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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, 2000
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file Number 0-12965
NESTOR, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3163744
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(State of incorporation) (I.R.S. Employer
Identification No.)
One Richmond Square, Providence, Rhode Island 02906
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(Address of principal executive offices) (Zip Code)
(401) 331-9640
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(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
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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
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Exhibit Index is on Page: 40
The aggregate market value of the 8,044,936 shares of voting stock held by
non-affiliates of the registrant, based on the average bid and asked prices of
such stock on February 28, 2001 was $5,908,201. The number of shares outstanding
of the Registrant's Common Stock at February 28, 2001 was 17,688,449.
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
The Company designs, develops, markets, installs and supports technologies and
intelligent software solutions for decision and data-mining applications in
real-time environments. The Company products employ proprietary neural network
predictive technologies to convert existing data and business experiences into
meaningful recommendations and actions. The Company designs and develops
high-value software products that can bring additional value to customers by
utilizing its proprietary technology and information-management knowledge. 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, through license to third parties, Traffic
Management and Intelligent Character Recognition Systems.
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 discussed below, 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 products 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. These applications include PRISM Credit,
PRISM Debit, PRISM Money-Laundering and PRISM Merchant products. Products in the
Risk Management group represent approximately 94% of the Company's 2000 revenue.
Customer Relationship Management - 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.
eCLIPSE, provides a comprehensive solution for effective enterprise-wide
customer marketing. eCLIPSE 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. eCLIPSE allows for
consistent personalization across all communication channels. Campaigns can be
further enhanced by the use of the Company's proprietary models in areas such as
customer profitability, retention, and cross selling. Products in this group
represent approximately 3% of the Company's 2000 revenue.
Traffic Management - These products, developed and marketed by Nestor Traffic
Systems, Inc. ("NTS"), 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. Through an exclusive licensing agreement with NTS, a 34.6%
owned affiliate of the Company (formerly a wholly-owned subsidiary), the Company
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 NTS is now accounted for under the
equity method of accounting, it did not contribute to revenues in 2000 or 1999.
In fiscal 1998, this group represented approximately 10% of consolidated
revenues. In January 2001, an agreement in principle was reached to combine the
Company and NTS by merging NTS into a wholly-owned subsidiary of the Company,
with Nestor, Inc., in effect, becoming the surviving entity. For a detailed
description of the proposed merger, see Note 16 of the Company's financial
statements.
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 2000 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, the Company formed two wholly-owned subsidiaries: Nestor
Traffic Systems, Inc. and Nestor Interactive, Inc. ("Interactive"). NTS develops
and markets the TrafficVision, CrossingGuard, and the Rail CrossingGuard product
lines. The Company now owns a 34.6% interest in NTS and uses equity accounting
to account for the investment. As discussed above, see Note 16 of the Company's
financial statements for details of a proposed merger of NTS into the Company.
Interactive developed InterSite, an Internet personalization solution, but this
subsidiary has been inactive since November 1998.
The Company offers complete application-software solutions that include adaptive
decision models, implementation, education, training, consulting, processing and
engineering support services. Current Company 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). The Company'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 twelve
months. The Company believes that PRISM customer payback periods for license,
installation, and first year user fees are typically less than one year.
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 40
financial-services and retail clients as of December 31, 2000. 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 February 1995, the Company announced PRISM. PRISM enhanced 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 1999, 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. The Company'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. The Company'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
sales, distribution and service forces through the appointment of partners with
expertise in various product channels (i.e. telecommunications and internet
transaction processing). The Company intends to continue developing domestic
markets while augmenting its international growth. On February 1, 2001, the
Company entered into a new non-exclusive license agreement with Applied
Communications, Inc. ("ACI"), a subsidiary of Transaction Systems Architects,
Inc. Pursuant to the license agreement, ACI has been granted the right to
integrate and distribute all of the Company's PRISM and fraud detection products
throughout ACI's worldwide sales and support network. ACI made an initial
payment of $1.1 million to the Company upon execution of the agreement, and is
required to make guaranteed minimum royalty payments during the first year in an
amount of approximately $500,000. The license requires the payment of a 15%
royalty starting on February 1, 2002, but no further guaranteed minimum royalty
payments will be required. This agreement replaces the license agreement signed
with ACI on April 18, 1997. See "Certain Relationships and Related
Transactions." The Company executed a non-exclusive PRISM reseller agreement
with CSK Corporation in Japan in 1996. The Company also intends to increase
sales efforts 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 up front 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 the Company:
CampaignOne and InterSite.
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.
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.
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. The Company's FDS and
PRISM products are an outgrowth of such development projects. In the United
States and Canada, the Company markets PRISM and eCLIPSE through ACI and
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 PRISM 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 2000, ACI accounted for 65% of the Company's revenues. 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
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 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, 2000 and 1999 the Company had
a backlog of approximately $1,046,000 and $1,208,000, respectively, 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 NTS backlog
as of December 31, 1998. NTS backlog is not included in the Company's 2000 or
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). The Company, 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.
The Company 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, 2000, primarily in the area of traffic management. These
improvements are incorporated into the Company's products where applicable.
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, 2000, 1999, and 1998,
respectively, $1,247,000, $921,000, and $2,113,000, in support of the various
aspects of Company-sponsored research and development. Expenses in 1998 include
$860,000 from NTS operations which are not consolidated in 2000 and 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 seven United States patents and seven foreign patents issued in
four countries and Europe. In addition, the Company has five applications
pending in the United States, is a joint owner of one United States application
and has three foreign applications pending, as of December 31, 2000. The foreign
patents and patent applications correspond to one or more of the United States
patents.
The Company believes that seven of its United States patents, and four of the
corresponding foreign patents, are material to its and its affiliates business.
These United States patents expire at various times from 2005 to 2019. The
corresponding foreign patents expire at various times through 2007. The
following table lists the Company's material United States patents:
Patent No. Title Date of Issue Expiration
- ---------- ----- ------------- ----------
4,760,604 Parallel, Multi-unit, Adaptive, Nonlinear Pattern Class July 26, 1988 2005
Separator and Identifier
4,897,811 N-Dimensional Coulomb Neural Network Which Provides for January 30, 1990 2007
Cumulative Learning of Internal Representations
4,958,375 Parallel, Multi-unit, Adaptive Pattern Classification September 18, 1990 2007
System Using Inter-unit Correlations And An Intra-class
Separator Methodology
5,054,083 Parallel, Multi-unit, Adaptive, Nonlinear Pattern Class October 1, 1991 2008
Separator and Identifier
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
6,188,329 Integrated Traffic Light Violation Citation Generation February 13, 2001 2019
and Court Date Scheduling System
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 and others. The market for Internet- oriented personalization
products is intensely competitive with new competitors emerging frequently.
