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, 1999
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 8,319,519 shares of voting
stock held by non-affiliates of the registrant, based on the
average bid and asked prices of such stock on February 29, 2000
was $24,126,605. The number of shares outstanding of the
Registrant's Common Stock at February 29, 2000 was 17,524,327.
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
General
Nestor, Inc. ("Nestor" or the "Company") designs, develops,
markets, installs and supports intelligent software solutions for
decision and data-mining applications in real-time environments.
Nestor products employ 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 e-Commerce Profitability, Risk
Management, Customer Relationship Management and Traffic
Management.
e-Commerce Profitability Solutions - Products in this market
represent the Company's newest solutions, and comprise the
PRISM(R) eFraud(TM)and eCLIPSE(TM)e-business decision-support
solutions. Targeted at on-line retailers, financial services
companies, commerce service providers and application service
providers, PRISM eFraud detects fraudulent on-line transactions
in real-time, and enables organizations to take immediate and
informed loss prevention actions. The eCLIPSE CRM product, also
targeted at this core set of e-businesses, enables companies to
dynamically personalize websites and off-line communications
using each organization's unique customer information.
Risk Management - Products in this market represent the
Company's largest product line and its most established
applications. These applications include PRISM Credit, PRISM
Debit, PRISM Money-Laundering and PRISM Merchant products.
Financial institutions, third-party processors and retailers use
these products to identify and manage transactions that may be
fraudulent, represent illicit funds (money laundering), or
otherwise undesirable to accept. Products in the Risk Management
group represent approximately 94.7% of the Company's fiscal 1999
revenue.
Customer Relationship Management - The Company's CRM
product, eCLIPSE, provides a comprehensive solution for effective
enterprise-wide customer marketing. The product accumulates
customer data from all customer contact points within an
organization, allows the development of comprehensive,
personalized marketing campaigns on segments or all of a
population, including champion-challenger and budget
considerations, and deploys the developed campaigns to the
appropriate channel, including the Internet. The product allows
for consistent personalization across all communication channels.
Campaigns can be further enhanced by the use of Nestor's
proprietary models in areas such as customer profitability,
retention, and cross selling. Products in the CRM group
represent approximately 5% of the Company's fiscal 1999 revenues.
Traffic Management - Through an exclusive licensing
agreement with Nestor Traffic Systems, Inc. ("NTS"), a 42% owned
affiliate of the Company (formerly a wholly-owned subsidiary),
Nestor applies its image-understanding technologies and other
patent-pending technologies to the field of intelligent traffic-
management systems. NTS products include CrossingGuard, Rail
CrossingGuard, and TrafficVision. Using standard video
equipment, NTS software is capable of understanding traffic
patterns in real-time allowing for red-light enforcement and
safety features at intersections and rail crossings, and also
data collection, analysis, and real-time exception alarms for
open roads. As the affiliate is now accounted for under the
equity method of accounting, it did not contribute to revenues in
1999. In fiscal 1998, this group represented approximately 10%
of revenues.
Intelligent Character Recognition Systems - Currently
marketed through National Computer Systems, Inc., this product
line includes packages of software applications such as
OmniTools, NestorReader, and N'Route which increase productivity
in document processing and fax distribution environments.
Royalties from this group represent less than 1% of the Company's
fiscal 1999 revenues.
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. and Nestor
Interactive, Inc. ("Interactive"). Nestor Traffic Systems, Inc.
develops and markets the TrafficVision, CrossingGuard, and the
Rail CrossingGuard product lines. Nestor now owns a 42% interest
in NTS and uses equity accounting to account for the investment.
Interactive developed InterSite, an Internet personalization
solution, but this subsidiary has been inactive since November
1998.
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 bankcard
(credit/debit) and private-label (retail) card, merchant and
other forms of fraud (PRISM), provide intelligent, enterprise-
wide marketing campaign management and real-time targeted
information to Internet Web site visitors (eCLIPSE), provide
traffic management and safety (through its affiliate NTS) of
freeways (TrafficVision), rail crossings (Rail CrossingGuard),
and intersections (CrossingGuard), and provide much greater
efficiencies in document processing and fax distribution
environments (NestorReader, OmniTools and N'Route which products
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 nine
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 high-value software products
that can bring additional value to customers by utilizing its
proprietary software and information-management knowledge, and,
to a lesser degree, designed hardware components that enhanced
the performance of its software products. The Company's products
comprise the following categories: Risk Management Systems - are
designed to effectively detect and control fraudulent
transactions for financial institutions and retailers that issue
or process credit, debit, or other financial use cards and
retailers that accept card payments over the phone or Internet
and are exposed to charge-back losses from fraud or liability for
other schemes such as money-laundering. Customer Relationship
Management Systems - are designed to synthesize information from
multiple data sources within an organization and provide
personalized content to individual customers, including Web site
visitors, based on the current state of the customer's
information. In 2000, the Company unveiled its eCLIPSE product,
which is a combination of two product initiatives in intelligent
personalization (CampaignOne and InterSite) into a product
capable of providing intelligent and consistent marketing
campaigns across all channels within an organization.
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. InterSite's purpose is to provide
measurements of site visitors, which are useful in predicting
their preferences and purchasing behavior. 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. 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 fraud detection and risk assessment solutions
include the Proactive Risk Management (PRISM) system which has
been licensed to more than 50 financial-services and retail
clients as of December 31, 1999. These systems can detect
bankcard 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.
In 1993, the Company completed the installation of the Nestor
Fraud Detection System (FDS), the predecessor of the PRISM
products, at Mellon Bank. The success of the FDS installation
at Mellon has been instrumental in obtaining additional orders
for 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
bankcard transactions involving currency exchange. 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.
In 1999, the Company released version 5.0 of PRISM. This enhanced
version features an open software framework that allows users to
customize PRISM's graphical user interface to meet their specific
processing and customer service requirements. Additionally, PRISM
5.0 facilitates the user's ability to interface the PRISM
software with their card processing authorization system, charge-
back recovery systems and other external applications to enhance
the organization's overall risk management operations.
Also in 1999, PRISM was expanded to include e-commerce risk
management (PRISM eFraud) and money laundering detection (PRISM
Money Laundering Detection). These solutions detect fraudulent on-
line transactions and money laundering activities, respectively.
The following are the primary attributes of the PRISM Risk
Management Systems:
Comprehensive Graphical User Interface and Case Management
System. PRISM 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.
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 clients' needs and profiles without
extensive custom programming. Unlike competitive 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
components that operate on a wide range of industry standard,
client-server platforms, including the IBM, MVS/CICS, Compaq's
proprietary, fault tolerant Non Stop Kernel (NSK), UNIX and
Windows NT operating platforms.
Nestor's Fraud Detection and Risk Assessment Strategy
The Company's objectives are: to deliver high quality products
and services including proprietary neural-network technology to
the banking, retail, Internet, 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. 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".) 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.
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 posses data characteristics similar to the financial
institution industry. The Company plans to extend the successes
of the PRISM product in card fraud detection to other areas with
a high level of transactions and a history of similar fraud-type
loss experience. Some of these market opportunities may include
health-care claim payments and long-distance telephone fraud.
Customer Relationship Management Systems
During 2000, the Company introduced eCLIPSE, a comprehensive
customer relationship and marketing campaign management solution
designed to maximize the effectiveness and efficiency of on-line
and off-line marketing campaigns for all aspects of financial
opportunity from: customer acquisition, retention, cultivation
and overall customer profitability. eCLIPSE can utilize
customers' internal models along with the Company's customized
neural-network models. eCLIPSE combines and improves on previous
products developed by Nestor: CampaignOne and InterSite.
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 dialogues is just beginning to be realized. However,
the Internet, or more specifically the World Wide Web, is
undergoing a revolution. New technologies are being introduced
which are causing Internet web sites to become dynamic and
personalized.
Nestor eCLIPSE 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.
During 1998, the Company introduced CampaignOne, a complete
customer relationship and marketing campaign management solution
for traditional marketing channels. The solution combines data
on customers from all channels of an enterprise and allows
organizations to develop comprehensive and consistent marketing
campaigns, including champion-challenger programs and result
analysis.
Traffic Management Systems
Developed and marketed by the Company's 42% owned affiliate NTS,
TrafficVision and CrossingGuard products are a combination of
Company-developed software and modular hardware components that
provide monitoring for traffic data collection, control of
traffic flows, and emergency response. These products are
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 loop
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
statutes. 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 a video sequence of the violation for ticket issuance and
sends a signal to the traffic light controller unit recommending
a delay in the change of the light to green for cross traffic.
Such delay may help prevent cross-traffic broadside collisions
caused by red-light violators.
The following are the primary attributes of NTS Traffic
Management Systems:
Accurate, real-time interpretation of traffic video images. NTS
has leveraged the Company's 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 image-
understanding technology is able to interpret video images
accurately and respond in a real-time environment.
Rapid deployment and increased services for customers. NTS
software solutions are designed for rapid deployment and to
provide additional information to customers beyond that delivered
by current loop systems. TrafficVision and CrossingGuard systems
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, speed, and vehicle detection), and additional benefits
such as remote real-time video monitoring for traffic flow,
vehicle tracking, automated alarms for incident response, video-
based red-light enforcement and intersection safety.
Multiple use of customer investment in video infrastructure.
Traffic departments are deploying roadside video cameras to
provide images of road and traffic conditions to better manage
traffic flows and incident response. NTS 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, NTS 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. NTS traffic
monitoring solutions are architected around dominant industry-
standard platforms: namely, the Windows 95/NT operating system,
tools and communication 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 traffic
monitoring systems are designed to support the emerging NTCIP
communications standards being mandated in the traffic 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 has granted an exclusive license to NTS for
application of its technology in the field of traffic management
applications. The Company will receive a license royalty of 5%
of gross profit (revenues less third-party costs of sales)
realized from products using the technology in 2000, and 10%
thereafter. Minimum annual royalties to retain exclusive rights
commence in 2002 and grow to $1,000,000 per year by 2005 and
beyond.
Ni1000 Chip, PCI 4000 Recognition Accelerator Board and IBM
ZISC(TM)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, which has since expired. (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 ZISC 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").
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:
NestorReader(TM)
NestorReader is a software product that is designed to perform
character recognition from images of hand-printed and machine-
printed characters in intelligent character recognition systems.
A principal application of NestorReader has been to replace the
human process of reading data from forms and entering the data
into computers by means of a keyboard. NestorReader is licensed
to original equipment manufacturers, value-added resellers and
systems integrators for integration into image-processing
systems. NestorReader extends the range of optical character
recognition to include hand print and faxed characters at a
price/performance ratio that the Company believes is unequaled by
competitive technologies. In optical character recognition,
existing techniques have successfully solved the problem of
reading conventional, clean, machine-printed characters.
Management believes that hand printed characters - with their
high degree of variability - and faxed characters, with their
high noise level, can only be read satisfactorily by more
powerful technologies like NestorReader.
OmniTools(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 and its affiliates product lines are targeted
toward large commercial users (e.g., banks for the PRISM and
eCLIPSE products), or federal, state and local government
agencies (e.g., Departments of Transportation for the
CrossingGuard and TrafficVision products). 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 PRISM and eCLIPSE products are licensed directly by
the Company and through select distributors, primarily to
financial institutions. The Traffic Management products are being
marketed directly by NTS and through distributors to governmental
traffic management departments or their chosen integrators. The
Company's Intelligent Character Recognition products are marketed
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 PRISM and eCLIPSE 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. Management of the Company believes that the
success of the PRISM and eCLIPSE products will create a valuable
franchise in each institution, leading to extensions of the
Company's technology to other risk-assessment and marketing
applications.
