10-Q 1 q3_00.txt 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, 2000 [ ] 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.) One Richmond Square, Providence, RI 02906 (Address of principal executive offices) (Zip Code) 401-331-9640 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period than the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Common stock, par value .01 per share: 17,678,449 shares outstanding as of September 30, 2000 NESTOR, INC. FORM 10 Q September 30, 2000 INDEX PART 1 FINANCIAL INFORMATION Item 1 Financial Statements: Condensed Consolidated Balance Sheets September 30, 2000 (Unaudited) and December 31, 1999 Condensed Consolidated Statements of Operations (Unaudited) Quarters and nine months ended September 30, 2000 and 1999 Condensed Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended September 30, 2000 and 1999 Notes to Condensed Consolidated Financial Statements Item 2 Management's Discussion and Analysis of Results of Operations and Financial Condition Item 3 Quantitative and Qualitative Disclosure of Market Risk PART 2 OTHER INFORMATION Nestor, Inc. Condensed Consolidated Balance Sheets
September 30, 2000 December 31, 1999 (Unaudited) (Note 1) Assets Current assets: Cash and cash equivalents $ 71,408 $ 1,048,802 Accounts receivable - net 625,710 984,318 Unbilled contract revenue 1,170,143 1,200,484 Due from affiliate 310,588 320,459 Other current assets 180,519 161,809 Total current assets 2,358,368 3,715,872 Noncurrent assets: Long term unbilled contract revenue 2,040,922 1,965,532 Investment in affiliate 395,927 710,690 Property and equipment - net 198,425 269,917 Deferred development costs - net 38,000 56,000 Patent development costs 70,324 55,894 Total Assets $ 5,101,966 $ 6,773,905 Liabilities and Stockholders' Equity Current liabilities: Accounts payable and other current liabilities $ 1,308,924 $ 1,133,398 Deferred income 1,204,333 1,371,217 Total current liabilities 2,513,257 2,504,615 Noncurrent liabilities: Long term deferred income 2,040,922 1,965,532 Total liabilities 4,554,179 4,470,147 Stockholders' equity: Preferred Stock Series B, $1.00 par value, authorized 10,000,000 shares; Issued and outstanding 235,000 shares at Sept. 30, 2000 and 345,000 shares at Dec. 31, 1999 (liquidation value $1.00 per share) 235,000 345,000 Common Stock, $.01 par value, authorized 30,000,000 shares; Issued and outstanding 17,678,449 shares at Sept. 30, 2000 and 17,499,327 shares at Dec. 31, 1999 176,784 174,993 Warrants and options 816,813 736,951 Additional paid-in capital 27,462,110 26,574,123 Retained deficit (28,142,920) (25,527,309) Total stockholders' equity 547,787 2,303,758 Total Liabilities and Stockholders' Equity $ 5,101,966 $ 6,773,905 The Notes to the Condensed Consolidated Financial Statements are an integral part of this statement
Nestor, Inc. Condensed Consolidated Statements of Operations (Unaudited)
Quarter Ended September 30, Nine Months Ended September 30, 2000 1999 2000 1999 Revenues: Software licensing $ 312,264 $ 930,735 $ 1,777,463 $ 2,935,672 Engineering services 256,381 210,236 1,021,639 851,286 Total revenues 568,645 1,140,971 2,799,102 3,786,958 Operating expenses: Engineering services 259,873 257,069 778,251 758,436 Research and development 325,579 174,236 999,556 581,359 Selling and marketing expenses 406,861 354,645 1,268,579 992,888 General and administrative expenses 350,111 328,185 1,276,468 823,154 Total operating expenses 1,342,424 1,114,135 4,322,854 3,155,837 Income (loss) from operations (773,779) 26,836 (1,523,752) 631,121 Other expense (25,373) (22,369) (76,079) (73,148) Income (loss) for the period before income taxes (benefit) and investment loss (799,152) 4,467 (1,599,831) 557,973 Income taxes (benefit) --- --- --- --- Loss from investment in affiliate (275,435) (396,371) (1,015,780) (1,070,919) Net loss for the period $ (1,074,587) $ (391,904) $ (2,615,611) $ (512,946) Loss per share, basic and diluted $ (0.06) $ (0.02) $ (0.15) $ (0.03) Basic and diluted shares 17,913,449 17,844,327 17,895,430 17,844,327 The Notes to the Condensed Consolidated Financial Statements are an integral part of this statement.