Most of the Company's competitors have significantly greater financial,
marketing and other resources than the Company. As a result, they may be able to
respond more quickly to new or emerging technologies or to devote greater
resources to the development, promotion and sale of their products than the
Company. Competitive pressures faced by the Company may materially adversely
affect its business, financial condition and results of operations.
Employees
As of December 31, 2000, the Company had forty-four full-time employees,
including twenty-three in software engineering and product development, eight in
sales and marketing and thirteen in management, finance and support. 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 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
engineering and 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 February 1, 2001, the Company entered into
a new non-exclusive license agreement with Applied Communications, Inc., a
subsidiary of Transaction Systems Architects, Inc. Pursuant to the license
agreement, ACI has been granted the right to integrate and distribute all of the
Company's PRISM and fraud detection products throughout ACI's worldwide sales
and support network. ACI will pay $1.1 million to the Company in four equal
installments over the four months following February 1, 2001, and is required to
make guaranteed minimum royalty payments during the first year in an amount of
approximately $500,000. The license requires the payment of a 15% royalty
starting on February 1, 2002, but no further guaranteed minimum royalty payments
will be required. This agreement replaces the license agreement signed with ACI
on April 18, 1997. Additionally, ACI hired twelve of the Company's engineering,
modeling, and customer support employees and assumes responsibility for product
enhancements, installation, modeling, and support for ACI licensees.
On April 18, 1997, the Company expanded its non-exclusive original 1996 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
provided a $1,000,000 Line of Credit at the prime interest rate plus 1%, which
matured on March 1, 2001. As of December 31, 2000, the Company had advances
against the line totaling $425,000. This balance is being repaid evenly over
twelve months commencing March 1, 2001.
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.
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. A portion of this facility is subleased to NTS, on a month-to-month
basis, for approximately $12,000 per month, including telephone, utilities and
other facilities related expenses.
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 violation
of Sections 1 and 2 of the Sherman Act (antitrust), violation of the Rhode
Island Antitrust Act, patent invalidity, and infringement of the Company's
patents (infringement claims withdrawn January 10, 2000). The suit seeked
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. In April 2000, HNC, ACI and its parent agreed
to dismiss the California lawsuit. ACI has requested that the Company provide
indemnification for approximately $850,000 of its legal counsel costs pursuant
to the PRISM License Agreement then in effect between ACI and the Company. The
Company is disputing the indemnification claim and does not believe it is
obligated to reimburse these costs.
On January 17, 2001, HNC and the Company agreed to settle the case. The Company
agreed to drop their claims in return for HNC agreeing not to enforce, or
threaten to enforce, the their patent against the Company or its customers.
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, 2000.
ITEM 5. Market for Registrant's Common Stock and Related
Security Holder Matters.
------------------------------------------------
The Company's common stock was first offered to the public in December 1983 and
is traded on the Nasdaq OTC Bulletin Board under the symbol "NEST."
Low Bid High Ask
------- --------
Year Ended December 31, 2000
- ----------------------------
1st Quarter 11/16 5-3/4
2nd Quarter 1-1/2 4-1/4
3rd Quarter 1-14/16 2-5/16
4th Quarter 17/64 2
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
As at February 28, 2001, the number of holders of record of the issued and
outstanding common stock of the Company was 394, which includes brokers who hold
shares for approximately 1493 beneficial holders.
The Company has not paid any cash dividends with respect to its Common Stock
since formation.
ITEM 6. Selected Financial Data.
------------------------
The following data includes the accounts of Nestor, Inc. and Interactive in 1999
and 2000 and Nestor, Inc., NTS and Interactive in prior years.
Six Months
Ended Year Ended
Years Ended December 31, December 31, June 30,
------------------------------------------------------------- ------------ -----------
2000 1999 1998 1997 1996 1996
---- ---- ---- ---- ---- ----
Operating revenue $ 3,652,422 $ 5,114,779 $ 2,241,376 $5,681,076 $1,195,904 $ 5,461,580
Operating income (loss) $(1,548,777) $ 742,451 $(5,236,975) $ (295,985) $ (919,117) $ (27,260)
Other income (expense) $ (106,675) $ (97,386) $ (26,178) $ 31,321 $ (16,220) $ 39,950
Net income (loss) $(2,994,574) $ (836,824) $(5,263,153) $ (294,664) $ (935,337) $ 12,690
Earnings per share
Weighted number of
outstanding shares -
basic and diluted 17,901,602 17,844,327 15,249,932 9,243,508 8,689,031 7,847,510
Loss per share $ (0.17) $ (0.05) $ (0.36) $ (0.08) $ (0.13) $ (0.03)
SELECTED BALANCE SHEET DATA:
Total assets $ 4,922,703 $ 6,773,905 $ 3,250,089 $2,613,031 $2,817,944 $ 3,351,871
Working capital $ (199,775) $ 1,211,257 $ 535,806 $ 146,081 $ 879,172 $ 1,983,661
Long-term
Redeemable Preferred
Stock $ -- $ -- $ -- $5,792,787 $5,398,908 $ 5,207,538
Capital leases $ -- $ -- $ -- $ 10,220 $ 9,455 $ 9,455
Deferred income $ 2,036,896 $ 1,965,532 $ 440,400 $ -- $ 430,899 $ 430,899
ITEM 7. Management's Discussion and Analysis
------------------------------------
Prospective Statements
The following discussion contains prospective statements regarding the Company,
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 $150,000 at
December 31, 2000 as compared with $1,049,000 at December 31, 1999. At December
31, 2000, the Company had a working capital deficit of $200,000, as compared
with working capital of $1,211,000 at December 31, 1999. The decrease in working
capital in 2000 reflects primarily the working capital used in operations in the
current year.
The Company had a net worth of $168,000 at December 31, 2000, as compared with a
net worth of $2,304,000 at December 31, 1999. The decrease in net worth resulted
from net operating losses realized by the Company of $1,549,000 in 2000 and the
net effect of the Company's portion of equity raised by its subsidiary, NTS,
totaling $666,000 in 2000 offset by the Company's equity portion if NTS's net
loss in 2000 of $1,339,000.
