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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, 2003
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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.)
400 Massasoit Avenue; Suite 200, East Providence, Rhode Island 02914
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(Address of principal executive offices) (Zip Code)
(401) 434-5522
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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.
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Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
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The aggregate market value of the 4,897,156 shares of voting stock held by
non-affiliates of the registrant on June 30, 2003, based on the closing price of
such stock on June 30, 2003, was $9,794,312.
The number of shares outstanding of the Registrant's Common Stock at March 16,
2004 was 18,009,526.
DOCUMENTS INCORPORATED BY REFERENCE
Sections of Nestor, Inc.'s definitive Proxy Statement for the 2004 Annual
Meeting of Stockholders are incorporated by reference into Parts II and III of
this report.
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PART I
ITEM 1. Business
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GENERAL
Nestor, Inc., and its wholly owned subsidiary Nestor Traffic Systems, Inc.
(together the "Company"), provides traffic safety solutions and services to
states and municipalities. The Company's products combine sophisticated digital
and analog video technologies with advanced image-processing to detect and
interpret a wide range of traffic-related elements and conditions. Using the
captured video images, Nestor applies proprietary neural network predictive
models and other algorithms to convert existing data into meaningful
recommendations and actions. This advanced technology, which effectively sees
and interprets objects captured in video images, is at the core of each product
solution. These products are a combination of Nestor-developed software and
modular hardware components that provide monitoring for traffic-data collection,
control of traffic flows, enforcement and emergency response. These products are
flexible and can be configured to a wide range of road configurations, including
open roads and intersections. The Company's systems offer an array of features
and unique functionality that address critical transportation management and
traffic safety needs. The Company formerly developed and marketed products in
the fields of risk management, customer relationship management and character
recognition.
The Company is currently devoting its resources to its core product,
CrossingGuard(R), and expects that all material revenue will come from
CrossingGuard or associated products and services. Offered as part of a turnkey
system for automated red light enforcement, CrossingGuard(R) is tailored to meet
clients specific needs, including intersection analysis, hardware and software
installation, user training and support, and backroom processing. The
CrossingGuard system provides a unique combination of aboveground vehicle
detection, multiple time-synchronized videos, and a collision avoidance safety
feature.
Exclusive rights in the field of traffic-management solutions were granted
Nestor Traffic Systems, Inc. (NTS) on January 1, 1997; co-exclusive rights in
the field of Risk Management and non-exclusive rights in the field of Customer
Relationship Management Systems (CRM) are held by Applied Communications, Inc.
(ACI) and Retail Decisions, Inc. (ReD); and non-exclusive rights in the field of
Intelligent Character Recognition Systems (ICR) are held by National Computer
Systems, Inc. (NCS). IBM has non-exclusive rights to incorporate Nestor's
technology into hardware products known as the ZISC family of computer chips.
NTS is an emerging leader in providing innovative, video-based monitoring
systems and services for traffic management and safety. NTS incorporates
patented pattern-recognition technologies into intelligent, real-time solutions
that promote traffic efficiency, intersection safety, and railway grade crossing
monitoring and safety. In the past, NTS has developed and marketed
CrossingGuard(R), Rail CrossingGuard(R), and TrafficVision(R). These products
are a combination of Nestor-developed software and modular hardware components
that provide monitoring for traffic-data collection, control of traffic flows,
enforcement and emergency response. These products are flexible and can be
configured to a wide range of road configurations, including open roads and
intersections.
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts solely on its red-light video enforcement
contracts for CrossingGuard(R) installations. The Company terminated 19
full-time employees, affecting all departments, and offices were consolidated
into smaller facilities.
Information about the industry segments and geographic areas in which the
Company operates can be found in Note 11 to the financial statements included in
this report.
PRODUCTS
The Company's traffic enforcement products use high speed image processing and
target-tracking technology applied to real-time video scenes. The products use
software and video cameras to detect red light violators at signalized
intersections.
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CrossingGuard(R). CrossingGuard is an automated, video-based monitoring system
that predicts and records the occurrence of a red light violation. The software,
through a video camera, tracks vehicles approaching an intersection. Based on
the vehicle's speed, acceleration, and distance from the intersection, the
system predicts whether a red light violation will occur. If a violation is
expected to occur, the system can send a signal to the traffic controller to
request a brief extension of the red phase for cross traffic. This helps prevent
a collision between the violator and vehicles in the cross traffic accelerating
on a green signal. The system simultaneously records the violation sequence,
including a close-up of the vehicle and license plate, and transmits video
evidence electronically to the police department, which reviews the violation
and issues a citation. Citation mailing and other back-office services are
provided by the Company.
The Company provides a complete turnkey solution, offering violation review,
citation preparation and processing, billing and collection, court scheduling,
evidence, and resolution. In addition, the Company provides direct, remote, and
online equipment monitoring and maintenance primarily through its field and
office personnel and through local contractors as necessary.
The CrossingGuard system consists of a video camera installed on top of a
traffic signal pole or a roadside pole installed by the Company used to track
approaching vehicles and record the actions of an approaching violator. Another
camera is positioned so as to see the signal heads as they change from green to
yellow to red and record the vehicles actions as the lights change and it enters
the intersection. The views from these two cameras can also be presented in a
side-by-side synchronized mode to demonstrate the complete view of the
violation, including extenuating circumstances, aggressive behavior, or other
factors. Finally, an enforcement camera is positioned to obtain a close-up image
of the vehicle license plate, and where needed the driver image, based upon
vehicle location instructions provided by the tracking camera. A personal
computer is installed in an enclosure by the wayside, or remotely if a fiber
connection to the roadside is used, that runs the intelligent software and
controls camera activity. High-speed communications transmit video and data from
the intersection to a designated facility for processing. The facility is
equipped with a CrossingGuard Server PC that receives and stores violation data
and supports authorized viewing of violation video sequences.
CrossingGuard is built upon standard PC hardware and software components. This
design provides the reliability and performance benefits of improving PC
hardware and the ability to upgrade and add functionalities as needed. The
Company purchases components from third party vendors, built in accordance with
Nestor's specifications, and the systems are installed by local contractors.
CrossingGuard VIP. The CrossingGuard Video Intersection Profiling (VIP) program
is a proprietary tool that the Company has developed to help municipalities
pre-qualify intersections. Since intersection violation rates can range from an
average of a few per day to over fifty per hour, the system helps the
municipality develop an estimate of safety issues at a given intersection and
the long-term ticket volume by counting and profiling violations for all
directions at a particular intersection.
CrossingGuard Services. CrossingGuard Services is the complete package of
services and support that can be customized to a client's needs. It consists of
site planning and equipment installation, equipment maintenance, user training
and support, violation review, citation preparation and processing, fine
collection and processing, account management, toll free hotline support, public
education, and expert testimony.
The economics of the CrossingGuard product are tied to the number of violations
processed by the systems and the number of operating systems in the field. Most
contracts compensate NTS on a per ticket paid or issued basis in return for both
equipment lease, maintenance and back office services. Generally, but not in all
cases, the contracts require a monthly minimum fee designed to allow NTS to
recover the value of the system delivered, including a finance factor and
maintenance costs, over the term of the contract. During 2003, there has been a
trend by states towards fixed monthly fee as opposed to variable per ticket fee
pricing structures.
As of December 31, 2003, NTS had 90 approaches installed and generating
citations, including two pilot program approaches, and an additional 47
approaches under contract and in various stages of delivery. In March 2004, NTS
executed a new contract for up to an additional 40 approaches (20
intersections). No assurances can be given that all approaches under contract
will ultimately be installed. The Company realizes from $25 to $97 per citation
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issued or paid or fixed monthly fees ranging from $4,000 to $12,000 per approach
for system delivery and lease, maintenance, software licensing, and processing
services, depending upon state statutes regarding driver versus registered owner
liability for a violation. Driver liability statutes require the driver be
identified in the photographic evidence and the citation be sent to the
identified driver. Registered owner statutes identify the vehicles owner,
through DMV records, as the responsible party for a violation. As only the
license plate is required for identification, program operating efficiencies are
much higher resulting in lower per citation or monthly fees to cities. Current
trends in the industry are towards compensating red-light program vendors on a
fixed fee basis instead of a variable fee basis tied to ticket volumes. Actual
results from deployment of CrossingGuard systems are expected to fluctuate
substantially depending upon intersection selection and configuration, driver
response to installed systems, and many other factors. Minimum monthly fee and
fixed monthly fees would reduce the risk of fluctuations in citation capture and
issuance rates.
During 2003, NTS realized $2,677,000 in CrossingGuard related revenues, a 217%
increase over the $844,000 earned in 2002 due to the increase in installed
approaches during the respective periods.
Status of the CrossingGuard market. Ineffective red-light safety enforcement is
a costly and growing problem that until recently has been largely unaddressed by
technology solutions. There are an estimated 300,000 intersections with traffic
signals in the United States where approximately 218,000 collisions and as many
as 181,000 injuries and 880 deaths occurred as a result of red-light running as
per Federal Highway Administration 2001 statistics. First-generation Red-Light
Camera Systems gained early acceptance as a means of automated traffic
enforcement. While these systems have validated the market opportunity, they
generally continue to rely on in-ground vehicle sensors ("loops") and still
photography and have become inferior solutions because of their (i) significant
roadbed installation issues, (ii) high maintenance requirements, and (iii)
general lack of functionality.
The use of cameras to enforce red light running violations requires specific
authority at the state or local government level (state statutes or home rule
statutes). To date, approximately 15 states, including the District of Columbia,
have authorized on a full or limited basis the use of red light cameras. Recent
studies have shown these systems to be effective in reducing red light running
at enforced intersections, and a positive halo effect at surrounding unenforced
intersections. The Federal Highway Administration and other organizations have
recently acknowledged these systems as positive tools in the reduction of red
light running and correspondingly the number of accidents. However, there
remains opposition to these systems, largely based upon concerns regarding
individual privacy rights and due process rights. Many additional states and
communities have or are considering authorization of cameras but need to address
these minority concerns first. The Company believes that the overall trend is
towards expanded state authorization of camera based red light enforcement
systems, and eventually speed enforcement systems, but it is difficult to
estimate when these changes may occur. The Company also believes that business
opportunities from the currently authorized communities will be enough to
support near term growth objectives.
Rail CrossingGuard. NTS developed Rail CrossingGuard, a system to monitor
grade-crossing vehicle and train traffic, as well as signalization activity, to
provide grade-crossing-integrity measurement, real-time crossing alert
capabilities and crossing violation enforcement. This product has the potential
to enhance rail-crossing safety by improving signal and crossing gate
monitoring, alerting personnel to dangerous crossing situations, and enforcing
train and vehicle safety regulations. Rail CrossingGuard may also be integrated
with train communications systems to provide a method of alerting trains to
dangerous rail crossing conditions.
On April 1, 2001, NTS completed its first Rail CrossingGuard installation in
DuPage County, Illinois and had completed design work necessary to commence
construction on the delivery of five Rail CrossingGuard units in Florida. In
addition, NTS had received a contract from the Federal Railroad Administration
(FRA) to develop a portable Rail CrossingGuard unit for non-permanent data
gathering capabilities. Also, NTS, working with GeoFocus, Inc., a Florida
company, won a contract to expand two of the Rail CrossingGuard units in Florida
to incorporate remote communication capabilities between Rail CrossingGuard
units and train operators. During 2003, NTS realized $10,000 in Rail
CrossingGuard related revenues as compared to $426,000 in 2002. During 2002, the
Company reduced its marketing and sales efforts in this product line to focus
its resources on the CrossingGuard red-light enforcement market. The Company
does not expect to receive material revenue related to Rail CrossingGuard in the
future.
TrafficVision. TrafficVision is a product that uses video cameras to monitor
traffic flow and to send traffic data to a central Traffic Operations Center.
Replacing short-life, high-maintenance, road-embedded copper-loop technologies
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from the 1950's, TrafficVision is a non-intrusive sensor system for traffic
management. TrafficVision uses Nestor's proprietary high-speed image-processing
technology to analyze video content to sense and monitor traffic on highways,
roadways and intersections in real-time. TrafficVision recognizes and classifies
multiple vehicles continuously so that surveillance and traffic management are
based upon detailed, real-time information. TrafficVision is installed at 26
locations in Rhode Island and in the state's centralized Traffic Operations
Center in Providence. During 2002, NTS realized $187,000 in TrafficVision
related revenues and no such revenues in 2003. During 2002, the Company reduced
its marketing and sales efforts in this product line to focus its resources on
the CrossingGuard red-light enforcement market. The Company does not expect to
receive material revenue related to TrafficVision in the future.
The following are the primary attributes of NTS products and services:
Accurate, real-time interpretation of traffic video images. NTS has applied
Nestor's high-speed pattern-recognition technologies in real-time processing and
video-image interpretation for traffic management, enforcement and safety. Prior
industry attempts to provide video-based detection of traffic have not proven
effective due to the difficulty of designing robust detection algorithms under a
variety of illumination, visibility and traffic conditions, as well as the need
to implement such algorithms on cost-effective computing platforms that provide
real-time operation. Nestor's image-understanding technology is able to
interpret video images accurately and respond in a real-time environment at
affordable cost.
Vehicle trajectory analysis for real-time forecasting. As each frame in a video
sequence is interpreted, the individual objects in the scene are identified and
located. This information, passed from frame to frame, enables accurate tracing
of vehicles' trajectories. Unlike competitive vision systems, which note
changing images in a fixed and static area of the image (so-called virtual
loops), NTS's proprietary vehicle-centric technology can use the trajectories to
predict vehicle positions. In the CrossingGuard application, when a vehicle is
about to run a red light, a signal can then be sent to the traffic controller to
extend the all-red phase of the traffic signal so that cross traffic vehicles
can be briefly delayed before they proceed into the intersection. Thus,
intersections equipped with CrossingGuard have the potential to become smarter
and safer.
Compatibility with industry standard platforms. NTS traffic monitoring solutions
are built upon dominant industry-standard platforms: namely, Microsoft Windows
operating systems, tools and communication components and general "WinTel"
hardware specifications. This facilitates integration into a customer's existing
computing environment, leverages PC economics to offer a compelling
price/performance advantage and lowers product engineering development costs.
Additionally, the traffic monitoring systems are designed to support the
emerging NTCIP communications standards being mandated in the traffic industry.
Further, roadside detector stations will be compatible with existing and new
traffic controller hardware, such as the CALTRANS 2070 controller standard.
Description of other products and services:
In 2001, Nestor ceased direct product development, sales and support in the
fields of fraud detection, financial risk management, and CRM. The Company does
not expect to receive material revenue related to fraud detection, financial
risk management, or CRM in the future. Through license agreements entered into
with ACI on February 1, 2001, and with ReD on May 18, 2001, co-exclusive
development, sales and support rights were granted to these resellers in fraud
and risk management; and non-exclusive rights in the field of CRM were granted
to ReD. In addition, all expenses associated with development, support and
selling these products were transferred to these parties.
Nestor's PRISM(R) fraud detection solutions help financial institutions detect
and prevent fraudulent payments, manage merchant risks and identify illicit
account usage (money laundering). The fraud detection products are used by many
of the world's largest financial institutions and represented approximately 31%
and 87% of Nestor's 2002 and 2001 revenues, respectively. Effective July 1,
2002, the Company assigned its ACI royalty rights (Note 13) and no longer
receives product royalties.
Nestor's ICR applications increase productivity in document image-processing
applications. Royalties from the ICR business represented less than 1% of
Nestor's 2003 and 2002 revenues.
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Nestor's technology is licensed to IBM on a non-exclusive basis for
incorporation into hardware products known as the ZISC family of computer chips.
Royalties from the IBM business represented less than 1% of Nestor's 2003 and
2002 revenues.
Sales, Marketing and Methods of Distribution
The Company distributes and markets its intelligent traffic-management solution
(ITS) software and services in North America through a direct sales
organization. The Company distributed its other software solutions in North
America and throughout the world through third- party licensing and distribution
agreements.
Currently, the Company markets its products and services to municipalities,
governmental traffic management departments, or their integrators through its
Providence and San Diego based two-person direct sales force. Since the traffic
products require technical assistance during the sales and installation
processes, the Company also maintains an in-house staff of four program managers
and eight engineers. The Company obtains product inquiries from product
mailings, attendance at trade shows, trade press coverage and its Internet site.
Most CrossingGuard contracts are obtained through competitive proposal processes
in response to RFP's issued by municipalities.
The Company's Intelligent Character Recognition products are marketed by NCS.
The Company's PRISM and eCLIPSE products are licensed through two distributors,
Applied Communications, Inc. (ACI) and Retail Decisions, Inc., primarily to
financial institutions. Effective with the sale of the future royalty revenues
due from the ACI license to Churchill Lane Associates, LLC (CLA) on September
30, 2002, no future revenues related to the PRISM business are expected to be
realized by the Company.
