48
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the period ended December 31, 1996
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
July 1, 1996 to December 31, 1996
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, Rhode Island 02906
(Address of principal executive offices)(Zip Code)
(401) 331-9640
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
(Title of Class)
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 if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of Registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
Exhibit Index is on Page _________
The aggregate market value of the voting stock held by non-
affiliates of the registrant, based on the average bid and asked
prices of such stock on March 21, 1997 was $11,229,203. The
number of shares outstanding of the Registrant's Common Stock at
March 21, 1997 was 8,915,741.
DOCUMENTS INCORPORATED BY REFERENCE.
Information to be included in registrant's definitive proxy or
information statement to be filed with the Commission not later
than 120 days following the end of registrant's fiscal year is
incorporated by reference in Part III of the Form 10-K. Forms
8-K dated September 19, 1996 and December 10, 1996 are
incorporated by reference.
ITEM 1. Business
Prospective Statements
The following discussion contains prospective statements
regarding Nestor, Inc. ("Nestor" or "the Company"), 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 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.
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.
General
Nestor, Inc. designs, develops, markets, and supports intelligent
software solutions for mission-critical decision applications in
real-time environments. Nestor employs proprietary neural
network predictive models to convert existing data and business
experiences into meaningful recommendations and actions. The
Company has leveraged its neural-network software architecture
across a wide range of markets, including financial-institution
credit/debit card fraud and real-time traffic-control systems.
In addition, the Company believes that its technology and
software architecture are well suited for intelligent decision
applications addressing a variety of other markets, including
health care payments, long distance and mobile phone fraud,
database marketing, and intranet/internet information discovery
applications.
On December 10, 1996, the Company changed its fiscal year-end
from June 30 to December 31 to better reflect the underlying
nature and timing of the Company's product lines. The change in
fiscal year-end was effective for the six months ended December
31, 1996 ("transition period").
Background
The Company was incorporated under the laws of the State of
Delaware on March 21, 1983, in order to exploit, develop and
succeed to certain patent rights and know-how relating to the
Nestor Learning SystemT ("NLS"), which the Company acquired in
1983 from its predecessor Nestor Associates, a limited
partnership. NLS is an adaptive or self-organizing software
system, commonly referred to as a neural network, that is capable
of extracting the salient features of input patterns without
being told what features to look for and of subsequently
recognizing similar patterns identified by such features. Thus,
NLS can be said to learn from its experience.
Nestor Products
Nestor offers complete application-software solutions that
include adaptive decision models, implementation, education,
training, consulting and engineering support services. Current
Nestor software products detect credit/debit card fraud (PRISMT),
provide remote traffic management of freeways and intersections
(TrafficVisionT), provide responsive on-line information to
internet Web site visitors (InterSite) and provide much greater
efficiencies in document processing and fax distribution
environments (OmniTools & N'Route, which were exclusively
licensed to NCS in June 1996). Nestor's software solutions are
designed for client-server implementation and flexible
integration with customers' existing computing infrastructures.
Installation time periods for the Company's software solutions
depend upon the particular product involved, and can take as
little as three days or as long as six months. The Company
believes that PRISM customer payback periods for license,
installation, and first year user fees are typically less than
one year.
The Company designs and develops specialized software products
utilizing its proprietary software and information-management
knowledge, and, to a lesser degree, designs hardware components
that will enhance the performance of its software products. The
Company's products comprise the following categories: Fraud
Detection and Risk Assessment Systems - are designed to
effectively detect and control fraudulent transactions for
financial institutions that issue credit, debit, or other
financial use cards. The Company is evaluating the expansion of
these product technologies into additional applications such as
health-care payments, long-distance telephone fraud, mobile-phone
service theft, and database marketing. Traffic Management
Systems - are a combination of internally developed software and
internally and externally developed hardware components that
perform as a traffic management system for open road and
intersection applications. The products enable dual use of video
networks to support both traffic/roadway. Internet Web Server0
Systems - are designed to synthesize information from multiple
data sources within an organization and provide content to
present to Web site visitors based on the current state of the
visitor's information. Intersite's purpose is to provide scores
of site visitors which are useful in predicting the purchasing
behavior of visitors. Intelligent Character Recognition Systems
- - include packages of software applications such as OmniTools,
NestorReader, and N'Route which increase productivity in document
processing and fax distribution environments.
Fraud Detection and Risk-Assessment Systems
Custom software packages developed by the Company are the
Proactive Risk Management (PRISMT) and the Nestor Fraud Detection
(FDST) systems, which have been licensed to six financial-
services clients as of December 31, 1996. These systems can
detect bank-card or credit-card fraud, and can be readily updated
by clients to adapt to changing patterns of fraudulent
transactions. By monitoring each cardholder's historical and
current transactions, PRISM is capable of detecting unusual
patterns of card use and of rapidly detecting a significant
proportion of fraudulent transactions with an extremely low error
rate. Customers have reported a reduction of more than 50% in
their credit-card fraud loss experience within 30 days of
installation.
In March 1993, the Company completed the installation of its FDS
product at Mellon Bank. The success of the FDS installation at
Mellon has been instrumental in obtaining additional orders for
FDS and PRISM. Like many other credit-card issuers, Mellon Bank
had been using a rule-based system for fraud detection. Mellon
has reported to the Company that FDS is finding 20 times as many
instances of fraud as their rule-based system, while requiring
reviews of only one-third as many accounts.
In December 1994, the Company installed a merchant-fraud
detection system at Europay International S.A., a Master Card
affiliated association of 700 banks that settle international
bank-card transactions involving currency exchange. Experience
with United Kingdom and Belgium banks indicates a counterfeit
detection rate of up to 50%.
In February 1995, the Company announced PRISMT. PRISM enhances
the fraud-detection capabilities of FDS to include workflow
management and other PC-based productivity tools that are
designed to enable the fraud manager and fraud-control team to
efficiently identify and track frauds detected by the system.
The initial PRISM system was an FDS installed at G.E. Capital
Consumer Financial Services, which was upgraded to incorporate
PRISM in 1995.
PRISM is currently being marketed to financial institutions
expanding the company's presence into the retail credit card
market and international markets.
The following are the primary attributes of the Fraud Detection
and Proactive Risk Management Systems:
Flexible neural-network decision engine. The Company's software
implements a powerful, patented neural-network technology for
adaptive fraud detection that is accurate, fast, field-trainable
and operates in real-time. The neural-network and rule-bases are
provided through software that allows the Company's products to
be customized to fit the customers needs and profiles without
extensive custom programming. Unlike other rule-based systems,
the Company's products learn from the experience of the specific
customer accounts instead of applying "industry" experience to
the customer's environment. The Company's software can be
rapidly trained to look for customer-specific fraud potential by
requiring as few as three training passes through a customer's
data. The system automatically adapts itself for problem
complexity and maximizes the detection of actual fraud while
minimizing false positive indications.
Automatic and ongoing learning ability. The Company's software
is trained to detect fraudulent patterns based upon the
customer's own historical data. Subsequent to installation, the
software continues to update its records for current patterns and
automatically modifies its predictive model to respond to fraud
pattern changes in the customer's user base and environment.
Other competitive systems may require extensive updating of the
software to reflect current industry or customer experience. The
Company's software allows the client to operate with the most
current and customer-specific database possible, with simple
updates entirely under client control.
Quick return on initial investment to customers. Due in part to
customizing the PRISM software to react based upon a client's
specific fraud experience, the product has resulted in fraud loss
savings of greater than 50% at G.E. Capital Consumer Financial
Services and over 50% in counterfeit detection at Europay
International S.A.. Performance at this level would provide a
customer experiencing average industry fraud losses a payback on
their first year installation and use fees of approximately four
to six months.
On-line, transaction-based capability. Nestor's software can
provide an immediate, situation-specific response to each
customer transaction. For example, the PRISM system can
immediately detect and report fraudulent activity within the
first one or two transactions, rather than within one or two days
of transactions.
Flexible client-server and operating solutions. Nestor's
solutions can be integrated into a customer's existing
environment or architecture. The Company's products are based
upon a distributed client-server architecture consisting of
operating components that operate on a wide range of industry
standard, client-server platforms, including the IBM, MVS/CICS,
Tandem's proprietary, fault tolerant Non Stop Kernel (NSK), UNIX
and Windows NT operating platforms. The Company believes that
its product is the only one available today that is adapted to
Tandem's NSK operating system, over which the Company estimates
more than 65% of the world-wide volume of ATM and Debit-card
transactions are processed. PRISM also provides an analysis
environment consisting of: a user-friendly, MS Windows-compatible
graphical user interface, an "open-systems" architecture that is
easily adapted to a client's working environment, fully
integrated work flow tools for enhanced productivity,
customizable reporting tools, and in-depth fraud analysis and
system maintenance tools.
Nestor's Fraud Detection and Risk Assessment Strategy
The Company's objectives are: to deliver high quality products
and services using proprietary neural-network technology to the
banking, retail, telecommunications and health-care management
industries, and to accrete a growing revenue stream from ongoing
product usage fees. The Company's strategy for achieving these
objectives includes the following key elements:
Expand current distribution network. The Company plans to expand
its worldwide direct sales, distribution and service forces. The
Company intends to continue developing domestic markets while
augmenting its international growth. Nestor has executed a
nonexclusive PRISM reseller agreement with CSK Corporation in
Japan during 1996 (See "Licensing, Joint Venture and Development
Agreements"), and is negotiating marketing agreements in Europe
and South America. The Company also intends to increase direct
sales efforts in North America through expansion of direct sales
staff and through marketing and service agreements with
established providers of products and services to its target
markets. On September 19, 1996, the Company signed a non-
exclusive license agreement with Applied Communications, Inc.
(ACI), a subsidiary of Transaction Systems Architects, Inc.,
under which ACI agreed to distribute PRISM throughout the world.
(See "Licensing, Joint Venture and Development Agreements".)
Earn recurring revenues through on-going fees based upon product
usage. The Company's products provide immediate and ongoing
savings to the client through a reduction in the occurrence of
undetected fraud losses. The Company has priced its product to
include upfront fees for licensing and installation, thereby
providing an attractive payback of the customer's initial
investment as discussed above, and including an ongoing usage fee
based upon the number of customer transactions or accounts being
reviewed by the software. This ongoing revenue stream is
expected to grow as new customers install the product. Future
growth may also result from the customer's internal growth in
the number of transactions or accounts being reviewed by the
software.
Apply PRISM products to other markets. The Company believes
that many markets exist which are experiencing fraud type losses
and possess data characteristics similar to the financial
institution industry. The Company plans to extend the successes
of the PRISM product in credit-card fraud detection to other
areas with a high level of transactions and a history of similar
fraud-type loss experience. Some of these market opportunities
may include health-care claim payments and long-distance
telephone fraud. Nestor's strategy is to broaden its product
offerings to address these markets in conjunction with
development funding from strategic government and industry
sources.
Traffic Management Systems
TrafficVision is a combination of Company-developed software and
modular hardware components that provide for remote monitoring to
support traffic data collection and control of traffic flows.
The product is flexible and can be configured to a wide range of
road configurations, including open roads and intersections.
Features include remote video monitoring, real-time vehicle
classification, individual vehicle tracking, simultaneous
communication of video and traffic data over a single
communication network, and generation and logging to a database
of a variety of traffic-information measurements.
Historically, traffic sensing and control has been handled by
wire induction loops buried beneath the road surface. The system
provides basic information such as vehicle counts and speed (with
multiple loop configurations), in support of the function of
controlling traffic light signals when traffic is present. Such
loops experienced a 100% failure rate within the first 10 years
of operation. Replacement/repair is often not performed or
performed long after loop failure due to the high cost of digging
up the roadway.
TrafficVision provides all the benefits currently offered by loop
systems and substantial additional options that increase the
traffic controller's effectiveness in managing traffic
congestion, infractions, and accidents. The fact that
TrafficVision operates completely above ground aids in effective
maintenance. Additionally, the Company believes that the
technology will prove to be cost effective in comparison to loop
technology in applications of multiple-lane intersections.
TrafficVision is designed to incorporate the Company's Ni1000
Recognition Accelerator hardware chip (See "Ni1000 Chip" below).
Development of a working prototype model commenced on September
1, 1995, in conjunction with a funding agreement with California
Institute of Technology Jet Propulsion Laboratory (see
"Licensing, Joint Venture, and Development Agreements"). The
project was completed in December 1996 and phase II field testing
is expected to be ordered and completed in fiscal 1997.
The following are the primary attributes of the Company's Traffic
Management Systems:
Accurate, real-time interpretation of traffic video images. The
Company has leveraged its patented neural-network decision engine
discussed above in Fraud Detection to the application of real-
time processing and learning in the context of video image
interpretation for traffic management and control. Prior
industry attempts to provide video-based detection of traffic
have not proven effective due to the difficulty of designing
robust detection algorithms under a variety of illumination,
visibility and traffic conditions, as well as the need to
implement such algorithms on cost-effective computing platforms
that provide real-time operation. The Company's neural-network
technology, combined with its Ni1000 chip, discussed below, is
able to interpret video images accurately and respond in a real-
time environment.
Rapid deployment and increased services for customers. The
Company's software solutions are designed for rapid deployment
and to provide additional information to customers beyond that
delivered by current loop systems. TrafficVision is designed to
be installed entirely above ground and to tie into existing
customer hardware where appropriate. Maintenance becomes more
efficient than with underground loop systems. TrafficVision
systems allow the customer to obtain the same information and
accuracy as is available through loop technology (e.g. vehicle
count and detection for signal control), and additional benefits
such as remote real-time video monitoring for traffic flow,
vehicle tracking or incidence response.
Leverages customer investment in video infrastructure. State
traffic departments are deploying roadside video cameras to
provide images of road and traffic conditions to better manage
traffic flows and incident response. Nestor's Traffic Monitoring
Systems are designed to support "dual use" of pan-tilt-zoom
equipped cameras for surveillance and traffic detection and
monitoring, thus leveraging the customer's investment in existing
video equipment. Additionally, Nestor's solution supports
simultaneous video and data communication over a single video
communication network, thus further leveraging the customer's
video infrastructure investment.
Compatibility with industry standard platforms. Nestor's traffic
monitoring solutions are architected around dominant industry-
standard platforms: namely, the Windows 95/NT operating system,
tools and communication support components and general "WinTel"
hardware specifications. This facilitates integration into a
customer's existing computing environment, leverages PC economics
to offer a compelling price/performance advantage and lowers
product engineering development costs. Additionally, the
Company's Traffic Monitoring Systems are designed to support the
emerging NTCIP communications standards being mandated in the
traffic detector industry. Further, roadside TrafficVision
detector stations will be compatible with existing and new
traffic controller hardware, such as the new CALTRANS 2070
controller standard.
Nestor's Traffic Management System Strategy
The Company's objectives are to be the high-quality supplier of
intelligent video-based traffic monitoring systems to replace
loop detectors at those sites where video has advantages in
either functionality or cost and to capture new traffic
monitoring applications beyond the capability of loop detector
systems. The Company's strategy for achieving these objectives
contains the following key elements:
Expand national and worldwide distribution. The Company plans to
target leading transportation departments (DOTs) through direct
sales to provide convincing demonstrations of TrafficVision's
superior performance, to create performance standards based upon
TrafficVision functionality and to generate a market pull that
will lead to volume distribution agreements with traffic
integrators and traffic equipment suppliers. The Company intends
to establish distribution agreements with foreign traffic
integrators, concentrating initially in the Far East where the
Company believes large investments are being planned in
transportation infrastructure.
Maintain technology leadership and patent protection in developed
solutions. As noted above, the Company has obtained patent
protection for its proprietary neural networks and hardware
systems (see "Patents") which the Company believes to be uniquely
suited to applications that require field trainability or self-
modification to adapt to new or changing patterns in the data.
The Ni1000 chip allows for high-speed processing applications,
such as video-image processing, on a personal computer platform.
The Company continues to maintain and explore new patent
protection rights for its proprietary software applications. The
Company was issued a new patent in fiscal 1996, and has an
application pending relating to its work in the traffic-
management areas.
Ni1000 Chip, PCI 4000 Recognition Accelerator Board and IBM ZISCT
Chip
Neural networks are inherently parallel systems whose operation,
until recently, has only been simulated on serial computers. The
relative slowness of serial simulation has prohibited the use of
neural networks in many high-value applications that require high-
speed learning and recognition. The Ni1000 Recognition
AcceleratorT chip is an embodiment of the Company's technology
that increases typical processing speeds by hundreds of times and
is expected to open these previously untapped markets to neural-
network solutions. Manufactured by Intel and introduced by the
Company in June 1994, the Ni1000 chip was developed with funding
by the Defense Advanced Projects Research Agency ("DARPA").
Commercial delivery of Ni1000 chips and Ni1000 Development
Systems began in June 1994. In April 1994, the Company and Intel
Corporation signed an agreement which provided the Company with
exclusive marketing rights to the Ni1000 Recognition Accelerator,
subject to certain minimum purchases of the Ni1000 Recognition
Accelerator by the Company. (See "Licensing, Joint Venture and
Development Agreements.")
In connection with the development of the Ni1000 Recognition
Accelerator, the Company and Intel were jointly named as winner
of the 1994 Discover Awards for Technological Innovation in the
category of Computer Hardware & Electronics. The Ni1000
Recognition Accelerator was selected by the editors of Electronic
Design News as a finalist in their 1994 "Innovation of The Year"
contest.
Continued development work in neural-network hardware was
centered on the development of a PC-compatible circuit-board
incorporating multiple Ni1000 Recognition Accelerators, and
associated development-environment software. Development of the
circuit board and software were funded, in part, by a contract
dated August 26, 1993, between the Company and Office of Naval
Research and administered by the Advanced Projects Research
Agency of the Department of Defense ("ARPA"). In connection with
such development work, the Company entered into a Technology
Development Subcontract with Alta Technology Corporation on
December 20, 1994 (see "Licensing, Joint Venture and Development
Agreements", below).