During 1999, ACI and CSK accounted for 61%, and 14% of the
Company's revenues, respectively. 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 1999, GE Consumer Credit
Financial Services and Mellon Bank accounts were acquired by
other banks and the annual use fees being realized from PRISM
ceased. The loss of these accounts in 1999 was offset by new
clients producing monthly usage fees. 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, 1999 the Company had a backlog of approximately
$1,208,000 in undelivered license, development and installation
contracts. At December 31, 1998, the Company had a backlog of
approximately $578,000 in undelivered development and
installation contracts, in addition to $914,000 in Nestor Traffic
Systems, Inc. backlog at December 31, 1998; such NTS backlog is
not included in the Company's 1999 figures.
Neural-network Technology
The Company's technology deals with the problem of pattern
recognition within complex data. 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, customer
buying behavior, handwritten characters, vehicles in a traffic
flow, or others. 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, statistical analysis, and neural networks. The Company's
products may combine all of these methods to optimize pattern
recognition capabilities.
Neural-networks simulate a virtual network of interconnected
units, processing data in parallel, and communicating with each
other at high speeds. A trained neural-network receives 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 patterns in multi-dimensional non-
linear input, such as attempting to recognize characters from a
scanned handwritten sample, which is ill-defined, affected by
"noise", 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
Model(TM)(RCE) which has been granted five patents.
The RCE model has many unique features. It has rapid learning
from sparse data and fast processing speeds. 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 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 System(TM)("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 continues to develop and improve its 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 funding the costs of developing new technologies or
products, but may bear all 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 and
patents pending relating to improvements to the Company's basic
technology (see "Patents"). The Company has six applications
pending as of December 31, 1999, primarily in the area of traffic
management. 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, 1999, 1998
and 1997, respectively, $921,000, $2,112,000 and $1,498,000, in
support of the various aspects of Company-sponsored research and
development. Expenses in 1998 and 1997 include $860,000 and
$586,000, respectively, from NTS operations which are not
consolidated in 1999.
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's RCE neural network exhibits rapid
learning and minimizes the internal connections needed for its
functioning. The Company believes that these capabilities make
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.
The Company owns six United States patents and four foreign
patents issued in three countries and Europe. In addition, there
are six applications pending in the United States, and four
foreign applications pending, as of December 31, 1999. The
foreign patents and patent applications correspond to one or more
of the United States patents.
The Company believes that six of its United States patents, and
four corresponding foreign patents, are material to its and its
affiliates business. These United States patents expire at
various times from 2005 to 2014. The corresponding foreign
patents expire at various times through 2007. The following
table lists the Company's material United States patents:
<TABLE>
<CAPTION> Yr. Of
Patent No. Title Date of Issue Expiration
<S> <C> <C> <C>
4,760,604 Parallel, Multi-unit,
Adaptive, Nonlinear Pattern
Class Separator and Identifier July 26, 1988 2005
4,897,811 N-Dimensional Coulomb Neural
Network Which Provides for
Cumulative Learning of
Internal Representations January 30, 1990 2007
4,958,375 Parallel, Multi-unit, Adaptive
Pattern Classification System
Using Inter-unit Correlations
And An Intra-class Separator
Methodology September 18, 1990 2007
5,054,093 Parallel, Multi-unit,
Adaptive, Nonlinear Pattern
Class Separator and Identifier October 1, 1991 2008
5,479,574 Method and Apparatus for
Adaptive Classification December 26, 1995 2012
5,701,398 Adaptive Classifier Having
Multiple Sub Networks December 23, 1997 2014
</TABLE>
Competition
In the field of fraud-detection and risk-assessment systems, the
Company encounters competition from a number of sources,
including (a) other software companies, (b) companies' internal
MIS departments, (c) network and service providers, and (d)
neural-network tool suppliers. In the fraud-detection market,
the Company has experienced competition from Fair, Isaac & Co.,
HNC Software, Inc., IBM, 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 customer relationship management 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, IBM and Oracle. Companies
providing vertical solutions include Acxiom, Experian, Harte-
Hanks, BroadVision, Cyber Dialogue, Engage Technologies, Net
Perceptions, Vignette, and HNC Software. The market for Internet-
oriented personalization products is intensely competitive with
new competitors emerging frequently.
In the field of traffic management systems, the NTS 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, Laser, and Acoustic. NTS believes that
these technologies have limitations and do not provide the full
range of options available through TrafficVision. Such systems
are also available through other companies such as Econolite,
EDS, Lockheed Martin, Peek Traffic, Odetics, Red Flex, Traficon,
Siemens and Rockwell International. However, NTS believes that
the platforms on which these products operate do not provide the
image processing capabilities possessed by TrafficVision,
CrossingGuard and Rail CrossingGuard.
Most of the Company's and NTS'scompetitors 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, 1999, the Company had forty full-time
employees, including twenty-two in software engineering and
product development, seven in sales and marketing and eleven 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 are
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.
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, transaction processing,
and other software to more than 2,300 customers in 79 countries
throughout the world. The Company receives royalties based on
PRISM and other product licensing, 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 to purchase an
additional 2,500,000 common shares for $7,500,000. The warrant
expires on March 1, 2002. Additionally, TSAI provides a
$1,000,000 Line of Credit at the prime interest rate plus 1%.
There have been no advances against the line.
Total System Services, Inc.
During 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 for Total's customers by PRISM.
CSK Corporation
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.
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. In June 1998, NCS did not meet its minimum royalty for the
license year and forfeited exclusive rights. NCS continues to
market the ICR products on a non-exclusive basis.
IBM ZISC
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 Company receives royalties from the sales by IBM of the chip
and related products.
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 the United States District Court in Providence, RI
on November 25, 1998 alleging a number of claims including;
violation of Sections 1 and 2 of the Sherman Act (antitrust), and
violation of the Rhode Island Antitrust Act, and patent
invalidity. The suit seeks various damages, including lost
profits and treble damages. On June 15, 1999, HNC answered the
lawsuit denying the allegations, bringing a counterclaim alleging
infringement of the above described patent by the Company, and
seeking a declaration of invalidity and unenforceability of one
of the Company's patents. On the same day, HNC brought suit in
San Diego, CA against Applied Communications, Inc. (ACI) and its
parent TSAI alleging various causes of action including patent
infringement of the above described patent by the Company's PRISM
product which ACI markets. ACI has requested that the Company
provide indemnification against some of the claims in the suit
pursuant to the licensing agreement between ACI and the Company.
Costs associated with the suit are being expensed as incurred,
and totaled approximately $356,000 in 1999. No estimate of the
outcome of this suit, the counterclaim, or the ACI suit 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, 1999.
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 December 31, 1999
1st Quarter 7/16 1-3/32
2nd Quarter 3/4 1-1/16
3rd Quarter 25/32 1
4th Quarter 23/32 1-63/64
Year Ended December 31, 1998
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
As at February 29, 2000, the number of holders of record of the
issued and outstanding common stock of the Company was 417, which
includes brokers who hold shares for approximately 1,440
beneficial holders.
The Company has not declared any cash dividends with respect to
its common stock since its formation.
ITEM 6. Selected Financial Data
The following data includes the accounts of Nestor, Inc. and
Interactive in 1999 and Nestor, Inc., NTS and Interactive in
prior years.
<TABLE>
Six-Months
<CAPTION> Ended
Years Ended December 31, December 31,
Years Ended June 30,
1999 1998 1997 1996 1996 1995
<S> <C> <C> <C> <C> <C> <C>
Operating revenue $ 5,114,779 $ 2,241,376 $ 5,681,076 $ 1,195,904 $ 5,461,580 $ 3,195,563
Operating income (loss) $ 742,451 $(5,236,975) $ (295,985) $ (919,117) $ (27,260) $(3,236,398)
Other income (expense) $ (97,386) $ (26,178) $ 31,321 $ (16,220) $ 39,950 $ (221,024)
Net income (loss) $ (836,824) $(5,263,153) $ (294,664) $ (935,337) $ 12,690 $ (3,457,422)
Earnings per share
Weighted
number of
outstanding shares -
basic and diluted 17,844,327 15,249,932 9,243,508 8,689,031 7,847,510 7,411,502
(Loss) per share $ (0.05) $ (0.36) $ (0.08) $ (0.13) $ (0.03) $ (0.48)
SELECTED BALANCE SHEET DATA:
Total assets $ 6,773,905 $ 3,250,089 $ 2,613,031 $ 2,817,944 $ 3,351,871 $ 1,812,495
Working capital $ 1,211,257 $ 535,806 $ 146,081 $ 879,172 $ 1,983,661 $ (1,882,875)
Long-term
Redeemable Preferred
Stock $ --- $ --- $ 5,792,787 $ 5,398,908 $ 5,207,538 $ 1,600,328
Capital leases $ --- $ --- $ 10,220 $ 9,455 $ 9,455 $ ---
Deferred income $ 1,965,532 $ 440,400 $ --- $ 430,899 $ 430,899 $ 438,896
</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 (see further discussion in Exhibit 99.1)
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
$1,049,000 at December 31, 1999 as compared with $1,175,000 at
December 31, 1998, as compared with $387,000 at December 31,
1997. At December 31, 1999, the company had working capital of
$1,211,000, as compared with $536,000 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
in 1999 reflects primarily the positive working capital generated
from operating results in the current year.
The Company had a net worth of $2,304,000 at December 31, 1999,
as compared with 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 net operating
profits realized by the Company of $742,000 in 1999 and the net
effect of the Company's portion of equity raised by its
subsidiary, Nestor Traffic Systems, Inc. ("NTS"), totaling
$2,050,000 in 1999 offset by the Company's portion of NTS's net
loss in 1999 of $1,482,000.
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, if any, 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, if any, 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. The Company had not used
this line of credit as of December 31, 1999.
On March 25 and November 30, 1999, Nestor Traffic Systems, Inc.
(NTS), a subsidiary of the Company, sold a 37.5% and 20.6%,
respectively, common-stock interest in it to a private group of
investors for $4,105,000 in cash. As a result of these
transactions, the Company changed from consolidation to equity
accounting for its interest in NTS for the year-ended December
31, 1999. Prior periods reported continue to account for NTS on
a consolidated basis (See Part II, Item 8, Footnote #12 for a
further discussion). The investor group includes three officers
of the Company and the subsidiary, who in the aggregate
contributed $770,000 of the cash invested on the same basis as
third-party investors. The proceeds are being used by NTS to
fund traffic-system product development and marketing efforts in
1999 and 2000. In addition, to the extent that facility and
administrative services of the Company are used by NTS,
reimbursement of allocated costs have been provided. NTS 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 raised by
NTS is being used to fund expenses incurred by NTS after January
1, 1999, which were funded by the Company in previous years. NTS
is in the development stage and is pursuing additional capital
investments to implement its business plan. There can be no
assurance that additional funds will be raised.
Management believes that the Company's revenues will generate
sufficient liquidity, when combined with its liquid assets as of
December 31, 1999, to meet the Company's anticipated cash
requirements from current operations for the foreseeable future.
Litigation
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 the United States District Court in Providence, RI
on November 25, 1998 alleging a number of claims including;
violation of Sections 1 and 2 of the Sherman Act (antitrust), and
violation of the Rhode Island Antitrust Act, and patent
invalidity. The suit seeks various damages, including lost
profits and treble damages. On June 15, 1999, HNC answered the
lawsuit denying the allegations, bringing a counterclaim alleging
infringement of the above described patent by the Company, and
seeking a declaration of invalidity and unenforceability of one
of the Company's patents. On the same day, HNC brought suit in
San Diego, CA against Applied Communications, Inc. (ACI) and its
parent TSAI alleging various causes of action including patent
infringement of the above described patent by the Company's PRISM
product which ACI markets. ACI has requested that the Company
provide indemnification against some of the claims in the suit
pursuant to the licensing agreement between ACI and the Company.