Nestor, Inc. Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30, 2000 1999 Cash flows from operating activities: Net loss $ (2,615,611) $ (512,946) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 89,492 88,678 Loss from investment in affiliate 1,015,780 1,070,919 Expenses charged to operations relating to options, warrants and capital transactions 79,863 79,863 Changes in assets and liabilities: Decrease in accounts receivable 358,608 215,638 (Increase) in unbilled contract revenue (45,049) (2,192,658) (Increase) in other assets (18,710) (217,782) Increase in accounts payable and other current liabilities 187,096 156,819 Increase (decrease) in deferred income (91,494) 1,165,346 Net cash used by operating activities (1,040,025) (146,123) Cash flows from investing activities: Payments from (advances to) affiliate - net 9,871 (324,931) Purchase of property and equipment --- (58,920) Patent development costs ______(14,430) --- Net cash used by investing activities (4,559) (383,851) Cash flows from financing activities: Repayment of obligations under capital leases (11,572) (30,037) Proceeds from issuance of common stock 78,762 --- Net cash provided (used) by financing activities 67,190 (30,037) Net change in cash and cash equivalents (977,394) (560,011) Cash and cash equivalents - beginning of period 1,048,802 1,175,183 Cash and cash equivalents - end of period $ 71,408 $ 615,172 Supplemental cash flows information Interest paid $ 4,920 $ 10,300 Income taxes paid $ --- $ --- The Notes to the Condensed Consolidated Financial Statements are an integral part of this statement.
Nestor, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2000 Note 1 - 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 accruals) considered necessary for a fair presentation have been included. Operating results for the quarter and nine months ended September 30, 2000 are not necessarily indicative of the results that may be expected for the year ended December 31, 2000. The balance sheet at December 31, 1999 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, 1999. Nestor, Inc. organized two wholly-owned subsidiaries, Nestor Traffic Systems, Inc. ("NTS") and Nestor Interactive, Inc. ("Interactive") effective January 1, 1997. On March 25 and November 30, 1999, NTS sold in the aggregate a 58.1% common-stock interest to a private group of investors. As a result of these transactions, the Company changed from consolidation to equity accounting for its interest in NTS for the year ended December 31, 1999. On June 23, 2000, NTS sold an additional 20.9% common-stock interest to private investors for approximately $2,025,000. This transaction increased the Stockholder Equity of the Company by $701,016, representing its 34.62% equity ownership of the new NTS equity. Effective November 7, 1998, the Company ceased further investment in the Interactive subsidiary. Any future marketing or development of Interactive's product has been transferred to Nestor, Inc. All intercompany transactions and balances have been eliminated. The following unaudited information presents summarized results for the quarter and nine months ended September 30, 1999, as previously reported and as presented in the accompanying condensed financial statements to reflect the equity method of accounting for NTS.
