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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, 2004
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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 8,277,780 shares of voting stock held by
non-affiliates of the registrant on June 30, 2004, based on the closing price of
such stock on June 30, 2004, was $33,856,120.
The number of shares outstanding of the Registrant's Common Stock at March 17,
2005 was 18,777,790.
DOCUMENTS INCORPORATED BY REFERENCE
Sections of Nestor, Inc.'s definitive Proxy Statement for the 2005 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., through its wholly owned subsidiary, Nestor Traffic Systems, Inc.,
is a leading provider of innovative, video based traffic safety and enforcement
systems to state and local governments throughout the United States. Our
principal product, CrossingGuard(R) incorporates our patented image processing
technology into an intelligent turnkey solution that predicts and records the
occurrence of a red light violation, and manages the entire process of issuing
and processing a citation. As of December 31, 2004, we had installed
CrossingGuard at 111 approaches for 13 customers throughout the United States,
and our contracts called for us to install CrossingGuard at an additional 128
approaches. We offer an advanced mobile speed enforcement product, through an
agreement with a third party vendor which provides us with exclusive rights to
market their product throughout North America. We also offer fixed speed
enforcement solutions.
The market for intelligent transportation systems and enforcement is
experiencing significant growth, particularly in the area of traffic light
safety enforcement. There are an estimated 300,000 intersections (1.2 million
approaches) with traffic signals in the United States. Technology solutions
manage enforcement at less than 0.5% of these approaches. In 2002, as many as
207,000 crashes, 178,000 injuries and 921 fatalities in the U.S. were attributed
to red light running. Fifteen states and the District of Columbia have already
authorized or allow municipalities to elect the use of automated traffic light
systems, such as CrossingGuard; more states are currently considering such
legislation.
CrossingGuard is an automated, video-based monitoring system that predicts and
records the occurrence of a red light violation. 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 collisions
between violators 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. We provide a complete turnkey solution, offering violation review,
citation preparation and processing, billing and collection, court scheduling,
evidence, and resolution. Our advanced technology captures approximately 270
images of each violation, enabling us to have an enforcement rate in excess of
95%. Depending on the terms of each contract, we realize from $11 to $99 per
citation issued or paid or fixed monthly fees ranging from $2,000 to $12,000 per
approach for system delivery and lease, maintenance, software licensing, and
processing services. We believe that our strong suite of patents covering our
image processing technology provides us with a strategic advantage and allows us
to offer a comprehensive solution to our state and local government clients.
In April 2004, we signed a contract to provide and install our systems at up to
60 approaches in Baltimore, under a prime contract that we believe to be the
largest contract awarded by a municipality to date. In March 2004, we signed a
contract with the state of Delaware to provide and install our systems at up to
40 approaches. We believe that our contract with Delaware is the first automated
red light enforcement contract issued by a state to date.
Information about the industry segments and geographic areas in which we operate
can be found in Note 13 to the financial statements included in this report.
OUR STRENGTHS
We believe that we possess many of the attributes that will be necessary for
long-term success in our industry, including the following:
o TRAFFIC ENFORCEMENT EXPERTISE. We have provided traffic products and
services to state and local governments for seven years. Given our
expertise and track record with these customers, we believe we are
well-positioned to take advantage of the expanding market and expected
increase in spending for traffic safety activities.
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o SUBSTANTIAL INSTALLED CUSTOMER BASE AND CONTRACTS. As of December 31,
2004 we had long-term contracts with 13 customers and 111 approaches
installed and generating citations, and an additional 128 approaches
under contract, waiting for customer orders for delivery or in various
stages of delivery.
o TECHNOLOGY AND INTELLECTUAL PROPERTY LEADERSHIP. Through innovative
use of pattern recognition technology, we have produced a number of
products to identify target patterns of information. We have a strong
patent portfolio. See "--Patents." With our team of veteran
innovators, we are focused and experienced in creating and protecting
our intellectual property. We intend to continue to invest in research
and development and product engineering to enable us to continue to
offer high quality, differentiated and cost-effective products to our
customers. In addition, through development, distribution and
licensing agreements with third parties such as Vitronic, we intend to
capitalize on leading technologies currently in the market and focus
our resources on those areas that provide the most value to our
customers.
o PRODUCT CAPABILITY. We believe video-based automated traffic
enforcement solutions are more technologically advanced than competing
systems such as in-ground sensor loops and "wet film," or on digital
still camera, red light camera systems. We believe that our expertise
in video-based solutions is a competitive advantage over many of our
competitors. We have a proven track record with our video-based
traffic enforcement systems performance and scalability with our
installed customer base.
o CUSTOMER SERVICE AND SUPPORT. We believe that our high level of
customer service and support differentiates us from our competitors.
We offer our customers an array of product support services including
intersection analysis and evaluation, user training, turnkey citation
processing, full system maintenance services, toll-free telephone
numbers for customer support and violator inquiries and assistance
with public education campaigns.
OUR STRATEGY
Our goal is to be the leading provider of traffic enforcement products and
services to state and local governments. Our strategy is to deliver to our
customers complete traffic enforcement solutions, which are designed to enhance
safety and generate sufficient revenue to pay the costs of the systems. We
believe that we possess many of the attributes that will be necessary for
long-term success in our industry by applying the following strategies:
o CAPITALIZE ON EMERGING AUTOMATED TRAFFIC ENFORCEMENT MARKET AND
INCREASE MARKET SHARE. We deliver complete solutions to our customers
and are dedicated to being the industry leader in automated traffic
enforcement products. We intend to continue to grow our installed base
of approaches as our primary emphasis through 2005. Our key target
customers are mid-sized and large municipalities with significant
traffic volume. New legislation in many states has enabled automated
traffic enforcement and increased demand for our products. As a
result, we have a significant opportunity to increase the number of
state and local government clients we serve. In particular, we are
seeing more municipalities seeking automated traffic enforcement, and
we plan to initiate new relationships and expand our existing
relationships with these customers. Currently, more than fifteen
states' legislatures are considering bills to enable or expand
automated traffic enforcement. We believe that through our innovative
technology and customer service, we will have significant
opportunities to new increase our number of approaches in newly opened
geographic markets across the U.S. In addition, we believe that we
will continue to grow our market share in our existing markets as our
customers become more comfortable and familiar with our products and
services.
o SUPPORT MARKET DEVELOPMENT EFFORTS. We have sought to accelerate
market adoption of our automated traffic enforcement products by
participating in the legislative process and in industry standards
committees. We also participate in industry trade groups to broaden
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acceptance and understanding of the market. We seek to continue these
efforts to grow the overall market opportunity. We intend to
accelerate our market development efforts by hiring additional
personnel in select areas, and leveraging the relationships that
members of our management and our advisory boards have with state and
local governments.
o CONTINUE TO LEAD TECHNOLOGICAL INNOVATION. We intend to strengthen our
position by continuing to make investments in research and development
while leveraging and improving our patented technologies. We believe
that we have been able to capture additional market share due
technological leadership with new products.
o LEVERAGE CUSTOMER RELATIONSHIPS TO EXPAND PRODUCT LINE. We believe we
will have significant opportunities to leverage our existing customer
relationships into other areas of automated traffic enforcement, such
as automated speed enforcement.
o EXPAND AND DEEPEN RELATIONSHIPS WITH CUSTOMERS. We intend to
strengthen and broaden the scope of our customer relationships by
expanding our customer support services to become an integrated part
of our customers' traffic enforcement solution. To implement this
strategy, we intend to continue to collaborate with our major
customers at the design and development stage of new products and to
seek to add value to our traffic systems.
o CONTINUE TO PURSUE SELECT ALLIANCES, OPPORTUNISTIC ACQUISITIONS AND
INVESTMENTS. We will continue to evaluate and selectively pursue
strategic alliances, opportunistic acquisitions and investments that
are complementary to our business. We will continue to seek
opportunities that provide us with enhanced technological expertise,
new markets for our products, a stronger product portfolio, increased
market share, new products or a diversification of risk.
o MAINTAIN STABLE CASH FLOWS FROM OPERATIONS AND DISCIPLINED CAPITAL
SPENDING. Our automated traffic enforcement systems are sold under
long-term contracts that provide visibility on our future sales and
cash flow. We intend to maintain our financial performance through
continued productivity initiatives designed to sustain our margins,
reduce costs and improve operating efficiency throughout our
businesses. We make disciplined capital expenditure decisions,
prioritized on the basis of cost structure improvement, potential for
profit generation and maintenance of high quality service.
COMPANY HISTORY
We were incorporated in 1983. We have engaged in various businesses since our
incorporation. Today, our business is limited to providing and installing
CrossingGuard systems and Vitronic speed enforcement products, processing
citations produced by those systems and related services.
Significant events in our recent corporate history, some of which are referred
to elsewhere in this annual report, are listed here:
o CHANGE IN CONTROL. On January 15, 2003, Silver Star Partners I, LLC
purchased 49 million shares of our pre-reverse stock split common
stock for $2,376,500 and on April 16, 2003, completed a second
closing, purchasing 4,013,557 post-reverse stock split shares for
$1,946,575. William B. Danzell, our Chairman, President and CEO, is
the Managing Director of Silver Star. Upon completion of the second
closing, Silver Star owned 64% of our outstanding shares of common
stock.
o REVERSE STOCK SPLIT. We amended our certificate of incorporation on
April 11, 2003, reverse splitting our common stock one for ten. We
issued one share of our common stock after the split for every ten
shares outstanding before the split.
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o MERGER OF NESTOR TRAFFIC SYSTEMS. In January 1997, we organized two
wholly-owned subsidiaries, Nestor Traffic Systems, Inc. and Nestor
Interactive, Inc. In November 1998, we ceased further investment in
Nestor Interactive. In 1999, Nestor Traffic Systems sold a majority
common stock interest to a group of investors. In June 2000, Nestor
Traffic Systems sold additional shares of its common stock to private
investors and our ownership of Nestor Traffic Systems was diluted to
approximately 35%. On September 12, 2001, we merged Nestor Traffic
Systems, Inc. into our wholly-owned subsidiary, which was then renamed
Nestor Traffic Systems, Inc.
o APPLIED COMMUNICATIONS, INC. On February 1, 2001, we entered into a
non-exclusive license agreement with Applied Communications, Inc. We
granted Applied Communications the right to integrate and distribute
all of fraud detection products throughout its worldwide sales and
support network. Applied Communications paid us $1.1 million in four
equal installments in the first six months of 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 are required. This agreement
replaced an earlier license to Applied Communications. We sold the
royalty rights to Churchill Lane Associates from this license on July
1, 2002. We do not expect to receive future revenues from this
license.
o RETAIL DECISIONS, INC. On May 18, 2001, we entered into a license
agreement with Retail Decisions, Inc. We granted Retail Decisions a
perpetual, fully-paid, worldwide license in the field of use of fraud
and money laundering detection and risk management in certain defined
industries; and a non-exclusive, perpetual, fully-paid, worldwide
license solely for use in the field of use of customer relationship
management in certain defined industries. Retail Decisions paid us
$1,800,000 under the license agreement, and for certain marketing and
transition services, we paid Retail Decisions $968,000 in 2001. No
ongoing revenues are expected to be realized from Retail Decisions.
o NATIONAL COMPUTER SYSTEMS, INC. On June 11, 1996, we entered into a
licensing agreement and an asset purchase agreement to transfer the
development, production, and marketing rights of our character
recognition products to National Computer Systems. National Computer
Systems continues to market the products on a non-exclusive basis.
Historically, we have received approximately $25,000 in minimum
royalties per year under this license.
INDUSTRY OVERVIEW
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, in 2000, there were approximately 106,000
red light running crashes that resulted in 89,000 injuries and 1,036 deaths,
according to the Federal Highway Administration. In 2002, as many as 207,000
crashes, 178,000 injuries and 921 fatalities in the U.S. were attributed to red
light running, according to the National Campaign to Stop Red Light Running.
First-generation red-light camera systems gained early acceptance as a means of
automated traffic enforcement. Although these systems validated the market
opportunity, they generally continue to rely on in-ground vehicle sensing 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, either through state enabling
statutes or home rule statutes. To date, approximately 15 states and the
District of Columbia authorize on a full or limited basis the use of red light
cameras. States allowing red light enforcement include:
Arizona Illinois Ohio
California Iowa Oregon
Colorado Maryland South Dakota
Delaware New York Tennessee
Georgia North Carolina Washington
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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.
According to the Federal Highway Administration, a 1998 Lou Harris poll
sponsored by Advocates for Highway & Auto Safety found that 65% of Americans
favored adoption of legislation to allow use of red light cameras. However,
there remains opposition to these systems, largely based upon concerns regarding
individual privacy rights and due process rights. Many states and communities
have or are considering authorization of cameras but need to address these
minority concerns first. We believe 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. We also believe that business opportunities from the
currently authorized communities will be enough to support near term growth
objectives.
PRODUCTS AND SERVICES
Our products combine sophisticated digital and analog camera technologies with
advanced image processing to detect and interpret a wide range of
traffic-related elements and conditions. Our 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. Our products are flexible and can be configured to a
wide range of road configurations, including open roads and intersections. Our
systems offer an array of features and unique functionality that address
critical transportation management and traffic safety needs. We formerly
developed and marketed products in the fields of risk management, customer
relationship management and character recognition.
CROSSINGGUARD RED LIGHT ENFORCEMENT
Our CrossingGuard systems 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 by
combining 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, we apply algorithms to
recognize objects as vehicles and predict their motion relative to the stop
line. This advanced technology, which effectively sees and interprets objects
captured in video images, is at the core of the CrossingGuard solution.
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. We provide citation mailing and other back-office
services.
We provide a complete turnkey solution, offering violation review, citation
preparation and processing, billing and collection, court scheduling, evidence,
and resolution. In addition, we provide 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 that is used to
track approaching vehicles and record the actions of an approaching violator.
Another camera is positioned so as to see the signal lights as they change from
green to yellow to red and record the vehicle's 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
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computer runs the intelligent software and controls camera activity and is
installed in an enclosure by the wayside or fiber connection to the roadside is
used. 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 functionality as needed. We purchase
all electronic and mechanical components from third party vendors, built in
accordance with our specifications, and local contractors install the systems.
The primary attributes of CrossingGuard are:
o ACCURATE, REAL-TIME INTERPRETATION OF TRAFFIC VIDEO IMAGES. We have
applied our 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. Our image-understanding technology
is able to interpret video images accurately and respond in a
real-time environment at affordable cost.
o 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), our 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.
o COMPATIBILITY WITH INDUSTRY STANDARD PLATFORMS. Our 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.
