105
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the period ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file Number 0-12965
NESTOR, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3163744
(State of incorporation) (I.R.S. Employer
Identification No.)
One Richmond Square, Providence, 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 12, 1999 was $5,412,000. The
number of shares outstanding of the Registrant's Common Stock at
March 12, 1999 was 17,499,327.
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.
ITEM 1. Business
Prospective Statements
The following discussion contains prospective statements
regarding Nestor, Inc. and its subsidiaries ("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, database marketing 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 and long distance and
mobile phone fraud applications.
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 System(Tm) ("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.
On January 1, 1997, Nestor, Inc. formed two wholly-owned
subsidiaries: Nestor Traffic Systems, Inc. (Traffic Systems),
formerly Nestor Intelligent Sensors, Inc., and Nestor
Interactive, Inc. (Interactive). Traffic Systems develops and
markets the TrafficVision(R), CrossingGuard(R) and the Ni1000
product lines while Interactive developed InterSite, an internet
commerce solution.
Nestor offers complete application-software solutions that
include adaptive decision models, implementation, education,
training, consulting, processing and engineering support
services. Current Nestor software products detect credit/debit
card, merchant and other forms of fraud (PRISM(R)), provide
remote traffic management of freeways (TrafficVision) and
intersections (CrossingGuard), provide intelligent, organization-
wide marketing campaign management (CampaignOne(TM)), provide
responsive on-line information to internet Web site visitors
(InterSite) and provide much greater efficiencies in document
processing and fax distribution environments (NestorReader,
OmniTools and N'Route, which were licensed to National Computer
Systems 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. CampaignOne was introduced in 1998 to the
financial services customers of the Company as a back-office
marketing solution that can manage programs ranging from risk
evaluation (bankruptcy) to marketing strategies. The Company is
evaluating the expansion of these product technologies into
additional applications such as health-care payments, long-
distance telephone fraud and mobile-phone service theft. 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 data and
surveillance. Internet Web Server 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
The Company's PRISM product line includes the Nestor Fraud
Detection System (FDS(TM)) and the flagship product, Proactive
Risk Management (PRISM) system which have been licensed to twelve
financial-services clients as of December 31, 1998. 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 found 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 PRISM. 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 upgrade to FDS installed at G.E.
Capital Consumer Financial Services; the upgrade incorporated
PRISM in 1995.
During 1997, the Company expanded its PRISM product line with the
introduction of PRISM Debit (Debit), PRISM Bankruptcy
(Bankruptcy), and PRISM Credit (Credit). Debit is an intelligent
risk management system that detects, monitors, responds to and
prevents off-line debit card fraud. Bankruptcy is a bankruptcy
decision-support system that provides transaction-level analysis
of each account and enables card issuers to better manage risk
while increasing portfolio profitability. Credit is a multi-
faceted fraud detection system that dramatically reduces losses
associated with credit and retail card application fraud.
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. 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 executed a non-
exclusive PRISM reseller agreement with CSK Corporation in Japan
during 1996 (See "Licensing, Joint Venture and Development
Agreements). 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
April 18, 1997, the Company expanded its non-exclusive license
agreement with Applied Communications, Inc. (ACI), a subsidiary
of Transaction Systems Architects, Inc., by allowing ACI to
distribute the newly developed PRISM products and other products
of the Company throughout its worldwide sales and support
network. (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 internet market fraud losses, 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.
Offer new products leveraging current services, customer
knowledge and relationships. During 1998, the Company introduced
CampaignOne, a comprehensive customer relationship and marketing
campaign management solution designed to maximize the
effectiveness and efficiency of marketing campaigns for all
aspects of financial opportunity from: customer acquisition,
retention cultivation and overall customer profitability.
CampaignOne can be basic decision tree models delivered by the
customer or utilize the Company's customized neural-network
models.
Traffic Management Systems
TrafficVision and CrossingGuard products are 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, detection and enforcement of
red-light violators, 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 experience nearly 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. CrossingGuard applies the TrafficVision
technologies to make intersections safer and to enforce red-light
running statues. Using video, the system predicts if a vehicle
will or will not stop at an intersection before a yellow light
turns red. If the system determines that a vehicle will not
stop, the system records the violation for ticket issuance and
sends a signal to the traffic light controller unit recommending
a delay in the change of light to green for cross traffic.
TrafficVision is designed to incorporate the Company's Ni1000
Recognition Accelerator(R) hardware chip (See "Ni1000 Chip"
below).
Development of a working TrafficVision 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. The Company began a
Phase II contract for field testing of the prototype in 1997 and
expects to complete this work in the second quarter of 1998.
In February 1998, the Rhode Island Department of Transportation
(RIDOT) formally opened its new Operations Center. As an
integral part of that facility, TrafficVision is providing real-
time traffic management capabilities which assist RIDOT in
improving safety, monitoring traffic flow, managing congestion
and planning for maximum highway efficiency.
The first CrossingGuard application commenced in Vienna, Virginia
in 1998 and is expected to be operational in April 1999.
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 and
CrossingGuard are 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. These 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, incidence response video-based
red-light enforcement, and intersection safety.
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 detector stations
will be compatible with existing and new traffic controller
hardware, such as the 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) initially
through direct sales to provide convincing demonstrations of the
products' superior performance, to create performance standards
based upon enhanced 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 domestic and foreign
traffic integrators and installers.
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 two
applications pending relating to its work in the traffic-
management areas.
Ni1000 Chip, PCI 4000 Recognition Accelerator Board and IBM ZISC
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
Accelerator 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 that 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 Defense Advanced Projects
Research Agency of the Department of Defense ("DARPA").
PCI 4000 Recognition Accelerator Board
An outgrowth of the Company's DARPA-funded development work is
the PCI 4000 Recognition Accelerator, 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 ZISC (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.
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.
In 1997, two customers selected InterSite for beta installations.
Lycos, Inc. is a free, global Internet navigation and community
network which experiences millions of hits each day, and Edward
Jones is the largest financial-services firm in the nation in
terms of offices and is the only firm that serves individual
investors exclusively. The firm traces its roots to 1871, and
today serves more than 2.5 million customers.
The Company has currently suspended further direct involvement in
marketing and developing this product. Product development may
resume if funded projects are requested by our current customers
or distributors.
Intelligent Character Recognition Products
On June 11, 1996, the Company licensed the 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 receives 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:
NestorReaderT
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(R)
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(R)
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, CampaignOne and InterSite
products), 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 PRISM and CampaignOne directly.
ACI is the Company's largest reseller, with offices and employees
around the world. ACI has reseller rights to all of the
Company's products on a stand-alone basis or packaged with their
proprietary products. The Company has a worldwide license with
Total System Services, Inc. (Total) to provide its PRISM product
to customers for which Total provides card processing services
(provided in North and Central America). 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 1998, ACI, GE Consumer Credit Financial Services and
Mellon Bank accounted for 28%, 20% and 14% of the Company's
revenues, respectively. During 1997, ACI and Europay accounted
for 39% and 16% of the Company's revenues, respectively. During
the six months ended December 31, 1996, 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. 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. As of
December 31, 1998, the Company had a backlog of approximately
$1,492,000 in undelivered development and installation contracts
and $192,000 in prepaid royalties. At December 31, 1997, the
Company had a backlog of approximately $248,000 in undelivered
development and installation contracts and $259,000 in prepaid
royalties. At December 31, 1996, the Company had a backlog of
$209,000 in undelivered development and installation contracts
and $582,000 in prepaid royalties. As of June 30, 1996, the
Company had a backlog of $408,000 in undelivered development and
installation contracts and $431,000 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 one new patent in fiscal 1997 and has two applications
pending as of December 31, 1998. 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 years ended December 31, 1998 and
1997, in the six months ended December 31, 1996, and in the
fiscal year ended June 30, 1996, respectively, $2,112,000,
$1,498,000, $294,000 and $823,000 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 Accelerator chip)
containing many more nodes than has been possible with other
designs.
The Company owns eight United States patents and eighteen foreign
patents issued in eleven countries. In addition, there are two
applications pending in the United States, and one application
pending in Japan as of December 31, 1998. The foreign patents
and patent application correspond to one or more of the United
States patents.
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 1999 to 2014. The corresponding foreign patents expire at
various times through 2007. The following table lists the
Company's material United States patents:
Year of
Patent Date of Expira-
Number Title Issue tion
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 Jan. 30, 1990 2007
4,958,375 Parallel, Multi-unit,
Adaptive Pattern
Classification System Using
Inter-unit Correlations And
An Intra-class Separator
Methodology Sept. 18, 1990 2007
5,054,093 Parallel, Multi-unit,
Adaptive, Nonlinear Pattern
Class Separator and
Identifier Oct. 1, 1991 2008
5,479,574 Method and Apparatus for
Adaptive Classification Dec. 26, 1995 2012
5,701,398 Adaptive Classifier Having
Multiple Subnetworks Dec. 23, 1997 2014
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, MasterCard Corporation, 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 and CrossingGuard 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, Lockheed Martin, 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, CrossingGuard and the Ni1000
Recognition Accelerator Chip. Red-light enforcement products are
also available using loops and wet-film cameras through companies
such as EDS, Lockheed Martin, Tellis and Red Flex.
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 HNC Software, Inc. The market for
internet-oriented products is intensely competitive with new
competitors emerging frequently.
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, 1998, the Company had 45 full-time employees,
including 28 in product development, 8 in sales and marketing
and 9 in finance and administration. 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, software development 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 System Services, Inc.
During the six month period ended December 31, 1996, the Company
designed and installed a fraud detection system for Total System
Services, Inc. (Total), a major provider of card processing
services for financial institutions. Total provides PRISM fraud
detection services to its customers along with the other
transaction processing services. The Company receives fees based
upon the number of transactions that are scored by PRISM.
Applied Communications, Inc. (ACI)
On April 18, 1997, the Company expanded its non-exclusive license
agreement with ACI. The expanded license grants to ACI the right
throughout the world to integrate and distribute all of the PRISM
products. ACI provides authorization and transaction processing
software to more than 500 customers throughout the world. The
Company will receive royalties based on PRISM and other product
license, engineering and ongoing use fees received by ACI from
ACI sublicenses.
In April 1998, ACI's parent company, Transaction Systems
Architects, Inc. (TSAI) entered into a Stock Purchase Agreement
with the Company. TSAI purchased 2.5 million shares of common
stock for $5,000,000 and obtained a warrant purchase an
additional 2,500,000 common shares for $7,500,000 shares which
expires on March 1, 2002.
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. To maintain
exclusive rights, minimum annual royalties range from $160,000 in
1997 to $350,000 in 2001 and beyond. In June 1998, NCS did not
meet its minimum royalty for the license year and forfeited
exclusive rights.
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 were 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 receives
royalties from the sales by IBM 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
began a Phase II contract for field testing of the prototype in
1997 and expects to complete this work in the first quarter of
1999.
The total value of the expanded contract is $730,000, of which
$726,000 had been recognized as revenue by December 31, 1998.
DARPA
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 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 was for an initial term of two years and is being
renewed annually. As of December 31, 1997, CSK had installed
PRISM at Nippon Shinpan Company (NICOS), a leading credit card
issuer in Japan.
Intel Corporation
On October 15, 1993, the Company and Intel Corporation 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. In accordance with the
license agreement, Intel notified the Company of its intention to
phase out manufacturing of chips based on the .8 micron geometry.
The Company placed a purchase order in 1997 and took delivery of
an order for 1,000 units in early 1999. Given the number of
chips the Company has in inventory and potential alternate
development options, management does not believe there will be a
material adverse impact on its operations as a result of the
termination of the manufacturing of the current version of the
Ni1000 chips.
ITEM 2. Properties.
The Company leases offices and research and development
facilities, consisting of approximately 13,000 square feet,
located at One Richmond Square, Providence, Rhode Island 02906,
for which the annual base rental is $195,000. The Company
believes these facilities will be adequate to serve its needs in
the foreseeable future.