PCI 4000 Recognition Accelerator Board
An outgrowth of the Company's ARPA-funded development work is the
PCI 4000 Recognition AcceleratorT, which was developed
cooperatively with Alta Technology Corporation. The PCI 4000 is
a circuit board containing up to four Ni1000 Recognition
Accelerators and a Pentium controller, which is compatible with
any PC or workstation that provides PCI (Peripheral Component
Interconnect) support.
IBM ZISCT Chip
On January 31, 1996, the Company signed a technology licensing
agreement with IBM to use Nestor's pattern recognition
technology in an IBM developed neural-network semiconductor
device called the ZISCT (see "Licensing, Joint Venture and
Development Agreements"). The Company believes that the entry of
IBM into the field of neural-network applications may assist the
Company in the marketing of its own hardware components.
Internet Web Server Systems
During 1996, the Company began development of an internet product
incorporating the neural-network technology called Nestor
InterSite. Nestor InterSite is server-side software that enables
the Web host to understand individual on-line customers and
dynamically present personalized content.
To date, the Internet has largely been used as a medium for the
broadcast of static information. Its potential for truly
interactive dialogs has not been realized. However, the
Internet, or more specifically the World Wide Web, is undergoing
a revolution. New technologies are being introduced which will
cause Internet web sites to become dynamic and personalized.
The growth of commerce on the Internet is just beginning.
However, the Company believes several industries are poised to
rapidly expand their sales through this channel. Most prominent
among these is the financial services industry, which is expected
to rapidly adopt the internet as a viable business medium.
Nestor InterSite will allow vendors to learn about their web
visitor community, permitting the web host to tailor its products
and services accordingly. Vendors should retain more customers,
sell more products to those customers and identify customers who
are interested in premium products and services.
The following are the primary attributes of Nestor InterSite:
Neural Network Scoring Models: Nestor InterSite employs multiple
models by which to score visitors, producing scores in several
basic categories:
Attitudinal: analyze visitors into psychographic categories
according to their answers to information source preferences and
produce a probability of affiliation with one attitudinal
segment.
Conceptual: analysis of full-text within visited Web pages,
call center logs, and chat and news groups enables the extraction
of semantic interests. Nestor InterSite produces the top 10
conceptual categories for each visitor.
Sales Receptivity: models the correlation between source
data and purchasing behavior. The purchasing behavior which is
scored includes the probability of interest in an up-sell, a
cross-sell, or a promotion.
Data Acquisition: Nestor InterSite stores a visitor profile for
all registered visitors. The system collects data from all
available sources which are relevant for scoring customer
interests. Supported data sources include legacy databases, call
center logs, Web page forms, and Web site text. Nestor InterSite
combines data from these sources into a set of SQL tables which
are stored locally on the Nestor InterSite server.
Control Center: Site visitors' scores are matched to available
content through a powerful user interface. The Control Center
enables the analysis of the visitor community according to model
measures along with the assignment of content based on scores.
Nestor's Internet Web Server System Strategy
The Company's objective is to deliver high quality products and
services coupling proprietary neural-network technology with
industry-standard Unix and Microsoft platforms. The financial
services industry will be the first industry the Company targets.
The Company's strategy for achieving its objective includes the
following key elements:
Complete initial installations. The Company will concentrate on
completing and installing beta versions of InterSite by mid 1997.
These installations will become the references for full product-
rollout in late 1997.
Develop sales channels. Nestor InterSite will be sold as a
complete backoffice solution to automate marketing communications
through the Web. A sale will include integration with legacy
systems, development of custom models, training of webmasters and
business managers and annual maintenance. This type of product
dictates a consultative sales strategy. The Company's initial
approach will be through direct sales. These efforts will be
augmented by teaming with partners who can complement the
productivity improvements provided by Nestor InterSite.
Internationally, Nestor will initially employ direct sales
efforts, leveraging off of the Company's international success
with the Prism product.
Intelligent Character Recognition Products
On June 11, 1996, the Company licensed the exclusive development
and marketing rights in its Intelligent Character-Recognition
("ICR") products (NestorReader, OmniTools, and N'Route) to
National Computer Systems, Inc. ("NCS"), and is no longer
involved in developing, packaging and marketing these products
(see "Licensing, Joint Venture and Development Agreements"). The
Company expects to receive royalties from the sales of these
products and any enhanced versions of these products by the
licensee. The following are the principal ICR products developed
and marketed by the Company through June 11, 1996, and marketed
by NCS since then:
NestorReader(TM)
NestorReader is a software product that is designed to perform
character recognition from images of hand-printed and machine-
printed characters in intelligent character recognition systems.
A principal application of NestorReader has been to replace the
human process of reading data from forms and entering the data
into computers by means of a keyboard. NestorReader is licensed
to original equipment manufacturers, value-added resellers and
systems integrators for integration into image-processing
systems. NestorReader extends the range of optical character
recognition to include hand print and faxed characters at a
price/performance ratio that the Company believes is unequaled by
competitive technologies. In optical character recognition,
existing techniques have successfully solved the problem of
reading conventional, clean, machine-printed characters.
Management believes that hand printed characters - with their
high degree of variability - and faxed characters, with their
high noise level, can only be read satisfactorily by more
powerful technologies like NestorReader.
OmniTools(TM)
OmniTools is a software product that enables corporate
applications developers to access the functionality of
NestorReader from within Windows applications without the need
for C programming. Developers need only use such familiar tools
as Visual Basic or applications macro languages including Visual
Basic for Applications. ICR solutions can thus be developed
from Access, Excel, Foxpro, Lotus 123, Paradox and other Windows
applications. The Company began marketing OmniTools in fiscal
1994.
N'Route
N'Route is a Windows end-user application that automatically
routes incoming faxes and scanned images directly to their
intended recipients. N'Route does this by recognizing the name
or other identifier written on a document and then routing the
document to its destination "mailbox" on Lotus Notes, cc:Mail or
Windows for Workgroups users with Microsoft Mail. Installation
and maintenance by a network administrator is by dialog boxes and
menus and requires no programming or character-recognition
expertise. In February 1995, N'Route was awarded the Imaging
Magazine "Product of The Year" award for 1994.
Sales, Marketing and Methods of Distribution
The Company sells and markets its software and services in North
America through a direct sales organization and through third-
party licensing agreements. Outside of North America, the
Company negotiates marketing agreements with various industry
service providers.
The Company's product lines are targeted toward large commercial
users (e.g., banks for the PRISM product), or federal and state
government agencies (e.g., Departments of Transportation for the
TrafficVision product). The products require technical
assistance through the sales and installation processes.
Accordingly, the Company maintains an in-house staff of engineers
to support the sales, installation, and customer-service
functions.
The Company's FDS and PRISM products are licensed directly by the
Company to financial institutions. The TrafficVision products
will be marketed directly to governmental traffic management
departments or their chosen integrators. The Ni1000 Recognition
Accelerator and the Ni1000 Development System are marketed
directly by the Company to developers of high-speed applications,
and are used in internally developed products. The Company's
Intelligent Character Recognition products are marketed
exclusively by NCS. The Company obtains product inquiries from
product mailings, attendance at trade shows, media advertising,
trade-press coverage and its internet site.
In financial services, the Company has in the past created custom
applications including risk assessment for bank-card fraud
detection, mortgage origination and insurance, consumer credit
and securities trading. Nestor's FDS and PRISM products are an
outgrowth of such development projects. In the United States and
Canada the Company markets FDS and PRISM directly. The Company
has worldwide licenses with Total Systems, Inc. (Total) to
provide its PRISM product to customers for which Total provides
card processing services, and ACI who packages PRISM with its
BASE24 and TRANS24 products for worldwide distribution. In
Japan, custom financial applications are marketed through its
licensee, CSK Corporation. FDS and Prism are licensed to
applications developers in Europe and Japan under a standard, non-
transferable, non-exclusive software license limited to a single
computer. Developers of applications may not make, use or sell
multiple copies of such applications without entering into
additional licensing arrangements with the Company. Management
of the Company believes that the success of the PRISM and FDS
products will create a valuable franchise in each institution,
leading to extensions of the Company's technology to other risk-
assessment applications.
During the transition period, the Jet Propulsion Laboratory, GE
Consumer Credit Financial Services, BankOne, Mellon Bank and
Customer Services, Inc. accounted for 19%, 18%, 15%, 13% and 11%,
of the Company's revenues respectively. In fiscal 1996, National
Computer Systems and Europay International accounted for 30% and
13% of the Company's revenues, respectively. In fiscal 1995,
Europay International accounted for 16% of the Company's
revenues. The loss of any of these customers for any reason
could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company is not required to maintain significant inventories
in order to deliver its products. The Company does not generally
grant payment terms to customers in excess of 90 days. At
December 31, 1996, the Company had a backlog of approximately
$209,000 in undelivered development and installation contracts
and approximately $582,000 in prepaid royalties. As of June 30,
1996, the Company had a backlog of approximately $408,000 in
undelivered development and installation contracts and $431,000
of prepaid royalties and fees. As of June 30, 1995, the Company
had a backlog of approximately $101,000 in undelivered
development and installation contracts and $439,000 of prepaid
royalties and fees.
Technology
The Company's technology deals with the problem of pattern
recognition. When presented with a pattern of information, it
can be valuable to identify that pattern, whether it is a pattern
of fraudulent credit card use, fraudulent health care claims,
handwritten characters, vehicles in a traffic flow, and so on.
Several methods currently exist to address the problem of
processing information in order to recognize a pattern in the
information. Included among these are "expert" systems of rules,
and neural networks. The Company's products combine both of
these methods to optimize pattern recognition capabilities.
Rule-Based Technology. The Company's systems employ expert or
rule-based technology to define customer strategy, policy and
procedures in its products. Rule-based systems contain decision
trees of conclusions based on the existence of various
conditions. For example, a credit card transaction has been
authorized. To determine if that transaction was fraudulent and
whether or not an account should be investigated, the following
set of questions may be asked: has the card been reported lost or
stolen since the transaction occurred? If "yes", the transaction
equals "fraud"; if no, did the purchase amount exceed the credit
limit? If "yes", did the purchase occur less than one hour after
the previous purchase? If "yes, and so on. It is almost
impossible to cover all possibilities of combinations of
circumstances even with the most comprehensive suite of rules.
So, while allowing the implementation of select rules may be
beneficial, a decision based solely on rules may not always be
correct or practical.
Neural-Network Technology. Neural-networks simulate a virtual
network of interconnected units, processing data in parallel, and
communicating with each other at lightning speeds. A trained
neural-network expects input and then outputs a response: either
"unrecognized", "recognized", or "not sure". Exceeding the
capability of if-then-else conditional rules, the power of the
neural-networks is in their ability to accurately recognize
input, such as attempting to recognize characters from a scanned
handwritten sample, which is ill-defined (i.e. written in very
light pencil), affected by "noise" (i.e. smudged), or blatantly
unusual (i.e. overly large or small, or containing skewed
characters). Nestor, as the result of extensive research, has
created a proprietary neural-network technology referred to as
the Restricted Coulomb Energy ModelT (RCE) which has been granted
five patents.
The RCE model has many unique features. It has the fastest
learning and processing speed of any neural-network system. It
has been demonstrated that the RCE will learn to recognize
patterns orders of magnitude faster than a typical public domain
neural-network such as Back Propagation (BP). RCE has the
ability to add new features or classes without the need to
retrain and re-engineer the complete system. For example, using
BP, experts must re-engineer and completely retrain the entire
system if new features or classes are added. Re-engineering and
retraining is impractical for many real-world applications. RCE
is a dynamic configuration of the network so that it can scale
and configure itself to accommodate the complexity of a problem
and make the most efficient use of available hardware. With BP,
one must precisely engineer the number of neurons through
experimentation in order to use the technology, and a stable
solution is not guaranteed.
Nestor has also been granted a sixth patent for a multi-unit
system referred to as the Nestor Learning SystemT (NLS) which is
ideally suited for many real-world pattern recognition
applications. The NLS has a patented hierarchical, multi-network
system for better control and accuracy. This approach is
analogous to the way the human neural-network is believed to
function. The Company believes that the rapid model development
and operational flexibility afforded by its technology provides a
competitive advantage in the development of intelligent-decision
software solutions.
Research and Development Activities of the Company
The Company believes that its future depends upon its ability to
improve its current technologies and products and to develop new
technologies and products. The Company intends to pursue new and
enhanced technologies and products. The Company attempts to
locate external resources to assist in the costs of developing
new technologies or products, but may bear all or a portion of
such costs internally.
The Company's research is almost entirely applied research
intended to develop solutions to specific pattern-recognition
problems. This research has resulted in various patents relating
to improvements to the Company's basic technology (see
"Patents"). The Company received one new patent in fiscal 1996
and has one application pending as of December 31, 1996. These
improvements are incorporated into the Company's products.
The market for the Company's products may be impacted by changing
technologies. The Company's success will depend upon its ability
to maintain and enhance its current products and develop new
products in a timely and cost-effective manner that meets
changing market conditions. There can be no assurance that the
Company will be able to develop and market on a timely basis, if
at all, product enhancements or new products that respond to
changing market conditions or that will be accepted by customers.
Any failure by the Company to anticipate or to respond adequately
to changing market conditions, or any significant delays in
product development or introduction could have a material adverse
effect on the Company's business, financial condition and results
of operations.
The Company expended, in the six months ended December 31, 1996,
and in the fiscal years ended June 30, 1996, 1995, and 1994
respectively, $294,000, $823,000, $2,093,000 and $1,160,000 in
support of the various aspects of Company-sponsored research and
development.
Patents
The Company has continually sought and obtained patent protection
for its proprietary neural networks and systems, which have as a
principal feature rapid learning from a relatively small number
of examples. The Company believes that this capability makes the
Company's technology uniquely suited to applications that require
field trainability or self-modification to adapt to new or
changing patterns in the data. The Company's patents also cover
multiple-neural-network systems, which enable the company to
develop products that combine high accuracy with high processing
speeds; and the Company's RCE neural network, which exhibits
rapid learning and minimizes the internal connections needed for
its functioning. This sparse connectivity has enabled the
Company to develop, with Intel Corporation, a neural-network
integrated circuit (the Ni1000 Recognition AcceleratorT chip)
containing many more nodes than has been possible with other
designs.
The Company owns ten United States patents and twenty-three
foreign patents issued in eleven countries. In addition, there
is one application pending in the United States, and there are
five applications pending in various foreign countries, as of
December 31, 1996. The foreign patents and patent applications
correspond to one or more of the United States patents.
In the field of web server systems, the Company faces competition
from a number of sources, including commodity-software providers,
traditional database vendors, and vertical solution providers.
The first two groups include such companies as Microsoft,
Netscape and Oracle. Companies providing vertical solutions
include BroadVision, Inc. and Firefly, Inc. The market for
internet-oriented products is intensely competitive with new
competitors emerging frequently.
The Company believes that seven of its United States patents, and
eleven corresponding foreign patents, are material to its
business. These United States patents expire at various times
from 1998 to 2008. The corresponding foreign patents expire at
various times from 1995 to 2008. The following table lists the
Company's material United States patents:
<TABLE>
<CAPTION
Patent Year of
Number Title Date of Issue
Expiration
<S> <C> <C> <C>
4,254,474 An Information Processing
System Using Threshold
Passive Modification March 3, 1981 1998
4,326,259 Self-organizing General
Pattern Class Separator and
Identifier April 20, 1982 1999
4,760,604 Parallel, Multi-unit,
Adaptive, Nonlinear Pattern
Class Separator and
Identifier July 26, 1988 2005
4,897,811 N-Dimensional Coulomb
Neural Network Which
Provides for Cumulative
Learning of Internal
Representations January 30, 1990 2007
4,958,375 Parallel, Multi-unit,
Adaptive Pattern
Classification System Using
Inter-unit Correlations And
An Intra-class Separator
Methodology September 18, 1991 2008
5,054,093 Parallel, Multi-unit,
Adaptive, Nonlinear Pattern
Class Separator and
Identifier October 1, 1991 2008
5,479,574 Method and Apparatus for
Adaptive Classification December 26, 1995 2012
</TABLE>
Competition
In the field of fraud-detection and risk-assessment systems, the
Company encounters competition from a number of sources,
including (a) other software companies, (b) companies' internal
MIS departments, (c) network and service providers, and (d)
neural-network tool suppliers. In the fraud-detection market,
the Company has experienced competition from Fair, Isaac & Co.,
HNC Software, Inc., IBM, NeuralTech Inc., Neuralware, Inc., Visa
International and others. The Company's fraud detection product
also competes against other methods of preventing credit-card
fraud, such as card-activation programs, credit cards that
contain the cardholder's photograph, smart cards and other card
authorization techniques. The introduction of these and other
new technologies will result in increased competition for the
Company and its products.
In the field of traffic management systems, the Company's
TrafficVision products (see "Recent Product Developments") face
competition primarily from standard providers of existing loop
system products. Other technologies exist from various sources
that provide some of the basic traffic management functions
provided by the loop system, such as Microwave, Ultrasonic,
Infrared, and Acoustic. The Company believes that these
technologies have limitations and do not provide the full range
of options available through TrafficVision. Video-based systems
are also available through other companies such as Econolite,
Peek Traffic, Odetics, Traficon, Siemens, and Rockwell
International. However, the Company believes that the platforms
on which these video-based products operate do not provide the
image processing capabilities possessed by TrafficVision and the
Ni1000 Recognition Accelerator Chip.
