has informed us that it
intends to file a motion for summary judgment on its counterclaims
asserting the invalidity of our patents.
In the ordinary course of business, we are a defendant in certain
claims and legal proceedings. In the opinion of management, the
outcome of these matters will not have a material effect on our
financial position.
Note 8 - Recent Accounting Pronouncements:
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment". SFAS 123 (revised 2004) requires companies to
recognize in their statement of operations the grant-date fair value
of stock options and other equity-based compensation. That cost will
be recognized over the period during which an employee is required to
perform service in exchange for the award, usually the vesting period.
Subsequent changes in fair value during the requisite service period,
measured at each reporting date, will be recognized as compensation
cost over the vesting period. In April 2005, the SEC adopted a new
rule that amended the FASB implementation date, to now require
adoption of SFAS 123 (revised 2004) in the first interim period in
2006, or our quarter ending March 31, 2006. We are evaluating the
impact of the adoption of SFAS 123 (revised 2004) on our financial
position and results of operations.
Note 9 - Subsequent Event - Laurus Fixed Price Convertible Note Financing:
On May 16, 2005, we entered into a Securities Purchase Agreement ("the
Agreement") with Laurus Master Fund, Ltd. ("Laurus"). Pursuant to the
Agreement, we issued to Laurus a convertible Note ("the Note") in the
principal amount of $6,000,000 with a fixed price conversion of $5.82
into shares of our common stock. The Note bears interest at the coupon
rate of the prime rate plus 4.00% (or 10.00% as of May 13, 2005) and
is subject to a floor interest rate of 6.00%. The Agreement provides
-9-
for a reduction in the interest rate to the prime rate plus 2.00% once
the price of our common stock exceeds the fixed conversion price of
$5.82, and additional reductions of 2.00% for every 25% increase in
the price of our common stock above the fixed conversion price of
$5.82 (an increase of $1.46), subject to a minimum coupon rate of
0.00%. The Note matures on May 16, 2008. The initial monthly principal
payment of $181,818 is due on September 1, 2005 and is payable in cash
or common stock at the fixed conversion rate; however, if payment is
made in cash it will be at 103% of the amount due. The net proceeds
from the Note shall be used for the design, engineering, construction,
installation and maintenance of certain of our traffic surveillance
systems. The Note restricts our ability to make repayment in our
common stock at the fixed conversion price, if the then current market
price is below 120% of the fixed conversion price (or $6.98).
Laurus also has a conversion right at any time through maturity to
convert the Note into shares of our common stock at the fixed
conversion price. We have the option of redeeming for cash all of the
outstanding principal balance by paying 115% of such amount plus any
applicable unpaid interest. Subject to certain limitations relating to
the market price and trading volume of our common stock, we also have
the option of requiring Laurus to convert all or a part of the Note to
common stock.
We are obligated to file a registration statement for the shares of
common stock into which the Note may be converted and for the shares
underlying the warrant issued as part of the Agreement (see below).
The registration statement is required to be filed within 30 days of
the Note funding and is required to be declared effective within 90
days of the funding. We may be obligated to pay Laurus damages if the
registration statement is not declared effective by its due date.
The Note is collateralized by a security interest in the proceeds of
our existing CrossingGuard contracts except for our Delaware contract,
and in the proceeds of any CrossingGuard contract that we enter into
with certain cities which have selected us to supply automated traffic
systems but which have not finalized their respective contracts with
us.
In connection with financing, Laurus was paid a fee of $234,000 and
had approximately $47,000 of its expenses reimbursed. Laurus received
five year warrants to purchase 100,000 shares of our common stock. The
exercise prices of the warrants are as follows: $6.69 per share for
the purchase of up to 60,000 shares; $7.28 per share for the purchase
of an additional 23,000 shares; and $8.44 per share for the purchase
of an additional 17,000 shares. The warrants expire on May 16, 2010.
The Black-Scholes value of the warrants issued in connection with this
financing totaled approximately $419,000 and are recorded as
additional paid-in capital and a corresponding discount (reduction) to
the note payable. We will amortize monthly approximately $11,700 of
the discount as interest expense.