ITEM 3. Legal Proceedings.
On October 6, 1998, HNC Software Corp. ("HNC"), a significant
competitor of the Company's in the field of Financial Services,
obtained a patent entitled "Fraud Detection Using Predictive
Modeling" and began advising prospective customers of the Company
of the patent. Upon review of the patent and consideration of
prior actions taken by HNC, the Company initiated a lawsuit
against HNC in Providence, RI on November 25, 1998 alleging a
number of claims including; violation of Sections 1 and 2 of the
Sherman Act (antitrust), violation of the Rhode Island Antitrust
Act patent invalidity, and infringement of Nestor's patent. The
suit seeks various damages, including lost profits and treble
damages. Costs associated with the suit are being expensed as
incurred. No estimate of the outcome of this suit, or a
potential countersuit, if any, can currently be made.
ITEM 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during
the fourth quarter of the year ended December 31, 1998.
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
Year Ended 12/31/98
1st Quarter 1-3/4 2-35/64
2nd Quarter 1-57/64 3-1/8
3rd Quarter 7/8 2-33/64
4th Quarter 5/16 1-7/16
Year Ended 12/31/97
1st Quarter 1-21/32 2-9/16
2nd Quarter 1-3/4 2-9/16
3rd Quarter 1-1/4 2-9/32
4th Quarter 1-1/4 3-1/16
Period Ended 12/31/96
1st Quarter 1-11/16 3-1/4
2nd Quarter 2-1/8 3
Year Ended 6/30/96
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
As at March 12, 1999, the number of holders of record of the
issued and outstanding common stock of the Company was 424, which
includes brokers who hold shares for approximately 1,546
beneficial holders.
The Company has not declared any cash dividends with respect to
its common stock since its formation.
<TABLE>
ITEM 6. Selected Financial Data
<CAPTION> Six Months
Years Ended Ended
December 31, December 31, Years Ended June 30,
1998 1997 1996 1996 1995 1994
<S> <C> <C> <C> <C> <C> <C>
Operating revenue $ 2,241,376 $ 5,681,076 $1,195,904 $5,461,580 $ 3,195,563 $ 2,230,474
Other income (expense) $ (26,178) $ 31,321 $ (16,220) $ 39,950 $ (221,024) $ (282,418)
Net income (loss) $(5,263,153) $ (294,664) $(935,337) $ 12,690 $(3,457,422) $ (1,758,584)
Earnings per share
Weighted
number of
outstanding shares--
basic and diluted 15,249,932 9,243,508 8,689,031 7,847,510 7,411,502 6,840,407
(Loss) per share $ (0.36) $ (0.08) $ (.13) $ (0.03) $ (.48) $ (.26)
SELECTED BALANCE SHEET DATA:
Total assets $ 2,591,589 $ 2,613,031 $2,817,944 $3,351,871 $ 1,812,495 $ 1,096,314
Working capital $ 551,461 $ 146,081 $ 879,172 $1,983,661 $(1,882,875) $ 220,243
Long-term
Redeemable Preferred
Stock $ --- $ 5,792,787 $5,398,908 $5,207,538 $ 1,600,328 $ ---
Capital leases $ 22,618 $ 10,220 $ 9,455 $ 9,455 $ --- $ 3,363
Deferred income $ --- $ --- $ 430,899 $ 430,899 $ 438,896 $ 954,491
</TABLE>
ITEM 7: Management's Discussion and Analysis
Prospective Statements
The following discussion contains prospective statements
regarding Nestor, Inc., its business outlook and results of
operations, all of which 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.
Liquidity and Capital Resources
Cash Position and Working Capital
The Company had cash and short-term investments of approximately
$1,175,000 at December 31, 1998, as compared with $387,000 at
December 31, 1997. At December 31, 1998, the Company had working
capital of $551,000, as compared with $146,000 at December 31,
1997. The increase in working capital from 1997 to 1998 reflects
primarily the proceeds from the sale of $5,000,000 in common
stock during the year offset by cash used by current-period
operating activities of $3,899,000 and equipment purchases of
$132,000.
The Company had a net worth of $984,000 at December 31, 1998, as
compared with a negative net worth of $4,519,000 at December 31,
1997. The increase in net worth resulted from the issuance of
$5,000,000 of common stock and the conversion of $5,793,000 in
redeemable preferred stock to common stock, offset by the current
period operating loss of $5,263,000.
As a result of its financial performance during 1998, the Company
ceased further investments in development and marketing of its
Internet product "InterSite". The net investment incurred by the
Company in this product in 1998 was $1,383,000.
Additional capital will be required to enable the Company to
carry out needed marketing campaigns for its products, for
continued development and upgrading of its products and for
customer support. On March 24, 1999, the Company entered into a
$1,000,000 Line of Credit agreement with Transaction Systems
Architect, Inc. ("TSAI"). The loan is secured by the royalty
stream and other fees produced by the Company's License
Agreements with Financial Services Division customers. Principal
payments are due in twelve equal installments beginning March 1,
2001. Interest on the loan is equal to the effective prime
interest rate plus 1% and payments are due quarterly in arrears
beginning July 10, 1999. The line may be reduced to $500,000 if
the Company's equity becomes negative or increased up to
$4,000,000 if certain financial requirements are attained.
On March 25, 1999, Nestor Traffic Systems, Inc., a subsidiary of
the Company, sold a 37.5% common-stock interest in it to a
private group of investors for $2,350,000 in cash and issued an
option for an additional 17.5% of its common stock for
$1,750,000. The investor group includes three officers of the
Company and the subsidiary, who in the aggregate contributed
$600,000 of the initial cash invested on the same basis as third-
party investors. The option expires on January 31, 2000. The
proceeds will be used by the subsidiary to fund traffic-system
product development and marketing efforts in 1999. In addition,
to the extent that facility and administrative services of the
Company are used by the subsidiary, reimbursement of allocated
costs will be provided. The subsidiary has an exclusive license
from the Company to apply the Company's proprietary technologies
in the area of traffic-management systems. The license provides
for royalties to the Company of 5% of related revenues, net of
direct cost of third party goods sold, in 2000 and 10% in 2001
and beyond. The capital invested in the subsidiary will be used
to fund the expenses of Traffic Systems incurred after January 1,
1999, which were funded by the Company in previous years.
Management believes that the Company's revenues will generate
sufficient liquidity, when combined with its liquid assets as of
December 31, 1998 and the financings described above, to meet the
Company's anticipated cash requirements from current operations
through the end of the year ending December 31, 1999. If the
Company does not realize revenues sufficient to maintain its
operations 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.
Litigation
On October 6, 1998, HNC Software Corp. ("HNC"), a significant
competitor of the Company in the field of Financial Services,
obtained a patent titled "Fraud Detection Using Predictive
Modeling" and began advising prospective customers of the Company
of the patent. Upon review of the patent and consideration of
prior actions taken by HNC, the Company initiated a lawsuit
against HNC in the United States District Court in Providence, RI
on November 25, 1998 alleging violation of Sections 1 and 2 of
the Sherman Act (antitrust), violation of the Rhode Island
Antitrust Act, patent invalidity, and infringement of Nestor's
patent. The suit seeks various damages, including lost profits
and treble damages. Costs associated with the suit are being
expensed as incurred. No estimate of the outcome of this suit,
or a potential countersuit, if any, can currently be made.
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 upon
delivery of the product and completion of related engineering or
other services necessary under the contract, or 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.
Total deferred income was $434,000 at December 31, 1998, as
compared with $408,000 at December 31, 1997.
In June 1997, the Company and Sligos, S.A. terminated their
license agreement dated October 26, 1990. The Company paid to
Sligos $225,000 in July 1997 in full settlement of its current
liability due to Sligos and of the repurchase of 452,064 shares
of the Company's Series A Preferred Stock. The Company also
eliminated $431,000 of long-term deferred income related to
Sligos prepayments received in 1990, which had not been taken
into income. (See "Results of Operations" below.)
Future Commitments
During the year ended December 31, 1998, the Company acquired
additional property and equipment (primarily computers and
related equipment) at a cost of $132,000. The Company valued its
investments in computers and related equipment (net of
depreciation) at $369,000 at December 31, 1998. The Company has
no material commitments for capital expenditures although
management expects that the Company may make future commitments
for the purchase of additional computers and related computing
equipment, for furniture and fixtures, for development of
hardware, for consulting and for promotional and marketing
expenses. The Company maintains a lease for office space
totaling approximately 13,000 square feet. The lease provides
for monthly rent, including utilities except electricity, in the
amount of $16,250 and expires in February 2000. The Company
believes the facilities are adequate for its 1999 needs.
The Company had placed purchase orders totaling $877,500 with
Intel Corporation for a supply of the Ni1000 Recognition
Accelerator Chips. The Company received delivery of $195,000 of
the chips during February 1999. The Company canceled its
outstanding purchase order for the remaining chips in February
1999.
The Company's subsidiary, Nestor Traffic Systems, Inc., entered
into an agreement on September 25, 1997, for the modification of
one of the components of the TrafficVision product. Nestor
agreed to pay Zeller Research, Ltd. $75,000 for engineering,
which is expected to be completed during the first quarter of
1999, and to purchase 100 units of the modified component at a
total cost of up to $53,000. Additional orders may be placed
with this vendor to supply components of traffic-system products
based upon third party orders received.
Year 2000
Year 2000 problems may arise in computer equipment and software,
as well as embedded electronic systems, because of the way these
systems are programmed to interpret certain dates that will occur
around and after the change in century. In the computer
industry, this is primarily the result of computer programs being
designed and developed using or reserving only two digits in year
fields (rather than four digits) to identify the century, without
considering the ability of the program to properly distinguish
the upcoming century change in the Year 2000. In addition, the
Year 2000 is a special-case leap year, and some programs may drop
February 29, 2000 from their internal calendars. Other dates may
present problems because of the way the digits are interpreted.
Because the Company's business is based on the licensing of
application software, the Company's business would be adversely
impacted if its products or its internal systems experience
problems associated with the century change. This issue also
potentially affects the software programs and systems used by the
Company in its operations.
In 1998, the Company initiated a company-wide program to analyze
three specific categories of systems; (1) software developed by
the Company which is licensed to customers, (2) software utilized
by the Company consisting of applications developed in-house and
purchased from third party suppliers, and (3) systems and
embedded technology which are integral components of the
infrastructure of the Company. The Company developed and
acquired tools, which were utilized during the testing of
software and systems. The Company believes that its remediation
efforts with respect to its licensed software will be successful.
The Company's belief is based upon its own testing by simulating
dates and upon testing by many of the customers of the Company
who have in turn completed their own Year 2000 testing. The
Company continues to actively monitor the status and progress of
customers and distributors and to assess the risk associated in
those cases where the customer has not taken delivery of the
compliant version or may not have made satisfactory progress in
their own Year 2000 testing.
Following analysis, remediation and testing efforts, the Company
began shipping Year 2000 compliant versions of all licensed
software applications in November 1998. As of December 31, 1998,
all of the Company's currently licensed software applications are
Year 2000 compliant and available to customers. With respect to
its own systems, testing, remediation, and/or replacement is
underway and has been substantially completed in the most
critical areas. The Company anticipates it will complete its
Year 2000 compliance efforts by the third quarter of 1999.
The Company expects to incur project costs of approximately
$250,000 over the life of the Year 2000 project. These costs
consist of: (i) internal staff costs related to licensed product
remediation and testing; (ii) internal staff costs related to
internal software and system compliance; (iii) hardware and
software costs for replacement of software; and (iv) costs
related to compliance involving embedded systems. Costs incurred
from the beginning of the project in 1997 through December 1998
have totaled approximately $150,000. The Company expects to
incur an additional $100,000 over the remaining life of the
project. All costs of the Year 2000 project are being expensed
as incurred. The estimated remaining costs are based upon
currently known circumstances and various assumptions regarding
future events. There can be no assurance that this estimate will
be achieved and actual results could differ materially from those
anticipated.