In the field of high-speed processing, the Company's Ni1000
Recognition Accelerator product (see "Recent Product
Developments", above) faces competition primarily from Adaptive
Solutions, Inc., whose CNAPS board contains proprietary parallel-
processing integrated circuits. The Company believes that the
CNAPS board is a general-purpose parallel processor that is not
optimized for pattern classification. The Company further
believes that the CNAPS board and associated software have a list
price that is approximately 50% higher than similar
configurations of the Company's Ni1000 products, and that the
Company's hardware products typically operate at speeds 10 to 50
times faster than the CNAPS product in pattern-classification
applications.
Most of the Company's competitors have significantly greater
financial, marketing and other resources than the Company. As a
result, they may be able to respond more quickly to new or
emerging technologies or to devote greater resources to the
development, promotion and sale of their products than the
Company. Competitive pressures faced by the Company may
materially adversely affect its business, financial condition and
results of operations.
Employees
As of December 31, 1996, the Company had 37 full-time employees,
including 23 in product development, 7 in sales and marketing
and 7 in finance and administration. Three of these employees
have earned Ph.D. degrees. One of the Company's current
directors (and a founder of Nestor Associates) received the Nobel
Prize in Physics in 1972. All of these employees are located in
the United States. None of the Company's employees is
represented by a labor union. The Company has experienced no
work stoppages and believes its employee relationships are
generally good.
The Company's success depends to a significant degree upon the
continued employment of the Company's key personnel.
Accordingly, the loss of any of the Company's key personnel could
have a materially adverse effect on the Company's business,
financial condition and results of operations. No employee
currently has an employment contract in place with the Company.
The Company believes its future success will depend upon its
ability to attract and retain industry-skilled managerial,
engineering, and sales personnel, for whom the competition is
intense. In the past, the Company has experienced difficulty in
recruiting a sufficient number of qualified sales people. In
addition, competitors may attempt to recruit the Company's key
employees. There can be no assurance that the Company will be
successful in attracting, assimilating and retaining such
qualified personnel, and the failure to attract, assimilate and
retain key personnel could have a materially adverse effect on
the Company's business, financial condition and results of
operations.
Licensing, Joint Venture and Development Agreements
The Company seeks to enter into license agreements and research
and development contracts in order to obtain greater market
penetration and additional funding of the development of its
technology in specific fields of use.
Total Systems, Inc.
During the six month period ended December 31, 1996, the Company
designed and installed a fraud detection system for Total
Systems, Inc., a major provider of card processing services for
financial institutions. Total Systems will provide PRISM fraud
detection services to its customers along with the other
transaction processing services. The Company will receive fees
based upon the number of transactions that are scored by PRISM
and expects revenues to commence in the second quarter of 1997.
Applied Communications, Inc. (ACI)
On September 19, 1996, the Company entered into a non-exclusive
license agreement with ACI which grants to ACI the right to
integrate PRISM with ACI's products and distribute on a worldwide
basis. ACI provides authorization and transaction processing
software to more than 475 customers throughout the world. The
Company will receive royalties based on PRISM license,
engineering and ongoing use fees received from ACI sublicenses.
National Computer Systems, Inc. (NCS)
On June 11, 1996, the Company entered into an exclusive Licensing
Agreement and an Asset Purchase Agreement with NCS transferring
the development, production, and marketing rights of the
Company's Intelligent Character Recognition (ICR) products to
NCS. The Company received $1,400,000 as an initial license fee
pursuant to the Licensing Agreement, and expects to receive
royalties on future sales of the product by NCS. Minimum annual
royalties range from $160,000 in 1997 to $350,000 in 2001 and
beyond. If NCS terminates its exclusive rights under the
contract, minimum royalty payments would not be required
subsequent to such termination.
The Asset Purchase Agreement transferred tangible and intangible
assets used exclusively in the ICR business to NCS for $300,000.
The initial license fee and asset sale proceeds are recognized as
revenues in Fiscal 1996.
IBM ZISC (TM)
On January 31, 1996, the Company signed a technology licensing
agreement with IBM to use Nestor's pattern recognition technology
in an IBM developed neural network semiconductor device. IBM has
the right to use the technology in the IBM ZISC (zero instruction
set computing) digital integrated Neural Network chip and in
future versions of the chip and related product enhancements.
The IBM ZISC chip is expected to enable such complex mission-
critical applications as image recognition for satellite,
military and medical operations, financial data management and
risk assessment, automotive applications, as well as highly
sensitive identification systems such as sonar and fingerprinting
and other crime-scene type analysis. The Company will receive
royalties from the sales of the chip and related products.
California Institute of Technology Jet Propulsion Laboratory
(JPL)
On September 1, 1995, the Company commenced a partially funded
development agreement with JPL to design a Traffic Surveillance
and Detection Technology capable of directly measuring desired
traffic parameters simultaneously, combined with higher accuracy
and at a lower cost than available with current technology. The
Company is applying its expertise in rapid pattern recognition
and neural network designs to the project. The prototype and
initial program was completed in December 1996. The Company
expects to receive a Phase II contract for field testing of the
prototype in early 1997.
The total value of the contract is $597,000, all of which had
been recognized as revenue by December 31, 1996.
DARPA/ARPA
The Company entered into a development agreement dated March 13,
1990 with DARPA for the development of a neural-network chip
prototype embodying the Company's proprietary technology. On
April 21, 1992 the Company and DARPA agreed to increase the
contract to approximately $1,630,000 and extended the expected
completion date to May 1993. In May 1990, the Company signed a
Technology Development Agreement with Intel Corporation, under
which Intel agreed to provide the design and manufacturing
capabilities to satisfy the requirements of the contract with
DARPA. The total cost to the Company of the subcontract with
Intel is $750,000. On April 30, 1992, the cost of the
subcontract was increased to $1,050,000. During the year ended
June 30, 1993 the Company included in revenue approximately
$436,000 relating to its work under the DARPA contract.
On August 26, 1993, the Company entered into a follow-on program
with ARPA (formerly known as DARPA) to design and produce a PC
compatible application design and development environment,
comprising both hardware and software, which will enable users to
incorporate the Ni1000 into products. The total value of this
contract, which was completed in December 1995, was $776,167, of
which approximately $423,000 was realized in fiscal 1994.
CSK
On June 13, 1996, the Company executed a nonexclusive PRISM
Reseller Agreement with CSK Corporation to market, install,
maintain, train and support the PRISM product in Japan. The
agreement is for a term of two years. As of December 31, 1996,
CSK had received orders from three Japanese financial
institutions for PRISM feasibility studies.
Intel Corporation
On October 15, 1993, the Company and Intel Corporation had
entered into a license agreement, pursuant to which Intel
acquired a non-exclusive right to develop and sell products
incorporating the Company's technology. On April 7, 1994, the
license agreement was amended to grant to the Company exclusive
marketing rights to the Ni1000 Recognition Accelerator Chip,
which Intel will manufacture and sell to the Company subject to
the Company's meeting certain minimum purchase requirements. If
such minimum purchase requirements are not met by the Company,
the Company's right to market the Ni1000 Recognition Accelerator
Chip will become non-exclusive. The Company placed the first
required minimum purchase order in June 1995 and has maintained
minimum order requirements.
Alta Technology
On December 20, 1994, the Company entered into a Technology
Development Subcontract ("the Subcontract") with Alta Technology
Corporation ("Alta") relating to the development of a multi-chip
Ni1000 circuit board. Pursuant to the Subcontract, the Company
and Alta granted to each other licenses to use certain of their
respective proprietary technologies that are required for
manufacturing the Ni1000 circuit board, including Ni1000 boards
to be delivered to ARPA under a contract between the Company and
the Office of Naval Research. The Subcontract is in the amount
of $154,200 payable by the Company to Alta, upon receipt by the
Company of payments by ARPA, during the period ending May 31,
1995. As of June 30, 1995, the Alta subcontract had been re-
negotiated to $194,200, and Alta had billed the Company in the
aggregate amount of $198,000. Of the total ARPA contract of
$776,167, the Company had billed $765,841 to ARPA at June 30,
1995, and the remainder in 1996.
Recent Financing
On August 4, 1994, Wand Partners, Inc. purchased from the
Company, for an aggregate purchase price of $1,500,000, (i) 1,500
shares of Series C Convertible Preferred Stock of the Company
which are presently convertible into 1,000,000 shares of Common
Stock of the Company, and (ii) a warrant to purchase 1,000,000
shares of Common Stock of the Company at a price of $1.50 per
share ("Wand Warrants"). The net proceeds to the Company of this
transaction, after expenses, were $1,470,000.
Pursuant to a Standby Financing and Purchase Agreement dated
March 16, 1995, Wand loaned to the Company the sum of $1,200,000
evidenced by a promissory note (the "Note") which bears interest
at the rate of 10% per annum payable in shares of Common Stock of
the Company valued at $1.00 per share until September 15, 1995
when the Note matures. On June 30, 1995, the Company and Wand
entered into a First Amended and Restated Standby Financing and
Purchase Agreement, pursuant to which Wand made an additional
loan to the Company bringing the principal amount of the Note to
$1,700,000 and extended the term of the note to October 15, 1995.
The Note is callable by the holder at any time up to the
commencement of the rights offering in the event of a material
adverse change in the condition or prospects of the Company.
Wand has agreed to waive the Rights that it otherwise would have
been entitled to receive in the rights offering to shareholders
described below. Instead, upon the conclusion of the rights
offering, Wand has agreed to cancel and surrender the Note to the
Company and to apply the principal amount of the Note, and an
additional $300,000 first to the purchase of up to a maximum of
220,000 Unregistered Units (in proportion to the Units purchased
by other stockholders of the Company pursuant to this offering)
and then to the purchase of additional shares of Series C
Convertible Preferred Stock. The terms and conditions of such
Series C Convertible Preferred Stock are the same as the 1,500
shares of Series C Convertible Preferred Stock previously owned
by Wand. Concurrently with the purchase by Wand of such
additional shares of Series C Convertible Preferred Stock, the
Company reduced the exercise price of the Wand Warrants from
$1.50 per share to $0.65 per share. The Company will record an
expense as a result of the reduction in exercise price upon
exercise of warrants. The expense will represent the difference
between the market value of the Company's Common Stock being
acquired and the aggregate reduced exercise price of the warrants
on the date of exercise, but not more than the reduction in
exercise price. The maximum such expense to be recorded will be
$850,000. During the period ended December 31, 1996, the Company
began recording, on a prorated basis, the maximum expense over
the remaining life of the warrants.
As consideration for this commitment, the Company has issued to
Wand as a commitment fee 100,000 shares of the Common Stock of
the Company, the market value of which was charged to operating
expenses in 1995. Upon completion of the offering and the
conversion of the Note as described above, the Company has agreed
to issue to Wand 700,000 ten-year warrants to purchase shares of
the Common Stock of the Company at $1.00 per share, and the
difference between the market value of the underlying Common
Stock of the Company and the aggregate exercise price of such
warrants was charged to operating expenses at the time of
issuance of such warrants in the amount of $131,250 during fiscal
1996.
On August 16, 1995, a registration statement filed by the Company
with the Securities and Exchange Commission became effective.
The registration statement related to the shares received upon
the exercise of warrants in April 1994 as described above, and to
the shares underlying certain warrants issued to the Selling
Agent of the first private placement described above. The
registration statement was filed principally to effect a rights
offering to shareholders of the Company, each of whom was granted
the right to purchase one Unit for each five shares of Common
Stock owned or into which convertible preferred stock was
convertible. A Unit consisted of one share of Series D
Convertible Preferred Stock, which is convertible into Common
Stock at any time after January 1, 1996, and a warrant to
purchase one-half share of Common Stock at a purchase price of
$2.00 per share. Such warrants are exercisable immediately and
for a term of three years after the effective date of the
registration statement.
At June 30, 1995, there were outstanding 1,500 shares of Series C
Convertible Preferred Stock. In early October 1995, Wand
exchanged certain Notes payable for an additional 1,970 shares of
Series C Preferred Stock. On January 31, 1996, Wand exchanged
all of its Series C Convertible Preferred Stock for 1,444 shares
of Series E Convertible Preferred Stock and 2,026 shares of
Series G Convertible Preferred Stock. In addition, on January
31, 1996, Wand purchased 599 shares of Series F Convertible
Preferred Stock for a total of $599,000. On March 7, 1996, Wand
purchased 777 shares of Series G Convertible Preferred Stock for
a total of $777,000. See below and Item III, Financial
Statements and Footnotes.
Series E, F,G and H Convertible Preferred Stock
Each share of Series F and G Preferred Stock is convertible at
the option of the holder at any time after June 30, 1996 into
shares of Common Stock at the conversion price of $1.25 per
share, subject to adjustment. Each share of Series E and H
Preferred Stock is convertible at the option of the holder at any
time and from time to time into shares of Common Stock at the
conversion price of (a) $1.50 per share subject to adjustment
prior to August 1, 2004 or (b) on or after August 1, 2004 at a
conversion price which is the lower of $1.00 or the conversion
price in effect pursuant to (a).
Except as provided herein, any holder of Series E and G Preferred
Stock that is subject to the Bank Holding Company Act of 1956
("BHCA Holder"), as amended, shall have no voting rights. Each
holder of Series E and G Preferred Stock that is not a BHCA
Holder shall be entitled to vote on all matters as to which
stockholders of the Company are entitled to vote, and each such
holder shall be entitled to cast a number of votes equal to the
greatest number of whole shares of Common Stock into which such
holder's shares of Series E and G Preferred Stock could be
converted. The holders of the Series F and H Convertible
Preferred Stock are entitled to one vote for each share of Common
Stock into which the shares are convertible.
In the event the Company is in default with respect to the
payment of (i) two consecutive cash dividends after the
"Restricted Period" as hereinafter defined or (ii) two dividends
within any six consecutive dividend periods the holders of the
Series F and G Preferred Stock shall have the right to elect two
directors and the holders of the Series E and H Preferred Stock
shall have the right to elect four directors for so long as the
default continues. In the event the Company is in default with
respect to the payment of (i) four consecutive cash dividends
after the Restricted Period as hereinafter defined or (ii) four
dividend payments within any eight consecutive quarterly dividend
periods, the holders of the Series F and G shall have the right
to elect four directors and the holders of the Series E and H
Preferred Stock shall have the right to elect eight directors for
so long as the default continues.
In the event the Company violates the provision of, or is in
default under the terms of any loan agreement or in the event a
judgment is entered against the Company or any subsidiary in the
amount of $50,000 or more, the holders of the Series F and G
Convertible Preferred Stock shall have the right to elect four
directors and the holders of the Series E and H Preferred Stock
shall have the right to elect eight directors for so long as the
default continues.
The holders of the Series F and G Preferred Stock, except during
the Restricted Period, are entitled to receive out of funds of
the Company legally available for such purpose as and when
declared by the Board of Directors of the Company quarterly
dividends in cash at a rate of nine percent (9%) compounded daily
per annum of the stated par value per share ($1,000 on original
issuance) of Series F and G Preferred Stocks. Dividends shall
accrue, be accumulated and added to the stated value whether or
not declared. So long as any shares of Series F and G Preferred
Stock are outstanding, the Company shall not declare or pay any
dividends on any outstanding Common or Preferred Stock, other
than the Series D, F and G Preferred Stock. The Restricted
Period as it relates to the payment of dividends on the Series F
and G Preferred Stock means a period beginning on the date of
issuance of the Series F and G Preferred Stock and ending on
September 30, 1997. While no dividends are payable during the
Restricted Period, they will accrue and accumulate during the
Restricted Period.
The holders of the Series E and H Preferred Stock, except during
the Restricted Period, are entitled to receive out of funds of
the Company legally available for such purpose as and when
declared by the Board of Directors of the Company quarterly
dividends in cash at a rate of seven percent (7%) compounded
daily per annum of the stated par value per share ($1,000 on
original issuance) of Series E and H Preferred Stocks. Dividends
shall accrue, be accumulated and added to the stated value
whether or not declared. So long as any shares of Series E and H
Preferred Stock are outstanding, the Company shall not declare or
pay any dividends on any outstanding Common or Preferred Stock,
other than the Series D, F and G Preferred Stock. The Restricted
Period as it relates to the payment of dividends on the Series E
and H Preferred Stock means a period beginning on the date of
issuance of the Series E and H Preferred Stock and ending on the
earlier of (a) the first day of the calendar quarter in which the
Company first pays cash dividends on its Common Stock or (b) June
30, 1998. While no dividends are payable during the Restricted
Period, they will accrue and accumulate during the Restricted
Period.
The Company is obligated to redeem all outstanding shares of
Series E, F, G and H Preferred Stock outstanding at the stated
value plus accrued dividends on August 1, 2004. The holders of
the Series E, F, G and H Preferred Stock have the right to
require that the Company redeem, to the extent the Company may
lawfully do so, all or a portion of the then outstanding shares
of Series E, F, G and H Convertible Preferred Stock at the stated
value plus accrued interest and unpaid dividends in the event of
a merger, reorganization, transfer of the majority of the voting
securities of the Company, or sale of more than 25% of the assets
of the Company.
ITEM 2. Properties.
The Company leases offices and research and development
facilities, consisting of approximately 10,000 square feet,
located at One Richmond Square, Providence, Rhode Island 02906,
for which the annual base rental is $141,742. The Company
believes these facilities will be adequate to serve its needs in
the foreseeable future.
ITEM 3. Legal Proceedings.
There are no material pending legal proceedings as of the date of
this filing.
ITEM 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during
the second quarter of the period ended December 31, 1996.
ITEM 5. Market for Registrant's Common Stock
and Related Securityholder Matters
The Company's common stock was first offered to the public in
December, 1983. The principal market in which the Company's
common stock is traded is the over-the-counter market. The
quotations below reflect inter-dealers prices, and do not include
retail markups, markdown or commissions and may not necessarily
represent actual transactions. The shares of common stock are
traded in the over-the-counter market and bear the symbol "NEST".