During 2002, ACI accounted for 31% of the Company's revenues. During 2002, Other
Income of $2,812,000 was recorded as a result of the sale of the ACI royalty
rights to CLA. No such revenues were recorded in 2003
Pattern-Recognition Technology
The Company's technology deals with the problem of pattern recognition within
complex data. When presented with complex high-volume data, it can be valuable
to identify target patterns of information often hidden in that data, whether
patterns of fraudulent credit card use, customer buying behavior, handwritten
characters, objects in a video stream, 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 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. 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.
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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 additional patent applications
pending as of December 31, 2003, primarily in the area of traffic management,
enforcement and safety.
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 $121,000, $1,604,000 and $1,641,000 in the years ended
December 31, 2003, 2002 and 2001 respectively, in support of the various aspects
of Company-sponsored research and development.
PATENTS
The Company has continually sought and obtained patent protection for its
proprietary neural networks and other systems, which have as a principal feature
rapid learning from a relatively small number of examples or the application of
video techniques in traffic management applications. The Company's RCE neural
network exhibits rapid learning and minimizes the internal connections needed
for it's 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.
During 2003, the Company received two additional patents relative to the
CrossingGuard product line. The first issued in June 2003 recognizes the
Company's method of predicting and recording a red light violation with a
video-based system including the use of violation probability scores. The second
patent issued in November 2003 defines a system and method of detecting and
filtering non-violations in a traffic light enforcement system employing a video
camera to improve the effectiveness of the system.
During 2002, the Company received two additional patents relative to the
CrossingGuard product line. The first patent recognizes the Company's invention
of providing for a collision avoidance feature in a video-based red light
enforcement system. The second patent recognizes the invention of a video-based
red light enforcement system integrating a client management system integrated
with a court scheduling system for ticket processing and issuance.
The Company owns 10 United States patents and 5 foreign patents issued in four
countries, Australia and Europe. The foreign patents correspond to one or more
of the United States patents. The United States patents expire at various times
from 2006 to 2021.
COMPETITION
The Company believes that CrossingGuard is more technologically advanced than
most competing systems for traffic safety enforcement. Its competition generally
consists of "wet film" or digital still image red light camera systems. These
systems generally rely on in-ground sensor loops and wet film, or on digital
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still cameras that record only a few frames of evidence regarding a violation.
For wet film systems, there is the added burden of retrieving, replacing,
developing, and scanning the film. By the end of 2003, most competitors have
developed digital still systems and do not promote wet film applications. The
Company is aware of two competitors that have included video cameras in their
systems. The Company has initiated patent infringement lawsuits against these
competitors on the basis of its February 13, 2001 patent entitled "Integrated
Traffic light Violation Citation Generation and Court Date Scheduling System".
See "Item 3 -- Legal Proceedings." There can be no assurance that the Company
will be successful in defending this patent and limiting the use of video by
competitors in the U.S. red light enforcement market.
CrossingGuard vehicle detection cameras, on the other hand, are installed above
the ground, on roadside poles or if needed, mast arms. (This helps avoid some of
the logistical problems associated with installing in-ground sensors at an
intersection.) In case of a dispute, unlike non-video systems, the violation
video sequence has the ability to provide an instant replay of the event. Its
digital video evidence consists of both front and rear vehicle images and is
viewed by the police who then issue (or give authorization to issue) a citation.
This ensures fairness so that violations may not be issued out of context (e.g.,
if the violation occurred to make way for an emergency vehicle, as part of a
funeral procession, or to avoid a crash). This perception of fairness makes the
Company's video evidence attractive to city councils, law enforcement officials,
courts, and the general public.
NTS's largest competitors in the intersection market are Affiliated Computer
Services, Inc. (ACS), which has the greatest number of red-light camera systems
installed, and Redflex Traffic Systems, Inc. (Redflex). Among others are Laser
Craft, Mulvihill ICS, Peek Traffic, Poltech, Traffipax, Transol, and Transcore.
Although these companies use buried loops, still or digital cameras and/or wet
film systems, some may pose a competitive threat due to their size, market
share, legacy customer relationships, enhanced driver image, additional products
offered, and/or citation-processing experience.
NTS's TrafficVision and Rail products face competition primarily from
traffic-management-systems companies such as ISS, Econolite, Traficon, Iteris,
Peek Traffic, Odetics, Computer Recognition Systems, Siemens, Sumitomo, and
Rockwell International. Management believes that the platforms on which these
products operate do not provide the image processing capabilities possessed by
TrafficVision and Rail CrossingGuard. However, the Company is not currently
investing substantial finances in the development, marketing or sales of these
product lines.
Most of the Company's competitors in the ITS market 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.
CONTRACTS WITH GOVERNMENTAL ENTITIES
NTS's CrossingGuard agreements are generally service contracts with states or
municipalities that in most circumstances may be cancelled by the customer for
various reasons including non-appropriation of annual program funding. As these
contracts are generally self-funded from ticket fees collected from red-light
violators and some contracts contain termination fee provisions, NTS does not
expect this to be a significant risk in the future. NTS's Rail CrossingGuard and
TrafficVision contracts were generally fixed-fee deliverable contracts and
termination rights were generally limited to non-performance conditions. NTS
retains all patent and other proprietary rights from products developed and
delivered under government-supported contracts.
EMPLOYEES
As of December 31, 2003, the Company had 49 full-time employees, including 11 in
software engineering and product development, 11 in processing and system
support, 17 in program management and field services, 3 in sales and marketing
and seven in management, finance and office support. 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.
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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. 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 has been 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 entered 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 paid $1.1 million to the Company in four equal
installments over the four months following February 1, 2001, and was 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. The Company
sold the royalty rights to CLA on July 1, 2002. The Company does not expect to
receive future revenues from this license.
Retail Decisions, Inc. (ReD) On May 18, 2001, Nestor entered into a license
agreement with Retail Decisions, Inc. in which Nestor granted to ReD: (i) an
exclusive (other than ACI), perpetual, fully-paid, worldwide license in the
field of use of fraud and money laundering detection and risk management in
certain defined industries; and (ii) a non-exclusive, perpetual, fully-paid,
worldwide license solely for use in the field of use of customer relationship
management in certain defined industries. Additionally, Nestor transferred to
ReD certain assets that were supportive of the technology licensed thereunder.
The assets transferred to ReD by Nestor include all of the right, title and
interest of Nestor in certain equipment, license agreements (excluding ACI) and
trademark rights. To support its newly acquired license, ReD hired 13 of
Nestor's employees. ReD paid $1,800,000 to Nestor under the license agreement,
and Nestor agreed, for certain marketing and transition services, to pay to ReD:
(i) $500,000 which was paid on July 2, 2001; (ii) $250,000 which was paid on
October 1, 2001; and (iii) $218,000 which was paid on December 31, 2001. The
Company recorded $832,000 as net license revenue in the second quarter in
connection with this agreement. No ongoing revenues are expected to be realized
from ReD.
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.
Nestor receives approximately $25,000 in minimum royalties per year under this
license.
ITEM 2. Properties.
----------
In 2000, NTS entered into a five-year lease for offices providing 9,600 square
feet for approximately $10,800 per month located at 400 Massasoit Avenue, East
Providence, Rhode Island 02914. NTS also maintains a local field office at 737
Pearl Street, La Jolla, CA 92037 on a month-to-month lease dated August 2002,
and pays approximately $1,500 per month. NTS also maintains a local field office
at 330 East Orangethorpe Ave. in Placentia, CA on a twenty-four month lease
dated March 2004, and pays approximately $1,400 per month. The Company believes
10
these facilities are adequate to meet its current needs and will require
additional space as new installations increase processing and support hiring
needs.
In April 2001, NTS entered into a forty-six month sublease for its California
operations at 10145 Pacific Heights Blvd., San Diego, CA 92121 providing for
approximately 5,700 square feet for $12,050 per month. As a result of the
Company's reorganization in early 2002, NTS could no longer use the amount of
space leased. Due to past due lease payments, the landlord terminated the lease
and notified NTS to leave the premises, which NTS did in early August 2002. The
Company is carrying a reorganization reserve related to projected costs of
settling this lease obligation, and reached a settlement with the landlord under
terms within the reserve established.
ITEM 3. Legal Proceedings.
-----------------
On November 6, 2003, the Company filed a complaint in the United States District
Court for Rhode Island against Redflex Traffic Systems, Inc., alleging that
Redflex's automated red light enforcement systems infringe the Company's patent.
Redflex denies this allegation. On November 25, 2003, the Company filed a
complaint in the United States District Court for the District of Central
California against Transol USA, Inc., alleging that Transol's automated red
light enforcement systems infringe the Company's patent. Transol has
counterclaimed that Nestor's patent is invalid and that Transol does not
infringe on it. Nestor was denied a preliminary injunction in the Transol
litigation. The Company cannot give assurance that we will be successful in
either action.
During April 2003, the former president of NTS resigned as a member of the board
of directors of the Company. The president's employment with the Company and NTS
terminated. The president filed a complaint against the Company and NTS in the
Providence Superior Court seeking severance benefits, including twelve months
salary of $180,000, upon termination. See Form 8-K dated April 9, 2003 for
further information. The parties reached a mutually agreeable settlement on
December 31, 2003, the terms of which are confidential. All claims have been
dismissed.
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, 2003.
11
PART II
ITEM 5. Market for Registrant's Common Stock and Related Stockholder 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 "NESO." The prices
below have been adjusted to reflect the 1 for 10 reverse stock split during the
second quarter of 2003. Before the stock split, the Company's common stock
traded under the symbol "NEST."
Low High
--- ----
Year Ended December 31, 2003
- ----------------------------
1st Quarter $ .30 $ 1.90
2nd Quarter $ .80 $ 2.60
3rd Quarter $ 1.30 $ 2.05
4th Quarter $ 1.60 $ 4.90
Year Ended December 31, 2002
- ----------------------------
1st Quarter $ 4.50 $10.30
2nd Quarter $ 1.80 $ 5.80
3rd Quarter $ .80 $ 2.80
4th Quarter $ .20 $ 1.00
Holders of Common Stock
At March 18, 2004, the number of holders of record of the issued and outstanding
common stock of the Company was 483, which includes brokers who hold shares for
approximately 1,555 beneficial holders.
Dividend Policy
The Company has not paid any cash dividends with respect to its common stock
since formation and does not expect to pay cash dividends in the foreseeable
future.
Securities Authorized for Issuance Under Equity Compensation Plans
Incorporated by reference from the Company's definitive proxy or information
statement to be filed with the Securities and Exchange Commission not later than
120 days following the end of the Company's fiscal year.
Recent Sales of Unregistered Securities
On December 31, 2003, the Company exercised its option to satisfy its
obligations to Silver Star Partners I, LLC under a $2,000,000 principal amount
convertible note by issuing 676,384 shares of the Company's common stock at a
conversion price of $3.00 per share.
The Company issued 2,843,000 shares of its common stock in January 2004 in a
series of private placements made to accredited investors, at an aggregate price
of $8,529,000. In connection with those private placements, the Company paid an
aggregate sales commission of $682,320. The shares of common stock were issued
without registration under the Securities Act in reliance on the exemption
provided by Section 4(2) of the Securities Act.
On January 14, 2004, the Company issued to Laurus Master Fund Ltd. ("Laurus") a
Convertible Note (the "Note") in the principal amount of $1,500,000 that bears
interest at the prime rate plus 1.25% (subject to a floor of 5.25% per year) and
12
matures on January 14, 2006. The Note may be repaid at the Company's option, in
cash or, subject to certain limitations, through the issuance of shares of
common stock. The Company will have an option to pay the monthly amortized
amount in shares at the fixed conversion price of $3.50 per share if the shares
are registered with the Securities and Exchange Commission ("SEC") for public
resale and the then current market price is 120% above the fixed conversion
price. The Note includes a right of conversion in favor of Laurus. If Laurus
exercises its conversion right at any time or from time to time at or prior to
maturity, the Note will be convertible into shares of the Company's common stock
at a fixed conversion price, subject to adjustments for stock splits,
combinations and dividends and for shares of common stock issued for less than
the fixed conversion price (unless exempted pursuant to the Company's agreement
with Laurus). In conjunction with this transaction, Sage Investments, Inc. will
be paid a fee of $60,000. The Company has agreed to file a registration
statement with the SEC to register the public resale by Laurus of the common
stock to be issued upon conversion of the Note. The Note was issued without
registration under the Securities Act in reliance on the exemption provided by
Section 4(2) of the Securities Act.
ITEM 6. Selected Financial Data.
-----------------------
The following data includes the accounts of Nestor, Inc. for all periods
presented and NTS for the period September 13, 2001 through December 31, 2001
and the years 2003 and 2002. (From January 1, 1999 through September 12, 2001,
the Company's investment in NTS was recorded on the equity method.)
Years Ended December 31,
----------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Revenue $ 2,705,534 $ 2,121,574 $ 3,520,924 $ 3,652,422 $ 5,114,779
Operating income (loss) $ (4,261,045) $ (15,127,235) $ (1,297,145) $ (1,548,777) $ 742,451
Contract termination reserve $ (125,000) $ --- $ --- $ --- $ ---
Gain on royalty assignment $ --- $ 2,811,590 $ --- $ --- $ ---
Other expense $ (504,413) $ (318,618) $ (186,809) $ (106,675) $ (97,386)
Net loss $ (4,890,458) $ (12,634,263) $ (1,565,054) $ (2,994,574) $ (836,824)
Earnings per share
Weighted number of
outstanding shares -
basic and diluted 12,964,498 5,047,611 2,881,877 1,790,160 1,784,433
Loss per share $ (0.38) $ (2.50) $ (0.54) $ (1.67) $ (0.49)
SELECTED BALANCE SHEET DATA:
Total assets $ 16,299,434 $ 9,200,964 $ 22,035,420 $ 4,922,703 $ 6,773,905
Working capital (deficit) $ 3,294,231 $ (1,572,209) $ 1,775,401 $ (199,775) $ 1,211,257
Long-term
Note and lease obligations $ 3,322,384 $ 2,849,126 $ 2,409,202 $ --- $ ---
Deferred income $ --- $ --- $ 421,399 $ 2,036,896 $ 1,965,532
(Note: Earnings per share information as previously reported at December 31, 2002 has been adjusted to a post-reverse split basis.)
13
ITEM 7. Management's Discussion and Analysis
------------------------------------
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The following discussion includes "forward-looking statements" within the
meaning of Section 21E of the Securities and Exchange Act of 1934, and is
subject to the safe harbor created by that section. Forward-looking statements
give our current expectations or forecasts of future events. All statements,
other than statements of historical facts, included or incorporated in this
report regarding our strategy, future operations, financial position, future
revenues, projected costs, prospects, plans and objectives of management are
forward-looking statements. The words "anticipates," "believes," "estimates,"
"expects," "intends," "may," "plans," "projects," "will," "would" and similar
expressions are intended to identify forward-looking statements, although not
all forward-looking statements contain these identifying words. Factors that
could cause results to differ materially from those projected in the
forward-looking statements are set forth in this section and in Exhibit 99.1.
The following discussion should also be read in conjunction with the
Consolidated Financial Statements and accompanying Notes thereto.
Readers are cautioned not to place undue reliance on these prospective
statements, which speak only as of the date of this report. The Company
undertakes no obligation to revise any forward-looking statements in order to
reflect events or circumstances that may subsequently arise. Readers are urged
to carefully review and consider the various disclosures made by the Company in
this report and in the Company's other reports filed with the Securities and
Exchange Commission.
EXECUTIVE SUMMARY
The Company considers following areas to be of highest importance in 2003 and
2004:
o During 2003 through January 2004, the Company raised $15.7 million in
financing. This was critical to the continuance of operations in early
2003 and the Company's ability to support construction on its 2003
customer contract backlog. Expensive debt obligations were eliminated
in January 2004 and the Company has both cash and available financing
to support anticipated 2004 business expansion.
o The Company has completed the transition from several lines of
business including financial services/PRISM, Rail and TrafficVision
which generated the majority of revenue in 2001 and 2002, to
intelligent traffic management products and services, primarily
red-light enforcement services and products, as the on-going operating
focus of the Company. The Company's leading product is its
CrossingGuard video-based red light enforcement system.
o Revenues are not yet sufficient to support operating expenses. The
Company needs to install additional CrossingGuard approaches and is
currently retrofitting some operating approaches to improve
performance. Over the past year, the Company more than doubled the
number of operating red-light enforcement approaches to 88 at December
31, 2003. Additional approaches to contribute to 2004 revenue are
expected to come from existing customer contracts which have not been
fully built out, the recently announced Delaware Department of
Transportation statewide contract and new customers to be signed.
o Over the past years, the Company has devoted substantial resources to
the development of its patented technology and it will vigorously
contest infringement thereon. In November 2003, the Company filed
complaints in United States District Courts against two of its
competitors, alleging that their automated red light enforcement
systems infringe upon the Company's patent. Further details are
discussed in the Liquidity and Capital Resources and Results of
Operations sections below.