Except for statements of existing or historical facts, the
foregoing discussion consists of forward-looking statements and
assumptions relating to forward-looking statements, including
without limitation the statements relating to the timetable for
completion of the Year 2000 compliance efforts, future costs,
potential problems relating to Year 2000, the Company's state of
readiness, third-party representations, and the Company's plans
and objective for addressing the Year 2000 problems. Certain
factors could cause actual results to differ materially from the
Company's expectations, including without limitation (i) the
failure of existing or future customers to achieve Year 2000
compliance; (ii) the failure of computer hardware system
providers on which the Company and its customers rely, or other
vendors or service providers of the Company or its customers, to
timely achieve Year 2000 compliance; (iii) the Company's product
and systems not containing all necessary data code changes; (iv)
the failure of the Company's analysis and testing to detect
operational problems in software utilized by the Company or in
the Company's products or services, whether such failure results
from the technical inadequacy of the Company's validation and
testing efforts, the technical unfeasibility of testing certain
software, and the unavailability of customers or other third
parties to participate in testing; (v) potential litigation
arising out of Year 2000 issues with respect to providers of
software and related technical and consulting services such as
the Company generally provides, and particularly in light of the
numerous interfaces between Company products and the products and
services of third parties, which are required to successfully
utilize the Company's products, which could involve the Company
in expensive, multiple-party litigation even though the Company
may have no responsibility for the alleged problem; and (vi) the
failure to timely implement a contingency plan to the extent that
Year 2000 compliance is not achieved.
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 the Years Ended December 31, 1998 and 1997
In the year ended December 31, 1998, the Company realized a 61%
decrease in revenues compared to the prior calendar year.
Expenses increased 25% in 1998 resulting in a 1,690% increase in
the operating loss when compared with the prior year.
During 1998, the Company determined that it would not have
adequate financial resources to continue the development and
marketing efforts required to commercialize the Internet
marketing product InterSite. After unsuccessful attempts to
obtain independent financing for the product line, during the
fourth quarter of 1998, the Company decided to eliminate all
current costs associated with the product and transferred it to
the Financial Services division. Intangible assets associated
with this product line totaling $295,000 were written-off in
1998.
The Company executed a license agreement on March 28, 1997 for a
customized copy of its PRISM Fraud Detection System, and had
capitalized $575,000 of costs associated with the installation of
the system as of December 31, 1997. Since the installation, the
Company has continued to modify and improve the software. The
system was deployed in December of 1998 to a limited number of
initial customers, and began generating monthly revenue. In
consideration of the delays in implementation, estimated ongoing
support costs in relation to current revenue levels, and the
remaining term of the license, the Company recorded an adjustment
to the carrying value of the system of approximately $400,000 in
the fourth quarter of 1998, reducing capitalized deferred costs
to $80,000. These costs are being amortized over the remaining
life of the associated license.
Revenues
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 year ended December 31, 1998, revenues
decreased $3,440,000 to $2,241,000 from $5,681,000 in the prior
calendar year. Non-recurring revenues in the year-earlier period
included $2,000,000 of revenues associated with a license
agreement with Applied Communications, Inc. ("ACI") in April
1997, and $480,000 recognized upon the termination of a license
agreement with Sligos in June 1997.
Software Licensing
Product-licensing revenues totaled $4,390,000 in 1997, as
compared with $1,352,000 in 1998. The decrease in these revenues
reflects a decrease in license fees realized from PRISM products.
PRISM licensing revenues amounted to $1,318,000 in 1998, a
decrease of $2,945,000 from year-earlier revenues of $4,263,000.
The decrease in PRISM-related licensing revenues reflects non-
recurring revenues in 1997 of $2,000,000 from ACI and $480,000
from Sligos. The remainder of the decrease reflects a decrease in
new initial licenses realized in 1998.
During the year ended December 31, 1997, the Company realized
$120,000 of royalty revenue from National Computer Systems, Inc.
("NCS"), as compared with $32,000 in 1998. In June 1998, NCS
elected not to meet its minimum royalty requirement to maintain
an exclusive right to the marketing of the Company's image
character recognition products. The license with NCS continues
on a non-exclusive basis.
Engineering Services
Engineering revenues totaled $746,000 in 1998, as compared with
$1,055,000 in 1997. Revenues relating to new license
installations and customer-funded modifications of Nestor's PRISM
product totaled $613,000 in 1998, a decrease of $356,000 from
$969,000 of such revenues in 1997. The decrease is related to
the drop in new PRISM licenses, and the associated installation
work, noted in "Software Licensing" above.
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 was valued at approximately $597,000. On March 31,
1997, the Company extended its contract with JPL to include in-
field evaluation of the prototype system developed under the
original JPL contract, and the value of the contract was
increased to $730,000, of which approximately $726,000 had been
earned as of December 31, 1998,. The terms of the JPL contract
call for delivery of prototype products, but do not specify any
subsequent purchasing or licensing provisions.
During the year ended December 31, 1998, the Company recognized
revenues totaling $89,000 under its government contracts. In the
year-earlier period such revenues totaled $86,000.
During 1998, the Company realized $44,000 of revenues related to
engineering work on its InterSite product. No such revenues were
realized in 1997.
Sales of Tangible Products
The tangible products currently sold by the Company are based
upon the Company's Ni1000 Recognition Accelerator Chip which is
incorporated into the Traffic Systems product line or is licensed
with development software that enables customers to develop their
own high-speed recognition applications. Revenues from the
Company's Ni1000 Development System totaled $70,000 in the year
ended December 1998, as compared with $111,000 in the prior year.
The Company is continuing its development of the TrafficVision
and CrossingGuard products, which incorporate the Ni1000
Recognition Accelerator Chip (see "Investment in Product
Development and Marketing," below). Revenues from the Company's
Traffic Systems products totaled $73,000 in the year ended
December 1998, as compared with $130,000 in the prior year.
Operating Expenses
Total operating expenses - consisting of engineering, research
and development, selling and marketing, and general and
administrative expenses - amounted to $7,478,000 in the year
ended December 31, 1998, an increase of $1,501,000 over total
operating costs of $5,977,000 in the prior year.
Included in operating expenses in 1998 are write-downs of
Deferred Development Costs and other intangibles of approximately
$400,000 in the financial services division and $295,000 in the
InterSite product line.
Engineering Services
Costs related to engineering services totaled $2,067,000 in 1998,
as compared with $1,151,000 in 1997. The increase in these costs
reflects the write-offs totaling approximately $695,000 discussed
above. The remaining increase is due primarily to general cost
increases incurred in 1998.
Research and Development
Research and development expenses totaled $2,112,000 in the year
ended December 31, 1998 as compared with $1,498,000 in the prior
year. The increase in such costs reflects the net of increased
investment in product development in all of the Company's product
lines in the current year, including PRISM V3.0 shipped in the
fourth quarter of 1998, development of CrossingGuard which is
being delivered to Vienna, VA in the first quarter of 1999, and
development of InterSite through November of 1998. Development
costs should decrease substantially in 1999 as a result of the
termination of further InterSite development in November 1998;
additionally, in view of its independent financing, the Company
will share the development costs associated with Nestor Traffic
Systems, Inc.
Selling and Marketing
Selling and marketing costs decreased $155,000 to $1,832,000 in
the year ended December 31, 1997, from $1,986,000 in the prior
year.
The decrease in selling costs in the year reflects, primarily,
reduced commissions incurred in conjunction with reduced
revenues. Selling costs relating to the Company's PRISM product
line totaled $1,103,000 in 1998, as compared to $1,360,000 in
1997. The decrease is due to a $174,000 decrease in commission
expense and reduced Advertising and Meeting expenses resulting
from charging an attendance fee to the 1998 Risk Symposium
meeting. Selling costs relating to the Company's Traffic Systems
product and Ni1000 Development System totaled $536,000 in 1998,
as compared with $552,000 in 1997. Selling costs associated with
InterSite, in which the Company ceased further investment
effective November 1998, totaled $192,000 in 1998, which was
unchanged from the prior year.
General and Administrative
General and administrative expenses totaled $1,413,000 in 1998,
as compared with $1,207,000 in the previous year. General and
administrative costs for the year ended December 1998 reflect
increased legal expenses related to the lawsuit initiated against
a competitor in November 1998 and increased accounting fees.
Other Income (Expense)
For 1998, net other expense was $26,000, as compared with net
other income of $31,000 in the year-earlier period. In June
1997, the Company recorded other income of $100,000 as a discount
on the payment relating to the termination of the License
Agreement with Sligos. In 1998, other expense was comprised
primarily of $106,000 of amortization expense related to the
assigned value of warrants outstanding offset by $73,000 of
interest income.
Investment in Product Development and Marketing
With the exception of $80,000 related to a custom PRISM
installation at December 31, 1998, the Company has not
capitalized any expenses relating to the development or marketing
of its products. The following information details the amounts
by which the Company's expenses in connection with each of its
major product lines exceeded revenues for such product lines.
The largest net investment made by the Company was in its Traffic
Systems subsidiary, which is responsible for the development and
marketing of the TrafficVision and CrossingGuard products. The
Company delivered a few TrafficVision products during 1998, but
concentrated most of its efforts on the development of the
CrossingGuard product of which a first beta version was delivered
in the first quarter of 1999. For the year ended December 31,
1998, expenses of this subsidiary exceeded revenues by
$1,933,000.
The Company began development in July 1996 of products for use in
Internet and intranet environments. Costs associated with this
effort totaled $628,000 in 1997. The Company continued its
investment in this subsidiary in 1998 and initiated efforts to
locate independent third party financing. These efforts were not
successful, and the Company ceased further investment in
development of this product line in November 1998. The net
investment in this subsidiary during 1998 was $1,383,000.
The Company made a net investment in its PRISM product line
during 1998 of $1,954,000.
Net Income
During 1998, the Company experienced a loss of $5,263,000, as
compared with a loss of $295,000 in the prior year. For the year
ended December 31, 1998, loss per share available for common
stock was $0.36 per share, as compared with a loss per share of
$0.08 in the corresponding period of the prior fiscal year. For
the year ended December 31, 1998, there was outstanding a
weighted average of 15,249,932 shares, as compared with 9,243,508
in the year-earlier period.
Analysis of the Years Ended December 31, 1997 and 1996
In the year ended December 31, 1997, the Company realized a 26%
increase in revenues compared to the prior calendar year.
Expenses increased 22% in 1997 resulting in a 27% decrease in the
operating loss when compared with the prior year.
On June 11, 1996, the Company entered into an exclusive Licensing
Agreement with NCS transferring the development, production, and
marketing rights of the Company's Intelligent Character
Recognition (ICR) products to NCS. Pursuant to the License
Agreement, NCS paid the Company an initial license fee of
$1,400,000, and has paid a ten percent royalty on revenues NCS
has realized from the ICR products since their transfer to NCS.
Such revenues, including the initial license fee, accounted for
47% of revenues in calendar 1996, including the initial license
fee, as compared to 2% in 1997.
In the quarter ended September 30, 1996, the Company began a
project to customize its PRISM Fraud Detection System for a
customer. Because the terms of the agreement had not been
finalized, the Company accounted 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. For the year ended December
31, 1996, the Company deferred $364,000 of costs associated with
this project.
The Company executed a license agreement on March 28, 1997, made
required deliveries, and recognized in the quarter ended March
31, 1997, $550,000 of revenues under this contract. Since the
installation, the Company has continued to modify and improve the
software although the customer has not yet deployed it. While
management expects that the customer will deploy the software,
management is not able to forecast when it will be deployed.
Accordingly, the revenues associated with this contract were
reversed in the fourth quarter of 1997 and $575,000 of costs were
capitalized as Deferred Development Costs at December 31, 1997.