Low Bid High Ask
Period Ended December 31, 1996
1st Quarter 1 11/16 3 1/4
2nd Quarter 2 1/8 3
Year Ended June 30, 1996
1st Quarter 1 1/4 1 11/16
2nd Quarter 9/16 1 3/8
3rd Quarter 23/32 2 3/16
4th Quarter 1 3/8 3 3/16
Year Ended June 30, 1995
1st Quarter 1 2-3/8
2nd Quarter 5/8 1-1/4
3rd Quarter 1/2 3-3/8
4th Quarter 1-1/4 2-1/2
As at March 21, 1997, the number of holders of record of the
issued and outstanding common stock of the Company was 415.
The Company has not declared any cash dividends with respect to
its common stock since its formation.
ITEM 6. Selected Financial Data
<TABLE>
<CAPTION
Six Months Ended
December 31, Years Ended June 30,
1996 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Operating
revenue $ 1,195,904 $ 5,461,580 $ 3,195,563 $ 2,230,474 $ 1,849,104 $ 2,219,425
Other income
(expense) $ 26,280 $ 39,950 $ (221,024) $ (282,418) $ (27,459) $ 3,137
Net income
(loss) $ (935,337) $ 12,690 $ (3,457,422) $ (1,758,584) $ (1,613,565) $(1,814,856)
Earnings per share
Weighted
number of
outstanding
shares 8,689,031 7,847,510 7,411,502 6,840,407 6,801,929 6,788,006
(Loss)
per share $ (.13) $ (.03) $ (.48) $ (.26) $ (.22) $ (.27)
SELECTED BALANCE SHEET DATA:
Total assets $ 2,817,944 $ 3,351,871 $ 1,812,495 $ 1,096,314 $ 935,337 $ 1,793,782
Working
capital $ 1,243,577$ 1,983,661 $ (1,882,875) $ 220,243 $ 131,827 $ 535,126
Long-term
Redeemable
Preferred
Stock $ 5,398,908 $ 5,207,538 $ 1,600,328 $ --- $ --- $ ---
Capital
leases $ 9,455 $ 9,455 $ --- $ 3,363 $ 5,413 $ ---
Deferred
income $ 430,899 $ 430,899 $ 438,896 $ 954,491 $ 954,491 $ 954,491
Prior period Selected Financial Data has been reclassified to conform to 1996
classifications.
ITEM 7: Management's Discussion and Analysis
Liquidity and Capital Resources
Cash Position and Working Capital
The Company had cash and short term investments of approximately
$774,000 at December 31, 1996; $2,013,000 at June 30, 1996;
$452,000 at June 30, 1995; and $416,000 at June 30, 1994. At
December 31, 1996, the Company had working capital of $1,244,000,
as compared with $1,983,000 at June 30, 1996, and a working-
capital deficiency of $1,882,000 at June 30, 1995. The decrease
in working capital from June 1996 to December 1996 reflects
primarily the loss for the period reduced by the proceeds from
the sale of common stock.
The Company had a negative net worth of $4,332,000 at December
31, 1996, as compared with negative net worth of $3,433,000 at
June 30, 1996, and negative net worth of $3,663,000 at June 30,
1995.
Management believes that the Company's revenues will generate
sufficient liquidity, when combined with its liquid assets as at
December 31, 1996, to meet the Company's anticipated cash
requirements through the end of the year ending December 31,
1997. If the Company does not realize revenues sufficient to
maintain its operation at the current level, management of the
Company would curtail certain of the Company's operations until
additional funds become available through investment or revenues.
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. Total deferred income was
$769,000 at December 31, 1996, as compared with $517,000 at June
30, 1996 and $516,000 at June 30, 1995.
Future Commitments
The Company purchased additional computers and related equipment
during the six months ended December 31, 1996, and the fiscal
years ended June 30, 1996 and 1995, and valued its investments in
computers and related equipment (net of depreciation) at $255,590
at December 31, 1996. 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 development of
hardware, for consulting and for promotional and marketing
expenses.
The company has no material commitments other than a commitment
to purchase from Intel Corporation a supply of Ni1000 Recognition
Accelerator chips. The Company placed a purchase order in the
amount of $195,000 with Intel Corporation in June 1996, and
expects to take delivery of this order during the second quarter
of 1997.
Inflation
Management believes that the rate of inflation in recent years
has not had a material effect on the Company's operations.
Results of Operations
Analysis of Six Months Ended December 31, 1996 Compared to Six
Months Ended December 31, 1995
On June 11, 1996, the Company entered into an exclusive Licensing
Agreement with National Computer Systems, Inc. (NCS) transferring
the development, production, and marketing rights of the
Company's Intelligent Character Recognition (ICR) products to
NCS. Largely as a result of the transfer of ICR operations to
NCS, for the transition period the Company realized a 26%
decrease in revenues compared to the corresponding period of the
prior fiscal year. Expenses in the transition period decreased
8% and the operating loss increased 62% when compared with the
corresponding period of the prior year.
The Company began in the quarter ended September 30, 1996, a
project to customize its PRISM Fraud Detection System for a
customer. Because the terms of the agreement have not been
finalized, the Company is accounting for the development costs in
accordance with SOP 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts," which
provides that costs be deferred until delivery is made under the
terms of an enforceable agreement. The Company executed its
agreement on March 28, 1997 and made required deliveries. For
the six months ended December 31, 1996, the Company deferred
$364,000 of costs associated with this project.
Revenues
The following table compares revenues for the transition period
with revenues for the comparable period of the preceding year,
including and excluding revenues from ICR operations transferred
to NCS:
Total
Revenues
Total Total Six-Month
Revenues Revenues Period
Six-Month Six-Month Ended
Period Period Dec. 31, 1995
Ended Ended Excluding
Dec. 31, 1996 Dec. 31, 1995 Change ICR Change
$1,196,000 $2,149,000 -44% $1,195,000 0%
The Company's revenues arise from licensing of the Company's
products and technology, from the sale of tangible products, and
from contract engineering services and are discussed separately
below. During the six months ended December 31, 1996, revenues
decreased $953,000 to $1,196,000 from $2,149,000 in the
corresponding period of the prior fiscal year. Revenues in the
year-earlier period included $954,000 of revenues associated with
the ICR products that were licensed to NCS in June 1996.
Software Licensing
Product-licensing revenues totaled $526,000 in the transition
period, as compared with $902,000 in the year-earlier period.
The decrease in software licensing revenues reflects, primarily,
the net of two effects: a decrease in ICR licensing revenues and
an increase in licensing revenues relating to the Company's Prism
Fraud Detection product.
During the transition period royalties paid by NCS relating to
its sales of ICR products amounted to $68,000, a decrease of
$704,000 in ICR revenues the Company recognized in the six months
ended December 31, 1995.
Revenues from the Company's Prism product totaled $396,000 in the
transition period, as compared with $150,000 in the corresponding
period of the prior fiscal year. The growth of such revenues
reflects additional Prism licenses and increased license fees
from existing licensees.
Engineering Services
During the six months ended December 31, 1996, revenues from
engineering contracts totaled $606,000 as compared to $1,076,000
in the year-earlier period, including $182,000 of engineering
revenues relating to the ICR products. Excluding engineering
revenues relating to ICR products, revenues in the transition
period decreased $470,000 compared with the corresponding period
of the prior fiscal year.
Revenues relating to customer-funded modifications of Nestor's
Fraud Detection System totaled $380,000 in the transition period,
as compared with $743,000 in the six months ended December 31,
1995.
The Company's contracts with the Defense Advanced Research
Projects Agency (DARPA) require engineering services rendered by
the Company to develop a generic commercial application of the
Company's technology to high-speed pattern recognition through
the creation of an integrated circuit, associated circuit boards,
and supporting development software. The Company has two
contracts with DARPA. The first contract, which was signed in
April 1990, is in the amount of $1,630,000; as of December 31,
1996, approximately $1,623,000 had been earned. The second
contract, signed August 26, 1993, is in the amount of $776,000;
as of September 30, 1996, approximately $773,000 had been earned.
On September 1, 1995, the Company signed an agreement with the
Jet Propulsion Laboratory (JPL) to develop a prototype sensor
system designed for vehicular-traffic surveillance and detection.
The contract, valued at approximately $597,000, was completed in
December 1996. The terms of the DARPA and JPL contracts call for
delivery of prototype products, but do not specify any subsequent
purchasing or licensing provisions.
During the six months ended December 31, 1996, the Company
recognized revenues totaling $226,000 under its government
contracts. In the year-earlier period such revenues totaled
$97,000.
Sales of Tangible Products
The tangible products currently sold by the Company are based
upon the Company's Ni1000 Recognition Accelerator Chip and the
PCI4000 Recognition Accelerator Board, which are marketed along
with development software that enables customers to develop high-
speed recognition applications. Revenues from the Company's
Ni1000 Development System totaled $64,000 in the transition
period, as compared with $191,000 in the corresponding period of
the prior fiscal year. The decrease in revenues is accounted for
by a decrease in unit volume as the Company focuses on its
TrafficVision product, which incorporates the Ni1000 Recognition
Accelerator Chip (see Investment in Product Development and
Marketing, below).
Operating Expenses
Total operating expenses - consisting of engineering, research
and development, sales and marketing, and general and
administrative expenses - amounted to $2,115,000 in the six
months ended December 31, 1996, as compared with $2,691,000 in
the year-earlier period.
Included in expenses for the six months ended December 31, 1995
are approximately $1,068,000 of expenses attributable to the ICR
products, which were licensed to NCS in June 1996. Most of the
expenses associated with the ICR products are no longer incurred
by the Company as NCS hired most of the staff assigned to
development, sales, and support of the ICR products.
Offsetting the decrease in expenses attributable to the absence
of the ICR products is the Company's increased spending on its
Prism Fraud Detection System, on its TrafficVision product, and
on its newest product, Nestor InterSite, which is designed for
use in internet and intranet environments. During the transition
period the Company increased its spending on its Prism Fraud
Detection System by approximately $23,000 as compared with the
year-earlier period. Spending on TrafficVision increased
$358,000 from last year to this year, and the Company spent
$167,000 on InterSite.
Engineering Services
Costs related to engineering services totaled $922,000 in the
transition period, as compared to $805,000 in the corresponding
period of the prior fiscal year. As a percentage of revenues,
these costs increased from 75% last year to 152% this year
reflecting additional costs incurred on projects that had been
expected to conclude in the quarter ended September 30, 1996.
Research and Development
Research and development expenses totaled $294,000 in the six
months ended December 31, 1996, as compared with $472,000 in the
corresponding period of the prior fiscal year. The decrease in
such costs was due, primarily, to the net of two effects:
research and development costs relating to the ICR products
totaled $350,000 in the year-earlier period, while there were no
such costs in the transition period; and the Company began
development in July 1996 of its Nestor InterSite product and such
development costs totaled $137,000.
Selling and Marketing
The largest decrease in expenses was in selling and marketing.
In the transition period selling and marketing expenses decreased
$440,000 to $457,000 from $897,000 in the corresponding period of
the prior fiscal year. The decrease in selling costs reflects
the net of the absence of selling and marketing costs associated
with the ICR products in the transition period and an increase in
selling costs associated with the Prism and TrafficVision
products. ICR selling costs in the six months ended December
1995 totaled $637,000.
General and Administrative
General and administrative expenses totaled $432,000 in the
transition period, as compared with $493,000 in the year-earlier
period. The decrease in costs from last year to this year
reflects the net of numerous account decreases and increases,
with no single expense changing materially.
Expenditures on Product Development and Marketing
Revenues relating to the Company's Prism and Fraud Detection
System exceeded expenses by $71,000 in the six months ended
December 31, 1996, The Company has installed its products at
Mellon Bank, GE Consumer Credit Financial Services, BankOne,
Europay International (an association of 700 banks in Europe).
In September 1996, the Company signed a license agreement with
Applied Communications, Inc. (ACI) enabling ACI to integrate and
market Nestor's products with certain products of ACI. ACI
provides authorization and transaction-processing software to
nearly 500 financial institutions worldwide.
The largest investment made by the Company was in its Intelligent
Sensors Division, which is responsible for the development and
marketing of the TrafficVision products, an outgrowth of work
under the JPL contract. The Company expects commercial products
will be available in the second quarter of 1997. For the six
months ended December 31, 1996, expenses of this group exceeded
revenues by $437,000.
The Company began development in July 1996 of a product for use
in internet applications. Nestor InterSite enables customers to
understand individual on-line customers as they visit Web sites
and to dynamically present personalized content to those
visitors. The Company expects beta products will be available in
the second quarter of 1997.
Net Income Per Share
During the transition period, the Company experienced a loss of
$935,000, as compared with a loss of $723,000 in the
corresponding period of the prior fiscal year. For the six
months ended December 31, 1996, loss per share available for
common stock was $0.13 per share, as compared with a loss per
share of $0.11 in the corresponding period of the prior fiscal
year. For the six months ended December 31, 1996, there were
outstanding a weighted average of 8,689,031 shares, as compared
with 7,719,371 in the year-earlier period.
Analysis of Years Ended June 30, 1996, 1995 and 1994
For its fiscal year ended June 30, 1996, the Company realized a
71% increase in revenues over the prior fiscal year while
expenses decreased 15% from the prior year, resulting in a profit
of $12,690 after taxes.
Included in Total Revenues for the fiscal year ended June 30,
1996 is an initial license fee of $1,400,000 that the Company
received pursuant to its License Agreement with NCS. In addition
to the initial license fee, the Company will receive royalties on
future sales of the products by NCS. Minimum annual royalties
range from $160,000 in 1997 to $350,000 in 2001 and beyond.
The Company also signed in June 1996 an Asset Purchase Agreement
which transferred tangible and intangible assets used exclusively
in the ICR business to NCS for $300,000. The net gain on the
sale of these assets was approximately $213,000 and is recognized
as "Other income" in the quarter ended June 30, 1996.
Revenues
The Company realized revenues from operations of $5,461,000
during the fiscal year ended June 30, 1996, including the
$1,400,000 license fee from NCS, as compared with $3,195,000
realized during fiscal 1995, and $2,230,000 realized during
fiscal 1994.
Total revenues for the fiscal year ended June 30, 1994 included
$300,000 of revenue received pursuant to an agreement with Intel
Corporation relating to the acquisition by the Company of
exclusive marketing rights to the Ni1000 Recognition Accelerator.
As part of this agreement, the Company agreed to a price increase
for the Ni1000 Recognition Accelerator and agreed to make minimum
purchases over a two-year period in order to retain its exclusive
marketing rights. Intel delivered to the Company certain
marketing materials; assigned to the Company its interest in
future accounts receivable under the beta program for the Ni1000
Recognition Accelerator; and, as additional consideration for the
Company's entering into the agreement, paid to the Company the
sum of $300,000. As there were no specific performance
requirements or identifiable costs associated with this payment
and the Company had no liability to return any part of such
payment, the Company recorded this payment as revenue, which
revenue is non-recurring.
Software Licensing
The Company's software licensing revenues in fiscal 1996 derived
primarily from licenses of its ICR products. Licensing fee
revenues totaled $2,825,000 in the fiscal year ending June 30,
1996, including the $1,400,000 license fee from NCS, as compared
with $1,714,000 in the prior fiscal year and $1,349,000 in the
fiscal year ended June 30, 1994. The increase in revenues from
1994 to 1995 was driven by an increase in unit volume. The
increase in revenues from 1995 to 1996 is attributable to the
initial license fee paid by NCS; excluding that transaction,
license fee revenues decreased from 1995 to 1996 as a result of
lower unit volume.
For 1997, the Company will not receive ICR licensing fees but
expects to receive royalties from NCS on future sales of the ICR
products by NCS under the Licensing Agreement signed in June
1996. The minimum annual royalty for 1997 is $160,000. (See
Expenses, below, for a discussion of the effect on the Company's
expenses of this licensing arrangement.)
Engineering Services
Revenues from engineering contracts totaled $2,378,000 in fiscal
1996, as compared with $1,195,000 in the prior year and $641,000
in fiscal 1994. The components of these revenues are separately
analyzed below.
During the fiscal year ended June 30, 1996, the Company realized
revenues from engineering contracts with industrial and
commercial customers of approximately $324,000, as compared with
$81,000 during the preceding year and $24,000 during fiscal 1994.
The increase in these revenues from 1995 to 1996 reflects a shift
in the allocation of engineering efforts from internally funded
product-development efforts to customer-funded projects, in part
intended to offset reduced ICR licensing revenues.
During fiscal 1996, customizing the Company's fraud-detection
system produced engineering revenues of approximately $1,593,000,
as compared with $771,000 in fiscal 1995 and $236,000 in fiscal
1994.
The Company's contracts with the Advanced Research Projects
Agency (ARPA), formerly called the Defense Advanced Research
Projects Agency, require engineering services rendered by the
Company to develop a generic commercial application of the
Company's technology to high-speed pattern recognition through
the creation of an integrated circuit, associated circuit boards,
and supporting development software. The Company has two
contracts with ARPA. The first contract, which was signed in
April 1990, is in the amount of $1,630,000; as of June 30, 1996,
approximately $1,623,000 had been earned. The second contract,
signed August 26, 1993, is in the amount of $776,000; as of June
30, 1996, approximately $773,000 had been earned.
On September 1, 1995, the Company signed a contract with the Jet
Propulsion Laboratory (JPL) to develop a prototype sensor system
designed for vehicular-traffic surveillance and detection. The
contract, valued at approximately $597,000, is expected to run
for 13 months from September 1995. The terms of the ARPA and JPL
contracts call for delivery of prototype products, but do not
specify any subsequent purchasing or licensing provisions.