-10-
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
FORWARD LOOKING 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. 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. The following discussion should also be
read in conjunction with the Condensed Consolidated Financial Statements and
accompanying Notes thereto.
Readers are cautioned not to place undue reliance on these prospective
statements, which speak only as of the date of this report. We undertake 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 us in this report
and in our other reports filed with the Securities and Exchange Commission.
Our expense levels are based in part on our product development efforts and our
expectations regarding future revenues and in the short term are generally
fixed. Therefore, we may be unable to adjust our 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, our operating results for
the quarter would be disproportionately affected. Operating results also may
fluctuate due to factors such as the demand for our products, product life
cycles, the development, introduction and acceptance of new products and product
enhancements by us or our competitors, changes in the mix of distribution
channels through which our 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.
Our quarterly revenues and operating results have varied significantly in the
past due to the timing of new customer contracts and approaches installed, and
we expect such fluctuations to continue for the foreseeable future. Accordingly,
we believe that period-to-period comparisons of our financial results should not
be relied upon as an indication of our future performance. No assurance can be
given that we will be able to achieve or maintain profitability on a quarterly
or annual basis in the future.
EXECUTIVE SUMMARY
We primarily operate through Nestor Traffic Systems, Inc. (NTS), a wholly owned
subsidiary. NTS' principal product is our 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.
The following is a summary of key performance measurements monitored by
management:
-11-
Quarter Ended March 31,
---------------------------
2005 2004
---- ----
Financial:
Revenue $ 1,852,000 $1,099,000
Loss from operations (1,896,000) (983,000)
Net loss (1,910,000) (525,000)
Additional investment in
capitalized systems 60,000 247,000
Cash and marketable securities 4,517,000 5,247,000
Working capital 5,314,000 4,680,000
Number of CrossingGuard Approaches*:
Installed and operational 119 91
Additional authorized under
existing contracts 123 144
----------- ----------
Total 242 235
========== ==========
* At the end of period. There can be no assurance that all approaches
authorized under existing contracts will ultimately be installed; moreover,
we have identified twenty of these approaches which we believe are highly
unlikely to be installed despite the authorizing contract.
The management team focus is to expand our market share in the emerging traffic
safety market. We plan 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 speed enforcement systems and
services to states and municipalities for speed enforcement and safety
o Participating in efforts to increase the public's acceptance of, and
state's authorization of, automated traffic safety systems
o Participating in industry standards setting bodies
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
Our condensed consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require us
to make estimates and assumptions (see Note 2 to the Financial Statements
included in our Annual Report on Form 10-K for the year ended December 31,
2004). We believe that of our significant accounting policies, the following may
involve a higher degree of judgment and complexity.
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Unbilled contract revenue
Unbilled contract revenue represents revenue earned by us in advance of being
billable under customer contract terms. Under the terms of some current
contracts, we 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
periodically reviewed and updated by management.
Revenue Recognition
Revenue is derived mainly from the lease of products, which incorporate NTS'
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,
our operating results may be significantly and negatively affected.
Long Term Asset Impairment
In assessing the recoverability of our long term assets, management must make
assumptions regarding estimated future cash flows, contract renewal options and
other factors to determine its fair value. If these estimates change in the
future, we may be required to record impairment charges that were not previously
recorded.
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Working Capital
We had cash, cash equivalents and marketable securities totaling $4,517,000 at
March 31, 2005 compared with $6,422,000 at December 31, 2004. At March 31, 2005,
we had working capital of $5,314,000 compared with $6,786,000 at December 31,
2004.
Our net worth at March 31, 2005 was $9,474,000 compared with $10,779,000 at
December 31, 2004. The decrease in net worth is primarily the result of our
quarterly net loss of $1,910,000, partially offset by conversions to common
stock by certain holders of our senior convertible notes in the amount of
$600,000. We continue to seek additional sources of equity and debt financing to
fund operations and to position ourselves to capitalize on new market and growth
opportunities; however, there can be no assurance that the funds will be
available on terms acceptable to us, if at all.