The deferred development costs will be amortized over the
remaining life of the license upon deployment by the customer.
(See 1998 developments previously discussed.)
Revenues
The following table compares revenues for calendar 1997 with
calendar 1996 including and excluding revenues from ICR
operations transferred to NCS:
Total
Total Total Revenues
Revenues Revenues Yr. Ended
Yr. Ended Yr. Ended 12/31/96
12/31/97 12/31/96 Change Excluding ICR Change
$5,681,000 $4,508,000 +26% $2,379,000 +138%
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 year ended December 31, 1997, revenues
increased $1,173,000 to $5,681,000 from $4,508,000 in the prior
calendar year. Revenues in the year-earlier period included
$2,129,000 of revenues associated with the ICR products that were
licensed exclusively to NCS in June 1996.
Software Licensing
Product-licensing revenues totaled $4,396,000 in 1997, as
compared with $2,450,000 in 1996. The increase in these revenues
reflects the net of an increase in license fees realized from the
PRISM products and the decrease in licensing revenues from the
ICR products transferred to NCS.
PRISM licensing revenues amounted to $4,263,000 in 1997, an
increase of $3,366,000 from year-earlier revenues of $416,000.
The increase in PRISM-related licensing revenues results from an
increase in unit volume through the Company's resellers, Applied
Communications, Inc. ("ACI"), Europay International, S.A., and
CSK Corporation ("CSK").
During the year ended December 31, 1997, the Company realized
$120,000 of royalty revenue from NCS, as compared with $1,958,000
of ICR licensing revenues, the initial license fee from NCS, and
subsequent royalties from NCS realized in 1996.
Engineering Services
Engineering revenues totaled $1,055,000 in 1997, as compared with
$1,908,000 in calendar 1996. Revenues relating to customer-
funded modifications of Nestor's PRISM product totaled $969,000
in 1997, a decrease of $260,000 from $1,229,000 of such revenues
in 1996.
The Company's contract with the Defense Advanced Research
Projects Agency (DARPA) requires engineering services rendered by
the Company to develop a circuit board for use with the Ni1000
Recognition Accelerator Chip. The contract, signed August 26,
1993, is in the amount of $776,000; as of December 31, 1997,
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 was valued at approximately $597,000. On March 31,
1997, the Company extended its contract with JPL to include in-
field evaluation of the prototype system developed under the
original JPL contract. The value of the contract was increased
to $730,000; as of December 31, 1997, approximately $657,000 had
been earned.
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 year ended December 31, 1997, the Company recognized
revenues totaling $67,000 under its government contracts. In the
year-earlier period such revenues totaled $507,000.
Sales of Tangible Products
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 $105,000 in the
year ended December 1997, as compared with $149,000 in the prior
year.
The Company is continuing its development of the TrafficVision
product, which will incorporate the Ni1000 Recognition
Accelerator Chip (see "Investment in Product Development and
Marketing," below). During the year ended December 1997, initial
commercial shipments of TrafficVision totaled $130,000.
Operating Expenses
Total operating expenses - consisting of engineering, research
and development, selling and marketing, and general and
administrative expenses - amounted to $5,977,000 in the year
ended December 31, 1997, an increase of $1,065,000 over total
operating costs of $4,912,000 in the prior year.
Included in the year ended December 31, 1997 and 1996, were $0
and $972,000, respectively, of expenses attributable to the ICR
products, which were licensed to NCS in June 1996. Expenses
associated with the ICR products are no longer incurred by the
Company as NCS hired most of the Company's staff assigned to
development, sales, and support of the ICR products.
Engineering Services
Costs related to engineering services totaled $1,151,000 in 1997,
as compared with $1,927,000 in 1996. The decrease in these costs
reflects the decrease in engineering-services revenues. As a
percentage of such revenues, engineering costs totaled 109% of
related revenues in 1997, as compared with 101% of similar
revenues in the year-earlier period.
Research and Development
Research and development expenses totaled $1,498,000 in the year
ended December 31, 1997, as compared with $628,000 in the prior
year. The increase in such costs reflects the net of increased
investment in product development in all of the Company's product
lines in the current year and the absence of product development
relating to the ICR products. Investment in the ICR products in
the year ended December 31, 1996 totaled $295,000.
Selling and Marketing
Selling and marketing costs increased $662,000 to $1,986,000 in
the year ended December 31, 1997, from $1,324,000 in the prior
year.
The increase in selling costs in the year reflects, primarily,
the net of two effects: an increase in sales and marketing costs
in each of the Company's product lines and the absence of selling
costs relating to the ICR products. PRISM selling costs totaled
$1,279,000 in the year ended December 1997, as compared with
$406,000 prior year. Selling costs relating to the Company's
TrafficVision product and Ni1000 Development System totaled
$514,000 in 1997, as compared with $279,000 in 1996. Selling
costs associated with InterSite, which the Company began to
develop in July 1996, totaled $195,000 in 1997, as compared with
$31,000 in the prior year. Selling and marketing costs relating
to the ICR products totaled $0 and $605,000 in 1997 and 1996,
respectively.
General and Administrative
General and administrative expenses totaled $1,207,000 in 1997,
as compared with $975,000 in the previous year. General and
administrative costs for the year ended December 1996 reflect the
capitalization of $76,000 of costs associated with the PRISM
development project. Apart from that item, the increase in
general and administrative costs reflects the growth of the
Company's three businesses.
Other Income (Expense)
For 1997, net other income was $31,000, as compared with net
other income of $204,000 in the year-earlier period. In June
1997, the Company recorded other income of $100,000 as a discount
on the payment relating to the termination of the License
Agreement with Sligos. In June 1996, the Company recorded other
income of $213,000 as a gain on the sale of intangibles relating
to the sale of the ICR products to NCS.
Investment in Product Development and Marketing
In 1996 and 1997, the Company had not capitalized any expense
relating to development or marketing of its products. The
following information details the amounts by which the Company's
expenses in connection with each of its major product lines in
those years exceeded early-stage revenues for such product lines.
The largest investment made by the Company was in its Intelligent
Sensors subsidiary, which is responsible for the development and
marketing of the TrafficVision products, an outgrowth of work
under the JPL contract. The Company extended its contract with
JPL and made initial commercial deliveries in the September 1997
quarter. For the year ended December 31, 1997, expenses of this
group exceeded revenues by $1,127,000.
The Company began development in July 1996 of products for use in
internet and intranet environments. Costs associated with this
effort totaled $628,000 in 1997. In October 1997 Lycos, Inc.,
which hosts one of the most active Web sites on-line, selected
Nestor's InterSite product to provide intelligent personalization
for Lycos' global Internet navigation center.
The Company did not make any net investment in its PRISM product
line or in its Fraud Detection System. Revenues relating to the
Company's PRISM Fraud Detection System exceeded expenses by
$2,544,000 in 1997, including $480,000 of license revenue
relating to the termination of the License Agreement with Sligos.
Net Income
During 1997, the Company experienced a loss of $295,000, as
compared with a loss of $199,000 in the prior year. For the year
ended December 31, 1997, loss per share available for common
stock was $0.08 per share, as compared with a loss per share of
$0.09 in the corresponding period of the prior fiscal year. For
the year ended December 31, 1997, there were outstanding a
weighted average of 9,243,508 shares, as compared with 8,376,345
in the year-earlier period.
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
In 1996, the Company changed its accounting period to a calendar
year from a fiscal year ending on June 30. The following table
compares revenues for the transition period in 1996 with revenues
for the comparable period of the preceding year, including and
excluding revenues from ICR operations transferred to NCS:
Total
Total Total Revenues
Revenues Revenues Six-Month
Six-Month Six-Month Period Ended
Period Ended Period Ended 12/31/95
12/31/96 12/31/96 Change Excluding ICR Change
1,196,000 $2,149,000 -44% $1,195,000 0%
During the six months ended December 31, 1996, total 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
In the transition period, product-licensing revenues totaled
$526,000, as compared with $902,000 in the prior 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 focused 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. 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
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.
ITEM 7(a): Not applicable.
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: April 8, 1999
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 Title Date
/s/Leon N Cooper Co-Chairman of the Board April 8, 1999
and Director
/s/Charles Elbaum Co-Chairman of the Board April 8, 1999
and Director
/s/David L. Fox President, Chief Executive April 8, 1999
Officer and Director
/s/Herbert S. Meeker Secretary and Director April 8, 1999
/s/Sam Albert Director April 8, 1999
/s/John Guinan Director April 8, 1999
/s/Jeffrey Harvey Director April 8, 1999
/s/Thomas F. Hill Director April 8, 1999
/s/Bruce Schnitzer Director April 8, 1999
CONSOLIDATED FINANCIAL STATEMENTS
FORM 10-K
December 31, 1998
NESTOR, INC. Part II
Item 8
CONTENTS
Independent Auditor's Report
Statement No.
Consolidated Balance Sheets 1
December 31, 1998 and 1997
Consolidated Statements of Operations -
For the Years Ended December 31, 1998 and 1997,
For the Six Months Ended December 31, 1996 and
For the Years Ended June 30, 1996 2
Consolidated Statements of Cash Flows -
For the Years Ended December 31, 1998 and 1997
For the Six Months Ended December 31, 1996 and
For the Year Ended June 30, 1996 3
Consolidated Statements of Stockholders' Equity -
For the Years Ended December 31, 1998 and 1997
For the Six Months Ended December 31, 1996 and
For the Years Ended June 30, 1996 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 sheets of
Nestor, Inc. as of December 31, 1998 and 1997, and the related
consolidated statements of operations, cash flows and
stockholders' equity for the years ended December 31, 1998 and
1997 and the period July 1, 1996 to December 31, 1996. Our audits
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 audits.
We conducted our audits 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 audits provide a reasonable basis for our opinion.
In our opinion, the 1998 and 1997 financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Nestor, Inc. at December 31,
1998 and 1997, and the consolidated results of its operations and
its cash flows for the years ended December 31, 1998 and 1997 and
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,
presents fairly in all material respects the information set
forth therein.
ERNST & YOUNG LLP
Providence, Rhode Island
February 17, 1999 (except for Note 23 as to which the date is
March 25, 1999)
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
of Nestor, Inc.
Providence, Rhode Island
We have audited the consolidated statements of operations, cash
flows and stockholders' equity of Nestor, Inc. for the year ended
June 30, 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 audits.
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 consolidated statements of operations, cash flows and
stockholders equity are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated statements of
operations, cash flows, and stockholders equity. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
presentation of the consolidated statements of operations, cash
flows, and stockholders equity. We believe that our audits of
the consolidated statements of operations, cash flows and
stockholders equity provide a reasonable basis for our opinion.
In our opinion, the consolidated statements of operations, cash
flows, and stockholder's equity present fairly, in all material
respects, the results of operations, cash flows, and stockholders
equity of Nestor, Inc. for the year ended June 30, 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.
GASSMAN, REBHUN & CO., P.C.
New York, New York
September 6, 1996
<TABLE>
NESTOR, INC.