Quarter Ended Nine Months Ended September 30, 1999 September 30, 1999 ____ As Previously As Previously Reported Reclassified Reported Reclassified Total revenues $ 1,171,994 $ 1,140,971 $ 3,918,991 $ 3,786,958 Income (loss) from operations (619,795) 26,836 (1,109,328) 631,121 Minority interest 237,823 --- 642,551 --- Loss from investment in affiliate --- (396,371) --- (1,070,919) Net loss (391,904) (391,904) (512,946) (512,946)
Presented below is summarized NTS financial information at September 30, 2000, December 31, 1999 and for the quarter and nine months ended September 30, 2000 and 1999: Sept. 30, 2000 December 31, 1999 Current assets $ 1,572,867 $ 2,215,602 Noncurrent assets 266,632 295,958 Current liabilities 695,864 723,781 Stockholders' equity 1,143,636 1,697,779 Quarter Ended Sept. 30, Nine Months Ended Sept. 30, 2000 1999 2000 1999 Total revenues $ 269,482 $ 31,024 $ 652,700 $ 132,034 Operating expenses 1,083,228 678,893 3,267,451 1,873,786 Net loss 795,595 634,129 2,579,030 1,713,470 NTS is a development stage company, focusing activities primarily on raising capital, research and development, establishing supply and production processes, and sales and marketing. Accordingly, NTS's continuation as a going concern is dependent on its ability to raise additional capital and generate sufficient revenue to support future operations. Note 2 - Litigation: On October 6, 1998, HNC Software Corp. ("HNC"), a significant competitor of the Company in the field of financial services, obtained a patent titled "Fraud Detection Using Predictive Modeling" and began advising prospective customers of the Company of the patent. Upon review of the patent and consideration of prior actions taken by HNC, the Company initiated a lawsuit against HNC in the United States District Court in Providence, RI on November 25, 1998 alleging violation of Sections 1 and 2 of the Sherman Act (antitrust), violation of the Rhode Island Antitrust Act, patent invalidity, and infringement of Nestor's patents (infringement claims withdrawn January 10, 2000). The suit seeks various damages, including lost profits and treble damages. On June 15, 1999, HNC answered the lawsuit denying the allegations, bringing a counterclaim alleging infringement of the above described patent by the Company, and seeking a declaration of invalidity and unenforceability of one of the Company's patents. On the same day, HNC brought suit in San Diego, CA against the Company's marketing partner, Applied Communications, Inc. (ACI) and ACI's parent alleging various causes of action including patent infringement of the above described patent by the Company's PRISM product which ACI markets. In April 2000, HNC, ACI and its parent agreed to dismiss the California lawsuit. ACI has requested that the Company provide indemnification for approximately $900,000 of its legal counsel costs pursuant to the PRISM license agreement between ACI and the Company. The Company is disputing the indemnification claim. On July 21, 2000, HNC filed a motion with the court to voluntarily dismiss its patent infringement counterclaim against Nestor. Nestor has not opposed the dismissal of the infringement claims. However, HNC has also requested the District Court to dismiss Nestor's claim that the HNC patent is invalid. HNC's request is based upon a covenant not to sue Nestor, that HNC has filed with the Rhode Island federal court hearing this matter. HNC has claimed that this covenant not to sue removes any legal threat to Nestor for past or present patent infringement and, thus, makes Nestor's claim moot. Nestor has opposed HNC's motion, in part. Notwithstanding any action by the court on HNC's motion, Nestor's other claims alleging antitrust violations and fraud on the patent office should continue as scheduled. Costs associated with the suit are being expensed as incurred. Although the Company believes that it will prevail, there can be no assurance as to the outcome of this suit, the counterclaim, or the ACI indemnity claim. Any conclusion of this litigation or indemnity claim in a manner adverse to the Company may have an adverse effect on its future financial condition and results of operations. Note 3 - Liquidity and Capital Resources: Management believes that the Company's liquid assets, backlog and available line of credit at September 30, 2000 are sufficient to meet the Company's anticipated cash requirements through December 31, 2000 but not beyond. The Company must raise additional capital to maintain current operations and continue as a going concern. There can be no assurance that the Company can raise such additional capital on terms acceptable to the Company and an investor or financial institution. Accordingly, management is evaluating and pursuing options to increase liquidity of the Company which may include, but are not limited to, raising additional capital, selling assets, and/or reducing operating expenses. ITEM 2: Management's Discussion and Analysis of Results of Operations and Financial Condition Prospective Statements The following discussion contains prospective statements regarding Nestor, Inc. and its subsidiaries, its business outlook and results of operations that are subject to certain risks and