On May 16, 2005, we sold a convertible note in the principal amount of
$6,000,000 to an accredited institutional investor (See Note 9 of Notes to
Condensed Consolidated Financial Statements -- Subsequent Event -- Laurus Fixed
Price Convertible Note Financing). The sale of that note will not be registered
under the Securities Act of 1933 and may not be sold in the United States
without registration or an applicable exemption from registration requirements.
Future Commitments
For the three months ended March 31, 2005, we invested $60,000 in capitalized
systems and $434,000 in system costs expensed under a sales-type lease for
Delaware approaches compared to $247,000 invested in capitalized systems and no
Delaware system costs expensed in the same period last year. Management expects
that NTS will make future commitments for systems related to our CrossingGuard
contracts.
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RESULTS OF OPERATIONS
For the quarter ended March 31, 2005, our revenues totaled $1,852,000 and
operating expenses were $3,748,000, which resulted in an operating loss for the
quarter of $1,896,000. We incurred a net loss of $1,910,000, or $0.10 per share,
for the current quarter after incurring $15,000 of other expenses, net. In the
corresponding quarter of the prior year, revenues and operating expenses totaled
$1,099,000 and $2,082,000, respectively, resulting in net loss of $525,000, or
$0.03 per share, after recording a net gain on extinguishment of debt of
$508,000 and other expenses, net in the amount of $50,000.
Revenues
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During the quarter ended March 31, 2005, revenues increased $753,000, or 69%, to
$1,852,000 from $1,099,000 in the quarter ended March 31, 2004. This increase is
primarily attributable to seven Delaware approaches being completed and funded
(under sales-type leasing) during the quarter and the start of revenue
generation on live approaches in Baltimore, while in the prior year quarter,
there was no corresponding revenue for these customers.
Operating Expenses
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Total operating expenses amounted to $3,748,000 in the quarter ended March 31,
2005, an increase of $1,666,000, or 80%, from total operating expenses of
$2,082,000 in the corresponding quarter of the prior year. The increase in
operating expenses in 2005 is primarily due to costs related to increased
revenue and business activity, specifically, costs associated with new live
Delaware approaches, and increases in patent lawsuit defense costs, continuation
of the building of a national sales force and implementation of our sales
strategy, an increase in inventory reserve for obsolescence and costs associated
with supporting the installed base of approaches.
Cost of Goods Sold
Cost of goods sold totaled $1,192,000 in the quarter ended March 31, 2005 an
increase of $557,000, or 88%, compared to $635,000 in the prior year quarter.
The increase in cost of goods sold is primarily due to the cost of seven
Delaware systems installed under sales-type leases and increased amortization of
capitalized system costs and other direct support costs due to the increase in
revenue producing live approaches.
Engineering and Operations
Expenses related to engineering and operations totaled $995,000 in the quarter
ended March 31, 2005, an increase of $402,000, or 68%, compared to $593,000 in
the corresponding quarter of the prior year. These costs include the salaries
and related costs of field and office personnel in engineering and operations
services, as well as, operating expenses related to product design, delivery,
configuration, maintenance and service of our installed base. The increases in
engineering and operating expenses are primarily attributable to increased
support costs driven by our increased installed base and an increase in
inventory reserve for obsolescence.
Research and Development
Research and development expenses totaled $297,000 in the quarter ended March
31, 2005, an increase of $77,000, or 35%, compared with $220,000 in the year
earlier period. The increase in research and development expenses primarily
resulted from increased spending in salary and related personnel costs
attributable to projects advancing our CrossingGuard product technology and
development of our PoliScan mobile speed technology.
Selling and Marketing
Selling and marketing expenses totaled $409,000 in the quarter ended March 31,
2005, an increase of $267,000, or 188%, compared with $142,000 in the
corresponding quarter of the prior year. The increase in selling and marketing
expenses reflects a more aggressive national selling and marketing effort,
including primarily, the costs associated with more than doubling the size of
the sales force and use of consultants in targeted areas to achieve our sales
strategy.