Consolidated Balance Sheets
<CAPTION> December 31,
ASSETS 1998 1997
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,175,183 $ 386,639
Accounts receivable, net of allowance
for doubtful accounts 512,748 557,212
Unbilled contract revenue 118,209 298,803
Other current assets 329,961 232,492
Total current assets 2,136,101 1,475,146
Property and equipment at cost -
net of accumulated depreciation 368,525 261,463
Deferred development costs 80,000 574,752
Intangible assets -
net of accumulated amortization --- 295,887
Other assets 6,963 5,783
Total Assets $ 2,591,589 $ 2,613,031
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 1,150,604 $ 920,833
Deferred income 434,036 408,232
Total current liabilities 1,584,640 1,329,065
Noncurrent liabilities:
Long term obligations under capital leases 22,618 10,220
Total liabilities 1,607,258 1,339,285
Series E, F, G and H redeemable convertible
preferred stock 4,846 shares at
December 31, 1997 (liquidation value $1,000
per share plus accrued dividends) --- 5,792,787
Commitments and contingencies --- ---
Stockholders' Equity (Deficit):
Preferred stock, $1.00 par value,
authorized 10,000,000 shares;
issued and outstanding:
Series B - 365,000 shares at December 31, 1998
And 1,445,000 shares at December 31, 1997 365,000 1,445,000
Series D - 0 shares at December 31, 1998 and
170,871 shares at December 31, 1997 --- 265,347
Common stock, $.01 par value, authorized
30,000,000 shares; issued and outstanding:
17,479,327 shares at December 31, 1998 and
9,403,987 shares at December 31, 1997 174,793 94,040
Warrants and options 630,467 523,984
Additional paid-in capital 24,504,556 12,579,920
Retained (deficit) (24,690,485) (19,427,332)
Total stockholders' equity (deficit) 984,331 (4,519,041)
Total Liabilities and
Stockholders' Equity (Deficit) $ 2,591,589 $ 2,613,031
The Notes to the Financial Statements are an integral part of
this statement.
</TABLE>
<PAGE>
<TABLE>
NESTOR, INC.
Consolidated Statements of Operations
<CAPTION>
Six Months
Ended Year Ended
Years Ended December 31, December 31, June 30,
1998 1997 1996 1996
<S> <C> <C> <C> <C>
Revenue:
Software licensing $ 1,352,071 $ 4,390,479 $ 526,353 $ 2,825,600
Engineering services 746,007 1,055,459 605,776 2,378,135
Tangible product sales 143,298 235,138 63,775 257,845
Total revenue 2,241,376 5,681,076 1,195,904 5,461,580
Operating Expenses:
Engineering services 2,066,558 1,151,147 922,325 1,833,531
Tangible product costs 54,010 134,305 8,978 32,189
Research and development 2,112,746 1,498,181 294,136 823,000
Selling and marketing 1,831,697 1,986,340 457,281 1,764,585
General and
administrative 1,413,340 1,207,088 432,301 1,035,535
Total operating
expenses 7,478,351 5,977,061 2,115,021 5,488,840
Loss from operations (5,236,975) (295,985) (919,117) (27,260)
Other income
(expense) - net (26,178) 31,321 (16,220) 39,950
Income (loss)
before income taxes (5,263,153) (264,664) (935,337) 12,690
Income taxes --- 30,000 --- ---
Net Income (Loss) $(5,263,153) $ (294,664) $ (935,337) $ 12,690
Loss Per Share:
Net Income (Loss) $(5,263,153) $ (294,664) $ (935,337) $ 12,690
Dividends accrued on
preferred stock 151,396 447,191 201,094 261,210
Net Loss Available for
Common Stock $(5,414,549) $ (741,855) $(1,136,431) $ (248,520)
Loss Per Share:
Basic and diluted $ (0.36) $ (0.08) $ (0.13) $ (0.03)
Shares Used in Computing
Loss Per Share:
Basic and diluted 15,249,932 9,243,508 8,689,031 7,847,510
The Notes to the Financial Statements are an integral part of this statement.
</TABLE>
<PAGE>
<TABLE>
NESTOR, INC.
Consolidated Statements of Cash Flows
<CAPTION>
Six Months
Ended Year Ended
Years Ended December 31, December 31, June 30,
1998 1997 1996 1996
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(5,263,153) $(294,664) $ (935,337) $ 12,690
Adjustments to reconcile
net income (loss)
to net cash used by
operating activities:
Write-down for
impairment loss 790,641 --- --- ---
Depreciation and
amortization 114,810 194,311 45,328 104,559
Loss on disposal of
fixed assets --- 3,573 --- 4,346
Expenses charged to
operations relating to
options, warrants and
capital transactions 106,483 161,684 42,500 178,375
Discount on payment of
vendor obligation --- (100,000) --- ---
Changes in assets and
liabilities:
(Increase) decrease in
accounts receivable 44,464 451,937 (414,839) 67,424
(Increase) decrease in
unbilled contract
revenue 180,594 (171,858) 155,991 (74,584)
(Increase) in deferred
development costs --- (210,347) (364,405) ---
(Increase) decrease in
other assets (98,649) 41,635 (45,877) (99,025)
(Decrease) increase in
accounts payable
and accrued expenses 199,750 (63,845) (83,593) (568,309)
(Decrease) increase in
deferred income 25,804 (361,071) 252,300 796
Net cash used by
operating activities (3,899,256) (348,645) (1,347,932) (373,728)
Cash flows from investing activities:
Purchase of property and
equipment (132,209) (88,622) (71,390) (57,531)
Proceeds from the disposal
of fixed assets --- --- --- 85,000
Net cash provided (used)
By investing activities (132,209) (88,622) (71,390) 27,469
Cash flows from financing activities:
Repayment of obligations
under capital leases (47,246) (11,913) (5,338) (7,924)
Proceeds from notes
payable 250,000 --- --- 300,000
Repayment of notes payable (250,000) --- --- ---
Rights offering expense --- --- --- (136,421)
Redemption of Preferred
Series D Stock (41,424) --- --- ---
Proceeds from issuance
of common stock - net 4,977,749 96,975 185,800 99,510
Proceeds from issuance
of preferred stock - net --- --- --- 1,651,823
Payments of dividends
on preferred stock (69,070) (35,613) --- ---
Net cash provided by
financing activities 4,820,009 49,449 180,462 1,906,988
Net change in cash and
cash equivalents 788,544 (387,818) (1,238,860) 1,560,729
Cash and cash equivalents-
beginning of period 386,639 774,457 2,013,317 452,588
Cash and cash equivalents-
end of period $1,175,183 $ 386,639 $ 774,457 $ 2,013,317
Supplemental cash flows information:
Interest paid $ 20,350 $ 3,598 $ 3,227 $ 4,372
Income taxes paid $ 37,500 $ --- $ --- $ ---
Significant non-cash transactions are described in Notes 7, 10, 12 and 19
</TABLE>
<TABLE>
Nestor, Inc. Consolidated Statement of Stockholders' Equity
<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 6/30/95 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 6/30/96 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) --- --- ---
Accretion of value
of warrants --- --- --- --- --- --- 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 12/31/96 8,916,141 $ 89,161 2,266,735 $ 2,366,294 $ 11,927,644 $(19,132,668) $417,500 $(4,332,069)
Issuance of
Common Stock 279,592 2,796 --- --- 472,769 --- --- 475,565
Conversion of
Preferred Stock to
Common Stock 198,800 1,988 (198,800) (203,200) 201,212 --- --- ---
Dividends on
Preferred Stock
Series D paid in
Common Stock
and cash 9,454 95 --- (18,381) 18,222 --- --- (64)
Repurchase of
Preferred Stock
Series A --- --- (452,064) (452,064) 352,063 --- --- (100,001)
Dividend accrued on
Preferred Stock
Series D --- --- --- 17,698 (17,698) --- --- ---
Dividends accrued on
Redeemable Convertible
Preferred Stock --- --- --- --- (429,492) --- --- (429,492)
Issuance of
non-qualified options --- --- --- --- 55,200 --- --- 55,200
Accretion of value
of warrants --- --- --- --- --- --- 106,484 106,484
Loss for the
year ended
December 31, 1997 --- --- --- --- --- (294,664) --- (294,664)
Balance at 12/31/97 9,403,987 $ 94,040 1,615,871 $ 1,710,347 $ 12,579,920 $(19,427,332) $523,984 $(4,519,041)
Issuance of
Common Stock 2,557,104 25,571 --- --- 5,060,282 --- --- 5,085,853
Conversion of
Preferred Stock to
Common Stock 1,223,255 12,232 (1,223,255) (1,294,882) 1,282,650 --- --- ---
Premium on Conversion
of Preferred Stock
Series B to
Common Stock 19,200 192 --- --- (192) --- --- ---
Dividends on
Preferred Stock
Series D paid in
Common Stock
and cash 8,889 89 --- (17,941) 17,827 --- --- (25)
Dividend accrued on
Preferred Stock
Series D --- --- --- 8,900 (8,900) --- --- ---
Repurchase of
Preferred Stock
Series D --- --- (27,616) (41,424) --- --- --- (41,424)
Conversion of
Redeemable
Convertible
Preferred Stock
to Common Stock 4,266,892 42,669 --- --- 5,823,568 --- --- 5,866,237
Dividends accrued
on Redeemable
Convertible
Preferred Stock --- --- --- --- (142,496) --- --- (142,496)
Costs incurred in
connection with
Redeemable
Preferred
conversion and
TSAI Common
Stock purchase --- --- --- --- (108,103) --- --- (108,103)
Accretion of value
of warrants --- --- --- --- --- --- 106,483 106,483
Loss for the
year ended
December 31, 1998 --- --- --- --- --- (5,263,153) --- (5,263,153)
Balance at 12/31/98 17,479,327 $174,793 365,000 $ 365,000 $ 24,504,556 $(24,690,485) $630,467 $ 984,331
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., Nestor Traffic Systems,
Inc. ("NTS"), formerly known as Nestor IS, Inc., and
Nestor Interactive, Inc. ("Interactive"). NTS and
Interactive are wholly owned subsidiaries formed
January 1, 1997. Effective November 7, 1998, the
Company ceased further investment in the Interactive
subsidiary. Any future marketing or development of
Interactive's product has been transferred to Nestor,
Inc. All intercompany transactions and balances have
been eliminated.
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 are
capitalized and subsequently reported at the lower of
unamortized cost or net realizable value. 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 expensed or
capitalized, as appropriate. Amortization of
capitalized costs would be on a straight-line basis
over the shorter of the estimated economic life, or
statutory life, of the patent. At December 31, 1998
and 1997, there were no capitalized patent-development
costs.
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 derives revenue from software
licenses (Initial License Fees), user fees (Monthly
License fees), other postcontract customer support
(PCS) and engineering services. Postcontract customer
support includes maintenance agreements. Engineering
services range from installation, training, and basic
consulting to modeling, software modification and
customization to meet specific customer needs. In
software arrangements that include multiple elements,
the Company allocates the total arrangement fee among
each deliverable based on the relative fair value of
each of the deliverables determined based on vendor-
specific objective evidence.
As of January 1, 1998, the Company adopted
AICPA Statement of Position 97-2 - Software Revenue
Recognition ("SOP 97-2"), which is effective for
transactions entered into in 1998. Prior years have
not been restated. The most significant impact of SOP
97-2 on the Company's revenue recognition accounting
policies is that for contracts with multiple elements,
revenue, in some instances, may be recognized later
than under past practices. Revenue has been recognized
as follows:
Since January 1, 1998:
Software Licenses - The Company recognizes
the revenue allocable to software licenses upon
delivery of the software product to the end user,
unless the fee is not fixed or determinable or
collectibility is not probable. The Company considers
all arrangements with payment terms extending beyond
twelve months and other arrangements with payment terms
longer than normal not to be fixed or determinable. If
the fee is not fixed or determinable, revenue is
recognized as payments become due from the customer.
In most situations, the Company considers its
acceptance terms as perfunctory. Arrangements that
include acceptance terms that are not considered
perfunctory are not recognized until acceptance has
occurred. If collectibility is not considered
probable, revenue is recognized when the fee is
collected. Revenue on arrangements with customers who
are not the ultimate users (distributors, other
resellers, etc.) is not recognized until the software
is delivered to an end user.
Before January 1, 1998:
Revenue from software licensing is recognized
upon delivery 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 delivery, 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. If customer acceptance
is uncertain, revenue is recognized upon approval by
the customer.
In all periods:
Postcontract Customer Support - Revenue
allocable to PCS is recognized on a straight-line basis
over the period the PCS is provided.