During the fiscal year ended June 30, 1996, revenues from the
Company's government contracts totaled $378,000, as compared with
such revenues of $342,000 in the prior year and $423,000 of such
revenues in the fiscal year ended June 30, 1994.
Tangible Product Sales
The tangible products currently sold by the Company are based
upon the Company's Ni1000 Recognition Accelerator Chip, which is
marketed along with development software that enables customers
to develop high-speed recognition applications. Revenues from
the Company's Ni1000 Development System totaled $257,000 in the
fiscal year ended June 30, 1996, as compared with $286,000 in the
preceding year and $239,000 in fiscal 1994. In April 1994, the
Company and Intel Corporation signed an agreement which provided
the Company with exclusive marketing rights to the Ni1000
Recognition Accelerator, subject to the Company's being obligated
to make minimum purchases of the Ni1000 Recognition Accelerator
in the amount of $97,500 to be ordered by June 30, 1995, and
$195,000 to be ordered by June 30, 1996. The Company has placed
orders for the required minimum purchases.
Expenses
Total operating expenses - consisting of operations, selling and
marketing, and general and administrative expenses - amounted to
$5,488,000 for the fiscal year ended June 30, 1996, as compared
with $6,431,000 in the prior year, and $3,706,000 in 1994.
Expenses in fiscal 1995 and 1994 reflect the reclassification of
$210,500 and $287,969, respectively, to "Other income (expense)".
These amounts represent non-cash charges relating to the issuance
of stock or exercise of warrants at below-market prices.
Included in fiscal 1996 expenses are approximately $1,997,000 of
expenses attributable to the ICR products, which were licensed to
NCS in June 1996. Most of the expenses associated with the ICR
products will no longer be incurred by the Company as NCS hired
most of the staff assigned to development, sales, and support of
the ICR products.
Management expects expenses to decrease initially in fiscal 1997
reflecting the License of the ICR products to NCS. However, as
the Company invests in existing and new product opportunities,
management expects expenses to increase.
The decrease in expenses from 1995 to 1996 reflects both staff
attrition and management's efforts to reduce expenses. The
majority of the decrease in total expenses derived from decreases
in promotion, salaries and consulting, recruiting and
subcontracting.
Labor costs continue to be the Company's single greatest expense
category. During fiscal 1996, the Company paid $3,103,000 for
wages and consulting fees, as compared with $3,302,000 in the
prior year and $1,955,000 in fiscal 1994. The decrease from 1995
to 1996 reflects a decrease in staffing: full-time employees
totaled 33 at June 30, 1996, as compared with 53 at June 30 1995,
and 31 at June 30, 1994. In mid-June 1996, NCS hired 14 full-
time employees who had been employed by the Company prior to
signing the License agreement with NCS. Immediately prior to the
transfer of these employees, the Company had 47 employees.
Operating Expenses
Operating expenses, which are primarily labor costs related to
product development, engineering and sales totaled $5,488,000 for
the fiscal year ended June 30, 1996, as compared with $6,431,000
in the prior year and $3,706,000 in fiscal 1994.
Operating costs and expenses related to the production of
revenues from software licensing totaled $686,000 in fiscal 1996,
as compared with $1,979,000 in the preceding year and $1,159,000
in fiscal 1994. The decrease in such costs from 1995 to 1996
reflects management's decision to shift engineering resources
from internally funded product-development efforts to customer-
funded engineering projects.
Costs related to engineering services totaled $1,833,000 in the
fiscal year ended June 1995, as compared to $665,000 in the prior
year and $628,000 in fiscal 1994. The increase of these costs
reflects the increase in engineering services revenues.
The Company's expenditures for research and development were
$2,639,000 in fiscal 1996; $2,759,000 in fiscal 1995; and
$1,788,000 in fiscal 1994.
Selling and marketing expenses represented the largest decrease
in expenses from 1995 to 1996. Such expenses totaled $1,764,000
in the fiscal year ending June 30, 1996, as compared with
$2,547,000 in the preceding year and $951,000 in fiscal 1994. The
decrease in expenses from 1995 to 1996 reflected management's
decision in the fourth quarter of 1995 to terminate an aggressive
marketing plan for the Company's ICR products, which had begun in
the second quarter of fiscal 1995. That plan had entailed
increases in sales staff, promotional expenditures, and the
staffing of a customer-support group dedicated to ICR product
support.
Sales and marketing compensation, consisting of salaries, fringe
benefits, and commissions, totaled $999,000 in fiscal 1996, as
compared with $1,030,000 in the prior year and $431,000 in the
fiscal year ending June 1994. Related consulting decreased to
$69,000 in fiscal 1996 from $195,000 in 1995 and $31,000 in 1994.
Promotional expenses, comprising advertising, promotion, and
conventions and meetings, decreased $513,000 to $232,000 in
fiscal 1996 from $745,000 in the prior year. Such costs totaled
$226,000 in the fiscal year ended June 30, 1994.
General and administrative expenses totaled $828,000 in fiscal
1996, as compared with $843,000 in the preceding year and
$782,000 in fiscal 1994. As noted above, general and
administrative expenses in fiscal 1995 and 1994 reflect the
reclassification of $210,500 and $287,969, respectively, to
"Other income (expense)". These amounts represent non-cash
charges relating to the issuance of stock or exercise of warrants
at below-market prices.
Other Income (Expense)
In fiscal 1996, the Company recorded "Other income" of
approximately $40,000, net of "Other expense". Included in this
amount is a gain on the sale of intangibles of $213,000 relating
to the Asset Purchase Agreement with NCS signed in June 1996.
The Company recorded interest expense, net of interest income,
totaling $39,000. Additionally, the Company recorded a non-cash
expense of $131,000 relating to the reduction of exercise price
of outstanding warrants in connection with the Rights Offering
completed in the second fiscal quarter.
In the fiscal year ended June 30, 1995, the Company recorded
"Other expense" of $221,000. Non-cash charges relating to the
issuance of stock at below-market prices totaled $210,000, and
the Company recorded net interest expense of $11,000.
In fiscal 1994, "Other expense" totaled $282,000, reflecting
primarily non-cash charges relating to the exercise of warrants
at below-market prices, of $288,000.
Investment in Product Development and Marketing.
The largest investment made by the Company was in its Intelligent
Character Recognition group. During the fiscal year ended June
1996, product-development and marketing expenses exceeded
revenues (excluding the initial license fee paid by NCS) by
approximately $436,000. As noted above, on June 11, 1996,
National Computer Systems, Inc. signed a License Agreement which
transferred to them the right to develop and market these
products. NCS is required to pay minimum annual royalties to
maintain its exclusive license. The Company has since terminated
most of the costs associated with these products.
Expenses of the Company's generic products (the Ni1000
Recognition Accelerator and the Company's proprietary software-
development tools) exceeded revenues by approximately $212,000 in
fiscal 1996. In September 1995, the Company began work on a
contract with the Jet Propulsion Laboratory to develop a
prototype sensor system designed for vehicular-traffic
surveillance and detection.
Revenues relating to the Company's PRISM and Fraud Detection
System exceeded expenses by approximately $256,000 in fiscal
1996. The Company has license agreements with Mellon Bank, GE
Consumer Credit Financial Services, Bank One, Europay
International (an association of 700 banks in Europe), and with a
European financial-services company for the use of these
products.
Net Income Per Share
For the fiscal year ended June 1996, the Company experienced a
gain of $12,690, as compared with a loss of $3,457,422 in the
prior year and a loss of $1,758,584 in fiscal 1994. For the
fiscal year ended June 1996, loss per share available for common
stock was $0.03 per share, as compared with a loss per share of
$0.48 in fiscal 1995 and a loss per share of $0.26 in fiscal
1994. For the fiscal year ended June 30, 1996, there were
outstanding a weighted average of 7,847,510 shares, as compared
with 7,411,502 in the prior year and 6,840,407 in the fiscal year
ended June 30, 1994.
<\PAGE>
<PAGE>
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
the report to be signed on its behalf by the undersigned,
thereunto duly authorized.
NESTOR, INC.
(Registrant)
/s/David Fox, President and
CEO
Date: March 31, 1997
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signatures
Signatures Title Date
/s/Leon N Cooper Co-Chairman of the Board March 31, 1997
and Director
/s/Charles Elbaum Co-Chairman of the Board March 31, 1997
and Director
/s/David L. Fox President, Chief Executive March 31, 1997
Officer and Director
/s/Herbert S. Meeker Secretary and Director March 31, 1997
/s/Sam Albert Director March 31, 1997
/s/Jeffrey Harvey Director March 31, 1997
/s/Thomas F. Hill Director March 31, 1997
/s/Bruce Schnitzer Director March 31, 1997
CONSOLIDATED FINANCIAL STATEMENTS
FORM 10-K
JUNE 30, 1996
NESTOR, INC. Part II
Item 8
CONTENTS
Independent Auditor's Report
Statement No.
Consolidated Balance Sheets 1
Consolidated Statements of Operations -
For the Six Months Ended December 31, 1996 and
For the Years Ended June 30, 1996, 1995 and 1994 2
Consolidated Statements of Cash Flows -
For the Six Months Ended December 31, 1996 and
For the Years Ended June 30, 1996, 1995 and 1994 3
Consolidated Statements of Stockholders' Equity -
For the Six Months Ended December 31, 1996 and
For the Years Ended June 30, 1996, 1995 and 1994 4
Notes to Consolidated Financial Statements
Part II
Item 8
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
of Nestor, Inc.
We have audited the accompanying consolidated balance sheet of
Nestor, Inc. as of December 31, 1996, and the related
consolidated statements of operations, cash flows and
stockholders' equity for the period July 1, 1996 to December 31,
1996. Our audit also included the financial statement schedule
listed in the Index at Item 14(a). These financial statements
and schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial
statements and schedule based on our audit.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Nestor, Inc. at December 31, 1996, and the
consolidated results of its operations and its cash flows for the
period July 1, 1996 to December 31, 1996, in conformity with
generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth
therein.
/s/Ernst & Young LLP
Providence, Rhode Island
March 14, 1997
Consolidated Balance Sheets
</TABLE>
<TABLE>
<CAPTION>
ASSETS December 31, June 30, June 30,
1996 1996 1995
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 774,457 $2,013,317 $ 452,588
Accounts receivable,
net of allowance for
doubtful accounts 1,009,149 594,310 661,734
Unbilled contract revenue 126,945 282,936 208,352
Deferred development costs 364,405 --- ---
Other current assets 276,615 230,738 131,163
Total current assets 2,551,571 3,121,301 1,453,837
Property and equipment at
cost - net of accumulated
depreciation 255,590 219,787 347,325
Other assets 10,783 10,783 11,333
Total Assets $ 2,817,944 $3,351,871 $ 1,812,495
<CAPTION>
LIABILITIES AND STOCKHOLDERS' DEFICIT
<S> <C> <C> <C>
Current liabilities:
Notes payable $ --- $ ---- $ 1,700,000
Accounts payable and
accrued expenses 670,742 724,727 1,294,123
Other current liabilities 298,848 326,809 265,278
Deferred income 338,404 86,104 77,311
Total current liabilities 1,307,994 1,137,640 3,336,712
Noncurrent liabilities:
Long term obligations
under capital leases 12,212 9,455 ---
Other noncurrent liabilities --- --- 100,000
Total liabilities 1,320,206 1,147,095 3,436,712
Long term portion of
deferred income 430,899 430,899 438,896
Series C, E, F, G and H
redeemable convertible
preferred stock 4,846 shares
at December 31, 1996 and
June 30, 1996 and 1,500
shares at June 30, 1995
(liquidation value $1,000
per share plus accrued
dividends) 5,398,908 5,207,538 1,600,328
Commitments and contingencies --- --- ---
Stockholders' deficit:
Preferred stock, $1.00 par value,
authorized 10,000,000 shares;
issued and outstanding:
Series A - 452,064 shares at
December 31, 1996,
June 30, 1996 and 1995 452,064 452,064 452,064
Series B - 1,635,000 shares
at December 31, 1996,
2,075,000 shares at
June 30, 1996 and
2,540,000 shares at
June 30, 1995 1,635,000 2,075,000 2,540,000
Series D - 179,671 shares
at December 31, 1996,
184,671 shares at
June 30, 1996 and none
at June 30, 1995 279,230 277,007 ---
Common stock, $.01 par value,
authorized 30,000,000 shares;
issued and outstanding:
8,916,141 shares at
December 31, 1996,
8,280,941 shares at
June 30, 1996 and
7,606,710 shares at
June 30, 1995 89,161 82,809 76,067
Warrants and options 417,500 375,000 375,000
Additional paid-in capital 11,927,644 11,501,790 11,103,449
Retained (deficit) (19,132,668) (18,197,331) (18,210,021)
Total stockholders' deficit (4,332,069) (3,433,661) (3,663,441)
Total Liabilities and
Stockholders' Deficit $ 2,817,944 $3,351,871 $ 1,812,495
The Notes to the Financial Statements are an integral part of this
statement.
</TABLE>
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Six Months
Ended
December 31, For the Years Ended June 30,
1996 1996 1995 1994
<S> <C> <C> <C> <C>
Revenue:
Software licensing $ 526,353 $ 2,825,600 $ 1,713,897 $ 1,349,470
Engineering services 605,776 2,378,135 1,195,201 641,579
Tangible product sales 63,775 257,845 286,465 239,425
Total revenue 1,195,904 5,461,580 3,195,563 2,230,474
Operating Expenses:
Engineering services 922,325 1,833,531 665,421 628,448
Tangible product sales 8,978 32,189 13,838 89,775
Research and development 294,136 823,000 2,093,616 1,159,920
Selling and marketing 457,281 1,764,585 2,661,453 951,426
General and admin. 432,301 1,035,535 997,633 877,071
Total operating
expenses 2,115,021 5,488,840 6,431,961 3,706,640
(Loss) from
operations (919,117) (27,260) (3,236,398) (1,476,166)
Other income
(expense) - net (16,220) 39,950 (221,024) (282,418)
Net Income (Loss) $ (935,337) $ 12,690 $(3,457,422) $(1,758,584)
Dividends accrued on
preferred stock 201,094 261,210 100,328 ---
Net Loss Available for
Common Stock $(1,136,431) $ (248,520) $(3,557,750) $(1,758,584)
Loss per share
(Note 3) $ (0.13) $ (0.03) $ (0.48)$ (0.26)
Weighted Average
Number of shares
Outstanding 8,689,031 7,847,510 7,411,502 6,840,407
The Notes to the Financial Statements are an integral part of this
statement.
</TABLE>
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Six Months
Ended For the Years Ended
December 31, June 30,
1996 1996 1995 1994
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (935,337) $ 12,690 $(3,457,422) $(1,758,584)
Adjustments to reconcile
net income (loss) to net
cash used by operating
activities:
Depreciation and
amortization 45,328 104,559 113,562 200,460
Loss on disposal
of fixed assets --- 4,346 --- 106
Expenses charged to
operations relating to
options, warrants and
capital transactions 42,500 178,375 210,500 287,969
Changes in assets
and liabilities:
(Increase) decrease
in accounts receivable (414,839) 67,424 (340,651) (69,791)
(Increase) decrease
in unbilled contract
revenue 155,991 (74,584) (87,674) (60,274)
Increase in deferred
development costs (364,405) --- --- ---
(Increase) in other
current assets (45,877) (99,575) (110,721) (8,193)
(Increase) decrease
in other assets --- 550 (5,000) ---
(Decrease) increase
in accounts payable,
accrued expenses and
other liabilities (83,593) (568,309) 786,010 144,294
(Decrease) increase
in deferred income 252,300 796 (15,630) 44,746
Net cash (used) by
operating activities (1,347,932) (373,728) (2,907,026) (1,219,267)
Cash flows from investing activities:
Purchase of property
and equipment (71,390) (57,531) (249,319) (66,292)
Proceeds from the
disposal of fixed
assets --- 85,000 --- 1,900
Net cash provided
(used) by investing
activities (71,390) 27,469 (249,319) (64,392)
Cash flows from financing activities:
Repayment of obligations
under capital leases (5,338) (7,924) (10,796) (5,998)
Proceeds from notes
payable --- 300,000 1,700,000 ---
Rights offering expense --- (136,421) (39,769) ---
Proceeds from issuance
of common stock 185,800 99,510 73,288 625,125
Proceeds from issuance
of preferred stock - net --- 1,651,823 1,470,000 811,608
Net cash provided
by financing
activities 180,462 1,906,988 3,192,723 1,430,735
Net change in cash
and cash equivalents (1,238,860) 1,560,729 36,378 147,076
Cash and cash equivalents
- beginning of year 2,013,317 452,588 416,210 269,134
Cash and cash equivalents
- End of Year $ 774,457 $ 2,013,317 $ 452,588 $ 416,210
Supplemental cash flows information:
Interest paid $ 3,227 $ 4,372 $ 3,728 $ 1,685
Income taxes paid $ --- $ --- $ --- $ ---
The Notes to the Financial Statements are an integral part of this statement.