Additional capital may be required to enable the Company to carry out needed
marketing campaigns for its products, for continued development and upgrading of
its products and for customer support. On February 1, 2001, the Company entered
into a source code license agreement with Applied Communications Worldwide,
Inc., a subsidiary of Transaction Systems, Architects, Inc. ("TSAI"). The
license included an initial and guaranteed minimum fees in 2001 of $1,577,000,
and an ongoing license fee equal to 15% of future revenues. In addition, ACI
hired twelve employees of the Company thereby assuming future product
enhancement, installation, modeling, and support services. Additionally, the
Company has reached an agreement to merger with NTS by reacquiring the 65%
common stock ownership it currently does not own in exchange for shares to
Nestor, Inc., and for additional shares, convert a $4,000,000 NTS note along
with an additional $4,000,000 cash contribution from a new investor group.
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. The loan matured on
February 29, 2001, and principal payments are due in twelve equal installments
beginning March 1, 2001. Interest on the loan is equal to the effective prime
interest rate plus 1%. The outstanding principal balance on the loan was
$420,000 at December 31, 2000 and February 28, 2001 when it matured. The loan
has not been replaced by the Company.
Management believes that the Company's revenues, new license agreement and
expense reduction realized on February 1, 2001, and the proposed merger with NTS
will generate sufficient liquidity, when combined with its liquid assets as of
December 31, 2000, to meet the Company's anticipated cash requirements from
current operations through the year ending December 31, 2001. If the Company
does not realize the merger or revenues sufficient to maintain its operations at
the current level, management of the Company would modify certain initiatives
until additional funds become available through investment or revenues.
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. In April 2000, HNC, ACI and its
parent agreed to dismiss the San Diego suit. ACI has requested that the Company
provide indemnification for approximately $900,000 of its legal counsel costs
pursuant to the PRISM licensing agreement between ACI and the Company. The
Company has denied and is disputing the indemnification claim.
The Company and HNC reached a mutually agreeable settlement on January 16, 2001,
the terms of which are confidential. All claims have been dismissed. Costs
associated with the suit were being expensed as incurred, and totaled
approximately $600,000 and $356,000 in 2000 and 1999.
Future Commitments
During 2000, the Company entered into a three year operating lease for computers
and related equipment valued at $97,000. The Company has no other 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 approximately $17,000 per month and expires in March 2003. The
Company believes the facilities are adequate for its 2000 needs.
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, 2000 and 1999
In the year ended December 31, 2000, the Company realized a 40% decrease in
revenues compared to the prior calendar year. Expenses increased 19% in 2000
resulting in an operating loss of $1,549,000 when compared to an operating
profit of $742,000 in the prior year. Revenues from our distribution partners,
ACI and CSK, were down in 2000 as were revenues from direct sales efforts.
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, 2000, revenues decreased $1,463,000 to
$3,652,000 from $5,115,000 in the prior calendar year. Customers held off
committing to new software integration projects in 2000 in part resulting from
the effects of the millennium change and perceived software issues.
Software Licensing
Product-licensing revenues totaled $2,537,000 in 2000, as compared with
$3,872,000 in 1999. The decrease in these revenues reflects a decrease in
initial license fees realized from new PRISM products of $900,000 as thirteen
new license were realized in 1999 as compared to eight in 2000, and a decrease
in monthly use fees of $360,000 resulting from licenses sold or terminated that
were not fully offset by the new licenses coming on-line in 2000.
Engineering Services
Engineering revenues totaled $1,115,000 in 2000, as compared with $1,243,000 in
1999. These revenues relate to new license installations and customer-funded
modifications of the Company's PRISM products. The decrease is related to the
drop in new PRISM licenses, and the associated installation work, noted in
"Software Licensing" above, offset in part by modeling and customization work in
2000 from 1999 licenses.
Operating Expenses
Total operating expenses - consisting of engineering, research and development,
selling and marketing, and general and administrative expenses - amounted to
$5,201,000 in the year ended December 31, 2000, an increase of $829,000 over
total operating costs of $4,372,000 in the prior year.
Engineering Services
Costs related to engineering services totaled $967,000 in 2000, as compared with
$1,023,000 in 1999. The decrease in these costs reflects related decrease in
engineering revenues realized in 2000.
Research and Development
Research and development expenses totaled $1,247,000 in the year ended December
31, 2000 as compared with $921,000 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 V6.0 shipped in the
fourth quarter of 2000, development of eCLIPSE, and development of PRISM eFraud
during 2000.
Selling and Marketing
Selling and marketing costs increased $276,000 to $1,494,000 in the year ended
December 31, 2000, from $1,218,000 in the prior year. The increase in selling
costs in the year reflects, primarily, an increase in staffing for the
development and support of partner and direct customer relationships for the
licensing of the PRISM products.
General and Administrative
General and administrative expenses totaled $1,493,000 in 2000, as compared with
$1,210,000 in the previous year. General and administrative costs for the year
ended December 2000 reflect increased legal expenses related to the lawsuit
initiated against a competitor in November 1998, settled in January 2001.
Other Expense
For 2000, net other expense was $107,000, as compared with net other expense of
$97,000 in the year-earlier period. In 2000, other expense was comprised
primarily of $106,000 of amortization expense related to the assigned value of
warrants outstanding and being amortized over their remaining life.
Loss from Investment in Affiliate
During 2000, the Company's affiliate NTS sold additional common stock interests
reducing the Company's equity interest in the affiliate to 34.6%. The Company's
interests in NTS are accounted for under the equity method of accounting in 2000
and 1999. As a result of the Company's equity interest in NTS, the Company
reported a loss from investment in affiliate of $1,339,000 in 2000, representing
34.6% of NTS's actual net loss in 2000 of $3,513,000, and the Company reported
$1,482,000 in 1999, representing 49% of NTS's actual net loss in 1999 of
$2,453,000 reflecting varying ownership percentages during 1999. NTS continues
to be a development stage company, incurring costs of raising capital, research
and development, establishing supplies and production processes, and sales and
marketing. During 1998, NTS was included in the consolidated financial results
of the Company and reported a net loss of $1,934,000.
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.
Net Income
During 2000, the Company experienced a loss of $2,995,000, as compared with a
loss of $1,289,000 in the prior year. For the year ended December 31, 2000, loss
per share available for common stock was $0.17 per share, as compared with a
loss per share of $0.05 in the corresponding period of the prior fiscal year.
For the year ended December 31, 2000, there was outstanding a weighted average
of 17,901,602 shares, as compared to 17,844,327 shares in the year-earlier
period.