Software Services - Arrangements that include
software services are evaluated to determine whether
those services are essential to the functionality of
other elements of the arrangement. When software
services are considered essential, revenue under the
arrangement is recognized using contract accounting
(see below). When the software services are not
considered essential, the revenue allocable to the
software services is recognized as the services are
performed.
Contract Accounting - For arrangements that
include customization or modification of the software,
or where software services are otherwise considered
essential, revenue is recognized using contract
accounting. Revenue from these software arrangements
is recognized on a percentage-of-completion method with
progress-to-completion measured based upon labor costs
incurred.
Training revenue is recognized upon the
completion of training sessions with the customer.
Adoption of SOP 97-2 had an insignificant
impact on net loss for the year ended December 31,
1998.
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 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. When the
Company induces warrant or option holders to exercise
at a price lower than the original exercise price, the
Company recognizes an expense equal to the fair value
of the securities issued less the proceeds received for
the securities, but not more than the reduction in the
exercise price.
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, valued at
$231,613 and $144,875 at December 31, 1998 and 1997,
respectively, 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 to the December 31, 1998
presentation, certain balances at December 31, 1997,
have been reclassified.
Note 2 - Comparative Financial Information:
The following financial information for the six months ended
December 31, 1995 and the year ended December 31, 1996, is
unaudited and is being presented for comparative purposes:
Year-Ended Six Months Ended
December 31, 1996 December 31, 1995
(Unaudited) (Unaudited)
Total revenues $4,508,397 $ 2,149,088
Loss from operations (403,741) (542,385)
Net loss (199,420) (723,227)
Net loss per share -
basic and diluted $ (0.09) $ (0.09)
Note 3 - Income (loss) per share:
The Company reports its income (loss) per share
("EPS") in accordance with the provisions of the
Financial Accounting Standards Board Statement No. 128,
Earnings Per Share ("FAS 128"). Basic EPS is calculated
by dividing the income available to common stockholders
by the weighted average number of common shares
outstanding for the period, without consideration for
common stock equivalents. "Fully diluted" EPS has been
replaced by "diluted" EPS. Diluted EPS is computed
giving effect to common stock equivalents and other
dilutive securities, unless the computation results in
anti-dilution.
Note 4 - Accounts receivable, net of allowance for doubtful
accounts:
December 31,
1998 1997
Trade accounts receivable $543,048 $ 711,766
Allowance for doubtful accounts (30,300) (154,554)
Accounts receivable,
net of allowance
for doubtful accounts $512,748 $ 557,212
Note 5 - 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. For the six months
ended December 31, 1996, the Company had deferred
$364,000 of costs associated with this project. During
1997, an additional $211,000 of such costs were
capitalized in connection with engineering and
installation of the project. Management believed that
these costs, which are subject to a binding contract
entered into upon delivery of the software on March 28,
1997, would be fully recovered over the five year term
of the aforementioned contract.
Although revenue had not yet been earned under
this contract, the Company began to amortize the
related deferred costs in June 1998. In December 1998
initial contract revenues were recognized. In view of
the level of revenue generated by this contract, the
Company evaluated the carrying value of the deferred
contract costs, utilizing estimated future contract
revenues and ongoing customer support costs,
appropriately discounted. In accordance with FAS 121 -
"Impairment of Long Lived Assets," the Company wrote-
down deferred development costs to $80,000 at December
31, 1998. The residual deferred costs will be
amortized on a straight-line basis over the remaining
term of the contract.
Note 6 - Property and equipment at cost - net:
Useful Life
in Years or
December 31, Lease Term
1998 1997
Leasehold
improvements $ --- $ 22,945 Lease Term
Office furniture
and equipment 234,706 199,254 5 - 7
Leased computer
equipment under
capital leases 113,893 46,730 5
Computer equipment 1,344,244 1,238,913 3 - 5
$1,692,843 $1,507,842
Less: Accumulated
depreciation and
amortization 1,324,318 1,246,379
$ 368,525 $ 261,463
Depreciation and amortization expense on the above
assets of $114,810, $95,682, $45,327, and $104,559 was
recorded for the years ended December 31, 1998 and
1997, for the six months ended December 31, 1996, and
for the year ended June 30, 1996, respectively.
Note 7 - Intangible Asset:
On March 31, 1997, the Company purchased from Cyberiad
Software, Inc. ("Cyberiad"), a Rhode Island corporation,
substantially all of Cyberiad's assets for use in the Company's
Interactive subsidiary product. In this transaction, the Company
issued 200,000 shares of its Common stock to Cyberiad and agreed
to assume approximately $10,500 of Cyberiad's liabilities.
Accordingly, the Company recorded as an intangible asset the
excess of its acquisition cost over the fair value of the net
liabilities assumed ($394,517) and began to amortize this asset
over 36 months. Amortization expense recorded in the year ended
December 31, 1997 was $98,629.
Since the Company has ceased further investment in the
Interactive subsidiary (see Note 1) and future realization of the
asset is uncertain, the remaining value of this asset was written
off in November 1998.
Note 8 - Accounts payable and accrued expenses:
Accounts payable and accrued expenses consists of the
following:
December 31,
1998 1997
Trade accounts payable $ 400,900 $ 316,670
Accrued salaries 279,929 333,046
Other accrued expenses 469,775 271,117
$1,150,604 $ 920,833
Note 9 - Lines of credit:
On July 29, 1997 Nestor, Inc. entered into a
$200,000 Revolving Line of Credit with a bank. In March
1998, the Line was increased to $500,000. The interest
rate was equal to the prime rate plus 1.5%, and the
Line was secured by the tangible assets of Nestor, Inc.
The Line was terminated in September 1998.
On March 25, 1998, TSAI granted the Company a
short-term note in contemplation of the TSAI stock
purchase (Note 12). This note was surrendered on April
29, 1998. On March 24, 1999, a new Line of Credit was
established with TSAI (Note 23).
Note 10 - Redeemable convertible preferred stock:
On March 31, 1998, the Company and Wand Partners,
owners of the outstanding redeemable convertible
preferred stock, agreed to modify certain terms and
conditions governing the stock. Wand Partners agreed
to release the Company from mandatory redemption in
exchange for the Company's agreement to increase the
dividend rate by one percent per annum beginning on
July 1, 2000. On April 29, 1998, Wand Partners
converted all of its redeemable convertible preferred
stock into common stock (see Note 12).
The Company was originally 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 was presented
separately outside of permanent stockholders' equity in
the accompanying financial statements.
December 31,
1998 1997
Series E, par value $1.00
per share, 1,444 shares
outstanding and $305,577
of accumulated dividends
at December 31, 1997. $ --- $ 1,749,577
Series F, par value $1.00
per share, 599 shares
outstanding and $95,821
of accumulated dividends
at December 31, 1997. --- 694,821
Series G, par value $1.00
per share, 777 shares
outstanding and $116,650
of accumulated dividends
at December 31, 1997. --- 893,650
Series H, par value $1.00
per share, 2,026 shares
outstanding and $428,739
of accumulated dividends
at December 31, 1997. --- 2,454,739
TOTAL $ --- $5,792,787
The redeemable convertible preferred stock
originally accrued and accumulated dividends at rates
of seven percent on Series E and H and nine percent on
Series F and G, compounded quarterly on the stated
value per share and such dividends not paid in cash
increased the stated value. The Company paid cash
dividends totaling $69,046 in 1998 and $35,613 in 1997
on the redeemable convertible preferred stock.
Note 11 - Convertible Preferred stock:
In June 1997 the Company repurchased from Sligos
S.A. all of the outstanding shares of the Series A
Preferred Stock. See Note 19, Termination of License
Agreement. Series A Preferred Stock was convertible at
any time into one fully paid and non-assessable share
of Common Stock. Series A Preferred had the same
dividend rights as shares of Common Stock but carried
no voting rights. Each share of Series A Preferred had
the right to receive in liquidation $2.00 before any
distribution was made on Common Stock or on any other
class of stock ranking junior to Series A.
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
$365,000, and $1,445,000, at December 31, 1998 and
1997, respectively.
In May 1998, the Company offered Series B stockholders
a 2% conversion premium payable in common stock for a
share-for-share conversion of all shares held. The
conversion offer, which expired on June 26, 1998,
resulted in a premium of 19,200 common shares as
960,000 Series B shares were converted. The rights and
benefits of remaining Series B stockholders are
unchanged, including ongoing standard conversion
rights.
Series D Convertible Preferred Stock was
convertible after January 1, 1996 at the option of the
holder into one fully paid and non-assessable share of
Common Stock of the Company on a share-for-share basis.
The Series D Preferred had the right to receive annual
dividends at the rate of seven percent (7%) of the
stated value per share ($1.50), paid in cash or in
shares of Common Stock at the option of the Company.
On June 30, 1997, the Company paid stock dividends on
the Series D Preferred totaling $18,381. The Company
had 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 $265,347 at December 31, 1997.
The Company issued a redemption call in May 1998 for
all of the outstanding Series D shares at a redemption
price of $1.50 plus unpaid dividends payable as of June
30, 1998. Stockholders had the option of converting
into common shares under the Preferred Shares
Agreement. After paying dividends of $17,941 on June
30, 1998, the Company reclassified the unconverted
Series D balance to accounts payable and accrued
expenses where $36,349 remains unpaid at December 31,
1998.
Note 12- Common Stock:
On April 29, 1998, Nestor sold to Transaction
Systems Architects, Inc. ("TSAI") $5 million of newly
issued common stock at a price of $2 per share and a
warrant to purchase an additional 2.5 million shares at
$3 per share expiring March 1, 2002. Proceeds from the
sale consisted of $4.5 million in cash and surrender of
a $500,000 note owed to TSAI. Concurrent with this
transaction, Wand Partners converted its $5.8 million
of redeemable convertible preferred stock (Note 10)
into common stock.
Additionally, a conversion offer to Series B
Preferred stockholders and call on Series D preferred
shares, resulted in 979,200 and 143,155 shares,
respectively, of common stock issued as of June 30,
1998 (Note 11).
Note 13- 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.
On May 6, 1997, the Company adopted the 1997 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 1997 Stock Option Plan has
authorized the grant of options to employees for up to
1,000,000 shares of the Company's common stock.
Options are exercisable for up to ten years from the
date of grant, although all options currently
outstanding expire five years from the date of grant.
The Company has adopted the disclosure-only
provisions of Financial Accounting Standards Board
Statement No. 123, Accounting for Stock-Based
Compensation ("FAS 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 in the
financial statements for qualifying grants issued
pursuant to the Company's Stock Option Plan.
On October 23, 1998, the Company's Board of
Directors approved a repricing of the Company's Stock
Option Plan. The price of the new options was $.6875,
the closing price on October 23, 1998. Options were
exchanged at equal value using the Black-Scholes model
and acceptance of the repricing offer was optional on
the part of the employee. Employees surrendered
543,500 options for repricing and the Company granted
254,085 repriced options in accordance with this offer.
The effect of this repricing is reflected in the tables
below.
The following table presents the activity of the
Company's Stock Option Plan for the years ended
December 31, 1998 and 1997, for the six months ended
December 31, 1996 and for the fiscal year ended June
30, 1996:
<TABLE>
<CAPTION>
Six Months Ended Year Ended
Years Ended December 31, December 31, June 30,
1998 1997 1996 1996
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 2,214,000 1.58 1,781,500 1.50 1,356,000 1.03 1,399,000 1.80
Granted 454,124 .99 484,000 1.81 612,000 2.38 1,406,000 1.04
Exercised 31,250 1.09 46,875 1.00 186,500 0.98 100,500 1.09
Canceled 1,057,750 1.88 4,625 1.67 --- --- 1,348,500 1.83
Outstanding
end of year 1,579,124 1.22 2,214,000 1.58 1,781,500 1.50 1,356,000 1.03
Options
exercisable
at year end 1,102,846 1.22 1,470,250 1.39 1,101,875 1.22 1,023,500 1.00
Weighted average
Fair value of
Options granted
During the year $ 0.71 $ 1.44
</TABLE>
<PAGE>
The following table presents weighted average
price and life information about significant option
groups outstanding at December 31, 1998.