</TABLE>
Nestor, Inc. Consolidated Statement of Stockholders' Equity
<TABLE>
<CAPTION>
Common Stock Preferred Stock Additional Retained Stock
Shares Amount Shares Amount Paid-in Capital (Deficit) Warrants Total
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at
June 30, 1993 6,802,710 $ 68,027 2,407,064 $2,407,064 $10,033,105 $(12,994,015) $ --- $ (485,819)
Issuance of
Capital Stock 332,625 3,326 815,000 815,000 906,367 --- --- 1,724,693
Conversion of
Preferred Stock
to Common Stock 95,000 950 (95,000) (95,000) 94,050 --- --- ---
(Loss) for the
year ended
June 30, 1994 --- --- --- --- --- (1,758,584) --- (1,758,584)
Balance at
June 30, 1994 7,230,335 $ 72,303 3,127,064 $3,127,064 $11,033,522 $(14,752,599) --- $ (519,710)
Issuance of
Capital Stock 141,375 1,414 --- --- 282,374 --- --- 283,788
Issuance of
Preferred Stock --- --- 100,000 100,000 100,000 --- --- 200,000
Cost of rights
offering --- --- --- --- (39,769) --- --- (39,769)
Conversion of
Preferred Stock
to Common Stock 235,000 2,350 (235,000) (235,000) 232,650 --- --- ---
Dividends accrued
on Redeemable
Convertible
Preferred Stock
Series C --- --- --- --- (100,328) --- --- (100,328)
Reclassification
of Series C
Redeemable
Convertible
Preferred Stock
from capital --- --- --- --- (405,000) --- 375,000 (30,000)
(Loss) for the
year ended
June 30, 1995 --- --- --- --- --- (3,457,422) --- (3,457,422)
Balance at
June 30, 1995 7,606,710 $ 76,067 2,992,064 $2,992,064 $11,103,449 $(18,210,021) $375,000 $(3,663,441)
Issuance of
Common Stock 177,998 1,780 --- --- 175,928 --- --- 177,708
Issuance of
Preferred Stock --- --- 210,549 315,824 (10,000) --- --- 305,824
Conversion of
Preferred Stock
to Common Stock 490,878 4,909 (490,878) (503,817) 498,908 --- --- ---
Dividends on
Preferred Stock
Series D paid in
Common Stock 5,355 53 --- --- 13,495 --- --- 13,548
Dividends accrued
on Preferred Stock --- --- --- --- (274,819) --- --- (274,819)
Expenses incurred
in reduction of
exercise price of
outstanding
warrants --- --- --- --- 131,250 --- --- 131,250
Costs incurred in
connection with
August 1995
securities
registration --- --- --- --- (136,421) --- --- (136,421)
Income for the
year ended
June 30, 1996 --- --- --- --- --- 12,690 --- 12,690
Balance at
June 30, 1996 8,280,941 $ 82,809 2,711,735 $2,804,071 $11,501,790 $(18,197,331) $375,000 $ (3,433,661)
Issuance of
Common Stock 190,200 1,902 --- --- 183,898 --- --- 185,800
Conversion of
Preferred Stock
to Common Stock 445,000 4,450 (445,000) (447,500) 443,050 --- --- ---
Dividends accrued
on Preferred
Stock Series D --- --- --- 9,723 (9,723) --- --- ---
Accural of value
of warrants
(Note 7) --- --- --- --- --- --- 42,500 42,500
Dividends accrued
on Redeemable
Convertible
Preferred Stock --- --- --- --- (191,371) --- --- (191,371)
(Loss) for the
six months ended
December 31, 1996 --- --- --- --- --- (935,337) --- (935,337)
Balance at
December 31, 1996 8,916,141 $ 89,161 2,266,735 $2,366,294 $11,927,644 $(19,132,668) $417,500 $(4,332,069)
The Notes to the Financial Statements are an integral part of this statement.
</TABLE>
Note 1 - Summary of significant accounting policies:
A. Organization
Nestor, Inc. (the "Company") was organized on March
21, 1983 in Delaware to exploit, develop and succeed to
certain patent rights and know-how which the Company
acquired from its predecessor, Nestor Associates, a
limited partnership. The Company's principal office is
located in Providence, RI.
The accompanying financial statements include the
accounts of Nestor, Inc. and Nestor Financial Services
Group, a joint venture (organized in December, 1986,
and dissolved effective December 31, 1995 - See Note
9). All intercompany transactions and balances have
been eliminated.
B. Product and patent development costs
The costs of development of the Company's software
which consist primarily of labor and outside consulting
and which are an inherent cost of the Company's
business and costs of research and development are
expensed until technological feasibility has been
established for the product. Thereafter, all software
production costs would be capitalized and subsequently
reported at the lower of unamortized cost or net
realizable value. At December 31, 1996, the Company
had no capitalized software development costs because
the products developed were simultaneously available
for general release to customers when technological
feasibility was established. Capitalized costs are
amortized on a straight-line basis over the estimated
economic life (three to five years) of the product.
Patent-development costs are similarly treated.
Their amortization would be on a straight-line basis
over the shorter of the estimated economic life, or
statutory life, of the patent.
C. Depreciation and amortization
Depreciable assets are recorded at cost.
Depreciation is provided on the straight-line method
over the estimated useful lives of the respective
assets.
Maintenance and repairs are expensed as incurred.
Major renewals and betterments are capitalized.
D. Revenue recognition
The Company recognizes revenue based upon the
following methods:
a) Revenue from software licensing/sales is
recognized upon shipment provided that no
significant vendor and post-contract support
obligations remain outstanding and collection of the
resulting receivable is deemed probable. Where
there are insignificant post-contract support
obligations and/or warranties remaining at the time
of shipment, the Company recognizes revenue and
accrues the estimated cost of fulfilling such
obligations or warranties.
Product returns or exchanges are charged
to operations as incurred. Where the Company
anticipates significant returns of products sold,
the Company establishes an allowance for anticipated
returns or exchanges at the time of sale. When a
product is sold subject to customer approval,
revenue is recognized upon approval by the customer.
b) Engineering contract revenue from long-
term contracts is recognized on the percentage-of-
completion method, based upon the pattern of actual
performance under the agreement with the customer.
Management records expected losses on contracts in
the period in which such losses become foreseeable.
c) Training revenue is recognized upon the
completion of training sessions with the customer.
E. Cash equivalents
For the purpose of the statement of cash flows, the
Company considers all highly liquid debt instruments
purchased with a maturity of 90 days or less to be cash
equivalents.
F. Accounting for issuance and exercise of warrants
and options to purchase Common Stock
The Company records no expense upon the issuance of
warrants and options issued at fair market value. For
employee warrants and options issued at an exercise
price below fair market value, the Company records an
expense equal to the difference between the market
value of the underlying shares of Common Stock and the
exercise price of such options or warrants. For other
options and warrants issued after December 31, 1995,
the Company records options and warrants at fair market
value.
G. Concentrations of credit risk
The Company's financial instruments that are exposed
to concentrations of credit risk consist primarily of
cash and cash equivalents and trade accounts
receivable. The Company places its cash and temporary
cash investments with high credit quality institutions.
At times such investments may be in excess of the FDIC
insurance limit. The Company routinely assesses the
financial strength of its customers and, as a
consequence, believes that its trade accounts
receivable credit risk exposure is limited. The
Company does not require collateral from its customers.
Management believes the allowance carried for doubtful
accounts receivable is adequate to cover potential
losses associated with uncollectible accounts
receivable.
H. Inventory
Inventory, consisting primarily of finished goods, is
valued at the lower of cost or market on the first-in,
first-out basis. Inventories are included as "Other
current assets" on the Consolidated Balance Sheets.
I. Estimates
The preparation of financial statements in conformity
with generally accepted accounting principles requires
management to make estimates and assumptions that
affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported
amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
J. Change in Fiscal Year
The Company changed its fiscal year from June 30 to
December 31 effective December 31, 1996. The results
for the six month period ended December 31, 1996 have
been presented in the main body of the financial
statements.
K. Change in Presentation
In order to conform with the December 31, 1996
presentation, expenses charged to operating expenses
for the fiscal years ended June 30, 1996, 1995 and 1994
have been reclassified in these financial statements
from "Software Licensing" and "Tangible Product Sales"
and are presented as "Research and Development" on the
Consolidated Statements of Operations.
Note 2 - Results for the six months ended December 31, 1995:
The following financial information for the six months
ended December 31, 1995 is unaudited and is being
presented for comparative purposes:
Six Months Ended
Six Months Ended December 31, 1995
December 31, 1996 (Unaudited)
Total revenues $ 1,195,904 $ 2,149,088
Net Loss (935,337) (723,227)
Net loss available
for common stock (1,136,431) (813,028)
Net (loss) per share $ (0.13) $ (0.11)
Note 3 - Income (loss) per share:
Income (loss) per share amounts are based on income
(loss) available for common stock divided by the
weighted average number of common shares outstanding.
For the six months ended December 31, 1996, and for the
years ended June 30, 1996, 1995 and 1994, the dilutive
effect of exercise or conversion of options, warrants
and preferred stock were not included in the
calculation as this would result in anti-dilution.
During the quarter ended December 31, 1996, the Company
modified its method for computing earnings per share to
give effect to dividends accrued on preferred stock.
The effect of this change on earnings per share is as
follows:
Period As Originally As
Ended Reported Adjusted
Quarter ended
Sept. 30, 1996 (0.03) (0.04)
Fiscal year ended
June 30, 1996 --- (0.03)
Fiscal year ended
June 30, 1995 (0.47) (0.48)
The following earnings per share calculations are based
on the Company's reported net income (loss) for the
periods presented. The reported net income (loss) has
been adjusted to reflect dividends accrued on
convertible preferred stock.
Note 4 - Income taxes:
The Company accounts for income taxes from the deferred
liability method as required by FASB Statement No. 109,
"Accounting for Income Taxes." Under Statement No.
109, deferred tax assets and liabilities are determined
based on differences between financial reporting and
the tax basis of assets and liabilities, and are
measured using the enacted rates and laws that will be
in effect when the differences are expected to reverse.
There was no current federal or state and no deferred
federal or state provision (benefit) for income taxes
for the six months ended December 31, 1996, and for the
fiscal years ended June 30, 1996, 1995, and 1994.
Significant components of the Company's deferred tax
liabilities and assets as of December 31, 1996, June
30, 1996 and June 30, 1995 are as follows:
<TABLE>
<CAPTION>
December 31, June 30, June 30,
1996 1996 1995
<S> <C> <C> <C>
Deferred tax liabilities:
Accounts receivable $ --- $ 237,000 $ 264,000
Unbilled contract revenue --- 113,000 83,000
Other - net --- 33,000 20,000
Total deferred tax liabilities --- 383,000 367,000
Deferred tax assets:
Accounts receivable 58,000 --- ---
Accrued expenses 104,000 277,000 507,000
Deferred income 173,000 206,000 206,000
Other - net 2,000 14,000 13,000
Net operating loss 6,354,000 6,224,000 5,998,000
Total deferred tax assets 6,691,000 6,721,000 6,724,000
Valuation allowance (6,691,000) (6,338,000) (6,357,000)
Net deferred tax assets --- 383,000 367,000
Net Deferred Tax Balance $ --- $ --- ---
</TABLE>
The Company provides a valuation allowance to reflect the
uncertainties associated with the realization of its
deferred tax assets including limitations provided by
Section 382 of the Internal Revenue Code.
A reconciliation of the provision for income taxes to the
amount computed using the Federal statutory tax rates
consists of the following:
<TABLE>
<CAPTION>
Six Months Ended Years Ended June 30,
December 31, 1996 1996 1995 1994
<S> <C> <C> <C> <C>
Income (Loss) Before Taxes $ (892,000) $ 13,000 $(3,457,000) $(1,759,000)
Tax at statutory rate of 34% $ (303,000) $ 4,000 $(1,176,000) $ (598,000)
State income tax (net of
federal benefit) (53,000) 1,000 (207,000) (106,000)
Effect of permanent
differences 3,000 7,000 7,000 1,000
Valuation allowance 353,000 (12,000) 1,376,000 703,000
Income Tax Expense $ --- $ --- $ --- $ ---
</TABLE>
The Company has available at December 31, 1996,
$17,328,000 and $7,863,000 of net operating loss
carryforwards for federal and state purposes,
respectively. These loss carryforwards may be
applied against future taxable income and begin to
expire in 1998.
Note 5 - Accounts receivable, net of allowance for doubtful
accounts:
<TABLE>
<CAPTION>
June 30,
December 31, 1996 1996 1995
<S> <C> <C> <C>
Trade accounts receivable $ 1,154,384 $ 760,019 $ 719,710
Allowance for doubtful accounts (145,235) (165,709) $(57,976)
Accounts receivable, net of allowance
for doubtful accounts $ 1,009,149 $ 594,310 $ 661,734
</TABLE>
Note 6 - Commitments and contingencies:
The Company leases a facility in Rhode Island under an
operating lease dated July 1, 1985, as amended. This
lease provides for minimum annual rentals of $134,993
until February 1997 and $141,742 until February 1998.
The Company is also obligated to pay its proportionate
share of increases in real estate taxes and common area
maintenance over a base period. Commencing March 1,
1996, the base rent is to be increased by the
percentage increase in the C.P.I. index over the prior
year, but not less than 5%.
Rent expense of $47,989, $171,928, $153,385, and
$118,731 was charged to operations for the six months
ended December 31, 1996 and for the years ended June
30, 1996, 1995 and 1994 respectively.
On August 1, 1994, the Company signed a Financial
Advisory Agreement with Wand Partners, Inc. The terms
of the Agreement specify that Wand Partners, Inc. will
provide consulting services for a fee of $40,000 per
year, plus out-of-pocket expenses. The Agreement is in
effect so long as Wand Partners, Inc. owns at least
500,000 shares of Nestor's Common Stock, or other
equities which are convertible into that number of
shares of Common Stock (See Note 16 - Related party
transactions).
The Company placed a purchase order in the amount of
$195,000 with Intel Corporation in June 1996 for a
supply of Ni1000 Recognition Accelerator chips and
expects to take delivery of the chips during the second
quarter of 1997.
The aggregate minimum payments due over the remaining
term of the above agreements is as follows:
December 31, 1997 $ 404,418
December 31, 1998 68,424
December 31, 1999 40,000
December 31, 2000 40,000
December 31, 2001 40,000
$ 592,842
Note 7 - Options and warrants:
On April 1, 1984, the Company adopted an Incentive
Stock Option Plan providing for the granting of
options to purchase shares of the Company's common
stock at a price equal to the market price of the
stock at the date of grant. The Company's Stock
Option Plan has authorized the grant of options to
employees for up to 2,450,000 shares of the
Company's common stock. Options are exercisable
for five years from the date of grant.
The Company has adopted the disclosure-only
provisions of SFAS No. 123, Accounting for Stock-
Based Compensation ("SFAS 123") which is first
applicable to the Company's fiscal year ended
June 30, 1996. The Company will continue to
account for its stock option plans in accordance
with the provisions of APB 25, Accounting for
Stock Issued to Employees. Accordingly, no
compensation cost has been recognized for the
Company's Stock Option Plan.
The following table presents the activity of the
Company's Stock Option Plan for the six months
ended December 31, 1996, and for the fiscal years
ended June 30, 1996, 1995, and 1994:
<TABLE>
<CAPTION>
Six Months Ended
December 31, Years Ended June 30,
1996 1996 1995 1994
Weighted Weighted Weighted Weighted
Av. Ex. Av. Ex. Av. Ex. Av. Ex.
Shares Price Shares Price Shares Price Shares Price
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding
beginning
of year 1,356,000 1.03 1,399,000 1.80 1,141,000 1.90 795,500 1.85
Granted 612,000 2.38 1,406,000 1.04 348,000 1.60 412,500 1.91
Exercised 186,500 0.98 100,500 1.09 13,875 1.52 37,000 1.19
Canceled --- --- 1,348,500 1.83 76,125 2.43 30,000 1.64
Outstanding
end of year 1,781,500 1.50 1,356,000 1.03 1,399,000 1.80 1,141,000 1.90
Options
exercisable
at year end 1,101,875 1.22 1,023,500 1.00 950,375 1.88 730,375 2.00
Weighted
average fair
value of
options
granted
during
the year $ 0.71 $ 0.71
</TABLE>
The following table presents weighted average price
and life information about significant option groups
outstanding at December 31, 1996.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Weighted
Average Weighted Weighted
Number Remaining Average Number Averaged
Range of Outstanding Contractual Exercise Exercisable Exercisable
Exercise Prices at 12/31/96 Life (Years) Price at 12/31/96 Price
<S> <C> <C> <C> <C> <C>
$.87 - $1.00 1,081,500 3.68 $0.99 911,875 $0.99
$1.50 - $1.94 84,500 4.35 1.58 21,125 1.58
$2.00 - $2.32 503,500 4.49 2.31 140,875 2.31
$2.41 - $2.94 112,000 4.66 2.69 28,000 2.69
1,781,500 4.00 $1.50 1,101,875 $1.22
</TABLE>
The following are the pro forma net loss and net loss
per share for the six months ended December 31, 1996,
and for the fiscal year ended June 30, 1996, as if the
compensation cost for the option plan had been
determined based on the fair value at the grant date
for grants in those periods, consistent with the
provisions of SFAS 123:
<TABLE>
<CAPTION>
Six Months Ended Fiscal Year Ended
December 31, 1996 June 30, 1996
As Pro As Pro
Reported Forma Reported Forma
<S> <C> <C> <C> <C>
Net income
(loss) $(935,337) $(1,241,072) $ 12,690 $(635,037)
Net (loss)
per share $ (0.13) (0.17) (0.03) (0.11)
</TABLE>
The effects on the six months ended December
31, 1996, and the fiscal year ended June 30, 1996, pro
forma loss per share of expensing the estimated fair
value of stock options are not necessarily
representative of the effects on reporting the results
of operations for future years because additional
options will vest subsequent to December 31, 1996 and
the Company expects to grant additional options in
future years. Because SFAS No. 123 is first applicable
to the Company's fiscal year ended June 30, 1996, the
full effects on pro forma earnings will not be felt
until 1998.
The fair value of each option grant was
estimated using the Black-Scholes model with risk-free
interest rates on the date of grant which ranged from
5.4% to 6.8%. The Company has never declared nor paid
dividends on its common stock and does not expect to in
the foreseeable future. The volatility factor of the
expected market price of the Company's common stock
used in estimating the fair value of the grants was
.858 and the expected life of the options was estimated
as five years.
The Company, at the discretion of the Board
of Directors, has granted warrants from time to time,
generally in conjunction with the sale of equities.