We also provide services related to our CrossingGuard systems:
CROSSINGGUARD VIP. The CrossingGuard Video Intersection Profiling (VIP) program
is a proprietary tool that we have 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.
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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. Many
contracts compensate us 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 us to
recover the value of the system delivered, including a finance factor and
maintenance costs, over the term of the contract. Throughout 2003 and 2004,
there has been a trend by states towards fixed monthly fee as opposed to
variable per ticket fee pricing structures.
As of December 31, 2004, we had 111 approaches installed and generating
citations and an additional 128 approaches under contract, waiting for customer
orders for delivery or in various stages of delivery. No assurances can be given
that all approaches under contract will ultimately be installed. Depending upon
contract terms, we realize from $11 to $99 per citation issued or paid or fixed
monthly fees ranging from $2,000 to $12,000 per approach for system delivery and
lease, maintenance, software licensing, and processing services. State statutes
providing for automated red light enforcement may impose liability on the driver
or the registered owner of a vehicle for a violation. Driver liability statutes
require that the driver be identified, from the photographic evidence, and that
the citation be issued and sent to the driver. Registered owner statutes require
that the vehicle's owner be identified, through registration records, and that
the citation be issued and sent to the driver. As only the license plate is
required for identification under a registered owner statute, program operating
efficiencies are much higher resulting in lower per citation or monthly fees.
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.
SPEED PRODUCTS
In August 2004, we entered into an exclusive distributorship agreement with a US
subsidiary of Vitronic GmbH, a German based corporation that provides solutions
for factory and industrial automation, quality inspection, logistics and traffic
management systems. Under the terms of the agreement, we have exclusive rights
to market and sell Vitronic's PoliScan Speed Mobile throughout the United
States, Canada, and Mexico, for an initial term of five years, subject to
minimum annual sales goals.
PoliScan Speed Mobile is a system for digital speed detection and recording. In
contrast to conventional measures such as radar, light barriers, and
piezo-section, a complex installation and calibration of the system at the
measurement site is not necessary. An additional feature is the ability to
simultaneously record and measure several vehicles in parallel lanes. Thus
ambiguities and measurement errors can be reliably avoided. The system uses a
high-resolution digital camera for documentation of the speeding offense,
including pictures of the license plate, an overview picture, as well as the
image of the driver where required.
We offer a fixed site speed camera system. The system will deliver video
evidence of vehicles speeding with advanced nonintrusive, performance similar to
our CrossingGuard systems. It is designed to allow for upgrading CrossingGuard
installations to enable dual 'red-and-speed' intersection monitoring. The system
may also be installed on a standalone basis. Our fixed speed solution uses two
independent speed detection sensors to cross-reference and verify the vehicle
speed, a feature that we believe is unique to our product.
We have begun marketing our speed products to jurisdictions in the
United States that allow the automated enforcement of speed limits.
OTHER TRAFFIC PRODUCTS
We have two other traffic safety and enforcement products - Rail CrossingGuard
and TrafficVision. We are no longer marketing or developing these products and
we do not expect to receive material revenue related to them in the future. In
2002 we eliminated our marketing and sales efforts for these product lines to
focus our resources on the CrossingGuard red-light enforcement market.
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RAIL CROSSINGGUARD. We 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.
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
from the 1950's, TrafficVision is a non-intrusive sensor system for traffic
management. TrafficVision uses our 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.
SALES, MARKETING AND METHODS OF DISTRIBUTION
We market our products and services to municipalities, governmental traffic
management departments, or their integrators through our nationwide direct sales
force. Because our products require technical assistance during the sales and
installation processes, we also maintain an in-house staff of program managers
and field engineers. We obtain product inquiries from product mailings,
attendance at trade shows, trade press coverage and our Internet site. Most
CrossingGuard contracts are obtained through competitive proposal processes in
response to requests for proposals issued by municipalities. We subscribe to a
service that advises us of relevant requests for proposal issued by state and
local governments. In 2004, we submitted fifteen proposals to state and local
governments. In 2004, as a result of bids submitted in 2003 and 2004, we were
awarded three contracts and we have been selected as the provider by, but not
entered into a contract with, six municipalities. No provider has been selected
with respect to five of the requests for proposals to which we responded in
2004.
RESEARCH AND DEVELOPMENT ACTIVITIES
The focus of our research and development is to develop and improve our products
and technologies in order to maintain and improve our products' competitive
advantages, our level of customer service and satisfaction and to consider the
development of new technologies and products. We have pursued new and enhanced
technologies and products extensively in the past and may do so again in the
future, but our current emphasis is on developing and improving existing
products with a proven market.
Our research and development includes 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 our basic
technology. See "--Patents." We have two additional patent applications pending
as of December 31, 2004, both in the area of traffic management, enforcement and
safety.
Changing technologies may affect the market for our products. Our 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 we 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 us 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 our business, financial condition and results of
operations.
We spent $157,000, $121,000 and $1,604,000 in the years ended December 31, 2004,
2003 and 2002 respectively, on research and development.
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PATENTS
We have continually sought and obtained patent protection for our traffic safety
systems and for our proprietary neural networks as, 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. Our patented
neural network exhibits rapid learning and minimizes the internal connections
needed for its functioning. We believe that these capabilities make our
technology uniquely suited to applications that require field trainability or
self-modification to adapt to new or changing patterns in the data. Our patents
also cover multiple-neural-network systems, which enabled us to develop products
that combined high accuracy with high processing speeds.
During 2004, we received two additional patents relative to the CrossingGuard
product line. The first patent recognizes the transmission of video as part of
the user interface in our CitationComposer software for ticket processing and
issuance. The second patent recognizes the invention of a traffic sensor.
During 2003, we received two additional patents relative to the CrossingGuard
product line. One of those patents recognizes our method of predicting and
recording a red light violation with a video-based system including the use of
violation probability scores. The second patent 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. We own 13
United States patents and 14 foreign patents. We have one pending U.S. patent
application and three foreign patent applications pending. Six of our U.S.
patents, two of our foreign patents and all of our patent applications have
relevance to our traffic safety business. 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
We believe 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 wet film or digital still cameras that record only a
few frames of evidence regarding a violation, and in-ground sensor loops.
In-ground sensor loops require digging up the pavement and are generally
unresponsive to vehicles moving below twelve miles per hour. 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.
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 our
video evidence attractive to city councils, law enforcement officials, courts,
and the general public. Our systems have a high enforceability rate; we average
99% in registered owner liability jurisdictions and 95% in driver liability
jurisdiction. The enforceability rate is the ratio of not successfully
challenged to citations issued. We believe that our enforceability rates are
higher than those of our many of our competitors and that part of the reason for
our high rate is the perception of fairness. Because of the ability to view the
violation video sequence, violators find it difficult to challenge our citations
based on context.
We are aware of at least six competitors that purport to have video in their
systems. We have initiated patent infringement lawsuits against two of these
competitors on the basis of our February 13, 2001 patent entitled "Integrated
Traffic Light Violation Citation Generation and Court Date Scheduling System"
and, with respect to one of those competitors, on our June 22, 2004 patent
entitled "Video-file based citation generation system for traffic light
violations." See "Risk Factors --If We Fail To Protect And Preserve Our
Intellectual Property, We May Lose An Important Competitive Advantage" and "--
Legal Proceedings." There can be no assurance that we will be successful in
defending this patent and limiting the use of video by competitors in the U.S.
red light enforcement market.
11
Our 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.
Most of our competitors have significantly greater financial, marketing and
other resources than we do. 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 we may. Competitive
pressures faced by us may materially adversely affect its business, financial
condition and results of operations.
CONTRACTS WITH GOVERNMENTAL ENTITIES
Our CrossingGuard agreements are generally service contracts with states or
municipalities that in most circumstances may be cancelled by the customer for
various reasons. As these contracts are generally self-funded from ticket fees
collected from red-light violators and some contracts contain termination fee
provisions, we do not expect this to be a significant risk in the future. Our
Rail CrossingGuard and TrafficVision contracts were generally fixed-fee
deliverable contracts and termination rights were generally limited to
non-performance conditions. We retain all patent and other proprietary rights
from products developed and delivered under government-supported contracts.
EMPLOYEES
As of December 31, 2004, we had 65 full-time employees, comprising 16 in
software engineering and product development, 11 in processing and system
support, 25 in program management and field services, 7 in sales and marketing
and 6 in management, finance and office support. All of our employees are
located in the United States. None of our employees are represented by a labor
union. We have experienced no work stoppages and management believes our
employee relationships are generally good.
RISK FACTORS THAT MAY AFFECT OUR RESULTS
This Annual Report on Form 10-K and certain other communications made by us
contain forward-looking statements, including statements about our growth and
future operating results, discovery and development of products, strategic
alliances and intellectual property. For this purpose, any statement that is not
a statement of historical fact should be considered a forward-looking statement.
We often use the words "believe," "anticipate," "plan," "expect," "intend,"
"will" and similar expressions to help identify forward-looking statements.
References in this exhibit "we," "us," and "our" refer to Nestor, Inc. and its
subsidiaries.
We cannot assure investors that our assumptions and expectations will prove to
have been correct. Important factors could cause our actual results to differ
materially from those indicated or implied by forward-looking statements. Such
factors that could cause or contribute to such differences include those factors
discussed below. We undertake no intention or obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
RISKS RELATED TO OUR BUSINESS
WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR LOSSES IN THE FUTURE
We have a history of net losses. For the years ended December 31, 2004, 2003,
2002, 2001 and 2000, our net losses have been approximately $4,473,000,
$4,890,000, $12,634,000, $1,565,000, $2,995,000 and $837,000, respectively. For
the three-month period ended December 31, 2004, our net loss was approximately
$1,959,000. We expect to incur continuing losses for the foreseeable future due
to significant engineering, product delivery, marketing and general and
administrative expenses, which losses could be substantial. We will need to
generate significantly higher revenue to achieve profitability, which we may be
unable to do. Even if we do achieve profitability, we may not be able to sustain
or increase our profitability in the future.
12
ALMOST ALL OF OUR CURRENT REVENUE IS FROM A SINGLE PRODUCT AND RELATED SERVICES
Currently, almost all of our revenue is from sales of our CrossingGuard systems,
services related to installing and maintaining CrossingGuard systems or
processing citations issued by CrossingGuard systems. There can be no assurance
that we will be able to develop other sources of revenue. Because our revenues
depend on a single product, any decrease in the market share held by
CrossingGuard would have a substantial adverse effect on our business and
financial results. If we fail to meet our expectations for the growth in sales
of CrossingGuard or if we are not able to develop other sources of revenue, we
will not be able to generate the significantly higher revenue that we believe we
must generate to achieve profitability.
OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED IF
WE ARE UNABLE TO SECURE AND MAINTAIN FUTURE CONTRACTS WITH GOVERNMENT AGENCIES
Contracts with government agencies account for substantially all of our net
revenues. The majority of these contracts may be terminated at any time on short
notice with limited penalties. Accordingly, we might fail to derive any revenue
from sales to government agencies in any given future period. If government
agencies fail to renew or if they terminate any of these contracts, it would
adversely affect our business and results of operations. In addition, many of
our contracts do not allow installations until sites have been approved by the
contracting agency; in those cases, if a government agency fails to approve
sites, we will not be able to deliver products and services.
WE FACE SUBSTANTIAL COMPETITION, WHICH MAY RESULT IN OTHERS DEVELOPING PRODUCTS
AND SERVICES MORE SUCCESSFULLY THAN WE DO
Many other companies offer products that directly compete with CrossingGuard and
our other products. Many of our current and potential competitors have
significantly greater financial, marketing, technical and other competitive
resources than we do and may be able bring new technologies to market before we
are able to do so. Some of our competitors may have a competitive advantage
because of their size, market share, legacy customer relationships, enhanced
driver imaging, additional products offered and/or citation-processing
experience. Current and potential competitors may establish cooperative
relationships with one another or with third parties to compete more effectively
against us. One of our competitors, ACS, offers state and local governments
solutions to a wide variety of data processing issues and may have a competitive
advantage because of the scope of its relationship with, and the volume of
transactions it conducts for, a particular government. It is also possible that
new competitors may emerge and acquire market share. If we are not successful in
protecting our patents, we would lose a competitive advantage. See "-- If We
Fail To Protect And Preserve Our Intellectual Property, We May Lose An Important
Competitive Advantage."
THE FAILURE OF GOVERNMENTS TO AUTHORIZE AUTOMATED TRAFFIC SAFETY ENFORCEMENT MAY
HINDER OUR GROWTH AND HARM OUR BUSINESS
Approximately fifteen states and the District of Columbia authorize some use of
automated red light enforcement or allow municipalities to elect to do so under
home rule laws. It is uncertain at this time which additional states, if any,
will authorize the use of automated red light enforcement or if there will be
other changes in the states that currently allow the practice. If additional
states do not authorize the use of automated red light enforcement, our
opportunities to generate additional revenue from the sale of CrossingGuard
systems and related services will be limited. Recently, the Virginia General
Assembly declined to extend authorization for automated red light enforcement
beyond the sunset date of June 30, 2005 in the enabling legislation.
We could be subject to differing and inconsistent laws and regulations with
respect to CrossingGuard. If that were to happen, we may find it necessary to
eliminate, modify or cancel components of our services that could result in
additional development costs and the possible loss of revenue. We cannot predict
whether future legislative changes or other changes in the eighteen states or
other states, in the administration of traffic enforcement programs, will have
an adverse effect on our business.
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The market for automated speed enforcement products in the United States is very
limited. At least five states and the District of Columbia have legislation
authorizing some use of automated speed enforcement or allow municipalities to
elect to do so under home rule laws. Some of these states authorize automated
speed enforcement only in limited circumstances such as school or work zones. If
additional states do not authorize automated speed enforcement, our
opportunities to generate additional revenue from the sale of automated speed
enforcement systems and related services will be limited.