Costs associated with the suit are being expensed as incurred,
and totaled approximately $356,000 in 1999. No estimate of the
outcome of this suit, the counterclaim, or the ACI suit can
currently be made.
Future Commitments
During 1999, the Company acquired additional property and
equipment (primarily computers and related equipment) at a cost
of $61,000. The Company valued its investments in property and
equipment (net of depreciation) at $270,000 at December 31, 1999.
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 per month and expires in March 2003. The
Company believes the facilities are adequate for its 2000 needs.
Year 2000
In 1998, the Company initiated a company-wide program to
anticipate and correct Year 2000 computer problems. The
Company's remediation efforts with respect to its licensed
software have been successful. With respect to the Company's own
systems, remediation, and/or replacement was completed
satisfactorily. The Company will continue to monitor any Year
2000 issues that may arise.
Costs incurred from the beginning of the project through December
1999 totaled approximately $250,000. These costs consisted 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. All costs, except hardware, were
expensed as incurred.
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, 1999 and 1998
During 1999, Nestor Traffic Systems, Inc. (a wholly-owned
subsidiary of the Company on December 31, 1998) sold an aggregate
58% common stock equity interest to third parties through two
transactions. This resulted in the Company reporting the
subsidiary in accordance with the equity method of accounting in
1999. The operating results of the subsidiary for the years
ended December 31, 1998 and 1997 are still reported on the
consolidation basis of accounting in the accompanying financial
statements. For the purpose of comparison, the following table
compares the results of operations for fiscal years 1999 and 1998
as if the subsidiary was accounted for under the equity method of
accounting in both periods with the 1998 results being
reclassified accordingly.
<TABLE>
<CAPTION>
December 31,
1999 1998
(As Reported) (Reclassified)
<S> <C> <C>
Software licensing revenues $ 3,872,016 $ 1,349,962
Engineering services revenues 1,242,763 656,890
Total revenues 5,114,779 2,006,852
Engineering services expense 1,023,046 1,799,629
Research and development expense 920,918 1,252,726
Selling and marketing expense 1,218,476 1,295,539
General and administrative expense 1,209,888 962,001
Total operating expenses 4,372,328 5,309,895
Income (loss) from operations 742,451 (3,303,043)
Other expenses (97,386) (26,178)
Income (loss) before taxes and loss
from investment in affiliate 645,065 (3,329,221)
Loss from investment in affiliate (1,481,889) (1,933,932)
Net Loss $ (836,824) $(5,263,153)
</TABLE>
The MD&A discussion that follows for the years ended December 31,
1999 and 1998 addresses the variances noted in the above table.
The differences in the December 31, 1998 financial statement
accounts as reported in the enclosed financial statements and
those above are solely due to reclassification of the results of
NTS to a single line entry "Loss from investment in affiliate".
In the year ended December 31, 1999, the Company realized a
154.9% increase in revenues compared to the prior calendar year.
Expenses increased 17.7% in 1999 resulting in an operating profit
of $742,000 in 1999 as compared to an operating loss of
$3,303,000 in the prior year.
Revenues
The Company's revenues arise from licensing of the Company's
products and technology and from contract engineering services
and are discussed separately below. During the year ended
December 31, 1999, revenues increased to $5,115,000 from
$2,007,000 in the prior calendar year (excluding $235,000 in NTS
1998 revenues).
Software Licensing
Product-licensing revenues totaled $3,872,000 in 1999, as
compared with $1,350,000 in 1998. The increase in these revenues
reflects an increase in license fees realized from PRISM
products.
PRISM licensing revenues amounted to $3,837,000 in 1999, an
increase of $2,519,000 from year-earlier revenues of $1,318,000.
The increase results from the increase in new licenses delivered
in 1999 versus 1998, fourteen versus three, respectively, and the
increase in use fee based revenues of $885,000 (101% versus 1998)
in 1999. Included in the 1999 use fee revenues is $423,000
related to the sale of a PRISM license to Applied Communications,
Inc. in the fourth quarter of 1999.
Engineering Services
Engineering revenues totaled $1,243,000 in 1999, as compared with
$657,000 in 1998. The increase relates to additional engineering
fees related to new license installations, associated customer-
specific model development, and custom enhancement work
contracted and delivered during 1999.
During 1998, the Company realized $44,000 of revenues related to
engineering work on its InterSite product. No such revenues were
realized in 1999.
Operating Expenses
Total operating expenses - consisting of engineering, research
and development, selling and marketing, and general and
administrative expenses - amounted to $4,372,000 in the year
ended December 31, 1999, a decrease of $938,000 over total
operating costs of $5,310,000 in the prior year (excluding
$2,168,000 in NTS 1998 operating expenses).
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 $1,023,000 in 1999,
as compared with $1,799,000 in 1998. The decrease in these costs
reflects the write-offs in 1998 totaling approximately $695,000
discussed above.
Research and Development
Research and development expenses totaled $921,000 in the year
ended December 31, 1999 as compared with $1,253,000 in the prior
year. The decrease in such costs reflects the termination of
further InterSite development in November 1998. Research and
development expenses related to the development of InterSite in
1998 were approximately $630,000 and the reduction was partially
offset by additional salary expense relative to new hiring in
financial services and other financial services staff salary
increases.
Selling and Marketing
Selling and marketing costs decreased $78,000 to $1,218,000 in
the year ended December 31, 1999, from $1,296,000 in the prior
year.
Selling costs associated with InterSite, in which the Company
ceased further investment effective November 1998, totaled
$192,000 in 1998, which was not incurred in 1999. In addition,
other marketing related expenses were reduced by approximately
$70,000 resulting from more focused advertising and trade show
activities. These decreases were partially offset by increases
from additional commissions relative to the increased revenues
($105,000) and foreign sales taxes ($61,000).
General and Administrative
General and administrative expenses totaled $1,209,000 in 1999,
as compared with $962,000 in the previous year. General and
administrative costs for the year ended December 1999 reflect
primarily the increased legal expenses related to the lawsuit
initiated against a competitor in November 1998.
Other Income (Expense)
For 1999, net other expense was $97,000 as compared with net
other expense of $26,000 in the year-earlier period. 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. During 1999, net interest
income recorded amounted to $9,000.
Loss from Investment in Affiliate
During 1999, the Company's subsidiary NTS sold common stock
interests totaling 58% of its equity. As a result, the Company's
interests in NTS are accounted for under the equity method of
accounting in 1999. As a result of the Company's equity interest
in NTS, the Company reported a loss from investment in affiliate
of $1,482,000 in 1999, representing 49% of NTS's actual net loss
in 1999 of $2,455,000, reflecting varying ownership percentages
during 1999. During 1998, NTS was included in the consolidated
financial results of the Company and reported a net loss of
$1,933,000.
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 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 and $1,383,000 in 1998. The
Company ceased further direct investment in development of this
product line in November 1998. The net investment in this
subsidiary during 1998 was $1,383,000. During 2000, the Company
integrated this product into the eCLIPSE product.
The Company's PRISM product line was profitable during 1999.
Net Income
During 1999, the Company experienced a net loss of $837,000, as
compared with a net loss of $5,263,000 in the prior year. For
the year ended December 31, 1999, loss per share available for
common stock was $0.05 per share, as compared with a loss per
share of $0.36 in the corresponding period of the prior fiscal
year. For the year ended December 31, 1999, there was
outstanding a weighted average of 17,844,327 shares, as compared
with 15,249,932 in the year-earlier period.
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 and
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.
Revenues from the Company's traffic systems products
(CrossingGuard and TrafficVision) 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.
Selling and Marketing
Selling and marketing costs decreased $154,000 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.
ITEM 7(a).
Quantitative and Qualitative Disclosure about Market Risk.
Management assesses their exposure to these risks as immaterial.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
the report to be signed on its behalf by the undersigned,
thereunto duly authorized.
NESTOR, INC.
(Registrant)
/s/David Fox, President and CEO
Date: March 30, 2000
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.
<TABLE>
<CAPTION>
Signatures Title Date
<S> <C> <C>
/s/Leon N Cooper Co-Chairman of the Board and Director March
30, 2000
/s/Charles Elbaum Co-Chairman of the Board and Director March
30, 2000
/s/David L. Fox President, Chief Executive Officer and Director March
30, 2000
/s/Herbert S. Meeker Secretary and Director March
30, 2000
/s/Sam Albert Director March
30, 2000
/s/Gregory Duman Director March
30, 2000
/s/Jeffrey Harvey Director March
30, 2000
/s/Thomas F. Hill Director March
30, 2000
/s/Bruce Schnitzer Director March
30, 2000
</TABLE>
CONSOLIDATED FINANCIAL STATEMENTS
FORM 10-K
December 31, 1999
NESTOR, INC. Part II
Item 8
CONTENTS
Independent Auditor's Report
Statement
Consolidated Balance Sheets - 1
December 31, 1999 and 1998
Consolidated Statements of Operations -
For the Years Ended December 31, 1999, 1998 and 1997 2
Consolidated Statements of Stockholders' Equity -
For the Years Ended December 31, 1999, 1998 and 1997 3
Consolidated Statements of Cash Flows -
For the Years Ended December 31, 1999, 1998 and 1997 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, 1999 and 1998, and the related
consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended
December 31, 1999. 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 auditing standards
generally accepted in the United States. 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 1999 and 1998 financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Nestor, Inc. at December 31,
1999 and 1998, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended
December 31, 1999 in conformity with accounting principles
generally accepted in the United States. 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 18, 2000
<TABLE>
NESTOR, INC.
Consolidated Balance Sheets
<CAPTION> December 31,
ASSETS 1999 1998
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,048,802 $ 1,175,183
Accounts receivable, net of allowance
for doubtful accounts 984,318 512,748
Unbilled contract revenue 1,200,484 336,309
Due from affiliate 320,459 ---
Other current assets 161,809 336,924
Total current assets 3,715,872 2,361,164
Long term unbilled contract revenue 1,965,532 440,400
Investment in affiliate 710,690 ---
Property and equipment at cost -
net of accumulated depreciation 269,917 368,525
Deferred development costs 56,000 80,000
Patent development costs 55,894 ---
Total Assets $ 6,773,905 $ 3,250,089
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 271,397 $ 400,900
Accrued employee compensation 314,202 279,929
Accrued liabilities 547,799 492,393
Deferred income 1,371,217 652,136
Total current liabilities 2,504,615 1,825,358
Noncurrent liabilities:
Long term deferred income 1,965,532 440,400
Total liabilities 4,470,147 2,265,758
Commitments and contingencies --- ---
Stockholders' Equity:
Preferred stock, $1.00 par value,
authorized 10,000,000 shares;
issued and outstanding:
Series B - 345,000 shares at
December 31, 1999 and
365,000 shares at December 31, 1998 345,000 365,000
Common stock, $.01 par value,
authorized 30,000,000 shares;
issued and outstanding:
17,499,327 shares at December 31, 1999 and
17,479,327 shares at December 31, 1998 174,993 174,793
Warrants and options 736,951 630,467
Additional paid-in capital 26,574,123 24,504,556
Retained deficit (25,527,309) (24,690,485)
Total stockholders' equity 2,303,758 984,331
Total Liabilities and Stockholders' Equity $ 6,773,905 $ 3,250,089
The Notes to the Financial Statements are an integral part of this statement.
</TABLE>
<TABLE>
NESTOR, INC.