<TABLE>
<CAPTION>
Dec. 31, June 30
1996 1996 1995 1994
<S> <C> <C> <C> <C>
Officers 10,000 10,000 88,000 198,000
Others 2,826,239 3,126,964 2,329,375 1,284,375
Eligible, End of Year for Exercise
Currently (at prices ranging from
$.65 to $4.62 per share) 2,836,239 3,136,964 2,417,375 1,482,375
Warrants issued --- 1,309,589 1,410,000 407,500
Low exercise price $ --- $ 0.65 $ 1.50 $ 3.00
High exercise price $ --- $ 2.00 $ 2.00 $ 3.00
</TABLE>
Of the warrants outstanding at December 31, 1996,
210,150 were issued in conjunction with the
issuance of the Series D Convertible Preferred
Stock. These warrants entitle the registered
owner to purchase one-half of one share of Common
Stock at the per-share exercise price of $2.00.
All other outstanding warrants entitle the owner
to purchase one share of Common Stock for each
warrant, at prices ranging from $0.65 to $2.00 per
share.
The warrants outstanding as of December 31, 1996,
are currently exercisable and expire at various
dates through October 5, 2005.
For the six months ended December 31, 1996, and
for the fiscal years ended June 30, 1996, 1995 and
1994, when warrants were issued at market value,
no expense was recorded by the Company. When
warrants were issued below market value, a charge
against earnings was recorded. During the year
ended June 30, 1996, the exercise price of
1,000,000 warrants issued in the prior year was
reduced from $1.50 to $.65. The maximum expense
to be recorded by the Company upon exercise of
these warrants will be $850,000. During the period
ended December 31, 1996, the Company began
recording, on a prorated basis, the maximum
expense over the remaining life of the warrants.
Note 8 - Major customers:
In the six months ended December 31, 1996, five
customers accounted for 19%, 18%, 15%, 13% and 11%
of the Company's revenues. In the fiscal year
ended June 30, 1996, one customer accounted for
30% of the Company's total revenues. Another
customer accounted for 13% of the Company's
revenues during the year ended June 1996 and 16%
of the Company's revenues during the year ended
June 1995. A third customer accounted for 11% of
the Company's revenues during the year ended June
1995 and 19% of the Company's revenues during the
year ended June 1994. A fourth customer accounted
for 17% of the Company's revenues during the
fiscal year ended June 30, 1994.
Note 9 - Property and equipment at cost - net:
<TABLE>
<CAPTION> Useful Life
In Years or
December 31, June 30, Lease Term
1996 1996 1995
<S> <C> <C> <C> <C>
Leasehold improvements $ 22,945 $ 22,945 $ 22,945 Lease Term
Office furniture and equipment 199,254 199,254 201,942 5 - 7
Computer equipment 1,184,981 1,103,851 1,200,514 3 - 5
1,407,180 $1,326,050 $1,425,401
Less: Accumulated depreciation
and amortization 1,151,590 1,106,263 1,078,076
$ 255,590 $ 219,787 $ 347,325
</TABLE>
Depreciation and amortization expense on the above
assets of $45,327, $104,559, $100,229, and $93,777 was
recorded for the six months ended December 31, 1996,
and for the years ended June 30, 1996, 1995 and 1994,
respectively.
Note 10 - Revenue from sources outside the United States:
Revenues from licenses, engineering and sales of
tangible products sold outside the United States were
as follows:
<TABLE>
<CAPTION>
Six Months
Ended
December 31,
Years Ended June 30,
1996 1996 1995 1994
<S> <C> <C> <C> <C>
France $ 30,000 $ 65,085 $ 98,785 $ 35,450
Belgium 42,000 727,375 507,900 169,000
Australia --- 66,590 18,400 63,195
Germany --- 173,877 81,649 23,000
Japan 14,094 36,424 2,100 21,368
Canada --- 41,710 27,985 17,145
Singapore 10,535 65,530 65,315 ---
All other
countries 14,225 213,208 271,101 156,935
$110,854 $1,389,799 $1,073,235 $ 486,093
</TABLE>
Note 11 - Accounts payable and accrued expenses:
Accounts payable and accrued expenses consists of the
following:
<TABLE>
<CAPTION>
December 31, June 30,
1996 1996 1995
<S> <C> <C> <C>
Trade accounts payable $231,395 $269,320 $ 795,692
Accrued salaries 185,842 276,004 327,812
Other accrued expenses 253,505 179,403 170,619
$670,742 $724,727 $1,294,123
</TABLE>
Note 12 - Preferred stock:
Series A Preferred Stock is convertible at any time
into one fully paid and non-assessable share of Common
Stock. Series A Preferred has the same dividend rights
as shares of Common Stock but carries no voting rights.
Each share of Series A Preferred has the right to
receive in liquidation $2.00 before any distribution is
made on Common Stock or on any other class of stock
ranking junior to Series A. The liquidation value of
Series A Preferred was $904,128 at December 31, 1996,
June 30, 1996 and June 30, 1995.
Series B Convertible Preferred Stock is convertible
into Common Stock of the Company at any time on a share-
for-share basis. Series B Convertible Preferred Stock
has the same rights with respect to voting and
dividends as the Common Stock, except that each share
of Series B Convertible Preferred Stock has the right
to receive in liquidation $1.00 before any distribution
is made to holders of the Common Stock. The
liquidation value of Series B Preferred was $1,635,000,
$2,075,000 and $2,540,000 at December 31, 1996, June
30, 1996 and June 30, 1995, respectively.
Series D Convertible Preferred Stock is convertible
after January 1, 1996 at the option of the holder at
any time, and from time to time, into one fully paid
and non-assessable share of Common Stock of the
Company. The Series D Preferred shall have the right
to receive annual dividends at the rate of seven
percent (7%) of the stated value per share ($1.50),
which dividend shall be paid in cash or in shares of
Common Stock at the option of the Company. On June 30,
1996, the Company paid a stock dividend on the Series D
Preferred totaling $13,548. The Company shall have the
right, after June 1, 1996, to redeem in cash the Series
D Preferred, in whole or in part from time to time, at
the stated value per share plus accrued dividends. The
liquidation value of Series D Preferred was $279,230
plus accrued dividends at December 31, 1996; $277,007
plus accrued dividends at June 30, 1996; and none at
June 30, 1995.
The Series D Convertible Preferred Stock ranks on a
parity with Series B Convertible Preferred Stock with
respect to dissolution, liquidation, or winding up of
the Company and is entitled to receive, out of assets
of the Company available for distribution upon
liquidation, dissolution or winding up of the Company,
$1.50 per share plus an amount equal to all dividends
on shares accrued but unpaid, and is junior to the
Series A Convertible Preferred Stock and all series of
Redeemable Convertible Preferred Stock. The holders of
the Series D Preferred are entitled to one vote for
each share of Common Stock into which the Series D
Preferred is convertible, and therefore shall have the
same voting rights on a share-for-share basis, as the
holders of the Common Stock. The holders of the Common
Stock and of the Series D Preferred shall vote together
as one class on all matters submitted to a vote of
shareholders of the Company.
Note 13 - Redeemable Convertible Preferred Stock:
The Company is required to redeem all of the following
series of convertible preferred stock on or before
August 1, 2004. Accordingly, this preferred stock
subject to mandatory redemption has been presented
separately outside of permanent stockholders' equity in
the accompanying financial statements.
<TABLE>
<CAPTION>
December 31, June 30, June 30,
1996 1996 1995
<S> <C> <C> <C>
Series C, par value $1.00
per share, 0 shares
outstanding at December 31,
1996 and June 30, 1996, and
1,500 shares issued and
outstanding at June 30,
1995. $0, $0 and $100,328
of accumulated dividends at
December 31, 1996, June 30,
1996 and 1995,
respectively. $ --- $ --- $1,600,328
Series E, par value $1.00
per share, 1,444 shares
outstanding at December 31,
1996 and June 30, 1996, and
0 shares issued and
outstanding at June 30,
1995. $189,226, $133,213
and $0 of accumulated
dividends at December 31,
1996, June 30, 1996 and
1995, respectively. 1,633,226 1,577,213 ---
Series F, par value $1.00
per share, 599 shares
outstanding at December 31,
1996 and June 30, 1996, and
0 shares issued and
outstanding at June 30,
1995. $51,313, $22,802 and
$0 of accumulated dividends
at December 31, 1996, June
30, 1996 and 1995,
respectively. 650,313 621,802 ---
Series G, par value $1.00
per share, 777 shares
outstanding at December 31,
1996 and June 30, 1996, and
0 shares issued and
outstanding at June 30,
1995. $46,875, $18,619 and
$0 of accumulated dividends
at December 31, 1996, June
30, 1996 and 1995,
respectively. 823,875 795,619 ---
Series H, par value $1.00
per share, 2,026 shares
outstanding at December 31,
1996 and June 30, 1996, and
0 shares issued and
outstanding at June 30,
1995. $265,494, $186,904
and $0 of accumulated
dividends at December 31,
1996, June 30, 1996 and
1995, respectively. 2,291,494 2,212,904 ---
TOTAL $5,398,908 $5,207,538 $1,600,328
</TABLE>
At June 30, 1995, there were issued and outstanding
1,500 shares of Series C Convertible Preferred Stock.
In early October 1995, Wand Partners, Inc. exchanged
certain Notes payable for an additional 1,970 shares of
Series C Preferred Stock. On January 31, 1996, Wand
Partners, Inc. exchanged all of its Series C
Convertible Preferred Stock for 1,444 shares of Series
E Convertible Preferred Stock and 2,026 shares of
Series H Convertible Preferred Stock. On January 31,
Wand Partners, Inc. purchased 599 shares of Series F
Convertible Preferred Stock for a total of $599,000,
and on March 7, 1996, Wand purchased 777 shares of
Series G Convertible Preferred Stock for a total of
$777,000. Each of these series of stock is described
below.
Series F and G Convertible Preferred Stock
Except as noted below the Series F and G Preferred
Stock have the same terms and conditions. Each share
of Series F and G Preferred Stock is convertible at the
option of the holder at any time and from time to time
into shares of Common Stock at a conversion price of
(a) $1.25 per share, subject to adjustment, after June
30, 1996. With respect to dividend rights, redemption
rights and rights on liquidation, winding up or
dissolution, the Series F Preferred Stock ranks pari
passus with the Series G Preferred Stock and ranks
prior to the Series A, B, D, E, and H Preferred Stocks
and the Common Stock of the Company.
Except as provided herein, any holder of Series G
Preferred Stock that is subject to the Bank Holding
Company Act of 1956 ("BHCA Holder"), as amended, shall
have no voting rights. Each holder of Series G
Preferred Stock that is not a BHCA Holder shall be
entitled to vote on all matters as to which
stockholders of the Company are entitled to vote, and
each such holder shall be entitled to cast a number of
votes equal to the greatest number of whole shares of
Common Stock into which such holder's shares of Series
G Preferred Stock could be converted. The holders of
the Series F Convertible Preferred Stock are entitled
to one vote for each share of Common Stock into which
the shares are convertible.
In the event the Company is in default with respect to
the payment of (i) two consecutive cash dividends after
the "Restricted Period" as hereinafter defined or (ii)
two dividends within any six consecutive dividend
periods the holders of the Series F and G Preferred
Stock shall have the right to elect two directors for
so long as the default continues. In the event the
Company is in default with respect to the payment of
(i) four consecutive cash dividends after the
Restricted Period as hereinafter defined or (ii) four
dividend payments within any eight consecutive
quarterly dividend periods, the holders shall have the
right to elect four directors for so long as the
default continues.
In the event the Company violates the provisions of, or
is in default under the terms of any loan agreement or
in the event a judgment is entered against the Company
or any subsidiary in the amount of $50,000 or more, the
holders of the Series F and G Convertible Preferred
Stock shall have the right to elect four directors.
The holders of the Series F and G Preferred Stock,
except during the Restricted Period, are entitled to
receive out of funds of the Company legally available
for such purpose as and when declared by the Board of
Directors of the Company quarterly dividends in cash at
a rate of nine percent (9%) compounded daily per annum
of the stated value per share ($1,000.00 on original
issuance) of Series F and G Preferred Stocks.
Dividends shall accrue, be accumulated and added to the
stated value whether or not declared. So long as any of
the shares of Series F and G Preferred Stock are
outstanding, the Company shall not declare or pay any
dividends on any outstanding Common or Preferred Stock,
other than the Series D, F and G Preferred Stock. The
Restricted Period as it relates to the payment of
dividends on the Series F and G Preferred Stock means
the period beginning on the date of issuance of the
Series F or G Preferred Stock and ending on September
30, 1997. While no dividends are payable during the
Restricted Period, they will accrue and accumulate
during the Restricted Period.
The Company is obligated to redeem all the outstanding
shares of Series F and G Preferred Stock outstanding at
the stated value plus accrued dividends on August 1,
2004. The holders of the F and G Preferred Stock have
the right to require that the Company redeem, to the
extent the Company may lawfully do so, all or a portion
of the then outstanding shares of Series F and G
Convertible Preferred Stock at the stated value plus
accrued and unpaid dividends in the event of a merger,
reorganization, transfer of the majority of the voting
securities of the Company, or sale of more than 25% of
the assets of the Company.
Series E and Series H Convertible Preferred Stock
Except as noted below, the Series E and Series H
Preferred Stock have the same terms and conditions.
Each share of Series E and H Preferred Stock is
convertible at the option of the holder at any time and
from time to time into shares of Common Stock at a
conversion price of (a) $1.50 per share subject to
adjustment prior to August 1, 2004 or (b) on or after
August 1, 2004 at a conversion price which is the lower
of $1.00 or the conversion price in effect pursuant to
(a). With respect to dividend rights, redemption
rights and rights on liquidation, winding up or
dissolution, the Series E and H Preferred Stocks rank
(i) junior to the Series F Preferred Stock and the
Series G Preferred Stock; (ii) pari passus with the
Series A Preferred Stock; and (iii) rank prior to the
Series B Preferred Stock and the Series D Preferred
Stock and the Common Stock of the Company.
Except as provided herein, any holder of Series E
Preferred Stock that is subject to the Bank Holding
Company Act of 1956 ("BHCA Holder"), as amended, shall
have no voting rights. Each holder of Series E
Preferred Stock that is not a BHCA Holder shall be
entitled to vote on all matters as to which
stockholders of the Company are entitled to vote, and
each such holder shall be entitled to cast a number of
votes equal to the greatest number of whole shares of
Common Stock into which such holder's shares of Series
E Preferred Stock could be converted. The holders of
the Series H Convertible Preferred Stock are entitled
to one vote for each share of Common Stock into which
the shares are convertible.
Except as hereinafter provided, the holders of the
Series E Preferred Stock and the Series H Preferred
Stock shall have the right, voting separately as a
class, to elect two directors to the Board of Directors
of the Company. However, in the event the Company is
in default with respect to the payment of (i) two
consecutive cash dividends after the "Restricted
Period" as hereinafter defined or (ii) two dividends
within any six consecutive quarterly dividend periods,
the holders shall have the right to elect four
directors for so long as the default continues. In the
event the Company is in default with respect to the
payment of (i) four consecutive cash dividends after
the 'Restricted Period" as hereinafter defined or (ii)
four dividend payments within any eight consecutive
quarterly dividend periods, the holders shall have the
right to elect six directors for so long as the default
continues.
In the event the Company violates the provisions of, or
is in default under the terms of any loan agreement or
in the event a judgment is entered against the Company
or any subsidiary in the amount of $50,000 or more, the
holders of the Series E and H Convertible Preferred
Stock shall have the right to elect eight directors.
The holders of the Series E Preferred Stock and the
Series H Preferred Stock, except during the Restricted
Period, are entitled to receive out of funds of the
Company legally available for such purpose as and when
declared by the Board of Directors of the Company
quarterly dividends in cash at a rate of seven percent
(7%) compounded daily per annum of the stated value per
share ($1,000.00 on original issuance) of Series E and
H Preferred Stocks. Dividends shall accrue, be
accumulated and added to the stated value whether or
not declared. So long as any of the shares of Series E
and H Preferred Stock are outstanding, the Company
shall not declare or pay any dividends on any
outstanding Common or Preferred Stock, other than the
Series D, F and G Preferred Stock. The Restricted
Period as it relates to the payment of dividends on the
Series E and H Preferred Stock means the period
beginning on the date of issuance of the Series E and H
Preferred Stock and ending on the earlier of (a) the
first day of the calendar quarter in which the Company
first pays cash dividends on its Common Stock or (b)
June 30, 1998. While no dividends are payable during
the Restricted Period, they will accrue and accumulate
during the Restricted Period.
The Company is obligated to redeem all the outstanding
shares of Series E and H Preferred Stock outstanding at
the stated value plus accrued dividends on August 1,
2004. The holders of the E and H Preferred Stock have
the right to require that the Company redeem, to the
extent the Company may lawfully do so, all or a portion
of the then outstanding shares of Series E and H
Convertible Preferred Stock at the stated value plus
accrued and unpaid dividends in the event of a merger,
reorganization, transfer of the majority of the voting
securities of the Company, or sale of more than 25% of
the assets of the Company.
Note 14 - Related party transactions:
Herbert S. Meeker, a
director of the Company, is a partner in the law firm
of Baer, Marks & Upham, which the Company uses for
legal services. For the six months ended December 31,
1996, and for the years ended June 30, 1996, 1995, and
1994, the Company recorded an expense for Baer, Marks &
Upham of $7,200, $14,440, $14,440 and $14,000,
respectively. In addition, in the year ended June 30,
1995, the Company recorded a charge against additional
paid-in capital of $26,736 for the work done by Baer,
Marks & Upham on the Company's Rights Offering.