OUR FINANCIAL RESULTS WILL DEPEND SIGNIFICANTLY ON OUR ABILITY TO CONTINUALLY
DEVELOP OUR PRODUCTS AND TECHNOLOGIES
The markets for which our products and technologies are designed are intensely
competitive and are characterized by short product lifecycles, rapidly changing
technology and evolving industry standards. As a result, our financial
performance will depend to a significant extent on our ability to successfully
develop and enhance our products. Because of the rapidly changing technologies
in the businesses in which we operate, we believe that significant expenditures
for research and development and engineering will continue to be required in the
future. To succeed in these businesses, we must anticipate the features and
functionality that customers will demand. We must then incorporate those
features and functionality into products that meet the design requirements of
our customers. The success of our product introductions will depend on several
factors, including:
o proper product definition;
o timely completion and introduction of enhanced product designs;
o the ability of subcontractors and component manufacturers to
effectively design and implement the manufacture of new or enhanced
products and technologies;
o the quality of our products and technologies;
o product and technology performance as compared to competitors'
products and technologies;
o market acceptance of our products; and
o competitive pricing of products, services and technologies.
We must successfully identify product and service opportunities and develop and
bring our products and technologies to market in a timely manner. We have in the
past experienced delays in completing the development or the introduction of new
products. Our failure to successfully develop and introduce new or enhanced
products and technologies or to achieve market acceptance for such products and
technologies may materially harm our business and financial performance.
WE MAY NEED ADDITIONAL FINANCING, WHICH MAY BE DIFFICULT TO OBTAIN AND MAY
RESTRICT OUR OPERATIONS AND DILUTE YOUR OWNERSHIP INTEREST
We may need to raise additional funds in the future to fund our operations,
deliver our products, to expand or enhance our products and services or to
respond to competitive pressures or perceived opportunities. We cannot make any
assurance that additional financing will be available on acceptable terms, or at
all. If adequate funds are not available or not available on acceptable terms,
our business and financial results may suffer.
The covenants in our outstanding 5% Senior Convertible Notes limit our ability
to raise additional debt. If we raise additional funds by issuing equity
securities, further dilution to our then existing stockholders will result and
the terms of the financing may adversely affect the holdings or the rights of
such stockholders. In addition, the terms and conditions of debt financing may
result in restrictions on our operations. We could be required to seek funds
through arrangements with collaborative partners or others that may require us
to relinquish rights to certain of our technologies, product candidates or
products which we would otherwise pursue on our own.
14
FLUCTUATIONS IN OUR RESULTS OF OPERATIONS MAKE IT DIFFICULT TO PREDICT OUR
FUTURE PERFORMANCE AND MAY RESULT IN VOLATILITY IN THE MARKET PRICE OF OUR
COMMON STOCK
Our quarterly operating results have fluctuated in the past and may fluctuate
significantly in the future. Most of our expenses are fixed in the short-term,
and we may not be able to reduce spending quickly if our revenue is lower than
expected. In addition, our ability to forecast revenue is limited. As a result,
our operating results are volatile and difficult to predict and you should not
rely on the results of one quarter as an indication of future performance.
Factors that may cause our operating results to fluctuate include the risks
discussed in this section as well as:
o costs related to customization of our products and services;
o the planned expansion of our operations, including opening new
offices, hiring new personnel, and the amount and timing of
expenditures related to this expansion;
o announcements or introductions of new products and services by our
competitors;
o the failure of additional states to adopt legislation enabling the use
of automated traffic safety enforcement systems;
o software defects and other product quality problems;
o the discretionary nature of our clients' purchasing and budgetary
cycles;
o the varying size, timing and contractual terms of orders for our
products and services; and
o the mix of revenue from our products and services.
OUR SALES CYCLES VARY SIGNIFICANTLY WHICH MAKES IT DIFFICULT TO PLAN OUR
EXPENSES AND FORECAST OUR RESULTS
Our sales cycles typically range from six to eighteen months or more. It is
therefore difficult to predict the quarter in which a particular sale will occur
and to plan our expenses accordingly. The period between our initial contact
with potential clients and the installation of our products and the use of our
services varies due to several factors, including:
o the complex nature of our products and services;
o the failure of the jurisdiction to adopt legislation enabling the use
of automated traffic safety enforcement systems or political or legal
challenges to existing legislation;
o the novelty of automated enforcement in many jurisdictions and a lack
of familiarity with automated enforcement systems on the part of
legislative, executive and judicial bodies and the public;
o our clients' budget cycles;
o the selection, award and contracting processes at municipalities and
other government entities, including protests by other bidders with
respect to competitive awards;
o our clients' internal evaluation, approval and order processes;
o the site evaluation and analysis process; and
o our clients' delays in issuing requests for proposals or in awarding
contracts because of announcements or planned introductions of new
products or services by our competitors.
15
Any delay or failure to complete sales in a particular quarter could reduce our
revenue in that quarter, as well as subsequent quarters over which revenue or
the license would likely be recognized. If our sales cycles unexpectedly
lengthen in general or for one or more large clients, it would delay our receipt
of the related revenue. If we were to experience a delay of several weeks or
longer on a large client, it could harm our ability to meet our forecasts for a
given quarter.
IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, OUR OPERATIONS WOULD BE DISRUPTED AND OUR BUSINESS WOULD BE HARMED
We believe that the hiring and retaining of qualified individuals at all levels
in our organization will be essential to our ability to sustain and manage
growth successfully. Competition for highly qualified technical personnel is
intense and we may not be successful in attracting and retaining the necessary
personnel, which may limit the rate at which we can develop products and
generate sales. We will be particularly dependent on the efforts and abilities
of our senior management personnel. The departure of any of our senior
management members or other key personnel could harm our business.
OUR PRODUCTS MIGHT NOT ACHIEVE MARKET ACCEPTANCE
The market for our products is still emerging. The rate at which state and local
government bodies have adopted CrossingGuard has varied significantly by market,
and we expect to continue to experience variations in the degree to which
CrossingGuard is accepted. To date, no state or local government bodies in our
market area have adopted our speed enforcement products. Our ability to grow
will depend on the extent to which our potential customers accept our products.
This acceptance may be limited by:
o the failure of prospective customers to conclude that our products are
valuable and should be acquired and used;
o the failure of additional states to adopt legislation enabling the use
of automated traffic safety enforcement systems;
o the novelty of automated enforcement in many jurisdictions and a lack
of familiarity with automated enforcement systems on the part of
legislative, executive and judicial bodies and the public;
o the reluctance of our prospective customers to replace their existing
solutions with our products;
o marketing efforts of our competitors; and
o the emergence of new technologies that could cause our products to be
less competitive or obsolete.
Because automated traffic enforcement in the United States is still in an early
stage of development, we cannot accurately predict how large the market will
become, and we have limited insight into trends that may emerge and affect our
business. For example, without knowing how commonplace automated enforcement
will become, we may have difficulties in predicting the competitive environment
that will develop.
OUR INTELLECTUAL PROPERTY MIGHT NOT BE PROTECTIBLE
We rely on a combination of copyright, trademark, patent, and trade-secret laws,
employee and third-party nondisclosure agreements, and other arrangements to
protect our proprietary rights. Despite these precautions, it may be possible
for unauthorized third parties to copy our products or obtain and use
information that we regard as proprietary to create products that compete
against ours. In addition, some license provisions protecting against
unauthorized use, copying, transfer, and disclosure of our licensed programs may
be unenforceable under the laws of certain jurisdictions and foreign countries.
In addition, the laws of some countries do not protect proprietary rights to the
same extent as do the laws of the United States. Were we to conduct
international activities, our exposure to unauthorized copying and use of our
products and proprietary information would increase. The scope of United States
patent protection in the software industry is not well defined and will evolve
16
as the United States Patent and Trademark Office grants additional patents.
Because some patent applications in the United States are not publicly disclosed
until the patent is issued or 18 months after the filing date, applications may
exist that would relate to our products and that are not publicly accessible.
Moreover, a patent search has not been performed in an attempt to identify
patents applicable to our business and, even if such a search were conducted,
all patents applicable to the business might not be located.
IF WE FAIL TO PROTECT AND PRESERVE OUR INTELLECTUAL PROPERTY, WE MAY LOSE AN
IMPORTANT COMPETITIVE ADVANTAGE
On November 6, 2003, we 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 our US Patent No. 6,188,329. On
November 25, 2003, we 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 that patent. We were
denied a preliminary injunction in the Transol litigation, in part because the
court determined that we had not shown a likelihood of success on our claim that
Transol's product infringes our patent. We subsequently filed additional claims
alleging that Transol and Redflex have also infringed our US Patent No.
6,754,663, but have withdrawn that claim with respect to Redflex. Transol has
filed a motion for summary judgment, on which motion a hearing is scheduled for
April 11, 2005.
We cannot give assurance that we will succeed in either action. If we are
unsuccessful in either action, it will be because either our one or both patents
are invalidated or because our competitors' products do not infringe our
patents. Were one or more of our patents invalidated, our competitors will be
able to offer the technology that those patents describe and we would lose the
competitive advantage of being the exclusive source of products using that
technology. Were our competitors' products to be found to be non-infringing, our
competitors would be able to continue to market products that are similar to
ours and we would lose some of the competitive advantages that we believe our
products enjoy.
WE ARE AT RISK OF CLAIMS THAT OUR PRODUCTS OR SERVICES INFRINGE THE PROPRIETARY
RIGHTS OF OTHERS
Given our ongoing efforts to develop and market new technologies and products,
we may from time to time be served with claims from third parties asserting that
our products or technologies infringe their intellectual property rights. If, as
a result of any claims, we were precluded from using technologies or
intellectual property rights, licenses to the disputed third-party technology or
intellectual property rights might not be available on reasonable commercial
terms, or at all. We may initiate claims or litigation against third parties for
infringement of our proprietary rights or to establish the validity of our
proprietary rights. Litigation, either as plaintiff or defendant, could result
in significant expense and divert the efforts of our technical and management
personnel from productive tasks, whether or not litigation is resolved in our
favor. An adverse ruling in any litigation might require us to pay substantial
damages, to discontinue our use and sale of infringing products and to expend
significant resources in order to develop non-infringing technology or obtain
licenses for our infringing technology. A court might also invalidate our
patents, trademarks or other proprietary rights. A successful claim against us,
coupled with our failure to develop or license a substitute technology, could
cause our business, financial condition and results of operations to be
materially adversely affected. As the number of software products increase and
the functionality of these products further overlaps, we believe that our risk
of infringement claims will increase.
IF WE ARE UNABLE TO SAFEGUARD THE INTEGRITY, SECURITY AND PRIVACY OF OUR DATA OR
OUR CLIENTS' DATA, OUR REVENUE MAY DECLINE, OUR BUSINESS COULD BE DISRUPTED AND
WE MAY BE SUED
We need to preserve and protect our data and our clients' data against loss,
corruption and misappropriation caused by system failures and unauthorized
access. We could be subject to liability claims by individuals whose data
resides in our databases for misuse of personal information, including
unauthorized marketing purposes. These claims could result in costly litigation.
Periodically, we have experienced minor systems errors and interruptions,
including Internet disruptions, which we believe may occur periodically in the
future. A party who is able to circumvent our security measures could
misappropriate or destroy proprietary information or cause interruptions in our
operations. We may be required to make significant expenditures to protect
against systems failures or security breaches or to alleviate problems caused by
any failures or breaches. Any failure that causes the loss or corruption of, or
17
unauthorized access to, this data could reduce client satisfaction, expose us to
liability and, if significant, could cause our revenue to decline.
WE MAY MAKE ACQUISITIONS, WHICH COULD DIVERT MANAGEMENT'S ATTENTION, CAUSE
OWNERSHIP DILUTION TO OUR STOCKHOLDERS AND BE DIFFICULT TO INTEGRATE
We have expanded and may seek to continue to expand our operations through the
acquisition of additional businesses that complement our core skills and have
the potential to increase our overall value. Our future growth may depend, in
part, upon the continued success of our acquisitions. Acquisitions involve many
risks, which could have a material adverse effect on our business, financial
condition and results of operations, including:
o acquired businesses may not achieve anticipated revenues, earnings or
cash flow;
o integration of acquired businesses and technologies may not be
successful and we may not realize anticipated economic, operational
and other benefits in a timely manner, particularly if we acquire a
business in a market in which we have limited or no current expertise
or with a corporate culture different from ours;
o potential dilutive effect on our stockholders from continued issuance
of common stock as consideration for acquisitions;
o adverse effect on net income of impairment charges related to goodwill
and other intangible assets and other acquisition-related charges,
costs and expenses on net income;
o competing with other companies, many of which have greater financial
and other resources to acquire attractive companies, making it more
difficult to acquire suitable companies on acceptable terms; and
o disruption of our existing business, distraction of management and
other resources and difficulty in maintaining our current business
standards, controls and procedures.
THE FAILURE OF OUR SUPPLIERS TO DELIVER COMPONENTS, EQUIPMENT AND MATERIALS IN
SUFFICIENT QUANTITIES AND IN A TIMELY MANNER COULD ADVERSELY AFFECT OUR BUSINESS
Our business employs a wide variety of components, equipment and materials from
a limited number of suppliers. To date, we have found that the components,
equipment and materials necessary for the development, testing, production and
delivery of our products and services have sometimes not been available in the
quantities or at the times we have required. Our failure to procure components,
equipment and materials in particular quantities or at a particular time may
result in delays in meeting our customer's needs, which could have a negative
effect on customer satisfaction and on our revenues and results of operations.
WE ARE SUBJECT TO POTENTIAL PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN COSTLY
AND TIME-CONSUMING LITIGATION
Although our license agreements typically contain provisions designed to limit
our exposure to product liability claims, existing or future laws or unfavorable
judicial decisions could negate these limitation of liability provisions. Any
product liability claim brought against us, even if unsuccessful, would likely
be time-consuming and costly, and potential liabilities could exceed our
available insurance coverage.
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RISKS RELATED TO OUR COMMON STOCK
OUR COMMON STOCK PRICE IS VOLATILE AND MAY DECLINE IN THE FUTURE
The market price of our common stock has fluctuated significantly and may be
affected by our operating results, changes in our business, changes in the
industries in which we conduct business, and general market and economic
conditions which are beyond our control. In addition, the stock markets in
general have recently experienced extreme price and volume fluctuations. These
fluctuations have affected stock prices of many companies without regard to
their specific operating performance. These market fluctuations may make it
difficult for stockholders to sell their shares at a price equal to or above the
price at which the shares were purchased. In addition, if our results of
operations are below the expectations of market analysts and investors, the
market price of our common stock could be adversely affected.