Consolidated Statements of Operations
<CAPTION>
Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
Revenue:
Software licensing $ 3,872,016 $ 1,352,071 $ 4,390,479
Engineering services 1,242,763 746,007 1,055,459
Tangible product sales --- 143,298 235,138
Total revenue 5,114,779 2,241,376 5,681,076
Operating Expenses:
Engineering services 1,023,046 2,066,558 1,151,147
Tangible product costs --- 54,010 134,305
Research and development 920,918 2,112,746 1,498,181
Selling and marketing 1,218,476 1,831,697 1,986,340
General and administrative 1,209,888 1,413,340 1,207,088
Total operating expenses 4,372,328 7,478,351 5,977,061
Income (loss) from operations 742,451 (5,236,975) (295,985)
Other income (expense) - net (97,386) (26,178) 31,321
Income (loss) before income taxes
and investment loss 645,065 (5,263,153) (264,664)
Income taxes --- --- 30,000
Loss from investment in affiliate (1,481,889) --- ---
Net Loss $ (836,824) $(5,263,153) $(294,664)
Loss Per Share:
Net Loss $ (836,824) $(5,263,153) $ (294,664)
Dividends accrued on preferred stock --- 151,396 447,191
Net Loss Available for Common Stock $ (836,824) $(5,414,549) $ (741,855)
Loss Per Share, basic and diluted $ (0.05) $ (0.36) $ (0.08)
Shares Used in Computing Loss Per Share:
Basic and diluted 17,844,327 15,249,932 9,243,508
The Notes to the Financial Statements are an integral part of this statement.
</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 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 12/31/97 --- --- --- --- --- (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 12/31/98 --- --- --- --- --- (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
Conversion of
Preferred Stock
to Common Stock 20,000 200 (20,000) (20,000) 19,800 --- --- ---
Issuance of
equity by
subsidiary --- --- --- --- 2,049,767 --- --- 2,049,767
Accretion value
of warrants --- --- --- --- --- --- 106,484 106,484
Loss for the
year ended 12/31/99 --- --- --- --- --- (836,824) --- (836,824)
Balance at 12/31/99 17,499,327 $174,993 345,000 $ 345,000 $ 26,574,123 $ (25,527,309) $ 736,951 $ 2,303,758
The Notes to the Financial Statements are an integral part of this statement.
</TABLE>
<TABLE>
NESTOR, INC.
Consolidated Statements of Cash Flows
<CAPTION> Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (836,824) $ (5,263,153) $(294,664)
Adjustments to reconcile net loss
to net cash used by operating activities:
Write-down for impairment loss --- 790,641 ---
Depreciation and amortization 120,257 114,810 194,311
Loss on disposal of fixed assets --- --- 3,573
Loss from investment in affiliate 1,481,889 --- ---
Expenses charged to operations relating to
options, warrants and capital transactions 106,484 106,483 161,684
Discount on payment of vendor obligation --- --- (100,000)
Changes in assets and liabilities:
(Increase) decrease in
accounts receivable (471,570) 44,464 451,937
(Increase) decrease in
unbilled contract revenue (2,397,648) (477,906) (171,858))
(Increase) in deferred
development costs --- --- (210,347)
(Increase) decrease in other
assets (168,053) (98,649) 41,635
(Decrease) increase in accounts payable
and accrued expenses 279,101 199,750 (63,845)
(Decrease) increase in
deferred income 2,244,213 684,304 (361,071)
Net cash provided (used) by
operating activities 357,849 (3,899,256) (348,645)
Cash flows from investing activities:
Advances to affiliate - net (320,459) --- ---
Purchase of property and equipment (61,337) (132,209) (88,622)
Patent development costs (55,894) --- ---
Net cash used by investing activities (437,690) (132,209) (88,622)
Cash flows from financing activities:
Repayment of obligations under capital leases (46,540) (47,246) (11,913))
Proceeds from notes payable --- 250,000 ---
Repayment of notes payable --- (250,000) ---
Redemption of Preferred Series D Stock --- (41,424) ---
Proceeds from issuance of common stock - net --- 4,977,749 96,975
Payments of dividends on preferred stock --- (69,070) (35,613)
Net cash provided (used) by financing
activities (46,540) 4,820,009 49,449
Net change in cash and cash equivalents (126,381) 788,544 (387,818)
Cash and cash equivalents - beginning of year 1,175,183 386,639 774,457
Cash and cash equivalents - end of year $ 1,048,802 $ 1,175,183 $ 386,639
Supplemental cash flows information:
Interest paid $ 13,054 $ 20,350 $ 3,598
Income taxes paid $ --- $ 37,500 $ ---
Significant non-cash transactions are described in Notes 5, 7, 8, 12 and 15
The Notes to the Financial Statements are an integral part of this statement.
</TABLE>
NESTOR, INC. - NOTES TO THE FINANCIAL STATEMENTS
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. in 1999 and Nestor, Inc.,
Nestor Traffic Systems, Inc. ("NTS") and Nestor
Interactive, Inc. ("Interactive") in prior years. NTS
and Interactive were organized effective January 1,
1997 as two wholly owned subsidiaries. On March 25 and
November 30, 1999, NTS sold in the aggregate a 58.1%
common-stock interest to a private group of investors
(Note 12). As a result of these transactions, the
Company changed from consolidation to equity accounting
for its interest in NTS for the year ended December 31,
1999. Prior periods reported continue to account for
NTS on a consolidated basis. Effective November 7,
1998, the Company ceased further investment in the
Interactive subsidiary. Any future marketing or
development of Interactive's product has been
transferred to Nestor, Inc. All intercompany
transactions and balances have been eliminated.
The following unaudited information presents
summarized quarterly results for 1999 as if NTS was
accounted for under the equity method in all 10-Q
filings, with results being reclassified accordingly
(000's omitted).
<TABLE>
<CAPTION>
Qtr. Ended 3/31/99 Qtr. Ended 6/30/
99 Qtr. Ended 9/30/99
As As As
Reported Reclassified Reported Reclassified Reported Reclassified
<S> <C> <C> <C> <C> <C> <C>
Total revenues 1,441 1,374 1,306 1,272 1,172 1,141
Income (loss)
from
operations (148) 353 (341) 251 (618) 27
Minority
interest 187 --- 217 --- 238 ---
Loss from
investment
in affiliate --- (312) --- (362) ---- (396)
Net income
(loss) 17 17 (138) (138) (392) (392)
</TABLE>
B. 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.
C. Unbilled contract revenues
Unbilled contract revenues represent primarily
minimum guaranteed monthly license fees (See F and G
below) where a customer pays a portion of the license
fees over the software license term (usually five
years) based on a contractually predetermined minimum
volume of transactions.
D. 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.
E. 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 is
on a straight-line basis over the shorter of the
estimated economic life, or statutory life, of the
patent.
F. Deferred Income
Corresponding with unbilled contract revenues, deferred
income represents primarily minimum guaranteed monthly
license fees (see C above and G below) where a customer
pays a portion of the license fees over the software
license term (usually five years) based on a
contractually predetermined minimum volume of
transactions.
Additionally, in certain instances, the Company bills
and/or collects payment from customers prior to the
delivery of the software product or performance of
contracted maintenance or services, resulting in
deferred income.
G. 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.
H. 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.
I. Inventory
Inventory, consisting primarily of finished goods, is
valued at the lower of cost or market on the first-in,
first-out basis. Inventory, valued at $231,613 at
December 31, 1998 is included as "Other current assets"
on the Consolidated Balance Sheets. There was no
inventory at December 31, 1999, as inventory primarily
related to NTS, which is no longer consolidated with
the Company.
J. 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.
K. Change in presentation
Certain December 31, 1998 amounts have been
reclassified to conform to the December 31, 1999
presentation.
L. Earnings (loss) per share
The Company reports its earnings (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. Diluted EPS is computed
giving effect to common stock equivalents and other
dilutive securities, unless the computation results in
anti-dilution.
Note 2 - Accounts receivable, net of allowance for doubtful
accounts:
<TABLE>
<CAPTION> December 31,
1999 1998
<S> <C> <C>
Trade accounts receivable $ 988,463 $ 543,048
Allowance for doubtful accounts (4,145) (30,300)
Accounts receivable,
net of allowance
for doubtful accounts $ 984,318 $ 512,748
</TABLE>
Note 3 - 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. During 1996 and 1997, the Company
deferred $364,000 and $211,000, respectively, of costs in
connection with engineering and installation of the
project. Management believed that these costs would be
fully recovered over the five year term of the contract.
In view of the level of revenue generated by this
contract, at December 31, 1998, 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
with an offsetting charge to engineering services. The
residual deferred costs are being amortized on a straight-
line basis over the remaining term of the contract.
Note 4 - Property and equipment at cost - net:
<TABLE>
<CAPTION>
Useful Life
in Years or
December 31, Lease Term
1999 1998
<S> <C> <C> <C>
Office furniture
and equipment $ 234,706 $ 234,706 5 - 7
Leased computer
equipment under
capital leases 113,893 113,893 5
Computer equipment 1,268,855 1,344,244 3 - 5
1,617,454 1,692,843
Less:
Accumulated
depreciation and
amortization 1,347,537 1,324,318
$ 269,917 $ 368,525
</TABLE>
Depreciation and amortization expense on the above assets
of $96,257, $114,810 and $95,682, was recorded for the
years ended December 31, 1999, 1998 and 1997,
respectively. Accumulated depreciation and amortization
includes $40,963 and $18,184 of amortization related to
leased equipment under capital leases at December 31,
1999 and 1998, respectively.
Note 5 - 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 ceased further investment in the
Interactive subsidiary (see Note 1) and future
realization of the asset was uncertain, the remaining
value of this asset was written off in November 1998.
Note 6 - Line of credit:
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.
Note 7 - Common and Preferred 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 into common stock. The
redeemable convertible preferred stock originally accrued
and accumulated dividends at rates of seven to nine
percent, 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 on the redeemable convertible preferred
stock.
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 $345,000 and $365,000 at December
31, 1999 and 1998, 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 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 and 143,155
common shares were issued. 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 $36,199 remains unpaid at December
31, 1999.
Note 8 - 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, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
Years Ended December 31,
1999 1998 1997
Weighted Weighted Weighted
Av. Ex. Av. Ex. Av. Ex.
Shares Price Shares Price Shares Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding
beginning
of year 1,579,124 $1.22 2,214,000 $1.58 1,781,500 $1.50
Granted 62,500 .72 454,124 .99 484,000 1.81
Exercised --- --- 31,250 1.09 46,875 1.00
Canceled 13,308 1.08 1,057,750 1.88 4,625 1.67
Outstanding end
of year 1,628,316 $1.20 1,579,124 $1.22 2,214,000 $1.58
Options
exercisable
at year end 1,322,786 $1.24 1,102,846 $1.22 1,470,250 $1.39
Weighted
average
fair value of
options
granted during
the year $ 0.42 $ 0.71 $ 1.44
</TABLE>
The following table presents weighted average price and life information
about significant option groups outstanding at December 31, 1999.
<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 12/31/99 Life (Years) Price at 12/31/99 Price
<S> <C> <C> <C> <C> <C>
$ .31 17,500 4.00 $0.31 4,375 $0.31
$ .69 - $1.00 1,123,066 1.89 0.90 912,786 0.94
$ 1.50 - $1.94 283,250 2.48 1.55 228,375 1.55
$ 2.09 - $2.32 143,000 2.03 2.26 124,000 2.27
$ 2.52 - $2.91 61,500 2.20 2.76 53,250 2.79
1,628,316 2.04 $1.20 1,322,786 $1.24
</TABLE>
The following are the pro forma net loss and net loss per
share for the years ended December 31, 1999, 1998 and
1997, 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>
Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
Net loss:
As Reported $ (836,824) $ (5,263,153) $(294,664)
Pro Forma $(1,022,488) $ (4,710,218) $(876,280)
Net loss per share:
As Reported $ (0.05) $ (0.36) $ (0.08)
Pro Forma $ (0.06) $ (0.32) $ (0.14)
</TABLE>
The effects on the years ended December 31, 1999, 1998
and 1997 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, 1999 and the Company
expects to grant additional options in future years.