Included in Other current liabilities at December 31,
1996, June 30, 1996 and 1995 are $8,045, $8,885 and
$10,181, respectively, due Baer, Marks & Upham.
Bruce W. Schnitzer,
who became a director of the Company in August 1994, is
Chairman of Wand Partners, Inc., a private investment
firm that the Company uses for management consulting.
For the six months ended December 31, 1996, and for the
years ended June 30, 1996 and 1995, the Company
recorded an expense for Wand Partners, Inc. of $25,060,
$46,076 and 43,530, respectively. Included in Other
current liabilities at December 31, 1996, June 30, 1996
and 1995 are $0, $0 and $32,592, respectively, due
Wand Partners, Inc.
Thomas F. Hill, who
became a director of the Company in August 1994, is
President of Hill & Partners, a consulting firm that
the Company uses for marketing consulting. For the
year ended June 30, 1995, the Company recorded an
expense for Hill & Partners of $106,679. Included in
Other current liabilities at June 30, 1995 is $37,661
due Hill & Partners.
Thomas D. Halket, who
became an officer of the Company in January 1993, is an
outside counsel for the Company. For six months ended
December 31, 1996, and for the years ended June 30,
1996, 1995 and 1994, the Company recorded an expense
for Thomas Halket of $65,425, $144,176, $103,326, and
$80,196, respectively. Included in Other current
liabilities at December 31, 1996, June 30, 1996 and
1995 are $6,864, $34,799 and $6,900, respectively.
Note 15 - Notes payable:
On August 16, 1995, a registration statement of the
Company relating primarily to rights granted to the
Company's shareholders became effective. Each right
enabled the holder to purchase a Unit consisting of one
share of Series D Convertible Preferred Stock,
convertible into one share of Common Stock after
January 1, 1996, and one warrant to purchase one-half
share of Common Stock for three years after the
effective date of the registration statement at a price
of $2.00 per share.
Gross proceeds of the rights offering, which closed on
September 29, 1995, totaled $285,823. In early October
the Company received the proceeds of the offering and
issued the stock. Costs of the offering, which were
charged to additional paid-in capital, totaled
approximately $136,000.
Pursuant to a Standby Financing and Purchase Agreement
dated March 16, 1995, as amended on June 30, 1995, Wand
Partners, Inc. loaned to the Company the sum of
$1,700,000 evidenced by promissory notes, which bore
interest at the rate of 10% per annum, payable in
shares of Common Stock of the Company. On September
12, 1995, Wand Partners, Inc. made an additional loan
to the Company in the amount of $300,000, bringing the
principal amount of all of the Company's promissory
notes to $2,000,000. In early October, Wand Partners,
Inc. exchanged these notes for 20,000 unregistered
Units and 1,970 shares of Series C Preferred Stock.
The terms and conditions of such Series C Convertible
Preferred Stock are the same as the 1,500 shares of
Series C Convertible Preferred Stock previously
purchased by Wand Partners, Inc..
Upon completion of the offering and the conversion of
the notes described above, the Company issued to Wand
Partners, Inc. 700,000 ten-year warrants to purchase
shares of the Common Stock of the Company at $1.00 per
share. The Company recorded a charge of $131,250
representing the difference between the market value of
the underlying Common Stock of the Company and the
aggregate exercise price of such warrants.
Note 16 - Long-term portion of deferred income:
In December 1994, a
customer agreed to convert $200,000 of its prepayment
into equity and the Company agreed to refund to the
customer its prepayments of royalties and engineering
fees under its license agreement with the Company. The
amounts to be refunded are equal to the greater of (a)
seven percent (7%) of the Company's revenues from
licensing of its credit-card risk assessment products
in Europe or (b) certain minimum payments during the
period ending December 31, 1996. The refunding of the
customer's prepayments based upon the Company's
European risk-assessment revenues is expected to
continue through December 1999, but in no event shall
exceed in the aggregate prepayments made by the
customer, reduced by refunds made to the customer and
by the amount of prepayments applied to the purchase of
Series A Preferred Stock of the Company. At December
31, 1996 and June 30, 1996, such long-term portion of
deferred income remaining on the books of the Company
amounted to $430,899 after giving effect to the
application of $200,000 of deferred income to the
purchase by the customer of 100,000 shares of Series A
Preferred Stock, $30,000 refunded by the Company to the
customer, and the reclassification of $275,000 to Other
current liabilities. At June 30, 1995, $100,000 of the
amount owed by the Company was recorded as Other
noncurrent liabilities and the balance was shown as
Other current liabilities. There is no interest on
these amounts due the customer.
Note 17 - Significant transactions:
On June 11, 1996, the
Company entered into an exclusive Licensing Agreement
and an Asset Purchase Agreement with National Computer
Systems, Inc. (NCS) transferring the development,
production, and marketing rights of the Company's
Intelligent Character Recognition (ICR) products to
NCS. The Company received $1,400,000 as an initial
license fee pursuant to the Licensing Agreement, and
has the right to receive royalties on future sales of
the products by NCS. Minimum annual royalties range
from $160,000 in 1997 to $350,000 in 2001 and beyond.
If NCS terminates its exclusive rights under the
contract, minimum royalty payments would not be
required subsequent to such termination. The initial
license fee was included in software licensing revenue
in the year-ended June 30, 1996.
The Asset Purchase
Agreement transferred tangible and intangible assets
used exclusively in the ICR business to NCS for
$300,000. The net gain on the sale of these assets was
recognized as Other income in the year-ended June 30,
1996.
Note 18 - Other income (expense) - net:
Other income (expense)
as reflected in the consolidated statements of
operations consists of the following:
<TABLE>
<CAPTION>
Six Months
Ended
December 31, Years Ended June 30,
1996 1996 1995 1994
<S> <C> <C> <C> <C>
Interest expense $(3,227) $(51,574) $ (34,801) $ (1,685)
Expense relating to
financing operations(42,500) (131,250) (210,500) (287,969)
Net gain on sale of
tangible and
intangible assets
(See Note 17) --- 213,185 --- ---
Other - net 29,507 9,589 24,277 7,236
Other Income
(Expense) - Net $(16,220) $ 39,950 $(221,024) $(282,418)
</TABLE>
Note 19 - Deferred development costs:
The Company began in the quarter ended September 30,
1996, a project to customize its PRISM Fraud Detection
System for a customer. Because the terms of the
agreement have not been finalized, the Company is
accounting for the development costs in accordance with
SOP 81-1, "Accounting for Performance of Construction-
Type and Certain Production-Type Contracts," which
provides that costs be deferred until delivery is made
under the terms of an enforceable agreement. During
the quarter ended December 31, 1996, the Company
recorded an adjustment to reverse revenues totaling
$211,000 and capitalize related costs of $118,000
originally recorded in the quarter ended September 30,
1996. This change had the effect of increasing net
loss per share by $.01. The Company expects to
conclude an agreement and make required deliveries in
early 1997. For the six months ended December 31,
1996, the Company deferred $364,000 of costs associated
with this project.
NESTOR, INC.
Part IV
Item 14
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<TABLE>
<CAPTION>
Balance Addition
at Charged Balance
Beginning Charged to at
of to Other Deductions End
Description Period Expense Accounts Reserve of Period
<S> <C> <C> <C> <C> <C>
Allowances
deducted from
accounts
receivable:
Year ended
June 30, 1994 $ 1,550 $ 21,680 $ --- $ --- $ 23,230
Year ended
June 30, 1995 $ 23,230 $ 45,276 $ --- $(10,530) $ 57,976
Year ended
June 30, 1996 $ 57,976 $120,656 $ --- $(12,923) $ 165,709
Six months
ended
December 31,
1996 $ 165,709 $ 38,888 $ --- $59,362 $ 145,235
</TABLE>
ITEM 8. Financial Statement and Supplementary Data
See annexed financial statements.
ITEM 9. Changes in or Disagreement with Accounting and
Financial disclosure
Information regarding changes in accountants was
previously filed under cover of Form 8-K which is
incorporated herein by reference.
ITEM 10. Directors and Executive Officers of the Registrant.
Incorporated by reference from the Company's
definitive proxy or information statement to be filed
with the Commission not later than 120 days following
the end of the Company's fiscal year.
ITEM 11. Executive Compensation.
Incorporated by reference from the Company's
definitive proxy or information statement to be filed
with the Commission not later than 120 days following
the end of the Company's fiscal year.
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management.
Incorporated by reference from the Company's definitive
proxy or information statement to be filed with the
Commission not later than 120 days following the end of
the Company's fiscal year.
ITEM 13. Certain Relationships and Related Transactions.
Incorporated by reference from the Company's
definitive proxy or information statement to be filed
with the Commission not later than 120 days following
the end of the Company's fiscal year.
ITEM 14. Exhibits, Financial Statement, Schedules and Reports on
Form 8-K.
(a)The following documents are filed as part of this
report:
(1) The financial statements of the Company and
accompanying notes, as set forth in the
contents to the financial statements annexed
hereto, are included in Part II, Item 8.
Schedule IV: Valuation and Qualifying Accounts and Reserves
All other schedules are omitted because such
information is not applicable.
(2) Exhibits numbered in accordance with Item 601
of Regulation S-K.
(See Exhibit Index)
Exhibits filed herewith:
(None)
(b) Reports on Form 8-K:
On October 4, 1996, the Company filed with the
Commission a Current Report on Form 8-K dated
September 19, 1996.
On December 17, 1996, the Company filed with the
Commission a Current Report on Form 8-K dated
December 10, 1996.
INDEX OF EXHIBITS
Exhibit Number Description of Exhibit
3.1 Certificate of
Incorporation of the Company, filed as an Exhibit to the Company's
Registration Statement on Form S18, Commission File No. 286182-B,
is hereby incorporated herein by reference.
3.2 Amendment to the
Certificate of Incorporation of the Company, dated December 5,
1985, filed as an Exhibit to the Company's Form 8 amending the
Company's Form 10-K for the fiscal year ended June 30 1987 (the
"1987 Form 8"), is hereby incorporated herein by reference.
3.3 Amendment to the
Certificate of Incorporation of the Company, dated December 4,
1986, filed as an Exhibit to the 1987 Form 8, is hereby
incorporated herein by reference.
3.4 Bylaws of the
Company, as amended, filed as Exhibit to the 1987 Form 8, is hereby
incorporated herein by reference.
4 Nestor, Inc.
Incentive Stock Option Plan, as amended, filed as an Exhibit to the
Company's Registration Statement on Form S-8, filed May 5, 1987, is
hereby incorporated herein by reference.
10.1 Non-Exclusive Field-
of-Use License Agreement dated June 21, 1988 between the Company
and Morgan Stanley & Co. Incorporated, filed as an Exhibit to the
Company's Form 10-K for the fiscal year ended June 30, 1988, is
hereby incorporated herein by reference.
10.2 Cooperative
Marketing Agreement dated May 26, 1988 between the Company and
Arthur D. Little, Inc., filed as an Exhibit to the Company's Form
10-K for the fiscal year ended June 30, 1988, is hereby
incorporated herein by reference.
10.3 Lease Rider dated
February 6, 1985 between Richmond Square Technology Park Associates
and the Company, filed as an Exhibit to the Company's Report on
Form 10-K for the fiscal year ended June 30, 1986, is hereby
incorporated herein by reference.
10.4 Employment Agreement
dated August 4, 1986 between the Company and Michael G. Buffa,
filed as Item 5 of the Company's Report on Form 8-K dated September
11, 1986, is hereby incorporated herein by reference.
10.5 Joint Venture
Agreement between the Company and Oliver, Wyman & Co., dated
December 4, 1986, filed as an Exhibit to the 1987 Form 10-K, is
hereby incorporated herein by reference.
10.6 Employment Agreement
dated as of July 1, 1989 between the Company and David Fox filed as
an Exhibit to the 1989 Form 10-K is hereby incorporated by
reference.
10.7 Employment Agreement
dated as of September 15, 1988 between the Company and Douglas L.
Reilly filed as an Exhibit to the 1989 Form 10-K is hereby
incorporated by reference.
10.8 Memorandum dated
January 1, 1989 regarding stock bonus plan for Douglas L. Reilly
filed as an Exhibit to the 1989 Form 10-K is hereby incorporated by
reference.
10.9 Amendment to Joint
Venture Agreement dated May 8, 1990 between the Company and Oliver,
Wyman & Co. filed as an Exhibit to the 1992 Annual Report on Form
10-K is hereby incorporated by reference.
10.10 License Agreement
dated October 26, 1990 by and between the Company and Sligos, S. A.
filed as an Exhibit to the Company's 1992 Annual Report on Form 10-
K is hereby incorporated by reference.
10.11 Supplemental License
Agreement dated September 9, 1991 by and between the Company and
Sligos, S. A., filed as an Exhibit to the Company's 1992 Annual
Report on Form 10-K, is hereby incorporated by reference.
10.12 NestorWriter(TM)
License and Development Agreement dated September 11, 1991 between
the Company and Poqet Computer Corporation.
10.13 License Agreement
for Product Development and Marketing dated October 30, 1990
between the Company and Lyonnaise des Eaux-Dumez.
10.14 Software Development
Agreement dated October 30, 1990 between the Company and Lyonnaise
des Eaux-Dumez.
10.15 License Agreement
dated November 27, 1990 between the Company and Atari Corporation.
10.16 License Agreement
for Product Development and Marketing dated March 18, 1991 between
the Company and Dassault Electronique.
10.17 Agreement of
Purchase and Sale dated August 16, 1991 between the Company and
Diversified Research Partners filed as Item 5 of the Company's
report on Form 8-K dated August 21, 1991 is hereby incorporated
herein by reference.
10.18 License Agreement
dated October 15, 1993, between the Company and Intel Corporation
filed as an Exhibit to the Company's 1994 Annual Report on Form 10-
K is hereby incorporated by reference.
10.19 Exclusive Marketing
Agreement dated April 7, 1994, between the Company and Intel
Corporation filed as an Exhibit to the Company's Current Report on
Form 8-K dated April 7, 1994, is hereby incorporated by reference.
10.20 Securities Purchase
Agreement dated August 1, 1994, between the Company and Wand/Nestor
Investments L.P. ("Wand") filed as Item 5 of the Company's report
on Form 8-K dated August 8, 1994, is hereby incorporated herein by
reference.
10.21 Standby Financing
and Purchase Agreement dated as of March 16, 1995 between the
Company and Wand, filed as an Exhibit to the Company's Current
Report on Form 8-K dated March 16, 1995, is hereby incorporated by
reference.
10.22 First Amended and
Restated Standby Financing and Purchase Agreement dated June 30,
1995 between the Company and Wand, filed as an Exhibit to the
Company's Current Report on Form 8-K dated July 7, 1995, is hereby
incorporated by reference.
10.23 Amendment Agreement
dated December 20, 1994 between the Company and Sligos, S.A., filed
as an Exhibit to the Company's Registration Statement on Form S-2,
Commission File No. 33-93548, is hereby incorporated herein by
reference.
10.24 Technology
Development Subcontract dated December 20, 1994, between the
Company and Alta Technology Corporation, filed as an Exhibit to the
Company's Registration Statement on Form S-2, Commission File No.
33-93548, is hereby incorporated herein by reference.
10.25 Agreements between
the Company and Europay International S.A. ("Europay") consisting
of: (i) Fraud Study Agreement dated August 3, 1993, together with
appendices and exhibits thereto; (ii) Confidentiality Agreement
dated August 3, 1993; (iii) Nestor Fraud Detection System User
License dated September 21, 1994; (iv) Source Code Addendum to
Nestor Fraud Detection System User License, dated September 22,
1994; and (v) Memorandum of Understanding dated May 5, 1995, filed
as an Exhibit to the Company's Registration Statement on Form S-2,
Commission File No. 33-93548, is hereby incorporated herein by
reference.
10.26Lease of executive
offices of the Company, together with the most recent rider
thereto, filed as an Exhibit to the Company's Registration
Statement on Form S-2, Commission File No. 33-93548, is hereby
incorporated herein by reference.
10.27 Non-Exclusive
License Agreement between the Company and International Business
Machines Corporation, filed as an Exhibit to the Company's Current
Report on Form 8-K dated January 30, 1996, is hereby incorporated
by reference.
10.28 Securities Purchase
and Exchange Agreement between the Company and Wand/Nestor
Investments L.P., filed as an Exhibit to the Company's Current
Report on Form 8-K dated January 30, 1996, is hereby incorporated
by reference.
10.29 Securities Purchase
Agreement between the Company and Wand/Nestor Investments L.P.,
filed as an Exhibit to the Company's Current Report on Form 8-K
dated March 7, 1996, is hereby incorporated by reference.
10.30 Asset Purchase
Agreement and License Agreement between the Company and National
Computer Systems, Inc., filed as an Exhibit to the Company's
Current Report on Form 8-K dated June 11, 1996, is hereby
incorporated by reference.
10.31 Prism Non-Exclusive
License Agreement between the Company and Applied Communications,
Inc., filed as an Exhibit to the Company's Current Report on Form 8-
K dated September 19, 1996, is hereby incorporated by reference.
Portions of the Exhibit omitted, pursuant to a grant of
confidential treatment.
22 Subsidiaries of the
Company, filed as an Exhibit to the 1987 Form 10-K, is hereby
incorporated herein by reference.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 774,457
<SECURITIES> 0
<RECEIVABLES> 1,009,149
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,551,571
<PP&E> 1,407,180
<DEPRECIATION> 1,151,590
<TOTAL-ASSETS> 2,817,944
<CURRENT-LIABILITIES> 1,307,994
<BONDS> 0
5,398,908
2,366,294
<COMMON> 89,161
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 2,817,944
<SALES> 63,775
<TOTAL-REVENUES> 1,195,904
<CGS> 8,978
<TOTAL-COSTS> 922,325
<OTHER-EXPENSES> 0
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