OUR BOARD OF DIRECTORS CAN, WITHOUT STOCKHOLDER APPROVAL, CAUSE PREFERRED STOCK
TO BE ISSUED ON TERMS THAT ADVERSELY AFFECT COMMON STOCKHOLDERS
Under our certificate of incorporation, our board of directors is authorized to
issue up to 10,000,000 shares of preferred stock, of which 180,000 shares are
issued and outstanding, and to determine the price, rights, preferences,
privileges and restrictions, including voting rights, of those shares without
any further vote or action by our stockholders. If the board causes any
additional preferred stock to be issued, the rights of the holders of our common
stock would be adversely affected. The board's ability to determine the terms of
preferred stock and to cause its issuance, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, could
have the effect of making it more difficult for a third party to acquire a
majority of our outstanding voting stock. We have no current plans to issue
additional shares of preferred stock.
OUR DIRECTORS, OFFICERS AND PRINCIPAL STOCKHOLDERS EXERCISE SIGNIFICANT CONTROL
OVER OUR BUSINESS AND AFFAIRS, INCLUDING THE APPROVAL OF CHANGE IN CONTROL
TRANSACTIONS
Our directors, officers, and principal stockholders who own more than 5% of the
outstanding common stock, and entities affiliated with them, beneficially own
approximately 52% of our common stock. These stockholders, acting together, will
be able to exert substantial influence over all matters requiring approval by
our stockholders. These matters include the election and removal of directors
and any merger, consolidation or sale of all or substantially all of our assets.
This concentration of ownership may have the effect of delaying, deferring or
preventing a change in control, or impeding a merger, consolidation, takeover or
business combination even if the transaction might be beneficial to our
stockholders.
In addition, Section 203 of the Delaware General Corporation Law restricts
business combinations with any "interested stockholder" as defined by the
statute. The statute may have the effect of delaying, deferring or preventing a
change in control of our company.
WE HAVE NOT PAID, AND DO NOT INTEND TO PAY, DIVIDENDS AND THEREFORE, UNLESS OUR
COMMON STOCK APPRECIATES IN VALUE, OUR INVESTORS MAY NOT BENEFIT FROM HOLDING
OUR COMMON STOCK
We have not paid any cash dividends since inception. We do not anticipate paying
any cash dividends in the foreseeable future. As a result, our investors will
not be able to benefit from owning our common stock unless the market price of
our common stock becomes greater than the basis that these investors have in
their shares.
THE PRICE OF OUR COMMON STOCK MAY DECLINE BECAUSE A SUBSTANTIAL AMOUNT OF OUR
COMMON STOCK IS AVAILABLE FOR TRADING IN THE PUBLIC
Availability of shares of our common stock could depress the price of our common
stock. A substantial amount of common stock is available for trading in the
public market. The stock in the market may cause the price of our common stock
19
to decline. In addition, if our stockholders sell substantial numbers of stock
of our common stock in the public markets, the market price of our common stock
could fall. These sales might also make it more difficult for us to sell equity
or equity related securities at a time and price that we would deem appropriate.
We also have issued options, warrants and convertible securities which can be
exercised for, or converted to, shares of common stock, many of which would be
freely tradable without restrictions or further registration under the
Securities Act of 1933.
There were approximately 18,777,790 shares of our common stock outstanding as of
March 17, 2005, of which 9,016,924 were freely tradable without restrictions or
further registration under the Securities Act of 1933.
As of March 17, 2005, we have issued and outstanding warrants and options to
purchase up to 2,951,066 shares of our common stock, preferred stock convertible
into 18,000 shares of our common stock and debt convertible into 927,836 shares
of our common stock. The exercise of such warrants and options and conversion of
convertible securities may dilute the interests of all stockholders. Possible
future resale of such warrants and options or conversion of such convertible
securities could adversely affect the prevailing market price of our common
stock.
OUR COMMON STOCK TRADES ON THE OTC BULLETIN BOARD AND MAY BE SUBJECT TO THE
SEC'S "PENNY STOCK" RULES
Our stockholders may find it difficult to buy, sell and obtain pricing
information about, as well as news coverage of, our common stock because it is
traded on the OTC Bulletin Board. Being traded on the OTC Bulletin Board, rather
than on a national securities exchange, may lessen investors' interest in our
securities generally and materially adversely affect the trading market and
prices for those securities and our ability to issue additional securities or to
secure additional financing. The price of our common stock could make it more
difficult for stockholders to sell their shares. Our common stock will be
subject to the penny stock rules under the Securities Exchange Act of 1934 if
its price is less than $5.00 per share. The last reported sale price on March
17, 2005 was $6.03 but our common stock traded below $5.00 per share throughout
2002, 2003 and until mid-October 2004.
The penny stock rules impose additional sales practice requirements on
broker-dealers who sell penny stock securities to people who are not established
customers or accredited investors. For example, the broker must make a special
suitability determination for the buyer and the buyer must be given written
consent before the sale. The rules also require that the broker-dealer:
o send buyers an SEC-prepared disclosure schedule before completing the
sale, disclose the broker's commissions and current quotations for the
security;
o disclose whether the broker-dealer is the sole market maker for the
penny stock and, if so, the broker's control over the market; and
o send monthly statements disclosing recent price information held in
the customer's account and information on the limited market in penny
stocks.
These additional burdens may discourage broker-dealers from effecting
transactions in our common stock. Thus, if our common stock were to fall within
the definition of a penny stock, our liquidity could be reduced, and there could
be an adverse effect on the trading market in its common stock.
20
ITEM 2. Properties.
----------
In 2000, we entered into a five-year office lease providing 9,600 square feet,
currently at $10,800 per month, located at 400 Massasoit Avenue, East
Providence, Rhode Island. In 2004, we entered into a three year lease for an
additional 4,800 feet at the same location for approximately $5,400 per month,
subject to periodic adjustments. We also maintain a local field office at 10225
Barnes Canyon Road, San Diego, California on a two-year lease dated July 2004,
and pay approximately $2,600 per month. In addition, we maintain a local field
office at 330 East Orangethorpe Ave. in Placentia, California on a two-year
lease dated February 2004, and pay approximately $1,400 per month. We believe
that these facilities are adequate to meet our current needs but will require
additional space as new installations increase processing and support hiring
needs.
ITEM 3. Legal Proceedings.
-----------------
On November 6, 2003, we 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 our U.S. Patent No.
6,188,329 describing a system using digitized video and integrating traffic
light violation related vehicle information with court date scheduling
information. Court-ordered mediation in that lawsuit took place on October 1,
2004, but no agreement was reached through that mediation. Redflex has asserted
as a defense that our patent is invalid.
On November 25, 2003, we 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 that same patent.
We were denied a preliminary injunction in the Transol litigation, in part
because we had not shown a likelihood of success on our claim that Transol's
products infringe on our patent. Transol has filed a counterclaim asserting the
invalidity of that patent.
On June 22, 2004, the United States Patent and Trademark Office issued Patent
Number 6,754,663 to us, describing a system using multiple cameras, including at
least one video camera, to capture multiple images of a traffic light violation
and a user interface that simultaneously displays those multiple images.
On July 13, 2004, we filed an additional lawsuit for patent infringement against
Redflex Traffic Systems, Inc., alleging that Redflex's automated red light
enforcement systems infringe our U.S. Patent Number 6,754,663, but we have since
withdrawn that additional lawsuit.
We have amended our lawsuit against Transol to include claims alleging that
Transol's automated red light enforcement systems infringe our U.S. Patent
Number 6,754,663. Transol has filed a counterclaim asserting the invalidity of
that patent as well.
Transol has moved for summary judgment against us on all of our claims of
infringement against Transol. A hearing on Transol's motion for summary judgment
is scheduled for April 11, 2005.
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, 2004.
21
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, 2004 --- ----
1st Quarter $ 2.85 $ 4.00
2nd Quarter $ 3.16 $ 4.10
3rd Quarter $ 4.05 $ 5.00
4th Quarter $ 4.75 $ 7.85
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
HOLDERS OF COMMON STOCK
At March 5, 2005, the number of holders of record of the issued and outstanding
common stock of the Company was 458, which includes brokers who hold shares for
approximately 1,994 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.
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 2004, 2003 and 2002. The Company's investment in NTS was recorded
on the equity method through September 12, 2001.
Years Ended December 31,
----------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Revenue $ 6,034,942 $ 2,705,534 $ 2,121,574 $ 3,520,924 $ 3,652,422
Operating loss $ (4,646,604) $ (4,261,045) $(15,127,235) $ (1,297,145) $ (1,548,777)
Gain on debt extinguishment, net $ 508,124 $ --- $ --- $ --- $ ---
Contract termination reserve $ --- $ (125,000) $ --- $ --- $ ---
Gain on royalty assignment $ --- $ --- $ 2,811,590 $ --- $ ---
Other expense $ (334,116) $ (504,413) $ (318,618) $ (186,809) $ (106,675)
Net loss $ (4,472,596) $ (4,890,458) $(12,634,263) $ (1,565,054) $ (2,994,574)
Earnings per share
Weighted number of outstanding
shares - basic and diluted 18,223,609 12,964,498 5,047,611 2,881,877 1,790,160
Loss per share $ (0.25) $ (0.38) $ (2.50) $ (0.54) $ (1.67)
SELECTED BALANCE SHEET DATA:
Total assets $ 18,847,164 $ 16,299,434 $ 9,200,964 $ 22,035,420 $ 4,922,703
Working capital (deficit) $ 6,785,719 $ 3,294,231 $ (1,572,209) $ 1,775,401 $ (199,775)
Long-term
Note and lease obligations $ 6,017,263 $ 3,322,384 $ 2,849,126 $ 2,409,202 $ ---
Deferred income $ 53,472 $ --- $ --- $ 421,399 $ 2,036,896
(Note: Earnings per share information as previously reported at December 31, 2002 has been adjusted to a post-reverse split basis.)
22
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 the section of
this annual report captioned "Risk Factors That May Affect Our Results." 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 primarily operates through Nestor Traffic Systems, Inc. (NTS), a
wholly owned subsidiary. NTS's principal product is its CrossingGuard
video-based red light enforcement system and services. CrossingGuard is
marketed, maintained, and distributed through direct sales to states and
municipalities in the United States. In August 2004, NTS entered into a
distributorship agreement with Vitronic Machine Vision Ltd. for exclusive rights
to market and sell PoliScan, a speed enforcement system, throughout the United
States, Canada and Mexico, subject to minimum sales goals.
The following is a summary of key performance measurements monitored by
management:
Quarter Ended December 31, Year Ended December 31,
--------------------------------- ---------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Financial:
Revenue $ 1,551,000 $ 1,122,000 $ 6,035,000 $ 2,706,000
Loss from operations 1,820,000 1,230,000 4,647,000 4,261,000
Net loss 1,959,000 1,592,000 4,473,000 4,890,000
Additional investment in
capitalized systems 310,000 822,000 1,829,000 2,341,000
Cash and marketable equity securities 6,422,000 5,410,000
Working capital 6,786,000 3,294,000
Number of CrossingGuard Approaches*: 111 88
Installed and operational
Authorized under existing contracts 128 47
------------- --------------
Total installed and planned 239 135
* At end of period. There can be no assurance that all approaches authorized under existing contracts will ultimately be installed.
23
The management team focus is to expand the Company's market share in the
emerging traffic safety market. The Company plans to expand that market share
by:
o Continuing to aggressively market CrossingGuard video-based red light
enforcement systems and services to states and municipalities for red
light enforcement and safety
o Implementing a marketing program for speed enforcement systems and
services to states and municipalities for speed enforcement and safety
o Participating in efforts to increase the public's acceptance of, and
state's authorization of, automated traffic safety systems
o Participating in industry standards setting bodies
o Enhancing and seeking patents for our traffic safety technology to
maintain or improve our position and competitive advantages in the
industry
o Vigorously defending our patented technology from competitors'
infringement
LIQUIDITY AND CAPITAL RESOURCES
CASH POSITION AND WORKING CAPITAL
The Company had cash and short-term investments of approximately $5,850,000 at
December 31, 2004 as compared with approximately $5,410,000 at December 31,
2003. At December 31, 2004, the Company had working capital of $6,786,000 as
compared with $3,294,000 at December 31, 2003. The increase in cash in 2004
primarily resulted from the sale of $6,000,000 of convertible notes and
$3,440,000 of common stock in a private placement, offset by $2,179,000 of lease
financing repayments, $2,061,000 invested in capitalized systems, property and
equipment and cash used by operations.
Working capital was favorably impacted by the net effect of these factors as the
current portion of the Laurus Note ($885,000) and lease ($639,000) payables at
December 31, 2003 were eliminated. Marketable equity securities of $572,000 and
a $590,000 increase in inventory at December 31, 2004 also contributed to
increased working capital at that date.
In November 2004, the Company completed the sale of $6 million aggregate
principal amount of its 5% Senior Convertible Notes to accredited investors in a
private placement, resulting in net proceeds to the Company of $5,555,000.
In January 2004, the Company received $3,440,000 in proceeds from the private
placement of common stock, $2,179,000 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 $2 million
convertible note issued to Laurus Master Fund, Ltd. in July 2003 by issuing
492,904 shares of Nestor common stock and repaying the note balance, accrued
interest and prepayment penalty. On the same date, the Company issued a new $1.5
million convertible note to Laurus. Although 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 second note. During 2004, the Company repaid $195,000
of principal in cash and the balance of the note was converted into common stock
by November 2004.
24
The Company had a net worth of $10,779,000 at December 31, 2004, as compared
with a net worth of $9,662,000 at December 31, 2003. The increase in net worth
is further detailed on the Consolidated Statements of Stockholders' Equity.
FUTURE COMMITMENTS
During 2004, the Company acquired additional property and leased equipment
(primarily computers and related equipment) at a cost of $232,000 and invested
$1,829,000 in capitalized systems. At December 31, 2004, Nestor recorded its
investments in computers and related equipment (net of depreciation) at $357,000
and in capitalized systems (net of depreciation to an estimated residual value)
at $3,749,000. Management expects that NTS will make future commitments for the
purchase of additional computers and related computing equipment, for furniture
and fixtures, for leasehold improvements, for delivery of capitalized systems,
for consulting and for promotional and marketing expenses.
The Company does not generally grant payment terms to customers in excess of 90
days.