The fair value of each option grant was estimated using
the Black-Scholes model with risk-free interest rates on
the date of grant, which ranged from 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 .875 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>
December 31,
1999 1998 1997
<S> <C> <C> <C>
Eligible, End of Year
for Exercise
Currently 5,000,580 5,000,580 2,709,089
Warrants issued --- 2,500,000 ---
Low exercise price $ --- $ 3.00 $ ---
High exercise price $ --- $ 3.00 $ ---
</TABLE>
The warrants outstanding as of December 31, 1999, 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 annually in 1999,
1998 and 1997.
Note 9 - Segment Information:
A. Description of reportable segments
In prior years, the Company had three reportable
segments. During 1998, the Internet segment ceased
operations, and in 1999, 58.1% of the Traffic Systems
segment was sold, leaving Financial Solutions as the
sole reportable segment at December 31, 1999. Segment
information for 1999 has been omitted since all
operations relate to a single segment.
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 provided 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 16) and,
in 1997, includes $480,000 relating to the termination
of a license agreement (Note 15).
<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
</TABLE>
D. Geographic Information
Revenues are attributed to countries based on the
location of customers. All long-lived assets are
located in the United States.
<TABLE>
<CAPTION>
Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
United States $ 4,196,612 $ 1,918,951 $ 3,391,825
France --- --- 480,899
Belgium 151,200 212,097 903,662
Germany --- 17,460 ---
Japan 685,850 55,333 531,590
Canada 81,117 27,000 223,000
Singapore --- 10,535 ---
All other countries --- --- 150,100
$ 5,114,779 $ 2,241,376 $ 5,681,076
</TABLE>
E. Revenues from Major Customers
All revenues presented are derived from the Company's
Financial Solutions segment with the exception of
Customer E, which relates to the Traffic Systems
segment.
<TABLE>
<CAPTION>
Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
Customer A $ 3,106,631 $ 620,732 $ 2,216,375
Customer B --- --- 903,662
Customer C 685,850 --- ---
Customer D --- 445,115 ---
Customer E --- 302,979 ---
</TABLE>
Note 10 -Other income (expense) - net:
Other income (expense) as reflected in the consolidated
statements of operations consists of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
Interest income (expense) $ 9,098 $(20,350) $ (3,598)
Expense relating to
financing operations (106,484) (106,483) (106,484)
Other - net --- 100,655 141,403
Other Income
(Expense) - Net $(97,386) $(26,178) $ 31,321
</TABLE>
Note 11 - 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 for income taxes are:
<TABLE>
<CAPTION>
December 31,
1999 1998 1997
<S> <C> <C> <C>
Current - Federal $ --- $ --- $30,000
Deferred --- --- ---
Total Income Taxes $ --- $ --- $30,000
</TABLE>
Significant components of the Company's deferred tax
liabilities and assets as of December 31, 1999 and 1998
are as follows:
<TABLE>
<CAPTION>
December 31,
1999 1998
<S> <C> <C>
Deferred tax liabilities:
Deferred development costs $ 22,000 $ 32,000
Total deferred tax liabilities 22,000 32,000
Deferred tax assets:
Accounts receivable 2,000 12,000
Accrued expenses 308,000 246,000
Deferred income 32,000 16,000
Tax credits 17,000 17,000
Net operating loss
Nestor, Inc. 5,988,000 6,414,000
Subsidiaries --- 2,205,000
Total deferred tax assets 6,347,000 8,910,000
Valuation allowance (6,325,000) (8,878,000)
Net deferred tax assets 22,000 32,000
Net deferred tax balance $ --- $ ---
</TABLE>
The December 31, 1998 deferred tax liabilities, assets
and valuation allowance reflect the consolidated balances
of Nestor, Inc. and its subsidiaries, whereas the
December 31, 1999 amounts represent Nestor, Inc. only
(Note 1).
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. Realization is not assured in future tax
projections.
A reconciliation of the provision for income taxes to
the amount computed using the Federal statutory tax rates
consists of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
Income (loss) before taxes
and investment loss $ 645,000 $(5,263,000) $(265,000)
Tax at statutory rate of 34% $ 219,000 $(1,789,000) $(101,000)
State income tax (net of
federal benefit) 47,000 (313,000) (19,000)
Effect of permanent differences 36,000 101,000 (36,000)
Valuation allowance (302,000) 2,001,000 186,000
Income tax expense $ --- $ --- $ 30,000
</TABLE>
The Company has available at December 31, 1999,
$16,703,000 and $5,200,000 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
2000.
Note 12 - Nestor Traffic Systems, Inc. Affiliate:
On March 25, 1999, Nestor Traffic Systems, Inc., a
subsidiary of the Company, sold a 37.5% common stock
interest (540,000 shares at $4.35 per share) to a private
group of investors for $2,350,000 in cash and issued an
option to purchase an additional 17.5% of its common
stock for $1,750,000. The option was scheduled to expire
on January 31, 2000. On November 30, 1999, the Company,
NTS and the investor group agreed to accelerate the
exercise of the option and an additional 20.6% interest
(710,000 shares at $2.47 per share) was sold for
$1,755,000. The investor group includes three officers
of the Company and the subsidiary, who in the aggregate,
contributed $600,000 of the initial cash and $170,059 in
the second sale, invested on the same basis as third-
party investors. Similar transactions may occur in the
future since NTS is in the development stage and it
continues to seek additional equity investors.
As a result of these transactions, the Company's interest
in NTS decreased to 42%, prompting the change from
consolidation to equity accounting for the year ended
December 31, 1999. The investment in affiliate balance
of $710,690 at December 31, 1999 reflects the Company's
interest in NTS's equity.
Presented below is summarized NTS financial information
at December 31, 1999 and for the year then ended:
Current assets $ 2,126,000
Noncurrent assets 296,000
Current liabilities 724,000
Stockholders' equity 1,698,000
Total revenues 167,000
Operating expenses 2,656,000
Net loss 2,453,000
During the period January 1, 1999 through March 31, 1999,
the Company advanced NTS financing to cover operating
expenses amounting to approximately $550,000. Of this
advance, $275,000 was reimbursed in March 1999, and the
balance is due on the earlier of NTS raising new equity
of at least $3,000,000 or December 31, 2000.
Periodically, additional advances are made by the Company
to NTS primarily as a result of shared accounts, and
these amounts are due as invoiced. The amount due from
NTS at December 31, 1999 was $320,459.
On January 1, 1999, the Company entered into an exclusive
license with NTS to apply certain proprietary
technologies in the fields of using video and other
sensors to analyze, monitor and respond to movement of
persons or objects in vehicular, rail, air or other modes
of transportation or supporting the foregoing. The
license expires upon the expiration of the underlying
patents protecting the technologies used in NTS's
products. The license provides for royalties to the
Company starting in 2000 equal to 5% of the gross margin
realized from sales or licensing or products subject to
the license, and increasing to 10% of the gross margin in
calendar years 2001 and beyond. The license requires
minimum annual royalties of $125,000 in 2001, increasing
to $1,000,000 in 2005 and beyond, in order to maintain
exclusive rights. No royalties were due or payable in
1999.
NTS uses facility and administrative services of the
Company, including use of office space and executive,
accounting and other support personnel. NTS reimburses
the Company monthly for these services at a rate of
$39,913 for up to 15 NTS employees, and $47,267 for above
15 employees. Such reimbursement will decrease as NTS
obtains its own office space and develops an independent
executive and support staff. Facility and
administrative fees charged to NTS during 1999 were
$479,000.
Note 13 - 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, 1999, 1998 and 1997, the Company recorded an
expense for Baer, Marks & Upham of $15,600, $15,600 and
$14,400, respectively.
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,
1999, 1998 and 1997, the Company recorded an expense for
Wand Partners, Inc. of $41,497, $47,770 and $49,479,
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 accrued
liabilities at December 31, 1999 and 1998 are $99,167 and
$63,738, 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 Hughes
Hubbard & Reed LLP, which the Company uses as outside
counsel. For the years ended December 31, 1999, 1998 and
1997, the Company recorded an expense for Hughes Hubbard
& Reed LLP of $76,106, $80,039, and $100,961,
respectively.
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 7). For the years ended
December 31, 1999 and 1998, the Company recorded revenues
of $3,106,631 and $620,730, respectively from ACI. At
December 31, 1999 and 1998, accounts receivable included
$489,494 and $157,808 due from ACI and unbilled was
$3,141,574 and $711,434. Also at December 31, 1999 and
1998, deferred income included $2,768,257 and $896,000
from ACI. Further related party transactions with TSAI
are discussed in Notes 6, 8 and 17.
See Note 12 for transactions with affiliate.
Note 14 - 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 $195,000, $193,953 and $188,936 was
charged to operations for the years ended December 31,
1999, 1998 and 1997, 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 13 - Related party
transactions).
The aggregate minimum payments due over the remaining
term of the above agreements is as follows:
December 31, 2000 $ 235,000
December 31, 2001 239,875
December 31, 2002 246,375
December 31, 2003 92,000
December 31, 2004 40,000
Thereafter 40,000
$ 893,250
Note 15 - Termination of license agreement:
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 16 - 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 $34,000, $32,000
and $120,000 of revenue under this license agreement in
calendar 1999, 1998 and 1997, respectively.
Note 17- Litigation:
On October 6, 1998, HNC Software Corp. ("HNC"), a
significant competitor of the Company's in the field of
Financial Services, obtained a patent titled "Fraud
Detection Using Predictive Modeling" and began advising
prospective customers of the Company of the patent. Upon
review of the patent and consideration of prior actions
taken by HNC, the Company initiated a lawsuit against HNC
in the United States District Court in Providence, RI on
November 25, 1998 alleging violation of Sections 1 and 2
of the Sherman Act (antitrust), violation of the Rhode
Island Antitrust Act, patent invalidity, and infringement
of Nestor's patents (infringement claims withdrawn
January 10, 2000). The suit seeks various damages,
including lost profits and treble damages.
On June 15, 1999, HNC answered the lawsuit denying the
allegations, bringing a counterclaim alleging
infringement of the above described patent by the
Company, and seeking a declaration of invalidity and
unenforceability of one of the Company's patents. On the
same day, HNC brought suit in San Diego, CA against ACI
and its parent alleging various causes of action
including patent infringement of the above described
patent by the Company's PRISM product which ACI markets.
ACI has requested that the Company provide
indemnification against some of the claims in the suit
pursuant to an agreement between ACI and the Company.
Costs associated with the suit are being expensed as
incurred. Although the Company believes that it will
prevail, there can be no assurance as to the outcome of
this suit, the counterclaim, or the ACI suit. 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.
<TABLE>
NESTOR, INC. Part IV
Item 14
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE Schedule II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<CAPTION>
Charged
Balance at Charged to Deductions Balance at
Beginning of to Other from end of
Period Expense Accounts Reserve Period
<S> <C> <C> <C> <C> <C>
Allowances deducted
from accounts receivable:
Year Ended December 31, 1997 $ 145,235 $ 80,495 $ --- $(71,176) $154,554
Year Ended December 31, 1998 $ 154,554 $ 40,081 $ --- $(163,450) $ 30,300
Year Ended December 31, 1999 $ 30,300 $ 5,000 $ --- $(31,155) $ 4,145
</TABLE>
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:
21.2 Nestor Traffic Systems, Inc. financial statements for the
year ended December 31, 1999.