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Working Capital
The Company had cash and short-term investments of approximately $5,410,000 at
December 31, 2003 as compared with approximately $309,000 at December 31, 2002.
At December 31, 2003, the Company had working capital of $3,294,000, as compared
with a working capital deficit of $1,572,000 at December 31, 2002. The increase
in cash and working capital in 2003 substantially relates to private placement
common stock sold at year-end.
14
In January 2004, the Company received $3.4 million in additional proceeds on the
remaining private placement offering, $2.2 million of which was used to settle
the remaining lease obligation to Electronic Data Systems Corporation (EDS). The
EDS settlement resulted in a gain on early extinguishment of debt of $681,000
and eliminated the 12% interest obligation.
Also in January 2004, the Company satisfied its obligations on a July 2003 $2
million Laurus Master Fund, Ltd. (Laurus) convertible note by issuing 492,904
shares of Nestor common stock and repaying the note balance, accrued interest
and prepayment penalty. On the same date, Laurus entered into a new $1.5 million
note ("second Laurus note"). While Nestor received $98,000 as a net result of
these transactions, the more beneficial change was increasing the fixed
conversion price, as defined in the notes, from $1.55 per share in the first
note to $3.50 in the new note.
The Company had a net worth of $9,662,000 at December 31, 2003, as compared with
a net worth of $3,865,000 at December 31, 2002. The increase in net worth
resulted primarily from the equity financing activities vigorously pursued
during the year, resulting in over $10 million being raised, offset by the
consolidated net loss. Silver Star Partners I, LLC (SSP) invested $4.2 million
through April 2003 and, on December 31, 2003, the Company converted an October
2003 $2 million note payable to SSP into common stock. Also in December 2003,
the Company raised $4.4 million from a private placement offering. See Note 9
for additional information.
Future Commitments
During 2003, the Company acquired additional property and leased equipment
(primarily computers and related equipment) at a cost of $86,000, and invested
$2,341,000 in capitalized systems. At December 31, 2003, Nestor recorded its
investments in computers and related equipment (net of depreciation) at
$385,000, and in capitalized systems (net of depreciation) at $3,515,000.
Management expects that NTS will make future commitments for the purchase of
additional computers and related computing equipment, for furniture and
fixtures, for delivery of capitalized systems, for consulting and for
promotional and marketing expenses.
As discussed above, the Laurus note payable and the EDS lease payable presented
on the December 31, 2003 balance sheet were satisfied in January 2004. The
second Laurus note calls for principal repayments to commence May 2004 with
$375,000 due in 2004, $1,012,500 due in 2005 and $112,500 due in January 2006
before maturity.
The Company does not generally grant payment terms to customers in excess of 90
days.
After satisfying the initial Laurus note payable and the EDS lease payable in
January 2004, the Company's future contractual obligations (assuming Laurus does
not exercise its conversion rights) and other commitments are as follows:
Contractual Obligations and Commercial Commitments:
Payment Due Date
----------------------------------------------------
Total < 1 Year 1-3 Years 3-5 Years Thereafter
----- -------- --------- --------- ----------
Second Laurus note $1,500,000 $375,000 $1,125,000 $ --- $ ---
payable
Operating leases $ 221,000 $137,000 $ 84,000 $ --- $ ---
Inflation
Management believes that the rate of inflation in recent years has not had a
material effect on the Company's operations.
15
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Nestor's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require the
Company to make estimates and assumptions (see Note 2 to the Consolidated
Financial Statements). The Company believes that of its significant accounting
policies (see Note 2 to the Consolidated Financial Statements), the following
may involve a higher degree of judgment and complexity.
Revenue Recognition
The Company's CrossingGuard product generates lease and service fee revenue
generally tied to the number of citations issued to red-light violators. Under
the terms of several current contracts, the Company cannot bill the municipality
until the court has collected the citation fine. On these contracts, management
estimates the percentage of citations that are expected to be collectible and
recognizes revenue accordingly. To the extent these estimates are not accurate,
the Company's operating results may be significantly and negatively affected.
This will have less impact on the Company going forward as new contracts do not
have this provision and are trending towards fixed fee terms.
In arrangements, some of which include software, or where software services are
deemed essential, revenue is recognized using contract accounting. This
methodology involves a percentage-of-completion approach, based on
progress-to-completion measures on estimated total costs. If the Company does
not accurately estimate these total costs, or the projects are not properly
managed to planned periods and expectations, then future margins may be
significantly and negatively affected or losses on existing contracts may need
to be recognized.
Long Term Asset Impairment
In assessing the recoverability of the Company's long term assets, management
must make assumptions regarding estimated future cash flows and other factors to
determine the fair value. If these estimates change in the future, the Company
may be required to record impairment charges that were not previously recorded
pursuant to Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" and SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets".
RESULTS OF OPERATIONS
During 2003, the Company completed the transition from several lines of business
including financial services/PRISM, Rail and TrafficVision which generated the
majority of revenue in 2001 and 2002, to red-light enforcement services and
products as the on-going operating focus of the Company. The Company's leading
product is its CrossingGuard video-based red light enforcement system and
services, and future growth will be tied to the increase in the number of
CrossingGuard approaches installed and operational. In 2002 and 2001, the
Company reorganized by (i) eliminating direct investment in its financial
services/Risk Management products, transferring all contracts through license
and/or assignment to other parties and (ii) through a further operations
reduction, restructured the Company to focus primarily on its CrossingGuard
product.
ANALYSIS OF THE THREE-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
In the quarter ended December 31, 2003, the Company realized a 236% ($788,000)
increase in revenues and 142% ($1,379,000) increase in operating expenses
compared to the prior year, same quarter. After consideration of $340,000 of
increased other expenses in 2003, the Company reported a net loss of $1,592,000
compared to $662,000 in the prior year fourth quarter. The revenue and expense
increases relate primarily to having more than double the number of installed
operational approaches in the current year fourth quarter compared to the prior
year fourth quarter. Additionally, operating expenses include $225,000 relating
to financing activities and $130,000 of patent lawsuit expenses in the current
year quarter. Other expense in the fourth quarter of 2003 included the write off
of the unamortized discount on the first Laurus note and EDS interest expense,
both of which did not occur in the prior year fourth quarter.
16
Revenues
- --------
The Company's revenues arose from CrossingGuard lease and service fees. During
the quarter ended December 31, 2003, revenues increased $788,000 to $1,122,000
from $334,000 in the prior year fourth quarter. The Company had 48 additional
installed approaches in the current year fourth quarter compared to the prior
year fourth quarter. At December 31, 2003, the Company had 88 installed
operational approaches.
Operating Expenses
- ------------------
Total operating expenses amounted to $2,353,000 in the quarter ended December
31, 2003, an increase of $1,379,000 as compared to total operating costs of
$974,000 in the prior year same quarter.
Cost of Goods Sold
Cost of goods sold (CGS) totaled $940,000 in the fourth quarter of 2003 as
compared to $97,000 in 2002. The 2003 CGS relates to amortization, maintenance
and processing costs to support 88 approaches compared to only 40 in the fourth
quarter of 2002. The 2003 quarter also includes a $417,000 net reclassification
of all 2003 citation processing costs from engineering and operations as
previously presented to CGS. Citation processing costs were not material in the
2002 quarter and were not reclassified to conform to the 2003 presentation.
Additionally, the fourth quarter of 2002 included a $102,000 reversal of EDS
processing costs which was not repeated in 2003.
Engineering and Operations
Costs related to engineering and operations totaled $419,000 in the fourth
quarter of 2003, as compared with $596,000 in 2002. These costs include the
salaries of field and office personnel as well as operating expenses related to
product design, delivery, configuration, maintenance and service. Increases in
headcount, travel and supplies generated $206,000 of additional costs in the
2003 quarter but were offset by a $417,000 net reclassification of all 2003
citation processing costs to CGS in fourth quarter 2003. Citation processing
costs were not material to 2002 engineering and operations and were not
reclassified to conform to the 2003 presentation.
Research and Development
Research and development expenses totaled $29,000 in the quarter ended December
31, 2003 as compared with $31,000 in the previous year's quarter. The Company
continues its R&D activities, as deemed necessary.
Selling and Marketing
Selling and marketing costs were $87,000 in the quarter ended December 31, 2003,
and $89,000 in the previous year's quarter. Sales and marketing efforts had been
limited recently due to cash constraints but are expected to increase in 2004.
General and Administrative
General and administrative expenses totaled $876,000 in the fourth quarter of
2003, as compared with $160,000 in the previous year's quarter. These costs were
unusually high in the current year quarter due to (i) $225,000 of Laurus and
Silver Star deferred financing fees being expensed in connection with note
redemptions/conversions, (ii) $130,000 of patent lawsuit defense expenses and
(iii) $84,000 of bad debt expense. Additionally, the fourth quarter of 2002
included a reversal of $113,000 of Wand Partners, Inc. fees in connection with a
Termination and Release Agreement.
Other Expense
For the fourth quarter 2003, net other expense was $362,000 as compared with net
other expense of $22,000 in the quarter-earlier period. In 2003, other expense
was primarily interest of (i) $169,000 relative to the write off of the
17
unamortized discount on the first Laurus note and $59,000 of other Laurus
interest, (ii) $89,000 to EDS. Both periods included warrant amortization
expense of $26,000.
Net Loss
- --------
During the fourth quarter 2003, the Company experienced a loss of $1,592,000, as
compared with a loss of $662,000 in the previous year's quarter. For the quarter
ended December 31, 2003, loss per share available for common stock was $0.11 per
share, as compared with a loss per share of $0.13 in the corresponding period of
the prior year. The weighted average shares outstanding were 13,987,905 for the
quarter ended December 31, 2003 and 5,047,611 for the quarter ended December 31,
2002.
ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2003 AND 2002
For the year ended December 31, 2003, the Company experienced a 28% ($584,000)
increase in revenues compared to the prior calendar year. Operating expenses
decreased 60% ($10,282,000) in 2003. After consideration of the $2,812,000 gain
on royalty assignment in 2002 and $311,000 of increased other expenses in 2003,
the Company reported a net loss of $4,890,000 in 2003 compared to a loss of
$12,634,000 in the prior year. Many significant changes occurred during these
two years as more fully described below.
Revenues
- --------
The Company's revenues arose from royalties and product sales, lease and service
fees as discussed separately below. During the year ended December 31, 2003,
revenues increased $584,000 to $2,706,000 from $2,122,000 in the prior calendar
year. CrossingGuard accounted for 40% of 2002 revenues and substantially all
2003 revenues.
Ongoing revenues from the risk management product line continued under the ACI
distributor agreement until July 2002 when it was assigned to CLA.
Product Royalties
Product royalties totaled $29,000 in 2003, as compared with $664,000 in 2002.
The Company continued to receive royalties from ACI until July 1, 2002 when
these royalty rights were assigned to Churchill Lane Associates, LLC. Residual
royalty streams from two customers account for 2003 royalty revenues.
Product Sales, Lease and Service Fees
Product sales, lease and service fee revenues from the traffic business totaled
$2,677,000 in 2003, as compared with $1,457,000 in 2002, due primarily to the
installed base of approaches more than doubling from December 31, 2002 to
December 31, 2003. Revenue in 2002 was comprised of $844,000 in CrossingGuard
video-based traffic enforcement, $387,000 in Rail business and $187,000 in
TrafficVision business, whereas 2003 revenue was substantially all
CrossingGuard.
CrossingGuard construction started slowly in Q1 '03 but by the end of Q2, there
were 20 additional approaches installed, followed by 12 and 16 more in Q3 and
Q4, respectively, to total 88 live approaches by the end of 2003. Construction
is not expected to continue at this pace in 2004 unless new contracts are
signed. During March 2004, the Company installed three new approaches under its
contract with the Delaware Department of Transportation. The Company is
currently retrofitting some operating approaches to improve performance and is
working with its customers to complete build outs of remaining approaches
committed under existing contracts.
Operating Expenses
- ------------------
Total operating expenses amounted to $6,967,000 in the year ended December 31,
2003, a decrease of $10,282,000 over total operating costs of $17,249,000 in the
prior year. The 2002 expenses include $743,000 in restructuring costs and
$9,294,000 of impairment charges. Excluding restructuring and impairment
18
charges, operating expenses in 2002 were $7,212,000. The most significant
changes in 2003 were $414,000 of increased amortization on live approaches,
$240,000 of increased financing fees and $130,000 of patent lawsuit defense
expenses; offset by $538,000 of CGS expense pertaining to discontinued product
lines (Rail, TrafficVision) and pilot programs.
Costs of Goods Sold
Cost of goods sold totaled $1,791,000 in 2003 as compared to $1,476,000 in the
prior year. CGS includes amortization, maintenance and processing costs related
to revenues recorded in the respective periods. Fiscal year 2002 includes
$289,000 (Rail), $138,000 (TrafficVision) and $111,000 (pilot program) CGS which
did not recur in 2003 but were offset by a $414,000 current year increase in
system amortization due to the increased number of installed approaches and a
$417,000 net reclassification of 2003 citation processing costs from engineering
and operations as previously presented to CGS. Additionally, 2002 included a
$102,000 reversal of EDS processing costs which was not repeated in 2003.
Engineering and Operations
Costs related to engineering and operations totaled $2,578,000 in 2003, as
compared with $2,070,000 in 2002. These costs include the salaries of field and
office personnel as well as operating expenses related to product design,
delivery, configuration, maintenance and service. The increase in these costs
reflects the addition of NTS expenses both internally and field-based, to
support the growing installed customer base. Staff realignments from R & D were
necessary to assist in engineering efforts. Also, $417,000 of net citation
processing costs were reclassified to CGS in fourth quarter 2003. Citation
processing costs were not material to 2002 engineering and operations and were
not reclassified to conform to the 2003 presentation.
Research and Development
Research and development expenses totaled $121,000 in the year ended December
31, 2003 as compared with $1,604,000 in the prior year. R & D efforts had been
significant to roll out the Rail and CrossingGuard products, which occurred in
2002. In March 2002, management took steps to reduce the heavy use of third
party contractors to support development projects (consulting costs decreased by
$183,000 in 2003) and also made staff realignments to assist engineering with
the increased customer base. Although the June 2002 restructuring further
contributed to a $361,000 reduction in salaries, talent and capacity remain for
research and development, as management deems appropriate.
Selling and Marketing
Selling and marketing costs decreased $253,000 to $355,000 in the year ended
December 31, 2003, from $608,000 in the prior year. The decrease in selling
costs in the year reflects, primarily, the re-focus of strategy to one product
line, which lowered salaries and collateral costs. Sales and marketing efforts
had been limited recently due to cash constraints but are expected to increase
in 2004.
General and Administrative
General and administrative expenses totaled $2,121,000 in 2003, as compared with
$1,453,000 in the previous year. The increase is the net result of (i) $240,000
of financing fees in conjunction with the July 2003 Laurus and the October 2003
Silver Star notes, (ii) $130,000 of legal expenses on patent lawsuit defense,
(iii) $102,000 in general legal expenses, (iv) $84,000 of bad debt expense and
(v) the 2002 reversal of $113,000 of Wand Partners, Inc. fees in conjunction
with a Termination and Release Agreement.
Restructuring Costs
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts solely on its red-light video enforcement
contracts for CrossingGuard installations. The Company terminated 19 full-time
employees, affecting all departments, and offices were consolidated into smaller
facilities. During the quarter ended June 30, 2002, the Company recorded
19
restructuring costs of $743,000 primarily comprised of $332,000 in employee
severance agreements and estimated lease obligations associated with closing its
Providence, RI and San Diego, CA offices. A settlement was reached in 2002 in
connection with the Providence office lease and in 2003 in connection with the
San Diego office lease.
Capitalized Systems Costs Impairment
During the quarter ended June 30, 2002, the Company determined that potential
citation revenues from certain CrossingGuard installations in two cities would
not exceed the cost of the underlying carrying value of the capitalized systems.
These contracts were signed in the early stages of CrossingGuard development and
the site selection procedures and contract terms have since been improved. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company wrote off capitalized systems costs of $794,000
and recorded a corresponding impairment charge in operating expenses. Ongoing
revenues from these installations are expected to offset future costs of system
operations.
Goodwill Impairment Loss
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." Under SFAS No. 142, the Company will test goodwill for
impairment on an annual basis, or whenever indicators of impairment are
identified. The Company completed the transitional impairment test of goodwill
during the quarter ended June 30, 2002 and concluded that no impairment existed
on January 1, 2002, when the standard was adopted. Management considers the
Company's quoted stock price to be the best indicator of fair value for purposes
of performing these analyses.
Based on the decline of the Company's stock price during the second and third
quarters of 2002, however, the fair value was recomputed using the quoted
quarter-end stock prices. Such computations resulted in goodwill impairment
charges of $3,000,000 and $5,500,000 recorded as operating expenses during the
respective 2002 quarters. The Company continues to monitor goodwill for
potential impairment.