Analysis of the Years Ended December 31, 1999 and 1998
During 1999, NTS (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 beginning in 1999. The operating
results of the subsidiary for the year ended December 31, 1998 are still
reported on the consolidation basis of accounting. 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.
December 31,
------------------------------------
1999 1998
(As Reported) (Reclassified)
------------- --------------
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)
============== ==============
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 $1,210,000 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 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 $1,934,000.
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's PRISM product line was profitable during 1999.
The Company began development in July 1996 of products for use in Internet and
intranet environments. Costs associated with this effort totaled $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. The net investment in the NTS product line was $1,933,000 in
1998. The net investment in the PRISM product line was $1,954,000 in 1998.
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.
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 31, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures Title Date
- ---------- ----- ----
/s/Leon N Cooper Co-Chairman of the Board and Director March 31, 2001
- --------------------
/s/Charles Elbaum Co-Chairman of the Board and Director March 31, 2001
- --------------------
/s/David L. Fox President, Chief Executive Officer March 31, 2001
- -------------------- and Director
/s/Herbert S. Meeker Secretary and Director March 31, 2001
- --------------------
/s/Sam Albert Director March 31, 2001
- --------------------
/s/Thomas H. Boje Director March 31, 2001
- --------------------
/s/Jeffrey Harvey Director March 31, 2001
- --------------------
/s/Thomas F. Hill Director March 31, 2001
- --------------------
/s/Bruce Schnitzer Director March 31, 2001
- --------------------
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
FORM 10-K
---------
December 31, 2000
-----------------
NESTOR, INC. Part II
------------
Item 8
CONTENTS
Page No.
Independent Auditor's Report 20
Consolidated Balance Sheets - 21
December 31, 2000 and 1999
Consolidated Statements of Operations - 22
For the Years Ended December 31, 2000, 1999 and 1998
Consolidated Statements of Stockholders' Equity - 23
For the Years Ended December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows - 24
For the Years Ended December 31, 2000, 1999 and 1998
Notes to Consolidated Financial Statements 25
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, 2000 and 1999, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 2000. 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 2000 and 1999 financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Nestor,
Inc. at December 31, 2000 and 1999, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000 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 26, 2001
NESTOR, INC.
Consolidated Balance Sheets
---------------------------
DECEMBER 31,
ASSETS 2000 1999
---------------------------
CURRENT ASSETS:
Cash and cash equivalents ...................... $ 150,035 $ 1,048,802
Accounts receivable, net of allowance
for doubtful accounts ........................ 693,555 984,318
Unbilled contract revenue ...................... 1,260,884 1,200,484
Due from affiliate ............................. 322,952 320,459
Other current assets ........................... 91,042 161,809
------------ ------------
Total current assets ......................... 2,518,468 3,715,872
Long term unbilled contract revenue .............. 2,036,896 1,965,532
Investment in affiliate .......................... 81,100 710,690
Property and equipment at cost,
net of accumulated depreciation ................ 177,377 269,917
Deferred development costs ....................... 32,000 56,000
Patent development costs ......................... 76,862 55,894
------------ ------------
TOTAL ASSETS ..................................... $ 4,922,703 $ 6,773,905
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit ................................. $ 419,769 $ --
Accounts payable ............................... 253,696 271,397
Accrued employee compensation .................. 265,779 314,202
Accrued liabilities ............................ 472,983 547,799
Deferred income ................................ 1,306,016 1,371,217
------------ ------------
Total current liabilities .................... 2,718,243 2,504,615
NONCURRENT LIABILITIES:
Long term deferred income ...................... 2,036,896 1,965,532
------------ ------------
Total liabilities ............................ 4,755,139 4,470,147
------------ ------------
Commitments and contingencies .................. -- --
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value,
authorized 10,000,000 shares; issued and
outstanding: Series B - 235,000 shares at
December 31, 2000 and 345,000 shares at
December 31, 1999 ............................ 235,000 345,000
Common stock, $.01 par value, authorized
30,000,000 shares; issued and outstanding:
17,688,449 shares at December 31, 2000 and
17,499,327 shares at December 31, 1999 ....... 176,884 174,993
Warrants and options ........................... 843,434 736,951
Additional paid-in capital ..................... 27,434,129 26,574,123
Retained deficit ............................... (28,521,883) (25,527,309)
------------ ------------
Total stockholders' equity ................... 167,564 2,303,758
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ....... $ 4,922,703 $ 6,773,905
============ ===========
Significant related party transactions are described in Note 13.
The Notes to the Financial Statements are an integral part of this statement.
NESTOR, INC.
Consolidated Statements of Operations
-------------------------------------
YEARS ENDED DECEMBER 31,
2000 1999 1998
---------------------------------------------
Revenue (Note 13):
Software licensing ...................... $ 2,537,511 $ 3,872,016 $ 1,352,071
Engineering services .................... 1,114,911 1,242,763 746,007
Tangible product sales .................. -- -- 143,298
------------- ------------ ------------
Total revenue ........................ 3,652,422 5,114,779 2,241,376
------------- ------------ ------------
Operating expenses:
Engineering services .................... 966,681 1,023,046 2,066,558
Tangible product costs .................. -- -- 54,010
Research and development ................ 1,247,205 920,918 2,112,746
Selling and marketing ................... 1,493,968 1,218,476 1,831,697
General and administrative .............. 1,493,345 1,209,888 1,413,340
------------- ------------ ------------
Total operating expenses ............. 5,201,199 4,372,328 7,478,351
------------- ------------ ------------
Income (loss) from operations .............. (1,548,777) 742,451 (5,236,975)
Other expense - net ....................... (106,675) (97,386) (26,178)
------------- ------------ ------------
Income (loss) before income taxes
and investment loss ...................... (1,655,452) 645,065 (5,263,153)
Income taxes ............................... -- -- --
Loss from investment in affiliate .......... (1,339,122) (1,481,889) --
------------- ------------ ------------
Net loss ................................... $ (2,994,574) $ (836,824) $ (5,263,153)
============= ============ ============
Loss Per Share:
Net loss ................................... $ (2,994,574) $ (836,824) $ (5,263,153)
Dividends accrued on preferred stock ....... -- -- 151,396
------------ ------------ ------------
Net loss available for common stock ........ $ (2,994,574) $ (836,824) $ (5,414,549)
============= ============ ============
Loss per share, basic and diluted .......... $ (0.17) $ (0.05) $ (0.36)
============= ============ ============
Shares used in computing loss per share:
Basic and diluted ....................... 17,901,602 17,844,327 15,249,932
============= ============ ============
The Notes to the Financial Statements are an integral part of this statement.