The Company's future contractual obligations and other commitments are as
follows:
Contractual Obligations and Commercial Commitments:
Payment Due Date
----------------------------------------------------------
Total < 1 Year 1-3 Years 3-5 Years Thereafter
----- -------- --------- --------- ----------
Senior Convertible
Note $6,000,000 $ --- $6,000,000 $ --- $ ---
Operating leases $ 314,000 $198,000 $ 116,000 $ --- $ ---
Inflation
Management believes that the rate of inflation in recent years has not had a
material effect on the Company's operations.
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.
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.
Revenue Recognition
Revenue is derived mainly from the lease of products which incorporate NTS's
software and the delivery of services based upon such products. Product license
and service fees include software licenses and processing service fees tied to
citations issued to red-light violators. NTS provides equipment (either under
direct sales or lease agreements), postcontract customer processing and support
services, and engineering services. In arrangements that include multiple
25
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. 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.
Long Term Asset Impairment
In assessing the recoverability of the Company's long term assets, management
must make assumptions regarding estimated future cash flows, contract renewal
options 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.
RESULTS OF OPERATIONS
In 2004, the Company focused on marketing and selling the Company's principal
product, CrossingGuard, a video-based red light enforcement system with
ancillary support services. During 2003, the Company completed the transition
from several lines of business, including financial services/PRISM, Rail and
TrafficVision, which had previously generated the majority of revenue, to
red-light enforcement services and products as the ongoing operating focus of
the Company. Future growth will depend on an increase in the number of
CrossingGuard approaches installed and operational and successful efforts to
develop and penetrate the automated speed enforcement market.
ANALYSIS OF THE THREE-MONTH PERIODS ENDED DECEMBER 31, 2004 AND 2003
In the quarter ended December 31, 2004, the Company realized a $428,000 (38%)
increase in revenues and a $1,018,000 (43%) increase in operating expenses
compared to last year's fourth quarter. The Company reported a net loss of
$1,959,000 compared to $1,592,000 in last year's fourth quarter. The increased
revenue relates primarily to $400,000 of revenue recorded under sales-type lease
accounting for Delaware approaches installed during the current year quarter.
Operating expense includes a corresponding $214,000 Delaware cost of sales, an
increase of $290,000 in amortization on capitalized systems, and costs
associated with the development of a larger sales force ($116,000 additional
internal sales expense, and $125,000 additional consultant expenses). Other
expenses--net in the fourth quarter of 2003 included the write off of the
unamortized discount on the first Laurus note and EDS interest expense.
Revenues
- --------
The Company's revenues arose from CrossingGuard lease and service fees. During
the quarter ended December 31, 2004, revenues increased $426,000 to $1,548,000
from $1,122,000 in last year's fourth quarter. This increase is due primarily to
additional revenue from Delaware installations along with increased revenue from
a larger installation base.
Operating Expenses
- ------------------
Total operating expenses amounted to $3,371,000 in the quarter ended December
31, 2004, an increase of $1,018,000 as compared to total operating costs of
$2,353,000 in last year's fourth quarter.
Cost of Goods Sold
Cost of goods sold (CGS) totaled $1,307,000 in the fourth quarter of 2004 as
compared to $614,000 in last year's fourth quarter. This year's fourth quarter
included $214,000 of costs associated with the Delaware installations, $184,000
of accelerated amortization on certain installed approaches which were not
renewed and a $106,000 overall increase in systems amortization due to a larger
installed base. Last year's fourth quarter also includes a $417,000 net
reclassification of all 2003 citation processing costs from engineering and
operations, as previously presented, to CGS.
26
Engineering and Operations
Costs related to engineering and operations totaled $999,000 in the fourth
quarter of 2004, as compared with $745,000 in 2003. These costs include the
salaries of field and office personnel as well as operating expenses related to
product design, delivery, configuration, maintenance and service. This expense
increased in 2004 as there were more customers and installations to support.
Increases in headcount and travel generated $149,000 of additional costs in the
2004 quarter and the inventory reserve, established in 2004, rose by $43,000
during the current year quarter. The 2003 comparable period includes a $417,000
net reclassification of all 2003 citation processing costs to CGS.
Research and Development
Research and development expenses totaled $32,000 in the quarter ended December
31, 2004 as compared with $29,000 in the previous year's quarter. The Company
continues its R&D activities, as deemed necessary.
Selling and Marketing
Selling and marketing costs were $377,000 in the quarter ended December 31,
2004, and $87,000 in the previous year's quarter. The increase reflects a more
aggressive marketing effort, including the cost associated with a nationwide
sales force. Outside consultants are also being used to cover strategic markets.
Attendance at trade shows escalated, as did the purchase of collateral material.
General and Administrative
General and administrative expenses totaled $654,000 in the fourth quarter of
2004, as compared with $876,000 in the previous year's quarter. The decrease is
primarily due to a $140,000 reduction in financing fees and a $62,000 reduction
in bad debt expense, offset by a $39,000 increase in patent lawsuit defense
expenses.
Other Expense
For this year's fourth quarter, net other expense was $139,000 as compared with
$362,000 in the quarter-earlier period. The decrease of $223,000 is due
primarily to the non-reoccurrence of a $169,000 write off of the unamortized
discount on the first Laurus note in 2003 and a $27,000 reduction in warrant
amortization as warrants were fully amortized in July 2004.
Net Loss
- --------
During the fourth quarter 2004, the Company experienced a loss of $1,959,000, as
compared with a loss of $1,592,000 in the previous year's quarter. For the
quarter ended December 31, 2004, loss per share available for common stock was
$0.11 per share, consistent with the corresponding period of the prior year. The
weighted average shares outstanding were 18,619,771 for the quarter ended
December 31, 2004 and 13,987,905 for the quarter ended December 31, 2003.
ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2004 AND 2003
For the year ended December 31, 2004, the Company experienced a 123%
($3,329,000) increase in revenues compared to the prior calendar year. Operating
expenses increased 53% ($3,715,000) in 2004. The Company reported a net loss of
$4,473,000 in 2004 compared to a loss of $4,890,000 in the prior year. Many
significant changes occurred during these two years as more fully described
below.
27
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, 2004,
revenues increased $3,329,000 to $6,035,000 from $2,706,000 in the prior
calendar year.
Product Royalties
Product royalties totaled $37,000 in 2004, as compared with $29,000 in 2003.
Residual royalty streams from two customers account for all royalty revenues.
Product Sales, Lease and Service Fees
Product sales, lease and service fee revenues totaled $5,998,000 in 2004, as
compared with $2,677,000 in 2003. This increase is largely attributable to a
full year of revenues in 2004 on 44 approaches installed on various dates in
2003, proceeds received under the Master Lease Agreement with the State of
Delaware and revenues recognized in connection with our ACS agreement for the
city of Baltimore. The Company continues to retrofit 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 $10,682,000 in the year ended December 31,
2004, an increase of $3,715,000 over total operating costs of $6,967,000 in the
prior year. The primary changes in 2004 include increased amortization on live
approaches, an increase in CGS as a result of the Delaware installations and
Baltimore revenue, a significant increase in sales consulting expenses, and
$381,000 of additional of lawsuit defense expenses. Additionally, headcount
increased 33% in 2004 over 2003, which caused an increase in salaries and
fringes, and related travel expenses.
Costs of Goods Sold
Cost of goods sold totaled $3,932,000 in 2004 as compared to $1,791,000 in the
prior year. CGS includes amortization, maintenance and processing costs related
to revenues recorded in the respective periods. The current year increase is
primarily due to an increase of $990,000 of amortization (more installed
approaches), including $184,000 of accelerated amortization on certain installed
approaches which were not renewed, $558,000 of Delaware systems installed under
sales-type lease accounting and $232,000 of costs associated with Baltimore
revenue.
Engineering and Operations
Costs related to engineering and operations totaled $3,464,000 in 2004, as
compared with $2,578,000 in 2003. 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 additional expenses both internally and field-based, to support the
growing installed customer base. Engineering and operations staff growth in 2004
includes redeployment of five people from other departments to field support, in
addition to six new employees hired. Expenses such as travel, tools and supplies
increased, as well.
Research and Development
Research and development expenses totaled $157,000 in the year ended December
31, 2004 as compared with $121,000 in the prior year. The increase in 2004 is
directly attributable to materials purchased in support of on-going research
activities.
28
Selling and Marketing
Selling and marketing costs increased $519,000 to $874,000 in the year ended
December 31, 2004, from $355,000 in the prior year. The increase in 2004 costs
reflects the hiring of a nationwide sales force with outside consultants to
support sales activity in strategic markets.
General and Administrative
General and administrative expenses totaled $2,254,000 in 2004, as compared with
$2,121,000 in the previous year. The $133,000 increase is largely the net result
of $381,000 increased 2004 patent lawsuit defense costs, offset by a $124,000
reduction in 2004 financing fees and last year's $180,000 expense for an
employee settlement agreement.
Gain on Debt Extinguishment
- ---------------------------
Obligations to EDS and Laurus (under the July 2003 note) were fully satisfied in
January 2004, resulting in a net gain of $508,000. The early payment to EDS
resulted in a gain of $681,000, which was offset in part by a prepayment penalty
of $173,000 incurred in the Laurus settlement.
Contract Termination Reserve
- ----------------------------
A significant customer contract in the Rail line of business was 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. Payment
was satisfied in December 2004.
Other Expense
- -------------
For 2004, net other expense was $334,000; as compared with net other expense of
$504,000 in the year-earlier period. In 2004, other expense included $80,000 of
interest expense accrued as a result of a 2004 sales and use tax audit, a
decrease of $144,000 in interest expenses associated with notes payable, a
realized loss on marketable equity securities of $96,000, and a decrease of
$44,000 in warrant amortization as warrants were fully amortized in July 2004.
Non-recurring 2003 items include $164,000 of interest expense paid to EDS offset
by a $64,000 favorable vendor settlement.
Net Loss
- --------
During 2004, the Company recorded a loss of $4,473,000, as compared with a loss
of $4,890,000 in the prior year. For the year ended December 31, 2004, loss per
share was $0.25 per share, as compared with a loss per share of $0.38 in
corresponding period of the prior fiscal year. For the year ended December 31,
2004, there was outstanding a weighted average of 18,223,609 shares, as compared
to 12,964,498 shares in the year-earlier period.
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.
29
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. 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
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 were 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 was 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.
30
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
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.
31
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.
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.
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk.
----------------------------------------------------------
The Company's marketable equity securities (primarily cash reserves and an
insured municipal bond fund), valued at $572,000 at December 31, 2004, are
exposed to market risk due to changes in U.S. interest rates and fluctuations in
foreign currency exchange rates. The primary objective of the Company's
investment activities is the preservation of principal while maximizing
investment income. The Company's exposure to this risk is moderately high in the
short-term. During 2004, the Company realized a net loss of $96,000 on
securities sold and has an unrealized loss of $10,000 on securities held at
December 31, 2004. The securities are classified as "trading securities" and
accordingly are reported at fair value with unrealized gains and losses included
in other income (expense).
The Company has a senior convertible note payable with interest fixed at 5%
through its October 2007 maturity. Management assesses the exposure to this risk
as immaterial.
32
ITEM 8. Financial Statements and Supplementary Data
-------------------------------------------
See annexed financial statements.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
----------------------------------------------------------------------
None.
ITEM 9A. Controls and Procedures
-----------------------
An evaluation was performed under the supervision and with the participation of
our management, including the Chief Executive Officer and Chief Financial
Officer, 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, 2004. 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 such date in that they provide
reasonable assurance that information required to be disclosed by us in the
reports we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. No change in the Company's internal control over financial reporting (as
defined in Rules 13a -15(f) and 15d - 15(f) under the Exchange Act) occurred
during the fiscal quarter ended December 31, 2004 that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
ITEM 9B. Other Information
-----------------
On March 25, 2005, Nigel P. Hebborn was appointed Executive Vice President of
Nestor, Inc. Mr. Hebborn previously served as Chief Operating Officer of Nestor,
Inc. He will continue to serve as President and Chief Executive Officer of the
Company's wholly owned subsidiary, Nestor Traffic Systems, Inc. His compensation
will remain unchanged from that previously reported.
Also on March 25, 2005, Tadas A. Eikinas was appointed Chief Operating Officer
of Nestor, Inc. Mr. Eikinas had been leading the Company's efforts to develop,
market and implement speed products. Prior to joining Nestor in 2004, Mr.
Eikinas was Director of Peek Traffic's red light and speed enforcement products
division. In connection with his appointment as Chief Operating Officer, the
Company entered into an employment agreement with Mr. Eikinas on March 29, 2005.
Mr. Eikinas's employment agreement provides for a base salary of $175,000 per
year, an option grant and bonuses based on reaching project objectives. The term
of the agreement is from its date until December 31, 2008 and by its own terms
renews for one year unless the Company elects not to renew by October 31, 2008.
The employment agreement provides that in the event of Mr. Eikinas's termination
without cause or resignation for good reason, each as defined in the agreement,
Mr. Eikinas will receive one year's base salary and one year of accelerated
vesting with respect to his option. The option granted is to purchase 30,000
shares of Nestor's common stock at $5.95 per share, of which 10,000 vest upon
grant, 10,000 vest on March 29, 2006 and 10,000 vest on March 29, 2007.
Mr. Eikinas will receive a bonus of $12,500 and an immediately exercisable
option to purchase 25,000 shares of the Company's common stock at the then
current fair market value if, on or before October 31, 2005, the Company
satisfactorily delivers, as reasonably determined by the Compensation Committee
of the Board, a "speed on green" product other than to defined test markets. In
addition, he will receive a bonus of $12,500 and an immediately exercisable
option to purchase 25,000 shares of the Company's common stock at the then
current fair market value if, on or before October 31, 2005, the Company
satisfactorily delivers, as reasonably determined by the Compensation Committee
of the Board, a mobile speed product other than to defined test markets. He will
also receive an immediately exercisable option to purchase 25,000 shares of the
Company's common stock at the then current fair market value if, on or before
December 31, 2005, the Company successfully develops and tests, as reasonably
determined by the Compensation Committee of the Board, a CrossingGuard system
using all digital imaging. The Compensation Committee may grant Mr. Eikinas
additional bonuses in its sole discretion.
33
Also on March 25, 2005 Benjamin M. Alexander was appointed Vice President and
General Counsel of Nestor, Inc. Mr. Alexander had been of counsel to Partridge
Snow & Hahn LLP and served as the Company's outside counsel since 2003. In
connection with his appointment as Vice President and General Counsel, the
Company entered into an employment agreement with Mr. Alexander on March 29,
2005. Mr. Alexander's employment agreement provides for a base salary of
$165,000 per year, an option grant and bonuses in the Compensation Committee's
sole discretion. The term of the agreement is from its date until December 31,
2008 and by its own terms renews for one year unless the Company elects not to
renew by October 31, 2008.