Gain on Royalty Assignment
On July 15, 2002, the Company entered into a Memorandum of Understanding ("MOU")
with Churchill Lane Associates, LLC ("CLA"), assigning CLA certain of the
Company's rights to royalty income under the license agreement between the
Company and ACI ("ACI License"). CLA is owned and controlled by Alan M. Wiener,
Alvin J. Siteman and Robert M. Carroll, former directors and shareholders of the
Company. The MOU also provided a schedule for advances by CLA to provide interim
financing to the Company during the period prior to the closing. Upon closing on
September 30, 2002, CLA paid the Company $3.1 million in cash (less advances)
for the irrevocable assignment of its royalty rights under the ACI License from
July 1, 2002 and in perpetuity. No obligations or other rights of the Company
were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000 of ACI
deferred income and $60,000 in related professional fees, the Company recorded a
$2,812,000 gain on this royalty assignment on September 30, 2002. The
elimination of ACI unbilled contract revenue and deferred income were recorded
as non-cash reductions.
Contract Termination Reserve
A significant customer contract in the Rail line of business may be terminated
by mutual agreement prior to its completion as a result of the Company's
decision to focus its resources on CrossingGuard systems and services. The
Company accrued $125,000 of estimated contract termination fees in June 2003.
20
Other Expense
- -------------
For 2003, net other expense was $504,000; as compared with net other expense of
$319,000 in the year-earlier period. In 2003, other expense included interest
expense of $470,000 as compared to $217,000 in 2002, 2003 also included a
$64,000 favorable settlement with a vendor and both years included $106,000 of
amortization expense related to the assigned value of warrants outstanding and
being amortized over their remaining life. Interest expense was high in 2003 due
to the $169,000 write off of the unamortized discount on the first Laurus note
and $59,000 of other Laurus interest.
Net Loss
- --------
During 2003, the Company experienced a loss of $4,890,000, as compared with a
loss of $12,634,000 in the prior year. For the year ended December 31, 2003,
loss per share was $0.38 per share, as compared with a loss per share of $2.50
in the corresponding period of the prior fiscal year. For the year ended
December 31, 2003, there was outstanding a weighted average of 12,964,498
shares, as compared to 5,047,611 shares in the year-earlier period.
ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2002 AND 2001
In the year ended December 31, 2002, the Company experienced a 40% decrease in
revenues compared to the prior calendar year. Operating expenses increased 258%
in 2002 resulting in a loss of $12,634,000 as compared to a loss of $1,565,000
in the prior year.
Revenues
- --------
The Company's revenues arose from royalties and product sales, lease and service
fees as discussed separately below. During the year ended December 31, 2002,
revenues decreased $1,399,000 to $2,122,000 from $3,521,000 in the prior
calendar year. The Company granted source-code distribution rights to two
companies in 2001 for up-front source-code license fees and, from ACI, ongoing
royalties of equal to 15% of future revenues realized from the licensed
software. Beginning in the fourth quarter of 2001, the Company's revenues were
generated primarily from sales, support, and services provided regarding its
intelligent traffic management product line. Ongoing revenues from the risk
management product line continued under the ACI agreement until July 2002 when
it was assigned to CLA.
Product Royalties
Product royalty revenues totaled $664,000 in 2002, as compared with $2,997,000
in 2001. The Company realized net ReD license revenues of $832,000 in the second
quarter of 2001, and $1,104,000 from the ACI license in the first quarter of
2001. The Company continued to receive royalties from ACI until July 1, 2002
when these royalty rights were assigned to CLA
Product Sales, Lease and Service Fees
Product sales, lease and service fee revenues from the traffic business totaled
$1,457,000 in 2002, as compared with $524,000 in 2001, which included only
post-merger revenues.
Operating Expenses
- ------------------
Total operating expenses amounted to $17,249,000 in the year ended December 31,
2002, an increase of $12,431,000 over total operating costs of $4,818,000 in the
prior year. The 2001 operating expenses reflect risk management operations that
were transferred to ACI and ReD in 2001 whereas the 2002 expenses reflect
current traffic management operations, which include $743,000 in restructuring
costs and $9,294,000 of impairment charges. Excluding restructuring and
impairment charges, operating expenses in 2002 were $7,212,000.
21
Costs of Goods Sold
Cost of goods sold totaled $1,476,000 in 2002 as compared to $692,000 in the
prior year, which included only post September 12, 2001 expenses. CGS includes
third party goods and services related to revenues recorded in the respective
periods and is high in proportion to revenues realized due to (i) rail projects
completed in the first quarter of 2002 that carried higher equipment and
construction costs than prior experience as NTS acted as prime contractor on
these construction related projects, and (ii) our back-office processing
agreement with EDS required a monthly minimum fee that was proportionately high
in relation to actual ticket volumes generated. In July 2002 a letter agreement
was reached and finalized in January 2003 to eliminate the monthly minimum fee,
reducing the per-ticket processing fees charged retroactive to January 1, 2002.
In December 2002, NTS recorded a $102,000 reduction in CGS in connection with
the modified terms. NTS performs these services internally as of March 31, 2003.
Additionally, in the quarter ended September 30, 2002, NTS reclassified
customer-related telecommunications expenses from various operating expenses to
CGS, effective October 1, 2001.
Engineering Services
Costs related to engineering services totaled $2,070,000 in 2002, as compared
with $509,000 in 2001. The increase reflects the addition of NTS engineering
expenses effective with the merger completed September 12, 2001.
Research and Development
Research and development expenses totaled $1,604,000 in the year ended December
31, 2002 as compared with $1,623,000 in the prior year. The increase in such
costs reflects the net increased investment in the NTS products included in the
consolidated expenses after the merger completed on September 12, 2001, offset
by the transfer of PRISM research and development activity to ACI and ReD during
early 2001.
Selling and Marketing
Selling and marketing costs decreased $171,000 to $608,000 in the year ended
December 31, 2002, from $779,000 in the prior year. The decrease in selling
costs in the year reflects, primarily, the transfer of sales and marketing
activity for the PRISM product to ACI and ReD during early 2001.
General and Administrative
General and administrative expenses totaled $1,453,000 in 2002, as compared with
$1,214,000 in the previous year. The increase is the net result of a full year
of combined Nestor and NTS expense in 2002, offset in part by the 2002 reversal
of $113,000 of Wand Partners, Inc. fees in connection with a Termination and
Release Agreement and reduced payroll expenses after the June 2002
restructuring.
Restructuring Costs
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts solely on its red-light video enforcement
contracts for CrossingGuard installations. The Company terminated 19 full-time
employees, affecting all departments, and offices were consolidated into smaller
facilities. During the quarter ended June 30, 2002, the Company recorded
restructuring costs of $743,000 primarily comprised of $332,000 in employee
severance agreements and estimated lease obligations associated with closing its
Providence, RI and San Diego, CA offices. A settlement was reached in 2002 in
connection with the Providence office lease and in 2003 in connection with the
San Diego office.
Capitalized Systems Costs Impairment
During the quarter ended June 30, 2002, the Company determined that potential
citation revenues from certain CrossingGuard installations in two cities would
not exceed the cost of the underlying carrying value of the capitalized systems.
These contracts were signed in the early stages of CrossingGuard development and
22
the site selection procedures and contract terms have since been improved. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company wrote off capitalized systems cost of $794,000
and recorded a corresponding impairment charge in operating expenses. Ongoing
revenues from these installations are expected to offset future costs of system
operations.
Goodwill Impairment Loss
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." Under SFAS No. 142, the Company will test goodwill for
impairment on an annual basis, or whenever indicators of impairment are
identified. The Company completed the transitional impairment test of goodwill
during the quarter ended June 30, 2002 and concluded that no impairment existed
on January 1, 2002, when the standard was adopted. Management considers the
Company's quoted stock price to be the best indicator of fair value for purposes
of performing these analyses.
Based on the decline of the Company's stock price during the second and third
quarters of 2002, however, the fair value was recomputed using the quoted
quarter-end stock prices. Such computations resulted in goodwill impairment
charges of $3,000,000 and $5,500,000 recorded as operating expenses during the
respective 2002 quarters. The Company continues to monitor goodwill for
potential impairment.
Gain on Royalty Assignment
On July 15, 2002, the Company entered into a Memorandum of Understanding ("MOU")
with Churchill Lane Associates, LLC ("CLA"), assigning CLA certain of the
Company's rights to royalty income under the license agreement between the
Company and ACI ("ACI License"). CLA is owned and controlled by Alan M. Wiener,
Alvin J. Siteman and Robert M. Carroll, former directors and shareholders of the
Company. The MOU also provided a schedule for advances by CLA to provide interim
financing to the Company during the period prior to the closing. Upon closing on
September 30, 2002, CLA paid the Company $3.1 million in cash (less advances)
for the irrevocable assignment of its royalty rights under the ACI License from
July 1, 2002 and in perpetuity. No obligations or other rights of the Company
were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000 of ACI
deferred income and $60,000 in related professional fees, the Company recorded a
$2,812,000 gain on this royalty assignment on September 30, 2002. The
elimination of ACI unbilled contract revenue and deferred income were recorded
as non-cash reductions.
Other Expense
- -------------
For 2002, net other expense was $319,000 as compared with net other expense of
$187,000 in the year-earlier period. In 2002, other expense included interest
expense of $217,000 as compared to $65,000 in 2001, and both years included
$106,000 of amortization expense related to the assigned value of warrants
outstanding and being amortized over their remaining life. Interest expense was
higher in 2002 in comparison to 2001 as 2001 only included three and one-half
months of NTS interest expense.
Loss from Investment in Affiliate
- ---------------------------------
The pre-merger loss from investment in affiliate recorded in 2001 of $81,100
reflected Nestor's portion of NTS losses realized under the equity method of
accounting prior to the merger, and limited by Nestor's net investment in the
subsidiary as of December 31, 2000. Effective as of the merger, NTS operating
results are included in the consolidated financial statements.
Net Loss
- --------
During 2002, the Company experienced a loss of $12,634,000, as compared with a
loss of $1,565,000 in the prior year. For the year ended December 31, 2002, loss
per share was $2.50 per share, as compared with a loss per share of $0.54 in the
corresponding period of the prior fiscal year. For the year ended December 31,
23
2002, there was outstanding a weighted average of 5,047,611 shares (post reverse
split), as compared to 2,881,877 shares in the year-earlier period.
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk.
---------------------------------------------------------
The Company has long term obligations, however the interest rate is fixed. The
Company also has a convertible note payable at prime plus 1.25% through its
January 2006 maturity. The Company does not hedge against this exposure.
Management assesses their exposure to these risks as immaterial.
ITEM 8. Financial Statements and Supplementary Data.
-------------------------------------------
See annexed financial statements.
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
------------------------------------------------------------------
On January 6, 2003, the Company filed with the Securities and Exchange
Commission a current report on Form 8-K dated January 2, 2003 to disclose the
change in Certifying Accountants. Ernst & Young LLP audited the Company's
financial statements for the year ended December 31, 2001. Their opinion on the
2001 financial statements did not contain an adverse opinion or disclaimer of
opinion nor was it qualified or modified as to uncertainty, audit scope or
accounting principles except that it included a paragraph indicating that there
was substantial doubt about the Company's ability to continue as a going
concern. There have been no disagreements with Ernst & Young LLP relating to any
matters of accounting principles or practices, financial statements, disclosures
or auditing scope or procedures for the year ended December 31, 2001, which
disagreements, if not resolved to the satisfaction of Ernst & Young LLP, would
have caused it to make a reference to the subject matter of the disagreement(s),
in connection with its report. During the year ended December 31, 2001 and the
subsequent period preceding Ernst & Young's resignation, no event occurred that
is required to be disclosed pursuant to paragraph (a)(1)(v) of Item 304 of
Regulation S-K.
On January 2, 2003, the Company's Audit Committee of the Board of Directors
engaged the independent accounting firm, Carlin, Charron & Rosen LLP, 50
Exchange Terrace, Providence, Rhode Island 02903, a member of the Securities and
Exchange Commission practice section of the AICPA, to audit the fiscal year
ended December 31, 2002. During the fiscal year ended December 31, 2002 or any
subsequent interim period prior to engaging Carlin, Charron & Rosen LLP, the
Company did not consult Carlin, Charron & Rosen LLP regarding the application of
accounting principles to a specific transaction or with respect to the type of
audit opinion that might be rendered on the Company's financial statements or
any matter to be disclosed pursuant to paragraph (a)(2) of Item 304 of
Regulations S-K.
ITEM 9A. Controls and Procedures.
-----------------------
Nestor, Inc. management, including the Chief Executive Officer and Chief
Financial Officer, conducted an evaluation of the effectiveness of the design
and operation of the Company's disclosure controls and procedures as defined in
Exchange Act Rule 13a-15(e) and 15d-15(e) as of December 31, 2003. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective as of
December 31, 2003. There have been no significant changes in internal controls,
or in factors that could significantly affect internal controls, subsequent to
the date the Chief Executive Officer and Chief Financial Officer completed their
evaluation.
24
PART II
ITEM 8.
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
FORM 10-K
---------
December 31, 2003
-----------------
25
NESTOR, INC.
------------
CONTENTS
--------
Page No.
--------
Independent Auditors' Reports 27
Consolidated Balance Sheets -
December 31, 2003 and 2002 29
Consolidated Statements of Operations -
For the Years Ended December 31, 2003, 2002 and 2001 30
Consolidated Statements of Stockholders' Equity -
For the Years Ended December 31, 2003, 2002 and 2001 31
Consolidated Statements of Cash Flows -
For the Years Ended December 31, 2003, 2002 and 2001 32
Notes to Consolidated Financial Statements 33
26
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
of Nestor, Inc.
East Providence, Rhode Island
We have audited the accompanying consolidated balance sheets of Nestor, Inc. as
of December 31, 2003 and 2002, and the related consolidated statements of
operations, stockholders' equity and cash flows for the years then ended. Our
audit also included the financial statement schedule for the years ended
December 31, 2003 and 2002 listed in the index at Item 15(a)(2). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audit.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 2003 and 2002 financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Nestor,
Inc. at December 31, 2003 and 2002 and the consolidated results of its
operations and its cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America. 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.
/s/Carlin, Charron & Rosen, LLP
Providence, Rhode Island
March 16, 2004
27
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
of Nestor, Inc.
We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows for the year ended December 31, 2001. Our
audit also included the financial statement schedule listed for the year ended
December 31, 2001 in the index at Item 15(a)(2). These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of Nestor, Inc.'s operations and
its cash flows for the year ended December 31, 2001 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.
The accompanying financial statements have been prepared assuming that Nestor,
Inc. will continue as a going concern. As discussed in Note 1, the Company is
currently expending cash in excess of cash generated from operations, as
revenues are not yet sufficient to support operations and the Company has
incurred significant losses. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are discussed in Note 1. The financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
/s/Ernst & Young LLP
Providence, Rhode Island
February 26, 2002
28
NESTOR, INC.
Consolidated Balance Sheets
---------------------------
DECEMBER 31,
ASSETS 2003 2002
---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 5,410,123 $ 308,894
Accounts receivable, net of allowance for doubtful accounts 521,872 141,263
Unbilled contract revenue 158,952 122,684
Inventory 442,298 281,108
Other current assets 75,791 60,963
------------- -------------
Total current assets 6,609,036 914,912
NONCURRENT ASSETS:
Capitalized system costs, net of accumulated depreciation 3,514,908 1,936,783
Property and equipment, net of accumulated depreciation 385,165 486,740
Goodwill 5,580,684 5,580,684
Patent development costs, net of accumulated amortization 175,216 153,275
Other long term assets 34,425 128,570
------------- -------------
TOTAL ASSETS $ 16,299,434 $ 9,200,964
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Note payable $ 884,750 $ ---
Accounts payable 468,289 616,878
Accrued employee compensation 386,652 354,269
Accrued liabilities 765,676 795,749
Leases payable 662,541 354,286
Restructuring reserve 146,897 365,939
------------- -------------
Total current liabilities 3,314,805 2,487,121
NONCURRENT LIABILITIES:
Long term note payable 1,030,000 ---
Long term leases payable 2,292,384 2,849,126
------------- -------------
Total liabilities 6,637,189 5,336,247
------------- -------------
Commitments and contingencies --- ---
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value, authorized 10,000,000 shares;
issued and outstanding: Series B - 190,000 shares at
December 31, 2003 and 235,000 shares at December 31, 2002 190,000 235,000
Common stock, $.01 par value, authorized 20,000,000 shares;
issued and outstanding: 13,997,238 shares at December 31, 2003
and 5,024,111 shares at December 31, 2002 139,972 50,241
Warrants 1,377,251 1,072,825
Additional paid-in capital 49,230,803 45,227,851
Stock pending issuance 6,335,877 ---
Accumulated deficit (47,611,658) (42,721,200)
------------- -------------
Total stockholders' equity 9,662,245 3,864,717
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 16,299,434 $ 9,200,964
============= =============
See Independent Auditors' Reports and Notes to the Financial Statements.