<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 12/31/98 Life (Years) Price at 12/31/98 Price
<S> <C> <C> <C> <C> <C>
$ .87- $1.00 1,086,374 2.79 $0.90 816,034 $0.97
$ 1.50- $2.00 288,250 3.48 1.55 160,688 1.55
$ 2.09- $2.44 143,000 3.03 2.26 88,250 2.27
$ 2.81- $2.94 61,500 3.20 2.76 37,875 2.81
1,579,124 2.96 $1.22 1,102,846 $1.22
</TABLE>
The following are the pro forma net loss and net
loss per share for the years ended December 31, 1998
and 1997, for the six months ended December 31, 1996,
and for the 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 and reflected in the
financial statements:
<TABLE>
<CAPTION>
Year Ended Year Ended Six Months Ended Year Ended
December 31, 1998 December 31, 1997 December 31, 1996 June 30, 1996
As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Income
(loss) $(5,263,153) $(4,710,218) $(294,664) $ (876,280) $(935,337) $(1,277,841) $ 12,690 $(633,262)
Net (loss)
per share $ (0.36) $ (0.32) $ (0.08) $ (0.14) $ (0.13) $ (0.17) $ (0.03) $ (0.11)
</TABLE>
<PAGE>
The effects on the years ended December 31, 1998
and 1997, the six months ended December 31, 1996, and
the 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, 1998 and the Company expects to grant
additional options in future years. Because FAS 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 that ranged from 4.3% 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
.815 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.
The following table presents warrants outstanding:
<TABLE>
<CAPTION>
Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996
<S> <C> <C> <C>
Officers --- --- 10,000
Others 5,000,580 2,709,089 2,826,239
Eligible, End of Year for Exercise
Currently 5,000,580 2,709,089 2,836,239
Warrants issued 2,500,000 --- ---
Low exercise price $ 3.00 $ --- $ ---
High exercise price $ 3.00 $ --- $ ---
</TABLE>
<PAGE>
The warrants outstanding as of December 31, 1998,
are currently exercisable and expire at various dates
through October 5, 2005. The outstanding warrants
entitle the owner to purchase one share of Common Stock
for each warrant, at prices ranging from $0.65 to $3.00
per share.
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 cumulative
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. Accordingly, the
Company recognized expenses totaling $106,000, $106,000
and $42,000 for the years and six months ended December
31, 1998, 1997 and 1996, respectively.
Also during the year ended June 30, 1996, 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 during
the fiscal year ended June 1996.
Note 14 - Segment Information:
A. Description of reportable segments
Nestor, Inc. has three reportable segments:
Financial Solutions, Traffic Systems and Internet
products. While the Company always differentiated
these segments internally, on January 1, 1997 the
latter two were separated from Nestor, Inc. into
distinct subsidiaries (see Note 1), leaving Financial
Solutions within the parent company. The reportable
segments are each managed separately because they
design, develop, market and support different products.
The Financial Solutions division produces and sells
credit and debit card fraud detection products and
database marketing products to financial institutions
and processors of financial data. The Traffic Systems
segment provides remote traffic management products,
mainly to municipalities and universities. The
Company's Internet segment was engaged in the
development of an internet commerce solution.
B. Measurement of segment profit or loss and segment assets
The Company evaluates performance based on profit or
loss from operations before income taxes. The
accounting policies of the reportable segments are the
same as those described in Note 1.
C. Segment profit or loss and segment assets
All revenues are from external customers. There are no
intercompany sales. The "All Other" category
represents general corporate activity. "All Other"
revenues consist primarily of royalties (Note 20) and,
in 1997, include $480,000 relating to the termination
of a license agreement (Note 19). Segment information
for the year ended June 30, 1996 has not been presented
because the Company did not account for the segments
separately at that time.
<TABLE>
<CAPTION>
Financial Traffic All
Solutions Systems Internet Other Totals
<S> <C> <C> <C> <C> <C>
Year Ended
Dec. 31, 1998:
Revenues $ 1,931,000 $ 235,000 $ 44,000 $ 31,000 $ 2,241,000
Depreciation and
amortization
expense 548,000 25,000 309,000 23,000 905,000
Segment profit
(loss) (1,954,000) (1,933,000) (1,383,000) 7,000 (5,263,000)
Segment assets 788,000 318,000 46,000 1,440,000 2,592,000
Expenditures for
long-lived
assets 29,000 37,000 8,000 58,000 132,000
Year Ended
Dec. 31, 1997:
Revenues $ 4,752,000 $ 328,000 $ --- $ 601,000 $ 5,681,000
Depreciation and
amortization
expense 50,000 19,000 106,000 19,000 194,000
Segment profit
(loss) 1,300,000 (1,492,000) (784,000) 711,000 (265,000)
Segment assets 1,520,000 225,000 355,000 513,000 2,613,000
Expenditures for
long-lived
assets 42,000 14,000 31,000 2,000 89,000
Six Months Ended
Dec. 31, 1996:
Revenues $ 776,000 $ 335,000 $ --- $ 85,000 $ 1,196,000
Depreciation and
amortization
expense 23,000 8,000 1,000 13,000 45,000
Segment profit
(loss) (194,000) (638,000) (214,000) 111,000 (935,000)
Segment assets 1,722,000 182,000 11,000 903,000 2,818,000
Expenditures for
long-lived
assets 31,000 23,000 8,000 9,000 71,000
</TABLE>
D. Geographic Information
Revenues are attributed to countries based on the
location of customers. All long-lived assets are
located in the Unites States.
<TABLE>
<CAPTION>
Six Months Ended Year Ended
Years Ended December 31, December 31, June 30,
1998 1997 1996 1996
<S> <C> <C> <C> <C>
U.S.A. $ 1,918,951 $ 3,391,825 $ 1,085,050 $ 4,071,781
France --- $ 480,899 $ 30,000 $ 65,085
Belgium 212,097 903,662 42,000 727,375
Germany 17,460 --- --- 173,877
Japan 55,333 531,590 14,094 36,424
Canada 27,000 223,000 --- 41,710
Singapore 10,535 --- --- 65,530
All other
countries --- 150,100 24,760 279,798
$ 2,241,376 $ 5,681,076 $ 1,195,904 $ 5,461,580
</TABLE>
E. Revenues from Major Customers
All revenues presented are derived from the Company's
Financial Solutions segment with the exception of
Customers E and H, which relate to the Traffic Systems
segment and the "All Other Category" (Note 20),
respectively.
<TABLE>
<CAPTION>
Six Months Ended Year Ended
Years Ended December 31, December 31, June 30,
1998 1997 1996 1996
<S> <C> <C> <C> <C>
Customer A $ 620,732 $ 2,216,375 $ --- $ ---
Customer B --- 903,662 --- 727,375
Customer C 445,115 --- 215,400 ---
Customer D 302,979 --- 153,750 ---
Customer E --- --- 225,994 ---
Customer F --- --- 185,000 ---
Customer G --- --- 132,382 ---
Customer H --- --- --- 1,614,510
</TABLE>
Note 15- Other income (expense) - net:
Other income (expense) as reflected in the
consolidated statements of operations consists of the
following:
<TABLE>
<CAPTION>
Six Months Year
Ended Ended
Years Ended December 31, December 31, June 30,
1998 1997 1996 1996
<S> <C> <C> <C> <C>
Interest expense $ (20,350) $ (3,598) $ (3,227) $ (51,574)
Expense relating
to financing
operations (106,483) (106,484) (42,500) (131,250)
Net gain on sale of
tangible and
intangible assets
(See Note 20) --- --- --- 213,185
Other - net 100,655 141,403 29,507 9,589
Other Income
(Expense) - Net $ (26,178) $ 31,321 $ (16,220) $ 39,950
</TABLE>
Note 16- Income taxes:
The Company accounts for income taxes using the
deferred liability method as required by Financial
Accounting Standards Board Statement No. 109,
Accounting for Income Taxes. Under FAS 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.
The components of the provision (benefit) for
income taxes are:
December 31, December 31,
1998 1997
Current:
Federal $ --- $ 30,000
State --- ---
Deferred:
Federal --- ---
State --- ---
--- ---
Total Income Taxes $ --- $ 30,000
Significant components of the Company's deferred tax
liabilities and assets as of December 31, 1998 and 1997
are as follows:
December 31, December 31,
1998 1997
Deferred tax liabilities:
Deferred development costs $ 32,000 $ ---
Accrued expenses --- 43,000
Total deferred tax liabilities $ 32,000 43,000
Deferred tax assets:
Accounts receivable 12,000 62,000
Accrued expenses 246,000 205,000
Deferred income 16,000 60,000
Tax credits 17,000 30,000
Net Operating Loss 8,619,000 6,563,000
Total deferred tax assets 8,910,000 6,920,000
Valuation allowance (8,878,000) (6,877,000)
Net deferred tax assets 32,000 43,000
Net Deferred Tax Balance $ --- $ ---
In accordance with FAS 109, a valuation allowance
must be established until it is more likely than not
that future benefits arising from net deferred tax
assets will be realized. Management has established an
allowance equal to the value of the net deferred tax
assets due to the Company's history of net losses. The
realization of the deferred tax assets is not assured
because of the potential for future losses and
potential limitations on the Company's ability to
utilize its net operating loss carryforwards due to
certain provisions contained in 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 Year
Ended Ended
Years Ended Dec. 31,
Dec. 31, June 30,
1998 1997 1996
1996
<S> <C> <C> <C> <C>
Income (Loss)
Before Taxes $(5,263,000) $(265,000) $ (935,000) $ 13,000
Tax at statutory
rate of 34% $(1,789,000) $(101,000) $ (303,000) $ 4,000
State income tax
(net of
federal benefit) (313,000) (19,000) (53,000) 1,000
Effect of permanent
differences 101,000 (36,000) 3,000 7,000
Valuation Allowance 2,001,000 186,000 353,000 (12,000)
Income Tax Expense $ --- $ 30,000 $ --- $ ---
</TABLE>
The Company and its subsidiaries have available at
December 31, 1998, $23,290,000 and $11,792,000 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 1999.
Note 17- 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 years
ended December 31, 1998 and 1997, the six months ended
December 31, 1996, and for the year ended June 30,
1996, the Company recorded an expense for Baer, Marks &
Upham of $15,600, $14,400, $7,200 and $14,440,
respectively. Included in Accounts payable and accrued
expenses at December 31, 1998 and 1997, are $6,726 and
$4,325, 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 years ended
December 31, 1998 and 1997, the six months ended
December 31, 1996, and for the year ended June 30,
1996, the Company recorded an expense for Wand
Partners, Inc. of $47,770, $49,479, $25,060 and
$46,076, respectively. During 1997 the Company granted
Mr. Schnitzer, as a director of the Company, a non-
qualified stock option for a total of 5,000 shares and
recognized an expense of $6,900. Additionally, during
1998 and 1997, the Company paid Wand Partners dividends
totaling $69,046 and $35,613, respectively, on the
redeemable preferred stock held by Wand. Included in
Accounts payable and accrued expenses at December 31,
1998 and 1997 are $63,738 and $23,301, respectively,
due Wand Partners, Inc.
Thomas F. Hill, who became a director of the
Company in August 1994, is President of Thomas F. Hill,
Inc., a consulting firm that the Company uses for
marketing consulting. During 1997 the Company granted
Mr. Hill, as a director of the Company, a non-qualified
stock option for a total of 5,000 shares and recognized
an expense of $6,900.