The employment agreement provides that in the event of Mr. Alexander's
termination without cause or resignation for good reason, each as defined in the
agreement, Mr. Alexander will receive one year's base salary and three years of
accelerated vesting with respect to his option The option granted is to purchase
135,000 shares of Nestor's common stock at $5.95 per share, of which 10,000 vest
upon grant, 15,000 vest on March 1, 2006, 20,000 vest on March 29, 2007, 25,000
vest on March 29, 2008, 30,000 vest on March 29, 2009 and 35,000 vest on March
29, 2010.
Each of the options granted to Messrs. Eikinas and Alexander provide that
following a change in control of the Company, in the event of a termination
without cause or a resignation for good reason by either will result in the
immediate vesting of that officer's option in its entirety.
Also on March 25, Harold A. Joannidi was appointed Chief Financial Officer of
Nestor, Inc., effective as of April 4, 2005. Claire M. Iacobucci, the Company's
Chief Financial Officer since April 2004 and employee since 1997, had requested
that the Company appoint a new Chief Financial Officer so as to allow her to
return to a part-time work schedule. Mr. Joannidi's annual salary will be
$125,000. Upon the commencement of his employment, Mr. Joannidi will receive
options to purchase 100,000 shares of Nestor's common stock at the then current
market price. Twenty thousand of those options will be immediately exercisable
and an additional 20,000 will vest on each of the first four anniversaries of
his employment by the Company.
Subsequent to Mr. Joannidi's appointment as Chief Financial Officer, Ms.
Iacobucci tendered her resignation, effective as of April 15, 2005.
34
PART II
ITEM 8.
CONSOLIDATED FINANCIAL STATEMENTS
FORM 10-K
December 31, 2004
35
NESTOR, INC.
------------
CONTENTS
--------
Page No.
--------
Report of Independent Registered Public Accounting Firm 37
Consolidated Balance Sheets -
December 31, 2004 and 2003 38
Consolidated Statements of Operations -
For the Years Ended December 31, 2004, 2003 and 2002 39
Consolidated Statements of Stockholders' Equity -
For the Years Ended December 31, 2004, 2003 and 2002 40
Consolidated Statements of Cash Flows -
For the Years Ended December 31, 2004, 2003 and 2002 41
Notes to Consolidated Financial Statements 42
36
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Nestor, Inc.
East Providence, Rhode Island
We have audited the accompanying consolidated balance sheets of Nestor, Inc. as
of December 31, 2004 and 2003, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Nestor, Inc. at
December 31, 2004 and 2003, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
2004, in conformity with accounting principles generally accepted in the United
States of America.
/s/ Carlin, Charron & Rosen, LLP
Providence, Rhode Island
March 18, 2005
37
NESTOR, INC.
Consolidated Balance Sheets
---------------------------
DECEMBER 31,
ASSETS 2004 2003
---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 5,849,992 $ 5,410,123
Marketable equity securities 571,860 ---
Accounts receivable, net of allowance for doubtful accounts 763,573 521,872
Unbilled contract revenue 111,117 158,952
Inventory, net 1,031,891 442,298
Other current assets 307,938 75,791
------------- -------------
Total current assets 8,636,371 6,609,036
NONCURRENT ASSETS:
Capitalized system costs, net of accumulated depreciation 3,749,293 3,514,908
Property and equipment, net of accumulated depreciation 357,052 385,165
Goodwill 5,580,684 5,580,684
Patent development costs, net of accumulated amortization 161,740 175,216
Other long term assets 362,024 34,425
------------- -------------
TOTAL ASSETS $ 18,847,164 $ 16,299,434
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Note payable $ --- $ 884,750
Accounts payable 620,013 468,289
Accrued employee compensation 460,556 386,652
Accrued liabilities 655,406 745,676
Deferred revenue 91,667 20,000
Leases payable 23,010 662,541
Restructuring reserve --- 146,897
------------- -------------
Total current liabilities 1,850,652 3,314,805
NONCURRENT LIABILITIES:
Long term note payable 6,000,000 1,030,000
Asset retirement obligation 146,577 ---
Long term deferred revenue 53,472 ---
Long term leases payable 17,263 2,292,384
------------- -------------
Total liabilities 8,067,964 6,637,189
------------- -------------
Commitments and contingencies --- ---
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value, authorized 10,000,000 shares;
issued and outstanding: Series B - 180,000 shares at
December 31, 2004 and 190,000 shares at December 31, 2003 180,000 190,000
Common stock, $.01 par value, authorized 30,000,000 shares;
issued and outstanding: 18,673,498 shares at December 31, 2004
and 13,997,238 shares at December 31, 2003 186,735 139,972
Warrants 66,358 1,377,251
Additional paid-in capital 62,430,361 49,230,803
Stock pending issuance --- 6,335,877
Accumulated deficit (52,084,254) (47,611,658)
------------- -------------
Total stockholders' equity 10,779,200 9,662,245
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 18,847,164 $ 16,299,434
============= =============
See Notes to the Financial Statements.
38
NESTOR, INC.
Consolidated Statements of Operations
-------------------------------------
YEARS ENDED DECEMBER 31,
2004 2003 2002
----------------------------------------------------
Revenue:
Product royalties $ 36,691 $ 28,555 $ 664,401
Product sales, lease and service fees 5,998,251 2,676,979 1,457,173
------------- ------------- -------------
Total revenue 6,034,942 2,705,534 2,121,574
------------- ------------- -------------
Operating expenses:
Cost of goods sold 3,931,962 1,791,203 1,475,945
Engineering and operations 3,463,754 2,578,056 2,070,476
Research and development 157,396 121,350 1,604,159
Selling and marketing 873,946 354,847 607,901
General and administrative 2,254,488 2,121,123 1,453,342
Restructuring costs --- --- 742,705
Capitalized system costs impairment --- --- 794,281
Goodwill impairment loss --- --- 8,500,000
------------- ------------- -------------
Total operating expenses 10,681,546 6,966,579 17,248,809
------------- ------------- -------------
Loss from operations (4,646,604) (4,261,045) (15,127,235)
Gain on debt extinguishment, net 508,124 --- ---
Contract termination reserve --- (125,000) ---
Gain on royalty assignment --- --- 2,811,590
Other expense - net (334,116) (504,413) (318,618)
------------- ------------- -------------
Net loss $ (4,472,596) $ (4,890,458) $ (12,634,263)
============= ============= =============
Loss Per Share:
Loss per share, basic and diluted $ (.25) $ (0.38) $ (2.50)
============= ============= ============
Shares used in computing loss per share:
Basic and diluted 18,223,609 12,964,498 5,047,611
============= ============= =============
See Notes to the Financial Statements.
39
Nestor, Inc.
Consolidated Statements of Stockholders' Equity
For the Years Ended December 31, 2004, 2003 and 2002
----------------------------------------------------
Preferred Stock Common Stock Additional Stock
----------------- -------------------- Paid-in Pending Accumulated
Shares Amount Shares Amount Warrants Capital Issuance Deficit Total
------ ------ ------ ------ -------- ---------- ---------- ------------ -----
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
Issuance of
Common Stock --- --- 3,519,384 35,194 --- 9,721,121 (6,335,877) --- 3,420,438
Conversion of
Laurus notes
payable --- --- 865,761 8,658 --- 2,060,342 --- --- 2,069,000
Exercise of
cashless
warrants --- --- 262,115 2,621 --- (2,623) --- --- (2)
Exercise of
incentive
stock
options --- --- 28,000 280 --- 37,720 --- --- 38,000
Conversion
of Preferred
Stock to
Common Stock (10,000 (10,000) 1,000 10 --- 9,990 --- --- ---
Accretion value
of warrants --- --- --- --- 62,115 --- --- --- 62,115
Expired
warrants --- --- --- --- (1,225,000) 1,225,000 --- --- ---
Variable
warrants --- --- --- --- (148,008) 148,008 --- --- ---
Loss for the
year ended
Dec. 31, 2004 --- --- --- --- --- --- --- (4,472,596) (4,472,596)
-------- -------- ---------- -------- ----------- ----------- ---------- ----------- ------------
Balance at
Dec. 31, 2004 180,000 $180,000 18,673,498 $186,735 $ 66,358 $62,430,361 $ --- $(52,084,254) $ 10,779,200
======= ======== ========== ======== =========== =========== ========== ============ =============
See Notes to the Financial Statements.
40
NESTOR, INC.
Consolidated Statements of Cash Flows
-------------------------------------
YEARS ENDED DECEMBER 31,
2004 2003 2002
-----------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,472,596) $ (4,890,458) $ (12,634,263)
Adjustments to reconcile net loss
to net cash used by operating activities:
Depreciation and amortization 2,037,217 1,012,123 601,938
Loss on disposal of fixed assets 5,378 5,291 17,402
Gain on extinguishment of debt, net (508,124) --- ---
Unrealized loss on marketable equity securities 9,912 --- ---
Realized loss on marketable equity securities 96,367 --- ---
Dividends reinvested (34,898) --- ---
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 62,115 264,862 106,483
Increase (decrease) in cash arising from
changes in assets and liabilities:
Restricted cash --- --- 943,926
Accounts receivable, net (241,701) (380,609) 16,943
Unbilled contract revenue 47,835 (36,268) 32,841
Inventory, net (599,634) (178,210) 46,447
Other assets (498,746) 83,041 108,740
Accounts payable and accrued expenses 163,152 (137,129) (257,207)
Deferred income 125,139 20,000 (270,904)
Restructuring reserve (146,897) (219,042) 365,939
------------- ------------- -------------
Net cash used by operating activities (3,955,481) (4,456,399) (4,439,024)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in marketable equity securities (1,500,000) --- ---
Liquidation of marketable equity securities 856,759 --- ---
Proceeds from royalty assignment, net --- --- 3,040,100
Investment in capitalized systems (1,829,373) (2,341,114) (1,016,985)
Purchase of property and equipment (232,267) (86,145) (47,849)
Proceeds from sale of property and equipment --- --- 11,600
Patent development costs (5,633) (31,196) (21,818)
------------- ------------- -------------
Net cash provided (used) by investing activities (2,710,514) (2,458,455) 1,965,048
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of obligations under capital leases (2,260,115) (292,641) (42,647)
Proceeds from notes payable 6,098,028 4,000,000 ---
Repayment of note payable (195,000) --- ---
Proceeds from leases payable --- --- 530,530
Proceeds from issuance of common stock, net 3,462,951 4,001,997 ---
Proceeds from stock pending issuance --- 4,306,727 ---
------------- ------------- -------------
Net cash provided by financing activities 7,105,864 12,016,083 487,883
------------- ------------- -------------
Net change in cash and cash equivalents 439,869 5,101,229 (1,986,093)
Cash and cash equivalents - beginning of year 5,410,123 308,894 2,294,987
------------- ------------- -------------
Cash and cash equivalents - end of year $ 5,849,992 $ 5,410,123 $ 308,894
============= ============= =============
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid $ 92,577 $ 361,730 $ 89,431
============= ============= =============
Income taxes paid $ --- $ --- $ ---
============= ============= =============
Significant non-cash transactions are described in Notes 4, 6, 7, 11 and 15.
See Notes to the Financial Statements.
41
NESTOR, INC.
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS
A. Organization
Nestor, Inc. was organized on March 21, 1983 in Delaware to
develop and succeed to certain patent rights and know-how, which
was 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, Nestor, Inc. 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. The consolidated financials
statements include the accounts of Nestor, Inc. and its
wholly-owned subsidiaries (collectively referred to as the
"Company"). 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, 2004 has an accumulated deficit. Management believes
that the significant financing obtained in 2004, strong liquidity
at December 31, 2004 and current contracts with municipalities
will enable the Company to continue the development and upgrading
of its products and sustain operations through the end of 2005.
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. Marketable equity securities
The Company's marketable equity securities consist of investments
in closed-end insured municipal bond funds. The securities are
classified as "trading securities" and accordingly are reported
at fair value with unrealized gains and losses included in other
income (expense).
C. Accounts receivable
Accounts receivable represents balances due from customers, net
of an $84,213 reserve for doubtful accounts at December 31, 2004
and 2003. The reserve was established during 2003. 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.
D. 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
42
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.
E. 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. The
December 31, 2004 inventory balance is presented net of a $50,000
inventory reserve which was established during the year.
F. 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.
G. 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.
H. 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.
I. Revenue recognition
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) 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
43
issuance of the related tickets. To the extent that maintenance
is provided, it is billed and recognized on a monthly basis.
Deferred revenue - Certain customer contracts allow the Company
to bill and/or collect payment prior to the performance of
services, resulting in deferred revenue.
Contracts may include penalty provisions relating to timely
performance and delivery. Penalties are charged to operations as
incurred.
J. Shipping and handling costs
Shipping and handling costs are capitalized if part of a leased
system or included in engineering services expense.
K. Research and development
Research and development costs associated with NTS products
consist principally of payroll and related costs, facilities
costs and the cost of prototype components.
L. 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, 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 has been made.
M. 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 for 2002
have been adjusted to a post-reverse split basis effective April
21, 2003.
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, marketable equity securities 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's marketable equity
securities (primarily cash reserves and an insured municipal bond
fund) are exposed to market risk due to changes in U.S. interest
rates and fluctuations in foreign currency exchange rates. The
44
Company's exposure to this risk is moderately high in the
short-term. The securities are classified as "trading securities"
and accordingly are reported at fair value with unrealized gains
and losses included in other income (expense). 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. 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.
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:
2004 2003 2002
---- ---- ----
Expected life (years) 8 8 8
Average risk-free
interest rate 1.6 to 6.8% 1.6 to 6.8% 2.6 to 6.8%
Volatility 113.2% 117.4% 109.8%
Dividend yield 0% 0% 0%
The weighted-average fair value of options granted during 2004,
2003 and 2002 was $4.17, $2.55 and $1.80, 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,
-------------------------------------------
2004 2003 2002
---- ---- ----
Net loss - reported $(4,472,596) $(4,890,458) $(12,634,263)
Add (Deduct): total stock-based
compensation expense
determined under fair-value
based method for all awards,
net of related tax effects $(4,912,682) $ 149,965 $ (22,464)
Pro Forma - net loss $(9,385,278) $(4,740,493) $(12,656,727)
Pro forma net loss per share -
basic and diluted $ (0.52) $ (0.37) $ (2.51)
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.
45
Q. Asset retirement obligations
Effective January 1, 2002, the Company implemented SFAS No. 143,
"Accounting for Asset Retirement Obligations," which addresses
financial accounting and reporting for obligations associated
with the retirement of tangible long-lived assets and the related
asset retirement costs. The statement requires that the fair
value of a liability for an asset retirement obligation be
recognized in the period in which it is incurred and capitalized
as part of the carrying amount of the long-lived asset. When a
liability is initially recorded, the entity capitalizes the cost
by increasing the carrying value of the related long-lived asset.
Over time, the liability is accreted to its present value each
period, and the capitalized cost is depreciated over the useful
life of the related asset. Upon settlement of the liability, a
gain or loss is recorded. As required by SFAS No. 143, the
Company records an obligation for the cost to remove its systems
and remediate the site, if contractually required.
R. Reclassification
Certain prior year balances have been reclassified to conform to
the current year presentation. These reclassifications had no
effect on the 2003 net loss as previously reported.
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 over the term of the
contract, generally either three or five years, less an applicable
residual value. Revenues realized from these agreements, generally in
the form of per-citation or monthly 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 $2,842,362 in 2005, $2,239,977 in 2006, $1,543,443 in
2007, $902,917 in 2008 and $0 in 2009, but management expects that
these annual amounts could increase and extend to future years as
additional intersections are installed.
December 31,
2004 2003
---- ----
Equipment under operating leases:
Work-in-process $ 43,021 $ 248,693
Installed and accepted 6,551,184 4,358,062
----------- -----------
6,594,205 4,606,755
Less: Accumulated depreciation (2,844,912) (1,091,847)
------------ -----------
Net investment in leased equipment $ 3,749,293 $ 3,514,908
=========== ===========
NOTE 4 - PROPERTY AND EQUIPMENT - NET:
December 31,
2004 2003
---- ----
Office furniture and equipment $ 146,690 $ 140,475
Computer equipment 1,960,797 1,747,454
Demonstration equipment --- 7,726
Leasehold improvements 246,077 231,915
----------- -----------
2,353,564 2,127,570
Less: Accumulated depreciation (1,996,512) (1,742,405)
----------- -----------
$ 357,052 $ 385,165
=========== ===========
Depreciation and amortization expense of $272,769 and $239,878 on the
above assets was recorded for the years ended December 31, 2004 and
2003, respectively.
In 2004, the Company disposed of $16,314 of computer equipment and
$7,727 of demonstration equipment. In 2003, the Company disposed of
$117,189 of demonstration equipment and transferred $17,020 of
46
computer equipment to inventory at net book value. 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.
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.
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 note was collateralized by a first lien on all available
CrossingGuard, Inc. assets. Laurus had a general security interest in
four customer contracts assigned by NTS to CrossingGuard, Inc. and NTS
had 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 was 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. These
warrants were exercised on a cashless basis during the quarter-ended
September 30, 2004, resulting in the Company issuing 76,466 shares of
its common stock at a conversion price of $4.18 per share.
Also in connection with financing, Management Services Group/Sage
Investments, Inc. ("Sage") was paid a fee of $80,000 and received
$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. During the
period June through August 2004, Sage exercised 11,720 of these
warrants on a cashless basis, resulting in the Company issuing 5,953
shares of stock at conversion prices of $3.54 to $4.46 per share. The
warrant expiration date is July 31, 2008.
47
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
(discount and deferred interest) and financing fees, respectively, at
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 bore interest at the prime rate plus 1.25%
(subject to a floor of 5.25% per year) and matured on January 14,
2006. Principal repayments commenced May 2004 with $195,000 paid in
cash. In conjunction with this transaction, Sage received 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.
During September 2004, Laurus converted $60,000 due on this note into
17,143 shares of Nestor common stock at $3.50 per share. Laurus
subsequently converted their remaining $1,245,000 note balance into
355,714 shares of Nestor common stock during the period October to
November 3, 2004.
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. 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. David N. Jordan and George L.
Ball, directors of Nestor, are each also affiliates of Silver Star
Partners I, LLC. Robert M. Krasne and Stephen H. Marbut, former
directors of Nestor, are also affiliates 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.
NOTE 7 - PRIVATE PLACEMENT OF SENIOR CONVERTIBLE NOTES:
In November 2004, the Company completed the sale of $6,000,000
aggregate principal amount of its 5% Senior Convertible Notes due
October 31, 2007 (the "Senior Convertible Notes") in a private
placement. The Company received $5,555,000 of note proceeds after
$445,000 of placement fees and related expenses. The Senior
Convertible Notes are convertible into Nestor common stock at the
option of the investors at $5.82 per share and accrue interest at 5%
per year. The Company must make quarterly interest-only payments until
48
the Senior Convertible Notes are either paid in full or are converted
into common stock. At the option of the holders, all amounts due may
be accelerated upon certain events of default, including failures to
pay principal or interest when due, breach of covenants that remain
uncured after notice, bankruptcy of the Company or certain similar
events and defaults under other material credit arrangements.
The Company may, at its option, redeem the Senior Convertible Notes in
whole or in part, at a redemption price of 105% before November 1,
2005, 102.5% before November 1, 2006, and 101% thereafter, plus unpaid
interest, upon 30 to 60 days prior written notice. The Company is
obligated to offer to repurchase the Senior Convertible Notes at the
then-current redemption price in the event of a change in control of
the Company or upon the occurrence certain financing events, as
defined. In connection with the Senior Convertible Notes, the Company
issued a warrant to a placement agent for the purchase of 60,000
shares of common stock at $5.21 per share exercisable through October
31, 2009.
The Securities and Exchange Commission declared the Registration
Statement on Form S-2 (SEC File No. 333-121015) for the resale of
these shares effective on January 28, 2005. Pursuant to the terms of
the warrant, the Company has agreed to include the resale of the
shares of the Company's common stock underlying the warrant in future
registration statements upon the request of such holder. During
February 2005, two noteholders converted an aggregate $600,000 note
face value into 103,092 shares of Nestor stock at $5.82 per share. Any
unamortized deferred financing costs associated with the converted
notes will be expensed upon conversion.
NOTE 8 - LEASES PAYABLE:
On June 28, 2001, NTS executed a Master Lease Purchase Agreement with
Electronic Data Systems Corporation ("EDS"), later amended on January
10, 2003, 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, which were collateralized
by equipment delivered under leased CrossingGuard systems. During
2003, the Company recorded $163,961 of EDS interest expense. In 2002,
the Company recorded $303,481 of EDS interest costs; $100,559 of which
was capitalized as capitalized systems costs and $202,922 was expensed
directly.
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 9 - 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. All obligations
associated with this restructuring reserve were settled or paid in
full in 2004.
NOTE 10 - ASSET RETIREMENT OBLIGATIONS:
The Company's video-based red light enforcement systems are installed
at traffic intersections under three to five year customer contracts.
At the end of many contracts, NTS is required to remove all
aboveground structures and restore the site. At December 31, 2004, the
Company has recorded a liability of $146,577 for this obligation.
49
NOTE 11 - 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 (1,246,440 shares). The shares were sold at $3.00 per
share, with net proceeds to Nestor (after $682,000 of expenses of the
offering) of $2.76 per share totaling $7,846,680 ($3,440,000 in
January 2004). The Securities and Exchange Commission declared the
Registration Statement on Form S-2 (SEC File No. 333-112359) for the
resale of these shares effective on April 23, 2004. 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 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 Conversions:
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. During the period September through November 3, 2004,
Laurus converted $1,305,000 due on its second note into 372,857 shares
of Nestor common stock at $3.50 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 (51.4% and 63.7% at
December 31, 2004 and 2003, respectively). 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.
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
50
Stock. The liquidation value of Series B Preferred was $180,000 at
December 31, 2004 and $190,000 at December 31, 2003.
NOTE 12 - OPTIONS AND WARRANTS:
On April 1, 1984, the Company adopted an Incentive Stock Option Plan,
which authorized the grant of options for up to 245,000 shares
(post-reverse split) of the Company's common stock. This plan
terminated April 1, 2004.
On May 6, 1997, the Company adopted the 1997 Stock Option Plan under
which the Board of Directors granted 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. No further
grants may be made under this Plan pursuant to the adoption of the
2004 Stock Incentive Plan.
On June 24, 2004, the Company adopted the 2004 Stock Incentive Plan,
which provides for the grant of awards to employees, officers and
directors. Subject to adjustments for changes in the Company's common
stock and other events, the stock plan is authorized to grant up to
4,500,000 shares, either in the form of options to purchase Nestor
common stock or as restricted stock awards. The Board of Directors
will determine the award amount, price usually equal to the market
price of the stock on the date of the grant, vesting provisions and
expiration period (not to exceed ten years) in each applicable
agreement. The awards 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, 2004, 2003 and 2002 on
post-reverse split basis. 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. The number of
options granted and outstanding in 2004 rose significantly due to
grants made pursuant to employment agreements (see Note 20) as well as
grants made to each employee and director during the year.
Years Ended December 31,
---------------------------------------------------------------------
2004 2003 2002
---- ---- ----
Weighted Weighted Weighted
Av. Ex. Av. Ex. Av. Ex.
Shares Price Shares Price Shares Price
------------------- ------------------ -------------------
Outstanding beginning of year 312,397 $ 5.75 324,199 $ 6.50 395,121 $ 7.10
Granted 2,777,650 4.66 176,250 3.34 36,800 2.00
Exercised 28,000 1.34 --- --- --- ---
Canceled 174,392 6.28 188,052 4.85 107,722 7.10
---------- -------- --------
Outstanding end of year 2,887,655 $ 4.71 312,397 $ 5.75 324,199 $ 6.50
========== ======== ========
Options exercisable at year end 1,010,236 $ 4.87 233,970 $ 6.80 224,730 $ 7.30
========== ======== ========
51
The following table presents weighted average price and life
information about significant option groups outstanding at December
31, 2004:
Options Outstanding Options Exercisable
----------------------------------------- ----------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Averaged
Range of Outstanding Contractual Exercise Exercisable Exercisable
Exercise Prices at 12/31/04 Life (Years) Price at 12/31/04 Price
---------------- ----------- ------------ -------- ----------- -----------
$ 1.00 - $ 1.90 28,550 5.41 $ 1.77 18,230 $ 1.77
$ 3.55 - $ 3.85 344,400 4.02 3.76 92,000 3.80
$ 4.50 - $ 5.50 2,463,243 8.35 4.82 856,276 4.90
$ 6.00 - $10.20 46,462 1.24 6.47 38,730 6.54
$15.00 - $28.90 5,000 0.85 17.60 5,000 8.80
--------- ---- ------- -------- -------
2,887,655 7.68 $ 4.71 1,010,236 $ 4.87
========= ==== ======= ========= =======
The Company, at the discretion of the Board of Directors, has granted
warrants from time to time, generally in conjunction with the sale of
equities. The Company issued 154,000 warrants in connection with the
first Laurus note financing in July 2003 and 60,000 warrants in
connection with the private placement in November 2004. The following
table presents warrants outstanding after adjusting to a post-reverse
split basis:
Years Ended December 31,
--------------------------------------
2004 2003 2002
---- ---- ----
Eligible, end of year for
exercise currently 80,611 660,936 532,141
======== ========= =========
Warrants issued 60,000 154,000 ---
Low exercise price $ 0.49 $ 1.78 $ ---
High exercise price $ 2.72 $ 2.25 $ ---
The warrants outstanding as of December 31, 2004 are currently
exercisable and expire at various dates through October 31, 2009. The
outstanding warrants entitle the owner to purchase one share of common
stock for each warrant, at prices ranging from $4.80 to $5.21 per
share.
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 Company recorded, on a prorated basis, the
$850,000 cumulative expense over the life of the warrants through
August 1, 2004. Accordingly, the Company recognized expenses totaling
$62,000, $106,000 and $106,000 in 2004, 2003 and 2002. During the
quarter ended September 30, 2004, all warrants with an expiration date
of August 1, 2004 were exercised on a cashless basis. This resulted in
Company issuing 136,292 shares of its common stock at conversion
prices from $3.98 to $4.28 per share in exchange for 269,856 warrants
with exercise prices from $.49 to $2.65 per share. The Company also
reclassified $850,000 related to these warrants and $375,000 related
to other expired warrants from warrants to additional paid-in capital
on the balance sheet.
Laurus Master Fund, Ltd. exercised their 140,000 warrants with
exercise prices from $1.78 to $2.25 per share on a cashless basis,
resulting in the Company issuing 76,466 shares of its common stock at
a conversion price of $4.18 per share. Sage also exercised 11,720
warrants on a cashless basis, resulting in the issuance of 5,953
shares of Nestor stock at conversion prices of $3.54 to $4.46 per
share.
In addition, NTS Investors, LLC (the "Group") received a warrant right
in January 2001 to acquire up to 298,071 additional shares of common
stock exercisable at the same price at which the then outstanding
52
warrants of Nestor, Inc. were exercisable, but only in the event the
then outstanding warrants were exercised, so as to maintain their
initial ownership interest percentage. This warrant right decreased by
125,000 shares on March 1, 2002 with the expiration of TSAI's warrant
on that date. The Group exercised 124,952 warrants on a cashless basis
during 2004 at prices of $3.98 to $ 4.63 per share, resulting in
59,898 shares of Nestor stock being issued. Warrants outstanding at
December 31, 2004 includes 18,331 warrants belonging to the Group. In
addition, the Group received a warrant to acquire 100,0000 shares of
the Company's common stock at $12.80 per share for three years as
dilution protection against both the Company's and NTS's converted
employee stock options outstanding at closing. This warrant expired on
September 12, 2004. Such remaining warrants are treated as variable
and, accordingly, are revalued quarterly with offsetting adjustments
to additional paid-in capital.
NOTE 13 - SEGMENT INFORMATION:
A. Description of reportable segments
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
in 2001. 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.
Nestor Traffic
Nestor, Inc. Systems, Inc. Totals
------------ -------------- ------
Year Ended
December 31, 2004:
Revenues $ 37,000 $ 5,998,000 $ 6,035,000
Segment net loss (1,416,000) (3,057,000) (4,473,000)
Segment assets 7,148,000 11,699,000 18,847,000
Year Ended
December 31, 2003:
Revenues $ 29,000 $ 2,677,000 $ 2,706,000
Segment net income (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 income (loss) 3,591,000 (16,225,000) (12,634,000)
Segment assets 598,000 8,603,000 9,201,000
D. Geographic Information
All revenues are derived from United States customers. All
long-lived assets are located in the United States.
53
E. Revenues from Major Customers
Years Ended December 31,
------------------------------------
2004 2003 2002
---- ---- ----
Customer A - NTS $1,212,410 $ --- $ ---
Customer B - NTS 1,187,000 399,067 ---
Customer C - Nestor, Inc. --- --- 629,569
Customer D - NTS --- 406,670 266,751
Customer E - NTS --- 348,143 150,331
Customer F - NTS --- --- 293,911
NOTE 14 - 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
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 15 - 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
a previous license. 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 16 - MASTER LEASE ASSIGNMENT:
The State of Delaware Department of Transportation (DelDOT) executed a
Master Lease Agreement with NTS in February 2004 whereby lease
financing for equipment installed under this CrossingGuard contract
would be financed under lease terms offered by GE Capital Public
Finance, Inc. ("GE"). Under this sales-type lease agreement, NTS
received $240,000 on April 27, 2004, $240,000 on September 17, 2004,
and $400,000 on December 31, 2004 from GE on behalf of DelDOT pursuant
to its Assignment and Security Agreement with GE. NTS retains a first
priority interest in the equipment and assigned its interest in the
DelDOT lease and right to receive rental payments thereunder to GE. As
a matter of convenience, NTS monthly billings to DelDOT include their
GE repayment of principal and interest, which NTS then remits to GE on
their behalf.
54
NOTE 17 - OTHER EXPENSE - NET:
Other expense as reflected in the consolidated statements of
operations consists of the following:
Years Ended December 31,
------------------------------------
2004 2003 2002
---- ---- ----
Interest and dividend income $ 78,990 $ 13,438 $ 11,229
Interest expense (239,282) (470,206) (217,023)
Expense relating to financing
operations (62,115) (106,484) (106,483)
Unrealized loss (9,963) --- ---
Realized loss (96,367) --- ---
Other income --- 64,130 ---
Loss on disposal of fixed assets (5,378) (5,291) (6,341)
---------- --------- ---------
Other expense - net $(334,115) $(504,413) $(318,618)
========== =========- =========
NOTE 18 - INCOME TAXES:
During 2004 and 2003, the Company recorded deferred tax assets
primarily for the benefit of net operating losses in the amount of
$2,697,000 and $1,742,000, respectively. The cumulative amount of
these assets, which is $17,469,000 and $16,514,000 at December 31,
2004 and 2003, 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, 2004, $44,771,000 and
$28,402,000 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 2005.
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.
NOTE 19 - RELATED PARTY TRANSACTIONS:
Benjamin Alexander, secretary of the Company (as of June 2003), was an
attorney with the firm of Partridge, Snow and Hahn LLP, which the
Company uses for legal services. For the years ended December 31, 2004
and 2003, the Company recorded legal and stockholder expenses to Mr.
Alexander's firm in the amounts of $133,367 and $0, and $63,973 and
$24,354, respectively. Also, in 2004, $44,300 was recorded relating to
the senior convertible note, $11,656 relating to the January 2004
Laurus financing, and $41,752 was recorded against amounts accrued in
prior years. Other 2003 payments include $11,261 recorded relating to
the July 2003 Laurus financing. All Laurus financing amounts have been
fully expensed. As of February 28, 2005, Mr. Alexander became salaried
general counsel to the Company, retaining his title of secretary.
On January 1, 1999, Nestor, Inc. entered into an exclusive license
with NTS through the expiration date of the underlying patents
protecting the technologies used in NTS's products. The license
provides for royalties, as defined, to be paid to Nestor, Inc. that
are eliminated in consolidation.
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 and Note 15
for royalty assignment to Churchill Lane Associates, LLC.
55
NOTE 20 - 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
increased to $10,800 monthly through July 2005. Rent expense for this
lease was $124,300 in 2002, $126,500 in 2003, and $139,129 in 2004.
Space was leased adjacent to this facility in July 2004, for
additional office and warehouse facilities. This lease provides for
monthly rentals of $5,400 through May 2005 then increases $200 monthly
in each of the two following years. Rent expense for this lease was
$40,108 in 2004.
NTS also leases office space in San Diego, California. The July 2004
operating lease calls for monthly rent of $2,627 through the lease
term expiration of June 2006. Rent expense was $14,576 in 2004.
The Company also leases warehouse space in Placentia, California. The
February 2004 operating lease calls for monthly rent of $1,398 through
the lease term expiration of January 2006. Rent expense was $15,378 in
2004.
On October 13, 2004, the Board of Directors approved employment
agreements for the Company's Chief Executive Officer and Chief
Operating Officer through December 31, 2007. The agreements
automatically renew for a two-year period unless the Company elects
not to renew. The agreements provide for a base salary of not less
than $250,000 (CEO)/$200,000 (COO) and annual performance-based
bonuses to be determined by the Company's Compensation Committee. The
Company also granted 1,000,000 stock options to the CEO and 600,000
stock options to the COO pursuant to the employment agreements. See
Form 8-K dated October 13, 2004 for further information. On March 25,
2005, the COO's position changed to Executive Vice President of
Nestor, Inc. and his compensation remains unchanged.
Further, in March 2005 the Board of Directors approved employment
agreements for a new Chief Operating Officer and a Vice President and
General Counsel of Nestor, Inc. through December 31, 2008. The
agreements automatically renew for one year unless the Company elects
not to renew. The agreements provide for a base salary of not less
than $175,000 (COO)/$165,000 (Counsel) and the COO is entitled to
receive performance-based cash and options bonuses, as defined. The
Company also granted 30,000 stock options to the COO and 135,000 stock
options to Counsel pursuant to the employment agreements. See Item 9B
to this annual report for further information.
The Company has two customers operating photo red light enforcement
programs under Virginia General Assembly authority, which currently
ends July 1, 2005. Many bills to extend the photo red program have
been defeated, despite significant program support. If the program is
not extended, one customer contract will terminate prematurely, with
approximately $194,000 of undepreciated costs at July 1, 2005.
Contract renewal discussions with the other customer are on hold until
program authorization is extended.
NOTE 21 - 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.
On July 13, 2004, the Company filed a second lawsuit for patent
infringement against Redflex Traffic Systems, Inc. but subsequently
withdrew this claim without prejudice. In addition, Nestor amended its
pending lawsuit against Transol USA, Inc., to assert like claims for
patent infringement. The additional lawsuit filed against Redflex, and
56
the amended claims asserted against Transol, allege infringement of
U.S. Patent No. 6,754,663, issued to Nestor on June 22, 2004. The
original lawsuit against Redflex is pending in US District Court,
District of Rhode Island.
The lawsuit against Transol is pending and interrogatories and
depositions have taken place. On December 30, 2004, Transol filed a
motion for summary judgment and partial summary judgment to which
Nestor filed an opposition on January 27, 2005. In February 2005, the
judge hearing the case voluntarily recused himself and a new judge was
assigned. A hearing on Transol's motion for summary judgment is
scheduled for April 11, 2005. 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. The parties reached a mutually agreeable settlement on
December 31, 2003, the terms of which are confidential. All claims
have been 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 22 - CONTRACT TERMINATION RESERVE:
A significant customer contract in the Rail line of business was
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. Payment was satisfied in December 2004.
NOTE 23 - RECENT ACCOUNTING PRONOUNCEMENTS:
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment". SFAS 123 (revised 2004) requires companies to
recognize in the statement of operations the grant-date fair value of
stock options and other equity-based compensation. That cost will be
recognized over the period during which an employee is required to
perform service in exchange for the award, usually the vesting period.
Subsequent changes in fair value during the requisite service period,
measured at each reporting date, will be recognized as compensation
cost over the period. SFAS 123 (revised 2004) is effective in the
first interim or annual period beginning after June 15, 2005. The
Company will be required to adopt SFAS 123 (revised 2004) in its third
quarter of 2005. The Company is evaluating the impact of the adoption
of SFAS 123 (revised 2004) on the Company's financial position and
results of operations.
57
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: Claire M. Iacobucci.
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.
58
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 the contents to
the financial statements annexed hereto, are included
in Part II, Item 8.
(2) All schedules have been omitted because the required
information is not applicable or because the
information required is included in the consolidated
financial statements or notes thereto.
(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 18, 2004, the Corporation filed with the
Securities and Exchange Commission a current report on Form
8-K dated October 13, 2004 under items 1.01 and 9.01,
reporting employment agreements between Nestor, Inc. and
William B. Danzell, and Nestor, Inc. and Nigel P. Hebborn.
On November 12, 2004, the Corporation filed with the
Securities and Exchange Commission a current report on Form
8-K dated November 5, 2004 under items 1.01, 2.03, 3.02 and
9.01, reporting sale of $6,000,000 aggregate principal
amount of its 5% Senior Convertible Notes to institutional
and accredited investors pursuant to a Note Agreement.
59
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/ Claire M. Iacobucci
--------------------------------------------
Claire M. Iacobucci, Chief Financial Officer
Date: March 30, 2005
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/ William B. Danzell
- ----------------------------
William B. Danzell Chairman of the
Board of Directors,
President, and March 30, 2005
Chief Executive Officer
/s/ George L. Ball
- ----------------------------
George L. Ball Director March 30, 2005
/s/ James S. Bennett
- ----------------------------
James S. Bennett Director March 30, 2005
/s/ Albert H. Cox
- ----------------------------
Albert H. Cox Director March 30, 2005
/s/ Terry E. Fields
- ----------------------------
Terry E. Fields Director March 30, 2005
/s/ Robert G. Flanders, Jr.
- ----------------------------
Robert G. Flanders, Jr. Director March 30, 2005
/s/ William J. Gilbane, Jr.
- ----------------------------
William J. Gilbane, Jr. Director March 30, 2005
/s/ David N. Jordan
- ----------------------------
David N. Jordan Director March 30, 2005
/s/ Donald R. Sweitzer
- ----------------------------
Donald R. Sweitzer Director March 30, 2005
60
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 Exhibit 4.1 to the
Company's Registration Statement on Form S-2 (File No.
333-108432), filed September 2, 2003, is hereby incorporated
herein by reference.
10.1 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.
10.2 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.
10.3 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.
10.4 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.
10.5 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.
10.6 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.
10.7 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.
10.8 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.
10.9 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.
10.10 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.
10.11 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.
10.12 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.
61
Exhibit No. Description of Exhibit
- ----------- ----------------------
10.13 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.
10.14 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.
10.15 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.
10.16 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
10.17 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.
10.18 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.
10.19 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.
10.20 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.
10.21 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.
10.22 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.
10.23 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.
10.24 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.
10.25 Nestor, Inc. 2004 Stock Incentive Plan filed as an Exhibit
to Nestor's Current Report on Form 8-K dated June 24, 2003
and filed as an Exhibit to the Company's Registration
Statement on Form S-8 filed January 21, 2005, is hereby
incorporated by reference.
62
Exhibit No. Description of Exhibit
- ---------- ----------------------
10.26 Employment Agreement dated October 13, 2004 between Nestor,
Inc. and William B. Danzell, filed as an Exhibit to Nestor's
Current Report on Form 8-K dated October 13, 2004, is hereby
incorporated by reference.
10.27 Employment Agreement dated October 13, 2004 between Nestor,
Inc. and Nigel P. Hebborn, filed as an Exhibit to Nestor's
Current Report on Form 8-K dated October 13, 2004, is hereby
incorporated by reference.
10.28 Note Purchase Agreement dated November 5, 2004 between
Nestor, Inc. and the purchasers named therein, filed as an
Exhibit to Nestor's Current Report on Form 8-K dated
November 5, 2004, is hereby incorporated by reference.
10.29 Registration Rights Agreement dated November 5, 2004 among
Nestor, Inc. and the purchasers named therein, filed as an
Exhibit to Nestor's Current Report on Form 8-K dated
November 5, 2004, is hereby incorporated by reference.
10.30 Warrant to Purchase Common Stock, issued by Nestor, Inc. to
Sanders Morris Harris, Inc. dated November 5, 2004, filed as
an Exhibit to Nestor's Current Report on Form 8-K dated
November 5, 2004, is hereby incorporated by reference.
10.31 Distributorship Agreement by and between Nestor, Inc. and
Vitronics Machine Vision, Ltd. dated August 17, 2004 filed
as an Exhibit to Nestor's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2004, is hereby incorporated
by reference.
10.32 Incentive Stock Option Agreement by and between Nestor, Inc.
and William B. Danzell dated October 13, 2004 filed as an
Exhibit to Nestor's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2004, is hereby incorporated by
reference.
10.33 Incentive Stock Option Agreement by and between Nestor, Inc.
and William B. Danzell dated October 13, 2004 filed as an
Exhibit to Nestor's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2004, is hereby incorporated by
reference.
10.34 Incentive Stock Option Agreement by and between Nestor, Inc.
and Nigel P. Hebborn dated October 13, 2004 filed as an
Exhibit to Nestor's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2004, is hereby incorporated by
reference.
10.35 Incentive Stock Option Agreement by and between Nestor, Inc.
and Nigel P. Hebborn dated October 13, 2004 filed as an
Exhibit to Nestor's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2004, is hereby incorporated by
reference.
10.36 Employment Agreement dated March 29, 2005 between Nestor,
Inc. and Tadas A. Eikinas.
10.37 Employment Agreement dated March 29, 2005 between Nestor,
Inc. and Benjamin M. Alexander.
10.38 Incentive Stock Option Agreement by and between Nestor, Inc.
and Tadas A. Eikinas dated March 29, 2005.
10.39 Incentive Stock Option Agreement by and between Nestor, Inc.
and Benjamin M. Alexander dated March 29, 2005.
10.40 Employment Offer Letter to Harold A. Joannidi from Nestor,
Inc. dated March 29, 2005.
10.41 Bonus Targets Letter to William B. Danzell dated March 29,
2005.
10.42 Bonus Targets Letter to Nigel P. Hebborn dated March 29,
2005.
31.1 Certification of principal executive officer pursuant to
Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as amended
63
Exhibit No. Description of Exhibit
- ----------- ----------------------
31.2 Certification of principal financial officer pursuant to
Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as amended
32 Statement Pursuant to 18 U.S.C. ss.1350*
- ------------------------------------------------------------------------
* 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.
64