29
NESTOR, INC.
Consolidated Statements of Operations
-------------------------------------
YEARS ENDED DECEMBER 31,
2003 2002 2001
-------------------------------------------------------
Revenue:
Product royalties $ 28,555 $ 664,401 $ 2,996,550
Product sales, lease and service fees 2,676,979 1,457,173 524,374
------------- ------------- -------------
Total revenue 2,705,534 2,121,574 3,520,924
------------- ------------- -------------
Operating expenses:
Cost of goods sold 1,791,203 1,475,945 692,418
Engineering and operations 2,578,056 2,070,476 508,955
Research and development 121,350 1,604,159 1,623,182
Selling and marketing 354,847 607,901 779,389
General and administrative 2,121,123 1,453,342 1,214,125
Restructuring costs --- 742,705 ---
Capitalized system costs impairment --- 794,281 ---
Goodwill impairment loss --- 8,500,000 ---
------------- ------------- -------------
Total operating expenses 6,966,579 17,248,809 4,818,069
------------- ------------- -------------
Loss from operations (4,261,045) (15,127,235) (1,297,145)
Contract termination reserve (125,000) --- ---
Gain on royalty assignment --- 2,811,590 ---
Other expense - net (504,413) (318,618) (186,809)
------------- ------------- -------------
Loss before investment loss (4,890,458) (12,634,263) (1,483,954)
Loss from investment in affiliate --- --- (81,100)
------------- ------------- --------------
Net loss $ (4,890,458) $ (12,634,263) $ (1,565,054)
============= ============= =============
Loss Per Share:
Loss per share, basic and diluted $ (0.38) $ (2.50) $ (0.54)
============= ============= =============
Shares used in computing loss per share:
Basic and diluted 12,964,498 5,047,611 2,881,877
============= ============= =============
See Independent Auditors' Reports and Notes to the Financial Statements.
30
Nestor, Inc.
Consolidated Statements of Stockholders' Equity
For the Years Ended December 31, 2003, 2002 and 2001
Preferred Stock Common Stock Additional Stock
------------------ -------------------- Paid in Pending Accumulated
Shares Amount Shares Amount Warrants Capital Issuance Deficit Total
------ ------ ------ ------ -------- ------- --------- --------- -----
Balance at
Dec. 31, 2000 235,000 $235,000 1,768,845 $ 17,688 $ 843,434 $27,593,325 $ --- $(28,521,883) $ 167,564
Issuance of
Common Stock --- --- 3,233,856 32,339 --- 17,490,520 --- --- 17,522,859
Accretion value
of warrants --- --- --- --- 106,484 --- --- --- 106,484
Variable
warrants --- --- --- --- 1,662,450 (1,662,450) --- --- ---
Options
exercised --- --- 21,410 214 --- 160,430 --- --- 160,644
Loss for the
year ended
Dec. 31, 2001 --- --- --- --- --- --- --- (1,565,054) (1,565,054)
-------- -------- ---------- --------- ---------- ----------- ---------- ------------ -----------
Balance at
Dec. 31, 2001 235,000 $235,000 5,024,111 $ 50,241 $2,612,368 $43,581,825 --- $(30,086,937) $16,392,497
Accretion value
of warrants --- --- --- --- 106,483 --- --- --- 106,483
Variable
warrants --- --- --- --- (1,646,026) 1,646,026 --- --- ---
Loss for the
year ended
Dec. 31, 2002 --- --- --- --- --- --- --- (12,634,263) (12,634,263)
-------- -------- ---------- --------- ---------- ----------- ---------- ------------ -----------
Balance at
Dec. 31, 2002 235,000 $235,000 5,024,111 $ 50,241 $1,072,825 $45,227,851 --- $(42,721,200) $ 3,864,717
Issuance of
Common Stock --- --- 8,968,627 89,686 --- 3,997,561 --- --- 4,087,247
Conversion
of Preferred
Stock to
Common Stock (45,000) (45,000) 4,500 45 --- 44,955 --- --- ---
Stock issuance
outstanding --- --- --- --- --- --- 6,335,877 --- 6,335,877
Issuance of
warrants --- --- --- --- --- 158,378 --- --- 158,378
Accretion value
of warrants --- --- --- --- 106,484 --- --- --- 106,484
Variable
warrants --- --- --- --- 197,942 (197,942) --- --- ---
Loss for the
year ended
Dec. 31, 2003 --- --- --- --- --- --- --- (4,890,458) (4,890,458)
-------- -------- ---------- --------- ---------- ----------- ---------- ------------ -----------
Balance at
Dec. 31, 2003 190,000 $190,000 13,997,238 $139,972 $1,377,251 $49,230,803 $6,335,877 $(47,611,658) $ 9,662,245
======== ======== ========== ======== ========== =========== ========== ============ ===========
See Independent Auditors' Reports and Notes to the Financial Statements.
31
NESTOR, INC.
Consolidated Statements of Cash Flows
-------------------------------------
YEARS ENDED DECEMBER 31,
2003 2002 2001
-----------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,890,458) $ (12,634,263) $ (1,565,054)
Adjustments to reconcile net loss
to net cash used by operating activities:
Depreciation and amortization 1,012,123 601,938 239,178
Loss on disposal of fixed assets 5,291 17,402 66,666
Loss from investment in affiliate --- --- 81,100
Goodwill impairment loss --- 8,500,000 ---
Capitalized system costs impairment --- 794,281 ---
Gain on royalty assignment --- (2,811,590) ---
Expenses charged to operations relating to
options, warrants and capital transactions 264,862 106,483 106,484
Increase (decrease) in cash arising from
changes in assets and liabilities:
Restricted cash --- 943,926 (943,926)
Accounts receivable - net (380,609) 16,943 702,114
Unbilled contract revenue (36,268) 32,841 384,068
Inventory (178,210) 46,447 126,801
Other assets 83,041 108,740 55,208
Accounts payable and accrued expenses (117,129) (257,207) (277,278)
Deferred income --- (270,904) (610,703)
Restructuring reserve (219,042) 365,939 ---
------------- ------------- -------------
Net cash used by operating activities (4,456,399) (4,439,024) (1,635,342)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments from (advances to) affiliate - net --- --- 322,952
Cash of acquired affiliate --- --- 361,804
Acquisition costs --- --- (555,269)
Proceeds from royalty assignment - net --- 3,040,100 ---
Investment in capitalized systems (2,341,114) (1,016,985) (454,778)
Purchase of property and equipment (86,145) (47,849) (90,052)
Proceeds from sale of property and equipment --- 11,600 ---
Patent development costs (31,196) (21,818) (60,335)
------------- ------------- -------------
Net cash provided (used) by investing activities (2,458,455) 1,965,048 (475,678)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of obligations under capital leases (292,641) (42,647) (17,124)
Proceeds from notes payable 4,000,000 --- ---
Repayment of line of credit --- --- (419,769)
Proceeds from leases payable --- 530,530 742,742
Proceeds from issuance of common stock - net 4,001,997 --- 3,950,123
Proceeds from stock pending issuance 4,306,727 --- ---
------------- ------------- -------------
Net cash provided by financing activities 12,016,083 487,883 4,255,972
------------- ------------- -------------
Net change in cash and cash equivalents 5,101,229 (1,986,093) 2,144,952
Cash and cash equivalents - beginning of year 308,894 2,294,987 150,035
------------- ------------- -------------
Cash and cash equivalents - end of year $ 5,410,123 $ 308,894 $ 2,294,987
============= ============= =============
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid $ 361,730 $ 89,431 $ 112,016
============= ============= =============
Income taxes paid $ --- $ --- ---
============= ============= =============
Significant non-cash transactions are described in Notes 9, 10, 13, 16 and 21.
See Independent Auditors' Reports and Notes to the Financial Statements.
32
NESTOR, INC.
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS
A. Organization
Nestor, Inc. (the "Company") was organized on March 21, 1983 in
Delaware to develop and succeed to certain patent rights and
know-how which the Company acquired from its predecessor, Nestor
Associates, a limited partnership. Two wholly-owned subsidiaries,
Nestor Traffic Systems, Inc. ("NTS") and Nestor Interactive, Inc.
("Interactive"), were formed effective January 1, 1997. Effective
November 7, 1998, the Company ceased further investment in the
Interactive subsidiary. CrossingGuard, Inc., a wholly owned
subsidiary of NTS, was formed July 18, 2003 in connection with
the financing discussed in Note 6. All intercompany transactions
and balances have been eliminated. The Company's principal office
is located in East Providence, RI.
The Company's current focus is to offer customers products and
services to be utilized in intelligent traffic management
applications. Its leading product is its CrossingGuard
video-based red light enforcement system and services, sold and
distributed exclusively by NTS. Effective July 1, 2002, the
Company assigned its royalty rights in the field of financial
services, substantially eliminating ongoing product royalty
revenue from prior non-traffic related lines of business.
B. Liquidity and management's plans
The Company has incurred significant losses to date and at
December 31, 2003 has an accumulated deficit. The 2003
consolidated financial statements do not include any adjustments
that might result should the Company not be able to continue as a
going concern. In previous years similar conditions led the
Company's auditors to modify their opinions to address going
concern uncertainties. Management believes that with the
significant financing obtained in 2003, the Company's strong
liquidity at December 31, 2003 and its current contracts with
municipalities, the Company will be able to continue the
development and upgrading of its products and sustain operations
through the end of 2004. There can be no assurance, however, that
the Company's operations will be sustained or be profitable in
the future, or that the Company's product development and
marketing efforts will be successful.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
A. Cash equivalents
The Company considers all highly liquid debt instruments
purchased with an original maturity of 90 days or less to be cash
equivalents.
B. Accounts receivable
Accounts receivable represent balances due from customers, net of
an $84,213 reserve for doubtful accounts at December 31, 2003.
The Company considered accounts receivable at December 31, 2002
to be fully collectible, and accordingly, no allowance for
doubtful accounts was necessary. In determining the need for an
allowance, objective evidence that a single receivable is
uncollectible as well as an historical pattern of collections of
accounts receivable that indicate that the entire face amount of
a portfolio of accounts receivable may not be collected is
considered at each balance sheet date.
C. Unbilled contract revenue
Unbilled contract revenue represents revenue earned by the
Company in advance of being billable under customer contract
terms. Under the terms of some current contracts, the Company
cannot bill the municipality until the court has collected the
citation fine. Management records unbilled contract revenue in
these situations at a net amount, based upon a historical pattern
of collections by the courts for the municipalities. The pattern
of collections on these citations is continually reviewed and
updated by management.
33
D. Inventory
Inventory is valued at the lower of cost or market, with cost
determined by the first-in, first-out basis and consists mostly
of equipment to be installed as capitalized system costs.
E. Property and equipment & depreciation and amortization
Property and equipment are recorded at cost. Depreciation and
amortization are calculated using the straight-line method at
rates sufficient to write off the cost of the assets over their
estimated useful lives.
F. Goodwill
Goodwill represents the excess of cost over the fair value of net
assets acquired. Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets," requires
that goodwill be tested for impairment at least annually and
whenever events or changes in circumstances indicate that the
carrying amount of the asset may not be recoverable. Goodwill is
reviewed for impairment using the Company's quoted stock price as
a measurement of the Company's fair value of assets, including
goodwill, and liabilities. Any resulting goodwill impairment will
be charged to operations.
G. 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 of the product. The Company currently has no costs
eligible for capitalization under the American Institute of
Certified Public Accountants Statement of Position 98-1.
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.
H. Revenue recognition Nestor Traffic Systems, Inc.:
Revenue is derived mainly from the lease of products which
incorporate NTS's software and the delivery of services based
upon such products. Lease and service fees include software
licenses and processing service fees tied to citations issued to
red-light violators. NTS provides equipment (either under sales
or operating lease agreements), postcontract customer support
(PCS) and engineering services. In arrangements that include
multiple elements, some of which include software, the total
arrangement fee is allocated among each deliverable based on the
relative fair value of each of the deliverables determined based
on vendor-specific objective evidence.
Product Sales - The Company recognizes the revenue allocable to
product sales upon delivery of the product.
Lease and Service Fees - The Company recognizes lease and service
fee revenue from operating lease arrangements with customers over
the terms of the lease agreements. The majority of NTS's
CrossingGuard revenues are expected to be generated from fees
received from red-light violation citations issued by the system
and associated services. Revenues are recognized upon the
issuance of the related tickets.
34
Nestor, Inc.:
During 2001, revenue was derived from software licenses (Initial
License Fees), user fees (Monthly License Fees), PCS and
engineering services. In software arrangements that included
multiple elements, the Company allocated 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 per AICPA Statement of Position 97-2 -
Software Revenue Recognition.
Software Licenses - During 2001, the Company recognized revenue
allocable to software licenses upon delivery of the software
product to the end user, unless the fee was not fixed or
determinable or collectibility was not probable. The Company
considered 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 was not
fixed or determinable, revenue was recognized as payments became
due from the customer. In most situations, the Company considered
its acceptance terms as perfunctory. Arrangements that included
acceptance terms that were not considered perfunctory were not
recognized until acceptance occurred. If collectibility was not
considered probable, revenue was recognized when the fee was
collected. Revenue on arrangements with customers who were not
the ultimate users (distributors, other resellers, etc.) was not
recognized until the software was delivered to an end user.
Both companies above:
Postcontract Customer Support - PCS includes maintenance
agreements. Revenue allocable to PCS is recognized on a
straight-line basis over the period the PCS is provided or upon
issuance of related tickets if a component of ticket fees.
Engineering Services - Engineering services range from
installation, training, and basic consulting to modeling,
software modification and customization to meet specific customer
needs. For arrangements that include customization or
modification of the software, or where software services are
otherwise considered essential, revenue is recognized using
contract accounting. Revenue from these software arrangements is
recognized on a percentage-of-completion method with
progress-to-completion measured based upon estimated total costs.
Contracts may include penalty provisions relating to timely
performance and delivery. Penalties are charged to operations as
incurred.
I. Shipping and handling costs
Shipping and handling costs are capitalized if part of a leased
system or included in engineering services expense.
J. Research and development
Research and development in 2002 and 2003 represents costs
associated with the NTS product line and consists principally of
payroll and related costs, facilities costs and the cost of
prototype components.
K. Income taxes
The Company accounts for income taxes using the liability method.
Under this method, deferred tax assets and liabilities are
determined based on differences between the financial reporting
and the tax bases of assets and liabilities, and are measured
using enacted tax rates and tax laws that will be in effect when
the differences are expected to reverse. The primary component of
the deferred tax asset as of December 31, 2003 and 2002, which is
fully reserved, is net operating loss carry forwards.
Although the Company reports consolidated results and balances
for financial reporting purposes, the individual companies file
separate tax returns. Due to operating losses throughout the
reporting periods, no provision for income tax was made in 2003,
2002 or 2001.
35
L. Earnings (loss) per share and common stock
The Company reports its earnings (loss) per share ("EPS") in
accordance with the provisions of Statement of Financial
Accounting Standards No. 128, Earnings Per Share ("SFAS 128").
Basic EPS is calculated by dividing the net income (loss) 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. Diluted per share computations are not presented
since the effect would be anti-dilutive.
Common stock and loss per share as previously reported have been
adjusted to a post-reverse split basis.
M. Reclassification
Certain operating expenses reported at December 31, 2001 have
been reclassified to conform to the December 31, 2002
presentation. These reclassifications had no effect on 2001 net
loss as previously reported.
N. Estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America 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.
O. 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 limit. However, senior management continually reviews the
financial stability of these financial institutions. The Company
routinely assesses the financial strength of its customers, most
of which are municipalities, and, as a result, believes that its
trade accounts receivable credit risk exposure is limited. The
Company does not require collateral from its customers.
P. Accounts payable
Included in accounts payable is a $221,000 note payable to a
vendor with a balance of $75,604 at December 31, 2003. The note
bears interest at 8% and monthly principal and interest payments
of $19,218 are due through April 2004.
Q. Stock option plans
The Company accounts for stock option awards granted to officers,
directors and employees (collectively "employees") under the
recognition and measurement principles of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). Under APB 25, no stock-based employee compensation
cost is reflected in net income, as all options granted to
employees under these plans have been granted at no less than
fair market value on the date of grant. The Company applies the
disclosure only provision of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-based
Compensation" ("SFAS 123") and SFAS No. 148, "Accounting for
Stock-based Compensation-Transition and Disclosure ("SFAS 148")
for such employee stock option awards. The Company accounts for
stock option awards granted to consultants under the fair value
recognition provisions of SFAS 123. Under this method, options
are valued using the Black-Scholes option pricing model, and the
calculated option value is recorded as an expense in the
financial statements.