uncertainties and to events that could cause the Company's actual business, prospects and results of operations to differ materially from those that may be anticipated by, or inferred from, such prospective statements. Factors that may affect the Company's prospects include, without limitation: the Company's ability to raise additional capital, the Company's ability to successfully develop new contracts for technology development; the impact of competition on the Company's revenues or market share; delays in the Company's introduction of new products; and failure by the Company to keep pace with emerging technologies. The Company's quarterly revenues and operating results have varied significantly in the past and may do so in the future. A significant portion of the Company's business has been derived from individually substantial licenses, and the timing of such licenses has caused material fluctuations in the Company's operating results. In addition, because the Company provides certain of its products to customers under licenses with no significant continuing obligations, it recognizes the majority of its revenue upon the delivery of the software and acceptance by the customer. Thus, revenues derived by the Company may be more likely to be recognized in irregular patterns that may result in quarterly variations in the Company's revenues. The Company's expense levels are based in part on its product development efforts and its expectations regarding future revenues and in the short term are generally fixed. Therefore, the Company may be unable to adjust its spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, if anticipated revenues in any quarter do not occur or are delayed, the Company's operating results for the quarter would be disproportionately affected. Operating results also may fluctuate due to factors such as the demand for the Company's products, product life cycles, the development, introduction and acceptance of new products and product enhancements by the Company or its competitors, changes in the mix of distribution channels through which the Company's products are offered, changes in the level of operating expenses, customer order deferrals in anticipation of new products, competitive conditions in the industry and economic conditions generally or in various industry segments. The Company expects quarterly fluctuations to continue for the foreseeable future. Accordingly, the Company believes that period-to-period comparisons of its financial results should not be relied upon as an indication of the Company's future performance. No assurance can be given that the Company will be able to achieve or maintain profitability on a quarterly or annual basis in the future. Readers are cautioned not to place undue reliance on these prospective statements, which speak only as of the date of this report. The Company undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's reports filed with the Securities and Exchange Commission, including Exhibit 99.1 to the Company's December 31, 1999 Form 10-K. Results of Operations For the quarter ended September 30, 2000, the Company realized consolidated revenues totaling $568,000 and expenses of $1,342,000, which resulted in a consolidated operating loss for the quarter of $774,000. The Company reported a consolidated net loss of $1,075,000 for the current quarter after allowance for a $275,000 loss from investment in affiliate, Nestor Traffic Systems, Inc. (a 35% owned affiliate). In the corresponding quarter of the prior year, consolidated revenues and expenses totaled $1,141,000 and $1,114,000, respectively, producing income from operations of $27,000 and a net loss of $392,000 after allowance for loss from investment in affiliate of $396,000. For the nine month period ended September 30, 2000, the Company realized consolidated revenues totaling $2,799,000 and expenses of $4,323,000, which resulted in a consolidated operating loss of $1,524,000. The Company reported a consolidated net loss of $2,616,000 for the nine month period after allowance for the loss from investment in affiliate of $1,016,000. In the corresponding period of the prior year, consolidated revenues and expenses totaled $3,787,000 and $3,156,000, respectively, producing income from operations of $631,000 and a net loss of $513,000 after allowance for the loss from investment in affiliate of $1,071,000. Revenues The Company's revenues arise from licensing of the Company's products and technology, and from contract engineering and modeling services. During the quarter ended September 30, 2000, consolidated revenues decreased 50% to $568,000 from $1,141,000 in the quarter ended September 30, 1999. During the nine month period ended September 30, 2000, consolidated revenues decreased 26% to $2,799,000 from $3,787,000 in the quarter ended September 30, 1999. Software Licensing Revenues Total product-licensing revenues were $312,000 in the quarter ended September 30, 2000, a 66% decrease from $931,000 reported in the same quarter of the prior year. The decrease in software license revenues in the quarter is attributable to a continued softness in initial license fees realized from the Company's direct sales efforts and those of its