Nestor, Inc.
Consolidated Statement of Stockholders' Equity
----------------------------------------------
Common Stock Preferred Stock Additional Warrants
-------------------- ---------------------- Paid-in Retained and
Shares Amount Shares Amount Capital (Deficit) Options Total
------ ------ ------ ------ ---------- --------- -------- -----
Balance at December 31, 1997 9,403,987 $ 94,040 1,615,871 $1,710,347 $12,579,920 $(19,427,332) $523,984 $(4,519,041)
Issuance of Common Stock 2,557,104 25,571 -- -- 5,060,282 -- -- 5,085,853
Conversion of Preferred Stock
to Common Stock 1,223,255 12,232 (1,223,255) (1,294,882) 1,282,650 -- -- --
Premium on Conversion of
Preferred Stock Series B
to Common Stock 19,200 192 -- -- (192) -- -- --
Dividends on Preferred Stock
Series D paid in Common Stock
and cash 8,889 89 -- (17,941) 17,827 -- -- (25)
Dividend accrued on
Preferred Stock Series D -- -- -- 8,900 (8,900) -- -- --
Repurchase of Preferred Stock
Series D -- -- (27,616) (41,424) -- -- -- (41,424)
Conversion of Redeemable
Convertible Preferred Stock
to Common Stock 4,266,892 42,669 -- -- 5,823,568 -- -- 5,866,237
Dividends accrued on
Redeemable Convertible
Preferred Stock -- -- -- -- (142,496) -- -- (142,496)
Costs incurred in connection
with Redeemable Preferred
conversion and TSAI
Common Stock purchase -- -- -- -- (108,103) -- -- (108,103)
Accretion of value of warrants -- -- -- -- -- -- 106,483 106,483
Loss for the year ended
December 31, 1998 -- -- -- -- -- (5,263,153) -- (5,263,153)
---------- -------- ---------- ----------- ----------- ------------ -------- ------------
Balance at December 31, 1998 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
December 31, 1999 -- -- -- -- -- (836,824) -- (836,824)
---------- -------- ---------- ----------- ------------ ------------ -------- -----------
Balance at December 31, 1999 17,499,327 $174,993 345,000 $ 345,000 $26,574,123 $(25,527,309) $736,951 $ 2,303,758
Issuance of Common Stock 79,122 791 -- -- 84,846 -- -- 85,637
Conversion of Preferred Stock
to Common Stock 110,000 1,100 (110,000) (110,000) 108,900 -- -- --
Issuance of equity by
subsidiary -- -- -- -- 666,260 -- -- 666,260
Accretion value of warrants -- -- -- -- -- -- 106,483 106,483
Loss for the year ended
December 31, 2000 -- -- -- -- -- (2,994,574) -- (2,994,574)
---------- -------- ---------- ----------- ------------ ------------ -------- -----------
Balance at December 31, 2000 17,688,449 $176,884 235,000 $ 235,000 $27,434,129 $(28,521,883) $843,434 $ 167,564
========== ======== ========== ========== =========== ============ ======== ===========
The Notes to the Financial Statements are an integral part of this statement.
NESTOR, INC.
Consolidated Statements of Cash Flows
-------------------------------------
YEARS ENDED DECEMBER 31,
2000 1999 1998
--------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ........................................... $ (2,994,574) $ (836,824) $ (5,263,153)
Adjustments to reconcile net loss
to net cash used by operating activities:
Write-down for impairment loss .................. -- -- 790,641
Depreciation and amortization ................... 116,540 120,257 114,810
Loss from investment in affiliate ............... 1,339,122 1,481,889 --
Expenses charged to operations relating to
options, warrants and capital transactions ..... 106,483 106,484 106,483
Changes in assets and liabilities:
(Increase) decrease in accounts receivable .... 290,763 (471,570) 44,464
(Increase) in unbilled contract revenue ........ (131,764) (2,397,648) (477,906)
(Increase) decrease in other assets ............ 70,767 (168,053) (98,649)
(Decrease) increase in accounts payable
and accrued expenses ......................... (124,624) 279,101 199,750
(Decrease) increase in deferred income ......... 6,163 2,244,213 684,304
------------- ----------- ------------
Net cash provided (used) by operating activities (1,321,124) 357,849 (3,899,256)
------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances to affiliate - net ........................ (45,764) (320,459) --
Purchase of property and equipment ................. -- (61,337) (132,209)
Patent development costs ........................... (20,968) (55,894) --
------------ ----------- ------------
Net cash used by investing activities (66,732) (437,690) (132,209)
------------ ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of obligations under capital leases ...... (16,317) (46,540) (47,246)
Proceeds from notes payable/line of credit ......... 419,769 -- 250,000
Repayment of notes payable ......................... -- -- (250,000)
Redemption of Preferred Series D Stock ............. -- -- (41,424)
Proceeds from issuance of common stock - net ....... 85,637 -- 4,977,749
Payments of dividends on preferred stock ........... -- -- (69,070)
------------ ----------- ------------
Net cash provided (used) by financing activities 489,089 (46,540) 4,820,009
------------- ----------- ------------
Net change in cash and cash equivalents ............. (898,767) (126,381) 788,544
Cash and cash equivalents - beginning of year ....... 1,048,802 1,175,183 386,639
------------ ----------- ------------
Cash and cash equivalents - end of year ............. $ 150,035 $ 1,048,802 $ 1,175,183
============ =========== ============
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid ...................................... $ 10,603 $ 13,054 $ 20,350
============ =========== ============
Income taxes paid .................................. $ -- $ -- $ 37,500
============ =========== ============
Significant non-cash transactions are described in Notes 3, 5, 7, 8 and 12
The Notes to the Financial Statements are an integral part of this statement.
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 2000 and Nestor, Inc., Nestor Traffic Systems, Inc. ("NTS") and
Nestor Interactive, Inc. ("Interactive") in 1998. NTS and Interactive were
organized effective January 1, 1997 as two wholly owned subsidiaries.
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.
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). In
accordance with Company policy, no gain was recognized on these
transactions, and the Company recorded an increase in the equity value of
its investment in affiliate. As a result of these transactions, the Company
changed from consolidation to equity accounting for its remaining interest
in NTS for the year ended December 31, 1999. In June 2000, NTS sold
additional shares of its common stock to private investors, bringing the
Company's ownership of NTS to 34.62%. As discussed in Note 16, in January
2001, an agreement in principle was reached to combine the Company and NTS
by merging NTS into a wholly-owned subsidiary of the Company with Nestor,
Inc., in effect, becoming the surviving entity.