36
For purposes of providing pro forma disclosures for employee
grants, the fair value for options was estimated at the date of
grant using the Black-Scholes pricing model with the following
weighted average assumptions:
2003 2002 2001
---- ---- ----
Expected life (years) 8 8 8
Average risk-free interest rate 1.6-6.8% 2.6 to 6.8% 4.2 to 6.8%
Volatility 117.4% 109.8% 105.9%
Dividend yield 0% 0% 0%
The weighted-average fair value of options granted during 2003,
2002 and 2001 was $2.55, $1.80 and $5.10, respectively. The
Company recognizes forfeitures as they occur.
Had the Company determined compensation expense for the Plan in
accordance with the fair value methodology prescribed by SFAS
123, the Company's pro forma net loss and loss per share would
have been:
Years Ended December 31,
---------------------------------------------
2003 2002 2001
---- ---- ----
Net loss - reported $(4,890,458) $(12,634,263) $(1,565,054)
Add (Deduct): total stock-based
compensation expense
determined under fair-value
based method for all awards,
net of related tax effects $ 149,965 $ (22,464) $ (23,679)
Pro Forma - net loss $(4,740,493) $(12,656,727) $(1,588,733)
Pro forma net loss per share -
basic and diluted $ (0.37) $ (2.51) $ (0.55)
For the purposes of this disclosure, the estimated fair value of
the options is amortized to expense over the options' vesting
periods. The effects on pro forma disclosures of applying SFAS
123 may not be representative of the effects on pro forma
disclosures of future years.
NOTE 3 - CAPITALIZED SYSTEM COSTS:
Equipment, installation and in some cases interest costs related to
operating lease contracts are capitalized and, after acceptance by the
municipality (customer), are depreciated generally over a three to
five year estimated useful life. Revenues realized from these
agreements, generally in the form of per-citation fees, are expected
to be adequate to cover the capitalized and future costs related to
these agreements. Most leases contain minimum payment requirements,
which currently aggregate to $2,746,512 in 2004, $2,528,824 in 2005,
$1,918,527 in 2006, $1,235,568 in 2007 and $902,917 in 2008, but
management expects that these annual amounts could increase and extend
to future years as additional intersections are installed. A
substantial portion of this equipment is collateral for the Company's
leases payable (see Note 7).
December 31,
------------
2003 2002
---- ----
Equipment under operating leases:
Work-in-process $ 248,693 $ 381,030
Installed and accepted 4,358,062 1,884,611
----------- -----------
4,606,755 2,265,641
Less: Accumulated depreciation (1,091,847) (328,858)
----------- -----------
Net investment in leased equipment $3,514,908 $ 1,936,783
=========== ===========
37
NOTE 4 - PROPERTY AND EQUIPMENT - NET:
December 31,
------------
2003 2002
---- ----
Office furniture and equipment $ 140,475 $ 140,475
Computer equipment 1,747,454 1,607,256
Demonstration equipment 7,726 125,562
Leasehold improvements 231,915 227,872
----------- -----------
2,127,570 2,101,165
Less: Accumulated depreciation (1,742,405) (1,614,425)
----------- -----------
$ 385,165 $ 486,740
=========== ===========
Depreciation and amortization expense of $239,878 and $235,361 on the
above assets was recorded for the years ended December 31, 2003 and
2002, respectively.
In 2003, the Company disposed of $117,189 of demonstration equipment.
Additionally, in 2003 equipment with a cost of $17,020 was transferred
to inventory at net book value. In 2002, the Company sold or disposed
of $56,877 in office furniture and equipment, $13,194 of computer
equipment and $2,442 of leasehold improvements. The loss on disposal
is included in Other expense - net.
NOTE 5 - GOODWILL AND OTHER TANGIBLE ASSETS:
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." Under SFAS 142, the Company will test
goodwill for impairment on an annual basis, or whenever indicators of
impairment are identified. The Company completed the transitional
impairment test of goodwill during the quarter ended June 30, 2002 and
concluded that no impairment existed on January 1, 2002, when the
standard was adopted. Management considers the Company's quoted stock
price to be the best indicator of fair value for purposes of
performing these analyses.
Based on the decline of the Company's stock price during the second
and third quarters of 2002, however, the fair value was recomputed
using the quoted quarter-end stock prices. Such computations resulted
in goodwill impairment charges of $3,000,000 and $5,500,000 recorded
as operating expenses during the respective 2002 quarters. The Company
continues to monitor goodwill for potential impairment.
As all of the goodwill recorded on the Company's books was created
subsequent to June 30, 2001, no goodwill amortization was recorded
during 2001, in accordance with SFAS No. 142. Since no amortization of
goodwill had been recorded in 2001, adoption of SFAS No. 142 has had
no pro forma effect on the net loss or earnings per share calculations
for fiscal year 2001.
Amortization of other intangible assets has been immaterial to
operating results to date.
NOTE 6 - NOTES PAYABLE:
First Laurus Convertible Note:
On July 31, 2003, the Company entered into a Securities Purchase
Agreement ("the Agreement") with Laurus Master Fund, Ltd. ("Laurus").
Pursuant to the Agreement, the Company issued to Laurus a Convertible
Note ("Note") in the principal amount of $2,000,000 that bore interest
at the prime rate plus 1.25% (subject to a floor of 5.25%) and matured
on July 31, 2005. The initial principal payment of $20,000 was due in
December 2003 and increased over the term of the loan such that
aggregate principal payments totaled $950,000 in 2004 and $1,030,000
in 2005. The Note allowed repayment, at the Company's option, in cash
or, subject to certain limitations, through the issuance of shares of
the Company's common stock at the fixed conversion price of $1.55 per
38
share if the then current market price was above 120% of the fixed
conversion price. Laurus also had a conversion right at any time or
from time to time at or prior to maturity, to convert the Note into
shares of the Company's common stock at the fixed conversion price,
subject to adjustments for shares of common stock issued for less than
the fixed conversion price (unless exempted pursuant to the
Agreement). The Company had the option of redeeming for cash any
outstanding principal by paying 115% of such amount plus accrued but
unpaid interest.
During November and December 2003, Laurus converted $85,250 of the
Note into 55,000 shares of Nestor common stock at $1.55 per share. On
January 14, 2004, the Company satisfied its remaining payment
obligations on the Note by issuing 492,904 shares of its common stock
to Laurus at the fixed conversion price of $1.55 per share and
redeeming the remaining $1,150,750 note balance by a "payment" of
$1,340,972, which included accrued interest and a $172,613 prepayment
penalty. This "payment" was netted against the proceeds from the
Second Laurus Convertible Note (see below), resulting in $98,028 net
cash proceeds to the Company.
The Company filed a Registration Statement on Form S-2 on September 2,
2003 (SEC File No. 333-108432), registering the resale of shares
issued to Laurus under that note, pursuant to a registration rights
agreement. That registration became effective on November 26, 2003.
The Company filed a post-effective amendment to that registration
statement on January 30, 2004, which became effective on February 13,
2004. Laurus has agreed to limit the volume of its sales of the
Company's common stock to a percentage of the total daily volume of
open market sales of the Company's common stock on its principal
trading market whenever the previous trading day's volume weighted
average price for shares of the Company's common stock is between
$2.00 and $5.00 per share (inclusive) until January 14, 2008. The
percentage to which Laurus will limit its sales varies with the
previous day's volume weighted average price. If the relevant price is
$2.00 or more and less than $3.00, the limit is 15% of the daily
volume on the day of the sale; if the relevant price is $3.00 or more
and less than $4.00, 22% of the daily volume on the day of the sale;
and if the relevant price is $4.00 or more and not greater than $5.00,
30% of the daily volume on the day of the sale. Laurus may seek, and
the Company may give, its approval to exceed those volume limitations
in negotiated transactions.
The note was collateralized by a first lien on all available
CrossingGuard, Inc. assets. Laurus has a general security interest in
four customer contracts assigned by NTS to CrossingGuard, Inc. and NTS
has pledged the common stock of CrossingGuard, Inc. In connection with
financing, Laurus was paid a fee of $80,000, had certain of its
expenses reimbursed and received a warrant to purchase 140,000 shares
of the Company's common stock. The warrant exercise price is as
follows: $1.78 per share for the purchase of up to 83,000 shares;
$1.94 per share for the purchase of an additional 33,000 shares; and
$2.25 per share for the purchase of an additional 24,000 shares. The
warrant exercise price may be paid in cash, in shares of the Company's
common stock (if the fair market value of a single share of common
stock exceeds the value of the per share warrant exercise price), or
by a combination of both. The warrant expiration date is July 31,
2008.
Also in connection with financing, Management Services Group/Sage
Investments, Inc. ("Sage") was paid a fee of $80,000 and will receive
$4,444 per month for nine months for continuing consultation. Sage
received warrants to purchase 14,000 shares of Company stock as
follows: $1.78 per share for the purchase of up to 8,300 shares; $1.94
per share for the purchase of an additional 3,300 shares; and $2.25
per share for the purchase of an additional 2,400 shares. The warrant
expiration date is July 31, 2008.
The Black-Scholes values of the warrants issued in connection with
this financing totaled $143,980 (Laurus) and $14,398 (Sage) and were
recorded as additional paid-in capital. The Laurus warrant value was
recorded as a discount on the note payable. During the quarter ended
September 30, 2003, the Company amortized $11,998 of the discount as
interest expense. As the Note was satisfied on January 14, 2004, the
remaining unamortized discount of $113,984, deferred interest of
$55,148 and deferred financing fees of $131,228 had negligible
continuing value and were consequently written off to interest expense
39
(discount and deferred interest) and financing fees, respectively, at
December 31, 2003. The warrants have not been exercised as of December
31, 2003.
Second Laurus Convertible Note:
On January 14, 2004, the Company also entered into a securities
purchase agreement with Laurus. Pursuant to that agreement, the
Company issued to Laurus a new convertible note in the principal
amount of $1,500,000 that bears interest at the prime rate plus 1.25%
(subject to a floor of 5.25% per year) and matures on January 14,
2006. Principal repayments commence May 2004 with $375,000 due in
2004, $1,012,500 due in 2005 and $112,500 due in 2006. The net
proceeds from the new note will be used for the construction,
installation, and maintenance of traffic surveillance systems and for
other general corporate purposes. The new note may be repaid at the
Company's option, in cash or, subject to limitations, through the
issuance of shares of its common stock. The Company has an option to
pay the monthly amortized amount in shares of its common stock at the
fixed conversion price of $3.50 per share if the shares are registered
with the Securities and Exchange Commission for public resale and the
then current market price is 120% above the fixed conversion price.
The Company agreed to file a registration statement with the
Commission to register the public resale by Laurus of the common stock
to be issued upon conversion of the note and to pay Laurus damages if
that registration statement is not declared effective by the
Commission by July 30, 2004. The note includes a right of conversion
in favor of Laurus. If Laurus exercises its conversion right at any
time or from time to time at or prior to maturity, the new note will
be convertible into shares of the Company's common stock at the fixed
conversion price, subject to adjustments for stock splits,
combinations, and dividends. In conjunction with this transaction,
Sage is entitled to a fee of $60,000 and an affiliate of Laurus
received a management fee of $45,000 and reimbursement of certain
expenses. The first lien, security interest and pledge of
CrossingGuard, Inc. stock from the first Laurus Note continued to this
second note.
Silver Star Convertible Note:
On October 15, 2003, the Company sold a $2,000,000 convertible note
("Silver Star Note") to Silver Star Partners I, LLC ("Silver Star").
The Silver Star Note was due on January 15, 2004 and bore interest at
the rate of 7% per year. The Company's obligations under the note
could, at the Company's option, be satisfied, in whole or part, by
issuing shares of the Company's common stock to Silver Star at a
conversion price equal to the gross price from the first offering of a
similar number of such shares made after October 15, 2003.
On December 31, 2003, the Company exercised its option to satisfy the
Silver Star note and accrued interest by issuing 676,384 shares of
Nestor common stock at $3.00 per share. See Common and Preferred Stock
footnote also.
Silver Star has the right to require the Company to register with the
SEC Silver Star's resale of all shares of common stock that it owns as
soon as practicable after Silver Star requests that registration. The
Company is obligated to pay all expenses associated with that
registration. The Company has other obligations in connection with
that registration, including causing the registration statement filed
to remain continuously effective until the distribution of shares
covered by the registration statement is complete and indemnifying
Silver Star from liabilities it may incur resulting from any untrue
statement or omission of a material fact in the registration statement
and related documents and from other liabilities related to the
registration. Danzell Investment Management, Ltd. received a 3%
finders fee from the Company in connection with the Silver Star Note.
William B. Danzell is the Chief Executive Officer of Nestor, Inc., the
President of Danzell Investment Management, Ltd. and the Managing
Director of Silver Star Partners I, LLC. Robert M. Krasne, David N.
Jordan and George L. Ball, each a director of Nestor, are each also
affiliates of Silver Star Partners I, LLC. Stephen H. Marbut, a former
director of Nestor, is also an affiliate of Silver Star Partners I,
LLC. The sale of the note by Nestor to Silver Star Partners I, LLC and
the satisfaction of our obligations under it by issuing common stock
were approved by the directors of Nestor not affiliated with Silver
Star Partners I, LLC.
40
NOTE 7 - LEASES PAYABLE:
On June 28, 2001, NTS executed a Master Lease Purchase Agreement with
Electronic Data Systems Corporation ("EDS"), whereby EDS provided
lease financing to support installation of the NTS CrossingGuard
product to municipalities under leasing terms. NTS received $3,183,180
in advances, drawn at $53,053 per approach contracted to fund system
equipment, design and installation costs. Advances were collateralized
by equipment delivered under leased CrossingGuard systems and were
being repaid interest (20%) only for the first 6 months and principal
and interest over the next 60 months from each advance date.
Payments were made as scheduled through February 2002, then the
Company became delinquent on payments and fell out of compliance with
the lease agreement. On January 10, 2003, the lease agreement was
amended, pursuant to a letter agreement between NTS and EDS dated July
18, 2002, to provide: (i) a moratorium on NTS' interest obligations
under the lease for the period from July 1, 2002 through June 30,
2003; (ii) a moratorium on all principal repayments through June 30,
2003, at which time regular monthly payments will resume; (iii) all
lease payments in arrears as of June 30, 2002 will be accrued and
payable as follows, $150,000 on September 30, 2003, $100,000 on
December 31, 2003, and $37,590 on March 30, 2004; and (iv) effective
July 1, 2002, the interest rate factor upon which the lease payments
are based was lowered to 12% per annum. EDS will not extend additional
financing under the Master Lease Purchase Agreement.
During 2003, the Company recorded $163,961 of EDS interest expense. In
2002 and 2001, the Company recorded $303,481 and $174,218 of EDS
interest costs; $100,559 and $105,193 of which were capitalized as
capitalized systems costs and $202,922 and $49,788 were expensed
directly, respectively. In addition, $19,237 of EDS interest in 2001
was expensed by NTS pre-merger.
On January 26, 2004, the Company satisfied its remaining obligations
to EDS by making a payment of $2,178,764. This transaction resulted in
the Company recording a gain on early extinguishment of debt of
$680,737 in January 2004.
NOTE 8 - RESTRUCTURING:
In June 2002, the Company underwent a significant restructuring
involving management changes and cost control to lower personnel and
facilities expenses as the Company refocused its efforts solely on its
red-light video enforcement contracts for CrossingGuard installations.
The Company terminated 19 full-time employees, affecting all
departments, and offices were consolidated into smaller facilities.
During the quarter ended June 30, 2002, the Company recorded
restructuring costs (which are separately disclosed in the Statement
of Operations) of $743,000 primarily comprised of $332,000 in employee
severance agreements and estimated lease obligations associated with
closing its Providence, RI and San Diego, CA offices. A settlement was
reached in 2002 in connection with the Providence office lease and in
2003 in connection with the San Diego lease. After offsetting security
and inventory deposits against restructuring costs and paying $142,000
and $119,000 in severance benefits, $15,000 and $89,000 in lease
settlement costs and $62,000 and zero purchase commitment costs in
2003 and 2002, respectively, $147,000 remains outstanding on the
balance sheet as a restructuring reserve at December 31, 2003.
NOTE 9 - COMMON AND PREFERRED STOCK:
Private Placement and Silver Star Note Conversion: The Company sold
2,843,000 shares of its common stock to accredited investors in
private placements conducted during December 2003 (1,596,560 shares),
and January 2004. The shares were sold at $3.00 per share, with net
proceeds to Nestor, excluding expenses of the offering, of $2.76 per
share totaling $7,846,680. The Company has continuing obligations in
connection with the registration of the resale of the shares offered,
including causing the registration statement filed to remain
continuously effective for two years or, if earlier, until the sale of
shares covered by the registration statement is complete and
41
indemnifying the holders from liabilities it may incur resulting from
any untrue statement or omission of a material fact in the
registration statement and related documents and from other
liabilities related to the registration.