distributor network. There were five licenses realized in the prior year quarter and none in the current year quarter, although two licenses were signed near quarter end and not delivered in the current quarter. Further affecting quarter comparability is a reduction in monthly license fees of four customers whose licenses were sold by the Company or terminated by the customer, offset slightly by three new customers who went live with PRISM during the quarter generating new monthly license fee revenues. Total product-licensing revenues were $1,777,000 in the nine month period ended September 30, 2000, a 39% decrease over $2,936,000 reported in the same period of the prior year. The decrease in software license revenues from the prior year is attributable to the experience in the quarter discussed above offset in part by a one-time fee of $226,800 received from Europay International upon the expiration of their license on June 1, 2000. The Company realized twelve new PRISM licenses in the first nine months of 1999 versus nine new PRISM licenses in 2000. However, the average initial license fee realized from these licenses decreased substantially in 2000, from approximately $157,000 in 1999 versus $70,000 in 2000. The reasons for the decrease in average initial license fees realized includes: two licenses were for PRISM eFraud which were granted for minimal initial fees in exchange for larger volume-based monthly fees expected in the future, and initial license discounts were granted to two customers that licensed multiple versions of PRISM at the same time. As of September 30, 2000, the Company has thirteen customers that are expected to begin producing monthly license fees in the coming year. Engineering Service Revenues During the quarter ended September 30, 2000, revenues from engineering services increased 22% to $256,000 from $210,000 in the corresponding quarter of the prior year. The increase in engineering revenues is primarily related to additional custom model development work. During the nine months ended September 30, 2000, revenues from engineering services increased 20% to $1,022,000 from $851,000 in the corresponding period of the prior year. The increase in engineering revenues is primarily the result of additional project management, customization and, in particular, custom modeling fees associated with the overall increase in new licenses during 1999 and 2000. Operating Expenses Operating expenses totaled $1,342,000 in the quarter ended September 30, 2000, an increase of $228,000 (20%) from total operating costs of $1,114,000 in the corresponding quarter of the prior year. Operating expenses totaled $4,323,000 in the nine month period ended September 30, 2000, an increase of $1,167,000 (37%) from total operating costs of $3,156,000 in the corresponding period of the prior year. Engineering Services Costs related to engineering services totaled $260,000 in the quarter ended September 30, 2000, as compared to $257,000 in the corresponding quarter of the prior year. Costs related to engineering services totaled $778,000 in the nine month period ended September 30, 2000, as compared to $758,000 in the corresponding period of the prior year. Engineering costs have remained stable despite the increase in engineering services revenue during the period. Research and Development Research and development expenses totaled $326,000 in the quarter ended September 30, 2000, as compared with $174,000 in the prior year period. Research and development expenses totaled $1,000,000 in the nine month period ended September 30, 2000, as compared with $581,000 in the corresponding period or the prior year. Increases in 2000 relate primarily to efforts in three areas, (i) PRISM 5.4 release modifications including work to enable the ePRISM internet fraud-detection application, (ii) modification of PRISM code for Money Laundering and NT-based scoring applications, and (iii) the update and integration of the Company's CampaignOne and InterSite products into eCLIPSE for enterprise-wide customer relationship management applications. Selling and Marketing Selling and marketing costs totaled $407,000 in the quarter ended September 30, 2000, as compared with $355,000 in the corresponding quarter of the prior year, an increase of 15%. Selling and marketing costs totaled $1,269,000 in the nine month period ended September 30, 2000, as compared with $993,000 in the corresponding period of the prior year, an increase of 28%. The increase reflects additional marketing efforts by the Company including the addition of a marketing support assistant and increased domestic and international travel costs. General and Administrative General and administrative expenses totaled $350,000 in the quarter ended September 30, 2000, as compared with $328,000 in the corresponding quarter of the prior year, representing an increase of 7%. General and administrative expenses totaled $1,276,000 in the nine month period ended September 30, 2000, as compared with $823,000 in the corresponding period of the prior year, representing an increase of 55%. The increase reflects a $357,000 increase in legal expenses primarily related to increased activity regarding the Nestor vs. HNC Software