B. CASH EQUIVALENTS
For the purpose of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with an original 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 AMORITIZATION
Depreciable assets are recorded at cost. Depreciation and amortization are
provided on the straight-line method over the estimated useful lives of the
respective assets or lease terms.
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 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. 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 is 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.
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 based upon costs incurred to date in
relation to estimated total costs.
Training revenue is recognized upon the completion of training sessions
with the customer.
H. REVENUE CONCENTRATION
The Company realizes a significant volume of business from Applied
Communications, Inc. (ACI). In 2000, 1999 and 1998, revenues from ACI
constituted 63%, 61% and 28%, respectively, of total revenues.
I. 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
result, 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.
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. 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:
December 31,
--------------------------
2000 1999
---- ----
Trade accounts receivable $ 697,700 $ 988,463
Allowance for doubtful accounts (4,145) (4,145)
--------- ---------
Accounts receivable, net of allowance
for doubtful accounts $ 693,555 $ 984,318
========= =========
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. By the end of
1997, the Company had deferred $575,000 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:
Useful Life
in Years or
December 31, Lease Term
------------------------ -----------
2000 1999
---- ----
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 1,268,855 3 - 5
---------- ----------
1,617,454 1,617,454
Less: Accumulated depreciation
and amortization 1,440,077 1,347,537
---------- ----------
$ 177,377 $ 269,917
========== ==========
Depreciation and amortization expense on the above assets of $92,540,
$96,257 and $114,810, was recorded for the years ended December 31, 2000,
1999, and 1998, respectively. Accumulated depreciation and amortization
includes $63,741, $40,963 and $18,184 of amortization related to leased
equipment under capital leases at December 31, 2000, 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. As of
December 31, 2000, $419,769 had been advanced against the loan. The Company
did not require additional advances through February 28, 2001 when the loan
matured. Principal payments are due in twelve equal monthly installments
($34,981) beginning March 1, 2001. Interest is based on the prime interest
rate plus 1% and is due quarterly in arrears. Included in accrued expenses
at December 31, 2000 is $4,296 of interest due to TSAI.
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 (Note 8). 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 $1.00 in liquidation before any distribution
is made to holders of the Common Stock. The liquidation value of Series B
Preferred was $235,000 and $345,000 at December 31, 2000 and 1999,
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, as a result, 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 accrued expenses where
approximately $36,000 remains unpaid at December 31, 2000 and 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 generally vest over three years and 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
vest over three years and are exercisable for up to ten years from the date
of grant, although most 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"). 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, 2000, 1999 and 1998:
Years Ended December 31,
------------------------------------------------------------------------------
2000 1999 1998
---- ---- ----
Weighted Weighted Weighted
Av. Ex. Av. Ex. Av. Ex.
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding beginning of year 1,628,316 $1.20 1,579,124 $1.22 2,214,000 $1.58
Granted 270,500 .94 62,500 .72 454,124 .99
Exercised 79,122 1.08 -- -- 31,250 1.09
Canceled 714,873 .99 13,308 1.08 1,057,750 1.88
--------- --------- ---------
Outstanding end of year 1,104,821 $1.28 1,628,316 $1.20 1,579,124 $1.22
========= ========= =========
Options exercisable at year end 805,928 $1.42 1,322,786 $1.24 1,102,846 $1.22
========= ========= =========
Weighted average fair value of
options granted during the year $ 0.75 $ 0.42 $ 0.71
========= ========= =========
The following table presents weighted average price and life information
about significant option groups outstanding at December 31, 2000.
Options Outstanding Options Exercisable
------------------------------------------- ---------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Averaged
Range of Outstanding Contractual Exercise Exercisable Exercisable
Exercise Prices at 12/31/00 Life (Years) Price at 12/31/00 Price
--------------- ----------- ------------ ----- ----------- -----
$ .31 15,000 3.00 $0.31 7,500 $0.31
$ .69 - $ .94 582,571 3.26 0.74 324,428 0.73
$1.38 - $1.94 283,750 2.01 1.54 274,000 1.55
$2.09 - $2.32 138,000 4.05 2.26 136,625 2.26
$2.50 - $2.91 85,500 5.08 2.69 63,375 2.75
--------- ---- ---- --------- -----
1,104,821 3.18 $1.28 805,928 $1.42
========= ==== ===== ========= =====
The following are the pro forma net loss and net loss per share for the
years ended December 31, 2000, 1999 and 1998, as if the compensation cost
for the option had been determined based on the fair value at the grant
date for grants in those periods and reflected in the financial statements:
Years Ended December 31,
---------------------------------------------
2000 1999 1998
---- ---- ----
Net loss:
As Reported $(2,994,574) $ (836,824) $(5,263,153)
Pro Forma $(2,573,487) $(1,022,488) $(4,710,218)
Net loss per share:
As Reported $ (0.17) $ (0.05) $ (0.36)
Pro Forma $ (0.14) $ (0.06) $ (0.32)
The effects on the years ended December 31, 2000, 1999 and 1998 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, 2000 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 1.009 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:
December 31,
------------------------------------
2000 1999 1998
---- ---- ----
Eligible, end of year for exercise
currently 4,999,040 5,000,580 5,000,580
========= ========= =========
Warrants issued -- -- 2,500,000
Low exercise price $ -- $ -- $ 3.00
High exercise price $ -- $ -- $ 3.00
The warrants outstanding as of December 31, 2000 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; however, upon
completion of the transactions contemplated by the merger agreement and the
secured note agreement (Note 16), the current exercise price will be
reduced in accordance with the terms and conditions of the warrant.
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 2000, 1999 and 1998.
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 and
2000 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.
Financial Traffic All
Solutions Systems Internet Other Totals
--------- ------- -------- ----- ------
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
D. Geographic Information
Revenues are attributed to countries based on the location of customers.
All long-lived assets are located in the United States.
Years Ended December 31,
----------------------------------------
2000 1999 1998
---- ---- ----
United States $2,841,558 $4,196,612 $1,918,951
Belgium 276,799 151,200 212,097
Germany -- -- 17,460
Japan 117,532 685,850 55,333
Canada 416,533 81,117 27,000
Singapore -- -- 10,535
---------- ---------- ----------
$3,652,422 $5,114,779 $2,241,376
========== ========== ==========
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. Customer A is a subsidiary of TSAI (see Notes 6, 7, 13, 15
and 16).