On December 31, 2003, after the initial closing of the private
placement above, the Company exercised its right to convert the Silver
Star Note and accrued interest (see Note 6 also) by issuing 676,384
shares of Nestor common stock at $3.00 per share.
Although the proceeds from the initial closing above were received in
December 2003 and the Silver Star note conversion was effective
December 31, 2003, the associated stock certificates were not issued
until January 2004. As such, these 2,272,944 shares are classified as
"Stock Pending Issuance" on the balance sheet at December 31, 2003.
Laurus Note Conversion:
As more fully described in Note 6, Laurus elected to convert $85,250
of their first note into 55,000 shares of Nestor common stock in 2003.
In January 2004, Laurus further converted $764,000 of the note into
492,904 shares of Nestor common stock. Both conversions were priced at
$1.55 per share.
Silver Star Equity Financing:
In a first closing on January 15, 2003, Silver Star purchased 49
million shares of Nestor common stock (pre-reverse stock split) for
$2,376,500 and on April 16, 2003, completed a second closing,
purchasing an additional 4,013,557 shares (post-reverse stock split)
for $1,946,575. Danzell Investment Management, Ltd., in which William
B. Danzell, the Managing Director of Silver Star, serves as president,
has provided investment-related services (including consulting
services) to the Company and has received a fee for services rendered
in an amount equal to 3% of the cash proceeds generated by the Company
in connection with the financing transactions with Silver Star. Upon
completion of the second closing, Silver Star owned 64% of the issued
and outstanding shares of Company common stock (63.7% at December 31,
2003). See Form 8-K dated April 9, 2003 for further information.
One-for-Ten Reverse Stock Split:
The Company filed a certificate of amendment to its certificate of
incorporation on April 11, 2003, causing a one-for-ten reverse stock
split of the outstanding shares of the Company common stock effective
on that date. The Company's common stock began trading on a post
reverse split basis on April 21, 2003 under the new trading symbol
"NESO" (previously "NEST"). These financials reflect common stock and
loss per share on a post-split basis.
Stock Issued in Connection with NTS Merger:
In September 2001, the Company completed a merger with NTS (Note 16),
which resulted in the issuance of 32,338,558 shares of Nestor, Inc.
common stock.
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 $190,000 at
December 31, 2003 and $235,000 at December 31, 2002.
NOTE 10 - OPTIONS AND WARRANTS:
On April 1, 1984, the Company adopted an Incentive Stock Option Plan
under which the Board of Directors may grant incentive or
non-qualified stock options to employees, directors and consultants 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
245,000 shares (post-reverse split) of the Company's common stock.
Options generally vest over three years and are exercisable for five
42
years from the date of grant. The options are not transferable except
by will or domestic relations order.
On May 6, 1997, the Company adopted the 1997 Stock Option Plan under
which the Board of Directors may grant incentive or non-qualified
stock options to employees, directors and consultants 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. In June 2001, the 1997 Stock
Option Plan was amended to increase the aggregate number of options
authorized to 500,000 shares (post-reverse split) of the Company's
common stock. Options vest over four years and are exercisable for up
to ten years from the date of grant, although most options currently
outstanding expire eight years from the date of grant. The options are
not transferable except by will or domestic relations order.
The following table presents the activity of the Company's Stock
Option Plans for the years ended December 31, 2003, 2002 and 2001 on
post-reverse split basis. The number of options granted and
outstanding in 2001 rose significantly due to the conversion of
302,800 NTS stock options into 277,500 Nestor, Inc. stock options
priced at $5.50. The number of options canceled in 2002 included
unexercised options previously held by employees who were terminated
in connection with the Company's restructuring. In 2003, options
granted were to directors of the Company; many of which were canceled
later in 2003 due to changes in the Board.
Years Ended December 31,
-----------------------------------------------------------
2003 2002 2001
---- ---- ----
Weighted Weighted Weighted
Av. Ex. Av. Ex. Av. Ex.
Shares Price Shares Price Shares Price
---------------- ---------------- ----------------
Outstanding
beginning of
year 324,199 $6.50 395,121 $7.10 110,482 $12.80
Granted 176,250 3.34 36,800 2.00 344,584 5.90
Exercised --- --- --- --- 17,413 7.00
Canceled 188,052 4.85 107,722 7.10 42,532 12.30
------- ------- -------
Outstanding-
end of year 312,397 $5.75 324,199 $6.50 395,121 $ 7.10
======= ======= =======
Options
exercisable
at year end 233,970 $6.80 224,730 $7.30 214,863 $ 8.20
======= ======= =======
The following table presents weighted average price and life
information about significant option groups outstanding at December
31, 2003.
Options Outstanding Options Exercisable
------------------------------- -------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Averaged
Range of Outstanding Contractual Exercise Exercisable Exercisable
Exercise Prices at 12/31/03 Life (Years) Price at 12/31/03 Price
- --------------- ----------- ------------ -------- ----------- -----------
$ 1.00 - $ 1.90 74,300 3.73 $ 1.45 17,321 $ 1.81
$ 5.50 126,485 3.51 5.50 120,802 5.50
$ 6.00 - $14.40 96,612 1.35 7.04 80,847 7.17
$15.00 - $28.90 15,000 1.12 20.97 15,000 2.60
------- ---- ------- ------ ------
312,397 2.78 $ 5.75 233,970 $ 6.80
======= ==== ======= ======= ======
The Company, at the discretion of the Board of Directors, has granted
warrants from time to time, generally in conjunction with the sale of
43
equities. During 2001, the Company issued 398,071 warrants in
connection with the NTS merger and converted a premerger NTS warrant
to purchase 9,166 common shares (post-reverse split). Transaction
Systems Architects, Inc.'s ("TSAI") warrant to purchase 250,000 common
shares (post-reverse split) expired on March 1, 2002, triggering the
concurrent expiration of 125,000 NTS merger warrants. During 2003, the
Company issued 154,000 warrants in connection with the convertible
note financing. The following table presents warrants outstanding
after adjusting to a post-reverse split basis:
Years Ended December 31,
--------------------------------
2003 2002 2001
---- ---- ----
Eligible, end of year
for exercise currently 660,936 532,141 907,141
======== ======== ========
Warrants issued 154,000 --- 407,237
Low exercise price $ 1.78 $ --- $ 0.10
High exercise price $ 2.25 $ --- $ 12.80
The warrants outstanding as of December 31, 2003 are currently
exercisable and expire at various dates through July 31, 2008.
outstanding warrants entitle the owner to purchase one share of common
stock for each warrant, at prices ranging from $0.10 to $12.80 per
share (post-reverse split). In 2003, the one-for-ten reverse split
impacted both the number of warrants and warrant prices
proportionately. The exercise price of warrants outstanding at
December 31, 2002 was adjusted downward as a result of anti-dilution
provisions of the warrants and the completion of the Silver Star
Partners I, LLC investment.
During the year ended June 30, 1996, the exercise price of 100,000
warrants issued in the prior year was reduced from $15.00 to $6.50
(post-reverse split). 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 in 2003, 2002 and 2001.
NOTE 11 - SEGMENT INFORMATION:
A. Description of reportable segments
Effective with the September 2001 merger, the Company has two
reportable segments: Nestor, Inc. and Nestor Traffic Systems,
Inc.
Nestor, Inc. produced and sold credit and debit card fraud
detection products and database marketing products to financial
institutions and processors of financial data until the Company
entered into reseller license agreements with Applied
Communications, Inc. on February 1, 2001 and with Retail
Decisions, Inc. on May 18, 2001. In addition, all expenses
associated with development, support and selling these products
were transferred to these parties. Subsequent to the reseller
agreements, Nestor, Inc. revenues were mainly royalties from
these licenses until the Company assigned its royalty rights as
of July 1, 2002. The NTS segment provides video-based monitoring
systems and services for traffic safety, mainly to
municipalities. Goodwill has been allocated to the NTS segment.
B. Measurement of segment profit or loss and segment assets
The Company evaluates performance based on income or loss before
investment income (loss). The accounting policies of the
reportable segments are the same as those described elsewhere in
these financial statements.
C. Segment income or loss and segment assets
All revenues are from external customers. There are no
intercompany sales.
44
Nestor Traffic
Nestor, Inc. Systems, Inc. Totals
------------ -------------- ------
YEAR ENDED
DECEMBER 31, 2003:
Revenues $ 29,000 $ 2,677,000 $ 2,706,000
Segment net loss (528,000) (4,362,000) (4,890,000)
Segment assets 5,702,000 10,597,000 16,299,000
YEAR ENDED
DECEMBER 31, 2002:
Revenues $ 665,000 $ 1,457,000 $ 2,122,000
Segment net income (loss) 3,591,000 (16,225,000) (12,634,000)
Segment assets 598,000 8,603,000 9,201,000
YEAR ENDED
DECEMBER 31, 2001:
Revenues $3,073,000 $ 448,000 $ 3,521,000
Segment income (loss) 1,295,000 (2,779,000) (1,484,000)
Segment assets 2,516,000 19,519,000 22,035,000
D. Geographic Information
Revenues are attributed to countries based on the location of
customers. All foreign revenues related to Nestor, Inc. All
long-lived assets are located in the United States.
Years Ended December 31,
---------------------------------------------------
2003 2002 2001
---- ---- ----
United States $2,705,534 $ 2,112,281 $ 3,450,613
Japan --- --- 46,844
Canada --- 9,293 23,467
---------- ------------ ------------
$2,705,534 $ 2,121,574 $ 3,520,924
========== ============ ============
E. Revenues from Major Customers
Years Ended December 31,
---------------------------------------------------
2003 2002 2001
---- ---- ----
Customer A - Nestor, Inc. $ --- $ 629,569 $ 1,841,031
Customer B - Nestor, Inc. --- --- 832,000
Customer C - NTS 406,670 266,751 34,925
Customer D - NTS 399,067 --- ---
Customer E - NTS 348,143 150,331 ---
Customer F - NTS --- 293,911 218,023
Customer G - Nestor, Inc. --- --- 285,536
NOTE 12 - IMPAIRMENT CHARGE:
During the quarter ended June 30, 2002, the Company determined that
potential citation revenues from certain CrossingGuard installations
in two cities would not exceed the cost of the underlying carrying
value of the capitalized systems. These contracts were signed in the
early stages of CrossingGuard development and the site selection
procedures and contract terms have since been improved. In accordance
with SFAS No. 144, "Accounting for the Impairment or Disposal of
45
Long-Lived Assets", the Company wrote off capitalized systems cost of
$794,000 and recorded a corresponding impairment charge in operating
expenses. Ongoing revenues from these installations are expected to
offset future costs of system operations.
NOTE 13 - ROYALTY ASSIGNMENT:
On July 15, 2002, the Company entered into a Memorandum of
Understanding ("MOU") with Churchill Lane Associates, LLC ("CLA"),
assigning CLA certain of the Company's rights to royalty income under
the license agreement between Nestor, Inc. and ACI ("ACI License")
(Note 21). CLA is owned and controlled by three former directors and
shareholders of the Company. The MOU also provided a schedule for
advances by CLA to provide interim financing to the Company during the
period prior to the closing. Upon closing on September 30, 2002, CLA
paid the Company $3.1 million in cash (less advances) for the
irrevocable assignment of its royalty rights under the ACI License
from July 1, 2002 and in perpetuity. No obligations or other rights of
the Company were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000
of ACI deferred income and $60,000 in related professional fees, the
Company recorded a $2,812,000 gain on this royalty assignment on
September 30, 2002. The elimination of ACI unbilled contract revenue
and deferred income were recorded as non-cash reductions.
NOTE 14 - OTHER EXPENSE - NET:
Other expense as reflected in the consolidated statements of
operations consists of the following:
Years Ended December 31,
--------------------------------------------
2003 2002 2001
---- ---- ----
Interest income $ 13,438 $ 11,229 $ 51,695
Interest expense (470,206) (217,023) (65,355)
Expense relating to financing
operations (106,484) (106,483) (106,483)
Other income 64,130 --- ---
Loss on disposal of fixed assets (5,291) (6,341) (66,666)
---------- --------- ---------
Other expense - net $(504,413) $(318,618) $(186,809)
========== ========== ==========
NOTE 15 - INCOME TAXES:
During 2003 and 2002, the Company recorded deferred tax assets
primarily for the benefit of net operating losses in the amount of
$1,742,000 and $1,573,000, respectively. The cumulative amount of
these assets, which is $16,514,000 and $14,772,000 at December 31,
2003 and 2002, respectively, is fully reserved. Due to the Company's
history of operating losses, management has concluded that realization
of the benefit is not likely.
The Company has available at December 31, 2003, $41,142,000 and
$26,700,000 of net operating loss carryforwards for federal and state
purposes, respectively. Approximately $13,318,000 and $9,960,000 of
these federal and state net operating loss carryforwards were acquired
as part of the merger with NTS. These loss carryforwards may be
applied against future taxable income and begin to expire in 2004.
Pursuant to Section 382 of the Internal Revenue Code, annual use of
the tax loss carryforwards may be limited if there is a change in
ownership. This limitation applies to the losses incurred by Nestor,
Inc., as well as to the losses incurred by NTS. The use of state net
operating losses may be limited in the future due to the apportionment
of net operating losses among different states and varying net
operating loss utilization requirements by state. The Company has not
determined the effect of these limitations.
46
NOTE 16 - NESTOR TRAFFIC SYSTEMS, INC.:
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.
On August 6, 2001, the Company filed Form S-4/A with the Securities
and Exchange Commission. The combination was approved by the
shareholders of both companies in meetings held on September 12, 2001.
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.
Upon consummation of the combination contemplated above, the Group
converted the note and accrued interest to equity and increased its
total investment to $8,000,000 in exchange for 16,757,368 pre-reverse
stock split shares (representing approximately 33.34%) of post-merger
Nestor, Inc. common stock. Concurrently, NTS shareholders exchanged
their NTS common shares held for Nestor, Inc. common stock and, in the
aggregate, received 15,581,190 pre-reverse stock split shares
representing approximately 31% of post-merger Nestor, Inc. common
stock.
In addition, the Group received a warrant right to acquire up to
2,980,712 additional shares of common stock exercisable at the same
price at which currently outstanding warrants of Nestor, Inc. are
exercisable, but only in the event the currently outstanding warrants
are exercised, so as to maintain their initial ownership interest
percentage. This warrant right decreased by 1,250,000 shares on March
1, 2002 with the expiration of TSAI's warrant on that date. In
addition, the Group received a warrant to acquire 1,000,000 shares of
the Company's common stock at $1.28 per share for three years as
dilution protection against both the Company's and NTS's converted
employee stock options outstanding at closing. Such warrants are
treated as variable and, accordingly, are revalued quarterly with
offsetting adjustments to additional paid-in capital. All shares above
are on a pre-reverse stock split basis.
The following is a summary of the purchase price and allocation to the
fair value of the assets acquired and liabilities assumed.
Value of common stock issued to consummate the merger $ 7,790,595
Value of options issued as a result of the merger 1,621,395
Value of warrants issued as a result of the merger 43,994
Acquisition costs 622,144
-----------
Total purchase price 10,078,128
Plus net NTS liabilities assumed by Nestor, Inc. 4,002,556
-----------
Goodwill $14,080,684
===========
Fair values of assets acquired and liabilities assumed:
Cash and cash equivalents $ 361,804
Accounts receivable 166,765
Inventory 501,899
Fixed assets - net 2,240,614
Other assets 281,540
Note payable (4,000,000)
Accounts payable and accrued expenses (1,519,444)
Other current liabilities (286,710)
Long term leases payable (1,749,024)
------------
Net liabilities assumed $(4,002,556)
===========
47
The following table presents the consolidated results of operations
for the year ended December 31, 2001 on an unaudited pro forma basis
as if the merger took place at the beginning of the period presented.
Revenues $ 4,435,000
Net loss $ 5,419,000
Loss per share, basic and diluted,
pre-reverse stock split $ 0.13
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 in 2001,
$250,000 in 2002, $500,000 in 2003, $750,000 in 2004 and $1 million
for each year thereafter, in order to maintain exclusive rights. The
annual minimum royalties were recorded and eliminated in
consolidation.
During 2001, NTS used facility and administrative services of the
Company, including office space and executive, accounting and other
support personnel. Prior to the September 2001 merger, facility and
administrative fees charged to NTS were $397,000 in 2001. Post-merger
charges were eliminated in consolidation.
NOTE 17 - RELATED PARTY TRANSACTIONS:
Herbert S. Meeker, a former director of the Company, is a partner in
the law firm of Brown Raysman Millstein Felder & Steiner, LLP, which
the Company uses for legal services. For the years ended December 31,
2003, 2002, and 2001, the Company recorded an expense to Mr. Meeker's
firm of $41,316, $7,254 and $121,065, respectively. In addition, for
the years ended December 31, 2003 and 2002, the Company recorded
$42,657 and $9,919 of fees relating to the 2003 Silver Star stock
purchase agreement. Lastly, $369,501 of fees were recorded in 2001 as
acquisition costs related to the NTS merger.