Thomas D. Halket, who became an officer of the
Company in January 1993, is a partner in the law firm
of Halket & Pitegoff LLP, which the Company uses as
outside counsel. For the years ended December 31, 1998
and 1997, the six months ended December 31, 1996, and
for the year ended June 30, 1996, the Company recorded
an expense for Halket & Pitegoff LLP of $80,039,
$100,961, $65,425, and $144,176, respectively.
Included in Accounts payable and accrued expenses at
December 31, 1998 and 1997 are $8,328 and $67,
respectively, due Halket & Pitegoff LLP.
During 1997 the Company issued non-qualified
options to Mr. Sam Albert, Dr. Leon Cooper,
Dr. Charles Elbaum, and Mr. Jeffrey Harvey as directors
of the Company. Each option was for 5,000 shares and
the Company recognized an expense of $27,600.
During 1998, TSAI, the parent company of Applied
Communications, Inc. (ACI), became a significant
shareholder of the Company (Note 12). For the year
ended December 31, 1998, the Company recorded revenues
of $620,730 from ACI. At December 31, 1998, accounts
receivable included $157,808 due from ACI and unbilled
was $52,934. Also at December 31, 1998, deferred
income included $237,500 from ACI. Further related
party transactions with TSAI are discussed in Notes 9,
13 and 23.
Note 18- Commitments and contingencies:
The Company leases a facility in Rhode Island
under an operating lease dated April 1, 1998, as
amended. This lease provides for annual rentals of
$195,000 through March 2001, $201,500 through March
2002, and $208,000 through March 2003.
Rent expense of $193,953, $188,936, $47,989 and
$171,928 was charged to operations for the years ended
December 31, 1998 and 1997, for the six months ended
December 31, 1996 and for the year ended June 30, 1996,
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 17 - Related party
transactions).
The Company had placed purchase orders, including an
end-of-life order, totaling $877,500 with Intel
Corporation for a supply of the Ni1000 Recognition
Accelerator Chips. During January 1999, the Company
took delivery of $195,000 of the chips and cancelled
the remaining order of $682,500 since the current
demand for the product no longer warranted such a
purchase and future third-party hardware is expected to
provide adequate capacity to operate the Company's
software.
The Company entered into an agreement on September 25,
1997, for the modification of one of the components of
the TrafficVision product. Nestor agreed to pay Zeller
Research, Ltd. $75,000 (of which $30,000 was paid in
1998) for engineering, which is expected to be
completed in 1999, and to purchase 100 units of the
modified component at a total cost of up to $53,000.
The aggregate minimum payments due over the remaining
term of the above agreements is as follows:
December 31, 1999 $ 528,000
December 31, 2000 235,000
December 31, 2001 239,875
December 31, 2002 246,375
December 31, 2003 92,000
Thereafter 40,000
$ 1,381,250
Note 19- Termination of license agreement:
In December 1994, Sligos agreed to convert
$200,000 of its prepayment into equity and the Company
agreed to refund to Sligos its prepayments of royalties
and engineering fees under its license agreement with
the Company, which was dated October 16, 1990. At
December 31, 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 Sligos
of 100,000 shares of Series A Preferred Stock, $30,000
refunded by the Company to Sligos, and the
reclassification of $275,000 to Other current
liabilities.
In June 1997 the Company and Sligos terminated
their License Agreement. Pursuant to the termination
agreement, the Company paid Sligos in July 1997,
$225,000 in full settlement of its obligation to
Sligos, which had been classified as a current
liability on the Company's balance sheet, and of the
repurchase from Sligos of 452,000 shares of Company's
Series A Preferred Stock. The Company allocated
$125,000 of the payment to the settlement of its
current liability to Sligos and consequently recorded
other income of $100,000 as discount on the obligation
to Sligos. The Company allocated the remaining
$100,000 of the payment to the repurchase of its Series
A Preferred Stock and, accordingly, reclassified
$352,000 to additional paid-in capital. The Company
also eliminated the long-term deferred income related
to Sligos prepayments (which were received in October
1990) and recorded software licensing revenues of
$480,000.
Note 20- 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. The minimum annual royalty to maintain exclusive
rights was $160,000 and $200,000 for the years ended
June 30, 1997 and 1998, respectively. NCS lost its
exclusive rights under the contract on June 30, 1998
upon failure to meet minimum royalty obligations.
Royalties are computed as 10% of the ICR product sales.
The Company recognized $32,000 and $120,000 of revenue
under this license agreement in calendar 1998 and 1997.
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 21- New accounting standards:
Comprehensive Income: In 1998, the Company adopted
Financial Accounting Standard 130, "Reporting
Comprehensive Income" ("FAS 130"). FAS 130
establishes new rules for the reporting and display of
comprehensive income and its components; however, the
Company's comprehensive income does not differ from net
income. Therefore, adoption of this Statement has had
no impact on the Company's results of operations.
Segment Reporting: Effective December 31, 1998, the
Company adopted the Financial Accounting Standards
Board's Statement of Accounting Standards No. 131,
"Disclosures About Segments of an Enterprise and
Related Information" ("Statement 131"). Statement 131
superseded FASB Statement No. 14, Financial Reporting
for Segments of a Business Enterprise. Statement 131
establishes standards for the way that public business
enterprises report information about operating segments
in annual financial statements and requires that those
enterprises report selected information about operating
segments in interim financial reports. Statement 131
also establishes standards for related disclosures
about products and services, geographic areas, and
major customers. The adoption of Statement 131 did not
affect results of operations or financial position, but
did require the disclosure of segment information. See
Note 14.
Note 22- Litigation:
On October 6, 1998, HNC Software Corp. ("HNC"), a
significant competitor of the Company's in the field of
Financial Services, claimed rights to a patent entitled
"Fraud Detection Using Predictive Modeling" and began
advising prospective customers of the Company of the
patent. Upon review of the claimed patent and
consideration of prior actions taken by HNC, the
Company initiated a lawsuit to protect its interest in
the marketplace. The suit, filed in the United States
District Court in Providence, RI on November 25, 1998,
makes numerous claims including violation of Sections 1
and 2 of the Sherman Act (antitrust), violation of the
Rhode Island Antitrust Act, patent invalidity, and
infringement of Nestor's patents. The suit seeks
various damages, including lost profits and treble
damages. Costs associated with the suit are being
expensed as incurred. Although the Company believes
that it will prevail, there can be no assurance as to
the outcome of this suit, or any potential countersuit.
Any conclusion of this litigation in a manner adverse
to the Company may have an adverse effect on its future
financial condition and results of operations.
Note 23- Subsequent Events:
On March 24, 1999, the Company entered into a
$1,000,000 Line of Credit agreement with Transaction
Systems Architect, Inc. ("TSAI"). The loan is secured
by the royalty stream and other fees produced by the
Company's License Agreements with Financial Services
Division customers. Principal payments are due in
twelve equal installments beginning March 1, 2001.
Interest on the loan is based on the prime interest
rate plus 1% and payments are due quarterly in arrears
beginning July 10, 1999. The line may be reduced to
$500,000 if the Company's equity becomes negative or
increased up to $4,000,000 if certain financial
requirements are attained.
On March 25, 1999, Nestor Traffic Systems, Inc., a
subsidiary of the Company, sold a 37.5% common-stock
interest to a private group of investors for $2,350,000
in cash and issued an option for an additional 17.5% of
its common stock for $1,750,000. The investor group
includes three officers of the Company and the
subsidiary, who in the aggregate contributed $600,000
of the initial cash invested on the same basis as third-
party investors. The option expires on January 31,
2000. The proceeds will be used by the subsidiary to
fund traffic-system product development and marketing
efforts in 1999. In addition, to the extent that
facility and administrative services of the Company are
used by the subsidiary, reimbursement of allocated
costs will be provided. The subsidiary has an
exclusive license from the Company to apply the
Company's proprietary technologies in the area of
traffic-management systems. The license provides for
royalties to the Company of 5% of related revenues, net
of direct cost of third party goods sold, in 2000 and
10% in 2001 and beyond.
NESTOR, INC. Part IV
Item 14
Schedule II
<TABLE>
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<CAPTION>
Addition
Balance at Charged to Deductions Balance at
Beginning Charged to Other from End
Description of Period Expense Accounts Reserve of Period
<S> <C> <C> <C> <C> <C>
Allowances deducted
from accounts
receivable:
Year ended
June 30, 1996 $ 57,976 $ 120,656 $ --- $(12,923) $165,709
Six months
ended
Dec. 31, 1996 $165,709 $ 38,888 $ --- $(59,362) $145,235
Year Ended
Dec. 31, 1997 $145,235 $ 80,495 $ --- $(71,176) $154,554
Year ended
Dec. 31, 1998 $154,554 $ 40,081 $ --- $(163,450) $ 30,300
</TABLE>
<PAGE>
ITEM 8. Financial Statement and Supplementary Data
See annexed financial statements.
ITEM 9. Changes in or Disagreement with Accounting and
Financial disclosure
Not Applicable.
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 II: 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 April 8, 1997, the Corporation filed with the
Securities and Exchange Commission a current report on
Form 8-K dated March 28, 1997 is hereby incorporated by
reference.
On April 10, 1997, the Corporation filed with the
Securities and Exchange Commission a current report on
Form 8-K dated March 31, 1997 is hereby incorporated by
reference.
On April 30, 1997, the Corporation filed with the
Securities and Exchange Commission a current report on
Form 8-K dated April 18, 1997 is hereby incorporated by
reference.
On May 7, 1997, the Corporation filed with the
Securities and Exchange Commission a current report on
Form 8-K dated May 6, 1997 is hereby incorporated by
reference.
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 NestorWriterT 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.
10.26 Lease 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.
21 Nestor IS, Inc., a wholly-owned subsidiary
of Nestor, Inc. incorporated January 1, 1997,
doing business as Nestor Intelligent Sensors.
21.1 Nestor Interactive, Inc. a wholly-owned
subsidiary of Nestor, Inc. incorporated January
1, 1997
4.1 Nestor, Inc. 1997 Incentive Stock Option
Plan, as amended, filed as an Exhibit to the
Company's Registration Statement on Form S-8,
filed May 16, 1997, is hereby incorporated by
reference.
10.32 License Agreement dated as of March
28, 1997, between Nestor, Inc. and Total System
Services, Inc. filed as an Exhibit to the
Company's Current report on Form 8-K dated
April 8, 1997, is hereby incorporated by
reference. Portions of the Exhibit omitted,
pursuant to a grant of confidential treatment.
10.33 Asset Acquisition Purchase Agreement
dated March 31, 1997 among Nestor Interactive,
Inc., Cyberiad Software, Inc., Christopher L.
Scofield and Jeffrey Pflum filed as an Exhibit
to the Company's Current Report on Form 8-K
dated April 10, 1997, is hereby incorporated by
reference.
10.34 Nestor, Inc. 1997 Incentive Stock
Option Plan, as amended, filed as an Exhibit to
the Company's Current Report on Form 8-K dated
May 6, 1997 is hereby incorporated by
reference.
10.35 Amendment to the PRISM Non-Exclusive
License Agreement dated as of April 18, 1997,
between Nestor, Inc. and Applied
Communications, Inc. filed as an Exhibit to the
Company's Current Report on Form 8-K dated
April 30, 1997 is hereby incorporated by
reference. Portions of the Exhibit omitted
pursuant to a grant of confidential treatment.
27 Financial data schedule for the year ended
December 31, 1998.
<TABLE> <S> <C>
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<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 1,175,183
<SECURITIES> 0
<RECEIVABLES> 512,748
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,136,101
<PP&E> 1,692,843
<DEPRECIATION> 1,324,318
<TOTAL-ASSETS> 2,591,589
<CURRENT-LIABILITIES> 1,584,640
<BONDS> 0
0
365,000
<COMMON> 174,793
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 2,591,589
<SALES> 143,298
<TOTAL-REVENUES> 2,241,376
<CGS> 54,010
<TOTAL-COSTS> 7,478,351
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
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<NET-INCOME> (5,263,153)
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