Years Ended December 31,
--------------------------------------
2000 1999 1998
---- ---- ----
Customer A $2,299,208 $3,106,631 $620,732
Customer B 285,834 -- --
Customer C -- 685,850 --
Customer D -- -- 445,115
Customer E -- -- 302,979
Customer F 276,799 -- --
Customer G 256,876 -- --
NOTE 10 - OTHER EXPENSE - NET:
Other income (expense) as reflected in the consolidated statements of
operations consists of the following:
Years Ended December 31,
---------------------------------------
2000 1999 1998
---- ---- ----
Interest income (expense) $ (192) $ 9,098 $ (20,350)
Expense relating to
financing operations (106,483) (106,484) (106,483)
Other - net -- -- 100,655
---------- --------- ---------
Other expense - net $(106,675) $ (97,386) $ (26,178)
========= ========= =========
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 ("FAS 109"). Under FAS 109, deferred tax assets
and liabilities are determined based on differences between the 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.
Due to operating losses throughout the reporting periods, no provision for
income taxes was made in 2000, 1999 or 1998. Significant components of the
Company's deferred tax liabilities and assets as of December 31, 2000 and
1999 are as follows:
December 31,
-----------------------------
2000 1999
---- ----
Deferred tax liabilities:
-------------------------
Property and equipment $ 3,000 $ --
Deferred development costs 13,000 22,000
----------- -----------
Total deferred tax liabilities 16,000 22,000
Deferred tax assets:
--------------------
Accounts receivable 2,000 2,000
Accrued expenses 347,000 308,000
Deferred income 35,000 32,000
Tax credits 17,000 17,000
Net operating loss 6,839,000 5,988,000
----------- -----------
Total deferred tax assets 7,240,000 6,347,000
Valuation allowance (7,224,000) (6,325,000)
----------- -----------
Net deferred tax assets 16,000 22,000
----------- -----------
Net deferred tax balance $ -- $ --
=========== ===========
In accordance with FAS 109, a valuation allowance must be established until
it is more likely than not that future benefits arising from net deferred
tax assets will be realized. 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:
Years Ended December 31,
-------------------------------------------
2000 1999 1998
---- ---- ----
Income (loss) before taxes
and investment loss $(1,655,000) $ 645,000 $(5,263,000)
=========== ========= ===========
Tax at statutory rate of 34% $ (563,000) $ 219,000 $(1,789,000)
State income tax (net of
federal benefit) (110,000) 47,000 (313,000)
Effect of permanent
differences (54,000) 36,000 101,000
Valuation allowance 727,000 (302,000) 2,001,000
------------ ---------- -----------
Income tax expense $ -- $ -- $ --
============ ========== ===========
The Company has available at December 31, 2000, $18,399,000 and $9,829,000
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 2001.
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. On June 23, 2000, NTS sold
additional shares of its common stock to private investors for $2,025,000
(450,000 shares at $4.50 per share). The investor group includes three
officers and a director of the Company and the subsidiary, who in the
aggregate, have contributed $970,085 of cash invested on the same basis as
third-party investors. As discussed in Note 16, in January 2001, an
agreement in principle was reached to combine the Company and NTS by
merging NTS into a wholly-owned subsidiary of the Company with Nestor,
Inc., in effect, becoming the surviving entity.
As a result of the 1999 transactions, the Company's interest in NTS
decreased to 41.9%, prompting the change from consolidation to equity
accounting for the year ended December 31, 1999. The Company owns 34.62% of
NTS at December 31, 2000. The investment in affiliate balances of $81,100
and $710,690 at December 31, 2000 and 1999, respectively, reflect the
Company's interest in NTS's equity.
Presented below is summarized NTS financial information at December 31,
2000 and 1999 and for the years then ended:
December 31,
------------------------------
2000 1999
---- ----
Current assets $ 466,000 $2,124,000
Noncurrent assets 694,000 298,000
Current liabilities 925,000 724,000
Stockholders' equity 234,000 1,698,000
Total revenues 873,000 167,000
Operating expenses 4,425,000 2,656,000
Net loss 3,513,000 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 was paid in January 2001. Periodically, other
advances are made by the Company to NTS primarily as a result of shared
accounts. These amounts are due as invoiced and are also included in the
due from affiliate balance. The amount due from NTS at December 31, 2000
and 1999 was $322,952 and $320,459, respectively.
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 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
beginning in 2001, increasing to $1,000,000 in 2005 and beyond, in order to
maintain exclusive rights. This license will be extinguished upon
effectiveness of the merger discussed in Note 16. The Company recorded
royalties of $9,548 for 2000 and such amount is included in due from
affiliate at December 31, 2000. No royalties were due or payable in 1999.
NTS uses facility and administrative services of the Company, including
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 moves into its own office space and
develops an independent executive and support staff. Facility and
administrative fees charged to NTS were $567,000 in 2000 and $479,000 in
1999. Included in the due from affiliate balance at December 31, 2000 is
$47,267 for December 2000 fees.
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, 2000, 1999 and 1998, the Company recorded an
expense for Baer, Marks & Upham of $4,874, $15,600 and $15,600,
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, 2000, 1999
and 1998, the Company recorded an expense for Wand Partners, Inc. of
$43,048, $41,497 and $47,770, respectively. During 1998, the Company paid
Wand Partners dividends totaling $69,046 on the redeemable preferred stock
held by Wand. Included in accrued liabilities at December 31, 2000, 1999
and 1998 are $141,243, $99,167 and $63,738, respectively, due Wand
Partners, Inc.
Thomas D. Halket, who became an officer of the Company in January 1993, was
a partner in the law firm of Hughes Hubbard & Reed LLP, which the Company
used as outside counsel. For the years ended December 31, 2000, 1999 and
1998, the Company recorded an expense for Hughes Hubbard & Reed LLP of
$35,852, $76,106 and $80,039, respectively.
During 1998, TSAI, the parent company of Applied Communications, Inc.
(ACI), became a significant shareholder of the Company (Note 7). Thomas H.