Bruce W. Schnitzer, a former director of the Company, is Chairman of
Wand Partners, Inc., a private investment firm that the Company used
for management consulting. For the year ended December 31, 2001, the
Company recorded an expense for Wand Partners, Inc. of $49,636. In
2002, the Company reversed $71,848 of previously expensed Wand fees
(recorded as a reduction to general and administrative expenses) in
connection with a Termination and Release Agreement agreed to in
principle prior to December 31, 2002 but dated January 15, 2003.
Included in accrued liabilities at December 31, 2002 is $96,250 due to
Wand Partners, Inc.
Benjamin Alexander, secretary of the Company (as of June 2003), is an
attorney with the firm of Partridge, Snow and Hahn LLP, which the
Company uses for legal services. For the year ended December 31, 2003,
the Company recorded legal and stockholder expenses to Mr. Alexander's
firm in the amounts of $63,973 and $24,354, respectively. In addition,
$11,261 was recorded relating to the July 2003 Laurus financing, which
was fully expensed as financing fees.
TSAI, the parent company of ACI, is a stockholder of the Company.
Thomas H. Boje, Vice President, Corporate Development of TSAI, was a
director of the Company April 2000 through 2001. For the years ended
December 31, 2002 and 2001, the Company recorded revenues of $629,569
and $1,841,031, respectively from ACI. Further related party
transactions with TSAI and ACI are discussed throughout these
financial statements.
48
Deferred compensation of $79,131 was recorded and accrued for the
period July 1, 2002 to December 31, 2002 for two officers of the
Company. The deferral was paid in full January 2003.
See Note 6 for transactions with Silver Star and Laurus, Note 13 for
royalty assignment to Churchill Lane Associates, LLC and Note 16 for
transactions with Nestor Traffic Systems, Inc.
NOTE 18 - COMMITMENTS AND CONTINGENCIES:
NTS entered into an operating lease dated June 21, 2000 for office and
warehouse facilities in East Providence, Rhode Island. This lease
provides for monthly rentals of $10,360 through July 2003 and then
increases to $10,800 monthly through July 2005. Rent expense for this
lease was $37,300 post-merger in 2001, $124,300 in 2002 and $126,500
in 2003.
NTS also leases office space in La Jolla, California. The July 17,
2002 operating lease called for monthly rent of $1,533 through the
lease term expiration of July 31, 2003. NTS remains in the space on a
month-to-month status at $1,691 per month. Rent expense was $8,500 in
2002 and $20,672 in 2003.
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. Rent expense was
$20,504 in 2003 and $40,134 in 2002 and 2001.
NOTE 19 - LITIGATION:
On November 6, 2003, the Company filed a complaint in the United
States District Court for Rhode Island against Redflex Traffic
Systems, Inc., alleging that Redflex's automated red light enforcement
systems infringe on the Company's patent. Redflex denies this
allegation. On November 25, 2003, the Company filed a complaint in the
United States District Court for the District of Central California
against Transol USA, Inc., alleging that Transol's automated red light
enforcement systems infringe on the Company's patent. Transol has
counterclaimed that Nestor's patent is invalid and that Transol does
not infringe on it. Nestor was denied a preliminary injunction in the
Transol litigation. The Company cannot give assurance that it will be
successful in either action.
During April 2003, the former president of NTS resigned as a member of
the board of directors of the Company. The president's employment with
the Company and NTS terminated. The president filed a complaint
against the Company and NTS in the Providence Superior Court seeking
severance benefits, including twelve months salary of $180,000, upon
termination. See Form 8-K dated April 9, 2003 for further information.
The parties reached a mutually agreeable settlement on December 31,
2003, the terms of which are confidential. All claims have been
dismissed.
On July 12, 2002, Baldwin Line Construction of Maryland, Inc. filed a
lawsuit against Nestor Traffic Systems, Inc. in Fairfax County,
Virginia, seeking $117,105 plus interest related to invoices they
claimed were owed for construction work in Falls Church, Virginia. NTS
and Baldwin reached a settlement agreement on April 22, 2003 whereby
NTS paid $7,500 and all claims of each party were dismissed.
In the ordinary course of business, the Company is a defendant in
certain claims and legal proceedings. In the opinion of management,
the outcome of these matters will not have a material effect on the
financial position of the Company.
NOTE 20 - CONTRACT TERMINATION RESERVE:
A significant customer contract in the Rail line of business may be
terminated by mutual agreement prior to its completion as a result of
the Company's decision to focus its resources on CrossingGuard systems
49
and services. The Company accrued $125,000 of estimated contract
termination fees in June 2003.
NOTE 21 - 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.
Under the new agreement, ACI paid a one-time license fee of $1,104,000
for source code license rights to the software products, and in
addition, agreed to pay an ongoing royalty fee of 15% with a first
year minimum of approximately $475,000. The license granted to ACI is
for products that constituted a significant portion of the Company's
gross revenues. During the quarter ended March 31, 2001, the Company
recorded the one-time initial license fee of $1,104,000 in connection
with this source code license. Reported ACI revenues thereafter
decreased significantly due to the termination of the previous ACI
contract that provided a 40% monthly license fee as well as additional
engineering revenues. Expenses relating to these revenues have also
decreased significantly because ACI hired thirteen employees from
Nestor, Inc., effective February 1, 2001, and reimbursed the Company
$13,000 per month for the continued use of Nestor, Inc. facilities and
equipment prior to their office relocation in May 2001. Unbilled
contract revenue and deferred income under the prior agreement were
replaced by the new royalty amounts during the quarter to reflect the
15% royalty rate under the new agreement. During the quarter ended
March 31, 2001, the Company recorded a non-cash reduction of
$3,037,000 and a non-cash increase of $1,111,000 in unbilled contract
revenue and deferred income related to these agreements.
Nestor continued to receive royalties under this agreement through
June 30, 2002. Effective July 1, 2002, the Company assigned its ACI
royalty rights to Churchill Lane Associates.
NOTE 22 - RETAIL DECISIONS, INC. LICENSE AGREEMENT:
On May 18, 2001, Nestor entered into a license agreement with Retail
Decisions, Inc. ("ReD") in which Nestor granted to ReD: (i) an
exclusive (other than ACI), perpetual, fully-paid, worldwide license
in the field of use of fraud and money laundering detection and risk
management in certain defined industries; and (ii) a non-exclusive,
perpetual, fully-paid, worldwide license solely for use in the field
of use of customer relationship management in certain defined
industries.
Additionally, Nestor transferred to ReD certain assets that were
supportive of the technology licensed thereunder. The assets
transferred to ReD by Nestor include all of the right, title and
interest of Nestor in certain equipment, license agreements (excluding
ACI) and trademark rights. To support its newly acquired license, ReD
hired 13 of Nestor's employees.
ReD paid $1,800,000 to Nestor under the license agreement, and Nestor
agreed, for certain marketing and transition services, to pay to ReD:
(i) $500,000 which was paid on July 2, 2001; (ii) $250,000 which was
paid on October 1, 2001; and (iii) $218,000 which was paid January 2,
2002. The Company recorded $832,000 as net license revenue in the
second quarter of 2001 in connection with this agreement. No ongoing
revenues have been realized from ReD.
NOTE 23 - RECENT ACCOUNTING PRONOUNCEMENTS:
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure and Amendment to
FASB No. 123", which provides three optional transition methods for
entities that decide to voluntarily adopt the fair value recognition
principles of SFAS No. 123, "Accounting for Stock Issued to
50
Employees", and modifies the disclosure requirements of that
Statement. The Company has not adopted the fair value recognition
principles of SFAS No. 123; therefore this Statement has had no effect
upon the Company's consolidated financial condition or results of
operations. The Company has provided the additional quarterly
disclosures required by SFAS No. 148.
See Independent Auditors' Reports.
51
PART III
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 Securities and Exchange
Commission not later than 120 days following the end of the Company's
fiscal year.
The Company has adopted a written code of ethics that applies to all
employees, including but not limited to, its principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions. A copy of
Nestor's code of ethics is available without charge by writing to:
Nestor, Inc., 400 Massasoit Avenue, Suite 200, East Providence, Rhode
Island 02914-2020, Attention: Nigel P. Hebborn.
ITEM 11. Executive Compensation.
----------------------
Incorporated by reference from the Company's definitive proxy or
information statement to be filed with the Securities and Exchange
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 Securities and Exchange
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 Securities and Exchange
Commission not later than 120 days following the end of the Company's
fiscal year.
ITEM 14. Principal Accounting Fees and Services.
--------------------------------------
Incorporated by reference from the Company's definitive proxy or
information statement to be filed with the Securities and Exchange
Commission not later than 120 days following the end of the Company's
fiscal year.
52
PART IV
Item 15. 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.
(2) Consolidated Financial Statement Schedule: Valuation
and Qualifying Accounts and Reserves
All other schedules are omitted because such
information is not applicable
(3) Exhibits numbered in accordance with Item 601 of
Regulation S-K and filed herewith.
See Exhibit Index.
(b) Reports on Form 8-K:
On October 17, 2003, the Corporation filed with the
Securities and Exchange Commission a current report on Form
8-K dated September 23, 2003 under Items 5 and 7, reporting
the increase in the number of directors of the Corporation
to seven, the election to the Board of Albert H. Cox, Terry
Fields and Susan A. Keller and the purchsae by Silver Star
Partners I, LLC of a convertible note in the principal
amount of $2,000,000 from the Corporation.
On October 28, 2003, the Corporation filed with the
Securities and Exchange Commission a current report on Form
8-K dated October 22, 2003 under Items 5 and 7, reporting
the resignation of Stephen H. Marbut from the Corporation's
Board of Directors and the election of George L. Ball
thereto.
53
PART IV
ITEM 15 (a)(2)
NESTOR, INC.
------------
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
-----------------------------------------
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
----------------------------------------------
Balance at Charged Charged Deductions Balance
Beginning to to Other from at End of
of Period Expense Accounts Reserve Period
--------- ------- -------- ------- ------
Allowances deducted
from accounts
receivable:
Year Ended
----------
December 31, 2001 $4,145 $(4,145) $ --- $ --- $ ---
December 31, 2002 $ --- $ --- $ --- $ --- $ ---
December 31, 2003 $ --- $84,213 $ --- $ --- $84,213
54
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/ William B. Danzell
---------------------------------------------
William B. Danzell, Chief Executive Officer
/s/ Nigel P. Hebborn
---------------------------------------------
Nigel P. Hebborn, Chief Financial Officer
Date: March 29, 2004
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/ Robert M. Krasne
- --------------------
Robert M. Krasne Chairman of the Board March 29, 2004
/s/ George L. Ball
- ------------------
George L. Ball Director March 29, 2004
/s/ Albert H. Cox, Jr.
- ----------------------
Albert H. Cox, Jr. Director March 29, 2004
/s/ William B. Danzell President
- ---------------------- Chief Executive Officer
William B. Danzell and Director March 29, 2004
/s/ Terry E. Fields
- -------------------
Terry E. Fields Director March 29, 2004
/s/ David N. Jordan
- -------------------
David N. Jordan Director March 29, 2004
/s/ Susan A. Keller
- -------------------
Susan A. Keller Director March 29, 2004
55
INDEX OF EXHIBITS
Exhibit
No. Description of Exhibit
------- ----------------------
3.1 Restated Certificate of Incorporation.
4.1 Specimen Certificate for shares of Common Stock, $.01 par value,
of the Registrant filed as an Exhibit to the Company's
Registration Statement on Form S-2, as amended (File No.
333-108432), is hereby incorporated by reference.
10.1 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.
10.2 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.
10.3 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.
10.4 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.
10.5 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.
10.6 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.
10.7 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.
10.8 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.
10.9 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.
10.10 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.
10.11 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.
10.12 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.
56
Exhibit
No. Description of Exhibit
------- ----------------------
10.13 License Agreement dated May 18, 2001 between the Company and
Retail Decisions, Inc. filed as an exhibit to the Company's
current report on Form 8K dated May 18, 2001 which is hereby
incorporated by reference.
10.14 Security Purchase Agreement dated July 31, 2003 between Nestor,
Inc. and Laurus Master Fund, Ltd. filed as an exhibit to the
Company's current report on Form 8-K dated July 31, 2003, which
is hereby incorporated by reference.
10.15 Convertible Note dated July 31, 2003 made by Nestor, Inc. to
Laurus Master Fund, Ltd. filed as an exhibit to the Company's
current report on Form 8-K dated July 31, 2003 which is hereby
incorporated by reference.
10.16 Registration Rights Agreement dated July 31, 2003 between
Nestor, Inc. and Laurus Master Fund, Ltd. filed as an exhibit to
the Company's current report on Form 8-K dated July 31, 2003,
which is hereby incorporated by reference.
10.17 Common Stock Purchase Warrant dated July 31, 2003 issued by
Nestor, Inc. to Laurus Master Fund, Ltd. filed as an exhibit to
the Company's current report on Form 8-K dated July 31, 2003
which is hereby incorporated by reference.
10.18 Stock Pledge Agreement dated July 31, 2003 between Nestor
Traffic Systems, Inc. and Laurus Master Fund, Ltd. filed as an
exhibit to the Company's current report on Form 8-K dated July
31, 2003, which is hereby incorporated by reference.
10.19 Pledge and Security Agreement dated July 31, 2003 between
CrossingGuard, Inc. and Laurus Master Fund, Ltd. filed as an
exhibit to the Company's current report on Form 8-K dated July
31, 2003 which is hereby incorporated by reference.
10.20 Guaranty dated July 31, 2003 by CrossingGuard, Inc. to Laurus
Master Fund, Ltd. filed as an exhibit to the Company's current
report on Form 8-K dated July 31, 2003 which is hereby
incorporated by reference.
10.21 Nestor, Inc. Incentive Stock Option Plan, as amended, filed as
an Exhibit to the Company's Registration Statement on Form S-8,
filed May 5, 1987, is hereby incorporated herein by reference
10.22 Nestor, Inc. 1997 Incentive Stock Option Plan, as amended, filed
as an Exhibit to the Company's Registration Statement on Form
S-8, filed May 16, 1997, is hereby incorporated by reference.
10.23 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 filed as an Exhibit to Nestor's Current
Report on Form 8-K dated May 7, 1998 is hereby incorporated by
reference.
10.24 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 filed as an Exhibit to Nestor's Current Report on
Form 8-K dated April 23, 1999 is hereby incorporated by
reference.
10.25 Security Purchase Agreement dated January 14, 2004 between
Nestor, Inc. and Laurus Master Fund, Ltd. filed as an Exhibit to
Nestor's Current Report on Form 8-K dated December 31, 2003 is
hereby incorporated by reference.
10.26 Convertible Note dated January 14, 2004 made by Nestor, Inc. to
Laurus Master Fund, Ltd. filed as an Exhibit to Nestor's Current
Report on Form 8-K dated December 31, 2003 is hereby
incorporated by reference.
57
Exhibit
No. Description of Exhibit
------- ----------------------
10.27 Registration Rights Agreement dated January 14, 2004 between
Nestor, Inc. and Laurus Master Fund, Ltd. filed as an Exhibit to
Nestor's Current Report on Form 8-K dated December 31, 2003 is
hereby incorporated by reference.
10.28 Redemption and Conversion Agreement dated January 14, 2004
between Nestor, Inc. and Laurus Master Fund, Ltd. filed as an
Exhibit to the Company's Registration Statement on Form S-2, as
amended (File No. 333-108432), is hereby incorporated by
reference.
10.29 Placement Agent Agreement dated December 24, 2003 among Nestor,
Inc., Sanders Morris Harris, Inc., and Barrett & Company, Inc.
filed as an Exhibit to the Company's Registration Statement on
Form S-2, as amended (File No. 333-108432), is hereby
incorporated by reference.
10.30 Registration Rights Agreement dated December 31, 2003 among
Nestor, Inc., Sanders Morris Harris, Inc., and Barrett &
Company, Inc. filed as an Exhibit to the Company's Registration
Statement on Form S-2, as amended (File No. 333-108432), is
hereby incorporated by reference.
31.1 Certification of Chief Executive Officer required by Exchange
Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer required by Exchange
Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer required by Exchange
Act Rules 13a-14(b) and 15d-14(b), as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.*
32.2 Certification of Chief Financial Officer required by ExchangeA
ct Rules 13a-14(b) and 15d-14(b), as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.*
99.1 Safe Harbor for Forward-Looking Statements Under the Private
Securities Litigation Reform Act of 1995.
*Certification is not deemed "filed" for purposes of Section 18 of the Exchange
Act, or otherwise subject to the liability of that section. Such certification
is not deemed to be incorporated by reference into any filing under the
Securities Act or the Exchange Act, except to the extent that the registrant
specifically incorporates it by reference.
58