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General and Administrative
General and administrative expenses totaled $855,000 in the quarter ended March
31, 2005, an increase of $362,000, or 73%, compared with $493,000 in the
corresponding quarter of the prior year. The increase in general and
administrative expenses over last year is primarily related to ongoing legal
expenses for the prosecution of patent infringement cases, an increase in
financing fees due to note conversions and costs associated with being a public
company.
Gain on Debt Extinguishment
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During the quarter ended March 31, 2004, a lease payable and a convertible note
payable were fully satisfied in January 2004, resulting in a net gain of
$508,000. An early payment on the lease payable resulted in a gain of $681,000,
which was partially offset by a prepayment penalty of $173,000 incurred in the
settlement of the convertible note payable.
Other Expense - Net
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Other expense, net totaled $15,000 in the quarter ended March 31, 2005, a
decrease of $35,000, or 70%, compared with other expense, net of $50,000 in the
corresponding quarter of the prior year. The current year amount includes a gain
on an insurance settlement of $32,000 and interest expense incurred on our
senior convertible notes of $70,000. The prior year amount primarily consists of
interest expense incurred on a convertible note of $25,000 and warrant
amortization of $27,000.
Loss Per Share
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During the quarter ended March 31, 2005, we incurred a net loss of $1,910,000,
or $0.10 per share, an increase of $1,385,000, or $0.07 per share, compared with
a net loss of $525,000, or $0.03 per share, in the corresponding period of the
prior year. During the quarter ended March 31, 2005, there was 18,752,000 basic
and diluted shares outstanding compared with 18,031,000 basic and diluted shares
outstanding during the corresponding quarter of the previous year. The increase
in net loss per share was primarily due to the increase in net loss, partially
offset by the increase in outstanding shares.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
Our marketable securities, an insured municipal bond fund, valued at $58,000 at
March 31, 2005, are exposed to market risk due to changes in U.S. interest
rates. The primary objective of our investment activities is the preservation of
principal while maximizing investment income. Our exposure to this risk is
moderately high in the short-term. During the quarter ended March 31, 2005, we
had an unrealized loss of $2,000 on securities held at March 31, 2005. The
securities are classified as "trading securities" and accordingly are reported
at fair value with unrealized gains and losses included in other income
(expense).
We had a senior convertible note payable with interest fixed at 5% through its
October 2007 maturity. Management assesses the exposure to market risk for this
obligation as immaterial.
ITEM 4: CONTROLS AND PROCEDURES
The management of Nestor, Inc., including the Chief Executive Officer and Chief
Financial Officer, conducted an evaluation of the effectiveness of the design
and operation of our disclosure controls and procedures as defined in Exchange
Act Rule 13a-15(e) and 15d-15(e) as of March 31, 2005. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that as of
March 31, 2005, our 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 our 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 March 31, 2005 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
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PART 2: OTHER INFORMATION
NESTOR, INC.
FORM 10 Q
March 31, 2005
Item 1: Legal Proceedings
On November 6, 2003, we 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 our U.S. Patent No. 6,188,329, describing a system using
digitized video and integrating traffic light violation related
vehicle information with court date scheduling information.
Court-ordered mediation in that lawsuit took place on October 1, 2004,
but no agreement was reached through that mediation. Redflex has
asserted as a defense that our patent is invalid.
On November 25, 2003, we 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 that same patent. We were denied a preliminary
injunction in the Transol litigation, in part because we had not shown
a likelihood of success on our claim that Transol's products infringe
on our patent. Transol has filed a counterclaim asserting the
invalidity of that patent.
On June 22, 2004, the United States Patent and Trademark Office issued
Patent Number 6,754,663 to us, describing a system using multiple
cameras, including at least one video camera, to capture multiple
images of a traffic light violation and a user interface that
simultaneously displays those multiple images.
On July 13, 2004, we filed an additional lawsuit for patent
infringement against Redflex Traffic Systems, Inc., alleging that
Redflex's automated red light enforcement systems infringe our U.S.
Patent Number 6,754,663, but we have since withdrawn that additional
lawsuit.
We have amended our lawsuit against Transol to include claims alleging
that Transol's automated red light enforcement systems infringe our
U.S. Patent Number 6,754,663. Transol has filed a counterclaim
asserting the invalidity of that patent as well.
Transol moved for summary judgment against us on all of our claims of
infringement against Transol. A decision granting Transol's motion for
summary judgment on all of our claims of infringement was granted on
April 29, 2005, finding that the Transol system did not infringe
either of our patents at issue. Transol has informed us that it
intends to file a motion for summary judgment on its counterclaims
asserting the invalidity of our patents.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds - None
Item 3: Defaults Upon Senior Securities - None
Item 4: Submission of Matters to a Vote of Security Holders - None
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Item 5: Other Information:
On May 16, 2005, we entered into a Securities Purchase Agreement ("the
Agreement") with Laurus Master Fund, Ltd. ("Laurus"). Pursuant to the
Agreement, we issued to Laurus a convertible Note ("the Note") in the
principal amount of $6,000,000 with a fixed price conversion of $5.82
into shares of our common stock. The Note bears interest at the coupon
rate of the prime rate plus 4.00% (or 10.00% as of May 13, 2005) and
is subject to a floor interest rate of 6.00%. The Agreement provides
for a reduction in the interest rate to the prime rate plus 2.00% once
the price of our common stock exceeds the fixed conversion price of
$5.82, and additional reductions of 2.00% for every 25% increase in
the price of our common stock above the fixed conversion price of
$5.82 (an increase of $1.46), subject to a minimum coupon rate of
0.00%. The Note matures on May 16, 2008. The initial monthly principal
payment of $181,818 is due on September 1, 2005 and is payable in cash
or common stock at the fixed conversion rate; however, if payment is
made in cash it will be at 103% of the amount due. The net proceeds
from the Note shall be used for the design, engineering, construction,
installation and maintenance of certain of our traffic surveillance
systems. The Note restricts our ability to make repayment in our
common stock at the fixed conversion price, if the then current market
price is below 120% of the fixed conversion price (or $6.98).
Laurus also has a conversion right at any time through maturity to
convert the Note into shares of our common stock at the fixed
conversion price. We have the option of redeeming for cash all of the
outstanding principal balance by paying 115% of such amount plus any
applicable unpaid interest. Subject to certain limitations relating to
the market price and trading volume of our common stock, we also have
the option of requiring Laurus to convert all or a part of the Note to
common stock.
We are obligated to file a registration statement for the shares of
common stock into which the Note may be converted and for the shares
underlying the warrant issued as part of the Agreement (see below).
The registration statement is required to be filed within 30 days of
the Note funding and is required to be declared effective within 90
days of the funding. We may be obligated to pay Laurus damages if the
registration statement is not declared effective by its due date.
The Note is collateralized by a security interest in the proceeds of
our existing CrossingGuard contracts except for our Delaware contract,
and in the proceeds of any CrossingGuard contract that we enter into
with certain cities which have selected us to supply automated traffic
systems but which have not finalized their respective contracts with
us.
In connection with financing, Laurus was paid a fee of $234,000 and
had approximately $47,000 of its expenses reimbursed. Laurus received
five year warrants to purchase 100,000 shares of our common stock. The
exercise prices of the warrants are as follows: $6.69 per share for
the purchase of up to 60,000 shares; $7.28 per share for the purchase
of an additional 23,000 shares; and $8.44 per share for the purchase
of an additional 17,000 shares. The warrants expire on May 16, 2010.
The Black-Scholes value of the warrants issued in connection with this
financing totaled approximately $419,000 and are recorded as
additional paid-in capital and a corresponding discount (reduction) to
the note payable. We will amortize monthly approximately $11,700 of
the discount as interest expense.
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Item 6: Exhibits
Exhibit
Number Description
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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
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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 16, 2005 By: /s/ Harold A. Joannidi
--------------------------------------
Harold A. Joannidi
Treasurer and Chief Financial Officer
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