lawsuit. Also contributing to the increase were the addition of one administrative person and increased public relations fees. Loss from Investment in Affiliate During March and November 1999, the Company's subsidiary NTS sold, in the aggregate, common stock interests totaling 58% of its equity. As a result, the Company's interest in NTS has been accounted for under the equity method of accounting since 1999. Additionally, on June 23, 2000, NTS sold an additional common stock interest to third parties reducing the Company's ownership position in NTS to 35%. In connection with this equity sale, the Company increased the equity value of its NTS investment and additional paid- in capital by $701,000. The Company recorded a loss of $275,000 from the Company's portion of the operating results of NTS in the quarter ended September 30, 2000, representing 35% of the affiliate's net loss in the quarter of $796,000. In the quarter ended September 30, 1999, the Company reported a loss from investment in affiliate of $396,000 representing 62.5% of NTS's actual net loss in the prior year quarter of $634,000. During the nine months ended September 30, 2000, the Company recorded a loss from NTS operations of $1,016,000, representing 42% of NTS's net loss through June 2000 and 35% for the last quarter. In the nine month period ended September 30, 1999, the Company reported a loss from investment in affiliate of $1,071,000, representing 62.5% of NTS's actual net loss in the prior year period. Net Loss Per Share During the quarter ended September 30, 2000, the Company experienced a net loss of $1,075,000, or $.06 per share as compared with a net loss of $392,000, or $.02 per share in the corresponding period of the prior year. During the quarter ended September 30, 2000, there were outstanding basic and diluted 17,913,000 shares of common stock as compared with 17,844,000 shares during the corresponding quarter of the previous year. During the nine month period ended September 30, 2000, the Company experienced a net loss of $2,616,000, or $.15 per share as compared with a net loss of $513,000, or $.03 per share in the corresponding period of the prior year. During the nine month period ended September 30, 2000, there were outstanding basic and diluted 17,895,000 shares of common stock as compared with 17,844,000 shares during the corresponding period of the previous year. Liquidity and Capital Resources Cash Position and Working Capital The Company had consolidated cash and cash equivalents of approximately $71,000 at September 30, 2000, as compared with $1,049,000 at December 31, 1999 and $72,000 at June 30, 2000. At September 30, 2000, the Company had a working capital shortfall of $155,000 as compared with working capital of $1,211,000 and $592,000 at December 31, 1999 and June 30, 2000, respectively. The decrease in working capital results primarily from the loss from operations reported in the current period. The Company's net worth at September 30, 2000 was $548,000, as compared with a net worth of $2,304,000 and $1,594,000 at December 31, 1999 and June 30, 2000, respectively. The decrease in net worth results primarily from net loss reported in the current period offset in part by the Company's equitable portion of the new equity raised by its minority-owned affiliate recorded in additional paid-in capital during the period. On March 24, 1999, the Company entered into a $1,000,000 Line of Credit agreement with Transaction Systems Architects, Inc. ("TSAI"). The loan is secured by the royalty stream and other fees produced by the Company's license agreements with Financial Solutions Division customers. Principal payments are due in twelve equal monthly installments beginning March 1, 2001. Interest on the loan is equal to the effective prime interest rate plus 1%. The line may be reduced to $500,000 if the Company's equity becomes negative or increased up to $4,000,000 if certain financial requirements are attained. On November 1, 2000, the Company drew $145,000 in its first advance against the line of credit. In view of current revenue and cash flow trends, the Company anticipates that additional borrowings will be required to meet working capital requirements. Management believes that the Company's liquid assets, backlog and available line of credit at September 30, 2000 are sufficient to meet the Company's anticipated cash requirements through December 31, 2000 but not beyond. The Company must raise additional capital to maintain current operations and continue as a going concern. There can be no assurance that the Company can raise such additional capital on terms acceptable to the Company and an investor or financial institution. Accordingly, management is evaluating and pursuing options to increase liquidity of the Company which may include, but are not limited to, raising additional capital, selling assets, and/or reducing operating expenses. However, as more fully described under the headline "Prospective Statements," operating results and resultant cash flows may vary significantly. Backlog As of September 30, 2000, December 31, 1999 and September 30, 1999, the Company had revenue backlogs of $3,291,000, $2,751,000, and $2,116,000, respectively, in software