Boje, Vice President, Corporate Development of TSAI, became a director of
the Company in April 2000. For the years ended December 31, 2000, 1999 and
1998, the Company recorded revenues of $2,299,208, $3,106,631 and $620,730,
respectively from ACI. At December 31, 2000 and 1999, accounts receivable
included $639,013 and $489,494 due from ACI and unbilled were $3,184,924
and $3,141,574. Also at December 31, 2000 and 1999, deferred income
included $3,192,849 and $2,904,634 from ACI. Further related party
transactions with TSAI and ACI are discussed in Notes 6, 7, 8, 15 and 16.
See Note 12 for transactions with affiliate.
NOTE 14 - COMMITMENTS AND CONTINGENCIES:
The Company maintains 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, $195,000 and $193,953 was
charged to operations for the years ended December 31, 2000, 1999 and 1998,
respectively.
During 2000, The Company began leasing computer equipment under an
operating lease agreement. The lease provides for monthly rent payments in
arrears over a three-year term. At the end of the lease term, the Company
may purchase the equipment at fair market value, extend the lease term or
return the equipment. The value of leased equipment was $97,035 at December
31, 2000 and rent expense was $33,233 for the year.
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 are as follows:
December 31, 2001 $ 280,000
December 31, 2002 287,000
December 31, 2003 106,000
December 31, 2004 40,000
December 31, 2005 40,000
Thereafter 40,000
---------
$ 793,000
=========
NOTE 15- 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).
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. In April 2000,
HNC, ACI and its parent agreed to dismiss the lawsuit. ACI has requested
that the Company provide indemnification for approximately $900,000 of its
legal counsel costs pursuant the PRISM license agreement between ACI and
the Company. The Company is disputing the indemnification claim and
therefore, no accrual has been established.
The Company and HNC reached a mutually agreeable settlement on January 16,
2001, the terms of which are confidential. All claims have been dismissed.
Costs associated with the suit have been expensed as incurred.
NOTE 16- SUBSEQUENT EVENTS:
A. MERGER AND SECURED NOTE AGREEMENT
In January 2001, an agreement in principle was reached to combine the
Company and Nestor Traffic Systems, Inc., by merging NTS into a
wholly-owned subsidiary of the Company, with Nestor, Inc. in effect
becoming the surviving entity. The combination is subject to certain
conditions including a fairness opinion of the transaction by a qualified
investment company and approval by the shareholders of both companies.
On January 9, 2001, the Company and NTS entered into a secured note
agreement with NTS Investors, LLC (an independent investment group
("Group")). The Group loaned NTS $4,000,000 as of February 1, 2001 with
principal and interest at 8% due on December 31, 2001. The note contains
various covenants including restrictions on the use of proceeds and
payments to Nestor, Inc. It is secured by NTS assets.
Upon consummation of the combination contemplated above, the Group will
convert the note to equity and increase its total investment to $8,000,000
in exchange for approximately 16,756,000 shares (33.34%) of Nestor, Inc.
common stock, the current NTS shareholders will receive approximately
15,580,000 shares (31%) of Nestor, Inc. common stock and current Nestor,
Inc. shareholders would then own approximately 17,922,000 shares (35.66%).
If the combination is not consummated on or before December 31, 2001, the
Group may elect on or before January 31, 2002 to convert the note into NTS
common stock for up to a 25% fully diluted equity interest and reacquire up
to an additional 25% fully diluted equity interest in NTS for an additional
$4,000,000.
In the event that the combination is completed, the Group will receive the
right to acquire additional common stock at the same price at which
warrants of Nestor, Inc. are exercised so as to maintain their ownership
interest percentage. In addition, the Group will receive the option to
acquire up to 1,000,000 shares of the Company's common stock at $.75 per
share for three years as dilution protection against both the Company's and
NTS's converted employee stock options outstanding.
B. NEW ACI LICENSE AGREEMENT
On February 1, 2001, the Company entered into a license agreement with ACI
pursuant to which ACI was granted a worldwide, perpetual, non-revocable,
non-transferable and non-exclusive license in the field of use of fraud
detection (including money laundering detection) in electronic payments.
ACI may brand, customize, and extend the software products covered by the
license agreement as well as use the software programs as a development
platform to develop new functional and new end-user products or
applications subject to the terms and conditions of the license. In return,
ACI is fully responsible and liable for the provision of services to its
licensees. Nestor, Inc. had previously provided support, maintenance and
enhancements for these products.
ACI has agreed to pay initial and guaranteed minimum license fees during
the first year in the aggregate of $1,576,650 and, in addition, an ongoing
license fee of 15% for source code license rights to the software products.
The license granted to ACI is for products that presently constitute a
substantial portion of the Company's gross revenues. During 2000, the
Company recorded license fees of $1,401,305 under the previous 40% royalty
rate and $897,903 of engineeirng revenues at normal full-fee rates (Note
13). Future ACI revenues are expected to decrease significantly due to the
decrease in the royalty rate from 40% to 15% and the elimination of ACI
engineering revenues. Future expenses relating to these revenues will also
decrease because ACI has hired twelve employees from Nestor, Inc.,
effective February 1, 2001 and is reimbursing the Company $13,000 per month
for up to six months for the continued use of Nestor, Inc. facilities and
equipment prior to their office relocation. This agreement replaces the
April 28, 1998 license agreement with ACI.
NESTOR, INC. Part IV
------------
Item 14
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE Schedule II
-----------------------------------------
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Balance at Charged to Deductions Balance at
Beginning of Charged to Other from End of
Period Expense Accounts Reserve Period
------ ------- -------- ------- ------
Allowances deducted
from accounts receivable:
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
Year Ended December 31, 2000 $ 4,145 $ 62,850 $ -- $ (62,850) $ 4,145
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 and filed herewith.
21.2 Nestor Traffic Systems, Inc. audited financial statements
for the year ended December 31, 2000.
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 which 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 which 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 which is hereby incorporated by reference.
On January 18, 2001, the Corporation filed with the Securities
and Exchange Commission a current report on Form 8-K dated
January 11, 2001 which is hereby incorporated by reference.
On February 9, 2001, the Corporation filed with the Securities
and Exchange Commission a current report on Form 8-K dated
February 1, 2001 which 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.
10.37 Secured Note Agreement by and among Nestor, Inc., Nestor Traffic
Systems, Inc. and NTS Investors LLC dated January 9, 2001 and filed as
an Exhibit to the Company's Current Report on Form 8-K on January 18,
2001 is hereby incorporated by reference.
10.38 License Agreement between Nestor, Inc. and ACI Worldwide, Inc. dated
February 1, 2001, filed as an Exhibit to the Company's Current Report
on Form 8-K on February 9, 2001 is hereby incorporated by reference.
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, 2000.
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.