99.1 Safe Harbor for Forward-Looking Statements Under the Private
Securities Litigation Reform Act of 1995.
(b) Reports on Form 8-K:
On May 7, 1998, the Corporation filed with the
Securities and Exchange Commission a current report on
Form 8-K dated April 28, 1998 is hereby incorporated by
reference.
On December 3, 1998, the Corporation filed with the
Securities and Exchange Commission a current report on
Form 8-K dated November 25, 1998 is hereby incorporated
by reference.
On April 23, 1999, the Corporation filed with the
Securities and Exchange Commission a current report on
Form 8-K dated March 25, 1999 is hereby incorporated by
reference.
INDEX OF EXHIBITS
Exhibit No. 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.
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.
4.2 Securities Purchase Agreement dated April 28,
1998 with Transaction Systems Architects, Inc. to
purchase 2,500,000 common shares of the Company and a
warrant for an additional 2,500,000 common shares.
4.3 Nestor Traffic Systems, Inc., Form of
Subscription Agreement dated March 25, 1999, to sell a
37.5% equity position in its common stock and issue a
warrant for an additional 17.5% common stock interest.
10.1 Non-Exclusive Field-of-Use License Agreement
dated June 21, 1988 between the Company and Morgan
Stanley & Co. Incorporated, filed as an Exhibit to the
Company's Form 10-K for the fiscal year ended June 30,
1988, is hereby incorporated herein by reference.
10.2 Cooperative Marketing Agreement dated May 26,
1988 between the Company and Arthur D. Little, Inc.,
filed as an Exhibit to the Company's Form 10-K for the
fiscal year ended June 30, 1988, is hereby incorporated
herein by reference.
10.3 Lease Rider dated February 6, 1985 between
Richmond Square Technology Park Associates and the
Company, filed as an Exhibit to the Company's Report on
Form 10-K for the fiscal year ended June 30, 1986, is
hereby incorporated herein by reference.
10.4 Employment Agreement dated August 4, 1986
between the Company and Michael G. Buffa, filed as Item
5 of the Company's Report on Form 8-K dated September
11, 1986, is hereby incorporated herein by reference.
10.5 Joint Venture Agreement between the Company
and Oliver, Wyman & Co., dated December 4, 1986, filed
as an Exhibit to the 1987 Form 10-K, is hereby
incorporated herein by reference.
10.6 Employment Agreement dated as of July 1, 1989
between the Company and David Fox filed as an Exhibit
to the 1989 Form 10-K is hereby incorporated by
reference.
10.7 Employment Agreement dated as of September
15, 1988 between the Company and Douglas L. Reilly
filed as an Exhibit to the 1989 Form 10-K is hereby
incorporated by reference.
10.8 Memorandum dated January 1, 1989 regarding
stock bonus plan for Douglas L. Reilly filed as an
Exhibit to the 1989 Form 10-K is hereby incorporated by
reference.
10.9 Amendment to Joint Venture Agreement dated
May 8, 1990 between the Company and Oliver, Wyman & Co.
filed as an Exhibit to the 1992 Annual Report on Form
10-K is hereby incorporated by reference.
10.10 License Agreement dated October 26, 1990 by
and between the Company and Sligos, S. A. filed as an
Exhibit to the Company's 1992 Annual Report on Form 10-
K is hereby incorporated by reference.
10.11 Supplemental License Agreement dated
September 9, 1991 by and between the Company and
Sligos, S. A., filed as an Exhibit to the Company's
1992 Annual Report on Form 10-K, is hereby incorporated
by reference.
10.12 NestorWriter(TM)License and Development
Agreement dated September 11, 1991 between the Company
and Poqet Computer Corporation.
10.13 License Agreement for Product Development and
Marketing dated October 30, 1990 between the Company
and Lyonnaise des Eaux-Dumez.
10.14 Software Development Agreement dated October
30, 1990 between the Company and Lyonnaise des Eaux-
Dumez.
10.15 License Agreement dated November 27, 1990
between the Company and Atari Corporation.
10.16 License Agreement for Product Development and
Marketing dated March 18, 1991 between the Company and
Dassault Electronique.
10.17 Agreement of Purchase and Sale dated August
16, 1991 between the Company and Diversified Research
Partners filed as Item 5 of the Company's report on
Form 8-K dated August 21, 1991 is hereby incorporated
herein by reference.
10.18 License Agreement dated October 15, 1993,
between the Company and Intel Corporation filed as an
Exhibit to the Company's 1994 Annual Report on Form 10-
K is hereby incorporated by reference.
10.19 Exclusive Marketing Agreement dated April 7,
1994, between the Company and Intel Corporation filed
as an Exhibit to the Company's Current Report on Form 8-
K dated April 7, 1994, is hereby incorporated by
reference.
10.20 Securities Purchase Agreement dated August 1,
1994, between the Company and Wand/Nestor Investments
L.P. ("Wand") filed as Item 5 of the Company's report
on Form 8-K dated August 8, 1994, is hereby
incorporated herein by reference.
10.21 Standby Financing and Purchase Agreement
dated as of March 16, 1995 between the Company and
Wand, filed as an Exhibit to the Company's Current
Report on Form 8-K dated March 16, 1995, is hereby
incorporated by reference.
10.22 First Amended and Restated Standby Financing
and Purchase Agreement dated June 30, 1995 between the
Company and Wand, filed as an Exhibit to the Company's
Current Report on Form 8-K dated July 7, 1995, is
hereby incorporated by reference.
10.23 Amendment Agreement dated December 20, 1994
between the Company and Sligos, S.A., filed as an
Exhibit to the Company's Registration Statement on Form
S-2, Commission File No. 33-93548, is hereby
incorporated herein by reference.
10.24 Technology Development Subcontract dated
December 20, 1994, between the Company and Alta
Technology Corporation, filed as an Exhibit to the
Company's Registration Statement on Form S-2,
Commission File No. 33-93548, is hereby incorporated
herein by reference.
10.25 Agreements between the Company and Europay
International S.A. ("Europay") consisting of: (i) Fraud
Study Agreement dated August 3, 1993, together with
appendices and exhibits thereto; (ii) Confidentiality
Agreement dated August 3, 1993; (iii) Nestor Fraud
Detection System User License dated September 21, 1994;
(iv) Source Code Addendum to Nestor Fraud Detection
System User License, dated September 22, 1994; and (v)
Memorandum of Understanding dated May 5, 1995, filed as
an Exhibit to the Company's Registration Statement on
Form S-2, Commission File No. 33-93548, is hereby
incorporated herein by reference.
10.26 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.
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.
10.36 Exclusive License Agreement between Nestor,
Inc. and Nestor Traffic Systems, Inc. dated January 1,
1999 filed as an Exhibit to the Company's Current
Report on Form 8-K dated March 25, 1999.
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.
21.2 Nestor Traffic Systems, Inc. financial
statements for year ended December 31, 1999.
27 Financial data schedule for the year ended
December 31, 1999.
99.1 Safe Harbor for Forward-Looking Statements
under the Private Securities Litigation Reform Act of
1995.
103 Copy of Complaint filed on November 25, 1998
against HNC Software, Inc. alleging anticompetitive,
exclusionary and predatory conduct in the Registrant's
market.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,048,802
<SECURITIES> 0
<RECEIVABLES> 984,318
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,682,752
<PP&E> 269,917
<DEPRECIATION> 0
<TOTAL-ASSETS> 6,773,905
<CURRENT-LIABILITIES> 2,504,615
<BONDS> 0
0
345,000
<COMMON> 174,993
<OTHER-SE> 1,783,765
<TOTAL-LIABILITY-AND-EQUITY> 6,773,905
<SALES> 0
<TOTAL-REVENUES> 5,114,779
<CGS> 0
<TOTAL-COSTS> 4,372,328
<OTHER-EXPENSES> 97,386
<LOSS-PROVISION> 1,481,889
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 645,065
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (836,824)
<EPS-BASIC> (.05)
<EPS-DILUTED> (.05)
</TABLE>
15
Exhibit 21.2
FINANCIAL STATEMENTS
NESTOR TRAFFIC SYSTEMS, INC.
(A Development Stage Company)
December 31, 1999
NESTOR TRAFFIC SYSTEMS, INC.
(A Development Stage Company)
CONTENTS
Independent Auditor's Report
Statement No.
Balance Sheet - 1
December 31, 1999
Statement of Operations -
For the Year Ended December 31, 1999 2
Statement of Stockholders' Equity -
For the Year Ended December 31, 1999 3
Statement of Cash Flows -
For the Year Ended December 31, 1999 4
Notes to Financial Statements
Report of Independent Auditors
The Board of Directors and Stockholders
of Nestor Traffic Systems, Inc.
We have audited the accompanying balance sheet of Nestor Traffic
Systems, Inc. (a development stage company) as of December 31,
1999, and the related statement of operations, stockholders'
equity and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards
generally accepted in the United States. Those standards require
that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the 1999 financial statements referred to above
present fairly, in all material respects, the financial position
of Nestor Traffic Systems, Inc. at December 31, 1999, and the
results of its operations and its cash flows for the year then
ended, in conformity with accounting principles generally
accepted in the United States.
The accompanying financial statements have been prepared assuming
that Nestor Traffic Systems, Inc. will continue as a going
concern. As discussed in Note 1, the Company is a development
stage company that since inception has expended cash in excess of
cash generated from operations. Additionally, the Company has
not achieved sufficient revenues to support future operations
without additional financing. These conditions raise substantial
doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are discussed in
Note 1. The financial statements do not include any adjustments
to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
ERNST & YOUNG LLP
Providence, Rhode Island
February 18, 2000
<TABLE>
NESTOR TRAFFIC SYSTEMS, INC.
(A Development Stage Company)
Balance Sheet
December 31, 1999
<CAPTION>
ASSETS
<S> <C>
Current assets:
Cash and cash equivalents $ 1,599,112
Accounts receivable 30,756
Unbilled contract revenue 20,000
Inventory 442,493
Other current assets 33,241
Total current assets 2,125,602
Investment in leased equipment -
net of accumulated depreciation 138,961
Property and equipment at cost -
net of accumulated depreciation 156,997
Total Assets $ 2,421,560
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 394,324
Due to affiliate 320,459
Deferred income 8,998
Total current liabilities 723,781
Commitments and contingencies ---
Stockholders' Equity:
Common stock, $.01 par value,
authorized 4,000,000 shares;
issued and outstanding 2,150,000 shares 21,500
Additional paid-in capital 7,554,446
Deficit accumulated during
the development stage (5,878,167)
Total stockholders' equity 1,697,779
Total Liabilities and Stockholders' Equity $ 2,421,560
The Notes to the Financial Statements are an integral part of
this statement.
</TABLE>
<TABLE>
NESTOR TRAFFIC SYSTEMS, INC.
(A Development Stage Company)
Statement of Operations
<CAPTION>
(Unaudited)
Cumulative
Year Ended January 1, 1997 to
December 31, 1999 December 31, 1999
<S> <C> <C>
Revenue:
Software licensing $ 18,474 $ 27,735
Engineering services 92,317 301,036
Tangible product sales 56,642 401,684
Total revenue 167,433 730,455
Operating Expenses:
Engineering services 675,315 1,207,852
Tangible product costs 36,644 180,847
Research and development 905,880 2,352,110
Selling and marketing 717,004 1,767,093
General and administrative 321,456 1,137,023
Total operating expenses 2,656,299 6,644,925
Loss from operations (2,488,866) (5,914,470)
Other income - net 36,333 36,303
Loss before income taxes (2,452,533) (5,878,167)
Income taxes --- ---
Net Loss $ (2,452,533) $(5,878,167)
The Notes to the Financial Statements are an integral part of this
statement.
</TABLE>
<TABLE>
Nestor Traffic Systems, Inc.
(A Development Stage Company)
Statement of Stockholders' Equity
<CAPTION>
Deficit
Accumulated
During the
Common Stock Additional Development
Shares Amount Paid-in Capital Stage Total
<S> <C> <C> <C> <C> <C>
Issuance of Common Stock 1,000 $ 1 $ 1,009 $ --- $ 1,010
Capital contributed
by Nestor, Inc. --- --- 1,565,780 --- 1,565,780
Loss for the year ended
December 31, 1997 --- --- --- (1,491,701) (1,491,701)
Balance at 12/31/97
(unaudited) 1,000 $ 1 $ 1,566,789 $ (1,491,701) $ 75,089
Capital contributed
by Nestor, Inc. --- --- 1,904,156 --- 1,904,156
Loss for the year ended
December 31, 1998 --- --- --- (1,933,933) (1,933,933)
Balance at 12/31/98
(unaudited) 1,000 $ 1 $ 3,470,945 $ (3,425,634) $ 45,312
Issuance of
Common Stock 2,149,000 21,499 4,083,501 --- 4,105,000
Loss for the year ended
December 31, 1999 --- --- --- (2,452,533) (2,452,533)
Balance at 12/31/99 2,150,000 $ 21,500 $ 7,554,446 $ (5,878,167) $ 1,697,779
The Notes to the Financial Statements are an integral part of this statement.
</TABLE>
<TABLE>
NESTOR TRAFFIC SYSTEMS, INC.
(A Development Stage Company)
Statement of Cash Flows
<CAPTION>
(Unaudited)
Year Cumulative
Ended 1/1/97 to
12/31/99 12/31/00
<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,452,533) $(5,878,167)
Adjustments to reconcile net loss
to net cash used by operating
activities:
Depreciation 51,033 94,863
Increases in assets and liabilities:
Accounts receivable (30,756) (30,756)
Unbilled contract revenue (11,659) (18,048)
Inventory (210,880) (323,035)
Other assets (19,186) (29,116)
Accounts payable and accrued expenses 121,939 270,555
Deferred income 8,998 8,998
Net cash used by operating
activities (2,543,044) (5,904,706)
Cash flows from investing activities:
Purchase of property and equipment (140,967) (191,612)
Investment in leased equipment (142,336) (142,336)
Net cash used by investing activities (283,303) (333,948)
Cash flows from financing activities:
Due to affiliate 320,459 320,459
Capital investments by affiliate - net --- 3,412,307
Proceeds from issuance of
common stock - net 4,105,000 4,105,000
Net cash provided by
financing activities 4,425,459 7,837,766
Net change in cash and
cash equivalents 1,599,112 1,599,112
Cash and cash equivalents -
beginning of period --- ---
Cash and cash equivalents -
end of period $ 1,599,112 $ 1,599,112
Supplemental cash flows information:
Interest paid $ --- $ ---
Income taxes paid $ --- $ ---
Non-cash transaction:
Net assets transferred from affiliate $ --- $ 58,639
The Notes to the Financial Statements are an integral part of this
statement.
</TABLE>
NESTOR TRAFFIC SYSTEMS, INC.
NOTES TO THE FINANCIAL STATEMENTS
Note 1 - Summary of significant accounting policies:
A. Organization
Nestor Traffic Systems, Inc. (the "Company") was
organized on January 1, 1997 in Delaware as a wholly-
owned subsidiary of Nestor, Inc. to exploit and develop
certain patent rights and know-how, which the Company
licenses from Nestor, Inc. During 1999, the Company
issued common stock to a group of private investors in
two separate transactions aggregating $4,105,000,
representing a 58.1% equity ownership in the Company.
The Company is no longer consolidated in Nestor, Inc.'s
financial statements. Nestor, Inc. owns the remaining
41.9% equity of the Company and accounts for the
investment using equity accounting. The Company's
principal office is located in Providence, RI, and it
maintains a branch office in Irvine, CA.
The Company is a development stage company and has
had limited revenues. Activities through December 31,
1999 consist primarily of raising capital, research and
development, establishing supplies and production
processes, and sales and marketing.
The financial statements have been prepared on a
going-concern basis. From its inception through
December 31, 1999, the Company has expended cash in
excess of cash generated from operations.
Additionally, the Company has not achieved sufficient
revenues to support future operations without
additional financing. Management is in the process of
identifying new customers and raising additional
capital to support its operations and provide
sufficient liquidity to enable it to continue as a
going concern (Note 10). The financial statements do
not include any adjustments that might result from the
outcome of this uncertainty.
B. Cash equivalents
The Company considers all highly liquid debt
instruments purchased with a maturity of 90 days or
less to be cash equivalents.
C. Depreciation
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 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.
Revenue has been recognized as follows:
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.
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.
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.
Training revenue is recognized upon the completion
of training sessions with the customer.
E. 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.
F. Inventory
Inventory is valued at the lower of cost or market on
the first-in, first-out basis and consists of the
following at December 31, 1999:
Work-in-progress $ 325,171
Finished goods 117,322
Total inventory $ 442,493
G. 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.
Note 2 - Investment in Leased Equipment:
The Company entered into an operating lease with a
customer providing for quarterly fixed payments of system
lease and software license fees of $13,497 over a term of
36 months, and providing for a lump-sum buyout at the end
of the term. Future minimum lease revenues are $53,988
in 2000 and 2001 and $49,489 in 2002, totaling $161,964
over the term of the lease. In addition, the agreement
calls for software license and processing fees tied to
citations issued to red light violators. Equipment and
installation costs related to these systems have been
capitalized and are being depreciated over the minimum
lease term of the related lease agreement, currently
three years.
Equipment under operating leases $ 142,336
Less: Accumulated depreciation (3,375)
Net investment in leased equipment $ 138,961
Note 3 - Property and equipment at cost - net:
Useful Life
Computer equipment 184,449 5 years
Demonstration equipment 93,244 3 years
277,693
Less: Accumulated depreciation (120,696)
$ 156,997
Depreciation expense on the above assets of $47,658 was
recorded for the year ended December 31, 1999.
Note 4 - Due to affiliate:
During the period January 1, 1999 through March 31, 1999,
Nestor, Inc. advanced the Company financing to cover
operating expenses amounting to approximately $550,000.
Of this advance, $275,000 was reimbursed to Nestor, Inc.
in March 1999, and the balance is due on the earlier of
the Company's raising of new equity of at least
$3,000,000 or December 31, 2000. Periodically,
additional advances are made on behalf of the Company by
Nestor, Inc., primarily as a result of shared accounts,
and these amounts are due and paid as invoiced.
Note 5 - Common stock:
On March 25, 1999, 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 to purchase an additional
17.5% of its common stock for $1,750,000. The option was
scheduled to expire on January 31, 2000. On November 30,
1999, the Company and the investor group agreed to
accelerate the exercise of the option and the investor
group purchased an additional 20.6% ownership in the
Company for $1,755,000. The investor group includes
three officers of the Company who, in the aggregate,
contributed $770,059 of cash invested on the same basis
as third-party investors.
Note 6 - Options:
On May 5, 1999, the Company adopted the 1999 Stock Option
Plan providing for the granting of options to purchase
shares of the Company's common stock at a price equal to
the fair market value of the common stock at the date of
grant as determined by the Board of Directors. The 1999
Stock Option Plan has authorized the grant of options to
employees for up to 200,000 shares of the Company's
common stock. Options are exercisable for up to ten
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"). 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.
The following table presents the activity of the
Company's Stock Option Plan for the year ended December
31, 1999:
<TABLE>
<CAPTION> Weighted
Average
Exercise
Shares Price
<S> <C> <C>
Outstanding beginning of year ---
Granted 90,000 $5.00
Exercised ---
Canceled 3,000 5.00
Outstanding end of year 87,000 $5.00
Options exercisable at year end 17,400 5.00
Weighted average fair value of options
granted during the year $ 1.42
</TABLE>
All options granted and outstanding during 1999 have a
ten-year life and vest 20% upon issuance and each
anniversary thereafter until fully vested.
Below is the pro forma net loss for the year ended
December 31, 1999, as if the compensation cost for the
option plan had been determined based on the fair value
at the grant date:
Net loss:
As Reported $ (2,452,533)
Pro Forma $ (2,468,730)
The fair value of each option grant was estimated using
the Minimum Value method with a risk-free interest rate
of 5.3% on the date of grant. The Company has never
declared nor paid dividends on its common stock and does
not expect to in the foreseeable future.
Note 7 - Other income - net:
Other income as reflected in the statement of operations
consists of interest income realized on short-term
investment grade investments.
Note 8 - 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.
Significant components of the Company's deferred tax
liabilities and assets as of December 31, 1999 are as
follows:
Deferred tax assets:
Accrued expenses $ 25,000
Net operating loss 2,317,000
Total deferred tax assets 2,342,000
Valuation allowance (2,342,000)
Net deferred tax assets ---
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. Realization is not assured in future tax
projections.
A reconciliation of the provision for income taxes to
the amount computed using the Federal statutory tax rates
consists of the following:
Loss before taxes $ (2,453,000)
Tax at statutory rate of 34% $ (834,000)
State income tax (net of
federal benefit) (145,000)
Effect of permanent differences 3,000
Valuation allowance 976,000
Income tax expense $ ---
The Company has available at December 31, 1999,
$5,800,000 of net operating loss carryforwards for
federal and state purposes. These loss carryforwards may
be applied against future taxable income and begin to
expire in 2002. The Company has had numerous equity
transactions during its history. These transactions may
affect the Company's ability to utilize these net
operating loss carryforwards due to certain provisions
contained in IRC Section 382.
Note 9 - Related party
transactions:
On January 1, 1999, the Company entered into an exclusive
license with Nestor, Inc. to apply certain proprietary
technologies in the fields of using video and other
sensors to analyze, monitor and respond to movement of
persons or objects in vehicular, rail, air or other modes
of transportation or supporting the foregoing. The
license expires upon the expiration of the underlying
patents protecting the technologies used in the Company's
products. The license provides for royalties to Nestor,
Inc. starting in 2000 equal to 5% of the gross margin
realized from sales or licensing of products subject to
the license, and increasing to 10% of the gross margin in
calendar years 2001 and beyond. The license requires
minimum annual royalties of $125,000 in 2001, increasing
to $1,000,000 in 2005 and beyond, in order to maintain
exclusive rights. No royalties were due or payable in
1999.
The Company uses facility and administrative services of
Nestor, Inc., including use of office space and
executive, accounting and other support personnel. The
Company reimburses Nestor, Inc. monthly for these
services at a rate of $39,913 for up to 15 Company
employees, and $47,267 for above 15 employees. These
fees will be replaced with direct expenses as the Company
obtains its own office space and develops an independent
executive and support staff. Facility and administrative
fees charged to the Company during 1999 were $479,000.
Note 10 - Commitments and contingencies:
The Company leases a sales and support office in
California under an operating lease dated July 1, 1999.
This lease provides for monthly rentals of $650, and can
be terminated upon 60 days advance notice. Total expense
under the lease for 1999 was $3,900.
On October 14, 1999, the Company entered into an
engagement letter with FAC Equities, a division of First
Albany Corporation, to provide financial advisory and
investment banking services to the Company relating to
the potential sale of additional equity securities by the
Company. The Company issued a warrant to FAC to purchase
up to 10,000 shares of the company's common stock at $.01
per share (expires October 14, 2004). If a transaction
occurs, FAC will receive a fee equal to 5% of the gross
proceeds in cash plus a warrant equal to 3% of the common
shares, or equivalents, sold in the transaction.
Exhibit 99.1
NESTOR, INC.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS UNDER THE PRIVATE
SECURITIES
LITIGATION REFORM ACT OF 1995
CERTAIN CAUTIONARY STATEMENTS AND RISK FACTORS
Nestor, Inc. and its subsidiaries (collectively, the Company)
or their representatives from time to time may make or may have
made certain forward-looking statements, whether orally or in
writing, including without limitation, any such statements made
or to be made in the Management's Discussion and Analysis
contained in its various SEC filings or orally in conferences or
teleconferences. The Company wishes to ensure that such
statements are accompanied by meaningful cautionary statements,
so as to ensure to the fullest extent possible the protections of
the safe harbor established in the Private Securities Litigation
Reform Act of 1995.
ACCORDINGLY, THE FORWARD-LOOKING STATEMENTS ARE QUALIFIED IN
THEIR ENTIRETY BY REFERENCE TO AND ARE ACCOMPANIED BY THE
FOLLOWING MEANINGFUL CAUTIONARY STATEMENTS IDENTIFYING CERTAIN
IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENTS.
This list of factors is likely not exhaustive. The Company
operates in a rapidly changing and evolving business involving
electronic commerce and payments, and new risk factors will
likely emerge. Management cannot predict all of the important
risk factors, nor can it assess the impact, if any, of such risk
factors on the Company's business or the extent to which any
factor, or combination of factors, may cause actual results to
differ materially from those in any forward-looking statements.
ACCORDINGLY, THERE CAN BE NO ASSURANCE THAT FORWARD-LOOKING
STATEMENTS WILL BE ACCURATE INDICATORS OF FUTURE ACTUAL RESULTS
AND IT IS LIKELY THAT ACTUAL RESULTS WILL DIFFER FROM RESULTS
PROJECTED IN FORWARD-LOOKING STATEMENTS. SUCH DIFFERENCES MAY BE
MATERIAL.
Nestor is dependent on its PRISM products
Nestor has derived a substantial majority of its total
revenues from licensing its PRISM family of software products and
providing services and maintenance related to those products. The
PRISM products and related services and maintenance are expected
to provide the majority of Nestor's revenues in the foreseeable
future. Nestor's results will depend upon continued market
acceptance of its PRISM products and related services as well as
Nestor's ability to continue to adapt and modify them to meet the
changing needs of its customers. Any reduction in demand for, or
increase in competition with respect to, PRISM products would
have a material adverse effect on Nestor's financial condition
and results of operations.
Nestor is subject to risks of conducting international operations
Nestor has derived a material portion of its total
revenues from sales to customers outside the United States.
International operations generally are subject to certain risks,
including:
- difficulties in staffing and management,
- reliance on independent distributors,
- fluctuations in foreign currency exchange rates,
- compliance with foreign regulatory requirements,
- variability of foreign economic conditions, and
- changing restrictions imposed by U.S. export laws.
There can be no assurance that Nestor will be able to manage the
risks related to selling its products and services in
international markets.
Nestor is dependent on the banking industry
Nestor's business is concentrated in the banking
industry, making Nestor susceptible to a downturn in that
industry. For example, a decrease in bank spending for software
and related services could result in a smaller overall market for
electronic payment software. Furthermore, banks are continuing to
consolidate, decreasing the overall potential number of buyers
for Nestor's products and services. These factors as well as
others negatively affecting the banking industry could have a
material adverse effect on Nestor's financial condition and
results of operations.
Nestor must manage its growth effectively
Nestor is experiencing a period of growth which is
placing demands on its managerial and operations resources.
Nestor's inability to manage its growth effectively or to
maintain its current level of growth could have a material
adverse effect on its financial condition and results of
operations.
Nestor may not be able to attract and retain key personnel
Nestor's success depends on certain of its executive
officers, the loss of one or more of whom could have a material
adverse effect on Nestor's financial condition and results of
operations. None of Nestor's U.S.-based executive officers is a
party to an employment agreement. Nestor believes that its future
success also depends on its ability to attract and retain highly-
skilled technical, managerial and marketing personnel, including,
in particular, additional personnel in the areas of research and
development and technical support. Competition for personnel is
intense. There can be no assurance that Nestor will be successful
in attracting and retaining the personnel it requires.
The market for software and related services is highly
competitive
Many applications software vendors offer products that
are directly competitive with PRISM and other products of Nestor.
Nestor also experiences competition from software developed
internally by potential customers and experiences competition for
its consulting services from professional services organizations.
In addition, processing companies provide services similar to
those made possible by Nestor's products. Many of Nestor's
current and potential competitors have significantly greater
financial, marketing, technical and other competitive resources
than Nestor. Current and potential competitors, including
providers of transaction-based software, processing, or
professional services, may establish cooperative relationships
with one another or with third parties to compete more
effectively against Nestor. It is also possible that new
competitors may emerge and acquire market share. In either case,
Nestor's financial condition and results of operations could be
adversely affected.
Nestor's future success depends on its ability to timely
develop and market product enhancements and new products.
The market for software in general is characterized by
rapid change in computer hardware and software technology and is
highly competitive with respect to the need for timely product
innovation and new product introductions. Nestor believes that
its future success depends upon its ability to enhance its
current applications and develop new products that address the
increasingly complex needs of customers. In particular, Nestor
believes that it must continue to respond quickly to users' needs
for additional functionality and multi-platform support. The
introduction and marketing of new or enhanced products requires
Nestor to manage the transition from current products in order to
minimize disruption in customer purchasing patterns. There can
be no assurance that Nestor will continue to be successful in the
timely development and marketing of product enhancements or new
products that respond to technological advances, that its new
products will adequately address the changing needs of the
domestic and international markets or that it will successfully
manage the transition from current products.
Nestor is continually developing new products, product
versions and individual features within a complex software
system. Development projects can be lengthy and are subject to
changing requirements, programming difficulties and unforeseen
factors which can result in delays in the introduction of new
products and features. Delays could have a material adverse
effect on Nestor's financial condition and results of operations.
In addition, new products, versions or features, when
first released by Nestor, may contain undetected errors that,
despite testing by Nestor, are discovered only after a product
has been installed and used by customers. To date, undetected
errors have not caused significant delays in product introduction
and installation or required substantial design modifications.
However, there can be no assurance that Nestor will avoid
problems of this type in the future.
Nestor is dependent on proprietary technology
Nestor relies on a combination of patents, trade secret
and copyright laws, nondisclosure and other contractual and
technical measures to protect its proprietary rights in its
products. There can be no assurance that these provisions will be
adequate to protect its proprietary rights. In addition, the laws
of certain foreign countries do not protect intellectual property
rights to the same extent as the laws of the United States.
Although Nestor believes that its intellectual property rights do
not infringe upon the proprietary rights of third parties, there
can be no assurance that third parties will not assert
infringement claims against Nestor.
Fluctuations in quarterly operating results may result in
volatility in Nestor's stock price
Nestor's quarterly revenues and operating results may
fluctuate depending on the timing of executed contracts, license
upgrades and the delivery of contracted business during the
quarter. In addition, quarterly operating results may fluctuate
due to the extent of commissions associated with third party
product sales, timing of Nestor's hiring of additional staff, new
product development and other expenses. No assurance can be given
that operating results will not vary due to these factors.
Our sales cycles vary significantly which makes it difficult to
plan our expenses and forecast our results
Nestor's sales cycles typically range from six to twelve
months, but may take longer. It is therefore difficult to
predict the quarter in which a particular sale will occur and to
plan our expenses accordingly. The period between our initial
contact with potential clients and their licensing of our
products and services varies due to several factors, including:
- the complex nature of our products and services,
- our clients' budget cycles,
- our clients' internal evaluation and approval
requirements, and
- our clients' delays of licensing due to announcements or
planned introductions of new products or services by our
competitors.
Any delay or failure to complete sales in a particular
quarter could reduce our revenue in that quarter, as well as
subsequent quarters over which revenue or the license would
likely be recognized. If our sales cycles unexpectedly lengthen
in general or for one or more large engagements, it would delay
our receipt of the related revenue. If we were to experience a
delay of several weeks or longer on a large engagement, it could
harm our ability to meet our forecasts for a given quarter.
Customers may cancel contracts
Nestor derives a substantial portion of its total
revenues from maintenance fees and monthly software license fees
pursuant to contracts which the customer has the right to cancel.
A substantial number of cancellations of these maintenance or
monthly license fee contracts would have a material adverse
effect on Nestor's financial condition and results of operations.
Nestor's stock price may be volatile
The stock market has from time to time experienced
extreme price and volume fluctuations, particularly in the high
technology sector, which have often been unrelated to the
operating performance of particular companies. Any announcement
with respect to any variance in revenue or earnings from levels
generally expected by securities analysts for a given period
could have an immediate and significant effect on the trading
price of the Class A Common Stock. In addition, factors such as
announcements of technological innovations or new products by
Nestor, its competitors or other third parties, as well as
changing market conditions in the computer software or hardware
industries, may have a significant impact on the market price of
the Class A Common Stock.
We cannot predict our future capital needs, and we may not be
able to secure additional financing in the future
We believe that our existing cash, working capital,
backlog, and line of credit will be sufficient to meet our
anticipated cash needs for working capital and capital
expenditures for at least the next 12 months. However, we may
need to raise additional funds in the future to fund our
operations, to expand or enhance our products and services or to
respond to competitive pressures or perceived opportunities.
Nestor cannot be assured that additional financing will be
available on acceptable terms, or at all. If adequate funds are
not available or not available on acceptable terms, Nestor's
business and financial results may suffer.
Nestor's growth strategy involves numerous risks and challenges
Nestor has expanded and may seek to continue to expand
its operations through the acquisition of additional businesses
that complement its core skills and have the potential to
increase its overall value. Nestor's future growth may depend, in
part, upon the continued success of its acquisition strategy.
Nestor may not be able to successfully identify and acquire, on
favorable terms, compatible businesses. Acquisitions involve many
risks, which could have a material adverse effect on Nestor's
business, financial condition and results of operations,
including:
- Acquired businesses may not achieve anticipated
revenues, earnings or cash flow;
- Integration of acquired businesses and technologies may
not be successful and Nestor may not realize anticipated
economic, operational and other benefits in a timely manner,
particularly if Nestor acquires a business in a market in
which Nestor has limited or no current expertise or with a
corporate culture different from Nestor's;
- Potential dilutive effect on Nestor's stockholders from
continued issuance of Common Stock as consideration for
acquisitions;
- Adverse effect on net income of amortization expense
related to goodwill and other intangible assets and other
acquisition-related charges, costs and expenses on net
income;
- Competing with other companies, many of which have
greater financial and other resources to acquire attractive
companies makes it more difficult to acquire suitable
companies on acceptable terms; and
- Disruption of Nestor's existing business, distraction
of management and other resources and difficulty in
maintaining Nestor's current business standards, controls
and procedures.
Directors, officers and principal shareholders exercise
significant control over the Company.
Nestor's directors, officers, and principal shareholders
who own greater than 5% of the outstanding common stock, and
entities affiliated with them, beneficially own approximately 49%
of our common stock. These shareholders, acting together, will
be able to exert substantial influence over all matter requiring
approval by Nestor's shareholders. These matters include the
election and removal of directors and any merger, consolidation
or sale of all or substantially all or Nestor's assets. This
concentration of ownership may have the effect of delaying,
deferring or preventing a change in control, or impeding a
merger, consolidation, takeover or business combination even if
the transaction might be beneficial to Nestor's shareholders.