license, engineering fees, and other product and service fees. The Company includes in its revenue backlog all fees specified in contracts that have been executed by the Company and its distributors to the extent that the Company contemplates recognition of the related revenue within one year. There can be no assurance that the contracts included in revenue backlog will actually generate the specified revenues or that the actual revenues will be generated within the one-year period. Deferred Income Operations of the Company have been partly funded by prepayments under engineering contracts and licenses of the Company's technology. Such prepayments are recognized as revenue under the percentage-of-completion method as engineering is completed or delivery obligations are fulfilled. The Company bases its estimate of the percentage of completion on the amount of labor applied to a given project compared with the estimated total amount of labor required. The remainder of such prepaid revenue is reflected on the Company's balance sheet as deferred income, and is treated as a liability. Additionally, most of the Company's licenses provide for a minimum monthly license fee over the term of the respective license. The Company defers recognition of theses license fees over the license term. Total deferred income was $3,245,000 at September 30, 2000 as compared with $3,337,000 at December 31, 1999. Future commitments The Company has no material commitments for capital expenditures although management expects that the Company may make future commitments for the purchase of additional computing and related equipment, for consulting, and for promotional and marketing expenses. ITEM 3: Quantitative and Qualitative Disclosure of Market Risk Management assesses their exposure to these risks as immaterial. Part 2: Other Information NESTOR, INC. FORM 10 Q - September 30, 2000 Item 1: Legal Proceedings On October 6, 1998, HNC Software Corp. ("HNC"), a significant competitor of the Company's in the field of Financial Services, obtained a patent titled "Fraud Detection Using Predictive Modeling" and began advising prospective customers of the Company of the patent. Upon review of the patent and consideration of prior actions taken by HNC, the Company initiated a lawsuit against HNC in the United States District Court in Providence, RI on November 25, 1998 alleging violation of Sections 1 and 2 of the Sherman Act (antitrust), violation of the Rhode Island Antitrust Act, patent invalidity, and infringement of Nestor's patents (infringement claims withdrawn January 10, 2000). The suit seeks various damages, including lost profits and treble damages. On June 15, 1999, HNC answered the lawsuit denying the allegations, bringing a counterclaim alleging infringement of the above described patent by the Company, and seeking a declaration of invalidity and unenforceability of one of the Company's patents. On the same day, HNC brought suit in San Diego, CA against the Company's marketing partner, Applied Communications, Inc. (ACI) and ACI's parent alleging various causes of action including patent infringement of the above described patent by the Company's PRISM product which ACI markets. In April 2000, HNC, ACI and its parent agreed to dismiss the lawsuit. ACI has requested that the Company provide indemnification for approximately $900,000 of its legal counsel costs pursuant the PRISM license agreement between ACI and the Company. The Company is disputing the indemnification claim. On July 21, 2000, HNC filed a motion with the court to voluntarily dismiss its patent infringement counterclaim against Nestor. Nestor has not opposed the dismissal of the infringement claims. However, HNC has also requested the District Court to dismiss Nestor's claim that the HNC patent is invalid. HNC's request is based upon a covenant not to sue Nestor, that HNC has filed with the Rhode Island federal court hearing this matter. HNC has claimed that this covenant not to sue removes any legal threat to Nestor for past or present patent infringement and, thus, makes Nestor's claim moot. Nestor has opposed HNC's motion, in part. Notwithstanding any action by the court on HNC's motion, Nestor's other claims alleging antitrust violations and fraud on the patent office should continue as scheduled. Costs associated with the suit are being expensed as incurred. Although the Company believes that it will prevail, there can be no assurance as to the outcome of this suit, the counterclaim, or the ACI indemnity claim. Any conclusion of this litigation or indemnity claim in a manner adverse to the Company may have an adverse effect on its future financial condition and results of operations. Item 2: Changes in Securities Item 3: Defaults on Senior Securities Item 4: Submission of Matters to a Vote of Security Holders Item 5: Other Information Item 6: Exhibits and reports on Form 8-K (a) Exhibits - None (b) The Company did not file any reports on Form 8-K during the nine months ended September 30, 2000. 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) DATE: November 14, 2000 By: /s/Nigel P. Hebborn Chief Financial Officer Principal Accounting Officer ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations